**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q/A**

 

**(MARK ONE)**

| **ý**                                           | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **                                           | ** ** | ** **                                                                                    |
| **FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2005** |
| ** **                                           |
| **COMMISSION FILE NUMBER:**                          | ** ** | **1-7935**                                                                                    |
|                                                      |            |                                                                                               |  |  |

** **

**International Rectifier Corporation**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITSCHARTER)

 

| **DELAWARE**                             | ** ** | **95-1528961**               |
|------------------------------------------|------------|------------------------------|
| (STATE OR OTHER JURISDICTION OF          |       | (IRS EMPLOYER IDENTIFICATION |
| INCORPORATION OR ORGANIZATION)           |       | 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 MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTSREQUIRED TO BE FILED BY SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THEREGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCHFILING REQUIREMENTS FOR THE PAST 90 DAYS. YES  ý    NO  o

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATEDFILER, AN ACCELERATED FILER, OR A NON-ACCELERATED FILER. SEE DEFINITION OF“ACCELERATED FILER AND LARGE ACCELERATED FILER” IN RULE 12B-2 OF THE EXCHANGEACT. (CHECK ONE):

 

| LARGE ACCELERATED FILER  ý |   | ACCELERATED FILER  o |   | NON-ACCELERATED FILER  o |
|-------------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (ASDEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES  o    NO  ý

 

THERE WERE 70,933,810 SHARES OF THE REGISTRANT’S COMMON STOCK, PARVALUE $1.00 PER SHARE, OUTSTANDING ON FEBRUARY 3, 2006.

 

 

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**Table of Contents**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                | ** ** |
|--------------|--------------------------------------------------------------------------------------------------------------------------|------------|
| ** **   | ** **                                                                                                               | ** ** |
| **ITEM 1.**  | **Financial Statements**                                                                                                 |       |
| ** **   | ** **                                                                                                               |       |
|         | Unaudited Consolidated Statements of Income for the Three and Six  Months Ended December 31, 2005 and 2004               |       |
|         |                                                                                                                     |       |
|         | Unaudited Consolidated Statements of Comprehensive Income for the  Three and Six Months Ended December 31, 2005 and 2004 |       |
|         |                                                                                                                     |       |
|         | Unaudited Consolidated Balance Sheets as of December 31, 2005 and  June 30, 2005                                         |       |
|         |                                                                                                                     |       |
|         | Unaudited Consolidated Statements of Cash Flows for the Six Months  Ended December 31, 2005 (Restated) and 2004          |       |
|         |                                                                                                                     |       |
|         | Notes to Unaudited Consolidated Financial Statements                                                                     |       |
|         |                                                                                                                     |       |
| **ITEM 2.**  | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations**                          |       |
| ** **   |                                                                                                                     |       |
| **ITEM 3.**  | **Quantitative and Qualitative Disclosures  about Market Risk**                                                          |       |
|         |                                                                                                                     |       |
| **ITEM 4.**  | **Controls and Procedures**                                                                                              |       |
| ** **   | ** **                                                                                                               |       |
| **PART II.** | **OTHER INFORMATION**                                                                                                    | ** ** |
| ** **   | ** **                                                                                                               | ** ** |
| **ITEM 1A.** | **Risk  Factors**                                                                                                        |       |
| ** **   | ** **                                                                                                               |       |
| **ITEM 2.**  | **Unregistered Sales of Equity Securities and  Use of Proceeds**                                                         |       |
|         |                                                                                                                     |       |
| **ITEM 4.**  | **Submission  of Matters to a Vote of Security Holders**                                                                 |       |
| ** **   | ** **                                                                                                               |       |
| **ITEM 6.**  | **Exhibits**                                                                                                             |       |

 

2

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**EXPLANATORY NOTE**

 

This amendment to our Quarterly Report on Form 10-Q for the fiscalquarter ended December 31, 2005, initially filed with the Securities andExchange Commission on February 10, 2006, is being filed to reflect the restatementof our unaudited consolidated statement of cash flows for the six months endedDecember 31, 2005, to correct an error in the classification of the excess taxbenefits generated from the exercise of stock options. As more fully describedin Note 1, “Certain Accounting Policies”, of the Notes to the unauditedconsolidated financial statements, the excess tax benefits from stock optionsexercised that was previously reported in the consolidated statement of cashflows as an operating activity has been restated to correctly present it as afinancing activity.

 

Generally, no attempt has been made in this Form 10-Q/A to modify orupdate other disclosures presented in the original report on Form 10-Q exceptas required to reflect the effects of the restatement. This Form 10-Q/Agenerally does not reflect events occurring after the filing of the originalForm 10-Q or modify or update those disclosures affected by subsequent events.Information not affected by the restatement is unchanged and reflects thedisclosures made at the time of the original filing of the Form 10-Q, includingany amendments to those filings. The following items have been amended as aresult of the restatement:

 

•                  Part I, Item 1,Financial Information;

 

•                  Part I, Item 2,Management’s Discussion and Analysis of Financial Condition and Results ofOperations;

 

•                  Part I, Item 4,Controls and Procedures; and

 

•                  Part II, Item 6,Exhibits.

 

Our Chief Executive Officer and Chief Financial Officer have alsoreissued certifications required by Sections 302 and 906 of the Sarbanes-OxleyAct of 2002.

 

3

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**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  Financial Statements.**

 

**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITEDCONSOLIDATED STATEMENTS OF INCOME**

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

 
| ** **                                                                            | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Revenue                                                                               |       | $                                                   | 278,811    |                                              | $          | 298,560 |   | $ | 551,383 |   | $ | 610,785 |   |
| Cost of sales                                                                         |       | 167,237                                             |       | 169,179                                           |       | 328,915 |   | 347,967 |   |
| Gross profit                                                                          |       | 111,574                                             |       | 129,381                                           |       | 222,468 |   | 262,818 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Selling and administrative expense                                                    |       | 46,148                                              |       | 40,863                                            |       | 91,315 |   | 87,278 |   |
| Research and development expense                                                      |       | 27,238                                              |       | 27,691                                            |       | 52,450 |   | 53,056 |   |
| Amortization of acquisition-related  intangible assets                                |       | 1,432                                               |       | 1,457                                             |       | 2,885 |   | 2,896 |   |
| Impairment of assets, restructuring and  severance charges                            |       | 3,060                                               |       | 6,831                                             |       | 7,353 |   | 13,522 |   |
| Other expense, net                                                                    |       | 1,040                                               |       | 690                                               |       | 1,165 |   | 656 |   |
| Interest (income) expense, net                                                        |       | (800                                                | )          | 650                                               |       | (2,353 | ) | 2,366 |   |
| Income before income taxes                                                            |       | 33,456                                              |       | 51,199                                            |       | 69,653 |   | 103,044 |   |
| Provision for income taxes                                                            |       | 9,200                                               |       | 11,685                                            |       | 19,155 |   | 25,950 |   |
| Net income                                                                            |       | $                                                   | 24,256     |                                              | $          | 39,514 |   | $ | 50,498 |   | $ | 77,094 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Net income per common share – basic                                              |       | $                                                   | 0.34       |                                              | $          | 0.59 |   | $ | 0.72 |   | $ | 1.16 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Net income per common share – diluted                                            |       | $                                                   | 0.34       |                                              | $          | 0.55 |   | $ | 0.70 |   | $ | 1.07 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Average common shares outstanding – basic                                        |       | 70,816                                              |       | 66,929                                            |       | 70,567 |   | 66,723 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Average common shares and potentially  dilutive securities outstanding – diluted |       | 71,602                                              |       | 76,490                                            |       | 71,663 |   | 76,098 |   |

 

The accompanying notes are an integral partof these statements.

 

4

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITEDCONSOLIDATED STATEMENTS OF**

**COMPREHENSIVE INCOME**

**(In thousands)**

 
| ** **                                                                                                                                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Net income                                                                                                                                     |       | $                                                   | 24,256     |                                              | $          | 39,514 |   | $ | 50,498 |   | $ | 77,094 |   |
|                                                                                                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Other comprehensive income (loss):                                                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Foreign currency translation adjustments                                                                                                       |       | (8,198                                              | )          | 23,406                                            |       | (13,334 | ) | 23,544 |   |
| Unrealized gains (losses) on securities:                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Unrealized holding gains (losses) on  available-for-sale securities, net of tax effect of ($6,920), $1,724,  ($5,232) and $7,246, respectively |       | 11,783                                              |       | (2,937                                            | )          | 8,911 |   | (12,337 | ) |
| Unrealized holding gains (losses) on  foreign currency forward contract, net of tax effect of ($80), $1,723, ($235)  and $1,246, respectively  |       | 136                                                 |       | (2,933                                            | )          | 399 |   | (2,122 | ) |
| Less: Reclassification adjustments of net  losses on available-for-sale securities and foreign currency forward contract                       |       | (7                                                  | )          | 336                                               |       | (30 | ) | 552 |   |
| Other comprehensive income (loss)                                                                                                              |       | 3,714                                               |       | 17,872                                            |       | (4,054 | ) | 9,637 |   |
|                                                                                                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Comprehensive income                                                                                                                           |       | $                                                   | 27,970     |                                              | $          | 57,386 |   | $ | 46,444 |   | $ | 86,731 |   |

 

The accompanying notes are an integral part of these statements.

 

5

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITEDCONSOLIDATED BALANCE SHEETS**

**(In thousands)**

 
| ** **                                                       | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                       | ** ** | **2005**              | ** ** | **2005****(1)**   | ** ** |
| **ASSETS**                                                       |       |                  |       |              |       |
| Current assets:                                                  |       |                  |       |              |       |
| Cash and cash equivalents                                        |       | $                     | 273,697    |              | $          | 359,978 |   |
| Short-term cash investments                                      |       | 303,186               |       | 278,157           |       |
| Trade accounts receivable, less allowance  for doubtful accounts |       | 159,149               |       | 158,510           |       |
| Inventories, net                                                 |       | 209,118               |       | 177,560           |       |
| Short-term deferred income taxes                                 |       | 31,228                |       | 34,784            |       |
| Prepaid expenses and other receivables                           |       | 59,829                |       | 53,387            |       |
|                                                             |       |                  |       |              |       |
| Total current assets                                             |       | 1,036,207             |       | 1,062,376         |       |
| Long-term cash investments                                       |       | 341,525               |       | 302,585           |       |
| Property, plant and equipment, net                               |       | 517,189               |       | 488,204           |       |
| Goodwill                                                         |       | 151,714               |       | 152,457           |       |
| Acquisition-related intangible assets, net                       |       | 32,338                |       | 35,354            |       |
| Long-term deferred income taxes                                  |       | 73,279                |       | 76,158            |       |
| Other assets                                                     |       | 121,203               |       | 106,410           |       |
|                                                             |       |                  |       |              |       |
| Total assets                                                     |       | $                     | 2,273,455  |              | $          | 2,223,544 |   |
|                                                             |       |                  |       |              |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                   |       |                  |       |              |       |
| Current liabilities:                                             |       |                  |       |              |       |
| Bank loans                                                       |       | $                     | 2,678      |              | $          | 18,168 |   |
| Long-term debt, due within one year                              |       | 48                    |       | 163               |       |
| Accounts payable                                                 |       | 70,996                |       | 81,893            |       |
| Accrued salaries, wages and commissions                          |       | 36,008                |       | 33,344            |       |
| Other accrued expenses                                           |       | 88,731                |       | 91,328            |       |
|                                                             |       |                  |       |              |       |
| Total current liabilities                                        |       | 198,461               |       | 224,896           |       |
| Long-term debt, less current maturities                          |       | 539,255               |       | 547,259           |       |
| Other long-term liabilities                                      |       | 23,742                |       | 26,186            |       |
| Long-term deferred income taxes                                  |       | 6,850                 |       | —            |       |
|                                                             |       |                  |       |              |       |
| Stockholders’ equity:                                       |       |                  |       |              |       |
| Common stock                                                     |       | 70,872                |       | 69,826            |       |
| Capital contributed in excess of par value  of shares            |       | 886,499               |       | 854,045           |       |
| Retained earnings                                                |       | 485,643               |       | 435,145           |       |
| Accumulated other comprehensive income                           |       | 62,133                |       | 66,187            |       |
|                                                             |       |                  |       |              |       |
| Total stockholders’ equity                                  |       | 1,505,147             |       | 1,425,203         |       |
|                                                             |       |                  |       |              |       |
| Total liabilities and stockholders’ equity                  |       | $                     | 2,273,455  |              | $          | 2,223,544 |   |

 

The accompanying notes are an integral part of these statements.

 

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(1) The consolidated balance sheet as of June 30,2005 has been derived from the audited financial statements at that date butdoes not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements.

 

6

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **December 31,**          | ** ** |
| ** **                                                                         | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(As Restated)**         | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              |       |                           |       |   |   |
| Net income                                                                         |       | $                              | 50,498     |   | $ | 77,094 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 40,048                         |       | 34,158 |   |
| Amortization of acquisition-related  intangible assets                             |       | 2,885                          |       | 2,896 |   |
| Stock compensation expense                                                         |       | 1,402                          |       | 410 |   |
| Unrealized (gains) losses on swap  transactions                                    |       | (1,287                         | )          | 518 |   |
| Deferred income taxes                                                              |       | 7,415                          |       | (9,425 | ) |
| Tax benefits from options exercised                                                |       | 8,382                          |       | 5,381 |   |
| Excess tax benefits from options exercised                                         |       | (4,264                         | )          | — |   |
| Change in operating assets and liabilities,  net                                   |       | (56,729                        | )          | (11,834 | ) |
|                                                                               |       |                           |       |   |   |
| Net cash provided by operating activities                                          |       | 48,350                         |       | 99,198 |   |
|                                                                               |       |                           |       |   |   |
| Cash flows from investing activities:                                              |       |                           |       |   |   |
| Additions to property, plant and equipment                                         |       | (75,980                        | )          | (68,575 | ) |
| Proceeds from sale of property, plant and  equipment                               |       | 298                            |       | 115 |   |
| Acquisition of business                                                            |       | —                         |       | (39,633 | ) |
| Sale or maturities of cash investments                                             |       | 233,134                        |       | 163,825 |   |
| Purchase of cash investments                                                       |       | (300,857                       | )          | (136,304 | ) |
| Change in other investing activities, net                                          |       | (1,859                         | )          | (6,405 | ) |
| Net cash used in investing activities                                              |       | (145,264                       | )          | (86,977 | ) |
|                                                                               |       |                           |       |   |   |
| Cash flows from financing activities:                                              |       |                           |       |   |   |
| (Repayments) proceeds from short-term debt,  net                                   |       | (15,236                        | )          | 1,264 |   |
| Repayments of capital lease obligations,  net                                      |       | —                         |       | (114 | ) |
| Proceeds from exercise of stock options and  stock purchase plan                   |       | 24,504                         |       | 16,770 |   |
| Excess tax benefits from options exercised                                         |       | 4,264                          |       | — |   |
| Other, net                                                                         |       | (5,966                         | )          | 579 |   |
|                                                                               |       |                           |       |   |   |
| Net cash provided by financing activities                                          |       | 7,566                          |       | 18,499 |   |
|                                                                               |       |                           |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                      |       | 3,067                          |       | 4,960 |   |
|                                                                               |       |                           |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                              |       | (86,281                        | )          | 35,680 |   |
| Cash and cash equivalents, beginning of  period                                    |       | 359,978                        |       | 339,024 |   |
|                                                                               |       |                           |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                              | 273,697    |   | $ | 374,704 |   |

 

The accompanying notes are an integral partof these statements.

 

7

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**December 31, 2005**

 

1.                           Certain Accounting Policies

 

Basis of Consolidation

 

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

 

The consolidated financial statements included herein are unaudited;however, they contain all normal recurring adjustments which, in the opinion ofthe Company’s management, are necessary to state fairly the consolidatedfinancial position of the Company at December 31, 2005, and the consolidatedresults of operations and the consolidated cash flows for the three and sixmonths ended December 31, 2005 and 2004. The results of operations for thethree and six months ended December 31, 2005 are not necessarily indicative ofthe results to be expected for the full year.

 

The accompanying unaudited consolidated financial statements should beread in conjunction with the Annual Report on Form 10-K for the fiscal yearended June 30, 2005.

 

The Company operates on a 52-53 week fiscal year under which the threemonths ended December 2005 and 2004 consisted of 13 weeks ending January 1,2006 and January 2, 2005, respectively. For ease of presenting the accompanyingconsolidated financial statements, the fiscal December quarter-end for allperiods presented is shown as December 31. Fiscal June 2005 year-end presentedis shown as June 30. Fiscal 2006 will consist of 52 weeks ending July 2, 2006.

 

Certain reclassifications have been made to the December 31, 2004 (i)cash flows from investing activities, (ii) net decrease in cash and cashequivalents, and (iii) ending cash and cash equivalents, as a result ofreclassification of auction rate securities (“ARS”) from cash and cashequivalents to short-term investments. Previously, the Company’s investments inARS were recorded in cash and cash equivalents rather than short-term cashinvestments. The Company reclassified ARS from cash and cash equivalents toshort-term investments because the underlying instruments have maturity datesexceeding ninety days. As a result of the reclassifications, the Company’sconsolidated cash flows were affected as follows:

 

•                  net cash usedfor the purchase of cash investments decreased by $74.1 million for the sixmonths ended December 31, 2004; and

 

•                  net change incash and cash equivalents increased by $74.1 million for the six months endedDecember 31, 2004.

 

8

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The reclassifications had no impact on the Company’s total currentassets, stockholders’ equity, cash flows provided by operating activities or totalconsolidated results reported in any period presented. At December 31, 2005 andJune 30, 2005, the Company had no investments in these securities.

 

Restatement of Consolidated Statement of CashFlows

 

The Company has restated the consolidated statement of cash flows forthe six months ended December 31, 2005 to correct an error in theclassification of the excess tax benefits generated from the exercise of stockoptions. Previously, the Company classified the excess tax benefits fromoptions exercised in cash flows from operating activities rather than as a cashflow from financing activity as required by Statement of Financial AccountingStandard No. 123(R), “Share-Based Payment,” which the Company adopted as of thebeginning of its fiscal year 2006 in July 2005. The restatement had no impacton the Company’s statement of cash flows for the six months ended December 31,2004. The restatement also had no impact on the Company’s overall net change incash and cash equivalents, the unaudited consolidated statements of income, theunaudited consolidated statements of comprehensive income, or the unauditedconsolidated balance sheet for any of the periods presented.

 

A summary of the effects of the restatement is as follows:

 
| ** **                                                        | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                        | ** ** | **December 31,**          | ** ** |
| ** **                                                        | ** ** | **2005**                       | ** ** |
| Net cash provided by operating activities  as previously reported |       | $                              | 52,614     |   |
| Restatement of the excess tax benefits from  options exercised    |       | (4,264                         | )          |
| Restated net cash provided by operating  activities               |       | $                              | 48,350     |   |
| ** **                                                        | ** ** | ** **                     | ** ** |
| Net cash provided by financing activities  as previously reported |       | $                              | 3,302      |   |
| Restatement of the excess tax benefits from  options exercised    |       | 4,264                          |       |
| Restated net cash provided by financing  activities               |       | $                              | 7,566      |   |

 

2.                           Net Income Per CommonShare

 

Net income per common share - basic is computed by dividing net incomeavailable to common stockholders (the numerator) by the weighted average numberof common shares outstanding (the denominator) during the period. Thecomputation of net income per common share - diluted is similar to thecomputation of net income per common share - basic except that the denominatoris increased to include the number of additional common shares that would havebeen outstanding for the exercise of stock options using the treasury stockmethod and the conversion of the Company’s convertible subordinated notes usingthe if-converted method. The Company’s use of the treasury stock method reducesthe gross number of dilutive shares by the number of shares purchasable fromthe proceeds of the options assumed to be exercised. 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.

 

The following table provides a reconciliation of the numerator anddenominator of the basic and diluted per-share computations for the three andsix months ended December 31, 2005 and 2004 (in thousands except per shareamounts):

 

9

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| ** **                                 | ** ** | **Net Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|----------------------------|------------|
|                                       |       |                             |       |                      |       |                       |       |
| Three months ended December 31, 2005:      |       |                             |       |                      |       |                       |       |
| Net income per common share – basic   |       | $                                | 24,256     |                      | 70,816     |                       | $          | 0.34 |   |
| Effect of dilutive securities:             |       |                             |       |                      |       |                       |       |
| Stock options and restricted stock units   |       | —                           |       | 786                       |       | —                     |       |
| Net income per common share – diluted |       | $                                | 24,256     |                      | 71,602     |                       | $          | 0.34 |   |

 
| Three months ended December 31, 2004:      |   |   |   |   |   |   |   |
|--------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Net income per common share – basic   |   | $      | 39,514 |   | 66,929 |   | $      | 0.59 |   |
| Effect of dilutive securities:             |   |   |   |   |   |   |   |
| Stock options and restricted stock units   |   | — |   | 2,122  |   | (0.01  | )      |
| Conversion of subordinated notes           |   | 2,312  |   | 7,439  |   | (0.03  | )      |
| Net income per common share – diluted |   | $      | 41,826 |   | 76,490 |   | $      | 0.55 |   |

 
| Six months ended December 31, 2005:        |   |   |   |   |   |   |   |
|--------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Net income per common share – basic   |   | $      | 50,498 |   | 70,567 |   | $      | 0.72 |   |
| Effect of dilutive securities:             |   |   |   |   |   |   |   |
| Stock options and restricted stock units   |   | — |   | 1,096  |   | (0.02  | )      |
| Net income per common share – diluted |   | $      | 50,498 |   | 71,663 |   | $      | 0.70 |   |

 

10

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| ** **                                 | ** ** | **Net Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|----------------------------|------------|
| Six months ended December 31, 2004:        |       |                             |       |                      |       |                       |       |
| Net income per common share – basic   |       | $                                | 77,094     |                      | 66,723     |                       | $          | 1.16 |   |
| Effect of dilutive securities:             |       |                             |       |                      |       |                       |       |
| Stock options and restricted stock units   |       | —                           |       | 1,936                     |       | (0.04                      | )          |
| Conversion of subordinated notes           |       | 4,698                            |       | 7,439                     |       | (0.05                      | )          |
| Net income per common share – diluted |       | $                                | 81,792     |                      | 76,098     |                       | $          | 1.07 |   |

 

The conversion effect of the Company’s outstanding convertiblesubordinated notes into 7,439,000 shares of common stock was not included inthe computation of diluted income per share for the three and six months endedDecember 31, 2005, since such effect would have been anti-dilutive.

 

3.                           Cash and 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 ofthese investments approximates fair value.

 

The Company investsexcess cash in marketable securities consisting primarily of commercial paper,corporate notes, corporate bonds and U.S. government securities. At December31, 2005 and June 30, 2005, all of the Company’s marketable securities areclassified as available-for-sale. In accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments inDebt and Equity Securities”, unrealized gains and losses on these investmentsare included in accumulated other comprehensive income, a separate component ofstockholders’ equity, net of any related tax effect. Realized gains and lossesand declines in value considered to be other than temporary are included ininterest (income) expense, net. At December 31, 2005 and June 30, 2005, noinvestment was in a material loss position for greater than one year.

 

Cash, cash equivalentsand cash investments as of December 31, 2005 and June 30, 2005 are summarizedas follows (in thousands):

 
| ** **                                         | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                         | ** ** | **2005**              | ** ** | **2005**          | ** ** |
| Cash and cash equivalents                          |       | $                     | 273,697    |              | $          | 359,978 |   |
| Short-term cash investments                        |       | 303,186               |       | 278,157           |       |
| Long-term cash investments                         |       | 341,525               |       | 302,585           |       |
| Total cash, cash equivalents and cash  investments |       | $                     | 918,408    |              | $          | 940,720 |   |

 

11

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Available-for-sale securitiesas of December 31, 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                         |       | $                   | 126,406    |                        | $          | —                      |       | $                         | (794       | )                 | $          | (794 | ) | $ | 125,612 |   |
| U.S. government and agency obligations |       | 169,932             |       | 1                           |       | (367                        | )          | (366                      | )          | 169,566           |       |
| Other debt                             |       | 8,010               |       | —                      |       | (2                          | )          | (2                        | )          | 8,008             |       |
| Total short-term cash investments      |       | $                   | 304,348    |                        | $          | 1                           |       | $                         | (1,163     | )                 | $          | (1,162 | ) | $ | 303,186 |   |

 

*Long-Term Cash Investments:*

 
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Net  Unrealized  Loss** | ** ** | **Market  Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|---------------------------|------------|-------------------|------------|
| Corporate debt                         |       | $                   | 132,137    |                        | $          | 3                           |       | $                         | (1,098     | )                 | $          | (1,095 | ) | $ | 131,042 |   |
| U.S. government and agency obligations |       | 151,063             |       | 1                           |       | (798                        | )          | (797                      | )          | 150,266           |       |
| Other debt                             |       | 60,629              |       | 9                           |       | (421                        | )          | (412                      | )          | 60,217            |       |
| Total long-term cash investments       |       | $                   | 343,829    |                        | $          | 13                          |       | $                         | (2,317     | )                 | $          | (2,304 | ) | $ | 341,525 |   |

 

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 |   |

 

12

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The Company holds as strategic investments the common stock of twopublicly-traded Japanese companies, one of which is Nihon Inter ElectronicsCorporation (“Nihon”), a related party as further disclosed in Note 16. TheCompany accounts for these available-for-sale investments under SFAS No. 115. Thesestocks are traded on the Tokyo Stock Exchange. The market values of the equityinvestments at December 31, 2005 and June 30, 2005 were $84.4 million and $71.2million, respectively, compared to their purchased cost of $24.2 million. Mark-to-marketgains (losses), net of tax, of $11.8 million and ($2.9) million for the threemonths ended December 31, 2005 and 2004, respectively, and $8.9 million and($12.3) million for the six months ended December 31, 2005 and 2004,respectively, were included in accumulated other comprehensive income, aseparate component of equity.

 

The amortized cost and estimated fair value of cash investments atDecember 31, 2005, by contractual maturity, are as follows (in thousands):

 
| ** **             | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|------------------------|------------|---------------------|------------|--------------------------------|------------|
| Due in 1 year or less  |       | $                   | 169,586    |                           | $          | 168,528 |   |
| Due in 1-2 years       |       | 243,872             |       | 242,735                        |       |
| Due in 2-5 years       |       | 200,764             |       | 199,770                        |       |
| Due after 5 years      |       | 33,955              |       | 33,678                         |       |
| Total cash investments |       | $                   | 648,177    |                           | $          | 644,711 |   |

 

Cash investments with contractual maturity greater than one year forwhich the Company has the intent and ability to hold for less than one year areclassified as short-term investments.

 

Gross realized gains were $0.01 million and $0.02 million for the threeand six months ended December 31, 2005, respectively, and gross realized losseswere ($0.1) and ($0.4) million for the three and six months ended December 31,2005, respectively. Gross realized gains were $0.01 million and $0.02 millionfor the three and six months ended December 31, 2004, respectively, and grossrealized losses were ($0.02) and ($0.08) million for the three and six monthsended December 31, 2004, respectively. The cost of marketable securities soldis determined by the weighted average cost method.

 

4.                           Derivative FinancialInstruments

 

*ForeignCurrency Risk*

 

The Company conductsbusiness on a global basis in several foreign currencies, and is primarilyexposed to fluctuations with the British Pound Sterling, the Euro and theJapanese Yen. Considering its foreign currency risks, the Company has thegreatest exposure to the Japanese Yen, since it has significant Yen-basedrevenues without the Yen-based manufacturing costs. The risk of the Company’srevenues in the European currencies is partially offset by the cost ofmanufacturing goods in the European currencies.

 

13

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The Company hasestablished a foreign-currency hedging program using foreign exchange forwardcontracts, including the Forward Contract described below, to hedge certainforeign currency transaction exposures. To protect against reductions in valueand volatility of future cash flows caused by changes in currency exchangerates, it has established revenue, expense and balance sheet hedging programs. Currencyforward contracts and local Yen and Euro borrowings are used in these hedgingprograms. The Company’s hedging programs reduce, but do not always eliminate,the impact of currency exchange rate movements.

 

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 theForward Contract, the Company is required to exchange 1.2 billion yen for $11.0million on a quarterly basis from June 2001 to March 2006. At December 31,2005, one payment of 1.2 billion yen remained to be swapped in March 2006, at aforward exchange rate of 109.32 yen per U.S. dollar. The market value of theforward contract was $0.7 million and $0.1 million at December 31, 2005 andJune 30, 2005, respectively. Mark-to-market gains (losses), includedin other comprehensive income, net of tax, were $0.1 million and ($2.9) millionfor the three months ended December 31, 2005 and 2004, respectively, and $0.4million and ($2.1) million for the six months ended December 31, 2005 and 2004,respectively. At December 31, 2005, based on effectiveness tests comparingforecasted transactions through the Forward Contract expiration date to itscash flow requirements, the Company does not expect to incur a material chargeto income as a result of the Forward Contract during the next three monthsthrough its maturity.

 

TheCompany had approximately $109.6 million and $75.9 million in notional amountsof forward contracts not designated as accounting hedges under SFAS No. 133 atDecember 31, 2005 and June 30, 2005, respectively. Net realized and unrealizedforeign-currency net gains recognized in earnings were less than $1million for the three and six months ended December 31, 2005 and 2004.

 

*InterestRate Risk*

 

In December 2001, the Company entered into an interest rate swaptransaction (the “Transaction”) with an investment bank, JP Morgan Chase Bank(the “Bank”), to modify the Company’s effective interest payable with respectto $412.5 million of its $550 million outstanding convertible debt (the “Debt”)(see Note 9, “Bank Loans and Long-Term Debt”). In April 2004, the Companyentered into an interest rate swap transaction (the “April 2004 Transaction”)with the Bank to modify the effective interest payable with respect to theremaining $137.5 million of the Debt. The Company will receive from the Bankfixed payments equal to 4.25 percent of the notional amount, payable on January15 and July 15. In exchange, the Company will pay to the Bank floating ratepayments based upon the London InterBank Offered Rate (“LIBOR”) multiplied bythe notional amount. At the inception of the Transaction, interest rates werelower than that of the Debt and the

 

14

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Company believed that interest rates would remain lower for an extendedperiod of time. The variable interest rate paid since the inception of theswaps has averaged 2.68 percent, compared to a coupon of 4.25 percent on theDebt. This arrangement increased (decreased) interest expense by $0.8 million and($2.5) million, for the three months ended December 31, 2005 and 2004,respectively, and ($0.1) million and ($4.7) million for the six months endedDecember 31, 2005 and 2004, respectively.

 

Accounted for as fair value hedges under SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities”, the mark-to-market adjustmentsof the Transaction and April 2004 Transaction were offset by the mark-to-marketadjustments on the Debt, resulting in no material impact to earnings. Themarket value of the Transaction was a liability of $5.8 million and $0.3million at December 31, 2005 and June 30, 2005, respectively. The market valueof the April 2004 Transaction was a liability of $4.7 million and $3.4 millionat December 31, 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 of the Company’s common stock equals orexceeds $77.63, both transactions will terminate.

 

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$7.5 million plus a collateral requirement for the Transaction and the April2004 Transaction, as determined periodically. At December 31, 2005, $17.0million in letters of credit were outstanding related to both transactions.

 

The Transaction and theApril 2004 Transaction qualify as fair value hedges under SFAS No. 133. To testeffectiveness of the hedge, regression analysis is performed quarterlycomparing the change in fair value of the two transactions and the Debt. Thefair values of the Transaction, the April 2004 Transaction and the Debt arecalculated quarterly as the present value of the contractual cash flows to theexpected maturity date, where the expected maturity date is based onprobability-weighted analysis of interest rates relating to the five-year LIBORcurve and the Company’s stock prices. For the three and six months endedDecember 31, 2005 and 2004, the hedges were highly effective and therefore, theineffective portion did not have a material impact 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. The notional amount of the Contract is $412.0million, representing approximately 75 percent of the Debt. Under the terms ofthe 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. The market value of the Contract at December31, 2005 and June 30, 2005, was $0.2 million and $0.1 million, respectively,and was included in other long-term assets. Mark-to-market (losses) gains of($0.05) million and ($0.3) million, for the three months ended December 31,2005 and 2004, respectively, and $0.1 million and ($0.6) million, for the sixmonths ended December 31, 2005 and 2004, respectively, were charged to interestexpense.

 

15

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5.                           Inventories

 

Inventories are stated at the lower of cost (principally first-in,first-out) or market. Inventories are reviewed for excess and obsolescencebased upon demand forecast within a specific time horizon and reserves areestablished accordingly. Inventories at December 31, 2005 and June 30, 2005were comprised of the following (in thousands):

 
| ** **        | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------|------------|-----------------------|------------|-------------------|------------|
| ** **        | ** ** | **2005**              | ** ** | **2005**          | ** ** |
| Raw materials     |       | $                     | 37,907     |              | $          | 33,328 |   |
| Work-in-process   |       | 94,260                |       | 82,802            |       |
| Finished goods    |       | 76,951                |       | 61,430            |       |
|              |       |                  |       |              |       |
| Total inventories |       | $                     | 209,118    |              | $          | 177,560 |   |

 

6.                           Goodwill and Acquisition-RelatedIntangible Assets

 

The Company accountsfor goodwill and acquisition-related intangible assets in accordance with SFASNo. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and OtherIntangible Assets”. The Company classifies the difference between the purchaseprice and the fair value of net assets acquired at the date of acquisition asgoodwill. 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 natureof the assets acquired, the amortization period may range from four to twelveyears for those acquisition-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 andintangible assets not subject to amortization, the Company completes thetwo-step goodwill impairment test as required by SFAS No. 142. The Companyidentified its reporting units and determined the carrying value of eachreporting unit by assigning the assets and liabilities, including the existinggoodwill and intangible assets, to those reporting units, in order to assessgoodwill for impairment. A reporting unit is the lowest level of the Companyfor 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 Company compared the discounted cash flows forthe reporting unit to its carrying value. If the fair value of a reporting unitexceeds its carrying value, goodwill of the reporting unit is considered notimpaired and no further testing is required. If the fair value does not exceedthe carrying value, the second step of the goodwill impairment test shall beperformed to measure the amount of impairment loss, if any. The second stepcompared the implied fair value of the reporting unit with the carrying amountof that goodwill. Based on its annual impairment test in the fourth quarter

 

16

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of fiscal year ended June 30, 2005, the Companydetermined that goodwill was not impaired.

 

At December 31, 2005 andJune 30, 2005 acquisition-related intangible assets included the following (inthousands):

 
| ** **                                  | ** ** | ** **                         | ** ** | **December 31, 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                        |       | $                               | 36,601     |                          | $          | (13,225 | ) | $ | 36,665 |   | $ | (11,859 | ) |
| Distribution rights and customer lists      |       | 5 – 12                        |       | 15,454                          |       | (8,029                        | )          | 15,667 |   | (7,243 | ) |
| Intellectual property and other             |       | 5 – 12                        |       | 7,313                           |       | (5,776                        | )          | 7,313 |   | (5,189 | ) |
| Total acquisition-related intangible assets |       |                               |       | $                               | 59,368     |                          | $          | (27,030 | ) | $ | 59,645 |   | $ | (24,291 | ) |

 

As of December 31, 2005, estimatedamortization expense for the next five years is as follows (in thousands):remainder of fiscal 2006: $1,840; fiscal 2007: $2,899; fiscal 2008: $2,527;fiscal 2009: $2,489, fiscal 2010: $2,489 and fiscal 2011: $1,710.

 

The carrying amount of goodwill by business segment as ofDecember 31, 2005, is as follows (in thousands):

 
| ** **                   | ** ** | **December 31, 2005** | ** ** |
|------------------------------|------------|---------------------------------|------------|
| Energy-Saving Products       |       | $                               | 70,310     |   |
| Aerospace and Defense        |       | 45,765                          |       |
| Computing and Communications |       | 28,803                          |       |
| Non-Aligned Products         |       | 3,575                           |       |
| Intellectual Property        |       | 3,261                           |       |
|                         |       |                            |       |
| Total goodwill               |       | $                               | 151,714    |   |

 

As of December 31, 2005 and June 30, 2005, $43.3 million ofgoodwill is deductible for income tax purposes.

 

Thechanges in the carrying amount of goodwill for the period ended December 31,2005 and June 30, 2005 are as follows (in thousands):

 
| ** **                 | ** ** | **Goodwill** | ** ** |
|----------------------------|------------|--------------|------------|
| Balance, June 30, 2004     |       | $            | 139,919    |   |
| New acquisitions           |       | 12,958       |       |
| Foreign exchange impact    |       | (420         | )          |
|                       |       |         |       |
| Balance, June 30, 2005     |       | $            | 152,457    |   |
| Purchase price adjustment  |       | 406          |       |
| Foreign exchange impact    |       | (1,149       | )          |
|                       |       |         |       |
| Balance, December 31, 2005 |       | $            | 151,714    |   |

 

During the fiscal year ended June 30, 2005,the Company acquired the specialty silicon epitaxial services business fromAdvanced Technology Materials, Inc. for

 

17

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$39.6 million, of which $12.5 million wasallocated to goodwill. The goodwill was assigned to the Computing andCommunications, Energy-Saving Products and Intellectual Property segments basedon revenue. During the six months ended December 31, 2005, the Companyconcluded the physical inventory of ATMI’s fixed assets and determined that thepurchased cost of the assets should be reduced by $1.1 million. The Companyreallocated ATMI’s purchase price and increased goodwill by $1.1 millionaccordingly. Also during the six months ended December 31, 2005, as describedin Note 10, “Impairment of Assets, Restructuring and Severance”, the Companydetermined that approximately $0.7 million of severance liability associatedwith the TechnoFusion acquisition was excess. The Company reduced TechnoFusionpurchased goodwill by $0.7 million accordingly.

 

7.                           Other long-term assets

 

Other long-term assetsat December 31, 2005 and June 30, 2005 were comprised of the following (inthousands):

 
| ** **                            | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2005**          | ** ** |
| Available-for-sale equity investments |       | $                     | 84,420     |              | $          | 71,224 |   |
| Other long-term assets                |       | 36,783                |       | 35,186            |       |
|                                  |       |                  |       |              |       |
| Total other long-term assets          |       | $                     | 121,203    |              | $          | 106,410 |   |

 

8.                           Other accrued expenses

 

Other accrued expensesat December 31, 2005 and June 30, 2005 were comprised of the following (inthousands):

 
| ** **             | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **             | ** ** | **2005**              | ** ** | **2005**          | ** ** |
| Accrued taxes          |       | $                     | 38,590     |              | $          | 46,704 |   |
| Accrued interest       |       | 11,929                |       | 9,289             |       |
| Other accrued expenses |       | 38,212                |       | 35,335            |       |
|                   |       |                  |       |              |       |
| Total accrued expenses |       | $                     | 88,731     |              | $          | 91,328 |   |

 

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9.                           Bank Loans and Long-TermDebt 

 

A summary of the Company’slong-term debt and other loans at December 31, 2005 and June 30, 2005 is asfollows (in thousands):

 
| ** **                                                                                                                                                                                                | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                | ** ** | **2005**              | ** ** | **2005**          | ** ** |
| Convertible subordinated notes at 4.25% due  in 2007 ($550,000 principal amount, plus accumulated fair value adjustment of  ($11,419) and  ($3,360) at December 31, 2005 and June 30, 2005, respectively) |       | $                     | 538,581    |              | $          | 546,640 |   |
| Other loans and capitalized lease  obligations                                                                                                                                                            |       | 2,199                 |       | 782               |       |
| Debt, including current portion of  long-term debt ($48 and $163 at December 31, 2005 and June 30, 2005,  respectively)                                                                                   |       | 540,780               |       | 547,422           |       |
| Foreign revolving bank loans at rates from  1.38% to 3.88%                                                                                                                                                |       | 1,201                 |       | 18,168            |       |
|                                                                                                                                                                                                      |       |                  |       |              |       |
| Total debt                                                                                                                                                                                                |       | $                     | 541,981    |              | $          | 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 15 andJuly 15. The notes are subordinated to all of the Company’s existing and futuredebt. The notes are convertible into shares of the Company’s common stock atany time on or before July 15, 2007, at a conversion price of $73.935 pershare, subject to certain adjustments. The Company may redeem any of the notes,in whole or in part, subject to certain call premiums on or after July 18,2004, as specified in the notes and related indenture agreement. In December2001 and April 2004, the Company entered into two transactions with JP MorganChase Bank for $412.5 million and $137.5 million in notional amounts,respectively, which had the effect to the Company of converting the interestrate to variable and requiring that the convertible notes be marked to market(see Note 4, “Derivative Financial 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 acredit line of $150 million of which up to $150 million may be used for standbyletters of credit. The Facility bears interest at (i) local currency rates plus(ii) a margin between 0.75 percent and 2.0 percent for base rate advances and amargin of between 1.75 percent and 3.0 percent for euro-currency rate advances.Other advances bear interest as set forth in the credit agreement. The annualcommitment fee for the Facility is subject to a leverage ratio as determined bythe credit agreement and was 0.375 percent of the unused portion of the totalfacility at each period-end. The Company pledged as collateral shares ofcertain of its subsidiaries. The Facility also contains certain financial andother covenants, with which the Company was in compliance at December 31, 2005.At December 31, 2005, the Company had $1.2 million borrowings and $21.4 millionletters of credit outstanding under the Facility. At June 30, 2005, the Companyhad $17.1 million borrowings and $16.4 million letters of credit outstandingunder the Facility. Of the letters of credit outstanding, $17.0

 

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million and $12.0 million were related to theinterest rate swap transactions (see Note 4) at December 31, 2005 and June 30,2005, respectively.

 

At December 31, 2005, the Company had $166.5million in total revolving lines of credit, of which $22.6 million had beenutilized, consisting of $21.4 million in letters of credit and $1.2 million inforeign revolving bank loans, which are included in the table above.

 

10.                     Impairment of Assets,Restructuring and Severance

 

During fiscal 2003 second quarter ended December 31, 2002, the Companyannounced its restructuring initiatives. Under these initiatives, the goal wasto reposition the Company to better fit the market conditions and de-emphasizeits commodity business. The Company’s 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 within its FocusProduct segments. The Company also planned to lower overhead costs across itssupport organizations. The Company has substantially completed theserestructuring activities as of December 31, 2005. The Company expects tocomplete the remaining activities, primarily the closing of a fabrication lineat El Segundo, California by fiscal year end 2006.

 

Total charges associated with the December 2002 initiatives areexpected to be approximately $273 million. These charges will consist ofapproximately $218 million for asset impairment, plant closure and other charges,$6 million of raw material and work-in-process inventory, and $49 million forseverance-related costs.

 

For the three monthsended December 31, 2005, the Company recorded $3.1 million in totalrestructuring-related charges, consisting of: $2.1 million for plant closureand relocation costs and other impaired assets charges, and $1.0 million forseverance costs. For the six months ended December 31, 2005, the Companyrecorded $7.4 million in total restructuring-related charges, consisting of:$5.1 million for plant closure and relocation costs and other impaired assetscharges, and $2.3 million for severance costs. For the three months endedDecember 31, 2004, the Company recorded $6.8 million in totalrestructuring-related charges, consisting of: $5.6 million for plant closureand relocation costs and other impaired assets charges, and $1.2 million forseverance costs. For the six months ended December 31, 2004, the Companyrecorded $13.5 million in total restructuring-related charges, consisting of:$10.5 million for plant closure and relocation costs and other impaired assetscharges, and $3.0 million for severance costs.

 

Restructuring-related costs were charged as incurred in accordance withSFAS No. 146, “Accounting for the Costs Associated with Exit or DisposalActivities”. Asset impairments were calculated in accordance with SFAS No. 144,“Accounting for Impairment or Disposal of Long-Lived Assets”. In determiningthe asset 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

 

20

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analyses were less than the carrying amount for certain of the assetgroups, 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 December 31, 2005, the Company had recorded $268.7 million in totalcharges, consisting of: $215.2 million for asset impairment, plant closurecosts and other charges, $6.0 million for raw material and work-in-processinventory charges, and $47.5 million for severance-related costs. Components ofthe $215.2 million asset impairment, plant closure and other charges includedthe following items:

 

•                  As the Company emphasizes more advanced generation planarproducts, it expects the future revenue stream from its less advancedfacilities in Temecula, California to decrease significantly. These facilitieshad a net book value of $138.3 million and were written down by $77.7 million. Itis expected that these facilities will continue in use until approximatelyDecember 2007 and the remaining basis is being depreciated over units ofproduction during this period. It is assumed that salvage value will equaldisposition costs.

 

•                  As the Company emphasizes more advanced generation trenchproducts, it expects the future revenue stream from its less advanced facilityin El Segundo, California to decrease significantly. This facility had a netbook value of $59.5 million and was 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 Company emphasizes more advanced generation Schottkyproducts, it expects the future revenue stream from its less advanced facilityin Borgaro, Italy to decrease significantly. This facility had a net book valueof $20.5 million and was written down by $13.5 million. It is expected thatthis facility will continue in use until approximately December 2007 and theremaining basis is being depreciated over units of production during thisperiod. It is assumed that salvage value will equal disposition costs.

 

•                  The Company restructured its manufacturing activities inEurope. Based on a review of its Swansea, Wales facility, a general-purposemodule facility, the Company determined in the December 2002 quarter that thisfacility would be better suited to focus only on automotive applications. Thegeneral-purpose module assets at this facility, with a net book value of $13.6million, were written down by $8.2 million. In addition, the Company hascompleted the move of its manufacturing activities from its automotive facilityin Krefeld, Germany to its Swansea, Wales and Tijuana, Mexico facilities as ofSeptember 30, 2005. The Company has also moved the production from its Venaria,Italy facility to its Borgaro, Italy and Mumbai, India facilities, which was completedas of December 31, 2003. The Company stopped manufacturing products at itsOxted, England facility as of September 30, 2003.

 

•                  The Company has eliminated the manufacturing of itsnon-space military products in its Santa Clara, California facility as of July31, 2004. Currently,

 

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subcontractors handle the Company’s non-space qualifiedproducts previously manufactured in this facility. The Company has alsotransitioned the assembly and test of non-space Power Components from itsLeominster, Massachusetts facility to its Tijuana, Mexico facility as ofDecember 31, 2005. Associated with these reductions in manufacturingactivities, certain assets with a net book value of $4.0 million were writtendown by $2.0 million.

 

•                  $56.6 million in other miscellaneous items were charged,including $47.8 million in relocation costs and other impaired asset chargesand $8.8 million in contract termination and settlement 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. The Company haddisposed of $1.1 million and $0.2 million of these inventories, for the threemonths ended December 31, 2005 and 2004, respectively, and $1.1 million and$0.7 million for the six months ended December 31, 2005 and 2004, respectively,which did not materially impact gross margin. As of December 31, 2005, $0.1 million of these inventories remained to bedisposed.

 

As of December 31, 2005, the Company has recorded $47.5 million inseverance-related charges:  $42.4 millionin severance termination costs related to approximately 1,200 administrative,operating and manufacturing positions, and $5.1 million in pension terminationcosts at its manufacturing facility in Oxted, England. The severance chargesassociated with the elimination of positions, which included the personsnotified to date, had been and will continue to be recognized over the futureservice period, as applicable, in accordance with SFAS No. 146. The Companymeasured the total termination benefits at the communication date based on thefair value of the liability as of the termination date. A change resulting froma revision to either the timing or the amount of estimated cash over the futureservice period will be measured using the credit-adjusted risk-free rate thatwas used to initially measure the liability. The cumulative effect of thechange will be recognized as an adjustment to the liability in the period ofthe change.

 

During fiscal 2002, the Company had recorded an estimated $5.1 millionin severance costs associated with the acquisition of TechnoFusion GmbH inKrefeld, Germany. In fiscal 2003, the Company finalized its plan and determinedthat total severance would be approximately $10 million, and accordingly, theCompany adjusted purchased goodwill by $4.8 million. The Company communicatedthe plan and the elimination of approximately 250 positions primarily inmanufacturing to its affected employees at that time. The Company has completedthe restructuring of its Krefeld facility as of December 31, 2005, anddetermined that $0.7 million of the severance reserve was excess. Accordingly,the Company decreased TechnoFusion purchased goodwill by $0.7 million.

 

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Thefollowing summarizes the Company’s accrued severance liability related to theJune 2001 restructuring, the TechnoFusion acquisition and the December 2002restructuring plan for the six months ended December 31, 2005 and the fiscalyear ended June 30, 2005. Severance activity related to the elimination of 29administrative and operating personnel as part of the previously reportedrestructuring in the fiscal quarter ended June 30, 2001, is also disclosed. Theremaining June 2001 severance relates primarily to certain legal accrualsassociated with that restructuring, which will be paid or released as theoutcome 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”         |       | —                        |       | 2,245                             |       | —                                 |       | 2,245                           |       |
| Purchase price adjustment                                                                           |       | —                        |       | —                            |       | (708                                   | )          | (708                            | )          |
| Costs paid                                                                                          |       | (90                           | )          | (3,858                            | )          | (684                                   | )          | (4,632                          | )          |
| Foreign exchange impact                                                                             |       | —                        |       | (14                               | )          | (40                                    | )          | (54                             | )          |
| Accrued severance, December 31, 2005                                                                |       | $                             | 281        |                              | $          | 6,497                                  |       | $                               | 675        |   | $ | 7,453 |   |

 

11.                     Segment and GeographicInformation

 

Revenue for the three andsix months ended December 31, 2005 and 2004, by the three broad productcategories, are as follows (in thousands):

 
| ** **                                         | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                               |       |                                                |       |                                              |       |   |   |   |   |
| Power Management ICs and Advanced Circuit  Devices |       | $                                                   | 198,892    |                                              | $          | 164,488 |   | $ | 374,037 |   | $ | 331,064 |   |
| Power Components                                   |       | 43,018                                              |       | 90,137                                            |       | 98,106 |   | 192,929 |   |
| Power Systems                                      |       | 26,827                                              |       | 33,398                                            |       | 58,726 |   | 66,236 |   |
| Total product revenue                              |       | 268,737                                             |       | 288,023                                           |       | 530,869 |   | 590,229 |   |
| Intellectual Property                              |       | 10,074                                              |       | 10,537                                            |       | 20,514 |   | 20,556 |   |
| Total consolidated revenue                         |       | $                                                   | 278,811    |                                              | $          | 298,560 |   | $ | 551,383 |   | $ | 610,785 |   |

 

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Segment results for thethree months ended December 31, 2005 and 2004, are as follows (in thousandsexcept percentages):

 
| ** **                   | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Business Segment**    | ** ** | **Revenue**                 | ** ** | **Gross  Profit**           | ** ** | **Revenue** | ** ** | **Gross  Profit** | ** ** |
| Computing and Communications |       | $                           | 95,178     |                        | 41.5       | % | $ | 101,843 |   | 44.7 | % |
| Energy-Saving Products       |       | 75,577                      |       | 47.9                        |       | 74,210 |   | 55.3 |   |
| Aerospace and Defense        |       | 34,400                      |       | 50.0                        |       | 32,183 |   | 42.6 |   |
| Intellectual Property        |       | 10,074                      |       | 100.0                       |       | 10,537 |   | 100.0 |   |
| Subtotal Focus Products      |       | 215,229                     |       | 47.8                        |       | 218,773 |   | 50.7 |   |
|                         |       |                        |       |                        |       |   |   |   |   |
| Commodity Products           |       | 39,542                      |       | 16.6                        |       | 52,482 |   | 26.6 |   |
| Non-Aligned Products         |       | 24,040                      |       | 8.5                         |       | 27,305 |   | 16.9 |   |
| Subtotal Non-Focus Products  |       | 63,582                      |       | 13.5                        |       | 79,787 |   | 23.3 |   |
| Consolidated total           |       | $                           | 278,811    |                        | 40.0       | % | $ | 298,560 |   | 43.3 | % |

 

Segment results for the sixmonths ended December 31, 2005 and 2004, are as follows (in thousands exceptpercentages):

 
| ** **                   | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Business Segment**    | ** ** | **Revenue**                 | ** ** | **Gross  Profit**           | ** ** | **Revenue** | ** ** | **Gross  Profit** | ** ** |
| Computing and Communications |       | $                           | 184,818    |                        | 41.6       | % | $ | 207,835 |   | 44.2 | % |
| Energy-Saving Products       |       | 147,963                     |       | 50.1                        |       | 147,360 |   | 54.5 |   |
| Aerospace and Defense        |       | 63,801                      |       | 47.1                        |       | 64,460 |   | 41.9 |   |
| Intellectual Property        |       | 20,514                      |       | 100.0                       |       | 20,556 |   | 100.0 |   |
| Subtotal Focus Products      |       | 417,096                     |       | 48.3                        |       | 440,211 |   | 49.9 |   |
|                         |       |                        |       |                        |       |   |   |   |   |
| Commodity Products           |       | 81,693                      |       | 18.0                        |       | 112,006 |   | 28.9 |   |
| Non-Aligned Products         |       | 52,594                      |       | 11.8                        |       | 58,568 |   | 18.3 |   |
| Subtotal Non-Focus Products  |       | 134,287                     |       | 15.6                        |       | 170,574 |   | 25.3 |   |
| Consolidated total           |       | $                           | 551,383    |                        | 40.3       | % | $ | 610,785 |   | 43.0 | % |

 

Product revenue fromunaffiliated customers is 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.

 

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Geographic information forthe Company on an aggregate basis, for the three months ended December 31, 2005and 2004, is presented below (in thousands):

 
| ** **            | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-----------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **            | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                  |       |                                                |       |                                              |       |   |   |   |   |
| United States         |       | $                                                   | 73,748     |                                              | $          | 89,900 |   | $ | 148,357 |   | $ | 181,877 |   |
| Asia                  |       | 136,416                                             |       | 132,267                                           |       | 266,045 |   | 272,954 |   |
| Europe                |       | 58,573                                              |       | 65,856                                            |       | 116,467 |   | 135,398 |   |
|                  |       |                                                |       |                                              |       |   |   |   |   |
| Total product revenue |       | 268,737                                             |       | 288,023                                           |       | 530,869 |   | 590,229 |   |
| Unallocated royalties |       | 10,074                                              |       | 10,537                                            |       | 20,514 |   | 20,556 |   |
|                  |       |                                                |       |                                              |       |   |   |   |   |
| Total revenue         |       | $                                                   | 278,811    |                                              | $          | 298,560 |   | $ | 551,383 |   | $ | 610,785 |   |

 
| ** **                             | ** ** | **December 31,  2005** | ** ** | **June 30,  2005** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Long-Lived Assets                      |       |                        |       |                    |       |
| North America, primarily United States |       | $                           | 369,555    |                    | $          | 347,892 |   |
| Asia                                   |       | 32,269                      |       | 23,598                  |       |
| Europe                                 |       | 236,568                     |       | 223,124                 |       |
|                                   |       |                        |       |                    |       |
| Total                                  |       | $                           | 638,392    |                    | $          | 594,614 |   |

 

No single original equipment manufacturer (“OEM”),customer, distributor or subcontract manufacturer accounted for more than tenpercent of the Company’s consolidated revenue for the three and six monthsended December 31, 2005 and 2004. No customer accounted for more than tenpercent of the Company’s accounts receivable at December 31, 2005 and June 30,2005.

 

For its Focus Product segments as a whole,the Company primarily sells direct to OEM customers. However, in the Computingand Communications segment, two distributors, individually accounting for greaterthan ten percent of segment revenue, accounted for approximately 27 percent and29 percent of revenue for the three and six months ended December 31, 2005,respectively. In the Aerospace and Defense segment, one distributor accountedfor approximately 13 percent of revenue for the three and six months endedDecember 31, 2005. No single OEM customer, distributor or subcontractmanufacturer accounted for more than ten percent of the Company’s other FocusProduct segment revenues for the three or six months ended December 31, 2005.

 

In the Commodity Product segment, onedistributor accounted for approximately 12 percent and 14 percent of revenuefor the three and six months ended December 31, 2005, respectively. In theNon-Aligned Product segment, two OEM customers and one distributor,individually accounting for greater than ten percent of segment revenue,accounted for approximately 45 percent and 44 percent of revenue for the threeand six months ended December 31, 2005, respectively.

 

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12.                     Stock-Based Compensation

 

For the three and sixmonths ended December 31, 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 became exercisablein annual installments of 25 percent beginning on the first anniversary date,and expire after seven years. Options granted after November 22, 2004,generally became exercisable in annual installments of 33 percent beginning onthe first anniversary date, and expire after five years.

 

Under the 1997 Plan, options to purchaseshares of the Company’s common stock may be granted to the Company’s employeesand consultants. In addition, other stock-based awards (e.g., restricted stockunits (“RSUs”), SARs and performance shares) may be granted. During the threeand six months ended December 31, 2005 and 2004, non-qualified options and RSUswere issued 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 purchaseshares of the Company’s common stock and other stock-based awards may begranted to the Company’s employees, consultants, officers and directors. Theterms of the 2000 Plan were substantially similar to those under the 1997 Plan.On November 22, 2004, the Company’s shareholders approved an amendment to the2000 Plan which increased the authorized number of shares to be granted from7,500,000 to 12,000,000. The amendment changed the options expiration term onfuture grants to five years, and contained certain limitations on the maximumnumber of shares that may be awarded to an individual. No awards may be grantedunder the 2000 Plan after August 24, 2014. As of December 31, 2005, there were4,124,348 shares available for future grants.

 

The following table summarizes the stockoption activities for the six months ended December 31, 2005 (in thousandsexcept per share price 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                        |       | 627        |       | $                                                              | 47.19      |                                                                | $          | 13.02                           |       | — |   |
| Exercised                      |       | (1,046     | )          | $                                                              | 23.43      |                                                                | —     |                            | $          | 23,142 |   |
| Expired or canceled            |       | (242       | )          | $                                                              | 44.02      |                                                                | —     |                            | —     |   |
| Outstanding, December 31, 2005 |       | 12,897     |       | $                                                              | 39.51      |                                                                | —     |                            | $          | 34,503 |   |
|                                |            |            |            |                                                                |            |                                                                     |            |                                 |            |  |  |  |

 

26

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The following table summarizes the RSUactivities for the six months ended December 31, 2005 (in thousands except pershare price data): 

 
| ** **                     | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair  Value Per  Share** | ** ** |
|--------------------------------|------------|------------|------------|---------------------------------------------------------------------|------------|
| Outstanding, June 30, 2005     |       | 24         |       | —                                                              |       |
| Granted                        |       | 6          |       | $                                                                   | 48.10      |   |
|                           |       |       |       |                                                                |       |
| Outstanding, December 31, 2005 |       | 30         |       | —                                                              |       |
|                                |            |            |            |                                                                     |            |  |

 

The following table summarizes the non-vestedstock option and RSU activities for the six months ended December 31, 2005 (inthousands):

 
| ** **                           | ** ** | **Stock  Options** | ** ** | **Restricted  Stock Units** | ** ** |
|--------------------------------------|------------|--------------------|------------|----------------------------------|------------|
| Non-vested shares, June 30, 2005     |       | 137                |       | 24                               |       |
| Granted                              |       | 627                |       | 6                                |       |
|                                 |       |               |       |                             |       |
| Non-vested shares, December 31, 2005 |       | 764                |       | 30                               |       |

 

The following table summarizes the stock options andRSUs outstanding at December 31, 2005, and related weighted average priceand life information (in thousands except year and price data):

 
| ** **                                                 | ** ** | **December 31, 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                                |       | 484                             |       | 3.19 |   | $ | 11.09 |   | 454 |   | $ | 11.82 |   |
| $15.62 to $25.35                                           |       | 1,976                           |       | 3.47 |   | $ | 20.62 |   | 1,975 |   | $ | 20.62 |   |
| $26.00 to $35.90                                           |       | 1,512                           |       | 5.43 |   | $ | 33.93 |   | 1,474 |   | $ | 33.92 |   |
| $36.39 to $45.87                                           |       | 6,475                           |       | 4.40 |   | $ | 42.77 |   | 6,457 |   | $ | 42.77 |   |
| $46.50 to $54.69                                           |       | 1,512                           |       | 4.60 |   | $ | 50.53 |   | 811 |   | $ | 52.44 |   |
| $55.31 to $63.88                                           |       | 968                             |       | 4.91 |   | $ | 61.99 |   | 968 |   | $ | 61.99 |   |
|                                                       |       | 12,927                          |       | 4.39 |   | $ | 39.51 |   | 12,139 |   | $ | 39.11 |   |

 

Additional information relating to the stock optionplans, including employee stock options and RSUs, at December 31, 2005 andJune 30, 2005 is as follows (in thousands):

 
| ** **                                                 | ** ** | **December 31,  2005** | ** ** | **June 30,  2005** | ** ** |
|------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                                                       |       |                        |       |                    |       |
| Options exercisable                                        |       | 12,139                      |       | 13,422                  |       |
| Options available for grant                                |       | 4,124                       |       | 4,632                   |       |
| Total reserved common stock shares for  stock option plans |       | 17,052                      |       | 18,214                  |       |

 

27

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Beginningin the fiscal year 2006, the Company adopted SFAS No. 123(R), “Share-BasedPayment” (“SFAS No. 123(R)”) on a modified prospective transition method toaccount for its employee stock options. Under the modified prospectivetransition method, fair value of new and previously granted but unvested equityawards are recognized as compensation expense in the income statement, andprior period results are not restated. As a result of the adoption, for thethree months ended December 31, 2005, the Company’s income from continuingoperations, which is the same as income before income taxes, decreased by $0.8million, net income was decreased by $0.6 million, and basic and dilutedearnings per share were negatively impacted by $0.01. For the six months endedDecember 31, 2005, the Company’s income from continuing operations decreased by$1.2 million, net income was decreased by $0.8 million, and basic and dilutedearnings per share were negatively impacted by $0.01. In addition, cash flowsfrom operating and financing activities decreased and increased, respectively,by $4.3 million for the six months ended December 31, 2005, reflecting theproper classification of the excess tax benefits from options exercised from anoperating to a financing activity (see Note 1, “Certain Accounting Policies”).

 

Theadoption of SFAS No. 123(R) did not affect the stock-based compensationassociated with the Company’s RSUs, which were already based on the market price of the stock at date ofgrant and recognized over the service period. Stock-compensation expense attributable to the RSUs were $0.1 millionand $0.2 million for the three months ended December 31, 2005 and 2004,respectively, and $0.2 million and $0.4 million for the six months endedDecember 31, 2005 and 2004, respectively.

 

Forthe three and six months ended December 31, 2005, stock-based compensationexpense associated with the Company’s stock options and restricted stock unitsrecognized in the income statement is as follows (in thousands):

 
| ** **                             | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Three Months  Ended**    | ** ** | **Six Months  Ended** | ** ** |
| Selling and administrative expense     |       | $                               | 619        |   | $ | 938 |   |
| Research and development expense       |       | 231                             |       | 365 |   |
| Cost of sales                          |       | 61                              |       | 99 |   |
|                                   |       |                            |       |   |   |
| Total stock-based compensation expense |       | $                               | 911        |   | $ | 1,402 |   |

 

 

Forthe three and six months ended December 31, 2004, stock-based compensationexpense associated with the Company’s restricted stock units recognized in theincome statement is as follows (in thousands):

 
| ** **                             | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Three Months  Ended**    | ** ** | **Six Months  Ended** | ** ** |
|                                   |       |                            |       |   |   |
| Selling and administrative expense     |       | $                               | 124        |   | $ | 207 |   |
| Research and development expense       |       | 105                             |       | 175 |   |
| Cost of sales                          |       | 17                              |       | 28 |   |
|                                   |       |                            |       |   |   |
| Total stock-based compensation expense |       | $                               | 246        |   | $ | 410 |   |

 

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Thetotal unrecognized compensation expense for outstanding stock options and RSUswas $7.5 million as of December 31, 2005, and will be recognized, in general,over three years. The weighted average number of years to recognize thecompensation expense is 1.6 years. The fair value of the options associatedwith the above compensation expense for the three and six months ended December31, 2005, was determined at the date of the grant using the Black-Scholesoption pricing model with the following weighted average assumptions:

 
| ** **              | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                    |       |                        |       |                        |       |
| Expected life           |       | 3.5 years              |       | 5.0 years              |       |
| Risk free interest rate |       | 3.9%                        |       | 3.9%                        |       |
| Volatility              |       | 30.0%                       |       | 75.0%                       |       |
| Dividend yield          |       | 0.0%                        |       | 0.0%                        |       |

 

In March 2005, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 107 (“SAB No. 107”) thatprovided the Staff’s views regarding valuation of share-based payment pursuantto SFAS No. 123(R). With respect to volatility, SAB No. 107 clarified thatthere is not a particular method of estimating volatility and to the extentthat the Company has traded financial instruments from which it can derive theimplied volatility, it may be appropriate to use only implied volatility in itsassumptions. The Company has certain financial instruments that are publiclytraded from which it can derive the implied volatility. Therefore, beginning inJanuary 2005, the Company has used implied volatility for valuing its stockoptions, whereas previously, it had used historical volatility. The Companybelieves implied volatility is a better indicator of expected volatilitybecause it is generally reflective of both historical volatility andexpectations of how future volatility will differ from historical volatility.

 

SAB No. 107 also provided certain “simplified” methodfor determining expected life in valuing stock 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. Subsequentto the 2000 Plan amendments on November 22, 2004, the Company issued stockoptions having five-year expiration with generally a three-year annual vestingterm, whereas, prior to then, the Company granted stock options having seven orten-year expiration with generally a four or five-year annual vesting term. Therefore,beginning in January 2005, the Company has applied SAB No. 107 “plain-vanilla”method for determining the expected life, whereas previously, it had usedhistorical exercise data to determine the expected life.

 

29

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Had the Company accounted for stock-based compensationplans using the fair value based accounting method described by SFAS No. 123for the periods prior to fiscal year 2006, the Company’s diluted net income percommon share–basic and diluted for the three and six months ended December 31,2004, would have approximated the following (in thousands except per sharedata):

 
| ** **                                                                                                                  | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                  | ** ** | **Three Months  Ended**    | ** ** | **Six Months  Ended** | ** ** |
|                                                                                                                        |       |                            |       |   |   |
| Net income                                                                                                                  |       | $                               | 39,514     |   | $ | 77,094 |   |
| Less: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of tax |       | (12,796                         | )          | (26,039 | ) |
| Pro forma net income                                                                                                        |       | $                               | 26,718     |   | $ | 51,055 |   |
|                                                                                                                        |       |                            |       |   |   |
| Net income per common share–basic, as  reported                                                                        |       | $                               | 0.59       |   | $ | 1.16 |   |
| Net income per common share–basic, pro  forma                                                                          |       | $                               | 0.40       |   | $ | 0.77 |   |
|                                                                                                                        |       |                            |       |   |   |
| Net income per common share–diluted, as  reported                                                                      |       | $                               | 0.55       |   | $ | 1.07 |   |
| Net income per common share–diluted, pro  forma                                                                        |       | $                               | 0.38       |   | $ | 0.73 |   |

 

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, theCompany recorded $6.0 million in non-cash compensation charge in the fourthquarter of fiscal year 2005, of which $3.9 million is related to the excess ofthe intrinsic value over the fair market value of the Company’s stock on theacceleration date of those options that would have been forfeited or expiredunexercised had the vesting not been accelerated, and $2.1 million is relatedto the recognition of outstanding RSUs, including $0.3 million for the excessof the intrinsic value over the fair market value of the Company’s stock on theacceleration date.  In determining the forfeiture rates of the stockoptions, the Company reviewed the unvested options’ original life, timeremaining to vest and whether these options were held by officers and directorsof the Company.  The compensation charge is adjusted in future periodfinancial results as actual forfeitures are realized. For the three and sixmonths ended December 31, 2005, there were no material changes in actualforfeitures from estimates.

 

13.       EnvironmentalMatters

 

Federal,state, foreign and local laws and regulations impose various restrictions andcontrols on the storage, use and discharge of certain materials, chemicals andgases used in semiconductor manufacturing processes. The Company does notbelieve that compliance with such laws and regulations as now in effect willhave a material adverse effect on the Company’s results of operations,financial position or cash flows.

 

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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 Companyand Rachelle Laboratories, Inc. (“Rachelle”), a former operatingsubsidiary of the Company that discontinued operations in 1986, were each nameda potentially responsible party (“PRP”) in connection with the investigation bythe United States Environmental Protection Agency (“EPA”) of the disposal ofallegedly hazardous substances at a major superfund site in Monterey Park,California (“OII Site”). Certain PRPs who settled certain claims with the EPAunder consent decrees filed suit in Federal Court in May 1992 against anumber of other PRPs, including the Company, for cost recovery and contributionunder the provisions of the Comprehensive Environmental Response, Compensationand Liability Act (“CERCLA”). IR has settled all outstanding claims that havearisen against it out of the OII Site. No claims against Rachelle have beensettled. The Company has taken the position that none of the wastes generatedby Rachelle were hazardous.

 

Counsel for Rachelle received a letter datedAugust 2001 from the U.S. Department of Justice, directed to all orsubstantially all PRPs for the OII Site, offering to settle claims against suchparties for all work performed through and including the final remedy for theOII Site. The offer required a payment from Rachelle in the amount ofapproximately $9.3 million in order to take advantage of the settlement. Rachelledid not accept the offer.

 

In as muchas Rachelle has not accepted the settlement, the Company cannot predict whetherthe EPA or others would attempt to assert an action for contribution orreimbursement for monies expended to perform remedial actions at the OII Site. TheCompany cannot predict the likelihood that the EPA or such others would prevailagainst Rachelle in any such action. It remains the position of Rachelle thatits wastes were not hazardous. The Company’s insurer has not acceptedliability, although it has made payments for defense costs for the lawsuitagainst the Company. The Company has made no accrual for potential loss, ifany; however, an adverse outcome could have a material adverse effect on theCompany’s results of operations and cash flows.

 

The Company received aletter in June 2001 from a law firm representing UDT Sensors, Inc. relating toenvironmental contamination (chlorinated solvents such as trichlorethene)assertedly found in UDT’s properties in Hawthorne, California. The letteralleges that the Company operated a manufacturing business at that location inthe 1970’s and/or 1980’s and that it may have liability in connection with theclaimed contamination. The Company has made no accrual for any potential lossessince there has been no assertion of specific facts on which to form the basisfor determination of liability.

 

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14.       Litigation

 

In June 2000, the Company filed suit in Federal District Court in LosAngeles, California against IXYS Corporation, alleging infringement of its keyU.S. patents 4,959,699; 5,008,725 and 5,130,767. The suit sought damages andother relief customary in such matters. The Federal District Court entered apermanent injunction, effective on June 5, 2002, barring IXYS from making,using, offering to sell or selling in, or importing into 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 theFederal Circuit stayed that injunction, pending appeal on the merits. In thatsame year, following trial on damages issues, a Federal District Court juryawarded the Company $9.1 million in compensatory damages. The Federal DistrictCourt subsequently tripled the damages, increasing the award from $9.1 millionto approximately $27.2 million, and ruled that the Company is entitled to anadditional award of reasonable attorney’s fees for a total monetary judgment ofabout $29.5 million. In March 2004, the U.S. Court of Appeals for the FederalCircuit reversed the summary judgment granted the Company by the FederalDistrict Court in Los Angeles of infringement by IXYS of the Company’s U.S.patents 4,959,699; 5,008,725 and 5,130,767. The Federal Circuit reversed inpart and vacated in part infringement findings of the District Court, grantedIXYS the right to present certain affirmative defenses, and vacated theinjunction against IXYS entered by the District Court. The ruling by theFederal Circuit had the effect of vacating the damages judgment obtainedagainst IXYS. The Federal Circuit affirmed the District Court’s rulings in theCompany’s favor regarding the validity and enforceability of the three Companypatents. Following remand, a federal court jury in Los Angeles, California heldon September 15, 2005, that IXYS elongated octagonal MOSFETs and IGBTsinfringed the Company’s 4,959,699 patent but did not infringe the Company’s5,008,725 and 5,130,767 patents. On October 6, 2005 the jury awarded theCompany $6.2 million in damages. Further proceedings are required in the trialcourt before final judgment can be entered. The Company anticipates that IXYSwill appeal the judgment. No amount has been recognized in the income statementfrom the pending litigation for the three and six months ended December 31,2005.

 

15.       IncomeTaxes

 

TheCompany’s effective tax provision for the three months ended December 31, 2005and 2004 was 27.5 percent and 22.8 percent, respectively, and 27.5 percent and25.2 percent for the six months ended December 31, 2005 and 2004, respectively,rather than the U.S. federal statutory tax provision of 35 percent as a resultof lower statutory tax rates in certain foreign jurisdictions, the benefit offoreign tax credits and research and development credits, partially offset bystate taxes and certain foreign losses without foreign tax benefit.

 

In December 2004, the FASB issued FASB Staff Position No.109-2, “Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creations Act of 2004”, whichintroduces a limited time 85 percent dividends received deduction on therepatriation of certain foreign earnings to a U.S. tax payer (“repatriationprovision”), provided certain criteria are met. The Company

 

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is currently evaluating the range of possible amounts of unremittedearnings that may be repatriated as a result of the repatriation provision; therelated range of income tax effects of such repatriation cannot be reasonablyestimated at this time.

 

16.                     Related Party Transactions

 

Asdiscussed in Note 3, the Company holds as strategic investment common stock ofNihon Inter Electronics Corporation (“Nihon”), a related party. At December 31,2005 and June 30, 2005, the Company owned approximately 17.5 percent of theoutstanding shares of Nihon. As previously reported, the Company’s ChiefFinancial Officer was the Chairman of the Board of Nihon until June 28, 2005. Inaddition, two managers of the Company’s Japan subsidiary are directors of Nihon.Although the Company has two positions on the Board of Directors of Nihon as ofDecember 31, 2005, it does not exercise significant influence, and accordingly,the Company records its interest in Nihon based on readily determinable marketvalues in accordance with SFAS No. 115 (see Note 3, “Cash and Investments”).

 

17.       StockRepurchase Program

 

On November 1, 2005, the Company’s Board of Directors authorized andthe Company announced a stock repurchase program, under which up to $100million of the Company’s common shares may be repurchased 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 the repurchase through the followingthirty days, no amounts under the Company’s $150 million credit facility willbe available. Shares repurchased will be paid with the Company’s existing cashand cash investments. As of December 31, 2005, no shares had been repurchasedunder the program.

 

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**ITEM 2.****                                     MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The followingdiscussion of our financial condition and results of operations should be readtogether with the consolidated financial statements and notes to consolidatedfinancial statements included elsewhere in this Form 10-Q. Except for historicinformation contained herein, the matters addressed in this Item 2 constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-lookingstatements may be identified by the use of terms such as “anticipate,” “believe,”“expect,” “intend,” “project,” “will,” and similar expressions. Such forward-lookingstatements are subject to a variety of risks and uncertainties, including thosediscussed under the heading “Statement of Caution Under the Private SecuritiesLitigation Reform Act of 1995” and elsewhere in this Quarterly Report on Form10-Q, that could cause actual results to differ materially from thoseanticipated by the Company. We undertake no obligation to update theseforward-looking statements to reflect events or circumstances after the date ofthis report or to reflect actual outcomes.

 

**Restatement of Statement of Cash Flows**

 

As discussed in Note 1 of Notes to the unaudited consolidated financialstatements, we have corrected the classification of the excess tax benefitsgenerated from options exercised of $4.3 million for the six months endedDecember 31, 2005 to present the tax benefits from options exercised as cashflows from financing activities rather than operating activities in ourconsolidated statement of cash flows, as required by Statement of FinancialAccounting Standards No. 123(R), “Shared-Based Payment,” which we adopted as ofthe beginning of our fiscal year 2006 in July 2005. The correction had noimpact on our overall net change in cash and cash equivalents, the unauditedconsolidated statements of income, the unaudited consolidated statements ofcomprehensive income, or the unaudited consolidated balance sheet for any ofthe periods presented.

 

**Overview of Results of Operations for the Three Months Ended December31, 2005**

 

Wereport 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”). Weinclude our C&C, ESP, A&D and IP segments in our Focus Product group,and our CP and NAP segments in our Non-Focus Product group.

 

Forthe three months ended December 31, 2005, consolidated revenue was $278.8million, compared to $298.6 million for the prior year three months endedDecember 31, 2004. Focus Product revenue was $215.2 million (77.2 percent ofrevenue) for the three months ended December 31, 2005, compared to $218.8million (73.3 percent of revenue) for the three months ended December 31, 2004.Non-Focus Product revenue was $63.6 million (22.8 percent of revenue) for thethree months ended December 31, 2005, compared to $79.8 million (26.7 percentof revenue) for the three months ended December 31, 2004. Current periodrevenues were adversely affected by price pressure on certain of our PowerComponents and capacity constraints in our C&C segment. Capacityutilization was above 95 percent for the three months ended December 31, 2005.

 

Revenue as a percentage of total product revenue based on saleslocation were approximately 27 percent, 51 percent and 22 percent for UnitedStates, Asia and Europe, respectively, for the three months ended December 31,2005, and 31 percent,

 

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46 percent and 23 percent forUnited States, Asia and Europe, respectively, for the three months endedDecember 31, 2004.

 

For the three months ended December 31, 2005, gross profit margin was40.0 percent, compared to 43.3 percent for the prior year three months endedDecember 31, 2004. Gross profit margin for our Focus Products was 47.8 percentfor the three months ended December 31, 2005, compared to 50.7 percent for thethree months ended December 31, 2004. Gross profit margin for our Non-FocusProducts was 13.5 percent for the three months ended December 31, 2005,compared to 23.3 percent for the three months ended December 31, 2004. Thegross profit margin decline across our Focus and Non-Focus Products reflectedprimarily price declines on certain of our Power Components, sale of alower-margin product mix, and profit sharing and employee stock option expense.We expect our overall Company gross margin for the three months ended March 31,2006 to be flat, plus or minus one percentage point, compared to the threemonths ended December 31, 2005, tempered by costs associated with the ramp ofour Newport, Wales facility.

 

Inventory increased by $15.3 million for the three months endedDecember 31, 2005 from September 30, 2005, of which $13.1 million waswork-in-process and raw material inventory. The increase in work-in-process andraw material inventory positions us to better support our growing backlog. Ordersfor the three months ended December 31, 2005, increased by 17 percent from theimmediately preceding three months ended September 30, 2005, reflectingend-market demand for servers, appliances, digital TVs and game stations.

 

In the March 2006quarter, for our Focus Product segments, we expect C&C revenue to reflectend-market demand for servers, dual-core notebook platforms and new consumerprograms including game stations. In the ESP segment, we expect end-marketdemand for energy-efficient appliances to be strong with the start of the newmodel year. In our A&D segment, we expect an increase in A&D revenuemainly due to seasonal increases in demand for certain military programs. Forour Non-Focus Product segments, we continue to manage our exposure to CommodityProducts and review our Non-Aligned Products. We have announced that we plan toenter into agreements for the Non-Aligned Product divestitures by the end ofthe June 2006 quarter.

 

As of December 31, 2005, we have substantially completed ourrestructuring activities previously announced in 2002 and 2003. We expect tocomplete the remaining activities, primarily the closing of a fabrication lineat El Segundo, California by fiscal year end 2006. For the three months endedDecember 31, 2005, we recorded $3.1 million in total restructuring-relatedcharges, consisting of: $2.1 million for asset impairment, plant closure costsand other charges and $1.0 million for severance-related costs. We estimatethat total charges associated with the restructuring will be approximately $273million. These charges will consist of approximately $218 million for assetimpairment, plant closure costs and other charges, $6 million of raw materialand work-in-process inventory, and approximately $49 million forseverance-related charges. Of the $273 million in total charges, we expect cashcharges to be approximately $110 million. As of December 31, 2005, we have realized annualized savings ofapproximately $80 million from the restructuring activities, with approximately70 percent of that savings affecting cost of goods sold.

 

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During the three months ended December 31, 2005, we spent $39.0 millionin capital expenditures, of which $13.2 million was at the Newport, Wales’sfacility. We began production at this facility during the quarter endedDecember 31, 2005.

 

We adopted Statement of Financial Accounting Standards No. 123(R), “Share-BasedPayment” (“SFAS No. 123(R)”) that became effective for us in the fiscal firstquarter ended September 30, 2005. SFAS No. 123(R) required that we recognizethe fair value of equity awards granted to our employees as compensationexpense in the income statement over the requisite service period. For thethree months ended December 31, 2005, we recognized $0.8 million in stock-basedcompensation expense associated with employee stock options as a result of theadoption of SFAS No. 123(R), which lowered our basic and diluted earnings pershare by $0.01.

 

During thethree months ended December 31, 2005, operating activities generated cash flowsof $38.6 million. Cash flows from operating activities decreased by $0.2million for the three months ended December 31, 2005, reflecting the properclassification of the excess tax benefits from options exercised from an operatingto a financing activity (see Note 1, “Certain Accounting Policies”). Our cash,cash equivalents and cash investments totaled $918.4 million at December 31,2005. Additionally, we have $143.9 million in unused credit facilities.

 

Our $550million convertible subordinated notes are due in July 2007. We anticipate thatthese notes will be refinanced through public or private offerings of debt orequity, or be paid down with our existing cash and cash investments.

 

On November 1, 2005, our Board of Directors authorized and we announceda stock repurchase program, under which up to $100 million of our common sharesmay be repurchased without prior notice, through block trades or otherwise. Weintend that any shares repurchased will be held as treasury shares that may beused for general corporate purposes. As of December 31, 2005, no shares hadbeen repurchased under the program.

 

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**Results of Operations for the Three and Six Months Ended December 31,2005 Compared with the Three and Six Months Ended December 31, 2004**

 

The following table sets forth certain items as a percentage of revenue(in millions except percentages):

 
| ** **                                                 | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                                    |       | $                                                   | 278.8      |                                              | 100.0      | % | $ | 298.6 |   | 100.0 | % | $ | 551.4 |   | 100.0 | % | $ | 610.8 |   | 100.0 | % |
| Cost of sales                                              |       | 167.2                                               |       | 60.0                                              |       | 169.2 |   | 56.7 |   | 328.9 |   | 59.7 |   | 348.0 |   | 57.0 |   |
|                                                       |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                               |       | 111.6                                               |       | 40.0                                              |       | 129.4 |   | 43.3 |   | 222.5 |   | 40.3 |   | 262.8 |   | 43.0 |   |
| Selling and administrative expense                         |       | 46.1                                                |       | 16.5                                              |       | 40.9 |   | 13.7 |   | 91.3 |   | 16.6 |   | 87.3 |   | 14.3 |   |
| Research and development expense                           |       | 27.2                                                |       | 9.8                                               |       | 27.7 |   | 9.3 |   | 52.5 |   | 9.5 |   | 53.0 |   | 8.7 |   |
| Amortization of acquisition-related  intangible assets     |       | 1.4                                                 |       | 0.5                                               |       | 1.5 |   | 0.5 |   | 2.8 |   | 0.5 |   | 2.9 |   | 0.4 |   |
| Impairment of assets, restructuring and  severance charges |       | 3.1                                                 |       | 1.1                                               |       | 6.8 |   | 2.3 |   | 7.4 |   | 1.3 |   | 13.5 |   | 2.2 |   |
| Other expense, net                                         |       | 1.1                                                 |       | 0.4                                               |       | 0.7 |   | 0.2 |   | 1.2 |   | 0.2 |   | 0.7 |   | 0.1 |   |
| Interest (income) expense, net                             |       | (0.8                                                | )          | (0.3                                              | )          | 0.6 |   | 0.2 |   | (2.4 | ) | (0.4 | ) | 2.4 |   | 0.4 |   |
| Income before income taxes                                 |       | 33.5                                                |       | 12.0                                              |       | 51.2 |   | 17.1 |   | 69.7 |   | 12.6 |   | 103.0 |   | 16.9 |   |
| Provision for income taxes                                 |       | 9.2                                                 |       | 3.3                                               |       | 11.7 |   | 3.9 |   | 19.2 |   | 3.5 |   | 25.9 |   | 4.3 |   |
|                                                       |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                 |       | $                                                   | 24.3       |                                              | 8.7        | % | $ | 39.5 |   | 13.2 | % | $ | 50.5 |   | 9.1 | % | $ | 77.1 |   | 12.6 | % |

 

Revenue and Gross Margin

 

For the three months ended December 31, 2005, consolidated revenuedecreased by 6.6 percent from the prior year three months ended December 31,2004. For the six months ended December 31, 2005, consolidated revenuedecreased by 9.7 percent from the prior year three months ended December 31,2004. Revenue for the three and six months ended December 31, 2005 was lowerthan the prior year, primarily due to the combination of price pressure oncertain of our Power Components and capacity constraints in our Computing andCommunications segment. Capacity utilization remained above 95 percent for thethree months ended December 31, 2005.

 

Gross profit margin was 40.0 percent and 40.3 percent for the three andsix months ended December 31, 2005, respectively, compared to 43.3 percent and43.0 percent for the three and six months ended December 31, 2004, respectively.The gross profit margin decline reflected primarily price pressure on certainof our Power Components, sale of a lower-margin product mix, and profit sharingand employee stock option expense. In general, our wafer manufacturingfacilities serve all business units as necessary and their operating costs arereflected in the segments’ cost of revenue on the basis of product cost. Manufacturingoverhead and variances are specifically

 

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allocated to the segments as appropriate, and general overhead areallocated based on the percentage of total revenue.

 

Revenue as a percentage of total product revenue based on saleslocation were approximately 27 percent, 51 percent and 22 percent for UnitedStates, Asia and Europe, respectively, for the three months ended December 31,2005, and 28 percent, 50 percent and 22 percent for United States, Asia andEurope, respectively, for the six months ended December 31, 2005. Revenue as apercentage of total product revenue based on sales location were approximately31 percent, 46 percent and 23 percent for United States, Asia and Europe,respectively, for the three months ended December 31, 2004, and 31 percent, 46percent and 23 percent for United States, Asia and Europe, respectively, forthe six months ended December 31, 2004.

 

Focus Product revenue for the three months ended December 31, 2005 was$215.2 million (77.2 percent of revenue), compared to $218.8 million (73.3percent of revenue) for the three months ended December 31, 2004. Focus Productrevenue for the six months ended December 31, 2005 was $417.1 million (75.6percent of revenue), compared to $440.2 million (72.1 percent of revenue) forthe six months ended December 31, 2004. Non-Focus Product revenue for the threemonths ended December 31, 2005 was $63.6 million (22.8 percent of revenue),compared to $79.8 million (26.7 percent of revenue) for the three months endedDecember 31, 2004. Non-Focus Product revenue for the six months ended December31, 2005 was $134.3 million (24.4 percent of revenue), compared to $170.6million (27.9 percent of revenue) for the six months ended December 31, 2004. Currentperiod revenues were adversely affected by price pressure on certain of ourPower Components and capacity constraints in our C&C segment.

 

Gross profit margin for our Focus Products was 47.8 percent for thethree months ended December 31, 2005, compared to 50.7 percent for the threemonths ended December 31, 2004. Gross profit margin for our Non-Focus Productswas 13.5 percent for the three months ended December 31, 2005, compared to 23.3percent for the three months ended December 31, 2004. The gross profit margindecline across our Focus and Non-Focus Products reflected primarily pricedeclines on certain of our Power Components, sale of a lower-margin productmix, and profit sharing and employee stock option expense.

 

Total inventory increased by $15.3 million for the three months endedDecember 31, 2005 from September 30, 2005, of which $13.1 million was work-in-processand raw material inventory. The increase in work-in-process and raw materialinventory positions us to better support our growing backlog. Orders for thethree months ended December 31, 2005, increased by 17 percent from the priorthree months ended September 30, 2005, reflecting end-market demand forservers, appliances, digital TVs and game stations.

 

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Revenue and grossmargin by business segments for the three and six months ended December 31, 2005,are as follows (in thousands except percentages):

 
| ** **                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **December 31, 2005**  | ** ** | **December 31, 2004** | ** ** |
| **Business Segment**    | ** ** | **Revenue**                      | ** ** | **Percentage  of Total  Revenue** | ** ** | **Gross  Margin** | ** ** | **Revenue** | ** ** | **Percentage  of Total  Revenue** | ** ** | **Gross  Margin** | ** ** |
| Computing and Communications |       | $                                | 95,178     |   | 34.2 | % | 41.5 | % | $ | 101,843 |   | 34.1 | % | 44.7 | % |
| Energy-Saving Products       |       | 75,577                           |       | 27.1 |   | 47.9 |   | 74,210 |   | 24.9 |   | 55.3 |   |
| Aerospace and Defense        |       | 34,400                           |       | 12.3 |   | 50.0 |   | 32,183 |   | 10.8 |   | 42.6 |   |
| Intellectual Property        |       | 10,074                           |       | 3.6 |   | 100.0 |   | 10,537 |   | 3.5 |   | 100.0 |   |
|                         |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Subtotal Focus Products      |       | 215,229                          |       | 77.2 |   | 47.8 |   | 218,773 |   | 73.3 |   | 50.7 |   |
|                         |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Commodity Products           |       | 39,542                           |       | 14.2 |   | 16.6 |   | 52,482 |   | 17.6 |   | 26.6 |   |
| Non-Aligned Products         |       | 24,040                           |       | 8.6 |   | 8.5 |   | 27,305 |   | 9.1 |   | 16.9 |   |
| Subtotal Non-Focus Products  |       | 63,582                           |       | 22.8 |   | 13.5 |   | 79,787 |   | 26.7 |   | 23.3 |   |
|                         |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated total           |       | $                                | 278,811    |   | 100.0 | % | 40.0 | % | $ | 298,560 |   | 100.0 | % | 43.3 | % |

 
| ** **                   | ** ** | **Six Months Ended**  | ** ** |
|------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| **Business Segment**    | ** ** | **Revenue**                     | ** ** | **Percentage  of Total  Revenue** | ** ** | **Gross  Margin** | ** ** | **Revenue** | ** ** | **Percentage  of Total  Revenue** | ** ** | **Gross  Margin** | ** ** |
| Computing and Communications |       | $                               | 184,818    |   | 33.5 | % | 41.6 | % | $ | 207,835 |   | 34.0 | % | 44.2 | % |
| Energy-Saving Products       |       | 147,963                         |       | 26.8 |   | 50.1 |   | 147,360 |   | 24.1 |   | 54.5 |   |
| Aerospace and Defense        |       | 63,801                          |       | 11.6 |   | 47.1 |   | 64,460 |   | 10.6 |   | 41.9 |   |
| Intellectual Property        |       | 20,514                          |       | 3.7 |   | 100.0 |   | 20,556 |   | 3.4 |   | 100.0 |   |
| Subtotal Focus Products      |       | 417,096                         |       | 75.6 |   | 48.3 |   | 440,211 |   | 72.1 |   | 49.9 |   |
|                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Commodity Products           |       | 81,693                          |       | 14.8 |   | 18.0 |   | 112,007 |   | 18.3 |   | 28.9 |   |
| Non-Aligned Products         |       | 52,594                          |       | 9.6 |   | 11.8 |   | 58,568 |   | 9.6 |   | 18.3 |   |
| Subtotal Non-Focus Products  |       | 134,287                         |       | 24.4 |   | 15.6 |   | 170,575 |   | 27.9 |   | 25.3 |   |
|                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated total           |       | $                               | 551,383    |   | 100.0 | % | 40.3 | % | $ | 610,786 |   | 100.0 | % | 43.0 | % |

 

*Computingand Communications (“C&C”)*

 

Our Computing and Communication segment is comprised of our PowerManagement ICs, Advanced Circuit Devices, including iPowirTMmulti-chip modules and DirectFETTM solutions, and Power Components(primarily MOSFET Power Components) that address servers and high-end desktops,notebooks, communications networking, and digitally-oriented consumer productslike game consoles. Our C&C products are also used in digital television, liquidcrystal displays (“LCDs”), portable handheld devices and cellular phones.

 

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C&C revenue for the three months ended December 31, 2005, declinedby $6.7 million (6.5 percent), compared to the three months ended December 31,2004. C&C revenue for the six months ended December 31, 2005, declined by$23.0 million (11.1 percent) compared to the six months ended December 31, 2004.The revenue decline primarily reflected price pressures on certain of our MOSFETPower Components and product mix. Additionally, C&C revenue wasinhibited by capacity constraints. We started production on our new eight-inch sub-micron wafer fabricationfacility in Newport, Wales in the December 2005 quarter to help addressour capacity limitations.

 

Gross margin for C&C was 41.5 percent and 44.7 percent for thethree months ended December 31, 2005 and 2004, respectively, and 41.6 percentand 44.2 percent for the six months ended December 31, 2005 and 2004,respectively. The gross margin decline reflected primarily profit sharing andemployee stock options expense and some price declines on our MOSFET PowerComponents.

 

In the March 2006quarter, we expect C&C revenue to reflect end-market demand for servers,dual-core notebook platforms and new consumer programs including game stations.

 

*Energy-Saving Products (“ESP”)*

 

Our Energy-Saving Product segment is comprised of our Power ManagementICs, Advanced Circuit Devices and Power Components (primarily HEXFET and IGBTPower Components) that provide solutions for variable speed motion control inenergy-saving appliances (such as washing machines, refrigerators and airconditioners), and industrial systems (such as fans, pumps and compressors),advanced lighting products (including fluorescent lamps, high intensitydischarge (“HID”) lamps, cold cathode fluorescent (“CCFL”) tubes and lightemitting diodes (“LED”) lighting), advanced automotive solutions (primarilydiesel injection, electric-gasoline hybrid and electric power steeringsystems), and consumer applications (for example, plasma TVs and digital-audiounits).

 

ESP revenue for the three months ended December 31, 2005, increased by$1.4 million (1.8 percent) compared to the three months ended December 31, 2004.ESP revenue for the six months ended December 31, 2005, increased by $0.6million (0.4 percent) compared to the six months ended December 31, 2004. Therevenue increase was primarily attributable to higher sales of our PowerManagement ICs, partially offset by a decline in our Power Component business.

 

Gross margin for ESP was 47.9 percent and 55.3 percent for the threemonths ended December 31, 2005 and 2004, respectively, and 50.1 percent and54.5 percent for the six months ended December 31, 2005 and 2004, respectively.The gross margin decline primarily reflected price declines on our automotivePower Components, sale of a lower-margin product mix, and profit sharing andemployee stock options expense. In addition, gross margin was impacted by thecost associated with the ramp of our Newport, Wales facility.

 

In the March 2006quarter, we expect end-market demand for energy-efficient appliances to bestrong with the start of the new model year.

 

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*Aerospace and Defense (“A&D”)*

 

The Aerospace and Defense segment is comprised of advanced powermanagement solutions, such as radiation-hardened power management modules,radiation-hardened Power Components, and other high-reliability PowerComponents that address power management requirements in satellites, launchvehicles, aircrafts, ships, submarines and other defense and high-reliabilityapplications.

 

A&Drevenue for the three months ended December 31, 2005, increased by $2.2 million(6.9 percent) from the three months ended December 31, 2004. Revenue for thesix months ended December 31, 2005, declined by $0.7 million (1.0 percent) fromthe six months ended December 31, 2004. The A&D revenue increase for thethree months ended primarily reflected a delayed shipment from the prior September2005 quarter.

 

Gross margin for the A&D segment increased to 50.0 percent for thethree months ended December 31, 2005, from 42.6 percent in the three monthsended December 31, 2004, and to 47.1 percent for the six months ended December31, 2005, from 41.9 percent for the six months ended December 31, 2004. Thegross margin improvement reflected primarily sale of a higher-margin productmix, manufacturing efficiencies and restructuring cost savings, partiallyoffset by profit sharing and employee stock option expense.

 

In the March 2006quarter, we expect an increase in A&D revenue mainly due to seasonalincreases in demand for certain military programs.

 

*Intellectual Property (“IP”)*

 

**The Intellectual Property segment reports ourroyalty income from licensing our intellectual property to third parties, whichmay include claims settlement from successful defense of our licenses. Ourlicensed MOSFET patents expire between 2005 and 2010, with the broadestremaining 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 revenue was $10.1 million and $10.5 million forthe three months ended December 31, 2005 and 2004, respectively, and $20.5million and $20.6 million for the six months ended December 31, 2005 and 2004,respectively.**

** **

*Commodity Products (“CP”)*

 

The Commodity Product segment is comprised primarily ofolder-generation Power Components that are sold with margins generally belowour strategic targets and are typically commodity in nature. These productshave widespread use throughout the power management product industry and areoften complementary to many of our Focus Products offerings or allow us toprovide a full range of customer or application offerings. We often offer theseproducts to take advantage of cross-selling opportunities with our otherproduct families.

 

For the three months ended December 31, 2005, CP revenue was $39.5 million,down 24.7 percent from $52.5 million for the three months ended December 31,2004. For the six months ended December 31, 2005, CP revenue was $81.7 million,down 27.1

 

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percent from $112.0 million for the six months ended December 31, 2004.In line with our strategy, we continue to manage our exposure to CommodityProducts.

 

Gross margin for CP was 16.6 percent and 26.6 percent for the threemonths ended December 31, 2005 and 2004, respectively, and 18.0 percent and28.9 percent for the six months ended December 31, 2005 and 2004, respectively.The gross margin decline reflected primarily price pressures, profit sharingand employee stock option expense.

 

*Non-Aligned Products (“NAP”)*

 

**The Non-Aligned Product segment includes businesses,product lines or products that we are targeting for realignment, whether bydivestiture or otherwise. We plan to support our Non-Aligned Products to theextent we believe appropriate, to manage, maintain or increase their value. Currently,product lines reported in this segment include certain modules, rectifiers,diodes and thyristors used in the automotive, industrial, welding and motorcontrol applications.**

** **

**Non-Aligned Product revenue was $24.0 million in thethree months ended December 31, 2005, decreasing 12.0 percent from $27.3million in the three months ended December 31, 2004, and $52.6 million in thesix months ended December 31, 2005, decreasing 10.2 percent from $58.6 millionin the six months ended December 31, 2004. The revenue decline primarilyreflected reduced production due in part to component shortages and productmix.**

** **

Gross margin for our NAP segment was 8.5 percent and 16.9 percent forthe three months ended December 31, 2005 and 2004, respectively, and 11.8percent and 18.3 percent for the six months ended December 31, 2005 and 2004,respectively, reflecting primarily sale of a lower-margin****productmix.

 

Selling and Administrative Expense

 

For the three and six months ended December 31, 2005, selling andadministrative expense was $46.1 million (16.5 percent of revenue) and $91.3million (16.6 percent of revenue), compared to $40.9 million (13.7 percent ofrevenue) and $87.3 million (14.3 percent of revenue) for the three and sixmonths ended December 31, 2004, respectively. Selling and administrativeexpense increased primarily reflecting profit sharing and employee stockoptions expense in the current year. In addition, we also increased spending onemployee benefits, Sarbanes-Oxley Rule 404 compliance, customer, intellectualproperty and claims support in the current three and six months ended December31, 2005, as compared to the comparable prior year periods. The selling andadministrative expense ratio increased primarily reflecting a lower revenuebase in the current year.

 

Research and Development Expenses

 

For the three and six months ended December 31, 2005, research anddevelopment expense was $27.2 million (9.8 percent of revenue) and $52.5million (9.5 percent of revenue), respectively, compared to $27.7 million (9.3percent of revenue) and $53.0 million (8.7 percent of revenue), for the threeand six months ended December 31,

 

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2004, respectively.Research and development expense primarily reflected our continued developmentactivities on our Focus Products.

 

Impairment of Assets, Restructuring and Severance

 

During fiscal 2003 second quarter ended December 31, 2002, we announcedour restructuring initiatives. Under our restructuring initiatives, our goalwas to reposition us to better fit the market conditions and de-emphasize thecommodity business. Our restructuring plan included consolidating and closingcertain manufacturing sites, upgrading equipment and processes in designatedfacilities and discontinuing production in a number of others that cannotsupport more advanced technology platforms or products. We also planned tolower overhead costs across our support organizations. We have substantiallycompleted these restructuring activities as of December 31, 2005. We expect tocomplete the remaining activities, primarily the closing of a fabrication lineat El Segundo, California by fiscal year end 2006.

 

We estimate that total charges associated with the restructuring willbe approximately $273 million. These charges will consist of approximately $218million for asset impairment, plant closure costs and other charges, $6 millionof raw material and work-in-process inventory, and approximately $49 millionfor severance. Of the $273 million in total charges, we expect cash charges tobe approximately $110 million. As ofDecember 31, 2005, we have realized annualized savings of approximately $80million from the restructuring activities, with approximately 70 percent ofthat savings affecting cost of goods sold.

 

For the three months ended December 31, 2005, we recorded$3.1 million in total restructuring-related charges, consisting of: $2.1million for plant closure costs and relocation costs and other impaired assetcharges, and $1.0 million for severance-related costs. For the six months endedDecember 31, 2005, we recorded $7.4 million in total restructuring relatedcharges, consisting of: $5.1 million for plant closure and relocation costs andother impaired assets charges and $2.3 million for severance costs. For thethree months ended December 31, 2004, we recorded $6.8 million in total restructuring-related charges, consisting of: $5.6million for plant closure and relocation costs and other impaired assetcharges, and $1.2 million for severance-related costs. For the six months endedDecember 31, 2004, we recorded $13.5 million in total restructuring-relatedcharges consisting of: $10.5 million for plant closure and relocation costs andother impaired assets charges, and $3.0 million for severance costs.

 

Restructuring-related costs were measured in accordancewith SFAS No. 146, “Accounting for the Costs Associated with Exit or DisposalActivities”. Asset impairments were calculated in accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets”. Indetermining the asset groups, we grouped assets at the lowest level for whichindependent identifiable cash flows information was available. In determiningwhether an asset was impaired we evaluated undiscounted future cash flows andother factors such as changes in strategy and technology. The undiscounted cashflows from our initial analyses were less than the carrying amount for certainof the asset groups, indicating impairment losses. Based on this, we determinedthe fair value of these asset groups using the present value technique, byapplying a discount rate to the estimated future cash flows that is consistentwith the rate used when analyzing potential acquisitions.

 

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As of December 31, 2005, we had recorded $268.7 million intotal charges, consisting of: $215.2 million for asset impairment, plantclosure costs and other charges, $6.0 million for raw material andwork-in-process inventory charges, and $47.5 million for severance-relatedcosts. Components of the $215.2 million asset impairment, plant closure andother charges included the following items:

 

•                  As we emphasize more advanced generation planar products,we expect the future revenue stream from our less advanced facilities inTemecula, California to decrease significantly. These facilities had a net bookvalue of $138.3 million and were written down by $77.7 million. It is expectedthat these facilities will continue in use until approximately December 2007and the remaining basis is being depreciated over units of production duringthis period. It is assumed that salvage value will equal disposition costs.

 

•                  As we emphasize more advanced generation trench products,we expect the future revenue stream from our less advanced facility in ElSegundo, California to decrease significantly. This facility had a net bookvalue of $59.5 million and was written down by $57.2 million. This facility hadsignificantly reduced production as of fiscal year ended June 30, 2003, and isbeing used primarily for research and development activities.

 

•                  As we emphasize more advanced generation Schottky products,we expect the future revenue stream from our less advanced 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 thisfacility will continue in use until approximately December 2007 and theremaining basis is being depreciated over units of production during thisperiod. It is assumed that salvage value will equal disposition costs.

 

•                  We are restructuring our manufacturing activities in Europe.Based on a review of our Swansea, Wales facility, a general-purpose modulefacility, we determined in the December 2002 quarter that this facility wouldbe better suited to focus only on automotive applications. The general-purposeassembly assets in this facility, with a net book value of $13.6 million, werewritten down by $8.2 million. In addition, we have completed the move of ourmanufacturing activities at our automotive facility in Krefeld, Germany to ourSwansea, Wales and Tijuana, Mexico facilities as of September 30, 2005. We havealso moved the production from our Venaria, Italy facility to our Borgaro, Italyand Mumbai, India facilities, which was completed as of December 31, 2003. Westopped manufacturing activities in our Oxted, England facility as of September30, 2003.

 

•                  We have eliminated the manufacturing of our non-spacemilitary products in our Santa Clara, California facility as of July 31, 2004.Currently, subcontractors handle our non-space qualified products formerlymanufactured in this facility. We have also transitioned the assembly and testof non-space Power Components from our Leominster, Massachusetts facility toour Tijuana, Mexico facility as of December 31, 2005. Associated with thisreduction 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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•                  $56.6 million in other miscellaneous items were charged,including $47.8 million in relocation costs and other impaired asset chargesand $8.8 million in contract termination and settlement 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 thesefactors we wrote down these inventories, with a carrying value of $98.2million, by $6.0 million. We disposed of $1.1 million and $0.2 million of theseinventories, for the three and six months ended December 31, 2005 and 2004,respectively, of these inventories, which did not materially impact grossmargin. As of December 31, 2005, $0.1 million of these inventories remained tobe disposed.

 

Our restructuring activities are expected to result in severancecharges of approximately $49 million through June 2006. Below is a table ofapproximate severance charges 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                                    |       | 15 million |       |
|                                                   |       |                                                          |       |       |       |
| Total                                                  |       |                                                          |       | $          | 49 million |   |

 

To date, of the $49 million noted above, we have recorded $47.5 millionin severance-related charges: $42.4 million in severance termination costsrelated to approximately 1,200 administrative, operating and manufacturingpositions, and $5.1 million in pension termination costs at our manufacturingfacility in Oxted, England. The severance charges associated with theelimination of positions, which included the 1,200 persons notified to date,had been and will continue to be recognized over the future service period, asapplicable, in accordance with SFAS No. 146, “Accounting for the CostsAssociated with Exit or Disposal Activities”. We measured the total terminationbenefits at the communication date based on the fair value of the liability asof the termination date. A change resulting from a revision to either thetiming or the amount of estimated cash over the future service period will bemeasured using the credit-adjusted risk-free rate that was used to initiallymeasure the liability. The cumulative effect of the change will be recognizedas an adjustment to the liability in the period of the change.

 

In fiscal 2002, we had recorded an estimated $5.1 million in severancecosts associated with the acquisition of TechnoFusion GmbH in Krefeld, Germany.In fiscal 2003, we finalized our plan and determined that total severance wouldbe approximately $10 million, and accordingly, we adjusted purchased goodwillby $4.8 million. We communicated the plan and the elimination of approximately250 positions primarily in manufacturing to our affected employees at that time.We have completed the restructuring of our Krefeld facility as of December 31,2005, and determined that $0.7

 

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million of the severancereserve was excess. Accordingly, we decreased TechnoFusion purchased goodwillby $0.7 million.

 

The following summarizes our accrued severanceliability related to the June 2001 restructuring, the TechnoFusion acquisitionand the December 2002 restructuring plan for the three months ended December31, 2005 and the fiscal year ended June 30, 2005. Severance activity related tothe elimination of 29 administrative and operating personnel as part of thepreviously reported restructuring in the fiscal quarter ended June 30, 2001, isalso 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”         |       | —                        |       | 2,245                             |       | —                                 |       | 2,245                           |       |
| Purchase price adjustment                                                                           |       | —                        |       | —                            |       | (708                                   | )          | (708                            | )          |
| Costs paid                                                                                          |       | (90                           | )          | (3,858                            | )          | (684                                   | )          | (4,632                          | )          |
| Foreign exchange impact                                                                             |       | —                        |       | (14                               | )          | (40                                    | )          | (54                             | )          |
| Accrued severance, December 31, 2005                                                                |       | $                             | 281        |                              | $          | 6,497                                  |       | $                               | 675        |   | $ | 7,453 |   |

 

Other Income and Expenses

 

Other expense was $1.1 million and $0.7 million for the three monthsended December 31, 2005 and 2004, respectively, and $1.2 million and $0.7million for the six months ended December 31, 2005 and 2004, respectively.

 

Interest Income and Expenses

 

Interest incomewas $7.8 million and $3.8 million for the three months ended December 31, 2005and 2004, respectively, and $14.9 million and $7.2 million for the six monthsended December 31, 2005 and 2004, respectively, reflecting higher prevailinginterest rates on higher average cash and cash investment balance in thecurrent year.

 

Interest expense was $7.0 million and $4.5 million for the three monthsended December 31, 2005 and 2004, respectively, and $12.6 million and $9.6million for the six months ended December 31, 2005 and 2004, respectively,primarily reflecting higher effective interest rate payable on our $550 millionconvertible subordinated notes outstanding, partially offset by higher incomefrom the mark-to-market adjustments on our interest rate swaps (see Notes 4, “DerivativeFinancial Instruments” and 9, “Bank

 

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Loans and Long-Term Debt” of the Notes to the unaudited consolidatedfinancial statements, regarding the modification of the effective interestpayable on our convertible notes).

 

Income Taxes

 

Our effective tax provision for the three months endedDecember 31, 2005 and 2004 was 27.5 percent and 22.8 percent, respectively, and27.5 percent and 25.2 for the six months ended December 31, 2005 and 2004,respectively, rather than the U.S. federal statutory tax provision of 35 percent,as a result of lower statutory tax rates in certain foreign jurisdictions, thebenefit of foreign tax credits and research and development credits, partiallyoffset by state taxes and certain foreign losses without foreign tax benefits.

 

In December 2004, the FASBissued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance forthe Foreign Earnings Repatriation Provision within the American Jobs CreationsAct of 2004”, which introduces a limited time 85 percent dividends receiveddeduction on the repatriation of certain foreign earnings to a U.S. tax payer (“repatriationprovision”), provided certain criteria are met. 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 December 31, 2005, we had cash and cash equivalent balances of$273.7 million and cash investments in marketable debt securities of $644.7million. We also have $143.9 million in unused credit facilities. Ourinvestment portfolio consists of available-for-sale fixed-income, principallyinvestment-grade securities as of December 31, 2005.

 

For the six months ended December 31, 2005, cash provided by operatingactivities was $48.4 million compared to $99.2 million in the comparable prioryear six months ended December 31, 2004. Cash flows from operating activities decreased by $4.3 million for thesix months ended, reflecting the proper classification of the excess taxbenefits from options exercised from an operating to a financing activity (seeNote 1, “Certain Accounting Policies”). Depreciation and amortizationadjusted cash flows from operations by $42.9 million. Changes in operatingassets and liabilities decreased cash by $56.7 million during the six monthsended December 31, 2005. The increase in working capital reflected the increasein our inventory balance as a result of the build up of inventory to supportour backlog, the timing of accounts and other receivable collections, taxes andother accrued expense payments.

 

For the six months ended December 31, 2005,cash used in investing activities was $145.3 million. We purchased $300.9million and sold $233.1 million of cash investments. Certain prior year’samounts have been reclassified to conform to the current-year presentation. Auctionrate securities are now classified as available-for-sale securities andreported as short-term cash investments instead of cash and cash equivalents,for all periods presented. For the six months ended December 31, 2004, proceedsfrom the sale of auction rate securities reduced net cash used in investingactivities by $74.1 million.

 

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During the six months ended December 31, 2005, we spent $76.0 millionin capital expenditures, of which $27.1 million was at the Newport, Walesfacility. As of December 31, 2005, demand for our Focus Products exceeded ourworldwide capacity. To help address our capacity limitations, we startedproduction at our new facility in Newport, Wales in the December 2005 quarter. Purchaseorder commitments for capital expenditures were $31.7 million as of December31, 2005. We intend to fund capital expenditures and working capitalrequirements through cash and cash equivalents on hand, anticipated cash flowsfrom operations and available credit facilities.

 

Financing activities for the six months ended December 31, 2005provided $7.6 million. Cash flows from financing activities increased by $4.3million for the six months ended, reflecting the proper classification of theexcess tax benefits from options exercised a financing activity (see Note 1, “CertainAccounting Policies”). Proceeds from the exercise of employee stock options andstock participation plan contributed $24.5 million while repayments ofshort-term debt decreased cash by $15.3 million. As of December 31, 2005, wehad revolving, equipment and foreign credit facilities of $166.6 million,against which $22.6 million had been used. As discussed in Note 4 of theunaudited consolidated financial statements, we are required to obtainirrevocable standby letters of credit in favor of JP Morgan Chase Bank, for$7.5 million plus the collateral requirement for the interest rate swaptransactions, as determined periodically. At December 31, 2005, $17.0 millionin letters of credit were outstanding related to the transactions. Thecollateral requirement of the transactions may be adversely affected by anincrease in the five-year LIBOR curve, a decrease 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 potentialimpact, had a 10 percent increase in the five-year LIBOR curve and a 10 percentdecrease in our stock price occurred at the close of the fiscal quarter endedDecember 31, 2005, our letter of credit commitment would have increased by $3.8million to $20.8 million. We do not have any off-balance sheet arrangements asof December 31, 2005.

 

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. Any shares repurchasedwill be paid with our existing cash and cash investments. As of December 31,2005, we have not repurchased any shares.

 

Our $550million convertible subordinated notes are due in July 2007. We anticipate thatthese notes will be refinanced through public or private offerings of debt orequity, or be paid down with our existing cash and cash investments.

 

We believethat our current cash and cash investment balances, cash flows from operationsand borrowing capacity, including unused amounts under the $150 million CreditFacility as discussed in Note 9 of the unaudited consolidated financialstatements, will be sufficient to meet our operations in the next twelvemonths. Although we believe that our current financial resources will besufficient for normal operating activities, we may also consider the use offunds from other external sources, including, but not limited to, public orprivate offerings of debt or equity.

 

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**Recent Accounting Pronouncements**

 

In November2005, the Financial Accounting Standards Board (“FASB”) issued FASB StaffPosition (“FSP”) on Statement of Financial Accounting Standard (“SFAS”) No.115-1 and SFAS No. 124-1, “The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments” (“FSP FAS No. 115-1”), which providesguidance on determining when investments in certain debt and equity securitiesare considered impaired, whether that impairment is other-than-temporary, andon measuring such impairment loss.  FSP FAS No. 115-1 also includesaccounting considerations subsequent to the recognition of another-than-temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments.  FSP FAS No. 115-1 is effective for reporting periodsbeginning after December 15, 2005.  Our adoption of FSP FAS No. 115-1 willnot have a material impact on our results of operations or financial condition.

 

On October 18,2005, the FASB issued FASB Staff Position on SFAS No. 123(R)-2 (“FSP FAS No.123(R)-2”). FSP FAS No. 123(R)-2 provides guidance on the application ofgrant date as defined in SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”).As a practical accommodation, in determining the grant date of an award,assuming all other criteria in the grant date definition have been met, FSP FASNo. 123(R)-2 provides that a mutual understanding of the key terms andconditions of an award to an individual employee shall be presumed to exist atthe date the award is approved in accordance with the relevant corporategovernance requirements (that is, by the Board or management with the relevantauthority) if both of the following conditions are met:

 

a. The awardis a unilateral grant and, therefore, the recipient does not have the abilityto negotiate the key terms and conditions of the award with the employer.

 

b.The key terms and conditions of the award are expected to be communicated to anindividual recipient within a relatively short time period(1)fromthe date of approval.

 

The guidancein FSP FAS No. 123(R)-2 is effective upon initial adoption of SFAS No. 123(R)or if an entity has adopted SFAS No. 123(R) prior to the issuance of this FSPand did not apply the provisions of FSP FAS No. 123(R)-2, this FSP will beeffective in the first reporting period after October 18, 2005, the date theFSP was posted to the FASB website. We have applied the provisions under FSPFAS No. 123(R)-2 in accounting for our equity awards as of July 4, 2005, thestart of our fiscal year 2006.

 

**Critical Accounting Estimates**

 

The consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States whichrequire us to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the consolidated financial statementsand revenues and expenses during the periods reported. Actual results coulddiffer from those estimates. Information with respect to our criticalaccounting policies which we believe could have the most significant effect onour reported results and require subjective or complex judgments is containedin Item 7, Management’s Discussion and Analysis of Financial Condition and 

 

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Results of Operations, of our Annual Report on Form 10-K for thefiscal year ended June 30, 2005.

 

Effective in the first fiscal quarter ended September 30, 2005, in July2005, we adopted the provisions of Statement of Financial Accounting StandardsNo. 123 “Share-Based Payment” (“SFAS No. 123R”) to account forstock-based compensation. Under SFAS No. 123R, we estimate the fair valueof stock options granted using the Black-Scholes option pricing model. The fairvalue for awards that are expected to vest is then amortized on a straight-linebasis over the requisite service period of the award, which is generally theoption vesting term. The amount of expense attributed is based on estimatedforfeiture rate, which is revised as information is updated. This optionpricing model requires the input of highly subjective assumptions, includingthe expected volatility of our common stock and an option’s expected life. Thefinancial statements include amounts that are based on our best estimates andjudgments.

 

**Statementof Caution Under the Private Securities Litigation Reform Act of 1995**

 

This Quarterly 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 of 1995.The materials presented can be identified by the use of forward-lookingterminology such as “anticipate,” “believe,” “estimate,” “expect,” “may,” “should,”“view,” or “will” or the negative or other variations thereof. We caution thatsuch statements are subject to a number of uncertainties, and actual resultsmay differ materially. Factors that could affect our actual results includethose set forth below under Part II, Item 1A, “Risk Factors” and otheruncertainties disclosed in our reports filed from time to time with theSecurities and Exchange Commission. Unless required by law, we undertake noobligation to publicly update or revise any forward looking statements, toreflect new information, future events or otherwise.

 

**ITEM 3.****     Quantitative andQualitative Disclosures about Market Risk**

 

We are exposed to various risks, including fluctuations in interest andforeign currency rates. In the normal course of business, we also face risksthat are either non-financial or non-quantifiable. Such risks principallyinclude country risk, credit risk and legal risk and are not discussed orquantified in the following analyses, as well as risks set forth under the heading“Factors that May Affect Future Results” in this Quarterly Report on Form 10-Qand in our Annual Report on Form 10-K for the fiscal year ended June 30, 2005.

 

*Interest Rate Risk*

 

Our financial assets and liabilities subject to interest rate risk arecash investments, convertible debt, credit facilities and interest rate swaps. Ourprimary objective is to preserve principal while maximizing yield withoutsignificantly increasing risk. At December 31, 2005, we evaluated the effectthat near-term changes in interest rates would have had on these transactions. Achange of as much as ten percent in the London InterBank Offered Rate (“LIBOR”)would have had a favorable impact of 

 

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approximately $0.3 million and $0.7 million on net interestincome/expense for the three and six months ended December 31, 2005, since theinterest income on our cash and cash investments would have outweighedadditional interest expense on our outstanding debt.  For our interestrate contract with Lehman Brothers, an increase of ten percent in interestrates would have had a favorable impact of $0.6 million, and a decrease of tenpercent in interest rates would have had an adverse impact 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, weentered 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 9, “Bank Loansand Long-Term Debt”). At the inception of the Transaction, interest rates werelower than that of the Debt and we believed that interest rates would remainlower for an extended period of time. In April 2004, we entered into aninterest rate swap transaction (the “April 2004 Transaction”) with the Bank tomodify the effective interest payable with respect to the remaining $137.5million of the Debt. The variable interest rate we have paid since theinception of the swap has averaged 2.68 percent, compared to a coupon of 4.25percent on the Debt. For the three months ended December 31, 2005 and 2004,this arrangement increased (decreased) interest expense by $0.8 million and($2.5) million, respectively, and ($0.1) million and ($4.7) million for the sixmonths ended December 31, 2005 and 2004, 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 ofthe hedge relationship, we used a regression analysis. To evaluate therelationship of the fair value of the two transactions and the changes in fairvalue of the Debt attributable to changes in the benchmark rate, we discountedthe estimated cash flows by the LIBOR swap rate that corresponds to the Debt’sexpected maturity date. In addition, our ability to call the Debt wasconsidered in assessing the effectiveness of the hedging relationship. Forthose years that were projected to include at least a portion of redemption ofthe convertible debentures, we employed a valuation model known as a MonteCarlo simulation. This simulation allowed us to project probability-weightedcontractual cash flows discounted at the LIBOR swap rate that corresponded tothe Debt’s expected maturity date. The market value of the December 2001Transaction was a liability of $5.8 million and $0.3 million at December 31,2005 and June 30, 2005, respectively. The market value of the April 2004Transaction was a liability of $4.7 million and $3.4 million at December 31,2005 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 of the Contract is $412.0 million,representing approximately 75 percent of the Debt. Under the terms of theContract, we have the option to receive a payout from Lehman covering ourexposure to LIBOR fluctuations between 5.5 percent and 7.5 percent for any fourdesignated quarters. The market value of the Contract at December 31, 2005 andJune 30, 2005, respectively, was $0.2 million and $0.1 million, respectively,and was included in other long-term assets. Mark-to-market (losses) gains of ($0.05)million and ($0.3) million for the three months ended December 31, 2005 and2004, respectively, and $0.1 million and ($0.6) million, for the 

 

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six months endedDecember 31, 2005 and 2004, respectively, were charged to interest expense.

 

*Foreign Currency Risk*

 

We conduct business on a global basis in several foreign currencies andhave currency exposure related primarily to the British Pound Sterling, theEuro and the Japanese Yen. Considering our foreign currency risks, we have thegreatest exposure to the Japanese Yen, since we have significant Yen-basedrevenue without the Yen-based manufacturing costs. The risk of our revenues inthe European currencies is partially offset by the cost of manufacturing goodsin the European currencies.

 

We have established a foreign-currency hedging program using foreignexchange forward contracts, including the Forward Contract described below, tohedge certain foreign currency transaction exposures. To protect againstreductions in value and volatility of future cash flows caused by changes incurrency exchange rates, we have established revenue, expense and balance sheethedging programs. Currency forward contracts and local Yen and Euro borrowingsare used in these hedging programs. Our hedging programs reduce, but do notalways eliminate, the impact of currency exchange rate movements. We consideredan adverse near-term change in exchange rates of ten percent for the BritishPound Sterling, the Euro and the Japanese Yen. 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 and six months ended December 31, 2005 and 2004.

 

InMarch 2001, we entered 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 havedesignated the Forward Contract as a cash flow hedge under which mark-to-marketadjustments are recorded in accumulated other comprehensive income ofstockholders’ equity, until the forecasted transactions are recorded inearnings. Under the terms of the Forward Contract, we are required to exchange1.2 billion Yen for $11.0 million on a quarterly basis from June 2001 to March2006. At December 31, 2005, one quarterly payment of 1.2 billion Yen remainedto be swapped at a forward exchange rate of 109.32 Yen per U.S. dollar. Themarket value of the forward contract was $0.7 million and $0.1 million atDecember 31, 2005 and June 30, 2005, respectively, and was included in otherlong-term assets. Mark-to-market gains (losses), included in other comprehensiveincome, net of tax, were $0.1 million and ($2.9) million for the three monthsended December 31, 2005 and 2004, respectively, and $0.4 million and ($2.1)million for the six months ended December 31, 2005 and 2004, respectively. AtDecember 31, 2005, based on effectiveness tests comparing forecastedtransactions through the Forward Contract expiration date to its cash flowrequirements, we do not expect to incur a material charge to income during thenext three months through its maturity.

 

We had approximately $109.6 million and $75.9 million in notionalamounts of forward contracts not designated as accounting hedges under SFAS No.133 at December 31, 2005 and June 30, 2005, respectively. Net realized andunrealized foreign-currency gains recognized in earnings were less than $1million for the three and six months ended December 31, 2005 and 2004.

 

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**ITEM 4.****     CONTROLS AND PROCEDURES**

 

(a)          Evaluationof disclosure controls and procedures

 

The term “disclosure controls and procedures” refers to the controlsand other procedures of a company that are designed to ensure that informationrequired to be disclosed by the company in the reports that it files under theSecurities Exchange Act of 1934 (“Exchange Act”) is recorded, processed,summarized and reported, within required time periods. Our management, with theparticipation of our Chief Executive Officer, Alexander Lidow, and ChiefFinancial Officer, Michael P. McGee, carried out an evaluation of the effectivenessof our disclosure controls and procedures pursuant to Exchange Act Rule13a-15(b).

 

In our Quarterly Reports on Form 10-Q for the fiscal quarter endedDecember 31, 2005, previously filed on February 10, 2006, we originallyreported that our disclosure controls and procedures were effective as of eachof December 31, 2005. As further discussed in Note 1 to the Company’sconsolidated financial statements included in Item 1 of this Quarterly Report, wehave restated the financial statements, specifically the statement of cashflows, included in this Form 10-Q/A to reflect the amended correctclassification of the excess tax benefits from stock options exercised as cashflows from financing activities rather than operating activities for the sixmonths ended December 31, 2005. In light of the restatement, we have reassessedthe effectiveness of our disclosure controls and procedures as of December 31,2005 and have concluded that our disclosure controls and procedures were noteffective, at the reasonable assurance level, as of December 31, 2005 due tothe material weakness discussed below.

 

Disclosure controls and procedures, no matter how well designed andimplemented, can provide only reasonable assurance of achieving an entity’sdisclosure objectives. The likelihood of achieving such objectives is affectedby limitations inherent in disclosure controls and procedures. These includethe fact that human judgment in decision-making can be faulty and thatbreakdowns in internal control can occur because of human failures such assimple errors, mistakes or intentional circumvention of the establishedprocesses.

 

(b)         Materialweakness in internal control over financial reporting

 

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A material weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected.

 

As of December 31, 2005, we did not maintain effective controls overthe preparation, review and presentation of our consolidated statements of cashflows. Specifically, the controls were not effective to ensure that cash flowsfrom the excess tax benefits from stock option exercised were presented as cashflows from financing activities in the consolidated statements of cash flows inaccordance with generally accepted accounting principles. This controldeficiency resulted in the restatement of our interim consolidated financialstatements for the first and second quarter of fiscal 2006. In addition, thiscontrol deficiency could result in a misstatement of our cash flows fromoperating activities and cash flows from financing activities that would resultin a material misstatement to our annual or interim consolidated statements ofcash flows that would not be prevented or detected. Accordingly, we havedetermined that this control deficiency constitutes a material weakness. 

 

Plan for remediation of material weakness

 

During the fourth quarter of fiscal 2006, we are implementing enhancedprocedures and controls which include improved training and review processes toensure proper preparation, review, presentation and disclosure of amountsincluded in our consolidated statement of cash flows.

 

(c)          Changesin internal controls

 

There was no change in our internal controls during the fiscal secondquarter 2006 that has materially affected, or are reasonably likely tomaterially affect, our internal controls over financial reporting.

 

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### **PARTII.**                                                OTHERINFORMATION

 

**ITEM 1A.****                                            RiskFactors**

 

***Changes inend-market demand or downturns in the highly cyclical semiconductor industrycould affect our operating results and the value of our business.***

 

We may experience significant changes in our profitability as a resultof variations in sales, changes in product mix sought by customers,seasonality, price competition for orders and the costs associated with theintroduction of new products and start-up of new facilities and additionalcapacity lines. The markets for our products depend on continued demand withthe product technological platforms and in the mix we plan for and produce inthe information technology, consumer, industrial, aerospace and defense and automotivemarkets. Changes in the demand mix, needed technologies and these end marketsmay adversely affect our ability to match our products, inventory and capacityto meet customer demand and could adversely affect our operating results andfinancial condition.

 

In addition, the semiconductor industry is highly cyclical and thevalue of our business may decline during the down portion of these cycles. Wehave experienced these conditions in our business in the recent past and wecannot predict when we may experience such downturns in the future. Futuredownturns in the semiconductor industry, or any failure of the industry torecover fully from its recent downturns could seriously impact our revenue andharm our business, financial condition and results of operations. Althoughmarkets for our semiconductors appear stable, we cannot assure you that theywill continue to be stable or that our markets will not experience renewed,possibly more severe and prolonged, downturns in the future.

 

***Consumer and/orcorporate spending for the end-market applications which incorporate ourproducts may be reduced due to increased oil prices or otherwise.***

 

Our revenue and gross margin guidance is dependent on a certain levelof consumer and/or corporate spending for the specific mix of products weproduce and have the capacity to produce. If our projections of theseexpenditures fail to materialize, or materialize in a mix different from thatfor which we anticipate and build inventory, whether due to reduced consumer orcorporate spending from increased oil prices or otherwise, our revenue andgross margin could be adversely impacted.

 

***We maintain backlogof customer orders that is subject to cancellation, reduction or delay indelivery schedules, which may result in lower than expected revenue.***

 

With certain exceptions related to products within our Aerospace andDefense and Non-Aligned Product segments, we manufacture primarily pursuant topurchase orders for current delivery or to forecast, rather than pursuant tolong-term supply contracts. The semiconductor industry is subject to rapidchanges in customer outlooks or unexpected build ups of inventory in the supplychannel as a result of shifts in end-market demand generally or in the mix ofthat demand. Accordingly, many of these purchase orders or forecasts may berevised or canceled without penalty. As a result, we must commit resources tothe manufacturing of products, and a specific mix of products, without anyadvance purchase commitments from customers. Our inability to sell productsafter we devote significant resources to build them could have a materialadverse effect on our 

 

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levels of inventory (the value of our inventory), our revenue and ouroperating results generally.

 

***We build andmaintain inventory in order to meet our historic and projected needs, butcannot guarantee that our inventory will be adequate to meet our needs or willbe usable at a future date.***

 

At the end of fiscal quarter ended December 31, 2005, we reported netinventories of approximately $209 million. We build and maintain inventory inorder to meet our historic and projected needs, but cannot guarantee that theinventory we build will be adequate or the right mix of products to meet marketdemand. If we do not project and build the proper mix and amount of inventory,our revenue and gross margin may be adversely 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 soldat a discount or may not be sold at all, resulting in the reduction in thecarrying value of our inventory and a material adverse effect on our financialcondition and operating results.

 

***The semiconductorbusiness is highly competitive and increased competition could adversely affectthe price of our products and otherwise reduce the value of an investment inour company.***

 

The semiconductor industry, including the sectors in which we dobusiness, is highly competitive. Competition is based on price, productperformance, technology platform, product availability, quality, reliabilityand customer service. Price pressures often emerge as competitors attempt togain a greater market share by lowering prices or by offering a more desirabletechnological solution. Pricing and other competitive pressures can adverselyaffect our revenue and gross margin, and hence, our profitability. We alsocompete in various markets with companies of various sizes, many of which arelarger and have greater financial and other resources than we have, and thusthey may be better able to withstand adverse economic or market conditions. Inaddition, companies not currently in direct competition with us may introducecompeting products in the future.

 

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***Failure to timelycomplete our expansion plans for our wafer fabrication facility could adverselyaffect our revenue growth and ability to achieve our margin targets.***

 

We are operating in the mid to high 90s percent of our worldwidesemiconductor fabrication and assembly/module manufacturing capacities, withouttaking into account subcontract or foundry capacity. We are also expanding ourmost advanced wafer fabrication facility in Newport, Wales to provideadditional capacity to support the growth of our Focus Products. We havestarted production on certain of such new facilities during the December 2005quarter, and expect to complete our expansion of that facility in aboutcalendar year 2006. If we fail to timely execute on those plans in advance ofdemand for our products, that failure could adversely affect our revenue growthand ability to achieve our margin targets. We cannot assure you that we willcomplete our plans timely, that the ramp-up of the expanded facilities willoccur effectively and without error or delay, or that sufficient third partysources would be available to satisfy our ability to meet customer demand. Evenif we fully execute and implement our plans, we cannot guarantee that we willhave sufficient worldwide semiconductor fabrication and assembly/modulemanufacturing capacities to meet demand and there may be other unforeseenfactors that could adversely impact our operating results.

 

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

 

Our manufacturing efficiency has been and will be an important factorin our future profitability, and we may not be able to maintain or increase ourmanufacturing efficiency. Our manufacturing and testing processes are complex,require advanced and costly equipment and are continually being modified in ourefforts to improve yields and product performance. Difficulties in themanufacturing process can lower yields. Technical or other problems could leadto production delays, order cancellations and lost revenue. In addition, anyproblems in achieving acceptable yields, construction delays, or other problemsin upgrading or expanding existing facilities, building new facilities,problems in bringing other new manufacturing capacity to full production orchanging our process technologies, could also result in capacity constraints,production delays and a loss of future revenue and customers. Our operatingresults also could be adversely affected by any increase in fixed costs andoperating expenses related to increases in production capacity if net sales inthe appropriate mix do not increase proportionately, or in the event of adecline in demand for some or all of our products.

 

***If we are unable toimplement our business strategy, our revenue and profitability may be adverselyaffected.***

 

Our future financial performance and success are largely dependent onour ability to implement our business strategy successfully of transforming ourbusiness to one led by our Focus Products and succeeding on our plans torestructure our company. We cannot assure you that we will continue tosuccessfully implement our business strategy or that implementing our strategywill sustain or improve our results of operations.

 

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***The failure toexecute on our plans to divest or discontinue product lines that are notconsistent with our business objectives, and replace those revenues withhigher-margin product sales could adversely affect our operating results.***

 

We have announced the divestiture, discontinuation or change inbusiness model of certain of our Non-Focus Products (and, may divestdiscontinue or charge the business model for others) that are not consistentwith our business objectives or margin targets. Our plan is to replace thedivested or discontinued revenues with (or change the business model toachieve) higher-margin product sales and target gross margin of greater 50percent. We cannot assure you that we will complete our plans or achieve ourtarget gross margin, timely or at all. Additionally, we have announced that weplan to enter into agreements with respect to certain divestitures by the endof June 2006. As a number of factors, among those factors controlled by thirdparties, affect our ability to complete those plans, we cannot assure you thatwe can achieve our target dates or complete such plans at all.

 

The activities involved with the divestiture, discontinuation andre-alignment of product sales could involve changes to various aspects of ourbusiness which could have a material adverse effect on our profitability to an extentwe have not anticipated. Even if we fully execute and implement our plans,there may be unforeseen factors that could have a material adverse impact onour operating results.

 

***The failure toimplement and complete our restructuring programs and accomplish planned costreductions could adversely affect our business.***

 

In December 2002, we announced a number of restructuring initiatives. Ourgoal was to reposition our company to better fit the market conditions,de-emphasize our commodity business and accelerate the move to what wecategorize as our proprietary products, which refer to our Power ManagementICs, Advanced Circuit Devices, and Power Systems. 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. Therestructuring also includes lowering overhead costs across our supportorganization. We cannot assure you that these restructuring initiatives willachieve their goals, accomplish the cost reductions planned, or be accomplishedwithin our expectations as to the amount of charges to be taken in connectionwith that activity. Additionally, because our restructuring activities involvechanges to many aspects of our business, the activities could adversely affectproductivity and sales to an extent we have not anticipated. Even if we fullyexecute and implement these restructuring activities, and they generate theanticipated cost savings, there may be other unforeseen factors that couldresult in the amount of charges to be taken in connection with ourrestructuring activities or otherwise adversely impact our profitability andbusiness.

 

***Our products may be found to be defectiveand, as a result, product claims may be asserted against us, which may harm ourbusiness and our reputation with our customers and significantly adverselyaffect our results and financial condition.***

 

Our products are typically sold at prices that are significantly lowerthan the cost of the equipment or other goods in which they are incorporated. Althoughwe maintain rigorous quality control systems, we shipped large quantities ofsemiconductor devices in 2005 to a wide range of customers around the world, ina variety of high profile and 

 

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critical applications, and continue to do so. 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 defector failure in our products could give rise to failures in the end products thatincorporate them (and consequential claims for damages against our customersfrom their customers depending on applicable law and contract), we often needto defend against claims for damages that are disproportionate to the revenueand profit we receive from the products involved. In addition, our ability toreduce such liabilities may be limited by the laws or the customary businesspractices of the countries where we do business. Even in cases where we do notbelieve we have legal liability for such claims, we may choose to pay for themto retain a customer’s business or goodwill or to settle claims to avoidprotracted litigation. Our results of operations and business would beadversely affected as a result of a significant alleged quality or performanceissues in our products, if we are required or choose to pay for the damagesthat result. In addition, in our Aerospace and Defense segment, we aresometimes subject to government procurement regulations and other laws thatcould result in costly investigations and other legal proceedings as aconsequence of allegedly defective products or other actions. Although wecurrently have product liability and other types of insurance, we have certaindeductibles and exclusions to such policies and may not have sufficientinsurance coverage. We also may not have sufficient resources to satisfy allpossible product liability or other types of product 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.

 

***While we attempt to monitor the creditworthiness of our customers, we may from time to time be at risk due to theadverse financial condition of one or more customers.***

 

We have established procedures for the review and monitoring of thecredit worthiness of our customers and/or significant amounts owing fromcustomers. However, from time to time, we may find that despite our efforts oneor more of our customers become insolvent or face bankruptcy proceedings(Delphi, one of our largest customers, is currently one such customer). Suchevents could have an adverse effect on our operating results if our receivablesapplicable to that customer become uncollectible in whole or in part, or if ourcustomers’ financial situation result in reductions in whole or in part of ourability to continue to sell our products or services to such customers at thesame levels or at all.

 

***If some originalequipment manufacturers (“OEMs”) do not design our products into theirequipment, a portion of our revenue may be adversely affected.***

 

A “design win” from a customer does not guarantee future sales to thatcustomer. We also are unable to guarantee that we will be able to convertdesign wins into sales for the life of any particular program, or at all, orthat the revenue from such wins would be significant. We also cannot guaranteethat we will achieve the same level of design wins as we have in the past, orat all. Without design wins from OEMs, we would only be able to sell ourproducts to these OEMs as a second source, if at all. Once an OEM designs anothersupplier’s semiconductor into one of its product platforms, it is moredifficult for us to achieve future design wins with that OEM’s product platformbecause changing suppliers involves significant cost, time, effort and risk.Achieving a design win 

 

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with a customer does not ensure that we will receive significantrevenue from that customer and we may be unable to convert design wins intoactual sales.

 

***Corporate investmentand expenditures in the Information Technology sector and in InformationTechnology purchases may not materialize as we have planned.***

 

Our revenue and gross margin guidance is dependent on a certain levelof corporate investment and expenditures in the Information Technology sectorand in Information Technology purchases. If our projections of theseexpenditures fail to materialize, whether due to increased oil prices, changein market conditions, or otherwise, our revenue and gross margin could beadversely impacted.

 

***New technologiescould result in the development of new products and a decrease in demand forour products, and we may not be able to develop new products to satisfy changesin demand.***

 

Our failure to develop new technologies or react to changes in existingtechnologies could materially delay our development of new products, whichcould result in decreased revenue and a loss of market share to ourcompetitors. Rapidly changing technologies and industry standards, along withfrequent new product introductions, characterize the semiconductor industry. Asa result, we must devote significant resources 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 cannot assure you that we will successfullyidentify new product opportunities and develop and bring new products to marketin a timely and cost-effective manner, or that products or technologiesdeveloped by others will not render our products or technologies obsolete ornoncompetitive. A fundamental shift in technologies in our product marketscould have a material adverse effect on our competitive position within theindustry. In addition, to remain competitive, we must continue to reduce diesizes and improve manufacturing yields. We cannot assure you that we canaccomplish these goals.

 

***Our failure toobtain or maintain the right to use certain technologies may negatively affectour financial results.***

 

Our future success and competitive position may depend in part upon ourability to obtain or maintain certain proprietary technologies used in ourprincipal products, which is achieved in part by defending and maintaining thevalidity of our patents and defending claims by our competitors of intellectualproperty infringement. We license certain patents owned by others. We have alsobeen notified that certain of our products may infringe the patents of thirdparties. Although licenses are generally offered in such situations, we cannoteliminate the risk of litigation alleging patent infringement. We are currentlya defendant in intellectual property claims and we could become subject toother lawsuits in which it is alleged that we have infringed upon the intellectualproperty rights of others.

 

Our involvement in existing and future intellectual property litigationcould result in significant expense, adversely affect sales of the challengedproduct or technologies and divert the efforts of our technical and managementpersonnel, whether or not such litigation is resolved in our favor. If any suchinfringements exist, arise or are claimed in the future, we may be exposed tosubstantial liability for damages and may need to obtain licenses from thepatent owners, discontinue or change our processes or products or 

 

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expend significant resources to develop or acquire non-infringingtechnologies. We cannot assure you that we would be successful in such effortsor that such licenses would be available under reasonable terms. Our failure todevelop or acquire non-infringing technologies or to obtain licenses onacceptable terms or the occurrence of related litigation itself could have amaterial adverse effect on our operating results and financial condition.

 

***Our ongoingprotection and reliance on our intellectual property assets expose us to risksand continued levels of revenue in our IP segment is subject to our ability tomaintain current licenses, licensee and market factors not within our controland our ability to obtain new licenses.***

 

We have traditionally relied on our patents and proprietarytechnologies. Patent litigation settlements and royalty income substantiallycontribute to our financial results. Enforcement of our intellectual propertyrights is costly, risky and time-consuming. We cannot assure you that we cansuccessfully continue to protect our intellectual property rights, especiallyin foreign markets. Our key MOSFET patents expire between 2005 and 2010,although our broadest MOSFET patents expire in 2007 and 2008.

 

Our royalty income is largely dependent on the following factors: theremaining terms of our MOSFET patents; the continuing introduction andacceptance of products that are not covered by our patents; remaining coveredunder unexpired MOSFET patents; the defensibility and enforceability of ourpatents; changes in our licensees’ unit sales, prices or die sizes; the terms,if any, upon which expiring license agreements are renegotiated; and ourability to obtain revenue from new licensing opportunities. Market conditionsand mix of licensee products, as well as sales of non-infringing devices cansignificantly adversely affect royalty income. We also cannot guarantee that wecan obtain new licenses to offset reductions in royalties from existinglicenses. While we try to predict the effects of these factors and efforts,often there are variations or factors that can significantly affect resultsdifferent from that predicted. Accordingly, we cannot guarantee that ourpredictions of our IP segment revenue will be consistent with actual results. Wealso cannot guarantee that our royalty income will continue at levelsconsistent with prior periods. Any decrease in our royalty income could have amaterial adverse effect on our operating results and financial condition.

 

***Our internationaloperations expose us to material risks.***

 

We expect revenue from foreign markets to continue to represent asignificant portion of total revenue. We maintain or contract with significantoperations in foreign countries. Among others, the following risks are inherentin doing business internationally: changes in, or impositions of, legislativeor regulatory requirements, including tax laws in the United States and in thecountries in which we manufacture or sell our products; trade restrictions;transportation delays; work stoppages; economic and political instability; andforeign currency fluctuations.

 

In addition, certain of our operations and products are subject to restrictionsor licensing under U.S. export laws. If such laws or the implementation ofthese restrictions change, or if in the course of operating under such laws webecome subject to claims, we cannot assure you that such factors would not havea material adverse effect on our financial condition and operating results.

 

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In addition, it is more difficult in some foreign countries to protectour products or intellectual property rights to the same extent as is possiblein the United States. Therefore, the risk of piracy or misuse of our technologyand products may be greater in these foreign 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 initiationof production at new facilities, implementing new production techniques orresolving problems associated with technical equipment malfunctions couldadversely affect our manufacturing efficiencies.***

 

Our manufacturing 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 highly complex, require advanced and costlyequipment and are continuously being modified in an effort to improve yieldsand product performance. Impurities, defects or other difficulties in themanufacturing process can lower yields.

 

In addition, as is common in the semiconductor industry, we have fromtime to time experienced difficulty in beginning production at new facilities orin effecting transitions to new manufacturing processes. As a consequence, wehave experienced delays in product deliveries and reduced yields. We mayexperience manufacturing problems in achieving acceptable yields or experienceproduct delivery delays in the future as a result of, among other things,capacity constraints, construction delays, upgrading or expanding existingfacilities or changing our process technologies, any of which could result in aloss of future revenue. Our operating results could also be adversely affectedby the increase in fixed costs and operating expenses related to increases inproduction capacity if revenue does not increase proportionately.

 

We have transferred manufacturing from our Krefeld, Germany to ourSwansea, Wales and Tijuana, Mexico facilities. We are ramping up our Newport,Wales’s facility, and anticipate transferring our El Segundo manufacturing tothe Newport, Wales facility by fiscal year end June 2006. We have experiencedsome delays and/or technical problems in moving our various facilities. Continueddelays and/or technical problems in completing the remaining transfers couldlead to increased costs, reduced yields, delays in product deliveries, ordercancellations and/or lost revenue.

 

***Interruptions,delays or cost increases affecting our materials, parts or equipment may impairour competitive position and our operations.***

 

Our manufacturing operations depend upon obtaining adequate supplies ofmaterials, parts and equipment, including silicon, mold compounds andleadframes, on a timely basis from third parties. Our results of operationscould be adversely affected if we were unable to obtain adequate supplies ofmaterials, parts and equipment in a timely manner from our third partysuppliers or if the costs of materials, parts or equipment increasesignificantly. From time to time, suppliers may extend lead times, limitsupplies or increase prices due to capacity constraints or other factors. Wehave a limited number of suppliers for some materials, parts and equipment, andany interruption could materially impair our operations.

 

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We manufacture a substantial portion of our wafer product at ourTemecula, California and Newport, Wales facilities. Any disruption ofoperations at those facilities could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

Also, some of our products are assembled and tested by third partysubcontractors. We do not have any long-term assembly agreements with thesesubcontractors. As a result, we do not have immediate control over our productdelivery schedules or product quality. Due to the amount of time often requiredto qualify assemblers and testers and the high cost of qualifying multipleparties for the same products, we could experience delays in the shipment ofour products if we are forced to find alternative third parties to assemble ortest them. Any product delivery delays in the future could have a materialadverse effect on our operating results and financial condition. Our operationsand ability to satisfy customer obligations could be adversely affected if ourrelationships with these subcontractors were disrupted or terminated.

 

***We must commitresources to product manufacturing prior to receipt of purchase commitments andcould lose some or all of the associated investment.***

 

We sell products primarily pursuant to purchase orders for currentdelivery or to forecast, rather than pursuant to long-term supply contracts.Many of these purchase orders or forecasts may be revised or canceled withoutpenalty. As a result, we must commit resources to the manufacturing of productswithout any advance purchase commitments from customers. Our inability to sellproducts after we devote significant resources to them could have a materialadverse effect on our levels of inventory and our business, financial conditionand results of operations.

 

***We receive asignificant portion of our revenue from a small number of customers anddistributors.***

 

Historically, a significant portion of our revenue has come from arelatively small number of customers and distributors. The loss or financialfailure of any significant customer or distributor, any reduction in orders byany of our significant customers or distributors, or the cancellation of asignificant order, could materially and adversely affect our business.

 

***We may fail toattract or retain the qualified technical, sales, marketing and managerialpersonnel required to operate our business successfully.***

 

Our future success depends, in part, upon our ability to attract andretain highly qualified technical, sales, marketing and managerial personnel.Personnel with the necessary semiconductor expertise are scarce and competitionfor personnel with these skills is intense. We cannot assure you that we willbe 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 are unable to retain existing key employees orare unsuccessful in attracting new highly qualified employees, our business,financial condition and results of operations could be materially and adverselyaffected.

 

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***We have acquired andmay continue to acquire other companies and may be unable to successfullyintegrate such companies with our operations.***

 

We have acquired several companies over the past few years. We maycontinue to expand and diversify our operations with additional acquisitions.If we are unsuccessful in integrating these companies with our operations, orif integration is more difficult than anticipated, we may experiencedisruptions that could have a material adverse effect on our business,financial condition and results of operations.

 

***The price of ourcommon stock has fluctuated widely in the past and may fluctuate widely in thefuture.***

 

Our common stock, which is traded on The New York Stock Exchange, hasexperienced and may continue to experience significant price and volumefluctuations that could adversely affect the market price of our common stockwithout regard to our operating performance. In addition, we believe thatfactors such as quarterly fluctuations in financial results, earnings belowanalysts’ estimates and financial performance and other activities of otherpublicly traded companies in the semiconductor industry could cause the priceof our common stock to fluctuate substantially. In addition, in recent periods,our common stock, the stock market in general and the market for shares ofsemiconductor industry-related stocks in particular have experienced extremeprice fluctuations which have often been unrelated to the operating performanceof the affected companies. Any similar fluctuations in the future couldadversely affect the market price of our common stock.

 

***Our investments incertain securities expose us to market risks.***

 

We invest excess cash in marketable securities consisting primarily ofcommercial paper, corporate notes, corporate bonds and governmental securities.We also hold as strategic investments the common stock of two publicly-tradedJapanese companies, one of which is Nihon Inter Electronics Corporation. Thevalue of these investments is subject to market fluctuations, which if adverse,could have a material adverse effect on our operating results and financialcondition.

 

***If we fail tomaintain an effective system of internal control over financial reporting ordiscover material weaknesses in our internal control over financial reportingor financial reporting practices, we may not be able to report our financialresults accurately or detect fraud, which could harm our business and thetrading price of our stock.***

 

We have disclosed that we have discovered a material weakness in ourinternal control over financial reporting. While we are implementing enhancedprocedures and controls in our fourth quarter of fiscal 2006 to cure thematerial weakness and management believes that it will cure such weaknesswithin a reasonable period of time, we cannot assure you that such procedureswill timely cure such weakness.

 

Effective internal controls are necessary for us to produce reliablefinancial reports and are important in our effort to prevent financial fraud.We are required to periodically evaluate the effectiveness of the design andoperation of our internal controls. These evaluations may result in theconclusion that enhancements, modifications or changes to our internal controlsare necessary or desirable. As noted with the disclosed material weakness, whilemanagement evaluates the effectiveness of our internal controls on a regularbasis, we cannot provide absolute assurance that these controls will always beeffective or any assurance that the controls, accounting processes, proceduresand underlying assumptions will not be subject to revision. There are alsoinherent limitations on the effectiveness of internal controls and financialreporting practices, including collusion, management override, and failure ofhuman judgment. Because of this, control procedures and financial reportingpractices are designed

 

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to reduce rather than eliminate business risks. If we fail to maintainan effective system of internal control over financial reporting or if, and foras long as, management or our independent registered public accounting firmwere to discover material weaknesses in our internal control over financialreporting (or if our system of controls and audits result in a change ofpractices or new information or conclusions about our financial reporting likethe disclosed material weakness), we may be unable to produce reliablefinancial reports or prevent fraud and it could harm our financial conditionand results of operations and result in loss of investor confidence and adecline in our stock price.

 

***Large potentialenvironmental liabilities, including those relating to a former operatingsubsidiary, may adversely impact our financial position.***

 

Federal, state, foreign and local laws and regulations impose variousrestrictions and controls on the discharge of materials, chemicals and gasesused in our semiconductor manufacturing processes. In addition, under some lawsand regulations, we could be held financially responsible for remedial measuresif our properties are contaminated or if we send waste to a landfill orrecycling facility that becomes contaminated, even if we did not cause thecontamination. Also, we may be subject to common law claims if we releasesubstances that damage or harm third parties. 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 to comply with environmental laws orregulations could subject us to serious liabilities and could have a materialadverse effect on our operating results and financial condition.

 

***Some of ourfacilities are located near major earthquake fault lines.***

 

Our corporate headquarters, one of our manufacturing facilities, one ofour research facility and certain other critical business operations arelocated near major earthquake fault lines. We could be materially and adverselyaffected in the event of a major earthquake. Although we maintain earthquakeinsurance, we can give you no assurance that we have obtained or will maintainsufficient insurance coverage.

 

***There can be noassurance that we will have sufficient capital resources to make necessaryinvestments in manufacturing technology and equipment.***

 

The semiconductor industry is capital intensive. Semiconductormanufacturing requires a constant upgrading of process technology to remain competitive,as new and enhanced semiconductor processes are developed which permit smaller,more efficient and more powerful semiconductor devices. We maintain certain ofour own manufacturing, assembly and test facilities, which have required andwill continue to require significant investments in manufacturing technologyand equipment. We are also attempting to add the appropriate level and mix ofcapacity to meet our customers’ future demand. There can be no assurance thatwe will have sufficient capital resources to make necessary investments inmanufacturing technology and equipment. Although we believe that anticipatedcash flows from operations, existing cash reserves and other equity or debtfinancings that we may obtain will be sufficient to satisfy our future capitalexpenditure requirements, there can be no assurance that this will be the caseor that alternative sources of capital will be available to us on favorableterms or at all.

 

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***The maturity of ouroutstanding Convertible Subordinated Notes due in July 2007 may expose us torisks.***

 

We haveoutstanding $550 million in Convertible Subordinated Notes due in July 2007.While we intend to refinance or pay down such notes prior to maturity, if we decideto refinance such notes, in whole or in part, we cannot guarantee that theterms, including interest rate and costs, would be comparable to the currentinterest rates and costs, and if higher, could adversely affect our futureresults. Additionally, if we elect in whole or in part to pay down such notes,it would lower the amount of funds we have available for operations orinvestment.

 

***Unforeseen changesin market conditions, tax laws and other factors could impact our judgmentabout the realizability of our deferred tax assets.***

 

We have made certain judgments regarding the realizability of ourdeferred tax assets. In accordance with SFAS No. 109, “Accounting for IncomeTaxes”, the carrying value of the net deferred tax assets is based on thebelief that it is more likely than not that we will generate sufficient futuretaxable income in certain jurisdictions to realize these deferred tax assets,after considering all available positive and negative evidence. If ourassumptions and estimates change in the future given unforeseen changes inmarket conditions, tax laws or other factors, then the valuation allowancesestablished may be increased, resulting in increased income tax expense. Conversely,if we are ultimately able to use all or a portion of the deferred tax assetsfor which a valuation allowance has been established, then the related portionof the valuation allowance will be released to income as a credit to income taxexpense.

 

***Final outcomes fromthe various tax authorities’ audits are difficult to predict and an unfavorablefinding may negatively impact our financial results.***

 

As is common with corporations of our size, we are from time to timeunder audit by various taxing authorities. It is often difficult to predict thefinal outcome or the timing of resolution of any particular tax matter. We haveprovided certain tax reserves which have been included in the determination ofour financial results. However, unpredicted unfavorable settlements may requireadditional use of cash and negatively impact our financial position or resultsof operations.

 

***Terrorist attacks,such as those that took place on September 11, 2001, or threats or occurrencesof other terrorist activities whether in the United States or internationallymay affect the markets in which our common stock trades, the markets in whichwe operate and our profitability.***

 

Terrorist attacks, such as those that took place on September 11, 2001,or threats or occurrences of other terrorist or related activities, whether inthe United States or internationally, may affect the markets in which ourcommon stock trades, the markets in which we operate and our profitability. Futureterrorist or related activities could affect our domestic and internationalsales, disrupt our supply chains and impair our ability to produce and deliverour products. Such activities could affect our physical facilities or those ofour suppliers or customers, and make transportation of our supplies andproducts more difficult or cost prohibitive. Due to the broad and uncertaineffects that terrorist attacks have had on financial and economic marketsgenerally, we cannot provide any estimate of how these activities might affectour future results.

 

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***Natural disasters,like those related to Hurricanes Katrina and Wilma, or occurrences of othernatural disasters whether in the United States or internationally may affectthe markets in which our common stock trades, the markets in which we operateand our profitability.***

 

Natural disasters, like those related to Hurricanes Katrina and Wilma,or threats or occurrences of other similar events, whether in the United Statesor internationally, may affect the markets in which our common stock trades,the markets in which we operate and our profitability. Such events could affectour domestic and international sales, disrupt our supply chains, and impair ourability to produce and deliver our products. While we do not have facilitieslocated near the affected areas, such activities could affect physicalfacilities, primarily for raw materials and process chemicals and gases of oursuppliers or customers, and make transportation of our supplies and productsmore 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 2.****     Unregistered Sales ofEquity Securities and Use of Proceeds**

 

On November 1, 2005, our Board of Directorsauthorized a stock repurchase program, under which up to $100 million of ourcommon shares may be repurchased without prior notice, through block trades orotherwise. We intend that any shares repurchased will be held as treasuryshares that may be used for general corporate purposes. The following lists thenumber of the shares purchased under the repurchase program and, as of eachmonth, the number of shares 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 30, 2005) |       | 0                                                   |       | 0                                              |       | 0                                                                                                     |       | $                                                                                                                              | 100 million |   |
|                                        |       |                                                |       |                                           |       |                                                                                                  |       |                                                                                                                           |        |
| Month #2  (December 1 to December 31, 2005) |       | 0                                                   |       | 0                                              |       | 0                                                                                                     |       | $                                                                                                                              | 100 million |   |

 

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**ITEM 4.****                  Submission of Matters to a Vote ofSecurity Holders**

 

The following matters were submitted to avote of the Company’s stockholders at its Annual Meeting of Stockholders heldon November 21, 2005. All such matters were approved by the Company’sstockholders. Below is a summary of, where applicable, the number of votes castfor, against or withheld, as well as the number of abstentions as to eachmatter.

 
| ** ** | ** ** | **Description of Matter** | ** ** | **For**    | ** ** | **Authority  Withheld** | ** ** |
|------------|------------|---------------------------|------------|------------|------------|-------------------------|------------|
| ** ** | ** ** | ** **                | ** ** | ** ** | ** ** | ** **              | ** ** |
| 1.         |       | Election of  Directors    |       |       | ** ** | ** **              | ** ** |
| ** ** | ** ** | ** **                | ** ** | ** ** | ** ** | ** **              | ** ** |
|       |       | Alexander  Lidow          |       | 60,343,984 |       | 2,279,352               |       |
|       |       | Rochus E.  Vogt           |       | 58,758,096 |       | 3,865,240               |       |

 
| ** ** | ** ** | ** **                                       | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstentions** | ** ** |
|------------|------------|--------------------------------------------------|------------|------------|------------|-------------|------------|-----------------|------------|
| 2.         |       | Proposal to  amend the Company’s 1984 Stock |       | 45,313,529 |       | 1,474,493   |       | 218,400         |       |
|       | ** ** | Participation Plan as described in the proxy     | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** |
|       | ** ** | materials                                        | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** |
|       | ** ** |                                             | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** |
|       |       | Broker  non-votes                                |       | 15,616,914 | ** ** | ** **  | ** ** | ** **      | ** ** |

 
| ** ** | ** ** | ** **                                   | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstentions** | ** ** |
|------------|------------|----------------------------------------------|------------|------------|------------|-------------|------------|-----------------|------------|
| 3.         |       | Ratification  of PricewaterhouseCoopersLLP   |       | 61,634,276 |       | 925,249     |       | 66,811          |       |
|       | ** ** | as the Company’s Independent Registered | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** |
|       | ** ** | Public Accounting Firm For Fiscal Year 2006  | ** ** | ** ** | ** ** | ** **  | ** ** | ** **      | ** ** |

 

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**ITEM 6.****                  Exhibits**

 

Index:

 

3.1                                 Certificate of Incorporation, as Amended todate (incorporated by reference to Exhibit 3.1 to the Company’s RegistrationStatement on Form S-8 filed with the Commission on July 19, 2005; RegistrationNo. 333-117489)

 

3.2                                 Bylaws, as Amended (incorporated by referenceto Exhibit 3.2 to the Company’s quarterly report on Form 10-Q filed with theCommission on November 11, 2005)

 

11.1                           Statement Regarding Computation of Per ShareEarnings (incorporated by reference to Note 2, “Net Income Per Common Share”,of the Notes to Unaudited Consolidated Financial Statements contained herein)

 

31.1                           Certification Pursuant to Rule 13a-14(a) ofthe Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

31.2                           Certification Pursuant to Rule 13a-14(a) ofthe Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

32.1                           Certification Pursuant to 18 U.S.C. 1350,Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2                           Certification Pursuant to 18 U.S.C. 1350,Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|         | **INTERNATIONAL RECTIFIER CORPORATION**     |
|--------------|---------------------------------------------|
|         | **Registrant**                              |
|         | ** **                                  |
|         | ** **                                  |
| May 17, 2006 | /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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