**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**Form 10-Q**

 

**(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**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | ** ** | ** **                                                                                         |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |                                                                                               |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **Transition report pursuant to  section 13 or 15(****d) of the securities exchange  act of 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |                                                                                               |
| **For the transition period from                                               to                                             ** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |                                                                                               |
| **Commission File  Number:           1-7935**                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

 

**InternationalRectifier Corporation**

(exact name of registrant asspecified in its charter)

 
| **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 telephonenumber, including area code:  **(310) 726-8000**

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT(1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCHSHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2)HAS BEEN 

SUBJECT TO SUCH FILING REQUIREMENTS FOR THEPAST 90 DAYS.      YES  ý NO o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-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 REGISTRANTIS A SHELL COMPANY (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).     YES o     NO  ý

 

There were 70,933,810 sharesof the registrant’s common stock, par value $1.00 per share, outstanding onFebruary 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 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 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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| **PART I.** | ** ** | **FINANCIAL  INFORMATION** |
|-------------|------------|----------------------------|
|        |       |                       |
| **ITEM 1.** | ** ** | **Financial  Statements.** |

 

**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED 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.

 

3

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED 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 partof these statements.

 

4

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED 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 partof 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.

 

5

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **December 31,**     | ** ** |
| ** **                                                                         | ** ** | **2005**             | ** ** | **2004** | ** ** |
|                                                                               |       |                 |       |   |   |
| Cash flow  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 benefit from options exercised                                                 |       | 8,382                |       | 5,381 |   |
| Change in operating assets and liabilities,  net                                   |       | (56,729              | )          | (11,834 | ) |
| Net cash  provided by operating activities                                         |       | 52,614               |       | 99,198 |   |
|                                                                               |       |                 |       |   |   |
| Cash flow  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 flow  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 |   |
| Other, net                                                                         |       | (5,966               | )          | 579 |   |
| Net cash  provided by financing activities                                         |       | 3,302                |       | 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.

 

6

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**INTERNATIONAL RECTIFIER CORPORATION ANDSUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**December 31, 2005**

 

1.         Basisof Consolidation

 

The consolidated financial statements includethe accounts of International Rectifier Corporation and its subsidiaries (“theCompany”), which are located in North America, Europe and Asia.  Intercompany transactions have beeneliminated in consolidation.

 

The consolidated financial statementsincluded herein are unaudited; however, they contain all normal recurringadjustments which, in the opinion of the Company’s management, are necessary tostate fairly the consolidated financial position of the Company at December 31,2005, and the consolidated results of operations and the consolidated cashflows for the three and six months ended December 31, 2005 and 2004.  The results of operations for the three andsix months ended December 31, 2005 are not necessarily indicative of theresults to be expected for the full year.

 

The accompanying unaudited consolidatedfinancial statements should be read in conjunction with the Annual Report onForm 10-K for the fiscal year ended June 30, 2005.

 

The Company operates on a 52-53 week fiscalyear under which the three months ended December 2005 and 2004 consisted of 13weeks 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 presented is shown as June 30.  Fiscal 2006 will consist of 52 weeks endingJuly 2, 2006.

 

Certain reclassifications have been made to the December 31, 2004 (i)cash flow 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 in ARS were recorded in cash andcash equivalents rather than short-term cash investments.  The Company reclassified ARS from cash andcash equivalents to short-term investments because the underlying instrumentshave maturity dates exceeding ninety days. As a result of thereclassifications, the Company’s consolidated cash flows were affected asfollows:

 

•      netcash used for the purchase of cash investments decreased by $74.1 million forthe six months ended December 31, 2004; and

•      netchange in cash and cash equivalents increased by $74.1 million for the sixmonths ended December 31, 2004.

 

The reclassifications had no impact on the Company’s total currentassets, stockholders’ equity, cash flows provided by operating activities ortotal

 

7

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consolidated results reported in any period presented.  At December 31, 2005 and June 30, 2005, theCompany had no investments in these securities.

 

2.         NetIncome Per Common Share

 

Net income per common share - basic iscomputed by dividing net income available to common stockholders (thenumerator) by the weighted average number of common shares outstanding (thedenominator) during the period. The computation of net income per common share- diluted is similar to the computation of net income per common share - basicexcept that the denominator is increased to include the number of additionalcommon shares that would have been outstanding for the exercise of stockoptions using the treasury stock method and the conversion of the Company’sconvertible subordinated notes using the if-converted method.  The Company’s use of the treasury stockmethod reduces the gross number of dilutive shares by the number of sharespurchasable from the proceeds of the options assumed to be exercised.  The Company’s use of the if-converted methodincreases reported net income by the interest expense related to theconvertible subordinated notes when computing net income per common share —diluted.

 

The following table provides a reconciliationof the numerator and denominator of the basic and diluted per-sharecomputations for the three and six months ended December 31, 2005 and 2004 (inthousands except per share amounts):

 
| ** **                                  | ** ** | **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 |   |

 

8

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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’soutstanding convertible subordinated notes into 7,439,000 shares of commonstock was not included in the computation of diluted income per share for thethree and six months ended December 31, 2005, since such effect would have beenanti-dilutive.

 

3.         Cashand Investments

 

The Company classifies all highly liquid investments purchased withoriginal or remaining maturities of ninety days or less at the date of purchaseas cash equivalents.  The cost of theseinvestments approximates fair value.

 

TheCompany invests excess cash in marketable securities consisting primarily ofcommercial paper, corporate notes, corporate bonds and U.S. governmentsecurities.  At December 31, 2005 andJune 30, 2005, all of the Company’s marketable securities are classified asavailable-for-sale.  In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting forCertain Investments in Debt and Equity Securities”, unrealized gains and losseson these investments are included in accumulated other comprehensive income, aseparate component of stockholders’ equity, net of any related tax effect.  Realized gains and losses and declines invalue considered to be other than temporary are included in interest (income)expense, net.  At December 31, 2005 andJune 30, 2005, no investment was in a material loss position for greater thanone year.

 

Cash,cash equivalents and cash investments as of December 31, 2005 and June 30, 2005are summarized as 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 |   |

 

9

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Available-for-salesecurities as 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 |   |
|                                         |            |                     |            |                             |            |                             |            |                                  |            |                   |            |  |  |  |  |  |  |

 

10

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The Company holds as strategic investmentsthe common stock of two publicly-traded Japanese companies, one of which isNihon Inter Electronics Corporation (“Nihon”), a related party as furtherdisclosed in Note 16.  The Companyaccounts for these available-for-sale investments under SFAS No. 115.  These stocks are traded on the Tokyo StockExchange.  The market values of theequity investments at December 31, 2005 and June 30, 2005 were $84.4 millionand $71.2 million, respectively, compared to their purchased cost of $24.2million.  Mark-to-market gains (losses),net of tax, of $11.8 million and ($2.9) million for the three months endedDecember 31, 2005 and 2004, respectively, and $8.9 million and ($12.3) millionfor the six months ended December 31, 2005 and 2004, respectively, wereincluded in accumulated other comprehensive income, a separate component ofequity.

 

The amortized cost and estimated fair valueof cash investments at December 31, 2005, by contractual maturity, are asfollows (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 maturitygreater than one year for which the Company has the intent and ability to holdfor less than one year are classified as short-term investments.

 

Gross realized gains were $0.01 million and$0.02 million for the three and six months ended December 31, 2005,respectively, and gross realized losses were ($0.1) and ($0.4) million for thethree and six months ended December 31, 2005, respectively.  Gross realized gains were $0.01 million and$0.02 million for the three and six months ended December 31, 2004,respectively, and gross realized losses were ($0.02) and ($0.08) million forthe three and six months ended December 31, 2004, respectively.  The cost of marketable securities sold isdetermined by the weighted average cost method.

 

4.         DerivativeFinancial Instruments

 

*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 foreigncurrency risks, the Company has the greatest exposure to the Japanese Yen,since it has significant Yen-based revenues without the Yen-based manufacturingcosts.  The risk of the Company’srevenues in the European currencies is partially offset by the cost ofmanufacturing goods in the European currencies.

 

11

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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 value and volatility of future cashflows caused by changes in currency exchange rates, it has established revenue,expense and balance sheet hedging programs. Currency forward contracts and local Yen and Euro borrowings are used inthese hedging programs.  The Company’shedging programs reduce, but do not always eliminate, the impact of currencyexchange 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 theCompany’s subsidiary in Japan. The Company has designated the Forward Contractas a cash flow hedge under which mark-to-market adjustments are recorded inaccumulated other comprehensive income, a separate component of stockholders’equity, until the forecasted transactions are recorded in earnings.  Under the terms of the Forward Contract, theCompany is required to exchange 1.2 billion yen for $11.0 million on aquarterly basis from June 2001 to March 2006. At December 31, 2005, one payment of 1.2 billion yen remained to beswapped in March 2006, at a forward exchange rate of 109.32 yen per U.S.dollar.  The market value of the forwardcontract was $0.7 million and $0.1 million at December 31, 2005 and June 30,2005, respectively.  Mark-to-marketgains (losses), included in other comprehensive income, net of tax, were $0.1million and ($2.9) million for the three months ended December 31, 2005 and2004, respectively, and $0.4 million and ($2.1) million for the six monthsended December 31, 2005 and 2004, respectively. At December 31, 2005, based on effectiveness tests comparing forecastedtransactions through the Forward Contract expiration date to its cash flowrequirements, the Company does not expect to incur a material charge to incomeas a result of the Forward Contract during the next three months through itsmaturity.

 

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 unrealized foreign-currencynet gains recognized in earnings were less than $1 million for the three andsix 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 Company entered into an interest rate swaptransaction (the “April 2004 Transaction”) with the Bank to modify theeffective interest payable with respect to the remaining $137.5 million of theDebt.  The Company will receive from theBank fixed payments equal to 4.25 percent of the notional amount, payable onJanuary 15 and July 15.  In exchange, theCompany will pay to the Bank floating rate payments based upon the LondonInterBank Offered Rate (“LIBOR”) multiplied by the notional amount.  At the inception of the Transaction, interestrates were lower than that of the Debt and the

 

12

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Company believed that interest rates would remain lower for an extendedperiod of time.  The variable interestrate paid since the inception of the swaps has averaged 2.68 percent, comparedto a coupon of 4.25 percent on the Debt. This arrangement increased (decreased) interest expense by $0.8 millionand ($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.  The market value of the Transaction was aliability of $5.8 million and $0.3 million at December 31, 2005 and June 30,2005, respectively.  The market value ofthe April 2004 Transaction was a liability of $4.7 million and $3.4 million atDecember 31, 2005 and June 30, 2005, respectively.

 

BothTransactions terminate on July 15, 2007 (“Termination Date”), subject tocertain early termination provisions.  Onor after July 18, 2004 and prior to July 14, 2007, if the ten-day averageclosing price of the Company’s common stock equals or exceeds $77.63, bothtransactions 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, $17.0 million in letters of credit wereoutstanding related to both transactions.

 

TheTransaction and the April 2004 Transaction qualify as fair value hedges underSFAS No. 133.  To test effectiveness ofthe hedge, regression analysis is performed quarterly comparing the change infair value of the two transactions and the Debt.  The fair values of the Transaction, the April2004 Transaction and the Debt are calculated quarterly as the present value ofthe contractual cash flows to the expected maturity date, where the expectedmaturity date is based on probability-weighted analysis of interest ratesrelating to the five-year LIBOR curve and the Company’s stock prices.  For the three and six months ended December31, 2005 and 2004, the hedges were highly effective and therefore, theineffective portion did not have a material impact on earnings.

 

In April 2002, the Company entered into aninterest rate contract (the “Contract”) with an investment bank, LehmanBrothers (“Lehman”), to reduce the variable interest rate risk of theTransaction.  The notional amount of theContract is $412.0 million, representing approximately 75 percent of theDebt.  Under the terms of the Contract,the Company has the option to receive a payout from Lehman covering itsexposure to LIBOR fluctuations between 5.5 percent and 7.5 percent for any fourdesignated quarters.  The market value ofthe Contract at December 31, 2005 and June 30, 2005, was $0.2 million and $0.1million, 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 six monthsended December 31, 2005 and 2004, respectively, were charged to interestexpense.

 

13

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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 obsolescence based upon demandforecast within a specific time horizon and reserves are established accordingly.  Inventories at December 31, 2005 and June 30,2005 were 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.         Goodwilland Acquisition-Related Intangible Assets

 

The Company accounts for goodwill and acquisition-relatedintangible assets in accordance with SFAS No. 141, “Business Combinations”, andSFAS No. 142, “Goodwill and Other Intangible Assets”.  The Company classifies the difference betweenthe purchase price and the fair value of net assets acquired at the date ofacquisition as goodwill.  The Companyclassifies intangible assets apart from goodwill if the assets have contractualor other legal rights or if the assets can be separated and sold, transferred,licensed, rented or exchanged.  Dependingon the nature of the assets acquired, the amortization period may range fromfour to twelve years for those acquisition-related intangible assets subject toamortization.

 

The Companyevaluates the carrying value of goodwill and acquisition-related intangibleassets, including the related amortization period, in the fourth quarter ofeach fiscal year.  In evaluating goodwilland intangible assets not subject to amortization, the Company completes thetwo-step goodwill impairment test as required by SFAS No. 142.  The Company identified its reporting unitsand determined the carrying value of each reporting unit by assigning theassets and liabilities, including the existing goodwill and intangible assets,to those reporting units, in order to assess goodwill for impairment.  A reporting unit is the lowest level of theCompany for which there is discrete information and whose results are regularlyreviewed by the Company.

 

In the first of atwo-step impairment test, the Company determined the fair value of thesereporting units using a discounted cash flow valuation model.  The Company compared the discounted cashflows for the reporting unit to its carrying value.  If the fair value of a reporting unit exceedsits carrying value, goodwill of the reporting unit is considered not impairedand no further testing is required.  Ifthe fair value does not exceed the carrying value, the second step of thegoodwill impairment test shall be performed to measure the amount of impairmentloss, if any.  The second step comparedthe implied fair value of the reporting unit with the carrying amount of thatgoodwill.  Based on its annual impairmenttest in the fourth quarter

 

14

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of fiscal yearended June 30, 2005, the Company determined 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; fiscal2009: $2,489, fiscal 2010: $2,489 and fiscal 2011: $1,710.

 

The carrying amount of goodwill by business segment as of December 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 of goodwill isdeductible for income tax purposes.

 

The changes in thecarrying 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

 

15

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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 endedDecember 31, 2005, the Company concluded the physical inventory of ATMI’s fixedassets and determined that the purchased cost of the assets should be reducedby $1.1 million. The Company reallocated ATMI’s purchase price and increasedgoodwill by $1.1 million accordingly. Also during the six months ended December 31, 2005, as described in Note10, “Impairment of Assets, Restructuring and Severance”, the Company determinedthat approximately $0.7 million of severance liability associated with theTechnoFusion acquisition was excess.  TheCompany reduced TechnoFusion purchased goodwill by $0.7 million accordingly.

 

7.         Otherlong-term assets

 

Otherlong-term assets at December 31, 2005 and June 30, 2005 were comprised of thefollowing (in thousands):

 
| ** **                             | ** ** | **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.         Otheraccrued expenses

 

Otheraccrued expenses at December 31, 2005 and June 30, 2005 were comprised of thefollowing (in thousands):

 
| ** **              | ** ** | **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 |   |

 

16

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9.         BankLoans and Long-Term Debt 

 

Asummary of the Company’s long-term debt and other loans at December 31, 2005and June 30, 2005 is as follows (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 |   |

 

InJuly 2000, the Company sold $550 million principal amount of 4.25 percentConvertible Subordinated Notes due 2007. The interest rate is 4.25 percent peryear on the principal amount, payable in cash in arrears semi-annually onJanuary 15 and July 15.  The notes aresubordinated to all of the Company’s existing and future debt. The notes areconvertible into shares of the Company’s common stock at any time on or beforeJuly 15, 2007, at a conversion price of $73.935 per share, subject to certainadjustments.  The Company may redeem anyof the notes, in whole or in part, subject to certain call premiums on or afterJuly 18, 2004, as specified in the notes and related indenture agreement.  In December 2001 and April 2004, the Companyentered into two transactions with JP Morgan Chase Bank for $412.5 million and$137.5 million in notional amounts, respectively, which had the effect to theCompany of converting the interest rate to variable and requiring that theconvertible notes be marked to market (see Note 4, “Derivative FinancialInstruments”).

 

In November 2003, the Company entered into athree-year syndicated multi-currency revolving credit facility, led by BNPParibas, expiring in November 2006 (the “Facility”).  The Facility provides a credit line of $150million of which up to $150 million may be used for standby letters ofcredit.  The Facility bears interest at(i) local currency rates plus (ii) a margin between 0.75 percent and 2.0percent for base rate advances and a margin of between 1.75 percent and 3.0percent for euro-currency rate advances. Other advances bear interest as set forth in the credit agreement.  The annual commitment fee for the Facility issubject to a leverage ratio as determined by the credit agreement and was 0.375percent of the unused portion of the total facility at each period-end.  The Company pledged as collateral shares ofcertain of its subsidiaries.  TheFacility also contains certain financial and other covenants, with which theCompany was in compliance at December 31, 2005. At December 31, 2005, the Company had $1.2 million borrowings and $21.4million letters of credit outstanding under the Facility.  At June 30, 2005, the Company had $17.1million borrowings and $16.4 million letters of credit outstanding under theFacility.  Of the letters of creditoutstanding, $17.0

 

17

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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.       Impairmentof 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 alsoplanned to lower overhead costs across its support organizations.  The Company has substantially completed theserestructuring activities as of December 31, 2005.  The Company expects to complete the remainingactivities, primarily the closing of a fabrication line at 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 of approximately$218 million for asset impairment, plant closure and other charges, $6 millionof raw material and work-in-process inventory, and $49 million forseverance-related costs.

 

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

 

Restructuring-related costswere charged as incurred in accordance with SFAS No. 146, “Accounting for theCosts Associated with Exit or Disposal Activities”.  Asset impairments were calculated inaccordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-LivedAssets”.  In determining the assetgroups, the Company grouped assets at the lowest level for which independentidentifiable cash flows were available. In determining whether an asset wasimpaired the Company evaluated undiscounted future cash flows and other factorssuch as changes in strategy and technology. The undiscounted cash flows fromthe Company’s initial

 

18

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analyses were less than thecarrying amount for certain of the asset groups, indicating impairmentlosses.  Based on this, the Companydetermined the fair value of these asset groups using the present valuetechnique, by applying a discount rate to the estimated future cash flows thatwas consistent with the rate used when analyzing potential acquisitions.

 

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

 

•      As the Company emphasizes more advanced generation planar products, itexpects the future revenue stream from its less advanced facilities inTemecula, California to decrease significantly. These facilities had a net book value of $138.3 million and were writtendown by $77.7 million.  It is expected thatthese facilities 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.

 

•      As the Company emphasizes more advanced generation trench products, itexpects the future revenue stream from its 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 had significantly reducedproduction as of fiscal year ended June 30, 2003, and is used primarily forresearch and development activities.

 

•      As the Company emphasizes more advanced generation Schottky products, itexpects the future revenue stream from its 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 this facility will continue in use untilapproximately December 2007 and the remaining basis is being depreciated overunits of production during this period. It is assumed that salvage value will equal disposition costs.

 

•      The Company restructured its manufacturing activities in Europe.  Based on a review of its Swansea, Walesfacility, a general-purpose module facility, the Company determined in theDecember 2002 quarter that this facility would be better suited to focus onlyon 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 has completed the move of its manufacturingactivities from its automotive facility in Krefeld, Germany to its Swansea,Wales and Tijuana, Mexico facilities as of September 30, 2005. The Company hasalso moved the production from its Venaria, Italy facility to its Borgaro,Italy and Mumbai, India facilities, which was completed as of December 31,2003.  The Company stopped manufacturingproducts at its Oxted, England facility as of September 30, 2003.

 

•      The Company has eliminated the manufacturing of its non-space militaryproducts in its Santa Clara, California facility as of July 31, 2004.Currently,

 

19

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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 thesereductions in manufacturing activities, certain assets with a net book value of$4.0 million were written down by $2.0 million.

 

•      $56.6 million in other miscellaneous items were charged, including $47.8million in relocation costs and other impaired asset charges and $8.8 millionin contract termination and settlement costs.

 

As a result of therestructuring initiatives, certain raw material and work-in-process inventorieswere impaired, including products that could not be completed in otherfacilities, materials that were not compatible with the processes used in thealternative facilities, and materials such as gases and chemicals that couldnot readily be transferred. Based on these factors the Company wrote down theseinventories, with a carrying value of $98.2 million, by $6.0 million. The Company had disposed of $1.1 million and $0.2 million of theseinventories, for the three months ended December 31, 2005 and 2004,respectively, and $1.1 million and $0.7 million for the six months endedDecember 31, 2005 and 2004, respectively, which did not materially impact grossmargin.  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 charges associated with theelimination of positions, which included the persons notified to date, had beenand will continue to be recognized over the future service period, asapplicable, in accordance with SFAS No. 146. The Company measured the total termination benefits at the communicationdate based on the fair value of the liability as of the termination date.  A change resulting from a revision to eitherthe timing or the amount of estimated cash over the future service period willbe measured using the credit-adjusted risk-free rate that was used to initiallymeasure the liability.  The cumulativeeffect of the change will be recognized as an adjustment to the liability inthe period of the 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, theCompany finalized its plan and determined that total severance would beapproximately $10 million, and accordingly, the Company adjusted purchasedgoodwill by $4.8 million.  The Companycommunicated the plan and the elimination of approximately 250 positionsprimarily in manufacturing to its affected employees at that time.    The Company has completed the restructuringof its Krefeld facility as of December 31, 2005, and determined that $0.7million of the severance reserve was excess. Accordingly, the Company decreased TechnoFusion purchased goodwill by$0.7 million.

 

20

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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.  Severanceactivity related to the elimination of 29 administrative and operatingpersonnel as part of the previously reported restructuring in the fiscalquarter ended June 30, 2001, is also disclosed. The remaining June 2001 severance relates primarily to certain legalaccruals associated with that restructuring, which will be paid or released asthe 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 |   |

 

11.       Segmentand Geographic Information

 

Revenue for the three and six months endedDecember 31, 2005 and 2004, by the three broad product categories, are asfollows (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 the three months endedDecember 31, 2005 and 2004, are as follows (in thousands except 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 six months endedDecember 31, 2005 and 2004, are as follows (in thousands except percentages):

 
| ** **                    | ** ** | **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 from unaffiliated customersis based on the location in which the sale originated. The Company includes inlong-lived assets all long-term assets excluding long-term cash investments,long-term deferred income taxes, goodwill and acquisition-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 morethan ten percent of the Company’s consolidated revenue for the three and sixmonths ended December 31, 2005 and 2004. No customer accounted for more than ten percent of the Company’saccounts 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 Computing and Communicationssegment, two distributors, individually accounting for greater than ten percentof segment revenue, accounted for approximately 27 percent and 29 percent ofrevenue for the three and six months ended December 31, 2005,respectively.  In the Aerospace andDefense segment, one distributor accounted for approximately 13 percent ofrevenue for the three and six months ended December 31, 2005.  No single OEM customer, distributor orsubcontract manufacturer accounted for more than ten percent of the Company’sother Focus Product segment revenues for the three or six months ended December31, 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 the Non-Aligned Product segment, two OEMcustomers and one distributor, individually accounting for greater than tenpercent of segment revenue, accounted for approximately 45 percent and 44percent of revenue for the three and six months ended December 31, 2005,respectively.

 

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12.       Stock-Based Compensation

 

For the three and six months ended December 31,2005, equity-based compensation awards were granted under one of two stockoption plans:  the 1997 Employee StockIncentive Plan (“1997 Plan”) and the 2000 Incentive Plan (“2000 Plan”). Optionsgranted before November 22, 2004, generally became exercisable in annualinstallments of 25 percent beginning on the first anniversary date, and expireafter seven years.  Options granted afterNovember 22, 2004, generally became exercisable in annual installments of 33percent beginning on the 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, otherstock-based awards (e.g., restricted stock units (“RSUs”), SARs and performanceshares) 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.  The terms of the 2000 Plan were substantiallysimilar to those under the 1997 Plan. On November 22, 2004, the Company’sshareholders approved an amendment to the 2000 Plan which increased the authorizednumber of shares to be granted from 7,500,000 to 12,000,000.  The amendment changed the options expirationterm on future grants to five years, and contained certain limitations on themaximum number of shares that may be awarded to an individual. No awards may begranted under the 2000 Plan after August 24, 2014. As of December 31, 2005,there were 4,124,348 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 |   |
|                                 |            |            |            |                                                           |            |                                                           |            |                                 |            |  |  |  |

 

24

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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 followingtable summarizes the stock options and RSUs outstanding at December 31,2005, and related weighted average price and life information (in thousandsexcept 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 |   |

 

Additionalinformation relating to the stock option plans, including employee stockoptions and RSUs, at December 31, 2005 and June 30, 2005 is as follows (inthousands):

 
| ** **                                                 | ** ** | **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             |       |

 

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Beginningin the fiscal year 2006, the Company adopted SFAS No. 123(R), “Share-BasedPayments” (“SFAS No. 123(R)”) on a modified prospective transition method toaccount for its employee stock options. Under the modified prospective transition method, fair value of new andpreviously granted but unvested equity awards are recognized as compensationexpense in the income statement, and prior period results are notrestated.  As a result of the adoption,for the three months ended December 31, 2005, the Company’s income fromcontinuing operations, which is the same as income before income taxes,decreased by $0.8 million, net income was decreased by $0.6 million, and basicand diluted earnings per share were negatively impacted by $0.01.  For the six months ended December 31, 2005,the Company’s income from continuing operations decreased by $1.2 million, netincome was decreased by $0.8 million, and basic and diluted earnings per sharewere negatively impacted by $0.01.

 

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 expenseattributable to the RSUs were $0.1 million and $0.2 million for the threemonths ended December 31, 2005 and 2004, respectively, and $0.2 million and$0.4 million for the six months ended December 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 |   |

 

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 averagenumber of years to recognize the compensation expense is 1.6 years. The fairvalue of the options associated with the

 

26

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abovecompensation expense for the three and six months ended December 31, 2005, wasdetermined at the date of the grant using the Black-Scholes option pricingmodel 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 payments pursuantto SFAS No. 123(R).  With respect tovolatility, SAB No. 107 clarified that there is not a particular method ofestimating volatility and to the extent that the Company has traded financialinstruments from which it can derive the implied volatility, it may beappropriate to use only implied volatility in its assumptions.  The Company has certain financial instrumentsthat are publicly traded from which it can derive the implied volatility.  Therefore, beginning in January 2005, theCompany has used implied volatility for valuing its stock options, whereaspreviously, it had used historical volatility. The Company believes implied volatility is a better indicator of expectedvolatility because it is generally reflective of both historical volatility andexpectations of how future volatility will differ from historical volatility.

 

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

 

27

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Had the Companyaccounted for stock-based compensation plans using the fair value basedaccounting method described by SFAS No. 123 for the periods prior to fiscalyear 2006, the Company’s diluted net income per common share—basic and dilutedfor the three and six months ended December 31, 2004, would have approximatedthe following (in thousands except per share data):

 
| ** **                                                                                                                  | ** ** | **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 |   |

 

On April 17, 2005, theCompany accelerated the vesting of all then outstanding equity awards,including employee stock options and restricted stock units, primarily to avoidrecognizing in its income statement approximately $108 million in associatedcompensation expense in future periods, of which approximately $60 millionwould have been recognized in fiscal year 2006 upon the adoption of SFAS No.123(R). As a result of the accelerated vesting, the Company recorded $6.0million in non-cash compensation charge in the fourth quarter of fiscal year2005, of which $3.9 million is related to the excess of the intrinsic valueover the fair market value of the Company’s stock on the acceleration date ofthose options that would have been forfeited or expired unexercised had thevesting not been accelerated, and $2.1 million is related to the recognition ofoutstanding RSUs, including $0.3 million for the excess of the intrinsic valueover the fair market value of the Company’s stock on the acceleration date. In determining the forfeiture rates of the stock options, the Companyreviewed the unvested options’ original life, time remaining to vest andwhether these options were held by officers and directors of the Company. The compensation charge is adjusted in future period financial results asactual forfeitures are realized.  For thethree and six months ended December 31, 2005, there were no material changes inactual forfeitures from estimates.

 

13.       EnvironmentalMatters

 

Federal, state, foreign and locallaws and regulations impose various restrictions and controls on the storage,use and discharge of certain materials, chemicals and gases used insemiconductor manufacturing processes. The Company does not believe thatcompliance with such laws and regulations as now in effect will have a materialadverse effect on the Company’s results of operations, financial position orcash flows.

 

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However, under some of these laws and regulations,the Company could be held financially responsible for remedial measures ifproperties are contaminated or if waste is sent to a landfill or recyclingfacility that becomes contaminated. Also, the Company may be subject to commonlaw claims if it releases substances that damage or harm third parties. TheCompany cannot make assurances that changes in environmental laws andregulations will not require additional investments in capital equipment andthe implementation of additional compliance programs in the future, which couldhave a material adverse effect on the Company’s results of operations,financial position or cash flows, as could any failure by the Company to complywith environmental laws and regulations.

 

The Company and RachelleLaboratories, Inc. (“Rachelle”), a former operating subsidiary of theCompany that discontinued operations in 1986, were each named a potentiallyresponsible party (“PRP”) in connection with the investigation by the UnitedStates Environmental Protection Agency (“EPA”) of the disposal of allegedlyhazardous substances at a major superfund site in Monterey Park, California(“OII Site”). Certain PRPs who settled certain claims with the EPA underconsent decrees filed suit in Federal Court in May 1992 against a numberof other PRPs, including the Company, for cost recovery and contribution underthe provisions of the Comprehensive Environmental Response, Compensation andLiability Act (“CERCLA”). IR has settled all outstanding claims that havearisen against it out of the OII Site. No claims against Rachelle have been settled.  The Company has taken the position that noneof the wastes generated by 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 paymentfrom Rachelle in the amount of approximately $9.3 million in order to takeadvantage of the settlement.  Rachelledid not accept the offer.

 

In as much as Rachelle has notaccepted the settlement, the Company cannot predict whether the EPA or otherswould attempt to assert an action for contribution or reimbursement for moniesexpended to perform remedial actions at the OII Site.  The Company cannot predict the likelihoodthat the EPA or such others would prevail against Rachelle in any suchaction.  It remains the position ofRachelle that its wastes were not hazardous. The Company’s insurer has not accepted liability, although it has madepayments for defense costs for the lawsuit against the Company.  The Company has made no accrual for potentialloss, if any; however, an adverse outcome could have a material adverse effecton the Company’s results of operations and cash flows.

 

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

 

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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 and other reliefcustomary in such matters.  The FederalDistrict Court entered a permanent injunction, effective on June 5, 2002,barring IXYS from making, using, offering to sell or selling in, or importinginto the United States, MOSFETs (including IGBTs) covered by the Company’s U.S.patents 4,959,699; 5,008,725 and/or 5,130,767. In August 2002, the Court of Appeals for the Federal Circuit stayed thatinjunction, pending appeal on the merits. In that same year, following trial on damages issues, a Federal DistrictCourt jury awarded the Company $9.1 million in compensatory damages.  The Federal District Court subsequentlytripled the damages, increasing the award from $9.1 million to approximately$27.2 million, and ruled that the Company is entitled to an additional award ofreasonable attorney’s fees for a total monetary judgment of about $29.5million.  In March 2004, the U.S. Courtof Appeals for the Federal Circuit reversed the summary judgment granted theCompany by the Federal District Court in Los Angeles of infringement by IXYS ofthe Company’s U.S. patents 4,959,699; 5,008,725 and 5,130,767. The FederalCircuit reversed in part and vacated in part infringement findings of theDistrict Court, granted IXYS the right to present certain affirmative defenses,and vacated the injunction against IXYS entered by the District Court. Theruling by the Federal 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 hasbeen recognized in the income statement from the pending litigation for thethree and six months ended December 31, 2005.

 

15.       IncomeTaxes

 

The Company’seffective tax provision for the three months ended December 31, 2005 and 2004was 27.5 percent and 22.8 percent, respectively, and 27.5 percent and 25.2percent 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 Earnings RepatriationProvision within the American Jobs Creations Act of 2004”, which introduces alimited time 85 percent dividends received deduction on the repatriation ofcertain foreign earnings to a U.S. tax payer (“repatriation provision”),provided certain criteria are met.  TheCompany

 

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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

 

As discussed in Note 3, the Company holdsas strategic investment common stock of Nihon Inter Electronics Corporation(“Nihon”), a related party.  At December31, 2005 and June 30, 2005, the Company owned approximately 17.5 percent of theoutstanding shares of Nihon.  Aspreviously reported, the Company’s Chief Financial Officer was the Chairman ofthe Board of Nihon until June 28, 2005. In addition, two managers of the Company’s Japan subsidiary are directorsof Nihon.  Although the Company has twopositions on the Board of Directors of Nihon as of December 31, 2005, it doesnot exercise significant influence, and accordingly, the Company records itsinterest in Nihon based on readily determinable market values in accordancewith 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 $100 millionof the Company’s common shares may be repurchased without prior notice, throughblock trades or otherwise.  The Companyintends that any shares repurchased will be held as treasury shares that may beused for general corporate purposes. From the date of the repurchase through the following thirty days, noamounts under the Company’s $150 million credit facility will beavailable.  Shares repurchased will bepaid with the Company’s existing cash and cash investments.  As of December 31, 2005, no shares had beenrepurchased under the program.

 

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

 

The following discussionof our financial condition and results of operations should be read togetherwith the consolidated financial statements and notes to consolidated financialstatements included elsewhere in this Form 10-Q.  Except for historic information containedherein, the matters addressed in this Item 2 constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended.  Forward-looking statements maybe identified by the use of terms such as “anticipate,” “believe,” “expect,” “intend,”“project,” “will,” and similar expressions. Such forward-looking statements are subject to a variety of risks anduncertainties, including those discussed under the heading “Statement ofCaution Under the Private Securities Litigation Reform Act of 1995” andelsewhere in this Quarterly Report on Form 10-Q, that could cause actualresults to differ materially from those anticipated 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.

 

**Overviewof Results of Operations for the Three Months Ended December 31, 2005**

 

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

 

For the three months endedDecember 31, 2005, consolidated revenue was $278.8 million, compared to $298.6million for the prior year three months ended December 31, 2004.  Focus Product revenue was $215.2 million(77.2 percent of revenue) for the three months ended December 31, 2005,compared to $218.8 million (73.3 percent of revenue) for the three months endedDecember 31, 2004.  Non-Focus Productrevenue was $63.6 million (22.8 percent of revenue) for the three months endedDecember 31, 2005, compared to $79.8 million (26.7 percent of revenue) for thethree 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.  Capacity utilization was above 95 percent forthe three months ended December 31, 2005.

 

Revenue as a percentage oftotal product revenue based on sales location were approximately 27 percent, 51percent and 22 percent for United States, Asia and Europe, respectively, forthe three months ended December 31, 2005, and 31 percent, 46 percent and 23percent for United States, Asia and Europe, respectively, for the three monthsended December 31, 2004.

 

For the three months endedDecember 31, 2005, gross profit margin was 40.0 percent, compared to 43.3percent for the prior year three months ended December 31, 2004.  Gross profit margin for our Focus Productswas 47.8 percent for the three months ended December 31, 2005, compared to 50.7percent for the three 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.  The gross profit margin decline across ourFocus

 

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and Non-Focus Productsreflected primarily price declines on certain of our Power Components, sale ofa lower-margin product mix, and profit sharing and employee stock optionexpense.   We expect our overall Companygross margin for the three months ended March 31, 2006 to be flat, plus orminus one percentage point, compared to the three months ended December 31,2005, tempered by costs associated with the ramp of our Newport, Walesfacility.

 

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

 

In the March 2006 quarter, for our Focus Productsegments, we expect C&C revenue to reflect end-market demand for servers,dual-core notebook platforms and new consumer programs including gamestations.  In the ESP segment, we expectend-market demand for energy-efficient appliances to be strong with the startof the new model year.  In our A&Dsegment, we expect an increase in A&D revenue mainly due to seasonalincreases in demand for certain military programs. For our Non-Focus Productsegments, we continue to manage our exposure to Commodity Products and reviewour Non-Aligned Products.  We haveannounced that we plan to enter into agreements for the Non-Aligned Productdivestitures by the end of the June 2006 quarter.

 

As of December 31, 2005, we have substantially completed ourrestructuring activities previously announced in 2002 and 2003.  We expect to complete the remainingactivities, primarily the closing of a fabrication line at El Segundo,California by fiscal year end 2006.  Forthe three months ended December 31, 2005, we recorded $3.1 million in totalrestructuring-related charges, consisting of: $2.1 million for assetimpairment, plant closure costs and other charges and $1.0 million forseverance-related costs. We estimate that total charges associated with therestructuring will be approximately $273 million. These charges will consist ofapproximately $218 million for asset impairment, plant closure costs and othercharges, $6 million of raw material and work-in-process inventory, andapproximately $49 million for severance-related charges.  Of the $273 million in total charges, weexpect cash charges to be approximately $110 million.  Asof December 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.

 

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.  SFASNo. 123(R) required that we recognize the fair value of equity awards grantedto our employees as compensation expense in the income statement over therequisite service period.  For the threemonths ended December 31, 2005, we recognized $0.8 million in stock-basedcompensation expense associated with

 

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employee stock options as a result of the adoption of SFAS No. 123(R),which lowered our basic and diluted earnings per share by $0.01.

 

During the three months ended December 31,2005, operating activities generated cash flow of $38.8 million.  Our cash, cash equivalents and cashinvestments totaled $918.4 million at December 31, 2005.  Additionally, we have $143.9 million in unusedcredit facilities.

 

Our $550 million convertible subordinatednotes are due in July 2007.  Weanticipate that these notes will be refinanced through public or privateofferings of debt or equity, or be paid down with our existing cash and cashinvestments.

 

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 orotherwise.  We intend that any sharesrepurchased will be held as treasury shares that may be used for generalcorporate purposes.  As of December 31,2005, no shares had been repurchased under the program.

 

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

 

The following table sets forth certain itemsas 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 endedDecember 31, 2005, consolidated revenue decreased by 6.6 percent from the prioryear 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 sixmonths ended December 31, 2005 was lower than the prior year, primarily due tothe combination of price pressure on certain of our Power Components andcapacity constraints in our Computing and Communications segment.  Capacity utilization remained above 95percent for the three months ended December 31, 2005.

 

Gross profit margin was 40.0percent and 40.3 percent for the three and six months ended December 31, 2005,respectively, compared to 43.3 percent and 43.0 percent for the three and sixmonths ended December 31, 2004, respectively. The gross profit margin decline reflected primarily price pressure oncertain of our Power Components, sale of a lower-margin product mix, and profitsharing and 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.  Manufacturing overhead and variances arespecifically

 

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allocated to the segments asappropriate, and general overhead are allocated based on the percentage oftotal revenue.

 

Revenue as a percentage oftotal product revenue based on sales location were approximately 27 percent, 51percent and 22 percent for United States, Asia and Europe, respectively, forthe three months ended December 31, 2005, and 28 percent, 50 percent and 22 percentfor United States, Asia and Europe, respectively, for the six months endedDecember 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 thethree months ended December 31, 2005 was $215.2 million (77.2 percent ofrevenue), compared to $218.8 million (73.3 percent of revenue) for the threemonths ended December 31, 2004.  FocusProduct revenue for the six months ended December 31, 2005 was $417.1 million(75.6 percent of revenue), compared to $440.2 million (72.1 percent of revenue)for the six months ended December 31, 2004. Non-Focus Product revenue for the three months ended December 31, 2005was $63.6 million (22.8 percent of revenue), compared to $79.8 million (26.7percent of revenue) for the three months ended December 31, 2004.  Non-Focus Product revenue for the six monthsended December 31, 2005 was $134.3 million (24.4 percent of revenue), comparedto $170.6 million (27.9 percent of revenue) for the six months ended December31, 2004.  Current period revenues wereadversely affected by price pressure on certain of our Power Components andcapacity constraints in our C&C segment.

 

Gross profit margin for ourFocus Products was 47.8 percent for the three months ended December 31, 2005,compared to 50.7 percent for the three months ended December 31, 2004.  Gross profit margin for our Non-FocusProducts was 13.5 percent for the three months ended December 31, 2005, comparedto 23.3 percent for the three months ended December 31, 2004.  The gross profit margin decline across ourFocus and Non-Focus Products reflected primarily price declines on certain ofour Power Components, sale of a lower-margin product mix, and profit sharingand employee stock option expense.

 

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

 

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Revenue and gross marginby business segments for the three and six months ended December 31, 2005, areas 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 | % |

 

***Computing andCommunications (“C&C”)***

 

OurComputing and Communication segment is comprised of our Power Management ICs,Advanced Circuit Devices, including iPowirTM multi-chip modules andDirectFETTM solutions, and Power Components (primarily MOSFET PowerComponents) that address servers and high-end desktops, notebooks,communications networking, and digitally-oriented consumer products like gameconsoles.  Our C&C products are alsoused in digital television, liquid crystal displays (“LCDs”), portable handhelddevices and cellular phones.

 

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C&Crevenue for the three months ended December 31, 2005, declined by $6.7 million(6.5 percent), compared to the three months ended December 31, 2004.  C&C revenue for the six months endedDecember 31, 2005, declined by $23.0 million (11.1 percent) compared to the sixmonths ended December 31, 2004.  Therevenue decline primarily reflected price pressures on certain of our MOSFETPower Components and product mix. Additionally, C&C revenue was inhibited by capacityconstraints.  We started production on our new eight-inchsub-micron wafer fabrication facility in Newport, Wales in the December 2005quarter to help address our capacity limitations.

 

Grossmargin for C&C was 41.5 percent and 44.7 percent for the three months endedDecember 31, 2005 and 2004, respectively, and 41.6 percent and 44.2 percent forthe six months ended December 31, 2005 and 2004, respectively.  The gross margin decline reflected primarilyprofit sharing and employee stock options expense and some price declines onour MOSFET Power Components.

 

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”)*

 

OurEnergy-Saving Product segment is comprised of our Power Management ICs,Advanced Circuit Devices and Power Components (primarily HEXFET and IGBT PowerComponents) 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).

 

ESPrevenue 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 December31, 2005, increased by $0.6 million (0.4 percent) compared to the six monthsended December 31, 2004. The revenue increase was primarily attributable tohigher sales of our Power Management ICs, partially offset by a decline in ourPower Component business.

 

Grossmargin for ESP was 47.9 percent and 55.3 percent for the three months endedDecember 31, 2005 and 2004, respectively, and 50.1 percent and 54.5 percent forthe six months ended December 31, 2005 and 2004, respectively.  The gross margin decline primarily reflectedprice declines on our automotive Power Components, sale of a lower-marginproduct mix, and profit sharing and employee 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”)*

 

TheAerospace and Defense segment is comprised of advanced power managementsolutions, 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&D revenue for thethree months ended December 31, 2005, increased by $2.2 million (6.9 percent)from the three months ended December 31, 2004. Revenue for the six months ended December 31, 2005, declined by $0.7million (1.0 percent) from the six months ended December 31, 2004.  The A&D revenue increase for the threemonths ended primarily reflected a delayed shipment from the prior September2005 quarter.

 

Grossmargin for the A&D segment increased to 50.0 percent for the three monthsended December 31, 2005, from 42.6 percent in the three months ended December31, 2004, and to 47.1 percent for the six months ended December 31, 2005, from41.9 percent for the six months ended December 31, 2004.  The gross margin improvement reflectedprimarily sale of a higher-margin product mix, manufacturing efficiencies andrestructuring cost savings, partially offset by profit sharing and employeestock option expense.

 

In the March 2006 quarter, we expect an increase inA&D revenue mainly due to seasonal increases in demand for certain militaryprograms.

 

*Intellectual Property (“IP”)*

 

**The Intellectual Property segmentreports our royalty income from licensing our intellectual property to thirdparties, which may include claims settlement from successful defense of ourlicenses.  Our licensed MOSFET patentsexpire between 2005 and 2010, with the broadest remaining in effect until 2007and 2008.  We continue to commit toresearch and development to generate new patents and other intellectual propertyand concentrate on incorporating our technologies into our Focus Products.**

** **

**IP revenue was $10.1 million and$10.5 million for the three months ended December 31, 2005 and 2004,respectively, and $20.5 million and $20.6 million for the six months endedDecember 31, 2005 and 2004, respectively.**

 

*Commodity Products (“CP”)*

 

TheCommodity Product segment is comprised primarily of older-generation PowerComponents that are sold with margins generally below our strategic targets andare typically commodity in nature.  Theseproducts have widespread use throughout the power management product industryand are often complementary to many of our Focus Products offerings or allow usto provide a full range of customer or application offerings. We often offer theseproducts to take advantage of cross-selling opportunities with our otherproduct families.

 

Forthe three months ended December 31, 2005, CP revenue was $39.5 million, down24.7 percent from $52.5 million for the three months ended December 31, 2004.  For the six months ended December 31, 2005, CPrevenue was $81.7 million, down 27.1

 

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percentfrom $112.0 million for the six months ended December 31, 2004.  In line with our strategy, we continue to manageour exposure to Commodity Products.

 

Grossmargin for CP was 16.6 percent and 26.6 percent for the three months endedDecember 31, 2005 and 2004, respectively, and 18.0 percent and 28.9 percent forthe six months ended December 31, 2005 and 2004, respectively.  The gross margin decline reflected primarilyprice pressures, profit sharing and employee stock option expense.

 

*Non-Aligned Products (“NAP”)*

 

**The Non-Aligned Product segmentincludes businesses, product lines or products that we are targeting forrealignment, whether by divestiture or otherwise. We plan to support ourNon-Aligned Products to the extent we believe appropriate, to manage, maintainor 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 the three months ended December 31, 2005, decreasing 12.0percent from $27.3 million in the three months ended December 31, 2004, and$52.6 million in the six months ended December 31, 2005, decreasing 10.2percent from $58.6 million in the six months ended December 31, 2004. Therevenue decline primarily reflected reduced production due in part to componentshortages and product mix.**

 

Grossmargin for our NAP segment was 8.5 percent and 16.9 percent for the threemonths ended December 31, 2005 and 2004, respectively, and 11.8 percent and18.3 percent for the six months ended December 31, 2005 and 2004, respectively,reflecting primarily sale of alower-margin****product mix.

 

Selling and Administrative Expense

 

Forthe three and six months ended December 31, 2005, selling and administrativeexpense was $46.1 million (16.5 percent of revenue) and $91.3 million (16.6percent of revenue), compared to $40.9 million (13.7 percent of revenue) and$87.3 million (14.3 percent of revenue) for the three and six months endedDecember 31, 2004, respectively.  Sellingand administrative expense increased primarily reflecting profit sharing andemployee stock options 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

 

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million (8.7percent of revenue), for the three and six months ended December 31, 2004,respectively.  Research and developmentexpense primarily reflected our continued development activities on our FocusProducts.

 

Impairment ofAssets, Restructuring and Severance

 

During fiscal 2003 secondquarter ended December 31, 2002, we announced our restructuring initiatives.Under our restructuring initiatives, our goal was to reposition us to betterfit the market conditions and de-emphasize the commodity business.  Our restructuring plan included consolidatingand closing certain manufacturing sites, upgrading equipment and processes indesignated facilities and discontinuing production in a number of others thatcannot support more advanced technology platforms or products.  We also planned to lower overhead costsacross our support organizations.  Wehave substantially completed these restructuring activities as of December 31,2005.  We expect to complete theremaining activities, primarily the closing of a fabrication line at ElSegundo, 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 intotal charges, we expect cash charges to be 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 monthsended December 31, 2005, we recorded $3.1 million in totalrestructuring-related charges, consisting of: $2.1 million for plant closurecosts and relocation costs and other impaired asset charges, and $1.0 millionfor severance-related costs.   For thesix months ended December 31, 2005, we recorded $7.4 million in totalrestructuring related charges, consisting of: $5.1 million for plant closureand relocation costs and other impaired assets charges and $2.3 million forseverance costs.  For the three monthsended December 31, 2004, we recorded $6.8 million in totalrestructuring-related charges, consisting of: $5.6 million for plant closureand relocation costs and other impaired asset charges, and $1.2 million forseverance-related costs.  For the six monthsended December 31, 2004, we recorded $13.5 million in totalrestructuring-related charges consisting of: $10.5 million for plant closureand relocation costs and other impaired assets charges, and $3.0 million forseverance costs.

 

Restructuring-relatedcosts were measured in accordance with SFAS No. 146, “Accounting for the CostsAssociated with Exit or Disposal Activities”. Asset impairments were calculated in accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”.  In determining the asset groups, we groupedassets at the lowest level for which independent identifiable cash flowsinformation was available. In determining whether an asset was impaired weevaluated undiscounted future cash flows and other factors such as changes instrategy and technology. The undiscounted cash flows from our initial analyseswere less than the carrying amount for certain of the asset groups, indicatingimpairment losses.  Based on this, wedetermined the fair value of these asset groups using the present valuetechnique, by applying a discount rate to the estimated future cash flows thatis consistent with the rate used when analyzing potential acquisitions.

 

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As of December 31,2005, we had recorded $268.7 million in total charges, consisting of: $215.2million for asset impairment, plant closure costs and other charges, $6.0million for raw material and work-in-process inventory charges, and $47.5million for severance-related costs. 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 expected that these facilities willcontinue in use until approximately December 2007 and the remaining basis isbeing depreciated over units of production during this period. It is assumedthat salvage value will equal disposition costs.

 

•      As we emphasize more advanced generation trench products, we expect thefuture revenue stream from our less advanced facility in El Segundo, Californiato decrease significantly. This facility had a net book value of $59.5 millionand was written down by $57.2 million. This facility had significantly reduced production as of fiscal yearended June 30, 2003, and is being used primarily for research and developmentactivities.

 

•      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 this facility will continue in use untilapproximately December 2007 and the remaining basis is being depreciated overunits of production during this period. It is assumed that salvage value will equal disposition costs.

 

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

 

•      We have eliminated 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 this reduction inmanufacturing activities, certain assets with a net book value of $4.0 millionwere 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 therestructuring initiatives, certain raw material and work-in-process inventorieswere impaired, including products that could not be completed in otherfacilities, materials that were not compatible with the processes used in thealternative facilities, and materials such as gases and chemicals that couldnot readily be transferred. Based on these factors we wrote down theseinventories, with a carrying value of $98.2 million, by $6.0 million.  We disposed of $1.1 million and $0.2 millionof these inventories, for the three and six months ended December 31, 2005 and2004, 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 activitiesare expected to result in severance charges of approximately $49 millionthrough 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 millionnoted above, we have recorded $47.5 million in severance-related charges: $42.4million in severance termination costs related to approximately 1,200administrative, operating and manufacturing positions, and $5.1 million inpension termination costs at our manufacturing facility 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 termination benefits at the communication datebased on the fair value of the liability as of the termination date.  A change resulting from a revision to eitherthe timing or the amount of estimated cash over the future service period willbe measured using the credit-adjusted risk-free rate that was used to initiallymeasure the liability.  The cumulativeeffect of the change will be recognized as an adjustment to the liability inthe period of the change.

 

In fiscal 2002, we had recordedan estimated $5.1 million in severance costs associated with the acquisition ofTechnoFusion GmbH in Krefeld, Germany. In fiscal 2003, we finalized our plan and determined that totalseverance would be approximately $10 million, and accordingly, we adjustedpurchased goodwill by $4.8 million.  Wecommunicated the plan and the elimination of approximately 250 positionsprimarily in manufacturing to our affected employees at that time.  We have completed the restructuring of ourKrefeld facility as of December 31, 2005, and determined that $0.7

 

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million of the severancereserve was excess.  Accordingly, wedecreased TechnoFusion purchased goodwill by $0.7 million.

 

Thefollowing summarizes our accrued severance liability related to the June 2001restructuring, the TechnoFusion acquisition and the December 2002 restructuringplan for the three months ended December 31, 2005 and the fiscal year endedJune 30, 2005.  Severance activityrelated to the elimination of 29 administrative and operating personnel as partof the previously reported restructuring in the fiscal quarter ended June 30,2001, is also disclosed.  The remainingJune 2001 severance relates primarily to certain legal accruals associated withthat restructuring, which will be paid or released as the outcome is determined(in thousands):

 
| ** **                                                                                          | ** ** | **June  2001  Restructuring** | ** ** | **December  2002  Restructuring** | ** ** | **TechnoFusion  Severance  Liability** | ** ** | **Total  Severance  Liability** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| Accrued severance, June 30, 2004                                                                    |       | $                             | 697        |                              | $          | 7,180                                  |       | $                               | 6,067      |   | $ | 13,944 |   |
| Costs incurred or charged to “impairment of  assets, restructuring and severance charges” |       | —                        |       | 8,677                             |       | —                                 |       | 8,677                           |       |
| Costs paid                                                                                          |       | (326                          | )          | (7,810                            | )          | (3,770                                 | )          | (11,906                         | )          |
| Foreign exchange impact                                                                             |       | —                        |       | 77                                |       | (190                                   | )          | (113                            | )          |
|                                                                                                |       |                          |       |                              |       |                                   |       |                            |       |
| Accrued severance, June 30, 2005                                                                    |       | $                             | 371        |                              | $          | 8,124                                  |       | $                               | 2,107      |   | $ | 10,602 |   |
| Costs incurred or charged to “impairment of  assets, restructuring and severance”         |       | —                        |       | 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 income was $7.8million and $3.8 million for the three months ended December 31, 2005 and 2004,respectively, and $14.9 million and $7.2 million for the six months endedDecember 31, 2005 and 2004, respectively, reflecting higher prevailing interestrates on higher average cash and cash investment balance in the current year.

 

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

 

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Loans and Long-Term Debt” of the Notes to theunaudited consolidated financial statements, regarding the modification of theeffective interest payable on our convertible notes).

 

Income Taxes

 

Oureffective tax provision for the three months ended December 31, 2005 and 2004 was27.5 percent and 22.8 percent, respectively, and 27.5 percent and 25.2 for thesix 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 statutorytax rates in certain foreign jurisdictions, the benefit of foreign tax creditsand research and development credits, partially offset by state taxes andcertain foreign losses without foreign tax benefits.

 

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. We are 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.

 

**Liquidity and Capital Resources**

 

At December 31, 2005, we had cash and cashequivalent balances of $273.7 million and cash investments in marketable debtsecurities of $644.7 million. We also have $143.9 million in unused creditfacilities.  Our investment portfolioconsists of available-for-sale fixed-income, principally investment-gradesecurities as of December 31, 2005.

 

For the six monthsended December 31, 2005, cash provided by operating activities was $52.6million compared to $99.2 million in the comparable prior year six months endedDecember 31, 2004.  Depreciation andamortization adjusted cash flows from operations by $42.9 million.  Changes in operating assets and liabilitiesdecreased cash by $56.7 million during the six months ended December 31,2005.  The increase in working capitalreflected the increase in our inventory balance as a result of the build up ofinventory to support our backlog, the timing of accounts and other receivablecollections, taxes and other accrued expense payments.

 

For the six months ended December 31, 2005, cash used in investingactivities was $145.3 million. We purchased $300.9 million and sold $233.1million of cash investments. Certain prior year’s amounts have beenreclassified to conform to the current-year presentation.  Auction rate securities are now classified asavailable-for-sale securities and reported as short-term cash investmentsinstead of cash and cash equivalents, for all periods presented.  For the six months ended December 31, 2004,proceeds from the sale of auction rate securities reduced net cash used ininvesting activities by $74.1 million.

 

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 ourcapacity limitations, we started production at our new facility in Newport,

 

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Wales in the December 2005 quarter. Purchase order commitments for capital expenditures were $31.7 millionas of December 31, 2005.  We intend tofund capital expenditures and working capital requirements through cash andcash equivalents on hand, anticipated cash flow from operations and availablecredit facilities.

 

Financing activities for the six months endedDecember 31, 2005 provided $3.3 million. Proceeds from the exercise of employeestock options and stock participation plan contributed $24.5 million whilerepayments of short-term debt decreased cash by $15.3 million. As of December31, 2005, we had revolving, equipment and foreign credit facilities of $166.6million, against which $22.6 million had been used.  As discussed in Note 4 of the unauditedconsolidated financial statements, we are required to obtain irrevocablestandby letters of credit in favor of JP Morgan Chase Bank, for $7.5 million plusthe collateral requirement for the interest rate swap transactions, asdetermined periodically.  At December 31,2005, $17.0 million in letters of credit were outstanding related to thetransactions.  The collateral requirementof the transactions may be adversely affected by an increase in the five-yearLIBOR curve, a decrease in our stock price, or both.  We cannot predict what the collateralrequirement of the transactions and the letter of credit requirement will beover 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 haveany off-balance sheet arrangements as of December 31, 2005.

 

On November 1, 2005, our Board of Directorsauthorized and we announced a stock repurchase program, under which up to $100million of our common shares may be repurchased without prior notice, throughblock trades or otherwise.  Any sharesrepurchased will be paid with our existing cash and cash investments.  As of December 31, 2005, we have notrepurchased any shares.

 

Our $550 million convertible subordinatednotes are due in July 2007.  Weanticipate that these notes will be refinanced through public or privateofferings of debt or equity, or be paid down with our existing cash and cashinvestments.

 

We believe that our current cash and cashinvestment balances, cash flows from operations and borrowing capacity,including unused amounts under the $150 million Credit Facility as discussed inNote 9 of the unaudited consolidated financial statements, will be sufficientto meet our operations in the next twelve months. Although we believe that ourcurrent financial resources will be sufficient for normal operating activities,we may also consider the use of funds from other external sources, including,but not limited to, public or private offerings of debt or equity.

 

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**Recent Accounting Pronouncements**

 

In November 2005, the Financial AccountingStandards Board (“FASB”) issued FASB Staff Position (“FSP”) on Statement ofFinancial Accounting Standard (“SFAS”) No. 115-1 and SFAS No. 124-1, “TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments” (“FSP FAS No. 115-1”), which provides guidance on determining wheninvestments in certain debt and equity securities are considered impaired,whether that impairment is other-than-temporary, and on measuring suchimpairment loss.  FSP FAS No. 115-1 also includes accountingconsiderations subsequent to the recognition of an other-than-temporaryimpairment and requires certain disclosures about unrealized losses that havenot been recognized as other-than-temporary impairments.  FSP FAS No.115-1 is effective for reporting periods beginning after December 15, 2005. Our adoption of FSP FAS No. 115-1 will not have a material impact on ourresults of operations or financial condition.

 

On October 18, 2005, the FASB issued FASBStaff Position on SFAS No. 123(R)-2 (“FSP FAS No. 123(R)-2”). FSP FAS No.123(R)-2 provides guidance on the application of grant date as defined in SFASNo. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”).  As a practical accommodation, in determiningthe grant date of an award, assuming all other criteria in the grant datedefinition have been met, FSP FAS No. 123(R)-2 provides that a mutualunderstanding of the key terms and conditions of an award to an individual employeeshall be presumed to exist at the date the award is approved in accordance withthe relevant corporate governance requirements (that is, by the Board ormanagement with the relevant authority) if both of the following conditions aremet:

 

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 andconditions of the award are expected to be communicated to an individualrecipient within a relatively short time period1 from the date ofapproval.

 

The guidance in FSP FAS No. 123(R)-2 iseffective upon initial adoption of SFAS No. 123(R) or if an entity has adoptedSFAS No. 123(R) prior to the issuance of this FSP and did not apply theprovisions of FSP FAS No. 123(R)-2, this FSP will be effective in the firstreporting period after October 18, 2005, the date the FSP was posted to theFASB website.  We have applied theprovisions under FSP FAS No. 123(R)-2 in accounting for our equity awards as ofJuly 4, 2005, the start of our fiscal year 2006.

 

**Critical Accounting Policies and Estimates**

 

The consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States which requireus to make estimates and assumptions that affect the reported amounts of assetsand liabilities at the date of the consolidated financial statements andrevenues and expenses during the periods reported. Actual results could differfrom those estimates. Information with respect to our critical accountingpolicies which we believe could have the most significant effect on ourreported results and require subjective or complex judgments is contained inItem 7, Management’s Discussion and Analysis of Financial Condition and Resultsof Operations, of our Annual Report on Form 10-K for the fiscal year ended

 

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June 30, 2005.  We believe thatat December 31, 2005, there has been no material change to this information.

 

**Statement of Caution Under the PrivateSecurities 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 of1995.  The materials presented can beidentified by the use of forward-looking terminology such as “anticipate,” “believe,”“estimate,” “expect,” “may,” “should,” “view,” or “will” or the negative orother variations thereof.  We cautionthat such statements are subject to a number of uncertainties, and actualresults may differ materially. Factors that could affect our actual resultsinclude those set forth below under “Factors that May Affect Future Results”and other uncertainties disclosed in our reports filed from time to time withthe Securities and Exchange Commission. Unless required by law, we undertake no obligation to publicly update orrevise any forward looking statements, to reflect new information, futureevents or otherwise.

 

**Factors that May Affect Future Results**

 

***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 andautomotive markets.  Changes in thedemand mix, needed technologies and these end markets may adversely affect ourability to match our products, inventory and capacity to meet customer demandand could adversely affect our operating results and financial condition.

 

In addition, the semiconductor industry is highly cyclical and thevalue of our business may decline during the down portion of these cycles.  We have experienced these conditions in ourbusiness in the recent past and we cannot predict when we may experience suchdownturns in the future.  Futuredownturns in the semiconductor industry, or any failure of the industry torecover fully from its recent downturns could seriously impact our 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 marginguidance is dependent on a certain level of consumer and/or corporate spendingfor the specific mix of products we produce and have the capacity to produce.If our projections of these expenditures fail to materialize, or materialize ina mix different from that for which we anticipate and build inventory,

 

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whether due to reduced consumeror corporate 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 relatedto products within our Aerospace and Defense and Non-Aligned Product segments,we manufacture primarily pursuant to purchase orders for current delivery or toforecast, rather than pursuant to long-term supply contracts.  The semiconductor industry is subject torapid changes in customer outlooks or unexpected build ups of inventory in thesupply channel as a result of shifts in end-market demand generally or in themix of that demand.  Accordingly, many ofthese purchase orders or forecasts may be revised or canceled withoutpenalty.  As a result, we must commitresources to the manufacturing of products, and a specific mix of products,without any advance purchase commitments from customers.  Our inability to sell products after wedevote significant resources to build them could have a material adverse effecton our levels of inventory (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 quarterended December 31, 2005, we reported net inventories of approximately $209million. We build and maintain inventory in order to meet our historic andprojected needs, but cannot guarantee that the inventory we build will beadequate or the right mix of products to meet market demand.  If we do not project and build the proper mixand amount of inventory, our revenue and gross margin may be adverselyaffected.  Additionally, if we produce orhave produced inventory that does not meet current or future demand, we maydetermine at some point that certain of the inventory may only be sold at adiscount or may not be sold at all, resulting in the reduction in the carryingvalue of our inventory and a material adverse effect on our financial conditionand 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 andother competitive pressures can adversely affect 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 tohigh 90s percent of our worldwide semiconductor fabrication and assembly/modulemanufacturing capacities, without taking into account subcontract or foundrycapacity.  We are also expanding our mostadvanced wafer fabrication facility in Newport, Wales to provide additionalcapacity to support the growth of our Focus Products.  We have started production on certain of suchnew facilities during the December 2005 quarter, and expect to complete ourexpansion of that facility in about calendar year 2006. If we fail to timelyexecute on those plans in advance of demand for our products, that failurecould adversely affect our revenue growth and ability to achieve our margintargets.  We cannot assure you that wewill complete our plans timely, that the ramp-up of the expanded facilitieswill occur effectively and without error or delay, or that sufficient thirdparty sources would be available to satisfy our ability to meet customerdemand.  Even if we fully execute andimplement our plans, we cannot guarantee that we will have sufficient worldwidesemiconductor fabrication and assembly/module manufacturing capacities to meetdemand and there may be other unforeseen factors that could adversely impactour operating results.

 

***Delays in initiation of production at new facilities, implementing newproduction techniques or resolving problems associated with technical equipmentmalfunctions could adversely affect our manufacturing efficiencies***.

 

Our manufacturing efficiencyhas been and will be an important factor in our future profitability, and wemay not be able to maintain or increase our manufacturing efficiency.  Our manufacturing and testing processes arecomplex, require advanced and costly equipment and are continually beingmodified in our efforts to improve yields and product performance. Difficultiesin the manufacturing process can lower yields. Technical or other problems could lead to production delays, ordercancellations and lost revenue.  Inaddition, any problems in achieving acceptable yields, construction delays, orother problems in upgrading or expanding existing facilities, building newfacilities, problems in bringing other new manufacturing capacity to fullproduction or changing our process technologies, could also result in capacityconstraints, production delays and a loss of future revenue and customers.  Our operating results also could be adverselyaffected by any increase in fixed costs and operating expenses related toincreases in production capacity if net sales in the appropriate mix do notincrease proportionately, or in the event of a decline in demand for some orall 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 in businessmodel of certain of our Non-Focus Products (and, may divert, discontinue or changethe business model for others) that are not consistent with our businessobjectives or margin targets.  Our planis to replace the divested or discontinued revenues with (or change thebusiness model to achieve) higher-margin product sales and target gross marginof greater 50 percent.  We cannot assureyou that we will complete our plans or achieve our target gross margin, timelyor at all.  Additionally, we haveannounced that we plan to enter into agreements with respect to certaindivestitures by the end of June 2006.  Asa number of factors, among those factors controlled by third parties, affectour ability to complete those plans, we cannot assure you that we can achieveour 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 anextent we have not anticipated.  Even ifwe fully execute and implement our plans, there may be unforeseen factors thatcould have a material adverse impact on our 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 restructuringinitiatives.  Our goal was to repositionour company to better fit the market conditions, de-emphasize our commoditybusiness and accelerate the move to what we categorize as our proprietaryproducts, which refer to our Power Management ICs, Advanced Circuit Devices,and Power Systems.  The restructuringincludes consolidating and closing certain manufacturing sites, upgradingequipment and processes in designated facilities and discontinuing productionin a number of others that cannot support more advanced technology platforms orproducts.  The restructuring alsoincludes lowering overhead costs across our support organization. We cannotassure you that these restructuring initiatives will achieve their goals,accomplish the cost reductions planned, or be accomplished within ourexpectations as to the amount of charges to be taken in connection with thatactivity.  Additionally, because ourrestructuring activities involve changes to many aspects of our business, theactivities could adversely affect productivity and sales to an extent we havenot 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 bedefective and, as a result, product claims may be asserted against us, whichmay harm our business and our reputation with our customers and significantlyadversely affect 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 areincorporated.  Although we maintainrigorous quality control systems, we shipped large quantities of semiconductordevices in 2005 to a wide range of customers around the world, in a variety ofhigh profile and critical applications, and continue to do so.  In the ordinary course of our business wereceive warranty claims for some of these products that are defective, or thatdo not perform to published specifications. Since a defect or failure in our products could give rise to failures inthe end products that incorporate them (and consequential claims for damagesagainst our customers from their customers depending on applicable law andcontract), we often need to defend against claims for damages that aredisproportionate to the revenue and

 

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profit we receive from the products involved.  In addition, our ability to reduce suchliabilities may be limited by the laws or the customary business practices ofthe countries where we do business.  Evenin cases where we do not believe we have legal liability for such claims, wemay choose to pay for them to retain a customer’s business or goodwill or tosettle claims to avoid protracted litigation. Our results of operations and business would be adversely affected as aresult of a significant alleged quality or performance issues in our products,if we are required or choose to pay for the damages that result.  In addition, in our Aerospace and Defensesegment, we are sometimes subject to government procurement regulations andother laws that could result in costly investigations and other legalproceedings as a consequence of allegedly defective products or otheractions.  Although we currently haveproduct liability and other types of insurance, we have certain deductibles andexclusions to such policies and may not have sufficient insurancecoverage.  We also may not have sufficientresources to satisfy all possible product liability or other types of productclaims.  In addition, any perception thatour products are defective would likely result in reduced sales of ourproducts, loss of customers and harm to our business and reputation.

 

***While we attempt to monitor thecredit worthiness of our customers, we may from time to time be at risk due tothe adverse 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 original equipment manufacturers (“OEMs”)do not design our products into their equipment, a portion of our revenue maybe adversely affected.***

 

A “design win” from a customerdoes not guarantee future sales to that customer. We also are unable toguarantee that we will be able to convert design wins into sales for the lifeof any particular program, or at all, or that the revenue from such wins wouldbe 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 our products to these OEMs as a second source, ifat all. Once an OEM designs another supplier’s semiconductor into one of itsproduct platforms, it is more difficult for us to achieve future design winswith that OEM’s product platform because changing suppliers involvessignificant cost, time, effort and risk. Achieving a design win with a customerdoes not ensure that we will receive significant revenue from that customer andwe may be unable to convert design wins into actual sales.

 

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

 

Our revenue and gross marginguidance is dependent on a certain level of corporate investment andexpenditures in the Information Technology sector and in Information Technologypurchases. If our projections of these expenditures fail to materialize,whether due to increased oil prices, change in market conditions, or otherwise,our revenue and gross margin could be adversely impacted.

 

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***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 currently a defendant in intellectualproperty claims and we could become subject to other lawsuits in which it isalleged that we have infringed upon the intellectual property 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 expendsignificant resources to develop or acquire non-infringing technologies. Wecannot assure you that we would be successful in such efforts or that suchlicenses would be available under reasonable terms. Our failure to develop oracquire non-infringing technologies or to obtain licenses on acceptable termsor the occurrence of related litigation itself could have a material adverseeffect on our operating results and financial condition.

 

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***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 we can obtain new licenses to offsetreductions in royalties from existing licenses. While we try to predict theeffects of these factors and efforts, often there are variations or factorsthat can significantly affect results different from that predicted.  Accordingly, we cannot guarantee that ourpredictions of our IP segment revenue will be consistent with actualresults.  We also cannot guarantee thatour royalty income will continue at levels consistent with prior periods.  Any decrease in our royalty income could havea material adverse effect on our operating results and financial condition.

 

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

 

Weexpect revenue from foreign markets to continue to represent a significantportion of total revenue. We maintain or contract with significant operationsin foreign countries.  Among others, thefollowing risks are inherent in doing business internationally: changes in, orimpositions of, legislative or regulatory requirements, including tax laws inthe United States and in the countries in which we manufacture or sell ourproducts; trade restrictions; transportation delays; work stoppages; economicand political instability; and foreign currency fluctuations.

 

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

 

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.

 

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***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 facilitiesor in effecting transitions to new manufacturing processes. As a consequence,we have 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 anticipatetransferring our El Segundo manufacturing to the Newport, Wales facility byfiscal year end June 2006.  We haveexperienced some delays and/or technical problems in moving our variousfacilities.  Continued delays and/ortechnical problems in completing the remaining transfers could lead toincreased 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.

 

We manufacture a substantial portion of our wafer product at ourTemecula, California and Newport, Wales facilities. Any disruption of operationsat those facilities could have a material adverse effect on our business,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.

 

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Due to the amount of time often required to qualify assemblers and testersand the high cost of qualifying multiple parties for the same products, wecould experience delays in the shipment of our products if we are forced tofind alternative third parties to assemble or test them. Any product deliverydelays in the future could have a material adverse effect on our operatingresults and financial condition. Our operations and ability to satisfy customerobligations could be adversely affected if our relationships with thesesubcontractors were disrupted or terminated.

 

***We must 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.

 

***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 may continue to expand and diversify ouroperations with additional acquisitions. If we are unsuccessful in integratingthese companies with our operations, or if integration is more difficult thananticipated, we may experience disruptions that could have a material adverseeffect on our business, financial condition and results of operations.

 

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***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 that factors such as quarterly fluctuations infinancial results, earnings below analysts’ estimates and financial performanceand other activities of other publicly traded companies in the semiconductorindustry could cause the price of our common stock to fluctuatesubstantially.  In addition, in recentperiods, our common stock, the stock market in general and the market forshares of semiconductor industry-related stocks in particular have experiencedextreme price fluctuations which have often been unrelated to the operatingperformance of the affected companies. Any similar fluctuations in the future could adversely affect the marketprice of our common stock.

 

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

 

We invest excess cash inmarketable securities consisting primarily of commercial paper, corporatenotes, corporate bonds and governmental securities.  We also hold as strategic investments thecommon stock of two publicly-traded Japanese companies, one of which is NihonInter Electronics Corporation.  The valueof these investments is subject to market fluctuations, which if adverse, couldhave a material adverse effect on our operating results and financial condition.

 

***If we fail to maintain an effective system ofinternal control over financial reporting or discover material weaknesses inour internal control over financial reporting or financial reporting practices,we may not be able to report our financial results accurately or detect fraud,which could harm our business and the trading price of our stock.***

 

Effective internal controls arenecessary for us to produce reliable financial reports and are important in oureffort to prevent financial fraud. We are required to periodically evaluate theeffectiveness of the design and operation of our internal controls. Theseevaluations may result in the conclusion that enhancements, modifications orchanges to our internal controls are necessary or desirable.  While management evaluates the effectivenessof our internal controls on a regular basis, we cannot provide absoluteassurance that these controls will always be effective or any assurance thatthe controls, accounting processes, procedures and underlying assumptions willnot be subject to revision. There are also inherent limitations on theeffectiveness of internal controls and financial reporting practices includingcollusion, management override, and failure of human judgment. Because of this,control procedures are designed to reduce rather than eliminate business risks.If we fail to maintain an effective system of internal control over financialreporting or if 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), wemay be unable to produce reliable financial reports or prevent fraud and itcould harm our financial condition and results of operations and result in lossof investor confidence and a decline 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

 

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manufacturing processes. In addition, under some laws and regulations,we could be held financially responsible for remedial measures if ourproperties are contaminated or if we send waste to a landfill or recyclingfacility that becomes contaminated, even if we did not cause the contamination.Also, we may be subject to common law claims if we release substances thatdamage or harm third parties. Further, we cannot assure you that changes inenvironmental laws or regulations will not require additional investments incapital equipment or the implementation of additional compliance programs inthe future. Any failure to comply with environmental laws or regulations couldsubject us to serious liabilities and could have a material adverse effect onour 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 remaincompetitive, as new and enhanced semiconductor processes are developed whichpermit smaller, more efficient and more powerful semiconductor devices. Wemaintain certain of our own manufacturing, assembly and test facilities, whichhave required and will continue to require significant investments inmanufacturing technology and equipment. We are also attempting to add theappropriate level and mix of capacity to meet our customers’ future demand.There can be no assurance that we will have sufficient capital resources tomake necessary investments in manufacturing technology and equipment. Althoughwe believe that anticipated cash flows from operations, existing cash reservesand other equity or debt financings that we may obtain will be sufficient tosatisfy our future capital expenditure requirements, there can be no assurancethat this will be the case or that alternative sources of capital will beavailable to us on favorable terms or at all.

 

***The maturity of our outstanding ConvertibleSubordinated Notes due in July 2007 may expose us to risks.***

*** ***

We have outstanding $550 million in Convertible Subordinated Notes duein July 2007.  While we intend torefinance or pay down such notes prior to maturity, if we decide to refinancesuch notes, in whole or in part, we cannot guarantee that the terms, includinginterest rate and costs, would be comparable to the current interest rate andcosts, and if higher, could adversely affect our future results.  Additionally, if we elect, in whole or inpart, to pay down such notes, it would lower the amount of funds we haveavailable for operations or investment.

 

***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 withSFAS No. 109, “Accounting for Income Taxes”, the carrying value of the netdeferred tax assets is based on the belief that it is more likely than not thatwe will generate sufficient future taxable income in certain jurisdictions torealize these deferred tax assets, after considering all available positive andnegative evidence.  If our assumptionsand estimates change in the future given unforeseen changes in marketconditions, 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 useall or a portion of the deferred tax assets for which a valuation allowance hasbeen established, then the related portion of the valuation allowance will bereleased to income as a credit to income tax expense.

 

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***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 the final outcome or the timing ofresolution of any particular tax matter. We have provided certain tax reserves which have been included in thedetermination of our financial results. However, unpredicted unfavorable settlements may require additional useof cash and negatively impact our financial position or results of 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 ourprofitability.  Future terrorist orrelated activities could affect our domestic and international sales, disruptour supply chains and impair our ability to produce and deliver ourproducts.  Such activities could affectour physical facilities or those of our suppliers or customers, and maketransportation of our supplies and products more difficult or cost prohibitive.  Due to the broad and uncertain effects thatterrorist attacks have had on financial and economic markets generally, wecannot provide any estimate of how these activities might affect our futureresults.

 

***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 affect our domestic andinternational sales, disrupt our supply chains, and impair our ability toproduce and deliver our products.  Whilewe do not have facilities located near the affected areas, such activitiescould affect physical facilities, primarily for raw materials and processchemicals and gases of our suppliers or customers, and make transportation ofour supplies and products more difficult or cost prohibitive.  Due to the broad and uncertain effects thatnatural events have had on financial and economic markets generally, we cannotprovide any estimate of how these activities might affect our future results.

 

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**ITEM 3.**            **Quantitative and Qualitative Disclosures about MarketRisk**

 

We are exposed to variousrisks, including fluctuations in interest and foreign currency rates. In thenormal course of business, we also face risks that are either non-financial ornon-quantifiable. Such risks principally include country risk, credit risk andlegal risk and are not discussed or quantified in the following analyses, aswell as risks set forth under the heading “Factors that May Affect FutureResults” in this Quarterly Report on Form 10-Q and in our Annual Report on Form10-K for the fiscal year ended June 30, 2005.

 

*Interest Rate Risk*

 

Our financial assets andliabilities subject to interest rate risk are cash investments, convertibledebt, credit facilities and interest rate swaps.  Our primary objective is to preserve principalwhile maximizing yield without significantly increasing risk.  At December 31, 2005, we evaluated the effectthat near-term changes in interest rates would have had on these transactions.  A change of as much as ten percent in theLondon InterBank Offered Rate (“LIBOR”) would have had a favorable impact ofapproximately $0.3 million and $0.7 million on net interest income/expense forthe three and six months ended December 31, 2005, since the interest income onour cash and cash investments would have outweighed additional interest expenseon our outstanding debt.  For our interest rate contract with LehmanBrothers, an increase of ten percent in interest rates would have had afavorable impact of $0.6 million, and a decrease of ten percent in interestrates would have had an adverse impact of ($0.1) million, on net interestincome/expense.  These changes would nothave had a material impact on our results of operations, financial position orcash flows.

 

InDecember 2001, we entered into an interest rate swap transaction (the “Transaction”)with JP Morgan Chase Bank (the “Bank”), to modify our effective interestpayable with respect to $412.5 million of our $550 million outstandingconvertible debt (the “Debt”) (see Notes 4, “Derivative Financial Instruments,”and 9, “Bank Loans and Long-Term Debt”). At the inception of the Transaction, interest rates were lower than thatof the Debt and we believed that interest rates would remain lower for anextended period of time.  In April 2004,we entered 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 variable interest rate we have paid since the inception of the swaphas averaged 2.68 percent, compared to a coupon of 4.25 percent on theDebt.  For the three months endedDecember 31, 2005 and 2004, this arrangement increased (decreased) interestexpense by $0.8 million and ($2.5) million, respectively, and ($0.1) millionand ($4.7) million for the six months ended December 31, 2005 and 2004,respectively.

 

Accountedfor as fair value hedges under SFAS No. 133, the mark-to-market adjustments ofthe two Transactions were offset by the mark-to-market adjustments on the Debt,resulting in no material impact to earnings. To measure the effectiveness of the hedge relationship, we used aregression analysis.  To evaluate 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, ourability to call the Debt was considered in assessing the effectiveness of thehedging relationship.  For those yearsthat were projected to include at least a portion of

 

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redemptionof the convertible debentures, we employed a valuation model known as a MonteCarlo simulation.  This simulationallowed us to project probability-weighted contractual cash flows discounted atthe LIBOR swap rate that corresponded to the Debt’s expected maturitydate.  The market value of the December2001 Transaction was a liability of $5.8 million and $0.3 million at December31, 2005 and June 30, 2005, respectively. The market value of the April 2004 Transaction was a liability of $4.7million and $3.4 million at December 31, 2005 and June 30, 2005, respectively.

 

InApril 2002, we entered into an interest rate contract (the “Contract”) with aninvestment bank, Lehman Brothers (“Lehman”), to reduce the variable interestrate risk of the Transaction.  Thenotional amount of the Contract is $412.0 million, representing approximately75 percent of the Debt. Under the terms of the Contract, we have the option toreceive a payout from Lehman covering our exposure to LIBOR fluctuationsbetween 5.5 percent and 7.5 percent for any four designated quarters.  The market value of the Contract at December31, 2005 and June 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 six monthsended December 31, 2005 and 2004, respectively, were charged to interestexpense.

 

*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.  Consideringour foreign currency risks, we have the greatest exposure to the Japanese Yen,since we have significant Yen-based revenue without the Yen-based manufacturingcosts.  The risk of our revenues in theEuropean currencies is partially offset by the cost of manufacturing goods inthe 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 against reductions in value andvolatility of future cash flows caused by changes in currency exchange rates,we have established revenue, expense and balance sheet hedging programs.  Currency forward contracts and local Yen andEuro borrowings are 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 into account our derivative financialinstruments and offsetting positions, would have resulted in an annualized adverseimpact on income before taxes of less than $1 million for the three and sixmonths ended December 31, 2005 and 2004.

 

In March 2001, weentered into a five-year foreign exchange forward contract (the “ForwardContract”) for the purpose of reducing the effect of exchange rate fluctuationson forecasted intercompany purchases by our subsidiary in Japan.  We have designated the Forward Contract as acash flow hedge under which mark-to-market adjustments are recorded inaccumulated other comprehensive income of stockholders’ equity, until theforecasted transactions are recorded in earnings.  Under the terms of the Forward Contract, weare required to exchange 1.2 billion Yen for $11.0 million on a quarterly basisfrom June 2001 to March 2006.  At December31, 2005, one quarterly

 

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payment of 1.2 billionYen remained to be swapped at a forward exchange rate of 109.32 Yen per U.S.dollar.  The market value of the forwardcontract was $0.7 million and $0.1 million at December 31, 2005 and June 30,2005, respectively, and was included in other long-term assets.  Mark-to-market gains (losses), included inother 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 comparing forecasted transactions through theForward Contract expiration date to its cash flow requirements, we do notexpect to incur a material charge to income during the next three monthsthrough 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 and unrealized foreign-currencygains recognized in earnings were less than $1 million for the three and sixmonths ended December 31, 2005 and 2004.

 

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

 

(a)   Evaluation ofdisclosure controls and procedures

 

The term “disclosurecontrols and procedures” refers to the controls and other procedures of acompany that are designed to ensure that information required to be disclosedby the company in the reports that it files under the Securities Exchange Actof 1934 (“Exchange Act”) is recorded, processed, summarized and reported,within required time periods.  Our management,with the participation of our Chief Executive Officer, Alexander Lidow, andChief Financial Officer, Michael P. McGee, carried out an evaluation of theeffectiveness of our disclosure controls and procedures pursuant to ExchangeAct Rule 13a-15(b).  Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat, as of the end of the period covered by this report, such controls andprocedures are effective at the reasonable assurance level in making known tothem material information related to us (including our consolidatedsubsidiaries) required to be included in this report.

 

Disclosurecontrols and procedures, no matter how well designed and implemented, canprovide only reasonable assurance of achieving an entity’s disclosureobjectives.  The likelihood of achievingsuch objectives is affected by limitations inherent in disclosure controls andprocedures.  These include the fact thathuman judgment in decision-making can be faulty and that breakdowns in internalcontrol can occur because of human failures such as simple errors, mistakes orintentional circumvention of the established processes.

 

(b)   Changesin internal controls

 

There was nochange in our internal controls during the fiscal second quarter 2006 that hasmaterially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

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### **PARTII.          OTHERINFORMATION**

 

**ITEM 2.**            **Unregistered Sales of Equity Securities and Use ofProceeds**

 

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

 
| **Period**                                 | ** ** | **(a) Total Number  of Shares (or  Units) Purchased** | ** ** | **(b) Average Price  Paid per Share (or  Unit)** | ** ** | **(c) Total Number  of Shares (or  Unites) Purchased  as part of Publicly  Announced Plans  or Programs** | ** ** | **(d) Maximum  Number (or  Approximate  Dollar Value) of  Shares (or Units)  that can be  Purchased Under  the Plans or  Programs** | ** **  |
|--------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|-------------|
| Month #1 (November 1 to November 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 of Security 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 matterswere approved by the Company’s stockholders. Below is a summary of, where applicable, the number of votes cast for,against or withheld, as well as the number of abstentions as to each matter.

 
| ** ** | ** ** | ** **                | ** ** | ** ** | ** ** | **Authority** | ** ** |
|------------|------------|---------------------------|------------|------------|------------|---------------|------------|
| ** ** | ** ** | **Description of Matter** | ** ** | **For**    | ** ** | **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 Participation Plan as described in the proxy  materials |   | 45,313,529 | ** ** | 1,474,493   |       | 218,400         | ** ** |
|   |   |                                                                                                     |   |       | ** ** | ** **  | ** ** | ** **      | ** ** |
|   |   | Broker  non-votes                                                                                        |   | 15,616,914 | ** ** | ** **  | ** ** | ** **      | ** ** |

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

 

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| **ITEM 6.** | ** ** | **Exhibits** |
|-------------|------------|--------------|
|        |       |         |
|        |       | Index:       |   |   |
|        |       |         |   |   |
|        |       | 3.1          |   | Certificate of Incorporation, as Amended to Date (incorporated by  reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-8  filed with the Commission on July 19, 2005; Registration No. 333-117489) |
|        |       |         |   |   |
|        |       | 3.2          |   | Bylaws, as Amended (incorporated by reference to Exhibit 3.2 to the  Company’s quarterly report on Form 10-Q filed with the Commission on November  11, 2005) |
|        |       |         |   |   |
|        |       | 11.1         |   | Statement Regarding Computation of Per Share Earnings (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) of the Securities Exchange Act  of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|        |       |         |   |   |
|        |       | 31.2         |   | Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act  of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|        |       |         |   |   |
|        |       | 32.1         |   | 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 theSecurities Exchange Act of 1934, the Registrant has duly caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 

 
|               | **INTERNATIONAL  RECTIFIER CORPORATION** |                                         |
|--------------------|------------------------------------------|----------------------------------------------|
|               | **Registrant**                           |                                         |
|               |                                     |
|               |                                     |
| February 10,  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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