INTEGRATED DEVICE TECHNOLOGY INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 26, 2004

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

For the transition period from to .

Commission File No. 0-12695

INTEGRATED DEVICE TECHNOLOGY, INC.

(Exact Name of Registrant as Specified in Its Charter)

DELAWARE		94-2669985
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

2975 STENDER WAY, SANTA CLARA, CALIFORNIA		95054
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone Number, Including Area Code: (408) 727-6116

NONE

Former name, former address and former fiscal year (if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes ý No o

The number of outstanding shares of the registrant’s Common Stock, $.001 par value, as of October 22, 2004, was approximately 106,752,000.

PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

INTEGRATED DEVICE TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE DATA)

	Three months ended						Six months ended
	Sep. 26, 2004			Sep. 28, 2003			Sep. 26, 2004			Sep. 28, 2003

Revenues	$	96,671		$	80,777		$	197,978		$	163,822
Cost of revenues	48,247			42,201			96,608			90,925
Asset impairment	(1,585		)	—			(1,794		)	—

Gross profit	50,009			38,576			103,164			72,897

Operating expenses:

Research and development	25,449			25,716			51,450			51,082
Selling, general and administrative	17,801			18,320			37,188			36,645
Acquired in-process research and development	—			264			1,736			264

Total operating expenses	43,250			44,300			90,374			87,991

Operating income (loss)	6,759			(5,724		)	12,790			(15,094		)

Gain (loss) on equity investments	—			3,151			(12,831		)	3,151
Interest expense	(26		)	(118		)	(73		)	(210		)
Interest income and other, net	2,824			3,142			5,329			7,366

Income (loss) before income taxes	9,557			451			5,215			(4,787		)
Provision for (benefit from) income taxes	704			(699		)	1,409			(1,185		)

Net income (loss)	$	8,853		$	1,150		$	3,806		$	(3,602	)

Basic net income (loss) per share	$	0.08		$	0.01		$	0.04		$	(0.03	)
Diluted net income (loss) per share	$	0.08		$	0.01		$	0.03		$	(0.03	)

Weighted average shares:
Basic	106,144			104,210			106,085			104,041
Diluted	107,661			106,148			109,117			104,041

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

INTEGRATED DEVICE TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS)

	Sep. 26, 2004			Mar. 28, 2004
Assets
Current assets:
Cash and cash equivalents	$	265,398		$	223,360
Short-term investments	334,380			384,854
Accounts receivable, net	56,908			53,091
Inventories, net	44,136			32,745
Prepayments and other current assets	9,897			12,101

Total current assets	710,719			706,151

Property, plant and equipment, net	109,765			108,424
Goodwill and other intangibles, net	87,663			52,784
Other assets	8,823			38,194
Total assets	$	916,970		$	905,553

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	21,758		$	20,190
Accrued compensation and related expenses	14,769			11,560
Deferred income on shipments to distributors	24,891			21,411
Income taxes payable	33,089			33,267
Other accrued liabilities	18,055			19,250

Total current liabilities	112,562			105,678

Long-term obligations	13,169			15,651

Total liabilities	125,731			121,329

Stockholders’ equity:
Common stock and additional paid-in capital	831,124			825,483
Deferred stock-based compensation	(228		)	(1,140		)
Treasury stock	(180,751		)	(180,751		)
Retained earnings	140,965			137,159
Accumulated other comprehensive income	129			3,473

Total stockholders’ equity	791,239			784,224
Total liabilities and stockholders’ equity	$	916,970		$	905,553

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

INTEGRATED DEVICE TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED; IN THOUSANDS)

	Six months ended
	Sep. 26, 2004			Sep. 28, 2003
Operating activities
Net income (loss)	$	3,806		$	(3,602	)
Adjustments:
Depreciation	25,782			24,356
Amortization of intangible assets	2,862			802
Acquired in-process research and development	1,736			264
Merger-related stock-based compensation	367			721
Other-than-temporary impairment loss on equity investments	12,831			—
Non-cash restructuring and other	—			164
Changes in assets and liabilities:
Accounts receivable	(3,639		)	(839		)
Inventories	(10,756		)	7,775
Prepayments and other assets	1,302			9,873
Accounts payable	1,133			(1,191		)
Accrued compensation and related expenses	2,885			865
Deferred income on shipments to distributors	3,247			(1,829		)
Income taxes payable	(178		)	815
Other accrued liabilities	(940		)	(1,319		)
Net cash provided by operating activities	40,438			36,855

Investing activities
Purchases of property, plant and equipment	(27,010		)	(17,120		)
Cash paid for acquisition of ZettaCom, net of cash acquired	(34,375		)	—
Purchases of marketable securities	(221,813		)	(230,846		)
Proceeds from sales and maturities of marketable securities	286,263			247,272
Purchases of technology and other investments, net	(2,100		)	(8,078		)
Net cash provided by (used for) for investing activities	965			(8,772		)

Financing activities
Issuance of common stock	6,186			6,107
Payments on capital leases and other debt	(5,551		)	(2,071		)
Net cash provided by financing activities	635			4,036

Net increase in cash and cash equivalents	42,038			32,119
Cash and cash equivalents at beginning of period	223,360			144,400
Cash and cash equivalents at end of period	$	265,398		$	176,159

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

INTEGRATED DEVICE TECHNOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 1

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Integrated Device Technology, Inc. (IDT or the Company) contain all adjustments which are, in the opinion of management, necessary to present fairly the interim financial information included therein. Certain prior period balances have been reclassified to conform with the current period presentation. All references are to our fiscal quarters ended September 26, 2004 (Q2 2005), June 27, 2004 (Q1 2005), March 28, 2004 (Q4 2004) and September 28, 2003 (Q2 2004), unless otherwise indicated.

These financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended March 28, 2004. The results of operations for the three and six-month periods ended September 26, 2004 are not necessarily indicative of the results to be expected for the full year.

Note 2

Net Income (Loss) Per Share

Net income (loss) per share has been computed using weighted-average common shares outstanding in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings Per Share.”

	Three months ended		Six months ended
(in thousands)	Sep. 26, 2004	Sep. 28, 2003	Sep. 26, 2004	Sep. 28, 2003

Weighted average common shares outstanding	106,144	104,210	106,085	104,041
Dilutive effect of employee stock options	1,517	1,938	3,032	—
Weighted average common shares outstanding, assuming dilution	107,661	106,148	109,117	104,041

Net loss per share for the six-month period ended September 28, 2003 is based only on weighted average shares outstanding. Stock options based equivalent shares for this period of 1.2 million were excluded from the calculation of diluted earnings per share, as their effect would be antidilutive in a net loss period. Employee stock options to purchase 7.0 million, 3.7 million, and 5.2 million shares for the three-month periods ended September 26, 2004, and September 28, 2003 and the six-month period ended September 26, 2004, respectively, were outstanding, but were excluded from the calculation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares and therefore, the effect would be antidilutive.

Note 3

Stock-Based Employee Compensation

The Company accounts for its stock option plans and employee stock purchase plan in accordance with the intrinsic value method prescribed in the Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). In certain instances, primarily in connection with acquisitions, the Company records stock-based employee compensation cost in net income (loss). The following table illustrates the effect on net income (loss) and income (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), to stock-based employee compensation.

	Three months ended						Six months ended
(in thousands)	Sep. 26, 2004			Sep. 28, 2003			Sep. 26, 2004			Sep. 28, 2003

Reported net income (loss)	$	8,853		$	1,150		$	3,806		$	(3,602	)
Add: Stock-based compensation included in reported net income (loss)	88			359			367			721
Deduct: Stock-based employee compensation expense determined under a fair-value based method for all awards	(7,896		)	(11,061		)	(19,540		)	(25,150		)
Pro forma net income (loss)	$	1,045		$	(9,552	)	$	(15,367	)	$	(28,031	)
Pro forma net income (loss) per share:
Basic	$	0.01		$	(0.09	)	$	(0.14	)	$	(0.27	)
Diluted	$	0.01		$	(0.09	)	$	(0.14	)	$	(0.27	)
Reported net income (loss) per share:
Basic	$	0.08		$	0.01		$	0.04		$	(0.03	)
Diluted	$	0.08		$	0.01		$	0.03		$	(0.03	)

Note 4

Cash Equivalents and Investments

Cash equivalents are highly liquid investments with original maturities of three months or less at the time of purchase. All of the Company’s investments are classified as available-for-sale at September 26, 2004 and March 28, 2004. Available-for-sale investments are classified as short-term investments, as these investments generally consist of highly marketable securities that are intended to be available to meet current cash requirements. Investment securities classified as available-for-sale are reported at market value, and net unrealized gains or losses are recorded in accumulated other comprehensive income, a separate component of stockholders’ equity, until realized. Realized gains and losses on investments are computed based upon specific identification and are included in interest income and other, net. Management evaluates investments on a regular basis to determine if an other-than-temporary impairment has occurred.

In Q1 2005, the Company recorded an impairment charge of $12.8 million related to our investment in NetLogic Microsystems. On July 8, 2004, NetLogic completed an initial public offering at an initial offering price of $12 per share. IDT was included in the offering as a selling shareholder. The IPO pricing, less related commissions, implied the investment was worth less than its carrying value. Based in part on the relative magnitude of the decline in value, the Company concluded that there was an other-than-temporary impairment on the investment at June 27, 2004 and accordingly, recorded an impairment charge to adjust the carrying value down to its estimated net realizable value. During Q2 2005, the Company sold its investment at the previously written down value. At March 28, 2004, this investment, which was accounted for on the cost basis, was classified in Other Assets at a value of $30.0 million.

Note 5

Inventories, Net

Inventories are summarized as follows:

(in thousands)	Sep. 26, 2004		Mar. 28, 2004

Raw materials	$	4,883	$	3,537
Work-in-process	26,309		20,984
Finished goods	12,944		8,224
Total inventories, net	$	44,136	$	32,745

Note 6 Business Combinations

On May 7, 2004, the Company acquired ZettaCom, Inc., a privately held provider of switch fabric and traffic management solutions. The Company paid $34.5 million in cash for ZettaCom. ZettaCom’s results subsequent to May 7, 2004 are included in the Company’s consolidated results.

The acquisition was accounted for under the purchase method of accounting. The total purchase price for ZettaCom is summarized below:

(in thousands)
Cash price	$	34,264
Direct costs of acquisition	252
Total purchase price	$	34,516

The total purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed based on management estimates, which considered independent appraisals as follows:

(in thousands)
Fair value of tangible net liabilities acquired	$	(2,798	)
In-process research and development	1,700
Existing technology	18,400
Non-compete agreements	1,200
Goodwill	16,014
Total purchase price	$	34,516

The Company valued the existing technology and in-process technology utilizing a discounted cash flow model which uses forecasts of future revenues and expenses related to the intangible asset. The non-compete agreements were valued by estimating the affect on future revenues and cash flows if a non-compete were not in-place thereby allowing former employees of ZettaCom to re-enter the market. IDT utilized a discount rate of 27% for existing technology, 31% for in-process technology, and 29% for the non-compete agreements. The purchase price allocation depicted is preliminary and subject to change when the Company obtains additional information concerning certain contingencies of ZettaCom.

In-process technology acquired was expensed at the date of acquisition. The existing technology is being amortized to cost of revenues over a seven year estimated life. The non-compete agreements are being amortized to research and development expense over the three year term of the agreements.

Acquired in-process research and development. In connection with the ZettaCom acquisition, the Company recorded a $1.7 million charge to in-process research and development (IPR&D). This amount was determined by identifying a research project which was not yet proven to be technically feasible and did not have alternative future uses. Estimated future expenses were deducted and economic rents charged for the use of other assets. Based on this analysis, a present value calculation of estimated after-tax cash flows attributable to the projects was computed using a discount rate of 31%. Present values were adjusted by factors representing the percentage of completion for the project, which was estimated at 73%.

Retention payments. In connection with the ZettaCom acquisition, the Company entered into retention agreements with the former employees of ZettaCom who became IDT employees as part of the transaction. The agreements include approximately $4.0 million which will be paid out over the 18-30 months following the close of the acquisition. The retention payments are earned by the passage of time. As such, the Company records these amounts as compensation expense as they are incurred.

Note 7 Asset Acquisitions

On April 22, 2004, the Company acquired a license to PCI-Express technology from Internet Machines Corporation (IMC) as well as certain other assets and liabilities, in a cash transaction, immaterial in value, that does not constitute a business combination. As such, the Company allocated the amount paid to the assets acquired based on their estimated fair values. The principal identifiable intangible assets acquired were existing technology and workforce in-place. The fair values assigned are based on estimates, assumptions, and other information compiled by management.

During the first quarter of 2005, the Company made a $1.1 million follow-on payment in connection with the Q2 2004 acquisition of technologies from IBM as a milestone was met. The amount of this payment was allocated consistent with the allocation of the initial purchase price. Per the agreement, the Company may pay an additional $2.9 million in the near future contingent upon IBM successfully achieving and IDT accepting two additional technology milestones.

Note 8

Goodwill and Other Intangible Assets

Goodwill is reviewed annually for impairment (or more frequently if indicators of impairment arise). For purposes of this assessment, the Company uses two reporting units, (1) Communications and Timing Products and (2) SRAMs. All Company goodwill relates to the Communications and Timing Products reporting unit.

Goodwill and identified intangible assets relate to the Company’s acquisitions of ZettaCom and IMC assets in Q1 2005, the technologies from IBM in Q2 2004, Solidum Systems (Solidum) in Q3 2003, and Newave Semiconductor Corp. (Newave) in Q1 2002. Balances as of September 26, 2004 and March 28, 2004 are summarized as follows:

	Sep. 26, 2004
(in thousands)	Gross assets		Accumulated amortization			Net assets

Goodwill	$	56,232	$	—		$	56,232

Identified intangible assets:
Existing technology	28,837		(3,523		)	25,314
Trademark	2,240		(1,090		)	1,150
Customer relationship	3,922		(796		)	3,126
Non-compete agreement	2,958		(1,173		)	1,785
Other	136		(80		)	56
Subtotal, identified intangible assets	38,093		(6,662		)	31,431
Total goodwill and identified intangible assets	$	94,325	$	(6,662	)	$	87,663

	Mar. 28, 2004
(in thousands)	Gross assets		Accumulated amortization			Net assets

Goodwill	$	40,218	$	—		$	40,218

Identified intangible assets:
Existing technology	8,986		(1,570		)	7,416
Trademark	2,240		(930		)	1,310
Customer relationship	3,452		(403		)	3,049
Non-compete agreements	1,625		(834		)	791
Other	63		(63		)	—
Subtotal, identified intangible assets	16,366		(3,800		)	12,566
Total goodwill and identified intangible assets	$	56,584	$	(3,800	)	$	52,784

Amortization expense for identified intangibles is summarized below:

	Three months ended		Six months ended
(in thousands)	Sep. 26, 2004	Sep. 28, 2003	Sep. 26, 2004	Sep. 28, 2003

Existing technology	1,116	289	1,953	523
Customer relationship	197	58	394	58
Trademark	80	80	160	162
Non-compete agreements	190	—	339	—
Other identified intangibles	6	59	16	59
Total	1,589	486	2,862	802

Based on the identified intangible assets recorded at September 26, 2004, the future amortization expense of identified intangibles for the next five fiscal years and thereafter is as follows (in thousands):

Year ending March,
Remainder of FY 2005	$	3,172
2006	6,347
2007	6,189
2008	5,612
2009	4,033
Thereafter	6,078
Total	$	31,431

Note 9

Comprehensive Income (Loss)

The components of comprehensive income (loss) were as follows:

	Three months ended					Six months ended
(in thousands)	Sep. 26, 2004		Sep. 28, 2003			Sep. 26, 2004			Sep. 28, 2003

Net income (loss)	$	8,853	$	1,150		$	3,806		$	(3,602	)
Currency translation adjustments	49		388			180			809
Change in unrealized gain (loss) on derivatives, net of taxes	—		—			—			(31		)
Change in net unrealized gain (loss) on investments, net of taxes	1,106		(4,109		)	(3,524		)	(2,570		)
Comprehensive income (loss)	$	10,008	$	(2,571	)	$	462		$	(5,394	)

The components of accumulated other comprehensive income were as follows:

(in thousands)	Sep. 26, 2004			Mar. 28, 2004

Cumulative translation adjustments	$	962		$	782
Unrealized gain (loss) on investments	(833		)	2,691
Total accumulated other comprehensive income	$	129		$	3,473

Note 10

Asset Impairment

During Q2 and Q1 2005, the Company recorded gains of $1.6 million and $0.2 million, respectively, related to the sales of land and equipment related to its closed Salinas facility, which had been impaired and reclassified as assets held for sale during Q3 2002. As the impairment charge in fiscal 2002 was included in the Cost of Goods Sold section, the gains on the sales of the related land and equipment are also included in that section in accordance with FAS 144.

Note 11

Derivative Instruments

As a result of its significant international operations, sales and purchase transactions, the Company is subject to risks associated with fluctuating currency exchange rates. The Company generally uses derivative financial instruments to hedge these risks when instruments are available and cost effective in an attempt to minimize the impact of currency exchange rate movements on its operating results and on the cost of capital equipment purchases. The Company does not enter into derivative financial instruments for speculative or trading purposes. The Company’s significant foreign currency exchange exposures and related hedging programs are described below.

Forecasted transactions. Historically, the Company has had foreign currency exposure related to its revenues in Japan, which were generally yen-denominated. With few exceptions, all other revenue was (and continues to be) US dollar-based. In fiscal 2003, the Company began offering its products in Japan denominated in US dollars and in yen. By the end of fiscal 2004, the Company had significantly transitioned its revenue in Japan from yen-based to US dollar-based, and had reduced its yen-based revenue exposure to a level that approximates its local yen-denominated operating expenses. As a result, the Company changed its functional currency in Japan to US Dollars. Thus, the Company has essentially eliminated the need for revenue hedging. There were no forecasted hedges executed during Q2 2005 and Q2 2004 or the six months then ended.

The Company reviews all of its currency exposures from time to time and may decide to enter into cash flow hedges when the transactions are forecasted and in general closely match the underlying forecasted transactions in duration. The contracts are carried on the balance sheet at fair value and the effectiveness is measured on at least a quarterly basis with the effective portion of the contracts’ gains and losses recorded as other comprehensive income until the forecasted transactions occur.

Firm commitments. The Company uses currency forward contracts to hedge certain foreign currency purchase commitments, primarily denominated in Japanese yen and the euro. These contracts are designated as fair value hedges, and changes in the fair value of the contracts are offset against changes in the fair value of the commitment being hedged, through earnings. There were no fair value hedges executed during Q2 2005 and Q2 2004 or the six months then ended.

Balance sheet exposures. The Company also utilizes currency forward contracts to hedge currency exchange rate fluctuations related to certain foreign currency assets and liabilities. Gains and losses on these undesignated derivatives offset gains and losses on the assets and liabilities being hedged and the net amount is included in earnings. An immaterial amount of net gains and losses were included in earnings during Q2 2005 and Q2 2004 and the six months then ended.

Besides foreign exchange rate exposure, the Company’s cash and investment portfolio are subject to the risks associated with fluctuations in interest rates and equity market prices, respectively. While the Company’s policies allow for the use of derivative financial instruments to hedge the fair values of such investments, the Company has yet to enter into this type of hedge.

Note 12

Industry Segments

The Company operates in two segments: (1) Communications and Timing Products and (2) SRAMs. The Communications and Timing Products segment includes network search engines, content inspection engines, integrated communications processors, FIFOs, multi-ports, flow control management devices, telecommunications products, clock management products and high-performance logic. The SRAMs segment consists of high-speed SRAMs.

The tables below provide information about these segments for the three and six month periods ended September 26, 2004 and September 28, 2003:

Revenues by segment

	Three months ended				Six months ended
(in thousands)	Sep. 26, 2004		Sep. 28, 2003		Sep. 26, 2004		Sep. 28, 2003

Communications and Timing Products	$	79,321	$	68,183	$	164,868	$	140,043
SRAMs	17,350		12,594		33,110		23,779
Total consolidated revenues	$	96,671	$	80,777	$	197,978	$	163,822

Income (Loss) by segment

	Three months ended						Six months ended
(in thousands)	Sep. 26, 2004			Sep. 28, 2003			Sep. 26, 2004			Sep. 28, 2003

Communications and Timing Products	$	10,222		$	3,999		$	24,392		$	5,484
SRAMs	(2,833		)	(7,579		)	(6,447		)	(16,881		)
Restructuring and asset impairment	—			(752		)	(677		)	(1,333		)
Amortization of intangible assets	(1,589		)	(486		)	(2,862		)	(802		)
Amortization of deferred stock-based compensation	(88		)	(359		)	(367		)	(721		)
Facility closure costs and other	1,541			(283		)	1,555			(577		)
Acquired in-process research and development	—			(264		)	(1,736		)	(264		)
Acquisition related costs	(494		)	—			(1,068		)	—
Gain (loss) on equity investments	—			3,151			(12,831		)	3,151
Interest income and other	2,824			3,142			5,329			7,366
Interest expense	(26		)	(118		)	(73		)	(210		)
Income (loss) before income taxes	$	9,557		$	451		$	5,215		$	(4,787	)

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

All references are to our fiscal quarters ended September 26, 2004 (Q2 2005), June 27, 2004 (Q1 2005), March 28, 2004 (Q4 2004) and September 28, 2003 (Q2 2004), unless otherwise indicated. Quarterly financial results may not be indicative of the financial results of future periods.

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements involve a number of risks and uncertainties. These include, but are not limited to: operating results; new product introductions and sales; competitive conditions; capital expenditures and resources; manufacturing capacity utilization; customer demand and inventory levels; intellectual property matters; and the risk factors set forth in the section “Factors Affecting Future Results.” As a result of these risks and uncertainties, actual results could differ from those anticipated in the forward-looking statements. Unless otherwise required by law, we undertake no obligation to publicly revise these statements for future events or new information after the date of this Report on Form 10-Q.

Forward-looking statements, which are generally identified by words such as “anticipates,” “expects,” “plans,” and similar terms, include statements related to revenues and gross profit, research and development activities, selling, general, and administrative expenses, intangible expenses, interest income and other, taxes, capital spending and financing transactions, as well as statements regarding successful development and market acceptance of new products, industry and overall economic conditions and demand, and capacity utilization.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such statements requires us to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be appropriate in the circumstances. However, actual future results may vary from our estimates.

We believe that the following accounting policies are “critical” as defined by the Securities and Exchange Commission, in that they are both highly important to the portrayal of our financial condition and results, and require difficult management judgments and assumptions about matters that are inherently uncertain. We also have other important policies, including those related to revenue recognition and concentration of credit risk. However, these policies do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are difficult or subjective. These policies are discussed in the Notes to the Consolidated Financial Statements, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 28, 2004.

Income Taxes. We account for income taxes under an asset and liability approach that requires the expected future tax consequences of temporary differences between book and tax bases of assets and liabilities be recognized as deferred tax assets and liabilities. Generally accepted accounting principles require us to evaluate the realizability of our net deferred tax assets on an ongoing basis. A valuation allowance is recorded to reduce the net deferred tax assets to an amount that will more likely than not be realized. Accordingly, we consider various tax planning strategies, forecasts of future taxable income and our most recent operating results in assessing the need for a valuation allowance. In the consideration of the realizability of net deferred tax assets, recent results must be given substantially more weight than any projections of future profitability. In the fourth quarter of fiscal 2003, under applicable accounting principles, we could not conclude that it was more likely than not that we would realize value for our net deferred tax assets. Accordingly, we established a valuation allowance equal to 100% of the amount of these assets. We reassess the requirement for the valuation allowance on an ongoing basis.

In addition, we record liabilities related to income tax contingencies. Determining these liabilities requires us to make significant estimates and judgments as to whether, and to what extent, additional taxes will be due based on potential tax audit issues in the U.S. and other tax jurisdictions throughout the world. Our estimates are based on the outcomes of our previous audits, as well as the precedents set in cases in which others have taken similar tax positions to those taken by the Company. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and affect a related change in our tax provision during the period in which we make such determination.

Inventories. Inventories are recorded at the lower of standard cost (which generally approximates actual cost on a first-in, first-out basis) or market value. We record reserves for obsolete and excess inventory based on our forecasts of demand over specific future time horizons. We also record reserves to value our inventory at the lower of cost or market value, which rely on forecasts of average selling prices (ASPs) in future periods. Actual market conditions, demand, and pricing levels in the volatile semiconductor markets that we serve may vary from our forecasts, potentially impacting our inventory reserves and resulting in material impacts on our gross margin.

Valuation of Long-Lived Assets and Goodwill. We own and operate our own manufacturing facilities, as further described in Part I of our Annual Report on Form 10-K for the fiscal year ended March 28, 2004. We have also acquired certain businesses and product portfolios in recent years. As a result we have significant property, plant and equipment, goodwill and other intangible assets. We evaluate these items for impairment on an annual basis, or sooner, if events or changes in circumstances indicate that carrying values may not be recoverable. Triggering events for impairment reviews may include adverse industry or economic trends, restructuring actions, lowered projections of profitability, or a sustained decline in our market capitalization to below book value. Evaluations of possible impairment and, if applicable, adjustments to carrying values, require us to estimate, among other factors, future cash flows, useful lives and fair market values of our reporting units and assets. Actual results may vary from our expectations. We recorded asset impairment charges of $121.4 million and $17.4 million in fiscal 2003 and 2002, respectively.

RESULTS OF OPERATIONS

Revenues (Q2 2005 compared to Q2 2004). Our revenues for Q2 2005 were $96.7 million, an increase of $15.9 million or 19.7% compared to the corresponding quarter of the previous year, as demand improved in the wireless communications and enterprise networking markets that we serve. Overall units sold were down slightly, from 52.0 million units in Q2 2004 to 50.3 million units in Q2 2005. In addition, as a result of favorable changes in the mix of product sold and price increases in certain product categories such as SRAM, our average selling price per unit (ASP) for our products increased by approximately 24% when compared to Q2 2004.

Revenues for our Communications and Timing Products segment (which includes network search engines (NSEs), FIFOs, multiports, and flow control management devices; communications applications-specific standard products (ASSPs); and high-performance logic and timing products) increased by $11.1 million or 16.3%, while revenues for our SRAM segment increased by $4.8 million or 37.8% as compared to Q2 2004. Units sold were flat in the Communications and Timing Products segment, while units sold were down by 19.6% in the SRAM segment as compared to Q2 2004. Overall ASPs in each of our two product segments increased, as we generally experienced a more favorable mix shift to higher performance and/or higher density products within our product divisions, as well as realizing the effects of higher market price levels within our SRAM segment.

When compared to the same quarter one year ago:

• Revenues in the Americas increased at the highest year-over-year rate, rising 40.4%;

• Revenues in Europe also showed strong growth in Q2 2005, growing 34.9%;

• Revenues in Japan increased by 21.9% in Q2 2005; and

• Revenues within the APAC region decreased by 2.0%.

As a result, the Americas and Europe grew to represent notably higher percentages of overall revenue, while the APAC region correspondingly declined. In part, these shifts in geographic share reflect changes in either mix of product sold, or the supply chain decisions being made by certain of our key customers.

Revenues (Q2 2005 compared to Q1 2005). Our revenues for Q2 2005 were sequentially lower by $4.6 million or 4.6%, as units sold declined by 6.4%. We experienced somewhat weaker demand conditions across most of our product families, resulting in lower unit sales for each of our product divisions. In part, we attribute these weak business conditions and order rates to excess inventory levels at our customers serving the enterprise networking and wireless infrastructure equipment markets. The lower unit sales were slightly offset by a small improvement in ASPs, due to better SRAM pricing and a favorable shift in our mix of products sold within each product division.

Revenues for our Communications and Timing Products segment decreased sequentially by $6.2 million or 7.3%, driven mainly by a 5.6% decrease in units sold as ASPs were virtually flat. Revenues from the SRAM segment increased sequentially by $1.6 million or 10.1%, as a significant increase in ASPs offset a moderate decrease in units sold.

During Q2 2005, consistent with the year-over-year discussion above, revenues shifted away from the APAC region, which fell to represent only about one-third of our total revenue for the first time since early fiscal 2004.

Revenues (First six months of fiscal 2005 compared to first six months of fiscal 2004). Our revenues year-to-date for fiscal 2005 were $198.0 million compared with $163.8 million for the first six months of fiscal 2004, an increase of $34.2 million, or 20.8%.

Within our Communications and Timing Products segment, revenues increased by $24.8 million or 17.7%, on increases in both unit sales and ASPs which were higher mostly due to product mix. Within our SRAM segment, revenues increased by $9.3 million or 39.2% as a slight decrease in units sales was more than offset by a significant increase in ASPs both at the device level and due to product mix.

Revenues (recent trends and outlook). During the second fiscal quarter of 2005, we began to see a weakening in customer order patterns, after signs of strength over the past few quarters in the communications markets that we serve. These weaker bookings translated into lower levels of backlog entering Q3 2005. In addition, during Q2 2005, it gradually became apparent that market prices for SRAM products had peaked, and by the end of the quarter we were forecasting that much of the recent strength in SRAM prices would reverse during Q3 2005. Considering this recent weakness in bookings, backlog, and expected near-term pricing, we are taking a cautious view on the prospects for sequential revenue growth from Q2 2005 to Q3 2005.

Gross profit (Q2 2005 compared to Q2 2004). Gross profit for Q2 2005 was $50.0 million, an increase of $11.4 million compared to the $38.6 million recorded in Q2 2004. Our gross profit margin percentage for Q2 2005 was 51.7% compared to 47.8% for Q2 2004. The improvement in gross margin is due primarily to:

• The incremental gross margin associated with higher revenues and better utilization of our manufacturing infrastructure (as production output at our Hillsboro Fab increased to 27.1 thousand wafers in Q2 2005, up from 20.8 thousand wafers in Q2 2004);

• The improved pricing environment for SRAM products. Adjusting for changes in mix, we estimate that SRAM prices increased by almost 25% year-over-year;

• Cost benefits associated with transitioning a higher proportion (58% in Q2 2005 versus 31% in Q2 2004) of our internal wafer production to 0.18 micron and finer-geometry wafers; and

• A $1.6 million gain on the sale of land and equipment related to our closed Salinas, California water fabrication facility, which was impaired during Q3 2002

These beneficial impacts on gross margin were only partially offset by higher inventory reserves in Q2 2005 vs. Q2 2004 (primarily lower of cost or market (LCM) reserves related to expected SRAM price declines in Q3 2005). Finally, gross margins did not benefit by selling inventory previously reserved as excess in either Q2 2005 or Q2 2004.

Gross profit (Q2 2005 compared to Q1 2005). Gross profit for Q2 2005 was down sequentially by $3.2 million, from $53.2 million in Q1 2005 to $50.0 million in Q2 2005. Our gross profit margin percentage also decreased from 52.5% in Q1 2005 to 51.7% in Q2 2005. The largest drivers of the decrease in gross profit in Q2 2005 were the decrease in revenues and the additional inventory reserves required (primarily LCM reserves associated with SRAM, as described above, as compared to a decrease in reserve requirements in Q1 2005, causing an overall $3.0 million difference). Overall manufacturing spending was essentially flat with the prior quarter, primarily as a result of the gain on the sale of the Salinas land and equipment described above. Partially offsetting the downward margin pressures were improved pricing on SRAM products sold in Q2 2005 and continued high utilization of our manufacturing facilities. Production output at our Hillsboro Fab increased 6.6% to 27.1 thousand wafers in Q2 2005, up from 25.4 thousand in Q1 2005.

Gross Profit (first six months of 2005 compared to the first six months of 2004). Gross profit for the first six months of 2005 increased to $103.2 million from $72.9 million in the first six months of 2004. Similarly, gross profit margin increased to 52.1% for the first six months of 2005 versus 44.5% for the first six months of 2004. As discussed above, the increase in gross profit in the first six months of 2005 was primarily driven by the significant increase in revenues, improved manufacturing utilization, higher proportion of 0.18 micron and finer geometry wafers, increased SRAM pricing, and lower LCM inventory reserve requirements. In the first six months of 2004, gross profit benefited from the sale of approximately $2.0 million of previously reserved inventory versus no related benefit in the first six months of 2005.

Considering the weaker business conditions that appear to have developed throughout the industry in Q2 2005, and the increased uncertainty in the near-term outlook, we are planning to lower production levels in Q3 2005 so as to better align our inventory position with the current level of demand. The resulting lower manufacturing utilization, combined with anticipated pricing declines (particularly for SRAM products), is expected to result in lower gross profit margin in Q3 2005.

Research and development. For Q2 2005, research and development (R&D) expenses were $25.4 million, a $0.3 million or 1.0% decrease from Q2 2004. Labor related spending was higher, primarily due to increased headcount and retention costs in connection with the ZettaCom and Internet Machines Corporation (IMC) transactions, higher performance-tied personnel costs, and salary increases implemented early in fiscal 2005. These amounts were more than offset by lower spending on outside design services and lower photomask and equipment related expenses.

R&D expenses decreased by $0.6 million in Q2 2005 from $26.0 million in Q1 2005. The sequential decrease is primarily attributable to lower personnel related costs, which were partially offset by higher allocations of manufacturing costs to development activities.

For the first six months of fiscal 2005, R&D spending increased by $0.4 million compared to the same period in fiscal 2004, mostly due to higher labor-related spending as noted above in the quarterly comparison of Q2 2005 to Q2 2004.

We currently expect that R&D spending in Q3 2005 will increase slightly in comparison to Q2 2005.

Selling, general and administrative. For Q2 2005, selling, general, and administrative (SG&A) expenses were $17.8 million, a $0.5 million or 2.8% decrease from Q2 2004. The decrease was primarily due to lower equipment depreciation costs and lower bad debt reserve requirements. Salary increases implemented in early fiscal 2005 and higher performance-tied personnel costs were offset by lower severance costs leaving labor costs essentially flat.

SG&A expenses decreased by $1.6 million in Q2 2005 from $19.4 million in Q1 2005. The decrease is primarily attributable to seasonably lower labor-related costs, lower labor-related benefits, lower spending on outside services and lower bad debt reserve requirements.

For the first six months of fiscal 2005, SG&A spending increased by $0.5 million compared to the same period in fiscal 2004. The increase is primarily related to salary increases implemented in early fiscal 2005, higher performance-tied personnel costs recorded in relation to the improved financial results in the current fiscal year partially offset by lower equipment depreciation costs and lower bad debt reserve requirements.

We currently expect that SG&A spending in Q3 2005 will increase slightly in comparison to Q2 2005.

Acquired in-process research and development. During Q1 2005, in connection with our acquisition of ZettaCom, we recorded a $1.7 million charge for acquired in-process research and development (IPR&D). The allocation of the purchase price to IPR&D was determined by identifying technologies that had not attained technological feasibility and that did not have future alternative uses.

Gain (loss) on equity investments. During Q1 2005, we recorded an impairment of $12.8 million related to our investment in NetLogic Microsystems (NetLogic). Shortly after the end of Q1 2005, NetLogic completed its initial public offering (IPO) at an offering price of $12 per share. We were included as a selling stockholder in connection with the offering. The IPO pricing, less related commissions, implied that the investment was worth less than its carrying value. Based on the relative magnitude of the decline in value, we concluded that there was an other-than-temporary impairment of the investment at June 27, 2004. Accordingly, we recorded an impairment charge to adjust the carrying value down to its estimated net realizable value. During Q2 2005, we completed the sale of our investment and realized essentially the same proceeds utilized to calculate the initial impairment charge. During Q2 2004, the Company sold its remaining shares of PMC Sierra (PMC). In connection with the sale, the Company recorded a net gain of $3.2 million.

Interest income and other, net. In Q2 2005, interest income and other, net, was $2.8 million, a decrease of $0.3 million compared to Q2 2004. The decrease was primarily due to lower capital gains in Q2 2005 along with lower interest income in Q2 2005 related to lower average interest rates in our investment portfolio, as the proceeds of maturing investments were reinvested in a lower interest rate environment.

Provision/Benefit for income taxes. The tax provision of $0.7 million for Q2 2005 was recorded to cover projected current worldwide income tax expense. The tax provision recorded does not reflect any projected change in net deferred taxes, as we continue to maintain the position that we cannot conclude that it is more likely than not that we will be able to utilize our deferred tax assets in the foreseeable future.

Liquidity and Capital Resources

Our cash and marketable securities were $599.8 million at September 26, 2004, a decrease of $8.4 million compared to March 28, 2004. There was no debt outstanding as of September 26, 2004.

Net cash provided by operating activities was $40.4 million for the first six months of fiscal 2005, compared to $36.9 million for the same period of fiscal 2004. During the first six months of fiscal 2005, we recorded net income of $3.8 million as compared to a net loss of $3.6 million in the same period of the prior year. Non-cash adjustments were significantly higher in the first six months of fiscal 2005, including those related to:

• Our other-than-temporary equity investment impairment charge of $12.8 million;

• Acquisition related costs, which were higher by $3.5 million primarily as a result of higher in-process R&D charges by $1.5 million and higher acquisition related intangible amortization; and

• Depreciation, which was higher by $1.4 million as a result of capital expenditures over the past year to ramp manufacturing capacity.

Net sources of cash related to working capital related items decreased by $21.1 million in the first six months of 2005 as compared to the same period of fiscal 2004. Working capital items consuming relatively more cash the first six months of fiscal 2005 included:

• An increase in inventories of $10.8 million as compared to a reduction of $7.8 million in the year ago period as we selectively grew our inventory levels to meet anticipated customer demand;

• Relatively higher increases in accounts receivable by $2.8 million as our revenues were higher during the first half of fiscal 2005 compared to 2004; and

• Relatively lower decreases in prepayments and other assets by $8.6 million, primarily as a result of the repayment of approximately $5.5 million related to a distributor financing arrangement in Q1 2004 which did not recur in 2005.

The above factors were partially offset by other working capital items that provided relatively more cash in the first six months of fiscal 2005, including:

• An increase in deferred income on shipments to distributors during fiscal 2005 of $3.2 million compared to a decrease of $1.8 million in fiscal 2004 generated $5.1 million more cash as distributors added more inventory in 2005 compared to the same period in 2004;

• Relatively higher (by $2.0 million) increases in accrued compensation and related expenses in the current period in connection with the higher performance-related compensation from improved financial results; and

• An increase in accounts payable during fiscal 2005 compared to a decrease in fiscal 2004, generating $2.3 million more net cash, as business volumes were relatively higher in the current period.

Our investing activities provided $1.0 million of cash in the first six months of fiscal 2005 as compared to a use of cash of $8.8 million in the first six months of fiscal 2004. In the first six months of fiscal 2005, our sales of short-term investments, net of purchases, were $48.0 million higher than in the comparable period of fiscal 2004. In the first six months of fiscal 2005, our acquisition related expenditures were significantly higher as we paid $34.4 million in connection with the acquisition of ZettaCom. Other than the ZettaCom transaction, technology acquisitions consumed $2.1 million in cash in the first half of 2005, down from $8.1 million in 2004. Finally, capital expenditures in the first six months of fiscal 2005 were higher by $9.9 million as we purchased new equipment to increase our manufacturing capacity.

Our financing activities provided $0.6 million of cash in the first six months of fiscal 2005 as compared to $4.0 million in the comparable period of fiscal 2004. Proceeds from issuances of common stock were essentially flat; however, payments on capital leases increased by $3.5 million in connection with early buyout options which were exercised in the period.

We anticipate capital expenditures of approximately $45-50 million during fiscal 2005, to be financed through cash generated from operations and existing cash and investments. This estimate includes $27.0 million in capital expenditures during the first six months of fiscal 2005. In addition, we announced in October 2004 that the Board of Directors has approved a stock repurchase program for the repurchase of up to $50 million of its Common Stock. Repurchases under the Company’s stock repurchase program may be made from time to time in the open market and in negotiated transactions, including block transactions or accelerated stock repurchase transactions, at times and at prices considered appropriate by the Company. The repurchase program is effective immediately and may be discontinued at any time.

We believe that existing cash and investment balances, together with cash flows from operations, will be sufficient to meet our working capital, capital expenditure, and common stock repurchase needs through remainder of fiscal 2005 and 2006. We may choose to investigate other financing alternatives; however, we cannot be certain that additional financing will be available on satisfactory terms.

Factors Affecting Future Results

Our operating results can fluctuate dramatically. We recorded net income of $6.4 million in fiscal 2004 after recording losses of $277.9 million and $46.2 million in fiscal 2003 and 2002, respectively. Fluctuations in operating results can result from a wide variety of factors, including:

• The cyclicality of the semiconductor industry and industry-wide wafer processing capacity;

• Changes in demand for our products and in the markets we and our customers serve;

• The success and timing of new product and process technology announcements and introductions from us or our competitors;

• Potential loss of market share among a concentrated group of customers;

• Competitive pricing pressures;

• Changes in the demand for and mix of products sold;

• Complex manufacturing and logistics operations;

• Availability and costs of raw materials, and of foundry and other manufacturing services;

• Costs associated with other events, such as intellectual property disputes, or other litigation; and

• Political and economic conditions in various geographic areas.

In addition, many of these factors also impact the recoverability of the carrying value of certain manufacturing, tax, goodwill, and other tangible and intangible assets. As business conditions change, future write-downs or abandonment of these assets may occur. For example, in Q1 2005, we recorded an impairment charge of $12.8 million for our investment in NetLogic.

Further, we may be unable to compete successfully in the future against existing or potential competitors, and our operating results could be harmed by increased competition. Our operating results are also impacted by changes in overall economic conditions, both domestically and abroad. Should economic conditions deteriorate, domestically or overseas, our sales and business results could be harmed.

The cyclicality of the semiconductor industry exacerbates the volatility of our operating results. The semiconductor industry is highly cyclical. Substantial changes in demand for our products have occurred rapidly and suddenly in the past. In addition, market conditions characterized by excess supply relative to demand and resulting pricing declines have also occurred in the past. Significant shifts in demand for our products and pricing declines resulting from excess supply may occur in the future. Large and rapid swings in demand and pricing for our products can result in significantly lower revenues and underutilization of our fixed cost infrastructure, both of which would cause material fluctuations in our gross margins and our operating results.

Demand for our products depends primarily on demand in the communications markets. The majority of our products are incorporated into customers’ systems in enterprise/carrier class network, wireless infrastructure and access network applications. A smaller percentage of our products also serve in customers’ computer storage, computer-related, and other applications. Customer applications for our products have historically been characterized by rapid technological change and significant fluctuations in demand. Demand for most of our products, and therefore potential increases in revenue, depends upon growth in the communications market, particularly in the data networking and wireless telecommunications infrastructure markets and, to a lesser extent, the computer-related markets. Any slowdown in these communications or computer-related markets could materially adversely affect our operating results, as most recently evidenced by conditions in fiscal 2003 and 2002.

Our results are dependent on the success of new products. New products and wafer processing technology will continue to require significant R&D expenditures. If we are unable to develop, produce and successfully market new products in a timely manner, and to sell them at gross margins comparable to or better than our current products, our future results of operations could be adversely impacted. In addition, our future revenue growth is also partially dependent on our ability to penetrate new markets, where we have limited experience and where competitors are already entrenched. Even if we are able to develop, produce and successfully market new products in a timely manner, such new products may not achieve market acceptance.

We are dependent on a concentrated group of customers for a significant part of our revenues. We are dependent on a limited number of original equipment manufacturers (OEMs) as our end-customers, and our future results depend significantly on the strategic relationships we have formed with them. If these relationships were to diminish, and if these customers were to develop their own solutions or adopt a competitor’s solution instead of buying our products, our results could be adversely affected. For example, any diminished relationship with Cisco or other key customers could adversely affect our results. While direct sales to Cisco are not significant, we estimate that when all channels of distribution are considered, Cisco represented approximately 20-25% of our total revenues for fiscal 2004.

Many of our end-customer OEMs have outsourced their manufacturing to a concentrated group of global electronic manufacturing service providers (EMSs) who then buy product directly from us on behalf of the OEM. EMSs have achieved greater autonomy in the design win, product qualification and product purchasing decisions, especially for commodity products. Furthermore, these EMSs have generally been centralizing their global procurement processes. This has had the effect of concentrating a significant percentage of our revenue with a small number of companies. Competition for the business of these EMSs is intense and there is no assurance we can remain competitive and retain our existing market share with these customers. If these companies were to allocate a higher share of commodity or second-source business to our competitors instead of buying our products, our results would be adversely affected. Furthermore, as these EMSs represent a growing percentage of our overall business, our concentration of credit and other business risks with these customers has increased. Competition among global EMSs is intense, they operate on extremely thin margins, and their financial condition, on average, declined significantly during the industry downturn in fiscal 2001- 2002. If any one or more of these global EMSs were to file for bankruptcy or otherwise experience significantly adverse financial conditions, our business would be adversely impacted as well. During fiscal 2004, one EMS, Celestica, accounted for approximately 14% of our revenue and represented approximately 21% of our accounts receivable as of March 28, 2004.

Finally, we utilize a relatively small number of global and regional distributors around the world, who also buy product directly from us on behalf of their customers. If our business relationships were to diminish or any one or more of these global distributors were to file for bankruptcy or otherwise experience significantly adverse financial conditions, our business could be adversely impacted. One distributor, Avnet represented 11% of revenues for fiscal 2004.

Our product manufacturing operations are complex and subject to interruption. From time to time, we have experienced production difficulties, including reduced manufacturing yields or products that do not meet our or our customers’ specifications, that have caused delivery delays, quality problems, and possibly lost revenue opportunities. While delivery delays have been infrequent and generally short in duration, we could experience manufacturing problems, capacity constraints and/or product delivery delays in the future as a result of, among other things; complexity of manufacturing processes, changes to our process technologies (including transfers to other facilities and die size reduction efforts), and ramping production and installing new equipment at our facilities.

Substantially all of our revenues are derived from products manufactured at facilities which are exposed to the risk of natural disasters. We have a wafer fabrication facility in Hillsboro, Oregon, and assembly and test facilities in the Philippines and Malaysia. If we were unable to use our facilities, as a result of a natural disaster or otherwise, our operations would be materially adversely affected. While we maintain certain levels of insurance against selected risks of business interruption, not all risks can be insured at a reasonable cost. Even if we have purchased insurance, the adverse impact on our business, including both costs and lost revenue opportunities, could greatly exceed the amounts, if any, that we might recover from our insurers.

We are dependent upon electric power generated by public utilities where we operate our manufacturing facilities and we have periodically experienced electrical power interruptions. We maintain limited backup generating capability, but the amount of electric power that we can generate on our own is insufficient to fully operate these facilities, and prolonged power interruptions could have a significant adverse impact on our business.

Much of our manufacturing capability is relatively fixed in nature. Much of our manufacturing cost structure remains fixed in nature and large and rapid swings in demand for our products can make it difficult to efficiently utilize this capacity on a consistent basis. Significant downturns, as we have most recently experienced in fiscal 2002-2003, will result in material under utilization of our manufacturing facilities while sudden upturns could leave us short of capacity and unable to capitalize on incremental revenue opportunities. These swings and the resulting under utilization of our manufacturing capacity or inability to procure sufficient capacity to meet end customer demand for our products will cause material fluctuations in the gross margins we report, and could have a material adverse affect thereon.

We build most of our products based on estimated demand forecasts. Demand for our products can change rapidly and without advance notice. Demand can also be affected by changes in our customers’ levels of inventory and differences in the timing and pattern of orders between them and their end customers. If demand forecasts are inaccurate or change suddenly, we may me be left with large amounts of unsold products, may not be able to fill all orders in the short term and may not be able to accurately forecast capacity utilization or make optimal investment and other business decisions. This can leave us holding excess and obsolete inventory or unable to meet customer short-term demands, either of which can have an adverse impact on our operating results.

We are dependent on a limited number of suppliers. Our manufacturing operations depend upon obtaining adequate raw materials on a timely basis. The number of vendors of certain raw materials, such as silicon wafers, ultra-pure metals and certain chemicals and gases, is very limited. In addition, certain packages require long lead times and are available from only a few suppliers. From time to time, vendors have extended lead times or limited supply to us due to capacity constraints. Our results of operations would be materially adversely affected if we were unable to obtain adequate supplies of raw materials in a timely manner or if they were only available at uncompetitive prices.

Although we currently fabricate most of our wafers internally, we are dependent on outside foundries for a small but growing portion of our wafer requirements. Similarly, while we currently conduct most assembly and test operations internally, we also rely upon subcontractors for our incremental assembly requirements which can be significant. We expect to continue utilizing outside foundries and subcontractors to supplement our own production capacity. If there were significant increases in the costs of these services, or if foundry or back-end subcontractor capacity was not available or only available on long lead times due to capacity constraints or any failure on our part to adequately forecast the mix of product demand, our results would adversely affected.

We are subject to a variety of environmental and other regulations related to hazardous materials used in our manufacturing processes. Any failure by us to adequately control the use or discharge of hazardous materials under present or future regulations could subject us to substantial costs or liabilities or cause our manufacturing operations to be suspended.

Intellectual property claims could adversely affect our business and operations. The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights, which have resulted in significant and often protracted and expensive litigation. We have been involved in patent litigation in the past, which adversely affected our operating results. Although we have obtained patent licenses from certain semiconductor manufacturers, we do not have licenses from a number of semiconductor manufacturers that have broad patent portfolios. Claims alleging infringement of intellectual property rights have been asserted against us and could be asserted against us in the future. These claims could result in our having to discontinue the use of certain processes; cease the manufacture, use and sale of infringing products; incur significant litigation costs and damages; and develop non-infringing technology. Further, the inability to obtain a key license, or the failure to renew or renegotiate an existing license on favorable terms, could materially adversely affect our business. As of September 26, 2004, we were in discussions to renegotiate one such existing license.

International operations add increased volatility to our operating results. A substantial percentage of our revenues are derived from international sales, as summarized below:

(percentage of total revenues)	First 6 months of Fiscal 2005		Twelve months of Fiscal 2004		Twelve months of Fiscal 2003

Americas	32	%	29	%	37	%
Asia Pacific	35	%	39	%	30	%
Japan	15	%	16	%	14	%
Europe	18	%	16	%	19	%

Total	100	%	100	%	100	%

In addition, our assembly and test facilities in Malaysia and the Philippines, our design centers in Canada, China and Australia, and our foreign sales offices incur payroll, facility and other expenses in local currencies. Accordingly, movements in foreign currency exchange rates can impact our revenues and costs of goods sold, as well as both pricing and demand for our products. Our offshore sites and export sales are also subject to risks associated with foreign operations, including:

• political instability and acts of war or terrorism, which could disrupt our manufacturing and logistical activities;

• currency controls and fluctuations;

• changes in local economic conditions; and

• changes in tax laws, import and export controls, tariffs and freight rates.

Contract pricing for raw materials and equipment used in the fabrication and assembly processes, as well as for foundry and subcontract assembly services, can also be impacted by currency exchange rate fluctuations.

Finally, in support of our international operations, a portion of our cash and investment portfolio resides offshore. At September 26, 2004, we had cash and investments of approximately $49 million invested overseas in accounts belonging to various IDT foreign operating entities. While these amounts are primarily invested in US dollars, a portion is held in foreign currencies, and all offshore balances are exposed to local political, banking, currency control and other risks.

We depend on the ability of our personnel, raw materials, equipment and products to move reasonably unimpeded around the world. Any political, military, world health or other issue which hinders this movement or restricts the import or export of materials could lead to significant business disruptions. Furthermore, any strike, economic failure, or other material disruption on the part of major airlines or other transportation companies could also adversely affect our ability to conduct business. If such disruptions result in cancellations of customer orders or contribute to a general decrease in economic activity or corporate spending on information technology, or directly or indirectly impact our marketing, manufacturing, financial and logistics functions our results of operations and financial condition could be materially adversely affected.

We are exposed to potential impairment charges on investments. From time to time, we have made strategic investments in other companies, both public and private. If the companies that we invest in are unable to execute their plans and succeed in their respective markets, we may not benefit from such investments, and we could potentially lose up to all of the amounts we invest. In addition, we evaluate our portfolio, including non-marketable equity securities, on a regular basis to determine if impairments have occurred. Impairment charges could have a material impact on our results of operations in any period. For example, in Q1 2005, we recorded a $12.8 million other-than-temporary impairment charge in connection with our investment in NetLogic.

Our common stock has experienced substantial price volatility. Such volatility may occur in the future, particularly as a result of quarter-to-quarter variations in the actual or anticipated financial results of IDT, other semiconductor companies, or our customers. Stock price volatility may also result from product announcements by us or our competitors, or from changes in perceptions about the various types of products we manufacture and sell. In addition, our stock price may fluctuate due to price and volume fluctuations in the stock market, especially in the technology sector.

We are dependent on key personnel. Our performance is substantially dependent on the performance of our executive officers and key employees. The loss of the services of any of our executive officers, technical personnel or other key employees could adversely affect our business. In addition, our future success depends on our ability to successfully compete with other technology firms in attracting and retaining key technical and management personnel. If we are unable to identify and hire highly qualified technical and managerial personnel, our business could be harmed.

We may have difficulty integrating acquired companies and technologies. We acquired ZettaCom and certain assets from IMC in Q1 2005. In addition, we acquired certain technologies from IBM in fiscal 2004. We also acquired Newave and Solidum in fiscal 2002 and 2003, respectively, and we may pursue other acquisitions in the future. Failure to successfully integrate acquired companies and technologies into our business could adversely affect our results of operations. Integration risks and issues may include, but are not limited to, key personnel retention and assimilation, management distraction, technology development, and unexpected costs and liabilities, including goodwill, technology or other related intangible asset impairment charges.

Changes in generally accepted accounting principles regarding stock option accounting may adversely impact our reported operating results, our stock price and our competitiveness in the employee marketplace. Technology companies like ours have a history of using broad-based employee stock option programs to recruit, incentivize and retain their workforces in what can be a highly competitive employee marketplace. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123) allows companies the choice of either using a fair value method of accounting for options, which would result in expense recognition for all options granted, or using an intrinsic value method, as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), with a pro forma disclosure of the impact on net income (loss) of using the fair value option expense recognition method. We have elected to apply APB 25 and accordingly we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.

During March 2004, the FASB issued a proposed Statement, “Share-Based Payment, an amendment of FASB Statements No. 123 and 95”. The statement proposes to eliminate the treatment for share-based transactions using APB 25 and generally would require share-based payments to employees be accounted for using a fair-value-based method and recognized as expenses in our statements of operations. The proposed standard would require the modified prospective method be used, which would require that the fair value of new awards granted from the beginning of the year of adoption plus unvested awards at the date of adoption be expensed over the vesting term. In addition, the proposed statement encourages companies to use the “binomial” approach to value stock options, as opposed to the Black-Scholes option pricing model that we currently use for the fair value of our options under SFAS 123 disclosure provisions.

In October 2004, the FASB delayed the effective date of the proposed standard to apply for fiscal years beginning after June 15, 2005. Should this proposed statement be finalized, it will have a significant adverse impact on our consolidated statement of operations, as we will be required to expense the fair value of our stock options rather than disclosing their impact on our consolidated results of operations within our footnotes in accordance with the disclosure provisions of SFAS 123. This will result in lower reported earnings per share which could negatively impact our future stock price, our access to the capital markets, and the effectiveness of current outstanding stock options in retaining key personnel. In addition, should the proposal be finalized, this could impact our ability or future practice of utilizing broad-based employee stock plans to attract, reward, and retain employees, which could also adversely impact our operations.

Our business is subject to changing regulation of corporate governance and public disclosure that has increased both our costs and the risk of noncompliance. Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC and NASDAQ, have recently issued new requirements and regulations and continue developing additional regulations and requirements in response to recent corporate scandals and laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. Our efforts to comply with these new regulations have resulted in, and are likely to continue resulting in, increased general and administrative expenses and diversion of management time and attention from revenue-generating activities to compliance activities.

ITEM 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

At September 26, 2004, the end of the quarter covered by this report, we carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level. There have been no significant changes in our internal controls over financial reporting during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On September 16, 2004, we held our 2004 Annual Meeting of Stockholders. On the record date, 106,118,610 shares of our Common Stock were outstanding and entitled to be voted. Tabulated proxies at the meeting represented 101,874,427 shares, or 96% of the total eligible. Voting results are summarized below:

Proposal I: Election of one director;

Name	Votes For	Withheld

John C. Bolger	97,770,338	4,104,089

Proposal II: To approve the adoption of the 2004 Equity Plan.

Votes For	Against	Abstained

55,449,101	28,046,955	18,378,371

Proposal III: To ratify the selection of PricewaterhouseCoopers LLP as the Company’s independent accountants for the fiscal year ended April 3, 2005.

Votes For	Against	Abstained

100,048,945	1,765,203	60,279

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following exhibits are filed herewith:

Exhibit number		Description

	10.25	2004 Equity Plan
	31.1	Certification of Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, dated November 3, 2004.
	31.2	Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, dated November 3, 2004.
	32.1	Certification of Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, dated November 3, 2004.
	32.2	Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, dated November 3, 2004.

Date Filed		Description

7/22/04		Financial Information for Integrated Device Technology, Inc. for the first quarter ended June 27, 2004, and forward looking statements relating to fiscal year 2005 as presented in a press release of July 22, 2004.

9/2/04		Financial Information for Integrated Device Technology, Inc. pertaining to the second quarter ending on September 26, 2004, as presented in a press release of September 2, 2004.

	INTEGRATED DEVICE TECHNOLOGY, INC.


Date: November 3, 2004	/s/ GREGORY S. LANG
	Gregory S. Lang
	President and Chief Executive Officer (duly authorized officer)

Date: November 3, 2004	/s/ CLYDE R. HOSEIN
	Clyde R. Hosein
	Vice President, Chief Financial Officer (Principal Financial and Accounting Officer)