INTEGRATED DEVICE TECHNOLOGY INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE 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 January 2, 2005

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 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 January 30, 2005, was approximately 105,136,000.

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						Nine months ended
	Jan. 2, 2005			Dec. 28, 2003			Jan. 2, 2005			Dec. 28, 2003

Revenues	$	95,658		$	87,100		$	293,636		$	250,922
Cost of revenues	49,833			45,625			146,441			136,550
Restructuring and asset impairment	213			—			(1,581		)	—

Gross profit	45,612			41,475			148,776			114,372

Operating expenses:

Research and development	26,365			23,607			77,815			74,689
Selling, general and administrative	18,291			17,888			55,479			54,533
Acquired in-process research and development	29			—			1,765			264

Total operating expenses	44,685			41,495			135,059			129,486

Operating income (loss)	927			(20		)	13,717			(15,114		)

Gain (loss) on equity investments	—			—			(12,831		)	3,151
Interest expense	(13		)	(69		)	(86		)	(279		)
Interest income and other, net	3,657			2,787			8,986			10,153

Income (loss) before income taxes	4,571			2,698			9,786			(2,089		)
Provision for (benefit from) income taxes	1,223			358			2,632			(827		)

Net income (loss)	$	3,348		$	2,340		$	7,154		$	(1,262	)

Basic net income (loss) per share	$	0.03		$	0.02		$	0.07		$	(0.01	)
Diluted net income (loss) per share	$	0.03		$	0.02		$	0.07		$	(0.01	)

Weighted average shares:
Basic	105,806			104,915			105,992			104,332
Diluted	107,444			108,360			108,544			104,332

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

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

	Jan. 2, 2005			Mar. 28, 2004
Assets
Current assets:
Cash and cash equivalents	$	247,392		$	223,360
Short-term investments	342,374			384,854
Accounts receivable, net	50,115			53,091
Inventories, net	44,425			32,745
Prepayments and other current assets	11,431			12,101

Total current assets	695,737			706,151

Property, plant and equipment, net	105,455			108,424
Goodwill and other intangibles, net	86,558			52,784
Other assets	9,170			38,194

Total assets	$	896,920		$	905,553

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	23,289		$	20,190
Accrued compensation and related expenses	15,170			11,560
Deferred income on shipments to distributors	19,783			21,411
Income taxes payable	33,743			33,267
Other accrued liabilities	19,135			19,250

Total current liabilities	111,120			105,678

Long-term obligations	12,903			15,651

Total liabilities	124,023			121,329

Stockholders’ equity:
Common stock and additional paid-in capital	833,953			825,483
Deferred stock-based compensation	(127		)	(1,140		)
Treasury stock	(204,909		)	(180,751		)
Retained earnings	144,313			137,159
Accumulated other comprehensive income (loss)	(333		)	3,473

Total stockholders’ equity	772,897			784,224

Total liabilities and stockholders’ equity	$	896,920		$	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)

	Nine months ended
	Jan. 2, 2005			Dec. 28, 2003
Operating activities
Net income (loss)	$	7,154		$	(1,262	)
Adjustments:
Depreciation	39,265			37,422
Amortization of intangible assets	4,838			1,564
Acquired in-process research and development	1,765			264
Merger-related stock-based compensation	438			1,079
Other-than-temporary impairment loss on equity investments	12,831			—
Non-cash restructuring and other	—			180
Changes in assets and liabilities:
Accounts receivable	3,154			(7,776		)
Inventories	(11,045		)	9,278
Prepayments and other assets	(579		)	16,749
Accounts payable	2,664			(281		)
Accrued compensation and related expenses	3,286			4,658
Deferred income on shipments to distributors	(1,861		)	197
Income taxes payable	476			987
Other accrued liabilities	672			(264		)

Net cash provided by operating activities	63,058			62,795

Investing activities
Purchases of property, plant and equipment	(36,170		)	(22,660		)
Cash paid for acquisition of ZettaCom, net of cash acquired	(34,375		)	—
Purchases of marketable securities	(324,671		)	(338,843		)
Proceeds from sales and maturities of marketable securities	379,854			334,664
Purchases of technology and other investments, net	(3,000		)	(8,078		)

Net cash used for investing activities	(18,362		)	(34,917		)

Financing activities
Issuance of common stock	9,045			11,046
Repurchases of common stock	(24,158		)	—
Payments on capital leases and other debt	(5,551		)	(3,121		)

Net cash provided by (used for) financing activities	(20,664		)	7,925

Net increase in cash and cash equivalents	24,032			35,803
Cash and cash equivalents at beginning of period	223,360			144,400

Cash and cash equivalents at end of period	$	247,392		$	180,203

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 January 2, 2005 (Q3 2005), September 26, 2004 (Q2 2005), March 28, 2004 (Q4 2004) and December 28, 2003 (Q3 2004), unless otherwise indicated. Q3 2005 was a fourteen week period, as occurs once every seven years to align our 364-day fiscal years with calendar year periods. All other quarters presented include thirteen weeks.

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 nine-month periods ended January 2, 2005 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		Nine months ended
(in thousands)	Jan. 2, 2005	Dec. 28, 2003	Jan. 2, 2005	Dec. 28, 2003

Weighted average common shares outstanding	105,806	104,915	105,992	104,332
Dilutive effect of employee stock options	1,638	3,445	2,552	—
Weighted average common shares outstanding, assuming dilution	107,444	108,360	108,544	104,332

Net loss per share for the nine-month period ended December 28, 2003 is based only on weighted average shares outstanding. Stock options based equivalent shares for this period of 2.0 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 7.4 million, 3.0 million, and 6.2 million shares for the three-month periods ended January 2, 2005 and December 28, 2003 and the nine-month period ended January 2, 2005, 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						Nine months ended
(in thousands)	Jan. 2, 2005			Dec. 28, 2003			Jan. 2, 2005			Dec. 28, 2003

Reported net income (loss)	$	3,348		$	2,340		$	7,154		$	(1,262	)
Add: Stock-based compensation included in reported net income (loss)	71			358			438			1,079
Deduct:Stock-based employee compensation expense determined under a fair-value based method for all awards	(9,947		)	(11,712		)	(29,487		)	(36,862		)
Pro forma net loss	$	(6,528	)	$	(9,014	)	$	(21,895	)	$	(37,045	)
Pro forma net loss per share:
Basic	$	(0.06	)	$	(0.09	)	$	(0.21	)	$	(0.36	)
Diluted	$	(0.06	)	$	(0.09	)	$	(0.21	)	$	(0.36	)
Reported net income (loss) per share:
Basic	$	0.03		$	0.02		$	0.07		$	(0.01	)
Diluted	$	0.03		$	0.02		$	0.07		$	(0.01	)

Note 4

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151 “Inventory Costs” (SFAS 151). This statement amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS 151 are effective for inventory cost incurred in fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of fiscal 2007. The Company does not expect the adoption of SFAS 151 to have a material impact on its consolidated financial statements.

In December 2004, the FASB issued SFAS 123R, Share-Based Payments. Generally, the requirements of SFAS 123R are similar to those of SFAS 123. However, SFAS 123R requires companies to now recognize all share-based payments to employees, including grants of employee stock options, in their statements of operations based on the fair value of the payments. Pro forma disclosure will no longer be an alternative. We are required to adopt SFAS 123R beginning with the second quarter of our fiscal year 2006.

SFAS 123R permits public companies to adopt its requirements using one of two methods: (1) a “modified prospective” method under which compensation cost is recognized beginning with the effective date based on the requirements of SFAS 123R for all share-based payments granted after the effective date and based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R that are unvested on the effective date; or (2) a “modified retrospective” method which includes the requirements of the modified prospective method and also permits companies to restate either all prior periods presented or prior interim periods of the year of adoption using the amounts previously calculated for pro forma disclosure under SFAS 123. We have not yet determined which method we will select for our adoption of SFAS 123R.

As permitted by SFAS 123, we currently account for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options through our statement of operations but rather disclose the effect in our financial statement footnotes. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on our reported results of operations. However, the impact of the adoption of SFAS 123R cannot be quantified at this time because it will depend on levels of share-based payments granted in the future, but had we applied the principles of SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123, as described in the disclosure of pro forma net income and earnings per share in Note 3 to these condensed consolidated financial statements.

On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret some provisions in the Act. Although we plan to take advantage of the incentive, we are not yet in a position to decide to what extent we might repatriate foreign earnings that have not yet been remitted to the United States. We expect to finalize our assessment by January 1, 2006.

Note 5

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 January 2, 2005 and March 28, 2004. Available-for-sale investments are classified as cash equivalents or 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 (loss), 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, indicated 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 6

Inventories, Net

Inventories are summarized as follows:

(in thousands)	Jan. 2, 2005		Mar. 28, 2004

Raw materials	$	4,775	$	3,537
Work-in-process	26,150		20,984
Finished goods	13,500		8,224
Total inventories, net	$	44,425	$	32,745

Note 7

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 8

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 and liabilities 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. In addition, during the third quarter of 2005, another milestone was met by IBM and as a result the Company accrued an additional $0.9 million. The amounts of these payments were allocated consistent with the allocation of the initial purchase price. Per the agreement, the Company may pay an additional $2.0 million in the near future contingent upon IBM successfully achieving and IDT accepting one additional technology milestone.

Note 9

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 January 2, 2005 and March 28, 2004 are summarized as follows:

	Jan. 2, 2005
(in thousands)	Gross assets		Accumulated amortization			Net assets

Goodwill	$	56,232	$	—		$	56,232

Identified intangible assets:
Existing technology	29,207		(4,791		)	24,416
Trademark	2,240		(1,170		)	1,070
Customer relationship	4,307		(1,151		)	3,156
Non-compete agreement	3,067		(1,435		)	1,632
Other	143		(91		)	52
Subtotal, identified intangible assets	38,964		(8,638		)	30,326
Total goodwill and identified intangible assets	$	95,196	$	(8,638	)	$	86,558

	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		Nine months ended
(in thousands)	Jan. 2, 2005	Dec. 28, 2003	Jan. 2, 2005	Dec. 28, 2003

Existing technology	1,268	400	3,221	923
Trademark	80	80	240	240
Customer relationship	354	173	748	231
Non-compete agreements	262	79	601	107
Other identified intangibles	12	30	28	63
Total	1,976	762	4,838	1,564

Based on the identified intangible assets recorded at January 2, 2005, 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	$	1,633
2006	6,533
2007	6,336
2008	5,757
2009	3,989
Thereafter	6,078
Total	$	30,326

Note 10

Comprehensive Income (Loss)

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

	Three months ended						Nine months ended
(in thousands)	Jan. 2, 2005			Dec. 28, 2003			Jan. 2, 2005			Dec. 28, 2003

Net income (loss)	$	3,348		$	2,340		$	7,154		$	(1,262	)
Currency translation adjustments	811			1,114			991			1,923
Change in unrealized gain (loss) on derivatives, net of taxes	—			—			—			(31		)
Change in net unrealized gain (loss) on investments, net of taxes	(1,273		)	(981		)	(4,797		)	(3,551		)
Comprehensive income (loss)	$	2,886		$	2,473		$	3,348		$	(2,921	)

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

(in thousands)	Jan. 2, 2005			Mar. 28, 2004

Cumulative translation adjustments	$	1,773		$	782
Unrealized gain (loss) on investments	(2,106		)	2,691
Total accumulated other comprehensive income (loss)	$	(333	)	$	3,473

Note 11

Share Repurchase Program

During Q3 2005, under a program authorized by the Board of Directors in October 2004, the Company repurchased 2.1 million shares of its common stock at an aggregate cost of $24.2 million. Since the Company first began buying back its stock in fiscal 2001, the Company has repurchased 9.1 million shares at a cost of $204.9 million. Repurchases are recorded as treasury stock and result in a reduction of stockholders’ equity. As of January 2, 2005, there is $25.8 million available to purchase additional shares under the current repurchase authorization. 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 may be discontinued at any time.

Note 12

Gain on sale of previously impaired assets

During each of the three quarters of FY 2005, the Company recorded gains of $0.2 million, $1.6 million, and $0.1 million, respectively, from sales of land and equipment related to its closed Salinas facility, which had been impaired and reclassified to assets held for sale during Q3 2002. As the impairment charge in fiscal 2002 was included in cost of goods sold , the gains on the sales of the related land and equipment are also included there in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

Note 13

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 may use 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 may enter into hedges of forecasted transactions when the underlying transaction is highly probable and reasonably certain to occur within the subsequent twelve months. Examples of these exposures would include forecasted expenses of a foreign manufacturing plant, design center or sales office. The Company may additionally enter into a derivative to hedge the foreign currency risk of a capital equipment purchase if the capital equipment purchase order is executed and designated as a firm commitment. The Company does not enter into derivative financial instruments for speculative or trading purposes. There were no hedges of forecasted transactions or firm commitments during Q3 2005 and Q3 2004 or the nine months then ended.

The Company also utilizes currency forward contracts to hedge currency exchange rate fluctuations related to certain short term 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 Q3 2005 and Q3 2004 and the nine months then ended.

Besides foreign exchange rate exposure, the Company’s cash and investment portfolios are subject to risks associated with fluctuations in interest rates. 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 14

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 nine month periods ended January 2, 2005 and December 28, 2003:

Revenues by segment

	Three months ended				Nine months ended
(in thousands)	Jan. 2, 2005		Dec. 28, 2003		Jan. 2, 2005		Dec. 28, 2003

Communications and Timing Products	$	81,207	$	73,052	$	246,075	$	213,095
SRAMs	14,451		14,048		47,561		37,827
Total consolidated revenues	$	95,658	$	87,100	$	293,636	$	250,922

Income (Loss) by segment

	Three months ended						Nine months ended
(in thousands)	Jan. 2, 2005			Dec. 28, 2003			Jan. 2, 2005			Dec. 28, 2003

Communications and Timing Products	$	10,527		$	11,018		$	34,919		$	16,502
SRAMs	(6,673		)	(9,422		)	(13,120		)	(26,303		)
Restructuring and asset impairment	(311		)	(227		)	806			(1,560		)
Amortization of intangible assets	(1,976		)	(762		)	(4,838		)	(1,564		)
Amortization of deferred stock-based compensation	(71		)	(358		)	(438		)	(1,079		)
Facility closure costs and other	(33		)	(269		)	(272		)	(846		)
Acquired in-process research and development	(29		)	—			(1,765		)	(264		)
Acquisition related costs	(507		)	—			(1,575		)	—
Gain (loss) on equity investments	—			—			(12,831		)	3,151
Interest income and other	3,657			2,787			8,986			10,153
Interest expense	(13		)	(69		)	(86		)	(279		)
Income (loss) before income taxes	$	4,571		$	2,698		$	9,786		$	(2,089	)

Note 15

Guarantees

The Company indemnifies certain customers, distributors, and subcontractors for attorney fees and damages awarded against these parties in certain circumstances in which the Company’s products are alleged to infringe third party intellectual property rights, including patents, registered trademarks, or copyrights. The terms of the Company’s indemnification obligations are generally perpetual from the effective date of the agreement. In certain cases, there are limits on and exceptions to the Company’s potential liability for indemnification relating to intellectual property infringement claims. The Company cannot estimate the amount of potential future payments, if any, that we might be required to make as a result of these agreements. The Company has not paid any claim or been required to defend any claim related to our indemnification obligations, and accordingly, the Company has not accrued any amounts for our indemnification obligations. However, there can be no assurances that the Company will not have any future financial exposure under these indemnification obligations.

The Company maintains a reserve for obligations it incurs under its product warranty program. The standard warranty period offered is one year, though in certain instances the warranty period may be extended, mostly to two years. Management estimates the fair value of its warranty liability based on actual past warranty claims experience, its policies regarding customer warranty returns and other estimates about the timing and disposition of product returned under the program. The related reserve was $1.1 million and $0.5 million, as of January 2, 2005 and March 28, 2004, respectively.

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

All references are to our fiscal quarters ended January 2, 2005 (Q3 2005), September 26, 2004 (Q2 2005), March 28, 2004 (Q4 2004) and December 28, 2003 (Q3 2004), unless otherwise indicated. Quarterly financial results may not be indicative of the financial results of future periods. Q3 2005 included 14 weeks while each of the other quarters presented included 13 weeks.

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, manufacturing activities and expenses, 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. We are currently under an IRS audit for the fiscal years 2000 – 2004. 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 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 (Q3 2005 compared to Q3 2004). Our revenues for Q3 2005 were $95.7 million, an increase of $8.6 million or 9.8% compared to the corresponding quarter of the previous year. The increase related to our average selling price per unit (ASP) for our products, which increased by approximately 13% when compared to Q3 2004, primarily as a result of a higher concentration of higher ASP units sold and, to some extent, price increases in our SRAM product segment. Overall, units sold were down slightly, from 54.5 million units in Q3 2004 to 53.1 million units in Q3 2005.

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 $8.2 million or 11.2%, while revenues for our SRAM segment increased by $0.4 million or 3.0% as compared to Q3 2004. Units sold in the Communications and Timing Products segment were up 2.8%, while units sold were down by 26.7% in the SRAM segment as compared to Q3 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 20.1%;

• Revenues in Europe also showed strong growth in Q3 2005, growing 14.2%;

• Revenues in Japan increased by 9.3% in Q3 2005; and

• Revenues within the APAC region also increased by 1.2%.

As a percentage of worldwide revenues, the Americas grew by 2.7%, representing 31.7% of the total in Q3 2005, while the APAC region correspondingly declined from 41.2% of the total to 38.0% in Q3 2005. In part, these shifts in geographic share may reflect changes in either mix of product sold, or the supply chain decisions being made by certain of our key customers.

Revenues (Q3 2005 compared to Q2 2005). Our revenues for Q3 2005 were sequentially lower by $1.0 million or 1.0%, despite units sold increasing by 6.2%. We experienced mixed results across our product lines and markets served, with the greatest strength in sales of timing products such as DIMM components and PC clocks going into computing applications. On the other hand, sales of SRAM products and certain communications products serving the enterprise networking and wireless infrastructure equipment markets remained weak, which we attribute to excess inventory conditions at some of our key customers.

Revenues for our Communications and Timing Products segment increased sequentially by $1.9 million or 2.4%, driven by a 9.7% increase in units sold, primarily related to strength in timing products noted above. ASPs, however, were down by 6.3%, primarily due to the mix of products sold. Revenues from the SRAM segment decreased sequentially by $2.9 million or 16.7%, as both units (down 11.8%) and ASPs (down 5.7%) declined.

During Q3 2005, we experienced a geographical shift in our business back to more closely align with the business over the past few years. The APAC region rebounded significantly during Q3 2005, as revenue increased by 14.6% sequentially and the region represented 38.0% of total revenue (up from 32.8% in Q2 2005). Most of this geographic shift also relates to strength in sales of timing products in Q3 2005.

Revenues (first nine months of fiscal 2005 compared to first nine months of fiscal 2004). Our revenues year-to-date for fiscal 2005 were $293.6 million compared with $250.9 million for the first nine months of fiscal 2004, an increase of $42.7 million, or 17.0%.

Within our Communications and Timing Products segment, revenues increased by $33.0 million or 15.5%, primarily related to increases in ASPs which were higher mostly due to product mix. Unit sales were essentially flat. Within our SRAM segment, revenues increased by $9.7 million or 25.7% as ASPs were up significantly as a result of price increases realized during fiscal 2005. Unit sales were down 11.9%.

Revenues (recent trends and outlook). During the third fiscal quarter of 2005, we continued to experience weak demand conditions in certain customer areas such as enterprise and wireless infrastructure, where we believe some customers are still trying to realign their inventory levels with current demand in the marketplace. While overall bookings levels improved somewhat during Q3 2005, pricing weakened, particularly for SRAM products. Considering the difficulty in projecting when customers will complete their inventory adjustments and the possibility of further near-term SRAM pricing declines, we currently expect Q4 2005 revenues to fall within a range from slightly below to slightly above the Q3 2005 level.

Gross profit (Q3 2005 compared to Q3 2004). Gross profit for Q3 2005 was $45.6 million, an increase of $4.1 million compared to $41.5 million recorded in Q3 2004. Our gross profit margin percentage for Q3 2005 was 47.7% compared to 47.6% for Q3 2004. Improvements in gross margin came primarily from:

• The incremental gross margin associated with higher revenues;

• The improved pricing environment for SRAM products;

• Cost benefits associated with transitioning a higher proportion (62%, compared with 43% in Q3 2004) of our internal wafer production to 0.18 micron and finer-geometry wafers;

• Increased allocations of manufacturing costs to R&D activities (by $0.9 million) associated with the increased cost of production of our Hillsboro wafer fabrication facility; and

These factors were partially offset by lower utilization of our manufacturing infrastructure, particularly in our Hillsboro wafer fabrication facility as wafers started into production were reduced by more than 40% and wafers completed were down 12% to 20.4 thousand wafers in Q3 2005 from 23.2 thousand wafers in Q3 2004.

Finally, gross margins did not benefit by selling inventory previously reserved as excess in Q3 2005 versus a $0.6 million benefit in Q3 2004.

Gross profit (Q3 2005 compared to Q2 2005). Gross profit for Q3 2005 was down sequentially by $4.4 million, from $50.0 million in Q2 2005 to $45.6 million in Q3 2005. Our gross profit margin percentage also decreased from 51.7% in Q2 2005 to 47.7% in Q3 2005. The decrease in gross margin is due primarily to:

• Lower utilization of our manufacturing infrastructure, particularly in our Hillsboro wafer fabrication facility as wafers started into production were reduced by more than 45% and wafers completed were down 25% to 20.4 thousand in Q3 2005 from 27.1 thousand wafers in Q2 2005;

• A $1.6 million gain on the sale of land and equipment related to our Salinas facility in Q2 2005 versus a $0.1 million related gain in Q3 2005; and

• Weaker SRAM pricing, as described above.

These factors were partially offset by increased allocations of manufacturing costs to development activities (by $0.6 million) associated with the increased cost of production of our Hillsboro wafer fabrication facility.

Gross Profit (first nine months of 2005 compared to the first nine months of 2004). Gross profit for the first nine months of 2005 increased to $148.8 million from $114.4 million in the first nine months of 2004. Similarly, gross profit margin increased to 50.7% for the first nine months of 2005 versus 45.6% for the first nine months of 2004. The increase in gross profit in the first nine months of 2005 was primarily attributable to the significant increase in revenues discussed above, improved manufacturing utilization in the first-half of the year, a higher proportion of our wafers at 0.18 micron and finer geometries, increased SRAM pricing, and lower pricing related inventory reserve requirements. In the first nine months of 2004, gross profit benefited from the sale of approximately $2.5 million of previously reserved inventory. In contrast, there was no related benefit in the first nine months of 2005.

Considering the weak business conditions that we experienced in Q3 2005, and the continued uncertainty in the near-term outlook, we are maintaining lower production levels in Q4 2005 to better align our inventory position with the current level of demand. The resulting lower levels of manufacturing spending are expected to be offset by poorer utilization of our production facilities, and by anticipated pricing declines (particularly for SRAM products). As a result, we currently anticipate that gross profit margin percentage in Q4 2005 could be similar to Q3 2005’s percentage, depending on revenue levels in Q4 2005.

Research and development (Q3 2005 compared to Q3 2004). For Q3 2005, research and development (R&D) expenses were $26.4 million, a $2.8 million or 11.7% increase from Q3 2004. Labor related spending was higher by $1.3 million, primarily due to increased headcount and retention costs in connection with the ZettaCom acquisition in FY 2005 and performance-tied personnel costs in connection with the improved financial results. Allocations of manufacturing spending to development activities increased by $0.9 million, reflecting a higher proportional usage of manufacturing infrastructure by R&D. In addition, product development services increased as a result of additional consulting and technology licenses purchased in the period, and higher software maintenance and photomask expenses.

R&D (Q3 2005 compared to Q2 2005). R&D expenses increased by $0.9 million in Q3 2005 from $25.4 million in Q2 2005. The sequential increase is primarily attributable to higher proportional allocations of manufacturing costs to development activities by $0.6 million, reflecting lower levels of production in Q3 2005. In addition, consistent with the year-over-year comparison above, maintenance contract expenses and photomask expenses increased during Q3 2005.

R&D (first nine months of 2005 compared to the first nine months of 2004). For the first nine months of fiscal 2005, R&D spending increased by $3.1 million compared to the same period in fiscal 2004, mostly due to higher labor-related spending and higher manufacturing allocations as noted above in the quarterly comparison of Q3 2005 to Q3 2004.

We currently expect that R&D spending in Q4 2005 will increase slightly in comparison to Q3 2005.

Selling, general and administrative (Q3 2005 compared to Q3 2004). For Q3 2005, selling, general, and administrative (SG&A) expenses were $18.3 million, a $0.4 million or 2.3% increase from Q3 2004. The increase related to higher labor related costs of $0.7 million, along with higher spending on outside services including consulting and auditing services to comply with Section 404 of the Sarbanes Oxley Act, and increased sales rep. commissions, as a larger portion of business has moved to rep. coverage. Partially offsetting the above amounts, equipment depreciation expenses and insurance costs were lower.

SG&A (Q3 2005 compared to Q2 2005). SG&A expenses increased by $0.5 million in Q3 2005 from $17.8 million in Q2 2005. The increase is primarily attributable to higher spending on outside services and sales rep. commissions, as described above and a reduction in bad debt reserve requirements in Q2 2005 that did not recur in Q3 2005. These amounts were partially offset by lower labor-related spending.

SG&A (first nine months of 2005 compared to the first nine months of 2004). For the first nine months of fiscal 2005, SG&A spending increased by $0.9 million compared to the same period in fiscal 2004. The increase is primarily related to higher performance-tied personnel costs in fiscal 2005; increased spending on outsides services, such as the consulting and auditing services as mentioned above, and increased sales-related expenses, including rep. commissions. These amounts were partially offset by lower equipment depreciation costs and bad debt reserve requirements.

We currently expect that SG&A spending in Q4 2005 will increase slightly in comparison to Q3 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. In addition, during Q3 2005, the Company recorded an additional IPR&D charge related to a follow-on payment made in connection with the acquisition of certain technologies from IBM in FY 2004.

Gain (loss) on equity investments. During Q1 2005, we recorded an impairment charge 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 Q3 2005, interest income and other, net, was $3.7 million, an increase of $0.9 million compared to Q3 2004. The increase was primarily attributable to higher interest rates in the Q3 2005 quarter.

Provision/Benefit for income taxes. In Q3 2005, we recorded a tax provision of $1.2 million to cover projected current worldwide income tax expense as compared to $0.4 million for Q3 2004. The increase reflects the improved financial results in the current fiscal year. 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 $589.8 million at January 2, 2005, a decrease of $18.4 million compared to March 28, 2004. There was no debt outstanding as of January 2, 2005.

Net cash provided by operating activities was $63.1 million for the first nine months of fiscal 2005, compared to $62.8 million for the same period of fiscal 2004. During the first nine months of fiscal 2005, we recorded net income of $7.2 million as compared to a net loss of $1.3 million in the same period of the prior year. Non-cash adjustments were significantly higher in the first nine 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 $4.8 million primarily as a result of higher in-process R&D charges (by $1.5 million) and higher acquisition related intangible amortization (by $3.3 million) as a result of the ZettaCom acquisition; and

• Depreciation, which was higher by $1.8 million as a result of capital expenditures over the past year.

Net sources of cash related to working capital related items decreased by $26.8 million in the first nine months of 2005 as compared to the same period of fiscal 2004. Working capital items consuming relatively more cash during the first nine months of fiscal 2005 included:

• An increase in inventories of $11.0 million as compared to a reduction of $9.3 million in the year-ago period. We grew inventory levels early in fiscal 2005 in anticipation of increased demand which did not materialized as compared to the previous year when we were purposely lowering our inventory levels;

• A swing in prepayments and other assets of $17.3 million, primarily as a result of $10.4 million of proceeds from the sales of building and equipment from our closed Salinas facility, and the receipt of approximately $5.5 million related to a distributor financing arrangement, occurring during 2004 which did not recur in 2005;

• A decrease in deferred income on shipments to distributors of $1.9 million as compared to an increase of $0.2 million in the year-ago period as distributors added more inventory in 2005 compared to the same period in 2004;

• A relatively lower (by $1.4 million) increase in accrued compensation and related expenses in the current period.

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

• A decrease in accounts receivable during fiscal 2005 of $3.2 million compared to an increase of $7.8 million in fiscal 2004 combined for a swing of approximately $10.9 million;

• An increase in accounts payable during fiscal 2005 compared to a decrease in fiscal 2004, generating $2.9 million more net cash, as business volumes were relatively higher in the current period.

Our investing activities used $18.4 million of cash in the first nine months of fiscal 2005 as compared to a use of cash of $34.9 million in the first nine months of fiscal 2004. In the first nine months of fiscal 2005, our sales of short-term investments, net of purchases, were $59.4 million higher than in the comparable period of fiscal 2004. In the first nine 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 $3.0 million in cash in the first nine months of 2005, down from $8.1 million in 2004. Finally, capital expenditures in the first nine months of fiscal 2005 were higher by $13.5 million as we purchased new equipment primarily to increase our manufacturing capacity early in FY 2005.

Our financing activities used $20.7 million of cash in the first nine months of fiscal 2005 as compared to $7.9 million of cash provided in the comparable period of fiscal 2004. Repurchases of common stock used $24.2 million in FY 2005 under the program approved by the board in early Q3 2005. Payments on capital leases increased by $2.4 million during FY 2005 in `connection with early buyout options which were exercised in the period to payoff the remaining debt. Proceeds from issuances of common stock were lower in the current period by $2.0 million.

We currently anticipate capital expenditures of approximately $70-75 million during fiscal 2005, to be financed through cash generated from operations and existing cash and investments. This estimate includes $36.2 million in capital expenditures during the first nine months of fiscal 2005, and approximately $29 million paid in early Q4 2005 related to the purchase of a new corporate campus facility. In addition, we have approximately $25 million remaining under the BOD’s authorization foradditional repurchases of common stock and may utilize all or a portion of the remaining authorization during the fourth fiscal quarter.. Considering these expenditures, we anticipate that our total cash and investments will decline during Q4 2005.

We believe that existing cash and investment balances, together with cash flows from operations, will be sufficient to meet our working capital and capital expenditure needs, and common stock repurchase plans through the 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.

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151 “Inventory Costs” (SFAS 151). This statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS 151 are effective for inventory cost incurred in fiscal years beginning after June 15, 2005. As such, the Company is required to adopt these provisions at the beginning of fiscal 2007. The Company does not expect the adoption of SFAS 151 to have a material impact on its consolidated financial statements.

As permitted by SFAS 123, we currently account for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options through our statement of operations but rather, disclose the effect in our financial statement footnotes. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on our reported results of operations. However, the impact of the adoption of SFAS 123R cannot be quantified at this time because it will depend on levels of share-based payments granted in the future, but had we applied the principles of SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123, as described in the disclosure of pro forma net income and earnings per share in Note 3 to these condensed consolidated financial statements.

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 as well as during the three and nine months ended Q3 2005.

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 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 January 2, 2005, 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 nine months of Fiscal 2005		Twelve months of Fiscal 2004		Twelve months of Fiscal 2003

Americas	32	%	29	%	37	%
Asia Pacific	36	%	39	%	30	%
Japan	15	%	16	%	14	%
Europe	17	%	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 January 2, 2005, 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.

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 certain 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.

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.

In particular, our efforts to prepare to comply with Section 404 of the Sarbanes-Oxley Act and related regulations regarding our management’s required assessment of our internal control over financial reporting and our independent auditors’ attestation of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. Although management currently believes that ongoing efforts to improve our internal control over financial reporting will enable management to provide the required report, and our independent auditors to provide the required attestation, under Section 404 as of April 3, 2005, we can give no assurance that such efforts will be completed on a timely and successful basis to enable our management and independent auditors to provide the required report and attestation.

Moreover, because the new and modified laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our interest rate risk relates primarily to our investment portfolio, which consisted of $247.4 million in cash and cash equivalents and $342.4 million in short-term investments as of January 2, 2005. By policy, we limit our exposure to longer-term investments, and a substantial majority of our investment portfolio has maturities of less than two years. Although a hypothetical 10% change in interest rates could have a material effect on the value of our portfolio at a given time, we normally hold these investments until maturity, which then results in no realized impact on results of operations or cash flows. We do not currently use derivative financial instruments in our investment portfolio.

By policy, we mitigate the credit risk to our investment portfolio through diversification and for, debt securities, adherence to high credit-rating standards.

At January 2, 2005, we had no outstanding debt.

We are exposed to foreign currency exchange rate risk as a result of international sales, assets and liabilities of foreign subsidiaries, local operating expenses of our foreign entities and capital purchases denominated in foreign currencies. We may use derivative financial instruments to help manage our foreign currency exchange exposures. We do not enter into derivatives for speculative or trading purposes. We performed a sensitivity analysis as of January 2, 2005 and determined that, without hedging the exposure, a 10% change in the value of the U.S. dollar could have a material near-term impact on our financial results of operations. We estimate that a 10% change would result in an approximately 1 point impact on gross profit margin percentage, as we operate manufacturing facilities in Malaysia and the Philippines, and a ½ point impact to operating expenses (as a percentage of revenue) as we operate sales offices in Japan and throughout Europe and design centers in China, Canada, and Australia.

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 January 2, 2005, 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 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EUITY SECURITIES

The following table sets forth information with respect to repurchases of our common stock during the third quarter of fiscal 2005:

Period	Total number of shares purchased	Average price paid per share		Total number of shares purchased as part of publicly announced programs	Approximate total dollar value of shares that may yet be purchased under the program (1)
September 27, 2004 – October 24, 2004	—	—		—	—
October 25, 2004 – November 21, 2004	1,922,000	$	11.75	1,922,000	$	27,400,000
November 22, 2004 – January 2, 2005	135,000	$	11.67	135,000	$	25,800,000
Total	2,057,000	$	11.74	2,057,000

(1) In October 2004, our board of directors authorized a program to repurchase up to $50,000,000 of the Company’s common stock. The program may be discontinued at any time.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following exhibits are filed herewith:

Exhibit number		Description

31.1		Certification of Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, dated February 9, 2005.
31.2		Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, dated February 9, 2005.
32.1		Certification of Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, dated February 9, 2005.
32.2		Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, dated February 9, 2005.

(b) Reports on Form 8-K:

Date Filed		Description

10/21/04		Financial Information for Integrated Device Technology, Inc. for the second quarter ended September 26, 2004, and forward looking statements relating to fiscal year 2005 as presented in a press release of October 21, 2004.
12/21/04		Announcement of entry into an agreement to purchase a new Silicon Valley headquarters.

	INTEGRATED DEVICE TECHNOLOGY, INC.


Date: February 9, 2005	/s/ GREGORY S. LANG
	Gregory S. Lang
	President and Chief Executive Officer
	(duly authorized officer)

Date: February 9, 2005	/s/ CLYDE R. HOSEIN
	Clyde R. Hosein
	Vice President, Chief Financial Officer
	(Principal Financial and Accounting Officer)