UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
		EXCHANGE ACT OF 1934
For the quarterly period ended June 1, 2006
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
		EXCHANGE ACT OF 1934
For the transition period from            to

 

Commission file number 1-10658

Micron Technology, Inc.

(Exact name of registrant as specified in its charter)

 

 

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 x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x         Accelerated Filer o         Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o   No x

The number of outstanding shares of the registrant’s common stock as of July 6, 2006, was 729,881,428.

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MICRON TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in millions except per share amounts)
(Unaudited)

		Quarter ended						Nine months ended
		June 1,			June 2,			June 1,			June 2,
		2006			2005			2006			2005
Net sales		$	1,312.3		$	1,054.2		$	3,899.1		$	3,622.4
Cost of goods sold		982.5			967.6			3,022.9			2,758.8
Gross margin		329.8			86.6			876.2			863.6
Selling, general and administrative		113.2			88.6			316.3			260.3
Research and development		167.7			153.4			492.7			453.2
Other operating (income) expense		1.5			(25.3		)	(229.8		)	(21.1		)
Operating income (loss)		47.4			(130.1		)	297.0			171.2
Interest income		31.1			9.3			61.7			22.3
Interest expense		(4.1		)	(13.1		)	(22.1		)	(35.6		)
Other non-operating income (expense)		3.4			(1.3		)	4.5			(2.5		)
Income (loss) before taxes		77.8			(135.2		)	341.1			155.4
Income tax (provision) benefit		(6.5		)	7.3			(14.0		)	(10.5		)
Noncontrolling interests in net loss		17.2			—			17.2			—
Net income (loss)		$	88.5		$	(127.9	)	$	344.3		$	144.9
Earnings (loss) per share:
Basic		$	0.12		$	(0.20	)	$	0.51		$	0.22
Diluted		0.12			(0.20		)	0.49			0.22
Number of shares used in per share calculations:
Basic		708.6			648.2			673.4			647.1
Diluted		720.1			648.2			713.8			701.4

 

See accompanying notes to consolidated financial statements.

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MICRON TECHNOLOGY, INC.

CONSOLIDATED BALANCE SHEETS
(Dollars in millions except par value amounts)
(Unaudited)

As of				June 1, 2006			September 1, 2005
Assets
Cash and equivalents				$	1,467.7		$	524.5
Short-term investments				1,362.3			765.9
Receivables				805.7			794.4
Inventories				799.7			771.5
Prepaid expenses				52.1			37.8
Deferred income taxes				33.4			31.5
Total current assets				4,520.9			2,925.6
Intangible assets, net				208.5			260.2
Property, plant and equipment, net				5,438.1			4,683.8
Deferred income taxes				45.6			29.9
Restricted cash				14.9			50.2
Other assets				72.7			56.7
Total assets				$	10,300.7		$	8,006.4
Liabilities and shareholders’ equity
Accounts payable and accrued expenses				$	951.9		$	752.5
Deferred income				43.4			30.3
Equipment purchase contracts				103.2			48.8
Deferred income taxes				0.1			—
Current portion of long-term debt				180.4			147.0
Total current liabilities				1,279.0			978.6
Long-term debt				338.8			1,020.2
Deferred income taxes				36.9			35.2
Other liabilities				446.8			125.6
Total liabilities				2,101.5			2,159.6
Commitments and contingencies
Noncontrolling interests in subsidiaries				1,112.4			—
Common stock, $0.10 par value, authorized 3.0 billion shares, issued and outstanding 678.5 million and 616.2 million shares				67.9			61.6
Additional capital				5,597.0			4,707.4
Retained earnings				1,422.2			1,078.1
Accumulated other comprehensive loss				(0.3		)	(0.3		)
Total shareholders’ equity				7,086.8			5,846.8
Total liabilities and shareholders’ equity				$	10,300.7		$	8,006.4

 

See accompanying notes to consolidated financial statements.

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MICRON TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in millions)
(Unaudited)

Nine months ended				June 1, 2006			June 2, 2005
Cash flows from operating activities
Net income				$	344.3		$	144.9
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization				936.2			949.6
Stock-based compensation				17.8			1.2
Loss (gain) from write-down or disposition of equipment				4.7			(13.1		)
Loss (gain) from write-down or disposition of investments				(0.3		)	0.8
Changes in operating assets and liabilities:
(Increase) decrease in receivables				(34.3		)	38.7
(Increase) decrease in inventories				75.9			(248.5		)
Increase in accounts payable and accrued expenses				79.9			59.4
Increase (decrease) in customer prepayments				251.1			(0.3		)
Deferred income taxes				(16.6		)	(4.4		)
Other				30.0			5.1
Net cash provided by operating activities				1,688.7			933.4
Cash flows from investing activities
Purchases of available-for-sale securities				(2,090.7		)	(1,429.7		)
Expenditures for property, plant and equipment				(790.1		)	(921.6		)
Proceeds from maturities of available-for-sale securities				1,477.4			1,344.9
Consolidation of TECH				319.0			—
(Increase) decrease in restricted cash				35.3			(23.7		)
Proceeds from sales of property, plant and equipment				32.2			38.6
Proceeds from sales of available-for-sale securities				31.3			10.3
Other				(27.8		)	(23.4		)
Net cash used for investing activities				(1,013.4		)	(1,004.6		)
Cash flows from financing activities
Capital contribution from noncontrolling interest in IMFT				500.2			—
Proceeds from settlement of call spread options				171.1			—
Proceeds from issuance of common stock				83.4			29.8
Proceeds from sale of noncontrolling interest in MP Mask				48.0			—
Proceeds from issuance of debt				—			221.4
Proceeds from equipment sale-leaseback transactions				—			161.3
Repayments of debt				(384.0		)	(183.1		)
Payments on equipment purchase contracts				(150.9		)	(170.8		)
Debt issuance costs				—			(3.2		)
Other				0.1			—
Net cash provided by financing activities				267.9			55.4
Net increase (decrease) in cash and equivalents				943.2			(15.8		)
Cash and equivalents at beginning of period				524.5			486.1
Cash and equivalents at end of period				$	1,467.7		$	470.3
Supplemental disclosures
Income taxes paid, net				$	(38.8	)	$	(11.7	)
Interest paid, net of amounts capitalized				(28.0		)	(39.6		)
Noncash investing and financing activities:
Conversion of debt to equity				632.5			—
Equipment acquisitions on contracts payable and capital leases				225.3			346.2

 

See accompanying notes to consolidated financial statements.

 

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MICRON TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All tabular dollar amounts in millions except per share amounts)
(Unaudited)

Significant Accounting Policies

Basis of presentation:  Micron Technology, Inc. and its subsidiaries (hereinafter referred to collectively as the “Company”) manufacture and market DRAM, NAND Flash memory, CMOS image sensors and other semiconductor components. The Company has two reportable segments, Memory and Imaging. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of the Company and its consolidated subsidiaries. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the consolidated financial position of the Company and its consolidated results of operations and cash flows.

The Company’s fiscal year is the 52 or 53-week period ending on the Thursday closest to August 31. The Company’s third quarter of fiscal 2006 and 2005 ended on June 1, 2006, and June 2, 2005, respectively. The Company’s fiscal 2005 ended on September 1, 2005. All period references are to the Company’s fiscal periods unless otherwise indicated. These interim financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Current Report on Form 8-K dated February 7, 2006.

Recently issued accounting standards:  In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments.”  SFAS No. 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. As of June 1, 2006, the Company did not have any hybrid financial instruments subject to the fair value election under SFAS No. 155. The Company is required to adopt SFAS No. 155 effective at the beginning of 2008.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.”  SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. The Company is required to adopt SFAS No. 154 for accounting changes and error corrections that occur after the beginning of 2007. The Company’s results of operations and financial condition will only be impacted following the adoption of SFAS No. 154 if it implements changes in accounting principle that are addressed by the standard or corrects accounting errors in future periods.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated even though uncertainty exists about the timing and (or) method of settlement. The Company adopted Interpretation No. 47 in the third quarter of 2006. The adoption of Interpretation No. 47 did not have a significant impact on the Company’s results of operations or financial condition.

Stock-based compensation:  Effective the beginning of 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment,” and elected to adopt the modified prospective application method. Accordingly, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. For stock awards granted in 2006, expenses are amortized under the straight-line attribution method. For stock awards granted prior to 2006, expenses are amortized under the multiple option method prescribed by FASB Interpretation No. 28. Previously reported amounts have not been restated.

Lexar Media, Inc.

Subsequent to the end of the Company’s third quarter of 2006, on June 21, 2006, the Company acquired Lexar Media, Inc. (“Lexar”), a designer, developer, manufacturer and marketer of flash memory products, in a stock-for-stock

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merger. Pursuant to the terms of the merger agreement, each issued and outstanding share of common stock of Lexar was converted into 0.5925 shares of Micron’s common stock (the “Exchange Ratio”), and each issued, outstanding and unexercised Lexar employee stock option with an exercise price per share of $9.54 or less was converted into a Micron employee stock option using the Exchange Ratio. In connection therewith, the Company issued approximately 50 million shares of common stock and assumed Lexar options, which were converted into options to purchase approximately 7 million shares of the Company’s common stock, with a combined value of approximately $900 million. The financial results of Lexar will be included in the Company’s consolidated financial results subsequent to the June 21, 2006, acquisition date.

Supplemental Balance Sheet Information

 

 

In connection with the consolidation of TECH in the third quarter of 2006, the Company recorded inventories of $103.8 million. (See “Joint Ventures — Tech Semiconductor Singapore Pte. Ltd.” note.)

				June 1, 2006						September 1, 2005
Intangible Assets				Gross Amount			Accumulated Amortization			Gross Amount			Accumulated Amortization
Product and process technology				$	413.0		$	(207.5	)	$	384.6		$	(177.7	)
TECH joint venture supply arrangement				—			—			105.0			(54.7		)
Other				5.6			(2.6		)	5.3			(2.3		)
				$	418.6		$	(210.1	)	$	494.9		$	(234.7	)

 

During the first nine months of 2006 and 2005, the Company capitalized $29.0 million and $24.9 million, respectively, for product and process technology with weighted-average useful lives of 9.8 years and 10.0 years, respectively.

In the third quarter of 2006, as a result of the Company’s consolidation of TECH, the intangible asset associated with the TECH joint venture supply arrangement became part of the Company’s investment in TECH’s net assets and was eliminated in consolidation. (See “Joint Ventures — TECH Semiconductor Singapore Pte. Ltd.” note.)

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Amortization expense for intangible assets was $10.5 million and $36.6 million for the third quarter and first nine months of 2006, respectively, and $12.7 million and $37.8 million for the third quarter and first nine months of 2005, respectively. Annual amortization expense for intangible assets held as of June 1, 2006, is estimated to be $47.3 million for 2006, $42.7 million for 2007, $42.0 million for 2008, $30.9 million for 2009 and $22.4 million for 2010.

 

Depreciation expense was $336.0 million and $914.1 million for the third quarter and first nine months of 2006, respectively, and $305.6 million and $908.4 million for the third quarter and first nine months of 2005, respectively.

In connection with the consolidation of TECH in the third quarter of 2006, the Company recorded property, plant and equipment of $562.0 million. (See “Joint Ventures — Tech Semiconductor Singapore Pte. Ltd.” note.)

 

 

In connection with the consolidation of TECH in the third quarter of 2006, the Company recorded accounts payable and accrued expenses of $68.6 million. (See “Joint Ventures — Tech Semiconductor Singapore Pte. Ltd.” note.)

 

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As of June 1, 2006, notes payable in the above table included $228.1 million, denominated in Japanese yen, at a weighted-average interest rate of 1.2%.

In connection with the consolidation of TECH in the third quarter of 2006, the Company recorded $245.7 million of notes payable (which were repaid in the third quarter of 2006) and $93.1 million of capital lease obligations. (See “Joint Ventures — Tech Semiconductor Singapore Pte. Ltd.” note.)

The Company’s TECH subsidiary has a credit facility that enables it to borrow up to $400.0 million at Singapore Interbank Offered Rate (“SIBOR”) plus 2.5%. As of June 1, 2006, TECH had not borrowed any amounts against the credit facility.

In the second quarter of 2006, the Company’s $632.5 million 2.5% Convertible Subordinated Notes (“Notes”) were converted into 53.7 million shares of the Company’s common stock. In addition, the Company’s related interest rate swap terminated by its terms on February 6, 2006 and, as a result, $34.8 million of cash pledged as collateral for the swap became unrestricted. On February 14, 2006, the Company terminated its outstanding call spread options covering a total of approximately 53.7 million shares of its common stock (“Call Spread Options”). The Company originally entered into the Call Spread Options in connection with its issuance of the Notes. The Company received $171.1 million for the settlement of the Call Spread Options. The settlement was accounted for as a capital transaction.

Contingencies

As is typical in the semiconductor and other high technology industries, from time to time, others have asserted, and may in the future assert, that the Company’s products or manufacturing processes infringe their intellectual property rights. In this regard, the Company is engaged in litigation with Rambus, Inc. (“Rambus”) relating to certain of Rambus’ patents and certain of the Company’s claims and defenses. Lawsuits between Rambus and the Company are pending in the United States, Germany, France, and Italy. The Company also is engaged in litigation with Tessera, Inc. (“Tessera”) relating to certain of Tessera’s patents and certain of the Company’s patents in the U.S. District Court for the Eastern District of Texas. Among other things, the above lawsuits pertain to certain of the Company’s SDRAM, DDR SDRAM, and DDR2 SDRAM products, which account for a significant portion of net sales. A Company subsidiary, Lexar Media, Inc. (“Lexar”), is engaged in litigation with Toshiba Corporation (“Toshiba”) relating to certain of Toshiba’s patents in the U.S. District Court for the Northern District of California. The lawsuit pertains to certain flash components that Lexar purchases from vendors.

The Company is unable to predict the outcome of assertions of infringement made against the Company. A court determination that the Company’s products or manufacturing processes infringe the intellectual property rights of others could result in significant liability and/or require the Company to make material changes to its products and/or manufacturing processes. Any of the foregoing could have a material adverse effect on the Company’s business, results of operations or financial condition.

On June 17, 2002, the Company received a grand jury subpoena from the U.S. District Court for the Northern District of California seeking information regarding an investigation by the Antitrust Division of the Department of Justice (the “DOJ”) into possible antitrust violations in the “Dynamic Random Access Memory” or “DRAM” industry. The Company is cooperating fully and actively with the DOJ in its investigation. The Company’s cooperation is pursuant to the terms of the DOJ’s Corporate Leniency Policy, which provides that in exchange for the Company’s full, continuing and complete cooperation in the pending investigation, the Company will not be subject to prosecution, fines or other penalties from the DOJ. Subsequent to the commencement of the DOJ investigation, at least eighty-four (seven of which have been dismissed) purported class action lawsuits have been filed against the Company and other DRAM suppliers in various federal and state courts in the United States and in Puerto Rico by direct and indirect purchasers alleging price-fixing in violation of federal and state antitrust laws, violations of state unfair competition law, and/or unjust enrichment relating to the sale and pricing of DRAM products. The complaints seek treble damages for the alleged damages sustained by purported class members, in addition to restitution, costs and attorneys’ fees, as well as an injunction against the allegedly unlawful conduct. Three purported class action lawsuits also have been filed in Canada, alleging violations of the Canadian Competition Act. The substantive allegations in these cases are similar to those asserted in the cases filed in the

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United States and Puerto Rico. The Company is unable to predict the outcome of these suits. In addition, the Attorneys General of Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Hawaii, Idaho, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Nebraska, Nevada, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia, and Wisconsin are investigating potential state and federal civil claims against the Company and other DRAM suppliers on behalf of state and governmental entities that were direct or indirect purchasers of DRAM and potentially on behalf of other indirect purchasers of DRAM. The Company has been served with civil investigative demands or subpoenas issued by many of the state Attorneys General and is responding to those requests. The Company is unable to predict the outcome of these lawsuits and investigations. The final resolution of these alleged violations of antitrust laws could result in significant liability and could have a material adverse effect on the Company’s business, results of operations or financial condition.

On May 5, 2004, Rambus filed a complaint in the Superior Court of the State of California (San Francisco County) against the Company and other DRAM suppliers. The complaint alleges various causes of action under California state law including conspiracy to restrict output and fix prices on Rambus DRAM (“RDRAM”) and unfair competition. Tessera also has asserted certain antitrust and unfair competition claims relating to Tessera’s packaging technology. These complaints seek treble damages, punitive damages, attorneys’ fees, costs, and a permanent injunction enjoining the defendants from the conduct alleged in the complaints. The Company is unable to predict the outcome of these suits. A court determination against the Company could result in significant liability and could have a material adverse effect on the Company’s business, results of operations or financial condition.

On February 24, 2006, a putative class action complaint was filed against the Company and certain of its officers in the U.S. District Court for the District of Idaho alleging claims under Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. Four substantially similar complaints subsequently were filed in the same Court. The cases purport to be brought on behalf of a class of purchasers of the Company’s stock during the period February 24, 2001 to February 13, 2003. The complaints generally allege violations of federal securities laws based on, among other things, claimed misstatements or omissions regarding alleged illegal price-fixing conduct or the Company’s operations and financial results. The complaints seek unspecified damages, interest, attorneys’ fees, costs, and expenses. The five lawsuits have been consolidated and the Company expects a consolidated amended class action complaint to be filed. The Company is unable to predict the outcome of these cases. A court determination in these actions against the Company could result in significant liability and could have a material adverse effect on the Company’s business, results of operations or financial condition.

In addition, on March 23, 2006 a shareholder derivative action was filed in the Fourth District Court for the State of Idaho (Ada County), allegedly on behalf of and for the benefit of the Company, against certain of the Company’s current and former officers and directors. The Company also was named as a nominal defendant. The complaint is based on the same allegations of fact as in the securities class actions filed in the U.S. District Court for the District of Idaho and alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, and insider trading. The complaint seeks unspecified damages, restitution, disgorgement of profits, equitable and injunctive relief, attorneys’ fees, costs, and expenses. The complaint is derivative in nature and does not seek monetary damages from the Company. However, the Company may be required, throughout the pendency of the action, to advance payment of legal fees and costs incurred by the defendants. The Company is unable to predict the outcome of this case. A court determination in this action against the Company could result in significant liability and could have a material adverse effect on the Company’s business, results of operations or financial condition.

In March 2006, following the Company’s announcement of a definitive agreement to acquire Lexar Media, Inc. (“Lexar”) in a stock-for-stock merger, four purported class action complaints were filed in the Superior Court for the State of California (Alameda County) on behalf of shareholders of Lexar against Lexar and its directors. Two of the complaints also name the Company as a defendant. The complaints allege that the defendants breached, or aided and abetted the breach of, fiduciary duties owed to Lexar shareholders by, among other things, engaging in self-dealing, failing to engage in efforts to obtain the highest price reasonably available, and failing to properly value Lexar in connection with a merger transaction between Lexar and the Company. The plaintiffs seek, among other

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things, injunctive relief preventing, or an order of rescission reversing, the merger, compensatory damages, interest, attorneys’ fees, and costs. On May 19, 2006, the plaintiffs filed a motion for preliminary injunction seeking to block the merger. On May 31, 2006, the Court denied the motion. The Company is unable to predict the outcome of these suits. A court determination against the Company could result in significant liability and could have a material adverse effect on the Company’s business, results of operations or financial condition. (See “Lexar Media, Inc.” note.)

The Company has accrued a liability and charged operations for the estimated costs of adjudication or settlement of various asserted and unasserted claims existing as of the balance sheet date. The Company is currently a party to other legal actions arising out of the normal course of business, none of which is expected to have a material adverse effect on the Company’s business, results of operations or financial condition.

In the normal course of business, the Company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party. It is not possible to predict the maximum potential amount of future payments under these types of agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these types of agreements have not had a material effect on the Company’s business, results of operations or financial condition.

Stock Plans

As of June 1, 2006, the Company had an aggregate of 152.6 million shares of its common stock reserved for issuance under its various stock plans, of which 123.5 million shares were subject to outstanding stock awards and 29.1 million shares were available for future grants. Awards are subject to terms and conditions as determined by the Company’s Board of Directors.

In connection with the Company’s acquisition of Lexar on June 21, 2006, the Company assumed Lexar options, which were converted into options to purchase approximately 7 million shares of the Company’s common stock. (See “Lexar Media, Inc.” note.)

Stock Options:   Stock options are generally exercisable in increments of 25% during each year of employment beginning one year from the date of grant. Stock options issued prior to January 19, 1998, and after September 22, 2004, expire six years from the date of grant. All other options expire ten years from date of grant.

Option activity for the first nine months of 2006 is summarized as follows:

		Number of shares (in millions)		Weighted average exercise price per share			Weighed average remaining contractual life (in years)		Aggregate intrinsic value
Outstanding at September 1,2005		119.1		$	20.58
Granted		10.5		13.70
Exercised		(6.6	)	12.32
Cancelled or expired		(1.8	)	23.70
Outstanding at June 1, 2006		121.2		20.38			5.1		$	269.9
Exercisable at June 1, 2006		108.3		$	21.24		5.1		$	222.1

 

The weighted average grant-date fair value per share was $6.32 and $5.90 for options granted during the third quarter and first nine months of 2006, respectively, and $4.20 and $5.11 for options granted during the third quarter and first nine months of 2005, respectively. The total intrinsic value was $11.8 million and $22.3 million for options exercised during the third quarter and first nine months of 2006, respectively, and $0.1 million and $0.2 million for options exercised during the third quarter and first nine months of 2005, respectively.

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Changes in the Company’s nonvested options for the first nine months of 2006 are summarized as follows:

 

As of June 1, 2006, there was $54.9 million of total unrecognized compensation cost related to nonvested stock options, which is expected to be recognized over a weighted-average period of 1.7 years.

The fair value of each option award is estimated as of the date of grant using the Black-Scholes model. Expected volatilities are based on implied volatilities from traded options on the Company’s stock and historical volatility. The expected life of options granted is based on historical experience and on the terms and conditions of the options. The risk-free rates are based on the U.S. Treasury yield in effect at the time of the grant. Assumptions used in the Black-Scholes model are presented below:

 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable and requires the input of subjective assumptions, including the expected stock price volatility and estimated option life. For purposes of this valuation model, no dividends have been assumed.

Restricted Stock:  As of June 1, 2006, there were 2.3 million shares of restricted stock and stock units outstanding, of which 0.6 million were performance-based restricted stock awards. For service-based restricted stock awards, restrictions lapse in one-third increments during each year of employment after the grant date. For performance-based restricted stock awards, vesting is contingent upon meeting certain Company-wide performance goals.

Restricted stock activity for the first nine months of 2006 and 2005 is summarized as follows:

 

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The weighted-average grant-date fair value per share was $12.91 and $12.17 for restricted stock awards granted during the first nine months of 2006 and 2005, respectively. The total value of awards for which restrictions lapsed during the first nine months of 2006 was $1.5 million. There were no restricted stock awards granted during the third quarter of 2005 or 2006.

As of June 1, 2006, there was $21.3 million of total unrecognized compensation cost, related to nonvested restricted stock and stock units awards, which is expected to be recognized over a weighted-average period of 1.2 years.

Stock-Based Compensation Expense:  Total compensation costs for the Company’s stock plans in the third quarter and first nine months of 2006 were $7.4 million and $17.8 million, respectively, and included the following:

 

Stock-based compensation expense of $1.2 million was capitalized and remained in inventory at the end of the third quarter of 2006. As of June 1, 2006, $76.2 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted-average period of 1.6 years.

Through 2005, the Company accounted for its stock plans using the intrinsic value method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation.”  The following presents pro forma income and per share data as if a fair value based method had been used to account for stock-based compensation for the third quarter and first nine months of 2005:

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Stock-based compensation expense in the above presentation does not reflect any significant income taxes, which is consistent with the Company’s treatment of income or loss from its U.S. operations. (See “Income Taxes” note.)

Other Operating (Income) Expense, Net

Other operating income for the first nine months of 2006 includes $230.0 million of net proceeds from Intel Corporation (“Intel”) for the sale of the Company’s existing NAND Flash memory designs and certain related technology to Intel and the Company’s acquisition of a perpetual, paid-up license to use and modify such designs. Other operating income for the third quarter of fiscal 2005 includes gains net of losses on write-downs and disposals of semiconductor equipment of $14.5 million and net gains of $12.2 million from changes in currency exchange rates. Other operating income for the first nine months of fiscal 2005 includes gains net of losses on write-downs and disposals of semiconductor equipment of $13.1 million and $12.0 million in receipts from the U.S. government in connection with anti-dumping tariffs.

Income Taxes

Income taxes for 2006 and 2005 primarily reflect taxes on the Company’s non-U.S. operations and U.S. alternative minimum tax. The Company has a valuation allowance for its net deferred tax asset associated with its U.S. operations. The provision for taxes on U.S. operations in 2006 and 2005 was substantially offset by a reduction in the valuation allowance. Until such time as the Company utilizes a significant portion of its U.S. net operating loss carryforwards and unused tax credits, the provision for taxes on the Company’s U.S. operations is expected to be substantially offset by a reduction in the valuation allowance. As of June 1, 2006, the Company had aggregate U.S. tax net operating loss carryforwards of $1.6 billion and unused U.S. tax credit carryforwards of $183.7 million. The Company also has unused state tax net operating loss carryforwards of $1.3 billion and unused state tax credits of $145.9 million. Substantially all of the net operating loss carryforwards expire in 2022 to 2025 and substantially all of the tax credit carryforwards expire in 2013 to 2026. During the first nine months of 2006, the Company utilized approximately $1.1 billion of its U.S. tax net operating loss carryforwards as a result of the IMFT, MP Mask and related transactions. (See “Joint Ventures — IM Flash Technologies, LLC” and “Joint Ventures — MP Mask Technology Center, LLC” notes.)

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Earnings Per Share

Basic earnings per share is computed based on the weighted-average number of common shares and stock rights outstanding. Diluted earnings per share is computed based on the weighted-average number of common shares outstanding plus the dilutive effects of stock options, warrants and convertible notes. Potential common shares that would increase earnings per share amounts or decrease loss per share amounts are antidilutive and are, therefore, excluded from earnings per share calculations. Antidilutive potential common shares that could dilute basic earnings per share in the future were 95.8 million and 97.9 million for the third quarter and first nine months of 2006, respectively, and 204.5 million and 147.1 million for the third quarter and first nine months of 2005, respectively.

		Quarter ended						Nine months ended
		June 1,			June 2,			June 1,			June 2,
		2006			2005			2006			2005
Net income (loss) available to common shareholders — Basic		$	88.5		$	(127.9	)	$	344.3		$	144.9
Net effect of assumed conversion of debt		—			—			6.0			10.9
Net income (loss) available to common shareholders — Diluted		$	88.5		$	(127.9	)	$	350.3		$	155.8
Weighted-average common shares outstanding — Basic		708.6			648.2			673.4			647.1
Net effect of dilutive stock options and assumed conversion of debt		11.5			—			40.4			54.3
Weighted-average common shares outstanding — Diluted		720.1			648.2			713.8			701.4
Earnings (loss) per share:
Basic		$	0.12		$	(0.20	)	$	0.51		$	0.22
Diluted		0.12			(0.20		)	0.49			0.22

 

Comprehensive Income

Comprehensive income for 2006 and 2005 includes net income (loss) and de minimis amounts of unrealized gains and losses on investments. Comprehensive income for the third quarter and first nine months of 2006 was $88.5 million and $344.3 million, respectively. Comprehensive income (loss) for the third quarter and first nine months of 2005 was $(127.7) million and $145.0 million, respectively.

Joint Ventures

IM Flash Technologies, LLC (“IMFT”):  IMFT, which began operations on January 6, 2006, is a joint venture between the Company and Intel that was formed to manufacture NAND Flash memory products for the exclusive benefit of its partners. In connection with the formation of IMFT, the Company contributed land and facilities in Lehi, Utah, a fully paid lease of a portion of the Company’s manufacturing facility in Manassas, Virginia, a wafer supply agreement to be supported by the Company’s operations located in Boise, Idaho and $250.0 million in cash. The aggregate fair value of these contributions was $1.245 billion. In connection with the contribution of land and facilities in Lehi, Utah, the Company recorded a $1.6 million gain in the second quarter of 2006, which is included in other non-operating income in the accompanying consolidated statement of operations. Intel contributed $1.196 billion in cash and notes to IMFT. As a result of these contributions, the Company owns 51% and Intel owns 49% of IMFT. The parties share the output of IMFT generally in proportion to their ownership in IMFT. The notes receivable from Intel for its contribution to IMFT are accounted for as a reduction to noncontrolling interest and are not included in receivables as of June 1, 2006.

Under the terms of the lease, IMFT has the use of approximately 50% of the Company’s manufacturing facility in Manassas, Virginia for a period of 10 years. IMFT purchases and installs manufacturing equipment into the

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leased facility which is operated and maintained by the Company. The cost of operating and maintaining the equipment is charged to IMFT. Under the terms of the wafer supply agreement, the Company manufactures wafers for IMFT in its Boise, Idaho facility for a period of five years.

IMFT manufactures NAND Flash memory products based on NAND Flash designs developed by the Company and Intel and licensed to the Company. Product design and other research and development costs for NAND Flash are shared equally among the Company and Intel. In the second quarter of 2006, the Company received net proceeds of $230.0 million from Intel for the sale of the Company’s existing NAND Flash memory designs and certain related technology and the Company’s acquisition of a perpetual, paid-up license to use and modify such designs.

The Company and Intel entered into various service contracts with IMFT under which they provide operational and administrative support services. The Company and Intel generally charge IMFT for costs of providing such services.

The Company has determined that IMFT is a variable interest entity as defined in FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities,” and that the Company is the primary beneficiary. Accordingly, IMFT’s financial results are included in the accompanying consolidated financial statements of the Company. All amounts pertaining to Intel’s interests in IMFT are reported as noncontrolling interest.

The Company is obligated to provide certain NAND Flash memory products to Apple Computer Inc. (“Apple”) until December 31, 2010, pursuant to a NAND Flash supply agreement. In connection with the obligation, Apple made a prepayment of $250.0 million to the Company in the second quarter of 2006. The prepayment is included in other liabilities in the accompanying consolidated balance sheet.

TECH Semiconductor Singapore Pte. Ltd. (“TECH”):  Since 1998, the Company has participated in TECH, a semiconductor memory manufacturing joint venture in Singapore among the Company, the Singapore Economic Development Board (“EDB”), Canon Inc. and Hewlett-Packard Company. On March 3, 2006, certain shareholders of TECH contributed approximately $260 million in cash as additional capital to TECH, of which the Company’s contribution was approximately $130 million. Following the contribution, the Company owned an approximate 43% interest in TECH. The shareholders’ agreement for the TECH joint venture expires in 2011.

Effective March 3, 2006, the Company entered into an agreement with EDB whereby EDB granted the Company an option to purchase from EDB, and the Company granted EDB an option to sell to the Company, EDB’s shares of TECH common stock (approximately 30% as of June 1, 2006) (collectively, the “TECH Options”). The Company’s option to purchase EDB’s shares in TECH is exercisable at any time prior to October 1, 2009. EDB’s option to put its shares in TECH to the Company is exercisable from March 3, 2008, until October 1, 2010. The Company has determined that TECH is a variable interest entity, and as a result of the put option agreement noted above, the Company concluded it is the primary beneficiary of TECH as defined by FIN 46(R) and therefore began consolidating TECH’s financial results as of the beginning of the Company’s third quarter of 2006.

Upon consolidation of TECH as of March 3, 2006, the Company’s basis of $133.6 million and the fair value of noncontrolling interests in TECH of $626.8 million were allocated to the assets and liabilities of TECH based on their estimated fair values. In connection with the consolidation of TECH, the Company recorded total assets of $990.1 million (net of $204.4 million of eliminated intercompany balances and the Company’s contribution to TECH), including cash of $319.0 million, inventories of $103.8 million and property, plant and equipment of $562.0 million, and total liabilities of $410.5 (net of $23.6 million of eliminated intercompany balances), including accounts payable and accrued expenses of $68.6 million and debt and capital lease obligations totaling $338.8 million.

The option granted by the Company to EDB to sell to the Company EDB’s shares in TECH is being accounted for as if the shares are mandatorily redeemable by the Company. The initial carrying value of the noncontrolling interest in TECH attributable to EDB of $286.9 million is being amortized to its estimated redemption value ($249.4 million as of March 3, 2006) through March 3, 2008, the date EDB’s option becomes exercisable. The amortization

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is recognized as other non-operating income in the accompanying consolidated statement of operations and amounted to $4.7 million for the third quarter of 2006.

TECH’s semiconductor manufacturing uses the Company’s product and process technology. Subject to specific terms and conditions, the Company has agreed to purchase all of the products manufactured by TECH. The Company generally purchases semiconductor memory products from TECH at prices determined quarterly, based on a discount from average selling prices realized by the Company for the preceding quarter. The Company performs assembly and test services on product manufactured by TECH. The Company also provides certain technology, engineering and training to support TECH. Through the second quarter of 2006, prior to the consolidation of TECH, all of these transactions with TECH were recognized as part of the net cost of products purchased from TECH. The net cost of products purchased from TECH amounted to $286.7 million for the first six months of 2006. The net cost of products purchased from TECH amounted to $227.4 million and $547.9 million for the third quarter and first nine months of 2005, respectively. Amortization expense resulting from the TECH supply arrangement, included in the cost of products purchased from TECH, was $5.8 million for the first six months of 2006 and $2.9 million and $8.8 million for the third quarter and first nine months of 2005, respectively. In connection with the consolidation of TECH, amortization of the TECH supply arrangement was discontinued as of the beginning of the third quarter of 2006.

MP Mask Technology Center, LLC (“MP Mask”):  In the third quarter of 2006, the Company formed a joint venture, MP Mask, with Photronics, Inc. (“Photronics”) to produce photomasks for leading-edge and advanced next generation semiconductors. The Company contributed its then existing reticle manufacturing operation to the venture. In exchange for a 49.99% interest in MP Mask, Photronics paid $48.0 million cash and $15.0 million in notes due over two years to the Company. In connection with the joint venture, the Company received $72.0 million in exchange for entering into a license agreement with Photronics, which will be recognized over the term of the 10-year agreement. The Company and Photronics also entered into supply arrangements wherein the Company is expected to purchase a substantial majority of the reticles produced by MP Mask. The financial results of MP Mask are included in the consolidated financial results of the Company.

Segment Information

The Company has determined, based on the nature of its operations and products offered to customers, that its reportable segments are Memory and Imaging. The Company’s Memory segment includes the operations of its joint ventures IMFT, TECH and MP Mask. (See “Joint Ventures” note.)  The Memory segment’s primary products are DRAM and NAND Flash memory products and the Imaging segment’s primary products are CMOS image sensors. Segment information reported below is consistent with how it is reviewed and evaluated by the Company’s chief operating decision maker. The Company does not identify or report depreciation and amortization, capital expenditures or assets by segment. Prior to the first quarter of 2006, the Company had a single reportable segment. The information below represents the Company’s reportable segments.

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		Quarter ended						Nine months ended
		June 1,			June 2,			June 1,			June 2,
		2006			2005			2006			2005
Net sales:
Memory		$	1,099.6		$	972.9		$	3,373.6		$	3,433.1
Imaging		212.7			81.3			525.5			189.3
Total consolidated net sales		$	1,312.3		$	1,054.2		$	3,899.1		$	3,622.4
Operating income:
Memory		$	7.2		$	(138.5	)	$	188.9		$	176.4
Imaging		40.2			8.4			108.1			(5.2		)
Total consolidated operating income (loss)		$	47.4		$	(130.1	)	$	297.0		$	171.2

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion contains trend information and other forward-looking statements that involve a number of risks and uncertainties. Forward-looking statements include, but are not limited to, statements such as those made in “Overview” regarding growth for CMOS image sensor and NAND Flash markets and allocations of wafer starts to these products; in “IM Flash Technologies, LLC” regarding NAND Flash production in future periods; in “Net Sales” regarding increases in and revenue from sales of NAND Flash and Imaging products; in “Selling, General and Administrative” regarding SG&A expenses for the fourth quarter of 2006; in “Research and Development” regarding R&D costs for the fourth quarter of 2006; in “Stock-Based Compensation” regarding increases in future stock-based compensation costs; in “Income Taxes” regarding future provisions for income taxes and a reduction in the valuation allowance; and in “Liquidity and Capital Resources” regarding capital spending in 2006 and 2007; and  future capital contributions to IMFT and TECH. The Company’s actual results could differ materially from the Company’s historical results and those discussed in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those identified in “Certain Factors.”  This discussion should be read in conjunction with the Consolidated Financial Statements and accompanying notes and with the Company’s Annual Report on Form 10-K for the year ended September 1, 2005 and the Company’s Current Report on Form 8-K dated February 7, 2006. All period references are to the Company’s fiscal periods unless otherwise indicated. All tabular dollar amounts are in millions. All production data reflects production of the Company and its TECH joint venture.

Overview

The Company is a global manufacturer of semiconductor devices, principally DRAM and NAND Flash memory products, and CMOS image sensors. Its products are used in a broad range of electronic applications including personal computers, workstations, network servers, mobile phones and other consumer applications including flash memory cards, USB storage devices, digital still cameras, automotive applications and MP3 players. The Company’s customers are principally original equipment manufacturers located around the world. The Company’s success is largely dependent on the market acceptance of a diversified semiconductor product portfolio, efficient utilization of the Company’s manufacturing infrastructure, successful ongoing development of advanced process technologies and generation of sufficient return on research and development investments.

The Company has strategically diversified its business by expanding into semiconductor products such as specialty memory products (including SDRAM, PSRAM, mobile SDRAM and reduced latency DRAM), NAND Flash memory products and CMOS image sensors. These products are used in a wider range of applications than the computing applications that use the Company’s highest volume products, DDR and DDR2. The Company leverages its expertise in semiconductor memory manufacturing and product and process technology to provide these products that are differentiated from competitors’ products based on performance characteristics. In the third quarter of 2006, sales of products other than PC DRAM products became a majority of the Company’s total net sales. The Company expects that the markets for these products will grow in the near term more rapidly than the overall semiconductor market. The Company plans to continue to allocate an increasing portion of its manufacturing capacity to CMOS image sensors and NAND Flash products. The Company believes that the strategic diversification of its product portfolio will strengthen its ability to allocate manufacturing resources to achieve the highest rate of return.

The Company makes significant ongoing investments to implement its proprietary product and process technology in its facilities in the United States, Europe and Asia to manufacture semiconductor products with increasing functionality and performance at lower costs. The Company continues to introduce new generations of products that offer improved performance characteristics, such as higher data transfer rates, reduced package size, lower power consumption and increased megapixel count. The Company generally reduces the manufacturing cost of each generation of product through advancements of its product and process technology such as its leading-edge line width process technology and innovative array architecture.

In order to maximize returns from investments in research and development (“R&D”), the Company develops process technology that effectively reduces production costs and leverages the Company’s capital expenditures. To be successfully incorporated in customers’ end products, the Company must offer qualified semiconductor solutions at a time when customers are developing their design specifications for their end products. This is especially true

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for specialty memory products and CMOS image sensors, which are required to demonstrate advanced functionality and performance well ahead of a planned ramp of production to commercial volumes. In addition, DRAM and NAND Flash products necessarily incorporate highly advanced design and process technologies. The Company must make significant investments in R&D to expand its product offering and develop its leading-edge product and process technologies.

Recent Developments

IM Flash Technologies, LLC (“IMFT”):  IMFT, which began operations on January 6, 2006, is a joint venture between the Company and Intel Corporation. IMFT manufactures NAND Flash memory products pursuant to NAND Flash designs developed by the Company and Intel and licensed to the Company. The parties share the output of IMFT generally in proportion to their investment in IMFT. IMFT’s financial results are included in the consolidated financial statements of the Company. As a result of their contributions to IMFT, the Company owns 51% and Intel owns 49% of IMFT. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Joint Ventures — IM Flash Technologies, LLC”)

TECH Semiconductor Singapore Pte. Ltd. (“TECH”):  On March 3, 2006, certain shareholders of TECH, including the Company and the Singapore Economic Development Board (“EDB”), contributed approximately $260 million in cash as additional capital to TECH, of which the Company’s contribution was approximately $130 million. Following the contribution, the Company owned an approximate 43% interest in TECH. Effective March 3, 2006, the Company entered into an agreement with EDB whereby EDB granted the Company an option to purchase from EDB, and the Company granted EDB an option to sell to the Company, EDB’s shares of TECH common stock (approximately 30% as of June 1, 2006). As a result of the put option agreement noted above, the Company concluded it is the primary beneficiary of TECH and therefore began consolidating TECH’s financial results as of the beginning of the Company’s third quarter of fiscal 2006. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Joint Ventures — TECH Semiconductor Singapore Pte. Ltd.”)

MP Mask Technology Center, LLC (“MP Mask”):  In the third quarter of 2006, the Company formed a joint venture, MP Mask, with Photronics, Inc. (“Photronics”) to produce photomasks for leading-edge and advanced next generation semiconductors. The Company contributed its then existing reticle manufacturing operation to the venture. In exchange for a 49.99% interest in MP Mask, Photronics paid cash and issued notes to the Company aggregating $63.0 million. In connection with the joint venture, the Company received $72.0 million in exchange for entering into a license agreement with Photronics, which will be recognized over the term of the 10-year agreement. The Company and Photronics also entered into supply arrangements wherein the Company is expected to purchase a substantial majority of the reticles produced by MP Mask. The financial results of MP Mask are included in the consolidated financial results of the Company. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Joint Ventures — MP Mask Technology Center, LLC”)

Lexar Media, Inc. (“Lexar”):  On June 21, 2006, the Company acquired Lexar, a designer, developer, manufacturer and marketer of Flash memory products, in a stock-for-stock merger. Pursuant to the terms of a merger agreement, each issued and outstanding share of common stock of Lexar was converted into 0.5925 shares of Micron’s common stock (the “Exchange Ratio”), and each issued, outstanding and unexercised Lexar employee stock option with an exercise price per share of $9.54 or less was converted into a Micron employee stock option using the Exchange Ratio. In connection therewith, the Company issued approximately 50 million shares of common stock and assumed stock options representing approximately 7 million shares with an aggregate value of approximately $900 million. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Lexar Media, Inc.”)

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Results of Operations

		Third Quarter										Second Quarter					Nine Months
		2006			% of net sales		2005			% of net sales		2006			% of net sales		2006			% of net sales		2005			% of net sales
Net sales:
Memory		$	1,099.6		83.8	%	$	972.9		92.3	%	$	1,066.0		87.0	%	$	3,373.6		86.5	%	$	3,433.1		94.8	%
Imaging		212.7			16.2	%	81.3			7.7	%	159.0			13.0	%	525.5			13.5	%	189.3			5.2	%
		$	1,312.3		100.0	%	$	1,054.2		100.0	%	$	1,225.0		100.0	%	$	3,899.1		100.0	%	$	3,622.4		100.0	%
Gross margin:
Memory		$	244.4		22.2	%	$	51.9		5.3	%	$	166.2		15.6	%	$	648.3		19.2	%	$	796.1		23.2	%
Imaging		85.4			40.2	%	34.7			42.7	%	69.1			43.5	%	227.9			43.4	%	67.5			35.7	%
		$	329.8		25.1	%	$	86.6		8.2	%	$	235.3		19.2	%	$	876.2		22.5	%	$	863.6		23.8	%
SG&A		$	113.2		8.6	%	$	88.6		8.4	%	$	107.8		8.8	%	$	316.3		8.1	%	$	260.3		7.2	%
R&D		167.7			12.8	%	153.4			14.6	%	159.5			13.0	%	492.7			12.6	%	453.2			12.5	%
Net income		88.5			6.7	%	(127.9		)	(12.1	)%	193.2			15.8	%	344.3			8.8	%	144.9			4.0	%

 

The Company’s two reportable segments are Memory and Imaging. The Memory segment’s primary products are DRAM and NAND Flash memory and the Imaging segment’s primary products are CMOS image sensors.

Net Sales

Total net sales for the third quarter of 2006 increased 7% as compared to the second quarter of 2006 reflecting a 34% increase in Imaging sales and a 3% increase in Memory sales. Total net sales for the third quarter of 2006 increased 24% as compared to the third quarter of 2005 reflecting a 162% increase in Imaging sales and a 13% increase in Memory sales. Total net sales for the first nine months of 2006 increased 8% as compared to the first nine months of 2005 due to a 178% increase in Imaging sales, partially offset by a slight decrease in Memory sales.

Memory:  Memory sales for the third quarter of 2006 increased by 3% as compared to the second quarter of 2006 primarily due to a 3% increase in DRAM sales and to a lesser extent an increase in NAND Flash memory sales. DRAM sales increased 3% due to an 18% increase in average selling prices per megabit partially offset by a 13% decrease in DRAM megabits sold. DRAM megabits sold decreased due to lower megabit production as wafer starts were allocated to Imaging products and NAND Flash products. DDR2 and DDR products were 28% and 21%, respectively, of the Company’s total net sales in the third quarter of 2006 as compared to 23% and 30%, respectively, of the Company’s total net sales in the second quarter of 2006. NAND Flash sales increased 18% in the third quarter of 2006 as compared to the second quarter of 2006 primarily due to a 63% increase in megabits sold partially offset by a 28% decrease in average selling prices. NAND Flash sales were approximately 5% of the Company’s total net sales in the third quarter of 2006. Sales of NAND Flash include sales from the Company’s consolidated joint venture, IMFT, to Intel at long-term negotiated prices approximating cost. The Company expects that NAND Flash revenue will increase significantly in future periods as the Company ramps additional production capacity through its IMFT joint venture. NAND Flash revenue in the fourth quarter of 2006 is not expected to be significantly affected by the acquisition of Lexar on June 21, 2006, as the Company does not expect to recognize revenue from Lexar’s products that were in the distribution channel at the acquisition date. Memory megabits in finished goods inventory at the end of the third quarter of 2006 were essentially unchanged from the second quarter of 2006 as megabit sales approximated megabit production.

Memory sales for the third quarter of 2006 increased 13% as compared to the third quarter of 2005 primarily due to a 9% increase in sales of DRAM and a 423% increase in sales of NAND Flash. The increase in DRAM sales was primarily due to an 8% increase in megabits sold. Memory sales for the first nine months of 2006 were slightly lower than for the first nine months of 2005 as increases in NAND Flash sales were offset by a 5% decrease in DRAM sales. The decrease in DRAM sales for the first nine months of 2006 was the result of a 27% decrease in average selling prices mitigated by a 31% increase in megabits sold. Megabit production increased 26% and 42% in the third quarter and first nine months of 2006, respectively, as compared to the corresponding periods of 2005, primarily due to production efficiencies including improvements in product and process technologies and to a shift

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in product mix to the manufacture of NAND Flash. DDR2 and DDR products were 15% and 45%, respectively, of the Company’s total net sales in the third quarter of 2005.

Imaging:  Imaging sales for the third quarter of 2006 increased by 34% as compared to the second quarter of 2006 primarily due to a 27% increase in unit sales and a shift in the Company’s product mix to sensors with higher pixel resolution. Imaging sales were 16% of the Company’s total net sales for the third quarter of 2006 as compared to 13% for the second quarter of 2006 and 8% for the third quarter of 2005. Imaging sales for the third quarter and first nine months of 2006 increased by 162% and 178%, respectively, from the corresponding periods of 2005 as unit sales more than tripled, the effect of which was partially offset by an approximate 25% decrease in the average selling price per unit. Production increased due to the allocation of more wafers to the manufacture of Imaging products as well as improvements in manufacturing efficiencies. The Company expects that Imaging revenue will continue to grow in future periods as additional manufacturing capacity is allocated to the production of these products.

Gross Margin

The Company’s overall gross margin percentage increased to 25.1% for the third quarter of 2006 from 19.2% for the second quarter of 2006 primarily due to increases in average selling prices for Memory products and a continued shift in product mix to higher margin products including CMOS image sensors. The Company’s overall gross margin percentage for the third quarter of 2006 increased from 8.2% for the third quarter of 2005 primarily due to improvements in the gross margin for Memory products as a result of cost reductions. The Company’s overall gross margin percentage for the first nine months of 2006 declined to 22.5% from 23.8% for the first nine months of 2005 primarily due to significant decreases in average selling prices for Memory products that were partially mitigated by cost reductions and shifts in product mix to higher margin products.

Memory:  The Company’s gross margin for Memory products for the third quarter of 2006 of 22.2% increased from 15.6% for the second quarter of 2006 primarily due to the 18% increase in the average selling price per megabit for DRAM products. The Company’s gross margin for Memory products for the third quarter of 2006 was adversely impacted by a 28% reduction in average selling prices for NAND Flash as compared to the second quarter of 2006. The Company’s overall cost of goods sold per megabit for the third quarter of 2006 declined slightly from the second quarter of 2006 primarily due to manufacturing efficiencies achieved from improved product yields and an increase in production utilizing the Company’s 110nm and 95nm process technologies.

The Company’s gross margin percentage for Memory products in the third quarter of 2006 increased from 5.3% for the third quarter of 2005 primarily due to reductions in costs of goods sold per megabit. The Company’s gross margin percentage for Memory products for the first nine months of 2006 declined to 19.2% from 23.2% for the first nine months of 2005 primarily due to a 37% decrease in the average selling prices per megabit for memory products, mitigated by improvements in costs of goods sold per megabit.

The Company’s TECH Semiconductor Singapore Pte. Ltd. (“TECH”) joint venture supplied approximately 20% to 25% of the total megabits of memory produced by the Company in recent periods. TECH primarily produced DDR and DDR2 products in 2006 and 2005. Through the second quarter of 2006, the Company purchased memory products from TECH at prices generally based on a discount from average selling prices realized by the Company for the preceding quarter. In the first six months of 2006, the Company realized higher gross margin percentages on sales of TECH products than on sales of similar products manufactured by the Company’s wholly-owned operations. As of the beginning of the third quarter of 2006, TECH’s results are included in the Company’s consolidated results. TECH utilizes the Company’s product designs and process technology and, as a result, the gross margin percentage on sales of TECH products in the third quarter of 2006 approximated those on sales of similar products manufactured by the Company’s wholly-owned operations. (See “Recent Developments — TECH Semiconductor Singapore Pte. Ltd.”)

Imaging:  The Company’s gross margin percentage of 40.2% for Imaging products for the third quarter of 2006 was slightly lower than the 43.5% gross margin for the second quarter of 2006, primarily due to decreases in average selling prices for certain high volume products and higher costs associated with the ramp in production of Imaging products at an additional fabrication facility. The Company’s gross margin for Imaging products for the third quarter of 2006 was slightly lower than the 42.7% gross margin for the third quarter of 2005 primarily due to decreases in average selling prices of 23% per unit that was mitigated by improvements in the cost of goods sold per

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unit. The Company’s gross margin for Imaging products for the first nine months of 2006 of 43.4% was significantly higher than the 35.7% gross margin for the third first nine months of 2005 primarily due to improvements in the average cost of goods sold per unit partially offset by a 23% decrease in the overall average selling price per unit.

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses for the third quarter of 2006 increased 5% from the second quarter of 2006 primarily due to increased costs associated with outstanding legal matters. SG&A expenses for the third quarter and first nine months of 2006 were 28% and 22% higher, respectively, than for the corresponding periods of 2005 primarily due to higher compensation costs and to increased costs associated with outstanding legal matters. The Company expects SG&A expenses to increase to approximately $130 million for the fourth quarter of 2006 to support growth for the ramp of IMFT, the acquisition of Lexar and the consolidation of TECH.

Research and Development

Research and development (“R&D”) expenses vary primarily with the number of development wafers processed, the cost of advanced equipment dedicated to new product and process development, and personnel costs. Because of the lead times necessary to manufacture its products, the Company typically begins to process wafers before completion of performance and reliability testing. The Company deems development of a product complete once the product has been thoroughly reviewed and tested for performance and reliability. R&D expenses can vary significantly depending on the timing of product qualification.

R&D expenses for the third quarter of 2006 increased 5% from the second quarter of 2006 primarily due to increased expenditures on NAND Flash memory products and processes. R&D expenses for the third quarter of 2006 increased 9% from the third quarter of 2005 primarily due to higher compensation costs. R&D expenses for the first nine months of 2006 increased 9% from the first nine months of 2006, principally due to higher compensation costs, increases in R&D equipment depreciation and increases in development wafers processed. The Company and Intel share R&D process and design costs for NAND Flash equally. The Company expects that its R&D costs will approximate $165 million to $175 million for the fourth quarter of 2006.

The Company’s process technology R&D efforts are focused primarily on development of successively smaller line-width process technologies which are designed to facilitate the Company’s transition to next generation memory products and CMOS image sensors. Additional process technology R&D efforts focus on specialty memory products (including PSRAM, mobile SDRAM and reduced latency DRAM) and new manufacturing materials. Product design and development efforts are concentrated on the Company’s 1 gigabit and 2 gigabit DDR, DDR2 and DDR3 products as well as high density and mobile NAND Flash memory (including multi-level cell technology), CMOS image sensors and specialty memory products.

Stock-Based Compensation

Through 2005, the Company accounted for its stock plans using the intrinsic value method. Effective the beginning of 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” and elected to adopt the modified prospective application method. SFAS No. 123(R) requires the Company to use a fair-value based method to accounting for stock-based compensation. Accordingly, stock-based compensation cost is measured as of the grant date, based on the fair value of the award, and is recognized as expense over the employees’ requisite service period. Total compensation cost for the Company’s stock plans in the third quarter and first nine months of 2006 was $7.4 million and $17.8 million, respectively, of which $1.2 million was capitalized and remained in inventory at the end of the third quarter of 2006. In 2005, the Company accelerated the vesting of substantially all of its unvested stock options then outstanding under the Company’s stock plans to reduce compensation costs recognized subsequent to the adoption of SFAS 123(R). Because the Company’s near-term, stock-based compensation costs were reduced by the acceleration of vesting in 2005, stock-based compensation costs would grow significantly in future periods if the Company continues to grant amounts of new stock-based compensation awards similar to recent periods.

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Other Operating (Income) Expense, Net

Other operating income for the first nine months of 2006 includes $230.0 million of net proceeds from Intel Corporation (“Intel”) for the sale of the Company’s existing NAND Flash memory designs and certain related technology to Intel and the Company’s acquisition of a perpetual, paid-up license to use and modify such designs.  Other operating income for the third quarter of 2005 includes gains net of losses on write-downs and disposals of semiconductor equipment of $14.5 million and net gains of $12.2 million from changes in currency exchange rates. Other operating income for the first nine months of 2005 includes gains net of losses on write-downs and disposals of semiconductor equipment of $13.1 million and $12.0 million in receipts from the U.S. government in connection with anti-dumping tariffs. The Company estimates that, based on its assets and liabilities denominated in currencies other than U.S. dollar as of June 1, 2006, a 1% change in the exchange rate versus the U.S. dollar would result in foreign currency gains or losses of approximately $0.9 million for the yen and $0.9 million for the euro.

Income Taxes

Income taxes for 2006 and 2005 primarily reflect taxes on the Company’s non-U.S. operations and U.S. alternative minimum tax. The Company has a valuation allowance for its net deferred tax asset associated with its U.S. operations. The provision for taxes on U.S. operations in 2006 and 2005 was substantially offset by a reduction in the valuation allowance. Until such time as the Company utilizes a significant portion of its U.S. net operating loss carryforwards and unused tax credits, the provision for taxes on the Company’s U.S. operations is expected to be substantially offset by a reduction in the valuation allowance. As of June 1, 2006, the Company had aggregate U.S. tax net operating loss carryforwards of $1.6 billion and unused U.S. tax credit carryforwards of $183.7 million. The Company also has unused state tax net operating loss carryforwards of $1.3 billion and unused state tax credits of $145.9 million. Substantially all of the net operating loss carryforwards expire in 2022 to 2025 and substantially all of the tax credit carryforwards expire in 2013 to 2026. During the first nine months of 2006, the Company utilized approximately $1.1 billion of its U.S. tax net operating loss carryforwards as a result of IMFT, MP Mask and related transactions. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Joint Ventures — IM Flash Technologies, LLC” and “Joint Ventures — MP Mask Technology Center, LLC” notes.)

Liquidity and Capital Resources

The Company’s liquidity is highly dependent on average selling prices for its products and the timing of capital expenditures, both of which can vary significantly from period to period. As of June 1, 2006, the Company had cash and marketable investment securities totaling $2.8 billion compared to $1.3 billion as of September 1, 2005. The Company’s cash and marketable investment securities as of June 1, 2006, included $747.8 million held at, and anticipated to be used in the near term by, IMFT and TECH.

Operating Activities:  For the first nine months of 2006, net cash provided by operating activities was $1,688.7 million, which principally reflects the Company’s $344.3 million of net income (which includes $230.0 million from the sale of the Company’s existing NAND Flash memory designs and certain related technology to Intel) adjusted by $936.2 million for non-cash depreciation and amortization expense. Cash provided by operations also included $250.0 million received from Apple as prepayment for future NAND Flash sales and $72 million received from Photronics in exchange for entering into a license agreement.

Investing Activities:  For the first nine months of 2006, net cash used by investing activities was $1,013.4 million, which included cash expenditures for property, plant and equipment of $790.1 million. For the first nine months of 2006, net cash provided by investing activities included $319.0 million that resulted from the consolidation of TECH. The Company believes that to develop new product and process technologies, support future growth, achieve operating efficiencies and maintain product quality, it must continue to invest in manufacturing technologies, facilities and capital equipment, research and development, and product and process technologies. The Company projects 2006 capital spending of approximately $2.2 billion, which includes approximately $850 million for planned expenditures by IMFT and approximately $400 million for planned expenditures by TECH. The Company projects 2007 capital spending of approximately $3.5 billion, which includes IMFT and TECH related expenditures. As of June 1, 2006, the Company had commitments extending into 2007 of approximately $1.0 billion for the acquisition of property, plant and equipment.

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Financing Activities:  For the first nine months of 2006, net cash provided by financing activities was $267.9 million, which includes $500.2 million received from Intel for its interest in IMFT, $48.0 million received from Photronics for its interest in MP Mask and $171.1 million from the settlement of call spread options, net of $534.9 million of payments on debt and equipment purchase contracts. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Joint Ventures.)

In the third quarter of 2006, the Company’s TECH joint venture repaid $245.7 million of its outstanding notes that had been included in the debt recorded by the Company in the consolidation of TECH. TECH also entered into a credit facility that will enable it to borrow up to $400 million. TECH expects to draw on this facility in future periods to fund its capital expenditures.

On February 14, 2006, the Company terminated its outstanding call spread options covering a total of approximately 53.7 million shares of its common stock (“Call Spread Options”). The Company originally entered into the Call Spread Options in connection with its issuance of the Notes. The Company received $171.1 million in the third quarter of 2006 for the settlement of the Call Spread Options.

In the second quarter of 2006, the Company’s $632.5 million 2.5% Convertible Subordinated Notes (“Notes”) were converted into 53.7 million shares of the Company’s common stock. In addition, the Company’s related interest rate swap terminated by its terms on February 6, 2006 and, as a result, $34.8 million pledged as collateral for the swap became unrestricted.

Access to capital markets has historically been important to the Company. Depending on market conditions, the Company may issue registered or unregistered securities to raise capital to fund a portion of its operations.

IMFT:  As of June 1, 2006, IMFT had $551.8 million of cash and marketable investment securities and $696.0 million due under the notes receivable from Intel. IMFT’s cash and marketable investment securities are not available or anticipated to be made available to finance the Company’s other operations. Subject to certain conditions, the Company expects to make additional contributions of approximately $1.4 billion over the next three years and additional investments as appropriate to support the growth of IMFT’s operations.

TECH:  As of June 1, 2006, TECH had $196.0 million of cash and marketable investment securities. TECH’s cash and marketable investment securities are not available or anticipated to be made available to finance the Company’s other operations. On March 3, 2006, certain shareholders of TECH, including the Company and the Singapore Economic Development Board (“EDB”), contributed approximately $260 million in cash as additional capital to TECH, of which the Company’s contribution was approximately $130 million. The Company’s option to purchase EDB’s shares in TECH is exercisable at any time until October 1, 2009. EDB’s option to put its shares in TECH to the Company is exercisable from March 3, 2008 until October 1, 2010. Exercise of either option would require the Company to pay approximately $250 million to EDB. (See “Item 1. Financial Statements — Notes to Consolidated Financial Statements — Joint Ventures — TECH Semiconductor Singapore Pte. Ltd.”)

Contractual Obligations:  As of June 1, 2006, future maturities of notes payable, minimum lease payments under capital lease obligations and minimum commitments under operating leases were as follows:

		Total			Remainder of 2006			2007			2008			2009			2010			2011 and thereafter
Notes payable		$	248.1		$	2.5		$	82.1		$	64.7		$	47.3		$	46.8		$	4.7
Capital lease obligations		302.8			31.6			95.4			76.2			71.2			6.5			21.9
Operating leases		61.8			4.5			15.2			9.1			4.8			3.8			24.4

 

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