Fairchild Semiconductor Financial

BACKGROUND
The predecessors of Fairchild Semiconductor International, Inc. and its wholly-owned subsidiary, Fairchild Semiconductor Corporation, were among the pioneers of the semiconductor industry. The founders of the original Fairchild Semiconductor invented the planar manufacturing process, regarded as one of the most significant achievements since the invention of the transistor. Later innovations, including Fairchild Advanced Schottky Technology (FAST®) and Fairchild Advanced CMOS Technology (FACT™), formed the basis for a rich company history. The Fairchild Semiconductor business was acquired in 1979 by Schlumberger Limited and by National Semiconductor in 1987. The assets of the Fairchild Semiconductor business were separated from National Semiconductor in March 1997 and Fairchild Semiconductor Corporation began operating as a stand-alone entity. At that time, the company’s business consisted of the Logic Products Group, historically a core business of Fairchild Semiconductor, the Discrete Products Group and the Non-Volatile Memory Products Group, historically multi-market businesses of National Semiconductor. On December 31, 1997, the company acquired all of the outstanding common stock of Raytheon Semiconductor Inc. for approximately $117.0 million in cash. Immediately prior to the closing of the transaction, Raytheon Semiconductor, Inc. was renamed Fairchild Semiconductor Corporation of California and, upon closing, became a wholly-owned subsidiary of Fairchild Semiconductor Corporation. The transaction was accounted for as a purchase. Accordingly, Fairchild International’s operating results in Fiscal 1998 include the operating results of Fairchild Semiconductor Corporation of California as of the date of the acquisition. On April 13, 1999, Fairchild International acquired the power device business of Samsung Electronics Co., Ltd. for $414.9 million in cash, including fees and expenses. The power device business designs, manufactures and markets power discrete semiconductors and standard analog integrated circuits serving the personal computer, industrial, telecommunications and consumer electronics markets. The transaction was accounted for as a purchase. Accordingly, Fairchild International’s operating results in Fiscal 1999 include the operating results of the power device business, as of the date of the acquisition.

FISCAL YEAR CHANGE
We have changed our fiscal year end from the last Sunday in May to the last Sunday in December. We refer to the seven-month transition period from May 31, 1999 to December 26, 1999 as Stub Year 1999. In the table below, we have provided unaudited pro forma quarterly consolidated statements of operations on a calendar-quarter basis for Fairchild International for the year ended December 26, 1999. The pro forma financial information is presented as if the acquisition of the power device business and our initial public offering, completed on August 9, 1999, had both been completed as of December 28, 1998, and is provided as a base for comparison against future quarterly operating results.

	Quarter Ended

(In millions, except per share data)	March 28, 1999 (1)		June 27, 1999 (1) (2)			September 26, 1999 (1) (2)		December 26, 1999

Revenue: —Net sales—trade		$251.5		$282.9			$302.5		$331.4
—Contract manufacturing		33.9		31.5			33.3		29.6

——Total revenue		285.4		314.4			335.8		361.0
Operating expenses: —Cost of sales—trade		192.8		225.1			213.0		228.8
—Cost of contract manufacturing		21.8		23.5			24.8		20.0
—Research and development		12.8		13.8			14.3		16.2
—Selling, general and administrative		32.3		42.2			54.2		50.9
—Restructuring and impairments		2.7		14.1			—		—

——Total operating expenses		262.4		318.7			306.3		315.9

Operating income (loss)		23.0		(4.3	)		29.5		45.1
Interest expense, net		18.0		18.0			18.0		17.7

Income (loss) before income taxes		5.0		(22.3	)		11.5		27.4
Provision (benefit) for income taxes		0.4		(1.3	)		1.7		2.9

Net income (loss)		$4.6		$(21.0	)		$9.8		$24.5

Net income (loss) per common share: —Basic		$0.05		$(0.24	)		$0.11		$0.28

—Diluted		$0.05		$(0.24	)		$0.11		$0.26

Weighted average common shares: —Basic		88.3		88.3			88.5		88.7

—Diluted		91.6		88.3			91.9		92.8

Supplemental data: —Adjusted net income (loss) (3)		$15.6		$14.6			$25.9		$33.0

—Diluted adjusted earnings (loss) per share (4)		$0.17		$0.16			$0.28		$0.36

Fairchild International has defined four reportable segments: the Analog and Mixed Signal Products Division, which we refer to as Analog; the Discrete Power and Signal Technologies Products Group, which we refer to as Discrete; the Interface and Logic Products Group, which we refer to as Interface and Logic; and the Non-Volatile Memory Division, which we refer to as Memory. Power device business products, which include analog and discrete power products and were previously reported as a separate segment, are now included in the Analog and Discrete segments. The following table sets forth the composition of trade revenue by reportable segments and contract manufacturing services, as a percentage of total revenues, excluding one-time charges totaling $5.5 million in the Memory segment in Fiscal 1999:

	Stub Year			Fiscal Year Ended

		1999			1999		1998		1997

Analog		22.1	%		13.0	%	4.1	%	—	%
Discrete		40.3			30.1		23.7		23.8
Interface and Logic		23.4			36.1		38.4		41.2
Memory		5.0			9.9		14.4		19.9

—Subtotal trade sales		90.8			89.1		80.6		84.9
Contract manufacturing services		9.2			10.9		19.4		15.1

Total		100.0	%		100.0	%	100.0	%	100.0	%

SEVEN MONTHS ENDED DECEMBER 26, 1999 COMPARED TO SEVEN MONTHS ENDED DECEMBER 27, 1998
Comparative financial information for Stub Year 1999 and the seven months ended December 27, 1998, which we refer to as the first seven months of Fiscal 1999, is as follows:

(In millions)	Stub Year 1999		Seven Months Ended December 27, 1998

			(unaudited)
Revenue: —Net sales—trade		$714.0		$322.3
—Contract manufacturing		72.2		38.0

——Total revenue		786.2		360.3
Operating expenses: —Cost of sales—trade		499.9		252.6
—Cost of contract manufacturing		51.4		32.9
—Research and development		35.0		21.3
—Selling, general and administrative		117.4		52.9
—Restructuring and impairments		—		4.5

——Total operating expenses		703.7		364.2

Operating income (loss)		82.5		(3.9	)
Interest expense, net		56.2		34.2

Income (loss) before income taxes		26.3		(38.1	)
Provision (benefit) for income taxes		5.0		(7.6	)

Net income (loss)		$21.3		$(30.5	)

Results of Operations. Fairchild International generated net income of $21.3 million in Stub Year 1999, compared to a net loss of $30.5 million in the first seven months of Fiscal 1999. Excluding unusual charges and amortization of acquisition-related intangibles of $15.5 million and $19.5 million, respectively, in Stub Year 1999, and $4.5 million and $2.0 million, respectively, in the first seven months of Fiscal 1999, net of tax effects, Fairchild International had adjusted net income of $54.5 million for Stub Year 1999 compared to an adjusted net loss of $25.3 million in the first seven months of Fiscal 1999. Unusual charges in Stub Year 1999 included initial public offering-related charges of $8.3 million, recorded in selling, general and administrative expenses (“SG&A”), for the forgiveness of certain loans made to Fairchild International’s management investors for payment of individual income tax liabilities resulting from their ownership of Fairchild International’s common stock, and $7.2 million, recorded in interest expense, for the write-off of deferred financing fees associated with the debt repaid with the proceeds from the initial public offering. Unusual charges in the first seven months of Fiscal 1999 were due to restructuring charges as a result of a workforce reduction. Operating income was $82.5 million in Stub Year 1999, compared to an operating loss of $3.9 million in the first seven months of Fiscal 1999. Excluding unusual charges, operating income was $90.8 million in Stub Year 1999, compared to $0.6 million in the first seven months of Fiscal 1999. The increase in operating income is due to the acquisition of the power device business from Samsung Electronics and higher revenues and gross profits due to new product introductions and improved business conditions, resulting in higher factory utilization in Stub Year 1999 as compared to the first seven months of Fiscal 1999.
Excluding depreciation and amortization of $82.3 million and $55.1 million in Stub Year 1999 and the first seven months of Fiscal 1999, respectively, and unusual charges, earnings before interest, taxes, depreciation and amortization (“EBITDA”) were $173.1 million in Stub Year 1999 compared to $55.7 million in the first seven months of Fiscal 1999. EBITDA is presented because the company believes that it is a widely accepted financial indicator of an entity’s ability to incur and service debt. EBITDA should not be considered as an alternative to net income, operating income, or other consolidated operations and cash flow data prepared in accordance with generally accepted accounting principles, as an indicator of the operating performance of Fairchild International, or as an alternative to cash flows as a measure of liquidity.

     Revenues. Fairchild International’s revenues consist of trade sales to unaffiliated customers (90.8% and 89.5% of total revenues in Stub Year 1999 and the first seven months of Fiscal 1999, respectively) and revenues from contract manufacturing services provided to National Semiconductor and Samsung Electronics (9.2% and 10.5% of total revenues in Stub Year 1999 and the first seven months of Fiscal 1999, respectively).
     Trade sales increased 121.5% to $714.0 million in Stub Year 1999 compared with $322.3 million in the first seven months of Fiscal 1999. Trade sales for Stub Year 1999 include sales from the power device business. Excluding sales from the power device business, trade sales increased 28.9% in Stub Year 1999 over the first seven months of Fiscal 1999, as higher sales volume offset lower average selling prices. The increase in trade sales is attributable to improved demand due to strength in end-markets such as personal computers and telecommunications and an economic recovery in the Asia/Pacific region.
     Geographically, 20.7%, 12.2%, 45.6% and 21.5% of trade sales were derived in the United States, Europe, Asia/Pacific and Korea, respectively, in Stub Year 1999. Excluding sales from the power device business, 31.8%, 17.5% and 50.7% of trade sales were derived from North America, Europe and Asia/Pacific (including Korea), respectively, in Stub Year 1999, compared to 40.3%, 18.4% and 41.3%, respectively, in the first seven months of Fiscal 1999. Excluding sales from the power device business, Asia/Pacific region revenues increased 58.2% in Stub Year 1999 over the first seven months of Fiscal 1999. The increase in the Asia/Pacific region is due to strength in the consumer and personal computer markets, as well as improved economic conditions. Revenues in the Europe region increased 22.5% in Stub Year 1999 over the first seven months of Fiscal 1999. The increase in Europe is due to improved telecommunications, consumer and distribution markets. North American revenues increased 2.0% in Stub Year 1999 over the first seven months of Fiscal 1999. The increase in North America is the result of improved market conditions offset by the continued move of contract manufacturers to locations outside North America.
     Contract manufacturing revenues increased 90.0% to $72.2 million in Stub Year 1999 compared to $38.0 million in the first seven months of Fiscal 1999. Excluding contract manufacturing services provided to Samsung Electronics, contract manufacturing revenues increased 42.1% in Stub Year 1999 as compared to the first seven months of Fiscal 1999, reflecting increased demand from National Semiconductor.

Gross Profit. Gross profit increased 214.0% to $234.9 million in Stub Year 1999 compared to $74.8 million in the first seven months of Fiscal 1999. Excluding the gross profit derived from power device products, gross profit increased 71.8% in Stub Year 1999 over the first seven months of Fiscal 1999. As a percentage of trade sales, gross trade profits were 30.0% in Stub Year 1999. Excluding the power device business, gross trade profits as a percentage of trade sales were 28.4% in Stub Year 1999 compared to 21.6% in the first seven months of Fiscal 1999. The increase in gross trade profit as a percentage of trade sales was due to the favorable effect of increased factory utilization and the full benefit of cost reduction actions undertaken in Fiscal 1999, offset by lower average selling prices. Average selling prices for Stub Year 1999 were lower than the first seven months of Fiscal 1999, despite higher average selling prices in the second quarter of Stub Year 1999 over the first quarter of Stub Year 1999, particularly for Discrete and Interface and Logic products. Contract manufacturing gross profit increased 307.8% to $20.8 million in Stub Year 1999 compared to $5.1 million in the first seven months of Fiscal 1999. The increase in contract manufacturing gross profit is due to incremental business with Samsung Electronics as a result of the acquisition of the power device business and greater demand from National Semiconductor reflective of improved market conditions. Contract manufacturing gross profit for the first seven months of Fiscal 1999 included $13.0 million of fixed cost reimbursement under Fairchild International’s manufacturing agreements with National Semiconductor.

Research and Development. Research and development expenses (“R&D”) were $35.0 million, or 4.9% of trade sales, in Stub Year 1999, compared to $21.3 million, or 6.6% of trade sales, in the first seven months of Fiscal 1999. The increase in R&D expenses is driven by the dedicated R&D costs incurred by the power device business in Stub Year 1999 which Fairchild International did not incur in the first seven months of Fiscal 1999. R&D efforts are focused on Fairchild International’s growth products (Analog, DMOS power and CMOS logic). R&D expenditures for these growth products were 5.7% and 9.0% of trade sales in Stub Year 1999 and the first seven months of Fiscal 1999, respectively. R&D expenditures for Fairchild International’s other products (Bipolar Logic, Bipolar Discretes and EPROM) were less than 1% of trade sales for both Stub Year 1999 and the first seven months of Fiscal 1999. The decrease in R&D expenditures for growth products as a percentage of trade sales is due to the relatively smaller R&D requirements of the power device business as a percentage of sales.

Selling, General and Administrative. SG&A expenses were $117.4 million, or 16.4% of trade sales, in Stub Year 1999, compared to $52.9 million, or 16.4% of trade sales, in the first seven months of Fiscal 1999. SG&A expenses for Stub Year 1999 include an unusual charge of $8.3 million for the forgiveness of certain loans made to Fairchild International’s management investors for payment of individual income tax liabilities resulting from their ownership of Fairchild International’s common stock. Excluding this unusual charge, SG&A was $109.1 million, or 15.3% of trade sales, in Stub Year 1999. The increase in SG&A expenses (excluding the unusual charge) is primarily the result of the incremental SG&A expenses of the power device business which Fairchild International did not incur in the first seven months of Fiscal 1999, including amortization of acquisition-related intangibles, and increased selling expenses for the pre-existing business due to higher sales volume.

Restructuring. Fairchild International incurred a pre-tax restructuring charge of approximately $4.5 million in the first seven months of Fiscal 1999. The charge consisted of $0.8 million related to non-cash asset impairments and $3.7 million of employee separation costs related to the reduction of approximately 600 salaried, hourly and temporary positions, then representing approximately 10% of Fairchild International’s payroll. Substantially all amounts have been expended with respect to Fairchild International’s Fiscal 1999 restructuring actions with the exception of the Analog wafer production transfer to South Portland, Maine.

Interest Expense, Net. Interest expense, net was $56.2 million in Stub Year 1999, compared to $34.2 million in the first seven months of Fiscal 1999. Interest expense, net in Stub Year 1999 includes an unusual charge of $7.2 million for the write-off of deferred financing fees associated with debt retired with the proceeds from the initial public offering. Excluding this charge, interest expense, net was $49.0 million in Stub Year 1999. The increase, excluding the unusual charges, is principally the result of indebtedness incurred to finance the power device business acquisition, which occurred in the fourth quarter of Fiscal 1999.

Income Taxes. Income tax expense was $5.0 million for Stub Year 1999, compared to a tax benefit of $7.6 million in the first seven months of Fiscal 1999. The effective tax rates for Stub Year 1999 and the first seven months of Fiscal 1999 on book pre-tax income were 19.0% and 19.9%, respectively. In Stub Year 1999, the current tax provision increased while deferred tax benefits decreased over the first seven months of Fiscal 1999. In Stub Year 1999, the current tax provision is based on income generated from Fairchild International’s foreign operations, excluding Korea where Fairchild International benefits from a tax holiday. The decrease in deferred tax benefits is due to profits earned in Stub Year 1999 and Fairchild International’s limited ability to recognize the future benefit of U.S. net operating loss carryforwards. In addition, deferred tax expense was recorded in Korea to account for future book deductions in excess of future tax deductions arising beyond the tax holiday period.

Fairchild International has adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. In accordance with the provisions of SFAS No. 131, comparative disclosures of selected operating results of Fairchild International’s reportable segments is as follows:

Analog and Mixed Signal Products Division. Fairchild International formed the Analog and Mixed Signal Products Division upon completion of the acquisition of Raytheon. This division has expanded due to the inclusion of the analog products of the power device business. Its product offerings include standard linear products such as operational amplifiers, low drop out regulators and ground fault interrupters, motor control integrated circuits, smart power switches and D/C to D/C converters. Analog revenues increased 347.2% to $173.5 million in Stub Year 1999 from $38.8 million in the first seven months of Fiscal 1999. Stub Year 1999 includes the analog revenues of the power device business, which is not included in the first seven months of Fiscal 1999. Normalized to exclude power device products, Analog revenues were $42.9 million in Stub Year 1999, an increase of 10.6% from the first seven months of Fiscal 1999. The increase is due to improved business conditions and new product revenues, which more than offset revenue decreases in mature products.
Analog had operating income of $24.0 million in Stub Year 1999 as compared to $0.2 million in the first seven months of Fiscal 1999. Excluding analog power device products, Analog had an operating loss of $8.0 million in Stub Year 1999. The increase in Analog’s operating loss (excluding analog power device products) was due to an unfavorable sales mix and increased inventory valuation reserves in anticipation of the closure of the Mountain View, California wafer fab, which occurred in the latter part of Stub Year 1999.

Discrete Power and Signal Technologies Products Group. Discrete designs, manufactures and markets a broad line of DMOS power MOSFETs, for both high and low-voltage applications, IGBT, bipolar power transistors, small signal transistors and diodes. This group has expanded due to the inclusion of the discrete products of the power device business. An increasing volume of DMOS power MOSFETs are manufactured using Fairchild International’s leading edge Trench technology. Discrete revenues increased 229.8% to $316.9 million in Stub Year 1999, compared to $96.1 million in the first seven months of Fiscal 1999. Stub Year 1999 includes the discrete revenues of the power device business which are not included in the first seven months of Fiscal 1999. Excluding discrete power device products, Discrete revenues increased 54.6% to $148.6 million in Stub Year 1999 from the first seven months of Fiscal 1999. The increase was across all product lines, DMOS products increased 81.9% over the first seven months of Fiscal 1999. Revenues for mature Bipolar products grew 13.7% in Stub Year 1999 over the first seven months of Fiscal 1999.
Discrete had operating income of $36.7 million in Stub Year 1999 as compared to $4.5 million in the first seven months of Fiscal 1999. Excluding discrete power device products, Discrete had operating income of $14.9 million in Stub Year 1999. The increase in Discrete operating income was due to higher revenues and improved gross profits due to improved factory utilization and higher average selling prices.

Interface and Logic Products Group. Interface and Logic designs, manufactures and markets a broad line of high-performance interface and standard logic products. Its interface products include building block products such as FST and GTL, and standards-specific products such as dual inline memory drivers and Universal Serial Bus. Its logic products focus on the growing CMOS logic market, from industry standard FACT and HCMOS to new products such as TinyLogic™, LCX and LVT. Its products also include mature bipolar logic products such as FAST, LS and TTL. Interface and Logic revenues increased 27.9% to $184.0 million in Stub Year 1999, compared to $144.0 million in the first seven months of Fiscal 1999. Revenues for interface products grew 224.4% in Stub Year 1999 over the first seven months of Fiscal 1999, due to success of new product introductions. Logic products revenues increased 22.8% in Stub Year 1999 over the first seven months of Fiscal 1999. The increase in Logic products revenues was across all product lines. CMOS revenues grew 34.6%, while Bipolar revenues grew 2.5% in Stub Year 1999 over the first seven months of Fiscal 1999.
Interface and Logic had operating income of $29.7 million in Stub Year 1999, compared to $11.6 million in the first seven months of Fiscal 1999. The increase in operating income was due to higher revenues and improved gross profits due to improved factory utilization.

     Non-Volatile Memory Division. Memory designs, manufactures and markets a broad line of serial EEPROM, EPROM and applications-specific standard products, including microcontrollers. Memory revenues decreased 8.8% to $39.6 million in Stub Year 1999 from $43.4 million in the first seven months of Fiscal 1999. The decrease was due to exiting certain unprofitable product lines in Stub Year 1999 as compared to the first seven months of Fiscal 1999, which include those revenues, offset by revenue growth in new applications-specific standard products, such as the ACEx family of microcontrollers.
     Memory had operating income of $0.4 million in Stub Year 1999 as compared to a loss of $15.7 million in the first seven months of Fiscal 1999. The decrease in the Memory operating loss was due to the benefit from the implementation of the Memory restructuring plan, implemented in the fourth quarter of Fiscal 1999.
     Approximately 68.7% of Fairchild International’s trade revenues were generated from Analog, Discrete and Power Device products in Stub Year 1999.

YEAR ENDED MAY 30, 1999 COMPARED TO YEAR ENDED MAY 31, 1998
Results of Operations. Fairchild International incurred a net loss of $114.1 million in Fiscal 1999, compared to net income of $20.6 million in Fiscal 1998. The net loss in Fiscal 1999 includes pre-tax charges totaling $75.9 million for in-process research and development ($34.0 million) and the write-off of deferred financing fees in connection with a refinancing of Fairchild International’s senior credit facilities ($5.2 million) as part of the acquisition of the power device business of Samsung Electronics in April 1999, and restructuring and related charges totaling $36.7 million. The Fiscal 1999 restructuring charges pertain to a workforce reduction undertaken in the first quarter ($4.5 million), the transfer of Analog assembly and test operations in the third quarter ($2.7 million), the closure of the Mountain View facility ($10.0 million) recorded in the fourth quarter and the restructuring of the Memory business ($19.5 million), also in the fourth quarter. The charge for the Memory restructuring includes $5.5 million and $9.9 million recorded as a reduction to revenue and an increase to cost of sales, respectively, for additional sales and inventory reserves associated with the restructuring. Net income in Fiscal 1998 includes pre-tax charges of $15.5 million for in-process research and development associated with the acquisition of Raytheon and an after-tax charge of $1.5 million for the cumulative effect of a change in accounting principle. Excluding unusual charges, net of tax effect, and amortization of acquisition-related intangibles of $8.4 million and $1.4 million in Fiscal 1999 and Fiscal 1998, respectively, Fairchild International incurred a net loss of $33.4 million in Fiscal 1999, compared to net income of $33.5 million in Fiscal 1998. The decrease is due primarily to soft market conditions in the semiconductor industry that persisted for much of Fiscal 1999, which resulted in severe price competition and factory underutilization, particularly in the first half of Fiscal 1999, which negatively impacted gross profit.
Fairchild International incurred an operating loss of $47.4 million in Fiscal 1999, compared to operating income of $87.3 million in Fiscal 1998. Excluding unusual charges, operating income was $23.3 million in Fiscal 1999, compared to $102.8 million in Fiscal 1998. Excluding unusual charges and depreciation and amortization of $103.7 million and $84.6 million in Fiscal 1999 and Fiscal 1998, respectively, earnings before interest, taxes and depreciation and amortization, which we refer to as EBITDA, was $127.0 million in Fiscal 1999, compared to $187.4 million in Fiscal 1998.

Revenues. Fairchild International’s revenues consist of trade sales to unaffiliated customers (89.0% and 80.6% of total revenues in Fiscal 1999 and Fiscal 1998, respectively) and contract manufacturing services to National Semiconductor (11.0% and 19.4% of total revenues in Fiscal 1999 and Fiscal 1998, respectively). Trade sales increased 2.9% to $654.1 million in Fiscal 1999 from $635.8 million in Fiscal 1998. Trade sales in Fiscal 1999 include those of the power device business since the acquisition date of April 13, 1999, and a full-year of Analog. Additionally, trade sales have been reduced by $5.5 million in Fiscal 1999 for one-time charges for additional sales reserves as a result of the Memory restructuring. Trade sales in Fiscal 1998 include those of Analog since the acquisition date of December 31, 1997. Excluding Power Device revenues, one-time charges and normalizing Analog sales for the non-comparable periods, trade sales decreased 14.0% in Fiscal 1999 from Fiscal 1998. All segments reported trade sales decreases from the prior year, due to industry-wide soft market conditions that were prevalent for much of Fiscal 1999. These soft market conditions, caused by the Asian financial crisis and excess capacity in the semiconductor industry as a whole, resulted in severe price pressures, which accounted for the majority of the revenue shortfall on a comparable basis. Unit volume was flat for Fiscal 1999 as compared to Fiscal 1998.
Geographically, 33%, 17% and 50% of Fairchild International’s trade sales in Fiscal 1999 were generated in the United States, Europe and Asia, respectively, compared to 38%, 21% and 41%, respectively, in Fiscal 1998. Soft market conditions prevalent in Fiscal 1999 negatively impacted all geographic regions. Trade sales in the United States decreased 9.8% in Fiscal 1999 from Fiscal 1998. Excluding one-time charges, trade sales decreased 7.6%. Trade sales in Europe decreased 16.1% in Fiscal 1999 from Fiscal 1998. Trade sales in Asia increased 24.3% in Fiscal 1999 over Fiscal 1998. Asia sales include those in Southeast Asia, Korea and Japan. The increase in trade sales is due entirely to the acquisition of the power device business. Excluding the power device business, Asia trade sales decreased 2.1% in Fiscal 1999 from Fiscal 1998. Contract manufacturing revenues decreased 47.2% to $81.0 million in Fiscal 1999, compared to $153.4 million in Fiscal 1998. Contract manufacturing revenues in Fiscal 1999 include $18.7 million of billings under the guaranteed annual revenue and fixed cost recovery provisions of the manufacturing agreements with National Semiconductor. The decrease was due to reduced demand from National Semiconductor.

Gross Profit. Gross profit decreased 33.9% to $152.3 million in Fiscal 1999 from $230.5 million in Fiscal 1998. Gross trade profit in Fiscal 1999 was negatively impacted by one-time charges of $15.4 million for additional sales and inventory reserves as a result of the Memory restructuring action. Excluding one-time charges, gross profit decreased 27.2% to $167.7 million in Fiscal 1999. Gross profit includes $16.6 million and $36.3 million in Fiscal 1999 and Fiscal 1998, respectively, attributable to contract manufacturing services provided to National Semiconductor. As a percentage of trade sales, gross trade profit, which excludes contract manufacturing, was 20.7% in Fiscal 1999 compared to 30.5% in Fiscal 1998. Excluding one-time charges, gross trade profit as a percentage of trade sales was 22.9% in Fiscal 1999. The decrease in gross trade profits as a percentage of sales in Fiscal 1999 from Fiscal 1998 was due to lower average trade selling prices and the negative effects of significantly decreased demand from National Semiconductor.
Contract manufacturing gross profit decreased 54.3% in Fiscal 1999 from Fiscal 1998. As a percentage of contract manufacturing revenue, contract manufacturing gross profit was 20.5% in Fiscal 1999, compared to 23.7% in Fiscal 1998. The decrease in contract manufacturing gross profit as a percent of contract manufacturing revenues is due to the negative effects of lower factory utilization due to reduced demand from National Semiconductor and an unfavorable shift in sales mix toward ABiC wafers produced in Fairchild International’s six-inch fab in South Portland, Maine.

Research and Development. R&D expenses were $39.3 million, or 6.0% of trade sales in Fiscal 1999, compared to $35.7 million, or 5.6% of trade sales in Fiscal 1998. The increase in R&D expenses is due to the addition of the R&D expenses of the power device business and a full year of Analog R&D expenses in Fiscal 1999, as compared to five months of Analog R&D expenses recorded in Fiscal 1998. R&D efforts are focused on Fairchild International’s growth products (CMOS logic, DMOS, Analog and the power device business products). In Fiscal 1999, R&D expenditures were 7.7% of trade sales for these growth products, and 3.0% of trade sales for all other products. In Fiscal 1998, R&D expenditures were 8.7% and 2.7% for growth and all other products, respectively. The decrease in R&D expenditures for growth products as a percentage of trade sales is due to the relatively small R&D requirements of the power device business as a percentage of sales.

Selling, General and Administrative. SG&A expenses were $105.1 million, or 16.1% of trade sales in Fiscal 1999, compared to $92.0 million or 14.5% of trade sales in Fiscal 1998. The increase in SG&A expenses is due to the addition of the SG&A expenses of the power device business, a full year of Analog SG&A expenses in Fiscal 1999, as compared to five months of Analog SG&A expenses recorded in Fiscal 1998, and amortization of acquisition-related intangibles, including a full year of amortization of intangibles related to the Raytheon acquisition in Fiscal 1999 as compared to five months in Fiscal 1998.

     Restructuring. Fiscal 1999 included restructuring charges of $21.3 million, as Fairchild International took several actions during Fiscal 1999 to reduce costs and improve profitability in a number of areas. In the fourth quarter of Fiscal 1999, Fairchild International took a pre-tax charge of $4.1 million for actions to improve the profitability of Memory. These actions included transferring wafer fabrication activities in Salt Lake City, Utah to third-party subcontractors and obsoleting Memory product lines. The charge consists of $3.9 million for non-cash asset impairments at Fairchild International’s facilities in Salt Lake City, Utah and Sunnyvale, California, and $0.2 million for severance and employee separation costs. In addition, Fairchild International took charges of $5.5 million and $9.9 million recorded to revenue and cost of sales, respectively, for additional sales and inventory reserves. Including these charges, the total charge for the Memory restructuring was $19.5 million.
     In the fourth quarter of Fiscal 1999, Fairchild International took a pre-tax charge of $10.0 million for the closure of its Mountain View facility, which supports the Analog Products Group. Fairchild International is transferring Analog wafer fabrication activities to its facility in South Portland, Maine. As a result of this transfer, Fairchild International expects a substantial reduction in Analog wafer costs and improved gross profit. The charge consists of $4.0 million for severance and employee separation costs, $4.5 million for non-cash asset impairments, including a one-time loss for the sale of the Mountain View facility of $1.9 million and $1.5 million in other exit costs. In March 1999, Fairchild International sold the facility for $30.2 million, net of closing costs, $0.5 million in escrow to cover demolition costs, and a $3.5 million holdback, payment of which is contingent upon either favorable action or no action within one year of the sale date by the City of Mountain View with respect to the buyer’s application to increase the building density on the site. Fairchild International views the holdback as a contingent gain, and as such did not record this amount in its Statement of Operations. Fairchild International expects, however, that a favorable ruling will be granted which will enable Fairchild International to record a one-time gain from receipt of the holdback in a subsequent period. In the third quarter of Fiscal 1999, Fairchild International took a pre-tax charge of $2.7 million for the transfer of Analog assembly and test activities from its Mountain View facility to Fairchild International’s facility in Penang, Malaysia and various third-party subcontractors. The charge consisted of $1.9 million for non-cash asset impairments and $0.8 million for severance and employee separation costs. Total charges for Analog restructuring activities, including the loss on sale of the Mountain View facility, were $12.7 million in Fiscal 1999.
     In the first quarter of Fiscal 1999, Fairchild International took a pre-tax restructuring charge of $4.5 million in connection with a plan to reduce costs and improve operating efficiencies. The charge consisted of $3.7 million for severance and employee separation costs related to the reduction of approximately 600 salaried, hourly and temporary positions in the United States and Cebu, the Philippines, representing approximately 10% of Fairchild International’s payroll. In addition, $0.8 million was recorded for the write-off of various idle assets in Fairchild International’s Mountain View and Salt Lake City facilities.

Interest Expense, Net. Interest expense, net was $71.8 million in Fiscal 1999, compared to $54.5 million in Fiscal 1998. The increase was due to the write-off of deferred financing fees of $5.2 million in connection with the refinancing of its senior credit facilities as part of the acquisition of the power device business, incremental interest expense as a result of additional indebtedness incurred to finance the acquisition, a full year of interest expense on borrowings to finance the Raytheon acquisition, as compared to five months in Fiscal 1998 and interest expense on short-term borrowings in Fiscal 1999 which did not occur in Fiscal 1998.

Income Taxes. Income tax expense (benefit) was a benefit of $(5.1) million in Fiscal 1999, compared to income tax expense of $10.7 million in Fiscal 1998. The effective tax rate for Fiscal 1999 was 4.3%, compared to 32.6% in Fiscal 1998. The decrease in the effective rate is due to the inability of Fairchild International to carry back its Fiscal 1999 operating loss due to the short time Fairchild International has operated as a stand-alone entity and a tax holiday for income generated by Fairchild International’s Korean subsidiary, Fairchild Korea Semiconductor Ltd., formed as a result of the acquisition of the power device business. Fairchild Korea Semiconductor Ltd. has been granted a ten year tax holiday. The first seven years are tax-free, followed by three years of income taxes at 50% of the statutory rate.
Comparative financial information for Fairchild International’s reportable segments is as follows:

Analog and Mixed Signal Products Division. Analog revenues increased 199.4% to $95.8 million in Fiscal 1999 from $32.0 million in Fiscal 1998. Fiscal 1999 includes the analog revenues of the power device business since the date of acquisition. Fiscal 1998 includes revenues of Analog from the acquisition date of Raytheon. Normalized to exclude power device products and the non-comparable period of Analog sales in Fiscal 1999, Analog revenues were $25.5 million in Fiscal 1999, a decrease of 20.3% from Fiscal 1998. The decrease for the comparable period in Fiscal 1999 from Fiscal 1998 is due to revenue decreases in its mature products, combined with lower than anticipated new product revenues.
Analog generated operating income of $8.1 million in Fiscal 1999 excluding restructuring charges, compared to $2.2 million in Fiscal 1998. Excluding the effect of the power device business and normalized for the non-comparable period of Analog operating results in Fiscal 1999, Analog generated an operating loss of $2.7 million in Fiscal 1999. The decrease in operating income is primarily driven by the decline in revenues.

Discrete Power and Signal Technologies Products Group. Discrete revenues increased 19.0% to $222.8 million in Fiscal 1999, compared to $187.3 million in Fiscal 1998. Fiscal 1999 includes the discrete revenues of the power device business since the date of acquisition. Excluding discrete power device products, Discrete revenues decreased 3.7% in Fiscal 1999 from Fiscal 1998. The decrease is attributable to lower revenues for its mature Bipolar products, which decreased 18.1% from Fiscal 1998, partially offset by higher revenues for its DMOS products, which increased 7.9% from Fiscal 1998.
Discrete generated operating income of $7.0 million in Fiscal 1999, compared to operating income of $44.9 million in Fiscal 1998. Excluding the effect of the power device business, Discrete generated operating income of $4.8 million in Fiscal 1999. The decrease was due primarily to lower gross profit as a result of lower contract manufacturing profits, unfavorable sales mix, the negative effect of underutilization of the Salt Lake City fab, driven by lower contract manufacturing and Memory volumes, and inventory write-downs in the Cebu, the Philippines assembly and test facility.

Interface and Logic Products Group. Price competition was particularly intense in Interface and Logic in Fiscal 1999. Logic revenues decreased 11.7% to $267.6 million in Fiscal 1999, compared to $303.0 million in Fiscal 1998. Revenues for interface products grew 573% in Fiscal 1999 over Fiscal 1998, due to success of new product introductions. This increase was more than offset by a 14.4% decrease in logic products revenues. The decrease in logic products revenues is primarily attributable to lower bipolar logic revenues, which decreased 29.4% from Fiscal 1998. CMOS revenues decreased 2.9% in Fiscal 1999 over Fiscal 1998. Overall, new product revenues doubled in Fiscal 1999 over Fiscal 1998.
Interface and Logic generated operating income of $35.7 million in Fiscal 1999, compared to $70.0 million in Fiscal 1998. The decrease in operating income is attributable to lower average selling prices due to soft market conditions in Fiscal 1999 and lower contract manufacturing profits.

Non-Volatile Memory Division. In order to improve the profitability of Memory, Fairchild International took a charge of $19.5 million in Fiscal 1999. Actions include transferring wafer fabrication activities in Salt Lake City, Utah to third-party subcontractors and obsoleting Memory product lines. Excluding a charge of $5.5 million recorded as a reduction to revenue in the form of increased sales reserves as part of the restructuring, Memory revenues decreased 35.3% to $73.4 million from $113.5 million in Fiscal 1998. The revenue decrease was across all product lines. EEPROM revenues decreased 30.7% in Fiscal 1999 from Fiscal 1998, and EPROM revenues decreased 46.6% in Fiscal 1999 from Fiscal 1998. The decreases are due to lower average selling prices, lower volumes due to soft market conditions, and in the case of EPROM, a rapidly shrinking market, which is being replaced by FLASH memory.
Memory generated an operating loss of $26.4 million in Fiscal 1999, excluding the restructuring charge, compared to an operating loss of $14.2 million in Fiscal 1998. The increase in the operating loss is due primarily to lower average selling prices as a result of soft market conditions in Fiscal 1999. Year Ended May 31, 1998 Compared To Year Ended May 25, 1999.

YEAR ENDED MAY 31, 1998 COMPARED TO YEAR ENDED MAY 25, 1997
Results of Operations. Net income increased 32.9% to $20.6 million in Fiscal 1998, as compared to $15.5 million in Fiscal 1997. Net income in Fiscal 1998 includes a pre-tax charge for in-process research and development associated with the acquisition of Raytheon ($15.5 million) and an after-tax charge for the cumulative effect of a change in accounting principle pertaining to business process reengineering costs associated with Fairchild International’s enterprise software system implementation ($1.5 million) which had been previously capitalized. Net income in Fiscal 1997 includes pre-tax charges related to payment of retention bonuses ($14.1 million) and a restructuring charge ($5.3 million) related to workforce reductions. In addition, Fiscal 1998 net income includes a full year of interest expense and income taxes, while Fiscal 1997 includes these charges only for the period subsequent to the recapitalization of Fairchild Semiconductor Corporation. Prior to the recapitalization, the Fairchild Semiconductor Business did not incur these costs. Excluding unusual charges and amortization of acquisition-related intangibles of $1.4 million in Fiscal 1998, net of tax effect, net income was $33.5 million and $34.9 million in Fiscal 1998 and Fiscal 1997, respectively.
Operating income, excluding unusual charges, increased 100.4% to $102.8 million in Fiscal 1998 from $51.3 million in Fiscal 1997. Included in operating income is $36.3 million and $6.8 million of gross profit on contract manufacturing services in Fiscal 1998 and 1997, respectively, under manufacturing agreements with National Semiconductor. Gross profit on contract manufacturing services in Fiscal 1997 was generated subsequent to the recapitalization of Fairchild Semiconductor Corporation. Prior to the recapitalization, contract manufacturing revenues were recorded at cost. In addition, operating income in Fiscal 1998 increased over Fiscal 1997 due to higher trade revenues as a result of the acquisition of Raytheon and improved market conditions, particularly in the first half of the year, higher trade gross profit due to improved factory utilization, and the favorable effect of currency devaluations in Southeast Asia on manufacturing costs. The following table depicts operating income for Fairchild International’s reportable segments:

     Analog was formed upon the completion of the acquisition of Raytheon. Its results are consolidated with those of Fairchild International as of the date of acquisition. Discrete and Interface and Logic operating profits increased 106.9% and 228.6%, respectively, in Fiscal 1998 from Fiscal 1997. Memory suffered an operating loss in Fiscal 1998, due primarily to lower revenues and gross profits as a result of intense price competition.
     Excluding unusual charges, depreciation and amortization of $84.6 million and $77.1 million in Fiscal 1998 and 1997, respectively, and other expense of $1.4 million in Fiscal 1997, EBITDA increased 46.0% to $187.4 million in Fiscal 1998 from $128.4 million in Fiscal 1997.
     Fairchild International’s results for the fiscal year ended May 31, 1998 consist of 53 weeks of activity, compared to 52 weeks for the fiscal years ended May 25, 1997 and May 26, 1996.

     Revenues. Fairchild International’s revenues consist of trade sales to unaffiliated customers (80.6% and 84.9% of total revenues in Fiscal 1998 and 1997, respectively) and revenues from contract manufacturing services provided to National Semiconductor (19.4% and 15.1% of total revenues in Fiscal 1998 and 1997, respectively).
     Trade sales increased 8.2% to $635.8 million in Fiscal 1998 compared to $587.8 million in Fiscal 1997. Trade sales for Fiscal 1998 include those of Raytheon since the acquisition. Excluding Raytheon, trade sales increased 2.7% in Fiscal 1998 over Fiscal 1997. The increase in trade sales was driven primarily by increased unit volume, as average selling prices were flat. Average selling prices increased year over year for the first three quarters in Fiscal 1998, but decreased significantly in the fourth quarter as industry-wide market conditions softened.
     Discrete trade sales increased 13.9% in Fiscal 1998 over Fiscal 1997. The increase was due to higher average selling prices, driven by new product introductions and a favorable sales mix, and slightly higher unit volume. DMOS trade sales increased 39.9% in Fiscal 1998 over Fiscal 1997, offsetting a decrease of 7.6% in Bipolar trade sales. The increase in DMOS trade sales was due to higher sales volume of new products featuring Fairchild International’s Trench technology, which offset price erosion in some of the more mature DMOS products. The decrease in Bipolar trade sales was driven by a combination of lower sales volume and slightly lower average selling prices. Reflective of Fairchild International’s growth strategy, trade sales of DMOS products in Fiscal 1998 exceeded trade sales in Bipolar products for the first time.
     Interface and Logic trade sales increased 6.2% in Fiscal 1998 over Fiscal 1997. The increase was driven by higher unit volume, which offset a decrease in average selling prices. In Fiscal 1998, CMOS trade sales increased 14.3% over Fiscal 1997, offsetting a decrease of 2.8% in Bipolar trade sales. The increase in CMOS trade sales was across all product lines, including VHC, LCX, FACT™ and HCMOS. The decrease in Bipolar trade sales is reflective of the general market trend toward lower power consuming CMOS products.
     Memory trade sales decreased 17.7% in Fiscal 1998 over Fiscal 1997. The decrease was driven by lower prices impacting all memory product lines due to competitive pressures, partially offset by higher volume, particularly in EEPROM. EEPROM had increased trade sales of 4.7% in Fiscal 1998 over Fiscal 1997. In a declining market, EPROM trade sales decreased 46.2% in Fiscal 1998 over Fiscal 1997, as EPROMs are being rapidly phased out by FLASH memory products in the marketplace.
     Geographically, 38%, 21% and 41% of trade sales were derived in the United States, Europe and Asia, respectively, in Fiscal 1998, compared to 38%, 20% and 42% in Fiscal 1997. Trade sales in all regions grew over Fiscal 1997 levels. Europe increased 12.7%, the United States increased 8.8% and Asia increased 5.4%, despite soft economic conditions in the region. Asia trade sales were influenced by strong growth in Southeast Asia, which offset a year over year decline in Japan.
     Contract manufacturing revenues increased 47.2% to $153.4 million in Fiscal 1998 compared to $104.2 million in Fiscal 1997. This increase, when normalized for higher prices to include a markup for all of Fiscal 1998, reflects greater demand from National Semiconductor, particularly in the first nine months of Fiscal 1998. During the fourth quarter, foundry revenues decreased 26.1% from the third quarter as National Semiconductor sharply cut back its demand in response to its own publicly-announced restructuring created by soft market conditions in the industry.

Gross Profit. Gross profit increased 51.2% to $230.5 million in Fiscal 1998, compared to $152.5 million in Fiscal 1997. Included in gross profit in Fiscal 1998 and 1997 is $36.3 million and $6.8 million, respectively, attributable to contract manufacturing services provided to National Semiconductor. Prior to the recapitalization of Fairchild Semiconductor Corporation in Fiscal 1997, these revenues were recorded at cost. Gross trade profit excluding contract manufacturing increased 33.3% in Fiscal 1998 over Fiscal 1997. As a percentage of trade sales, gross trade profits were 30.5% and 24.8% in Fiscal 1998 and 1997, respectively. The increase in gross trade profit as a percentage of trade sales was due to increased factory utilization due to improved market conditions that existed through the third quarter of Fiscal 1998, the favorable effect on fixed cost absorption of increased demand from National Semiconductor in the first nine months of Fiscal 1998, the favorable effects of currency devaluations in Southeast Asia on Fairchild International’s manufacturing costs and the acquisition of Raytheon, which increased Fairchild International’s portfolio of higher-margin products.

Research and Development. R&D expenses were $35.7 million, excluding a $15.5 million pre-tax charge for purchased in-process R&D expenses associated with the acquisition of Raytheon, or 5.6% of trade sales in Fiscal 1998, compared to $18.9 million, or 3.2% of trade sales in Fiscal 1997. The increase in R&D expenses is driven by higher spending to support new product development, reflecting Fairchild International’s renewed emphasis on R&D efforts as a stand-alone company following the recapitalization of Fairchild Semiconductor Corporation. Prior to the recapitalization, R&D expenditures of the business primarily consisted of allocations from National Semiconductor. Reflective of increased R&D efforts, Fairchild International approximately doubled the number of new products introduced in Fiscal 1998 from Fiscal 1997. In addition, Fairchild International is spending higher levels of R&D expenses for its Analog and Mixed Signal products, reflecting its strategy to focus on and grow this segment of its business. R&D efforts are focused on Fairchild International’s growth products: CMOS Logic, DMOS, EEPROM and Analog. In Fiscal 1998, R&D expenditures were 8.9% of trade sales for these growth products, and 0.5% of trade sales for Fairchild International’s other products (Bipolar Logic, Bipolar Discretes and EPROM). Comparison of the above to Fiscal 1997 is not meaningful as Fairchild International was not a stand-alone entity for the entire year.

Selling, General and Administrative. SG&A expenses were $92.0 million, or 14.5% of trade sales, in Fiscal 1998, compared to $96.4 million, or 16.4% of trade sales, in Fiscal 1997. Excluding one-time retention bonuses of $14.1 million charged in Fiscal 1997, SG&A expenses were $82.3 million, or 14.0% of trade sales in Fiscal 1997. The increase in SG&A expenses as a percent of trade sales after elimination of retention bonuses is due to higher selling and marketing expenses driven by inefficiencies experienced in the first half of Fiscal 1998 while operating under transition service agreements with National Semiconductor, and in the second half of Fiscal 1998 due to the integration of the Raytheon sales force into Fairchild International. The increase in selling and marketing expenses was partially offset by a decrease in general and administrative expenses due to lower expenses incurred as a stand-alone entity in Fiscal 1998 compared to Fiscal 1997, which reflects nine months of direct and allocated expenses of the Fairchild Semiconductor Business while operated by National Semiconductor.

Restructuring. Fiscal 1997 included a restructuring charge of $5.3 million, incurred in the first quarter, for severance and other costs directly attributable to a workforce reduction.

Interest Expense, Net. Interest expense, net was $54.5 million and $11.2 million in Fiscal 1998 and 1997, respectively. Fiscal 1998 includes a full year of interest expense on indebtedness incurred to finance the recapitalization of Fairchild Semiconductor Corporation, while Fiscal 1997 contains approximately one quarter of such interest expense. In addition, Fairchild International incurred additional indebtedness due to the purchase of Raytheon in the third quarter of Fiscal 1998. Prior to the recapitalization in Fiscal 1997 of Fairchild Semiconductor Corporation, the Fairchild Semiconductor Business was allocated net interest expense from National Semiconductor. This amount is included in other expense.

Other Expenses. Other expense was $1.4 million in Fiscal 1997, consisting primarily of net interest expense allocated to the Fairchild Semiconductor Business by National Semiconductor. There were no comparable amounts incurred in Fiscal 1998.
In the third quarter of Fiscal 1998, Fairchild International took a pre-tax charge of $15.5 million for purchased in-process research and development in conjunction with the acquisition of Raytheon and an after-tax charge of $1.5 million for the cumulative effect of an accounting charge pertaining to treatment of business process reengineering costs associated with Fairchild International’s enterprise software system implementation. The enterprise software system implementation costs, relating to activities to assess the system’s capabilities in light of Fairchild International’s current business processes, were previously capitalized as part of the cost of the software. Emerging Issues Task Force Issue 97-13, dated November 20, 1997, requires companies to expense such costs as incurred.

Income Taxes. Income taxes were $10.7 million and $3.8 million in Fiscal 1998 and 1997, respectively. In Fiscal 1998, income taxes were recorded at an effective tax rate of 32.6%. In Fiscal 1997, income taxes were recorded only for the period subsequent to the recapitalization of Fairchild Semiconductor Corporation, at an effective rate of 39.1%. The lower tax rate in Fiscal 1998 is due to a higher proportion of taxable income in lower tax countries as compared to Fiscal 1997. Prior to the recapitalization of Fairchild Semiconductor Corporation, the Fairchild Semiconductor Business did not record a tax provision or pay income taxes as it operated as a division of National Semiconductor.

ACQUISITION OF THE POWER DEVICE BUSINESS
In connection with the acquisition of the power device business, Fairchild International allocated $34.0 million of the purchase price to in-process research and development projects. This allocation represents the estimated fair value based on risk-adjusted cash flows related to the incomplete products. At the date of acquisition, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the acquisition date.
Fairchild International’s management assessed and allocated values to the in-process research and development. The value assigned to these assets was determined by identifying significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the power device business’ next generation products. A discussion of the most significant projects follows.

Smart Power Switch (“SPS”). This product line combines a Power Discrete MOSFET and an analog IC in a single package to provide customers with low cost, high functionality, high reliability and high productivity solutions. These products are used in power chargers, and power supplies for PCs, TVs, VCRs and monitors. Research and development is focused on cost reduction and further reliability improvement of existing products. Long-term research and development is focused on proprietary chip-on-chip assembly technology as well as developing a one-chip solution.

Motor IC. This product line specializes in IC products that control various motor drives. These products are used for driving motors in automotive, camera, CD-ROM, CD player, floppy disk drive, hard disk drive and video recorder applications. Current research and development is focused on adding more channels as well as adding more intelligence/functionality onto the IC chips.

Integrated Gate Bipolar Transistor (“IGBT”). This product line uses a proprietary silicon bonding process to fabricate devices for very high voltage applications. Industrial segment applications include power supplies, welding machines, robotics, ignition controls and battery chargers. Consumer segment applications include lighting ballasts, camera strobes, induction heaters, microwave ovens and washing machines. Research and development is focused on developing IGBTs that will work with products that operate at higher frequency ranges as well as higher voltages and higher currents.
The fair values assigned to each of the significant projects and estimated time to complete are reported below. The estimated costs to complete for these projects, which are estimated to be $4.7 million, are expected to be spent evenly for the remainder of their respective development cycles.

As of December 26, 1999 there were no significant changes from the original estimates of time and cost to complete.
     The material risks associated with the successful completion of the in-process technology are associated with the power device business’ ability to successfully finish the creation of viable prototypes and successful design of the chips and masks required. Fairchild International expects to benefit from the in-process projects as the individual products that contain the in-process technology are put into production and sold to end-users. The release dates for each of the products within the product families are varied. The initial benefit received from the significant in-process technologies occurred during the second half of calendar year 1999.
     The methodology used to assign value to purchased in-process research and development was the income approach, which included an analysis of the markets, cash flows, and risks associated with achieving such cash flows. Significant assumptions that had to be made using this approach included revenue and operating margin projections and determination of the applicable discount rate. The forecast for the in-process project related products relied on sales projections that were based on targeted market share and pricing estimates over the expected product life cycles. In the model used to value the in-process research and development projects, total projected revenues were expected to exceed $200.0 million by 2003. Operating expenses for these products included cost of goods sold and selling, general, and administrative expenses. Operating expenses were estimated as a percentage of revenue, and were consistent with historical results.
     The forecasts used by Fairchild International in valuing in-process research and development were based upon assumptions Fairchild International believes to be reasonable but which are inherently uncertain and unpredictable. We cannot assure you that the underlying assumptions used to estimate expected project sales or profits, or the events associated with such projects, will transpire as estimated. Fairchild International’s assumptions may be incomplete or inaccurate, and unanticipated events and circumstances are likely to occur. For these reasons, actual results may vary from the projected results.
     The discount rate selected for power device business’ in-process technology was 20%. This discount rate is greater than Fairchild International’s weighted average cost of capital (approximately 15% at the date of acquisition of the power device business) and reflects the risk premium associated with achieving the forecasted cash flows associated with these projects. These risks include the uncertainties in the economic estimates described above; the inherent uncertainty surrounding the successful development of the purchased in-process technology; the useful life of such technology; the profitability levels of such technology; and the uncertainty of technological advances that are unknown at this time.
     As of December 26, 1999, revenues recognized from these projects were not lower than the forecasted revenues and cash flows in the calculation of the in-process research and development value.

ACQUISITION OF RAYTHEON
In connection with the acquisition of Raytheon, Fairchild International allocated $15.5 million of the purchase price to in-process research and development projects. This allocation represents the estimated fair value based on risk-adjusted cash flows related to the incomplete products. At the date of acquisition, the development of these projects had not yet reached technological feasibility and the R&D in progress had no alternative future uses. Accordingly, these costs were expensed as of the acquisition date.
Fairchild International’s management assessed and allocated values to the in-process research and development. The values assigned to each purchased R&D project were determined by identifying significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the related products. The products associated with these projects include a broad range of semiconductor products used in power management and video integrated circuits, including personal computers, broadcast video and data communications. The projects identified can be categorized in the analog or video product families.

Analog Family. This family’s strategy focuses on (i) a higher integration of Ground Fault Interruptor chips and (ii) power for desktop personal computers, notebook personal computers and cellular telephones. As of the acquisition date, the remaining efforts for the projects to be completed included starting and completing the beta testing phase of the development process, with a total remaining cost to complete the testing of approximately $2.5 million, and anticipated release dates by the end of Fiscal 1998.

Video Family. This family’s in-process research and development was identified in the following projects: (i) decoders and genlocks; (ii) digital video encoders; and (iii) personal computer to television plug-n-play converters. The remaining efforts for the projects to be completed included the completion of the beta-testing phase of the development process for each project. As of the acquisition date, remaining costs to complete were estimated to be approximately $1.0 million for anticipated release dates by the end of Fiscal 1998.

Decoders and Genlocks. These adaptive, combination based video decoders are optimized for the video professional, allowing flexibility in system performance while utilizing a common design approach. The genlocking analog to digital converter is a companion product for both the new product decoders and encoders. The products include analog, high-performance encoders which are in the beta testing phase of development; a digital design, improved decoder for personal computer and television applications which is in the alpha testing phase of development; an improved genlocking digitizer which is in the design phase of development; and an analog, genlocking decoder which is in the concept phase of development.

Digital Video Encoders. The in-process product in this category is a digital design video data processor, which is in the concept phase of development.

     Personal Computer to Television Plug-N-Play Converter. The in-process product in this category is an analog personal computer to television plug-n-play converter, which is in the beta testing stage of development. This product will be the next generation of the current offering with many enhancements.
     The material risks associated with the successful completion of the in-process technology include Fairchild International’s ability to successfully finish the creation of viable prototypes, successful design of the chips and masks required and the degree of the market’s acceptance of these new products. As of the acquisition date, Fairchild International expected to benefit from the in-process projects as the individual products that contain the in-process technology are put into production and sold to end-users. Significant positive cash flows from these projects were expected to begin during 1999.
     The methodology used to assign value to purchased in-process research and development projects was the income approach, which includes an analysis of the markets, cash flows, and risks associated with achieving such cash flows. Significant assumptions that had to be made using this approach included projected revenues, operating margins and determining an appropriate discount rate. The forecast for the in-process project related products relied on sales estimates that were based on targeted market share, pricing estimates and expected product life cycles. In the model used to value the in-process research and development projects, total projected revenues from these products were expected to exceed $150.0 million by Fiscal 2002. Revenues were expected to peak in Fiscal 2001 and decline thereafter as other new products and technologies were expected to enter the market. Operating expenses for these products included cost of goods sold and selling, general and administrative expenses. Operating expenses were estimated as a percentage of revenues and were consistent with historical results. The discount rate utilized for the acquired in-process technologies was estimated at 22.5% in consideration of Fairchild International’s 15% weighted average cost of capital. The discount rate utilized for the in-process technology was determined to be higher than Fairchild International’s weighted average cost of capital due to the fact that the technology had not yet reached technological feasibility as of the date of valuation.
     As of December 26, 1999, total actual revenues in the analog and video families on the in-process R&D projects were approximately 60% of total expected revenues, impacting both analog and video products. The revenue shortfall in the analog family and the associated reduction in expected cash flows was driven by lower demand from personal computer customers. The revenue and cash flow shortfall in the video family was driven by unfavorable market conditions which began during Fiscal 1999. The weaker cash flows from these projects has not had, nor is expected to have, any material adverse impact on the results of operations of Fairchild International or its financial position, including the recoverability of intangible assets.

LIQUIDITY AND CAPITAL RESOURCES
     Fairchild International has a borrowing capacity of $100.0 million for working capital and general corporate purposes under the revolving credit facility. No amount was drawn under the revolving credit facility at December 26, 1999.
     The senior credit facilities, the 10 1/8% Senior Subordinated Notes and the 10 3/8% Senior Subordinated Notes do, and other debt instruments Fairchild International may enter into in the future may, impose various restrictions and covenants on Fairchild International which could potentially limit Fairchild International’s ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities. The restrictive covenants include limitations on consolidations, mergers and acquisitions, restrictions on creating liens, restrictions on paying dividends or making other similar restricted payments, restrictions on asset sales, limitations on borrowing money, and limitations on capital expenditures, among other restrictions. The covenants relating to financial ratios include minimum fixed charge and interest coverage ratios and a maximum leverage ratio. The senior credit facilities also limit our ability to modify our certificate of incorporation, bylaws, shareholder agreements, voting trusts or similar arrangements. In addition, the senior credit facilities, the 10 1/8% Senior Subordinated Notes and the 10 3/8% Senior Subordinated Notes contain additional restrictions limiting the ability of our subsidiaries to make dividends or advances to our company. However, our subsidiaries are permitted without material restrictions under our debt instruments to make dividends or advances to Fairchild Semiconductor Corporation. We believe that those funds permitted to be transferred to us, together with existing cash, will be sufficient to meet our cash obligations. Fairchild International expects that its existing cash and available funds from its amended senior credit facilities and funds generated from operations, will be sufficient to meet its anticipated operating requirements and to fund its research and development and capital expenditures for the next twelve months. We intend to invest approximately $240.0 million in 2000 to expand capacity at all of our major manufacturing fabs and assembly/test centers. In the long-term, additional borrowing or equity investment may be required to fund future acquisitions.
     As of December 26, 1999, Fairchild International’s cash and cash equivalents balance was $138.7 million, an increase of $76.3 million from May 30, 1999.
     During Stub Year 1999, Fairchild International’s operations provided $115.7 million in cash compared to a use of $12.8 million of cash in the first seven months of Fiscal 1999. The increase in cash provided by operating activities reflects an increase in net income adjusted for non-cash items of $91.8 million as well as an increase in cash flows from changes in operating assets and liabilities of $36.7 million. Cash used in investing activities during Stub Year 1999 totaled $34.3 million, compared to a use of $25.2 million in the first seven months of Fiscal 1999. The difference primarily relates to the refund of Korean value added taxes paid as a result of the acquisition of the power device business offset by increased capital expenditures in Stub Year 1999 as compared to the first seven months of Fiscal 1999. Capital expenditures in Stub Year 1999 were made principally to add capacity in Fairchild International’s assembly and test manufacturing facilities, whereas in the first seven months of Fiscal 1999, capital expenditures were made primarily to install Fairchild International’s enterprise software system. Cash used in financing activities of $5.1 million for Stub Year 1999 includes proceeds received from Fairchild International’s initial public offering of its Class A Common Stock of $345.0 million, net of fees and expenses. The net proceeds from the initial public offering were used to repay an 11.74% Subordinated Note due 2008 ($101.4 million), to repay a 12.5% Subordinated Note due 2008 ($53.0 million, including a prepayment penalty of $0.8 million) and to repay the Tranche A term loan and partially repay the Tranche B term loan, in each case under Fairchild International’s senior credit facilities, in the aggregate amount of $190.6 million. In addition, cash was used for the repurchase of shares of our common stock. Cash provided by financing activities of $34.7 million in the first seven months of Fiscal 1999 was due to proceeds received from Fairchild International’s revolving credit line.

LIQUIDITY AND CAPITAL RESOURCES OF FAIRCHILD INTERNATIONAL, EXCLUDING OUR SUBSIDIARIES
Fairchild International is a holding company, the principal asset of which is the stock of its subsidiary, Fairchild Semiconductor Corporation. Fairchild International on a stand-alone basis had no cash flow from operations in Stub Year 1999, nor in the first seven months of Fiscal 1999. Fairchild International on a stand-alone basis has no cash requirements for the next twelve months.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     Fairchild International is exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. To mitigate these risks, Fairchild International utilizes derivative financial instruments. Fairchild International does not use derivative financial instruments for speculative or trading purposes. All of the potential changes noted below are based on sensitivity analyses performed on Fairchild International’s financial position at December 26, 1999. Actual results may differ materially.
     Fairchild International uses forward and option contracts to hedge firm commitments and option contracts to hedge anticipated transactions. Gains and losses on these foreign currency exposures would generally be offset by corresponding losses and gains on the related hedging instruments, resulting in negligible net exposure to Fairchild International.
     A majority of Fairchild International’s revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, Fairchild International does conduct these activities by way of transactions denominated in other currencies, primarily the Korean won, Malaysian ringgit, Philippine peso, Japanese yen, British pound, and the Euro. Exposures in the Korean won are minimal as won denominated revenues and costs generally offset one another. To protect against reductions in value and the volatility of future cash flows caused by changes in other foreign exchange rates, Fairchild International has established hedging programs. We utilize currency forward contracts and currency option contracts in these hedging programs. Fairchild International’s hedging programs reduce, but do not always entirely eliminate, the short-term impact of foreign currency exchange rate movements. For example, during the twelve months ended December 26, 1999, an adverse change in any one exchange rate (defined as 20%) over the course of the year would have resulted in an adverse impact on income before taxes of less than $5.0 million.
     Fairchild International has no interest rate exposure due to rate changes for the 10 1/8% Senior Subordinated Notes or the 10 3/8% Senior Subordinated Notes. However, Fairchild International does have interest rate exposure with respect to the $118.6 million outstanding balance of its tranche B term loan due to its variable LIBOR pricing. For example, a 50 basis point increase in interest rates would result in increased annual interest expense of $0.6 million. From time to time, Fairchild International enters into interest rate swaps or interest rate caps, primarily to reduce its interest rate exposure. As of December 26, 1999, Fairchild International had no such instruments in place.

NATIONAL SEMICONDUCTOR RELATIONSHIP
Fairchild International and National Semiconductor have arrangements relating to services and sale of Fairchild International’s products as follows: First, National Semiconductor has agreed to purchase products and services from Fairchild International until June 11, 2000 under a foundry services agreement. Second, National Semiconductor has agreed to provide administrative services to Fairchild International under a transition services agreement. Third, National Semiconductor has agreed to indemnify Fairchild International against losses relating to infringement of intellectual property rights of third parties under a technology licensing and transfer agreement.
National Semiconductor, under the terms of the Asset Purchase Agreement with Fairchild International, is obligated to purchase an aggregate of $330.0 million of contract manufacturing services during the 39-month period which began March 11, 1997, including a minimum of $80.0 million of contract manufacturing services for the twelve months ended May 28, 2000. In addition, National Semiconductor is obligated to cover a contractually agreed-upon amount of fixed costs in Fairchild International’s 6-inch wafer fabrication plant in South Portland, Maine for the twelve months ended May 28, 2000. In the event National Semiconductor does not purchase $80.0 million of contract manufacturing services for the twelve months ended May 28, 2000, the Asset Purchase Agreement requires National Semiconductor to reimburse Fairchild International for unabsorbed fixed costs and lost profit on the revenue shortfall.

FORWARD-LOOKING STATEMENTS
This annual report includes “forward-looking statements” as that term is defined in Section 21E of the Securities Exchange Act of 1934. Forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” “anticipates,” or “hopeful,” or the negative of those terms or other comparable terminology, or by discussions of strategy, plans or intentions. For example, the Outlook section below contains numerous forward-looking statements. All forward-looking statements in this annual report are made based on management’s current expectations and estimates, which involve risks and uncertainties, including those described in the following paragraph. Among these factors are the following: changes in overall economic conditions; changes in demand for our products; changes in inventories at our customers and distributors; technological and product development risks; availability of manufacturing capacity; availability of raw materials; competitors’ actions; loss of key customers; order cancellations or reduced bookings; changes in manufacturing yields or output; significant litigation; and the impact on the company’s business due to internal systems or systems of suppliers and other third parties adversely affected by year 2000 problems. Other factors that may affect the company’s future operating results are described in Fairchild International’s annual report on Form 10-K, under the Risk Factors caption in the Business section. Such risks and uncertainties could cause actual results to be materially different than those in forward-looking statements. Readers are cautioned not to place undue reliance on the forward-looking statements in this annual report. Fairchild International assumes no obligation to update such information.

OUTLOOK
Market conditions have been generally improving since the third quarter of Fiscal 1999. Strong bookings and demand throughout the historically slower summer season continued throughout Stub Year 1999, which ended December 26, 1999. A portion of the bookings increase seen during Stub Year 1999 has occurred as industry-wide leadtimes have extended and customers have committed their backlog for a longer period of time. Going forward, Fairchild International expects sequential bookings increases to return to more normal seasonal patterns. Further significant lengthening of leadtimes is not anticipated. The Semiconductor Industry Association forecasts calendar year 2000 industry sales growth of 14–22% compared to calendar year 1999 for our targeted investment areas in the power transistor, voltage regulator/reference generator and interface markets. Fairchild International expects its revenue growth in these focused areas to be at least at market growth rates. Fairchild International believes that industry-wide demand is meeting supply in many product areas, leading to some price firming during the second half of Stub Year 1999. If tightening market trends continue, Fairchild International management expects that prices will continue to stabilize or rise slowly through the first half of calendar year 2000. Fairchild International expects that margins will continue to improve slowly as a result of these price increases, better new product mix, manufacturing cost reductions and better overhead spreading. Potential factors that may preclude us from realizing any or all of these expectations include, but are not limited to, softening of industry-wide demand, renewed industry-wide price competition, failure to execute new product development plans and failure to execute capacity expansion plans.

YEAR 2000 COMPLIANCE
In the fourth quarter of Fiscal 1997, Fairchild International commenced its enterprise software system implementation project for the purpose of separating from National Semiconductor’s business systems. The system, which became operational for several of Fairchild International’s critical business processes in the first half of Fiscal 1999, is year 2000 compliant. Additional modules of the system are scheduled to be implemented through Fiscal 2000. For those legacy systems that were not converted by December 31, 1999, year 2000 remediation projects were completed in October 1999. Fairchild International’s business is dependent upon its information systems as an integral part of all major business processes. Additionally, internal resources had been redeployed to identify, test and correct year 2000 problems in other systems throughout Fairchild International, including those systems embedded in Fairchild International’s machinery and equipment. Identification of systems and equipment that are not year 2000 compliant and remediation projects to correct identified problems have been completed. Fairchild International also reviewed the year 2000 readiness and compliance of its principal suppliers of products and services, in order to identify and assess any negative impacts that such non-compliances could have on Fairchild International. In addition, Fairchild International worked with its customers to identify potential year 2000 issues with its products. The company has completed its assessments. Fairchild International does not believe there are any year 2000 problems with its products. No year 2000 issues were noted with its key suppliers which in Fairchild International’s opinion would cause a major disruption to its operations. In Stub Year 1999 and in the first seven months of Fiscal 1999, incremental amounts incurred and charged to expense to identify, test and correct such other year 2000 problems were immaterial to the financial statements. Future incremental expenditures are currently estimated to be less than $0.1 million. Although we believe Fairchild International’s systems are year 2000 compliant, the failure of Fairchild International’s suppliers and customers to address the year 2000 issue could result in disruption to Fairchild International’s operations and have a significant adverse impact on its results of operations, the extent of which Fairchild International has not yet estimated. Fairchild International has completed the preparation of contingency plans. These plans cover manufacturing equipment, information services and facilities. In addition, contingency plans have been prepared in the event that key suppliers fail to become year 2000 compliant. For example, for key materials which are imported from outside the U.S., arrangements were made to insure at least four weeks of available supply. Fairchild International, in the ordinary course of business, seeks to expand its customer base to lessen dependence on any one customer for a significant portion of its revenues, and seeks second sources of supply for its key products and services where appropriate.
As of the date of this Annual Report, Fairchild International has not experienced any significant year 2000 problems with its internal systems or equipment, nor has Fairchild International detected any significant year 2000 problems affecting its customers or suppliers.

RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In Fiscal 1999, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivatives and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000.
Fairchild International intends to adopt SFAS No. 133 in 2001. Fairchild International is presently analyzing SFAS No. 133, and has not yet determined its impact on Fairchild International’s consolidated financial statements.

	Fiscal Year Ended May

(In millions)	1998			1997

Analog		$2.2			$—
Discrete		44.9			21.7
Interface and Logic		70.0			21.3
Memory		(14.2	)		5.0

Product (In millions)	Fair Value		Man-Months to Complete

Smart Power Switch		$13.9		$57
Motor IC		8.2		131
IGBT		6.5		25
All Others		5.4		147

Total		$34.0		$360