ITEM 1. BUSINESS

General

Cypress Semiconductor Corporation (“Cypress,” the “Company” or “We”) designs, develops, manufactures and markets a broad range of silicon-based products and solutions for various markets including consumer, computation, data communications, automotive, industrial and solar power. Leveraging a strong commitment to customer service and performance-based process and manufacturing expertise, our product portfolio includes a selection of wired and wireless universal serial bus (“USB”) devices, complementary metal oxide semiconductor (“CMOS”) image sensors, timing solutions, network search engines (“NSE”), specialty memories, high-bandwidth synchronous and micropower memory products, optical solutions, reconfigurable mixed-signal arrays and, through our majority-owned subsidiary SunPower, solar power products.

During the first quarter of fiscal 2005, in conjunction with our restructuring plan, we reorganized our internal organization into the following reportable business segments:

We were incorporated in California in December 1982. The initial public offering of our common stock occurred in May 1986, at which time our common stock commenced trading on the Nasdaq National Market. In February 1987, we were reincorporated in Delaware and in October 1988, we began listing our common stock on the New York Stock Exchange under the symbol “CY.” Our corporate headquarters are located in 198 Champion Court, San Jose, California 95134, and our main telephone number is (408) 943-2600. We maintain a website at www.cypress.com. The contents of our website are not incorporated into, or otherwise to be regarded as part of, this Annual Report on Form 10-K.

Business Strategies

Our primary objective is to continue to be a leading supplier of a broad range of silicon-based products and solutions for all markets and industries we serve. Specifically, we are committed to pursuing the following key strategies:

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As we continue to implement our strategies, there are internal and external factors that could impact our ability to meet any or all of our objectives. Some of these factors are discussed under Item 1A “Risk Factors.”

SunPower Initial Public Offering (“IPO”)

During the fourth quarter of fiscal 2005, SunPower completed the IPO of 8.8 million shares of its class A common stock. Following the IPO, SunPower has two classes of authorized common stock: class A and class B common stock. As of January 1, 2006, we owned 52.0 million shares of SunPower’s class B common stock, or approximately 85% of SunPower’s total outstanding shares of capital stock (approximately 77% of SunPower’s total outstanding shares of capital stock on a fully diluted basis, and approximately 98% of the total voting power of SunPower’s outstanding shares of capital stock). Only we, our successors in interest and our subsidiaries may hold shares of SunPower’s class B common stock unless we distribute the shares to our stockholders in a tax-free distribution. We currently do not have a plan to make such a distribution, although we may elect to effect such a distribution in the future. We have agreed not to sell or distribute any of our shares of SunPower’s class B common stock without prior consent of Credit Suisse First Boston and Lehman Brothers, lead underwriters of SunPower’s IPO transaction, until 270 days after November 16, 2005.

See Note 2 of Notes to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K for further discussion of our relationship with SunPower.

The principal purposes for the IPO were to:

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SunPower intends to use approximately $100.0 million of the net proceeds for the expansion of its manufacturing capacity and the remainder of the net proceeds for general corporate purposes, including working capital. SunPower may use a portion of the proceeds to purchase its Philippines manufacturing facility from us, which it will have the option to do under the lease agreement for that facility. SunPower may also use a portion of the net proceeds to acquire businesses, products and technologies that it believes will complement its business.

Business Segments and Product Overview

CCD:

CCD designs and develops solutions for many of the world’s leading manufacturers of consumer and computation products. Our product offerings include the industry’s broadest selection of USB controllers, WirelessUSB, timing solutions, and PSoC products. USB is used primarily in PC applications and is finding increased adoption rates in consumer devices such as MP3 players and set-top boxes. Timing solutions are widely used in personal computers, disk drives, modems, small office/home office network routers, DVD players and home video games. PSoC products are used in various consumer applications such as MP3 players, mass storage, household appliances, laptop computers and toys.

USB Controllers. USB provides the primary connection between a PC and peripherals, including keyboards, mice, printers, joysticks, scanners and modems and among various non-PC systems, such as games and digital still cameras. The USB standard facilitates a “plug-and-play” architecture that enables instant recognition and interoperability when a USB-compatible peripheral is connected into a system. We offer a full range of USB solutions, including low-speed (1.5 Mbps), full-speed (12 Mbps) and high-speed (480 Mbps) USB products. We also offer a variety of USB hubs, transceivers, serial interface engines and embedded-host products for a broad range of applications.

WirelessUSB. Designed for short-range multipoint-to-point wireless connectivity, WirelessUSB enables personal computer peripherals, gaming controllers, remote controls, toys, and any other point-to-point or multipoint-to-point applications with the ability to replace wires with a low-cost, 2.4-GHz wireless solution. The WirelessUSB system acts as a USB human interface device, so the wireless connectivity is transparent to the designer at the operating system level. WirelessUSB also operates as a simple, cost-effective wireless link in a host of other applications including industrial, consumer, and medical markets.

Programmable Clocks . Programmable timing solutions combine the flexibility and fast time to market of field-programmable devices with high performance at a cost that is competitive against custom clocks at equivalent volumes. Working with our easy-to-use CyberClocks software, designers can optimize device parameters such as drive strength, phased-lock loop bandwidth and crystal input capacitive loading.

Registered Buffers. As processor and signal speeds in systems increase, buffers are required to move data to and from memory more quickly. To meet the demands of high-capacity memory modules in servers and workstations, our registered buffers operate at clock frequencies up to 280 MHz.

RoboClock Clock Buffers. Our RoboClock family of clock buffers offers features including programmable output skew, programmable multiply/divide factor, and user-selectable redundant reference clocks that provide fault tolerance. Designers can control output skew and multiply and divide factors to help accommodate last-minute changes. RoboClock offers a high-performance timing solution for designers of communications, computation and storage networking applications.

PSoC . Our PSoC products are mixed-signal arrays with an on-board microcontroller, providing a low-cost, single-chip solution for a variety of consumer, industrial and control applications. The mixed-signal arrays integrate a microcontroller and the analog and digital components that typically surround it in an embedded system. A single PSoC device can integrate as many as 100 peripheral functions with a microcontroller, saving customers design time, board space, power consumption, and system costs. Our PSoC CapSense device can

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replace dozens of mechanical switches and controls with simple, touch-sensitive controls. CapSense-based “button” and slider controls are more reliable than their mechanical counterparts because they are not prone to the environmental wear-and-tear that affects exposed buttons and switches.

Programmable Radio-on-a-Chip (“PRoC”). PRoC includes two of our technologies—WirelessUSB and PSoC—in one integrated device. It offers access to a general-purpose mixed signal array with four programmable analog and four programmable digital blocks, 8 KBytes of flash program memory storage, 512 Bytes of SRAM data storage, 8 bit microcontroller, and a powerful direct sequence spread spectrum 2.4 GHz radio system. It is designed to implement highly-integrated, space-saving, low-cost, wireless systems operating in the worldwide 2.4-GHz ISM band.

DCD:

DCD is a product division focusing on specialty memories, communication products, programmable logic devices and NSE products. Our specialty memory products consists of first-in, first-out and dual port memories. First-in, first-out memories are used for applications such as switches and routers, and dual port memories are used in switching applications and handsets, including networking switches and routers, cellular base stations, mass storage devices, mobile handsets, and telecommunication equipment. Our communication products are primarily used in the networking and telecommunications market. Our NSE products target the networking market. During the first quarter of fiscal 2006, we completed the sale of certain products in our NSE product family to NetLogic Microsystems, Inc. (“NetLogic”).

First-In, First-Out (“FIFO”) Memories. FIFOs are used as a buffer between systems operating at different frequencies. Our high-performance FIFO products provide the ideal solution to interconnect problems such as flow control, rate matching, and bus matching. Our FIFO portfolio is comprised of over 100 synchronous and asynchronous memories in a variety of speeds, bus widths, densities and packages. Using industry standard pinouts, these products are easily integrated into new and existing designs. Uni-directional, bi-directional, tri-bus and double sync configurations are available with built-in expansion logic and message passing capabilities for various markets including video, data communications, telecommunications and network switching/routing.

Dual-Port Memories. Dual-ports, which can be accessed by two different processors or buses simultaneously, target shared-memory and switching applications, including networking switches and routers, cellular base stations, mass storage devices and telecommunications equipment. We offer a portfolio of over 160 synchronous and asynchronous dual-port interconnects ranging in densities from 8 Kb to 36 Mb with speeds of up to 250 Mhz. Our dual-ports are the ideal solutions for inter-processor communication in a broad range of applications. For high-volume multi-processor applications (wireless handsets, PDAs, consumer), we offer the industry’s lowest-power dual-port, the MoBL dual-port, providing a low cost, quick time-to-market interconnect solution.

Framers. Our high-performance synchronous optical network/synchronous digital hierarchy (“SONET/SDH”) framers transport SONET or SDH frames at data rates of 2.488 Gbps and 9.952 Gbps. This family includes our POSIC2GVC framer, one of the industry’s first devices to offer both generic framing procedures and virtual concatenation. These innovations enable the efficient transport of multiple data protocols over existing SONET/SDH networks.

Physical Layer Devices. Our portfolio includes HOTLink , HOTLinkDX and HOTLinkII.   These transceiver families cover data transmission rates of 50 Mbps up to 1.5 Gbps. These flexible devices are ideal for proprietary serial backplane applications. They also comply with many industry standards such as 10 gbps ethernet, gigabit ethernet, fibre channel, enterprise system connection, digital video broadcast, and high-definition television. In addition, we supply a chipset for the transmission of digital video signals. This chipset is based on our HOTLink family and is widely used in professional digital video equipment such as editing, routing, recording and storage.

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Programmable Logic Devices ( “PLDs” ) . System logic performs non-memory functions such as floating-point mathematics or the organization and routing of signals throughout a computer system. We manufacture several types of PLDs, which facilitate the replacement of multiple standard logic devices with a single programmable device, increasing flexibility and reducing time to market. Our wide range of PLDs includes products ranging from 32 to over 3000 macrocells. Our PLD products are in an end-of-life cycle.

NSEs. Our NSE solutions address the packet processing requirements of Internet infrastructure companies. They include devices with up to 1.5 million entries and data widths configurable from 36 bits to 576 bits. They can search the network database at up to 266 MSPS and can accelerate layers 2 to 7 protocols.

MID:

MID consists of our memory business and image sensor business. Our memory business designs and manufactures SRAM products, which are used to store and retrieve data in networking, wireless infrastructure and handsets, computation, consumer, automotive, industrial and other electronic systems. Migrating to advanced processes and reducing manufacturing costs continue to be important criteria for success in the memory business.

Our memory products target a variety of markets including networking, telecommunications, wireless communications and consumer applications. Our image sensor products are used in various consumer applications including digital still cameras, video cameras, security surveillance cameras, camera phones, PC cameras, and interactive video games.

Asynchronous SRAMs. We manufacture a wide selection of fast asynchronous SRAMs with densities ranging from 16 kilobits to 4 megabits. Our fast asynchronous portfolio includes the high-performance 16-bit-wide and 24-bit-wide families, which are optimized for the latest generation of fast digital signal processors. These memories are available in many combinations of bus widths, packages and temperature ranges.

MicroPower SRAMs. Our family of micropower SRAM products provides solutions for wireless and other battery-powered applications, such as cell phones, pagers, radios, handheld games, and GPS systems. Available in densities of up to 32 megabits, these low-speed, low-power SRAMs extend the operating time of battery-powered products.

QuadPort Datapath Switching Elements (“DSEs”). QuadPort DSEs are non-blocking switch devices that allow four independent buses, processors or backplanes to access the DSE simultaneously in separate time domains. Applications for these devices include 2 x 2 switch buffer, data aggregation, data redundancy and packet header manipulation to help remove costly field programmable gate arrays out of the datapath. QuadPort DSEs are used in redundant arrays of independent disks and storage switches, metropolitan area network/wide area network switches and routers, and wireless base station applications.

Pseudo SRAMs (“PSRAMs”). Our Speciality Dynamic Random Access Memory (“DRAM”) business unit manufactures PSRAMs, which is a memory technology that combines a DRAM (a high-density, low-cost-per-bit, random access memory device that provides high-speed data storage and retrieval) with an asynchronous SRAM external interface. PSRAM combines the minimal power consumption of SRAM with a much lower cost-per-bit to provide an economical alternative to SRAM. The target applications include mobile phones and other low-power applications that need low-power SRAM or PSRAM.

Synchronous SRAMs. Our high-speed synchronous SRAMs include standard synchronous pipelined, No Bus Latency, Quad Data Rate, and Double Data Rate SRAMs, and are typically used in networking applications. No Bus Latency synchronous SRAMs are optimized for high-speed applications that require maximum bus bandwidth, including those in the networking, instrumentation, video and simulation businesses. Quad Data Rate products are targeted toward next-generation networking applications, particularly switches and routers that operate at data rates beyond 300 MHz. Double Data Rate SRAMs target network applications and servers that operate at data rates up to 400 MHz.

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Image Sensors. Our CMOS image sensor portfolio spans both the high-end and consumer mass markets where we deliver high-performance sensors for custom and high-end digital photography; ultra high-speed and high dynamic range imaging solutions for automotive safety, machine vision and motion analysis; and consumer-oriented solutions for ultra-slim digital still cameras, single-use cameras and camera-enabled mobile devices. Targeting the next generation of camera phones, the CMOS 3.0-megapixel imager combines high-quality resolution with low cost. On-chip analog binning enhances image quality and a 1/3-inch optical format provides 3.0-megapixel quality at 2.0-megapixel form factors.

SunPower:

SunPower designs, manufactures and sells solar power products based on its proprietary processes and technologies, offering products including solar cells, solar panels and inverters which convert sunlight to electricity compatible with the utility network. SunPower’s initial solar sales efforts have been focused on residential and commercial applications where the high performance and superior aesthetics of its solar power products provide compelling customer benefits.

Solar Cells. Solar cell s are semiconductor devices that directly convert sunlight into electricity. SunPower’s current standard solar cell product is the A-300 solar cell, a silicon solar cell with a specified power value of 3.1 watts and a sunlight conversion efficiency of between 20% and 21.5%.

SunPower’s A-300 solar cell is designed without highly reflective metal contact grids or current collection ribbons on the front of the solar cells. This feature enables SunPower’s solar cells to be assembled into solar panels that exhibit a more uniform appearance than conventional solar panels.

Solar Panels. Solar panels are solar cells electrically connected together and encapsulated in a weatherproof package. We believe solar panels made with SunPower’s solar cells are the highest efficiency solar panels available for the mass market. Because SunPower’s A-300 solar cells are more efficient relative to conventional solar cells, when SunPower’s solar cells are assembled into panels, the assembly cost per watt is less because more power can be incorporated into a given size package. Higher solar panel efficiency allows installers to mount a solar power system with more power within a given roof or site area and reduces per watt installation costs.

Inverters. Inverters transform direct current electricity produced by solar panels into the more common form of alternating current electricity. Inverters are used in virtually every on-grid solar power system and typically feed power either directly into the home electrical circuit or into the utility grid. SunPower’s inverter product line currently includes three models spanning a power range of 2.0 to 3.2 kilowatts, and the inverters are optimized specifically for use with its solar panels.

Imaging Detectors and Infrared Detectors. SunPower’s imaging detectors are high performance, back contact light sensor arrays for medical imaging applications where digital flat panel and computed tomography systems are replacing conventional film-based X-ray imaging. Digital imaging is a demanding application for imaging detectors. X-rays pose a risk of radiation exposure, and this limits the practical dose that can be applied to the patient. A sensor must therefore maximize the conversion of incoming photons into electricity, the same fundamental challenge of solar power generation. SunPower’s imaging detectors are designed to have low current leakage and high sensitivity.

SunPower also offers infrared detectors based on its high performance all back contact technology. SunPower’s infrared detectors are semiconductors which detect light signals primarily for use in computing and mobile phone applications. SunPower’s infrared detectors are used in devices such as personal digital assistants to beam information from one device to another.

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Other:

The “Other” business segment includes: (1) SLM, a subsidiary of Cypress, (2) SVTC, a division of Cypress, and (3) certain foundry-related services performed by us on behalf of others.

Grating Light Valve (“GLV”). Designed by SLM, GLV technology switches, modulates and attenuates light in a variety of applications. The GLV is used for applications in the communications, digital imaging, simulation, display and direct-to-print markets.

SVTC. SVTC offers start-up and established companies the opportunity to develop and characterize their silicon-based technologies cost-effectively. SVTC’s development facility bridges the “lab to fab” to facilitate breakthrough silicon, nanotech and biotech product development by providing access to a 65-nanometer, state-of-the-art research and development facility and allowing third-party engineering groups to take advantage of our 20+ years of technology development and design experience.

Acquisitions

The markets in which we compete require a wide variety of technologies, products and capabilities. As discussed above, we are committed to the ongoing evaluation of strategic opportunities and, where appropriate, to the acquisition of additional products, technologies or businesses that are complementary to, or broaden the markets for our products. During fiscal 2005, we completed the following acquisitions:

SMaL Camera Technologies, Inc. (“SMaL”):

During the first quarter of fiscal 2005, we acquired all of the outstanding capital stock of SMaL, a company specializing in digital imaging solutions for a variety of business and consumer applications, such as digital still cameras, automotive vision systems, and mobile phone cameras. Through this acquisition, our goals are to accelerate our entry into the high-volume CMOS image sensor business and SMaL’s product line will complement new mobile phone products introduced by FillFactory, which we acquired in fiscal 2004. SMaL is a business unit in our MID segment.

Cypress MicroSystems (“CMS”):

Prior to the fourth quarter of fiscal 2005, CMS was a majority-owned subsidiary of Cypress. CMS develops and markets PSoC devices for consumer electronics, handsets, networking equipment, industrial and automotive systems. Through our ownership in CMS, we are able to diversify our product offerings, build CMS into a supplier of high-performance and cost-effective configurable mixed-signal arrays and expand its market share. During the fourth quarter of fiscal 2005, we acquired the outstanding minority interest in CMS. CMS is a business unit in our CCD segment.

See Note 3 of Notes to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K for further discussion.

Divestiture

In February 2006, we completed the sale of certain products in our NSE product line to NetLogic. NetLogic acquired the Ayama 10000, Ayama 20000, and NSE70000 Network Search Engine families as well as the Sahasra 50000 Algorithmic Search Engine family. The Company retained and continues to support the custom TCAM1 and TCAM2 products in its NSE product family. The NSE product line is a part of our DCD segment.

See Note 20 of Notes to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K for further discussion.

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Manufacturing

During fiscal 2005, we manufactured approximately 79% of our semiconductor products at our two sub-micron wafer fabrication facilities in Round Rock, Texas and Bloomington, Minnesota. These fabrication facilities utilize our proprietary 90-nanometer and 0.13 through 0.8-micron CMOS, 0.25 and 0.8-micron BiCMOS, and 0.35-micron Silicon Nitride Oxide Silicon (“SONOS”) processes. Wafer foundries manufactured the balance of our products.

During fiscal 2005, we continued our transition to more advanced process technologies in our facility in Bloomington, Minnesota including our 90-nanometer and 0.13-micron CMOS process technologies. This transition to processes with smaller line widths results in more die per wafer thereby reducing die costs.

In December 2005, we entered into a strategic foundry partnership with China’s Grace Semiconductor Manufacturing Corporation (“Grace”). Under the terms of the agreement, we will transfer certain of our proprietary process technologies to Grace. We expect to purchase wafers from Grace that are produced using these process technologies beginning in fiscal 2006. This agreement will provide additional production capacity to augment output from our manufacturing facilities in Texas and Minnesota.

We conduct assembly and test operations, excluding SunPower products, at our highly automated assembly and test facility in the Philippines. This facility accounted for approximately 55% of our total assembly output and approximately 83% of our total test output in fiscal 2005. Various subcontractors in Asia performed the balance of the assembly and test operations.

Our Philippines facility manufactures primarily volume products and packages where our ability to leverage manufacturing costs is high. This facility has six fully integrated, automated manufacturing lines enabling complete assembly and test operations with minimal human intervention. These autolines have shorter manufacturing cycle times than conventional assembly/test operations, which enable us to respond more rapidly to changes in demand.

SunPower manufactures its solar cells in a separate facility in the Philippines. This plant began operations in the fall of fiscal 2004 and is capable of housing four production lines with a total production plant capacity to approximately 100 megawatts per year. SunPower’s third manufacturing line was placed into service in the first quarter of 2006 and will increase SunPower’s annual manufacturing capacity to 75 megawatts.

In addition, SunPower’s board of directors has approved an increase of its manufacturing capacity to up to 300 megawatts, which will require a second solar cell manufacturing facility. This second facility is expected to house six production lines capable of producing incremental annual capacity of at least 200 megawatts. SunPower is currently evaluating the timing for construction of this second production facility.

Research and Development

Research and development expenses are primarily focused on the development of new manufacturing process technologies and the design of new semiconductor and solar power products. Our goal is to increase efficiency in order to maintain our competitive advantage. Our research and development organization works closely with our manufacturing facilities, suppliers and customers to improve our semiconductor and solar cell designs and lower manufacturing costs. We spent $226.8 million, $261.6 million and $251.4 million on research and development expenses in fiscal 2005, 2004 and 2003, respectively.

Our process technology research focuses primarily on the continuous migration to smaller geometries. We are currently developing our 65-nanometer technology in our research and development facility in San Jose, California. In addition, we are developing derivatives of our .13-micron and 90-nanometer technologies for use in new products including image sensors.

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We have both central and division-specific design groups that focus on new product creation and improvement of design methodologies. This group conducts ongoing efforts to reduce design cycle time and increase first pass yield through structured re-use of intellectual property blocks from a controlled intellectual property library, development of computer-aided design tools and improved design business processes. We currently have 41 design teams working on new product designs. Design and related software development work primarily occurs at design centers located in the United States, Europe, India and China.

Sales and Marketing

We sell our products through several channels: sales to direct original equipment manufacturers by our sales force; sales by manufacturing representative firms; sales through global domestically-based distributors; and sales through international distributors, trading companies and representative firms. SunPower products are sold worldwide to system integrators and original equipment manufacturers through a direct sales force. Our marketing and sales efforts are organized around four regions: North America, Europe, Japan and Asia/Pacific. We also have a strategic-account group and a contract-manufacturing group which are responsible for specific customers with worldwide operations. We augment our sales effort with field application engineers, specialists in our products, technologies and services who work with customers to design our products into their systems. Field application engineers also help us to identify emerging markets and new products.

International revenues accounted for 70% of our total revenues in fiscal 2005, compared with 66% in fiscal 2004 and 63% in fiscal 2003. Sales to distributors accounted for 53% of our total revenues in fiscal 2005, compared with 50% in fiscal 2004 and 48% in fiscal 2003.

Sales to a distributor accounted for 11% and 15% of total revenues in fiscal 2005 and 2004, respectively, and no end customers accounted for more than 10% of total revenues in fiscal 2005 and 2004. No customer accounted for greater than 10% of total revenues in fiscal 2003.

Backlog

Our sales typically rely upon standard purchase orders for delivery of products. Customer relationships are generally not subject to long-term contracts. However, Cypress has entered into long-term supply agreements with certain customers. These long-term supply agreements generally do not contain minimum purchase commitments. Products to be delivered and the related delivery schedules are frequently revised to reflect changes in customer needs. For these reasons, our backlog at any particular date is not representative of actual sales for any succeeding period and we believe that our backlog is not a meaningful indicator of future revenues.

Competition

We face competition from domestic and foreign integrated circuit manufacturers, many of which have advanced technological capabilities and have increased their participation in the markets in which we operate. We compete with a large number of companies primarily in the telecommunications, data communications, computation and consumer markets. Companies who compete directly with some of our products include Altera, Applied Micro Circuits, Atmel, Freescale Semiconductor, Integrated Device Technology, Microchip, Micron Technology, Motorola, NEC, OmniVision Technologies, PMC-Sierra, Samsung Electronics, Standard Microsystems, STMicroelectronics, Texas Instruments, Vitesse Semiconductor and Xilinx.

SunPower faces competition from solar power product manufacturers, including BP Solar, Evergreen Solar, Mitsubishi, Q-Cells, Sanyo, Sharp and Suntech Power Holdings. In addition, SunPower competes with Hamamatsu Photonics and UDT Sensors in the market for high-performance imaging detectors, and Vishay, Rohm and Agilent Technologies for infrared detectors.

The semiconductor and the solar power industries are intensely competitive. This intense competition results in a challenging operating environment for most companies in these industries, including Cypress. This

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environment is characterized by potential erosion of product sale prices over the life of each product, rapid technological change, limited product life cycles and strong domestic and foreign competition in many markets. Our ability to compete successfully depends on many factors, including:

We believe that we currently compete effectively in the above areas to the extent they are within our control; however, given the pace at which events change in the industry, our current abilities are not a guarantee of future success. If we are not able to compete successfully in this environment, our business, operating results and financial condition will be harmed.

Environmental Regulations

We use, generate and discharge hazardous chemicals and wastes in our research and development and manufacturing activities. Federal, state and local regulations, in addition to those of other countries in which we operate, impose various environmental controls on the use, storage and discharge of certain hazardous substances. We are committed to the prevention of pollution and continual improvement of our environmental systems and controls. We believe that our activities conform to current environmental regulations. While to date we have not experienced any material adverse impact on our business from environmental regulations, we cannot provide assurance that environmental laws will not be amended so as to impose expensive obligations on us in the future. In addition, violations of environmental laws by us or impermissible discharges of hazardous substances could result in the following actions:

Intellectual Property

We rely on a combination of patents, copyrights, trade secrets, trademarks and proprietary information to maintain and enhance our competitive position. As of January 1, 2006, we had approximately 1,400 issued patents and approximately 800 additional patent applications on file with the United States Patent and Trademark Office. We are preparing to file more than 150 new patent applications in fiscal 2006. In addition to factors such as innovation, technological expertise and experienced personnel, we believe that patents are increasingly important to remain competitive in our industry. We have an active program to obtain patent and other intellectual property protection.

We have entered into, and in the future may continue to enter into, technology license agreements with third parties that give those parties the right to use patents and other technology developed by us. Some of these agreements also give us the right to use patents and other technologies developed by such other parties, some of which involve payment of royalties. Historically, these arrangements have not been a material source of revenues to us.

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Employees

As of January 1, 2006, we had approximately 5,100 employees worldwide, which included 788 SunPower employees. Of the total employees, approximately 3,455 employees were engaged in manufacturing. Geographically, 2,473 employees were located in the Philippines, 2,118 employees were located in the United States and 509 employees were located in other countries. None of our employees is represented by a collective bargaining agreement, nor have we ever experienced organized work stoppages.

Available Information

We make available our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, free of charge on our website at www.cypress.com , as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission. The contents of our website are not incorporated into, or otherwise to be regarded as part of, this Annual Report on Form 10-K.

Executive Officers of the Registrant

Certain information as of January 1, 2006 regarding each of our executive officers is set forth below:

T.J. Rodgers is a co-founder of Cypress and has been a Director and its President and Chief Executive Officer since 1982. Mr. Rodgers serves as a director of SolarFlare Communications, Infinera, Ion America, SunPower and SLM.

Brad Buss joined Cypress in 2005 as Executive Vice President, Finance and Chief Financial Officer. Prior to joining Cypress, Mr. Buss served as Vice President of Finance at Altera Corp. Mr. Buss spent seven years as a finance executive with Wyle Electronics, culminating as Chief Financial Officer and Secretary of the Atlas Services Division. Mr. Buss was also a member of Cisco System’s worldwide sales finance team. In addition, he served as Senior Vice President of Finance and Chief Financial Officer and Secretary at Zaffire Inc.

Ahmad Chatila was appointed Executive Vice President of MID in 2005. Prior to his current position, Mr. Chatila served as managing director of the Low Power Memory business unit in MID. Mr. Chatila has been with Cypress since 1991, and has held a number of management roles in wafer technology development, manufacturing and sales.

Paul Keswick is the Executive Vice President of New Product Development since 1997. Mr. Keswick is responsible for managing our global design resources and for driving design technology, CAD and advanced design methods. Prior to his current position, Mr. Keswick has held various management positions, including vice president and general manager for various business divisions. Mr. Keswick has been with Cypress since 1986.

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William Minor, Jr. was appointed Executive Vice President of Human Resources in 2002. Mr. Minor directs our global human resource practices in hiring, developing and retaining our employees. Prior to joining Cypress in 2002, Mr. Minor held senior level human resource positions at Lam Research Corporation, KLA Instruments and the Electric Power Research Institute.

Dinesh Ramanathan was named Executive Vice President of DCD in 2005. Prior to his current appointment, Dr. Ramanathan was a business unit director for the Specialty Memory and Communications business units. Prior to joining Cypress in 2004, Dr. Ramanathan held senior marketing and engineering positions at Raza Microelectronics, Raza Foundries and Forte Design Systems.

Christopher Seams was named Executive Vice President of Sales and Marketing and Operations in 2005. Prior to his current appointment, Mr. Seams was Executive Vice President, Manufacturing and Research and Development. Mr. Seams joined Cypress in 1990 and has held a variety of positions in process and assembly technology research and development and manufacturing operations.

Shahin Sharifzadeh was named Executive Vice President of Manufacturing and Research and Development in 2005. Dr. Sharifzadeh directs our process technology research and development and wafer manufacturing operations worldwide. Prior to his current position, Dr. Sharifzadeh served as Vice President of Research and Development, where he was responsible for all aspects of technology development. Dr. Sharifzadeh joined Cypress in 1989.

Norman Taffe was named Executive Vice President of CCD in 2005. Prior to his current position, Mr. Taffe has held numerous positions, including marketing director of the Programmable Logic and Interface Products Divisions, managing director of our M&A and venture funds, managing director of the Wireless business unit and most recently, Vice President of the Personal Communications Division. Mr. Taffe joined Cypress in 1989.

Thomas H. Werner was Chief Executive Officer of SunPower since 2003. Prior to joining SunPower, Mr. Werner served as Chief Executive officer of SLM from 2001 to 2003. Prior to SLM, Mr. Werner was Vice President and General Manager of the Business Connectivity Group of 3Com Corp., a network solutions company.

There are no family relationships between any of our directors or executive officers.

ITEM 1A. RISK FACTORS

We face significant volatility in supply and demand conditions for our products and this volatility, as well as any failure by us to accurately forecast future supply and demand conditions, could materially and negatively impact our business.

The semiconductor industry has historically been characterized by wide fluctuations in the demand for, and supply of, semiconductors. Demand for our products depends in large part on the continued growth of various electronics industries that use our products, including:

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In addition, certain of our products, including USB micro-controllers and high-frequency clocks, are incorporated into computer and computer-related products, which have historically experienced, and may in the future experience, significant fluctuations in demand. Any downturn or reduction in the growth of these industries could seriously harm our business, financial condition and results of operations.

We order materials and build our products based primarily on our internal forecasts and secondarily on existing orders, which may be cancelled under many circumstances. Because our markets are volatile and subject to rapid technological and price changes, our forecasts may be wrong causing us to make too many or too few of certain products. Also, our customers frequently place orders requesting product delivery almost immediately after the order is made, which makes forecasting customer demand even more difficult, particularly when supply is abundant. In addition, we have in the past spent, and will continue to spend, significant amounts of money to upgrade and increase our wafer fabrication, assembly and test manufacturing capability and capacity. If we experience inadequate demand or a significant shift in the mix of product orders that makes our existing capacity and capability inadequate, our fixed costs per semiconductor produced will increase, which will harm our financial condition and results of operations. Alternatively, if we should experience a sudden increase in demand, we will need to quickly ramp our inventory and/or manufacturing capacity to adequately respond to our customers. If we are unable to ramp our inventory or manufacturing capacity in a timely manner or at all, we risk losing our customer’s business, which could have a negative impact on our financial performance and reputation.

In some cases, such downturns have lasted more than a year. Prior experience has shown that restructuring of our operations, resulting in significant restructuring charges, may become necessary if an industry downturn persists. During the second half of fiscal 2004 and continuing into the first quarter of fiscal 2005, we experienced a rapid decline of demand for our products that may represent a period of industry over-supply. While we experienced sequential increase in sales in the second, third and fourth quarters of fiscal 2005, no assurance can be given that such increase is an indication of the beginning of a long-term recovery for us or the semiconductor industry.

Our business, financial condition and results of operations will be seriously harmed if we fail to compete successfully in our highly competitive industry and markets.

The semiconductor industry is intensely competitive. This intense competition results in a difficult operating environment that is marked by erosion of average selling prices over the lives of each product and rapid technological change resulting in limited product life cycles. In order to offset selling price decreases, we attempt to decrease the manufacturing costs of our products and to introduce new, higher priced products that incorporate advanced features. If these efforts are not successful or do not occur in a timely manner, or if our newly introduced products do not gain market acceptance, our business, financial condition and results of operations could be seriously harmed. Furthermore, we expect our competitors to invest in new manufacturing capacity and achieve significant manufacturing yield improvements in the future. These developments could dramatically increase the worldwide supply of competitive products and result in further downward pressure on prices.

A primary cause of this highly competitive environment is the strength of our competitors. The industry consists of major domestic and international semiconductor companies, many of which have substantially greater financial, technical, marketing, distribution and other resources than we do. We face competition from other domestic and foreign high-performance integrated circuit manufacturers, many of which have advanced technological capabilities and have increased their participation in markets that are important to us. We believe that there is a variety of competing technologies under development by other companies that could result in lower manufacturing costs than those expected for our products. Our development efforts may be rendered obsolete by the technological advances of others, and other technologies may prove more advantageous for the commercialization of solar power products and semiconductors generally.

Our ability to compete successfully in the rapidly evolving semiconductor technology industry depends on many factors, including:

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Although we believe we currently compete effectively in the above areas to the extent they are within our control, given the pace of change in the industry, our current abilities are not a guarantee of future success. If we are unable to compete successfully in this environment, our business, financial condition and results of operations will be seriously harmed.

Our financial results could be adversely impacted if we fail to develop, introduce and sell new products or fail to develop and implement new technologies.

Like many semiconductor companies, which frequently operate in a highly competitive, quickly changing environment marked by rapid obsolescence of existing products, our future success depends on our ability to develop and introduce new products that customers choose to buy. We introduce significant numbers of products each year, which are important sources of revenue for us. If we fail to introduce new product designs in a timely manner or are unable to manufacture products according to the requirements of these designs, or if our customers do not successfully introduce new systems or products incorporating our products, or market demand for our new products does not exist as anticipated, our business, financial condition and results of operations could be seriously harmed.

For us and many other semiconductor companies, introduction of new products is a major manufacturing challenge. The new products the market requires tend to be increasingly complex, incorporating more functions and operating at faster speeds than prior products. Increasing complexity generally requires smaller features on a chip. This makes manufacturing new generations of products substantially more difficult than prior generations. Ultimately, whether we can successfully introduce these and other new products depends on our ability to develop and implement new ways of manufacturing semiconductors. If we are unable to design, develop, manufacture, market and sell new products successfully, our business, financial condition and results of operations would be seriously harmed.

The complex nature of our manufacturing activities makes us highly susceptible to manufacturing problems and these problems can have a substantial negative impact on us when they occur.

Making semiconductors is a highly complex and precise process, requiring production in a tightly controlled, clean environment. Even very small impurities in our manufacturing materials, difficulties in the wafer fabrication process, defects in the masks used to print circuits on a wafer or other factors can cause a substantial percentage of wafers to be rejected or numerous chips on each wafer to be non-functional. We may experience problems in achieving an acceptable success rate in the manufacture of wafers and the likelihood of facing such difficulties is higher in connection with the transition to new manufacturing methods. For example, we believe that certain manufacturing limitations on our PSoC, USB and clock businesses negatively affected our performance in fiscal 2005. The interruption of wafer fabrication or the failure to achieve acceptable manufacturing yields at any of our facilities would seriously harm our business, financial condition and results of operations. We may also experience manufacturing problems in our assembly and test operations and in the introduction of new packaging materials.

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Problems in the performance or availability of other companies we hire to perform certain manufacturing and transport tasks can seriously harm our financial performance.

A high percentage of our products are currently fabricated in our manufacturing facilities located in Texas, Minnesota and the Philippines. However, we also rely on independent contractors to manufacture some of our products. If market demand for our products exceeds our internal manufacturing capacity and available capacity from our foundry partners, we may seek additional foundry manufacturing arrangements. A shortage in foundry manufacturing capacity, which is more likely to occur at times of increasing demand, could hinder our ability to meet demand for our products and therefore adversely affect our operating results. We cannot guarantee that any foundries that supply our wafers will not experience manufacturing problems, including delays in the realization of advanced manufacturing process technologies. In addition, greater demand for wafers produced by any such foundries without an offsetting increase in foundry capacity raises the likelihood of potential wafer price increases.

While a high percentage of our products are assembled, packaged and tested at our manufacturing facility located in the Philippines, we rely on independent subcontractors to assemble, package and test the balance of our products. We cannot be certain that these subcontractors will continue to assemble, package and test products for us on acceptable economic and quality terms or at all and it might be difficult for us to find alternatives if they do not do so.

We also rely on independent carriers and freight haulers to move our products between manufacturing plants and our customers. Transport or delivery problems due to their error or because of unforeseen interruptions in their business due to factors such as strikes, political instability, terrorism, natural disasters or accidents could seriously harm our business, financial condition and results of operations and ultimately impact our relationship with our customers.

Our subsidiary SunPower is currently facing an industry-wide shortage of polysilicon. The prices that SunPower pays for polysilicon have increased recently and SunPower expects these price increases to continue, which may constrain SunPower’s revenue growth and decrease its gross margins and profitability.

Polysilicon is an essential raw material in SunPower’s production of photovoltaic, or solar, cells. There is currently an industry-wide shortage of polysilicon, which has resulted in significant price increases. Based on its experience, SunPower believes that the average price of polysilicon has continued to increase. Increases in polysilicon prices have in the past increased SunPower’s manufacturing costs and may impact its manufacturing costs and operating results in the future. As demand for solar cells has increased, many of SunPower’s principal competitors have announced plans to add additional manufacturing capacity. As this manufacturing capacity becomes operational, it will increase the demand for polysilicon and further exacerbate the current shortage. Polysilicon is also used in the semiconductor industry generally and any increase in demand from that sector will compound the shortage. The production of polysilicon is capital intensive and adding additional capacity requires significant lead time. While SunPower is aware that several new facilities for the manufacture of polysilicon are under construction, it does not believe that the supply imbalance will be remedied in the near term. SunPower expects that polysilicon demand will continue to outstrip supply in the foreseeable future.

There are a limited number of polysilicon suppliers. Since SunPower has only been purchasing polysilicon in bulk for approximately one year, its competitors may have longer and perhaps stronger relationships with the suppliers than SunPower does. Some of SunPower’s competitors also have inter-locking board members with their polysilicon suppliers. In addition, since some of the arrangements are with suppliers who do not themselves manufacture polysilicon but instead purchase their requirements from other vendors, it is possible that these suppliers will not be able to obtain sufficient polysilicon to satisfy their contractual obligations to SunPower.

Although SunPower has purchase orders and contracts for what it believes will be an adequate supply of silicon ingots through 2006, its estimates regarding the supply needs may not be correct, its purchase orders may be cancelled, or the volume or pricing terms may be changed by the suppliers. Based on market conditions, SunPower’s purchase orders are generally non-binding in nature.

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The inability to obtain sufficient polysilicon at commercially reasonable prices or at all would adversely affect SunPower’s ability to meet customer demand for its products, which could cause SunPower to lose customers, market share and revenue, thereby seriously harming SunPower’s and our business, financial condition and results of operations.

If the market for solar power products takes longer to develop than we anticipate or does not develop at all, or if we fail to compete successfully in the solar power market, our revenue and profitability could be adversely affected.

The market for solar power products manufactured by SunPower is emerging and rapidly evolving. If solar power technology proves unsuitable for widespread commercial deployment or if demand for SunPower’s products or solar power products generally fails to develop sufficiently or at all, our revenues and profitability could be affected adversely. In addition, demand for solar power products in the markets and geographic regions we target may develop more slowly than we anticipate or not at all. The solar cell market has not historically been a part of our core semiconductor business. If we are unable to keep pace with this rapidly evolving industry, our results of operations could suffer. Many factors will influence the adoption of solar power technology as well as our ability to compete in the solar power products market, including:

Because SunPower has fixed-price agreements with two of its largest customers and operate on a purchase order basis with its third largest customer, its financial results, and therefore ours, may suffer if SunPower’s manufacturing costs were to increase or purchase orders were changed or cancelled.

SunPower’s agreements with PowerLight Corporation and SOLON provide that they will purchase products from SunPower on a fixed-price basis. The agreement with SOLON provides for a fixed-price basis for the first two years of the agreement, which expires in 2010. However, SunPower’s manufacturing costs, including the cost of polysilicon, are variable. If SunPower’s manufacturing costs increase, SunPower would be unable to raise its prices to these customers, which in turn would negatively impact its operating results.

SunPower does not have a long-term agreement with Plexus but instead operate on a purchase order basis. Although SunPower believes that cancellations to date have been insignificant, its customers may cancel or reschedule purchase orders with SunPower on relatively short notice. Cancellations or rescheduling of customer

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orders could result in the delay or loss of anticipated sales without allowing SunPower sufficient time to reduce, or delay the incurrence of, its corresponding inventory and operating expenses. In addition, changes in forecasts or the timing of orders from these or other customers expose SunPower to the risks of inventory shortages or excess inventory. This in turn could cause SunPower’s operating results to fluctuate.

Our ability to meet our cash requirements depends on a number of factors, many of which are beyond our control.

Our outstanding debt obligations primarily include $600.0 million of aggregate principal amount of the 1.25% convertible subordinated notes (“1.25% Notes”) that are due in June 2008. As of January 1, 2006, our total cash, cash equivalents and short-term investments excluding restricted cash were $330.3 million, which was less than our outstanding indebtedness if it were currently due.

Each holder of our 1.25% Notes is permitted at any time prior to maturity to convert his or her 1.25% Notes into 55.172 shares of our common stock plus a cash payment of $300. If all of the holders of our 1.25% Notes were to elect to convert their 1.25% Notes to shares of our common stock and cash, we would be required to issue approximately 33.1 million additional shares of common stock, which could have a dilutive impact on any future earnings per share, as well as to make cash payments of approximately $180 million. We have the right to issue shares in lieu of making cash payments.

Our ability to meet our cash requirements (including our debt service obligations) is dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. We cannot guarantee that our business will generate sufficient cash flows from operations to fund our cash requirements or to meet our debt service obligations. If we are unable to meet our cash requirements from operations, we would be required to fund these cash requirements by alternative financing. The degree to which we may be leveraged could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes, could make us more vulnerable to industry downturns and competitive pressures or could limit our flexibility in planning for, or reacting to, changes and opportunities in our industry, which may place us at a competitive disadvantage. There can be no assurance that we would be able to obtain alternative financing, that any such financing would be on acceptable terms or that we will be permitted to do so under the terms of our existing financing arrangements. In the absence of such financing, our ability to respond to changing business and economic conditions, make future acquisitions, react to adverse operating results, meet our debt service obligations, or fund required capital expenditures may be adversely affected.

Any guidance that we may provide about our business or expected future results may prove to differ from actual results.

From time to time we have shared our views in press releases or SEC filings, on public conference calls and in other contexts about current business conditions and our expectations as to potential future results. Identifying correctly the key factors affecting business conditions and predicting future events is inherently an uncertain process. Our analyses and forecasts have in the past and, given the complexity and volatility of our business, will likely in the future, prove to be incorrect. We offer no assurance that such predictions or analysis will ultimately be accurate, and investors should treat any such predictions or analyses with appropriate caution.

In addition, because we recognize revenues from sales to certain distributors only when these distributors make a sale to customers, we are highly dependent on the accuracy of their resale estimates. The occurrence of inaccurate estimates also contributes to the difficulty in predicting our quarterly revenue and results of operations and we can fail to meet expectations if we are not accurate in our estimates.

We consolidate SunPower’s financial results in the results of operation we report to the public in press releases and our SEC filings. SunPower’s financial performance may be affected by a number of factors, including, but not limited to:

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Any analysis or forecast that we make which ultimately proves to be inaccurate may adversely affect our stock price.

We may be unable to protect our intellectual property rights adequately and may face significant expenses as a result of ongoing or future litigation.

Protection of our intellectual property rights is essential to keeping others from copying the innovations that are central to our existing and future products. Consequently, we may become involved in litigation to enforce our patents or other intellectual property rights, to protect our trade secrets and know-how, to determine the validity or scope of the proprietary rights of others or to defend against claims of invalidity. We are also from time to time involved in litigation relating to alleged infringement by us of others’ patents or other intellectual property rights.

Intellectual property litigation is frequently expensive to both the winning party and the losing party and could take up significant amounts of management’s time and attention. In addition, if we lose such a lawsuit, a court could find that our intellectual property rights are invalid, enabling our competitors to use our technology, or require us to pay substantial damages and/or royalties or prohibit us from using essential technologies. For these and other reasons, this type of litigation could seriously harm our business, financial condition and results of operations. Also, although in certain instances we may seek to obtain a license under a third party’s intellectual property rights in order to bring an end to certain claims or actions asserted against us, we may not be able to obtain such a license on reasonable terms or at all.

For a variety of reasons, we have entered into technology license agreements with third parties that give those parties the right to use patents and other technology developed by us and/or give us the right to use patents and other technology developed by them. Historically, these arrangements have not been a material source of revenue to the Company. We anticipate that we will continue to enter into these kinds of licensing arrangements in the future. It is possible, however, that licenses we want will not be available to us on commercially reasonable terms or at all. If we lose existing licenses to key technology, or are unable to enter into new licenses that we deem important, our business, financial condition and results of operations could be seriously harmed.

It is critical to our success that we are able to prevent competitors from copying our innovations. Therefore, we intend to continue to seek intellectual property protection for our technologies. The process of seeking patent protection can be long and expensive and we cannot be certain that any currently pending or future applications

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will actually result in issued patents, or that, even if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Furthermore, others may develop technologies that are similar or superior to our technology or design around the patents we own.

We also rely on trade secret protection for our technology, in part through confidentiality agreements with our employees, consultants and third parties. However, these parties may breach these agreements and we may not have adequate remedies for any breach. Also, others may come to know about or determine our trade secrets through a variety of methods. In addition, the laws of certain countries in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as the laws of the United States.

We are subject to many different environmental regulations and compliance with them may be costly.

We are subject to many different governmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing process. Compliance with these regulations can be costly. In addition, over the last several years, the public has paid a great deal of attention to the potentially negative environmental impact of semiconductor manufacturing operations. This attention and other factors may lead to changes in environmental regulations that could force us to purchase additional equipment or comply with other potentially costly requirements. If we fail to control the use of, or to adequately restrict the discharge of, hazardous substances under present or future regulations, we could face substantial liability or suspension of our manufacturing operations, which could seriously harm our business, financial condition and results of operations.

We face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and other hazardous substances that will apply to specified electronic products put on the market in the European Union as of July 1, 2006 (Restriction on the Use of Hazardous Substances Directive 2002/95/EC, also known as the “RoHS Directive”) and similar legislation proposed for China and other countries (including the United States). We are redesigning our products regulated under the RoHS Directive in order to be able to continue to offer them for sale within the European Union. Certain electronic products that we maintain in inventory may be rendered obsolete if not in compliance with the RoHS Directive, which could negatively impact our ability to generate revenue from those products. Our customers and other companies in the supply chain may require us to certify that our products are RoHS compliant. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products.

We face additional problems and uncertainties associated with international operations that could seriously harm us.

International revenues accounted for approximately 70%, 66% and 63% of our total revenues during fiscal 2005, 2004 and 2003, respectively. Our Philippine fabrication, assembly and test operations, as well as our international sales offices, face risks frequently associated with foreign operations including:

To the extent any such risks materialize, our business, financial condition or results of operations could be seriously harmed.

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We may face automotive product liability claims that are disproportionately higher than the value of the products involved.

Although all of our products sold in the automotive market are covered by our standard warranty, we could incur costs not covered by our warranties including, but not limited to, labor and other costs of replacing defective parts, lost profits and other damages. These costs could be disproportionately higher than the revenue and profits we receive from the products involved. If we are required to pay for damages resulting from quality or performance issues of our automotive products, our business, financial condition and results of operations could be adversely affected.

We compete with others to attract and retain key personnel, and any loss of, or inability to attract, such personnel would harm us.

To a greater degree than most non-technology companies, we depend on the efforts and abilities of certain key members of management and other technical personnel. Our future success depends, in part, upon our ability to retain such personnel and to attract and retain other highly qualified personnel, particularly product and process engineers. We compete for these individuals with other companies, academic institutions, government entities and other organizations. Competition for such personnel is intense and we may not be successful in hiring or retaining new or existing qualified personnel.

If we lose existing qualified personnel or are unable to hire new qualified personnel, as needed, our business, financial condition and results of operations could be seriously harmed.

Our operations and financial results could be severely harmed by certain natural disasters.

Our headquarters, some manufacturing facilities and some of our major vendors’ facilities are located near major earthquake faults. We have not been able to maintain earthquake insurance coverage at reasonable costs. Instead, we rely on self-insurance and preventative/safety measures. If a major earthquake or other natural disaster occurs, we may need to spend significant amounts to repair or replace our facilities and equipment and we could suffer damages that could seriously harm our business, financial condition and results of operations.

Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace.

Technology companies like ours have a history of using broad-based employee stock option programs to hire, incentivize and retain our workforce in a competitive marketplace. Currently, Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” allows companies the choice of either using a fair value method of accounting for options, which would result in expense recognition for all options granted, or using an intrinsic value method, as prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” with a pro forma disclosure of the impact on our financial results using the fair value recognition method. We have in the past elected to apply APB Opinion No. 25 and accordingly, we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share-Based Payment,” which replaces SFAS No. 123 and supersedes APB Opinion No. 25. Under SFAS No. 123(R), companies are required to measure the compensation costs of share-based compensation arrangements based on the grant-date fair value and recognize the costs in the financial statements over the period during which employees are required to provide services. Most public companies were initially required to apply SFAS No. 123(R) as of the first interim or annual reporting period beginning after June 15, 2005. In April 2005, the SEC postponed the implementation date to fiscal years beginning after June 15, 2005.

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The implementation of SFAS No. 123(R) beginning in the first quarter of fiscal 2006 will have a significant adverse impact on our financial results as we will be required to expense the fair value of our stock options rather than disclosing the impact within our footnotes in accordance with the disclosure provisions of SFAS No. 123. This will result in lower reported earnings per share, which could negatively impact our future stock price. In addition, this could impact our ability to utilize broad-based employee stock plans to reward employees and could result in a competitive disadvantage to us in the employee marketplace.

We may fail to integrate our business and technologies with those of companies that we have recently acquired and that we may acquire in the future.

We completed two acquisitions in fiscal 2005 and three in fiscal 2004. We may pursue additional acquisitions in the future. If we fail to integrate these businesses successfully or properly, our quarterly and annual results may be seriously harmed. Integrating these businesses, people, products and services with our existing business could be expensive, time-consuming and a strain on our resources. Specific issues that we face with regard to prior and future acquisitions include:

We may incur losses in connection with loans made under our stock purchase assistance plan.

We have outstanding loans, consisting of principal and cumulative accrued interest, of $54.2 million as of January 1, 2006, to employees and former employees under the shareholder-approved 2001 employee stock purchase assistance plan. We made the loans to employees for the purpose of purchasing our common stock. Each loan is evidenced by a full recourse promissory note executed by the employee in favor of Cypress and is secured by a pledge of the shares of our common stock purchased with the proceeds of the loan. In accordance with the plan, the Chief Executive Officer and the Board of Directors do not participate in this program. To date, bad debt write-offs have been negligible. As of January 1, 2006, we had an allowance for uncollectible loans of $8.5 million. In determining the allowance for uncollectible loans, management considered various factors, including a review of borrower demographics (including geographic location and job grade), loan quality and an independent fair value analysis of the loans and the underlying collateral. While the loans are secured by the shares of our stock purchased with the loan proceeds, the value of this collateral would be adversely affected if our stock price declined significantly.

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Our results of operations may be adversely affected if a significant amount of these loans were not repaid. Similarly, if our stock price were to decrease, our employees bear greater repayment risk and we would have increased risk to our results of operations. Further, it is likely that our ability to recover outstanding loan amounts from current employees will be greater than our ability to recover these amounts from ex-employees who have left Cypress. However, we are willing to pursue every available avenue, including those covered under the Uniform Commercial Code, to recover these loans by pursuing employees’ and ex-employees’ personal assets should the borrower not repay these loans.

We maintain self-insurance for certain indemnities we have made to our officers and directors.

Our certificate of incorporation, by-laws and indemnification agreements require us to indemnify our officers and directors for certain liabilities that may arise in the course of their service to us. We self-insure with respect to indemnifiable claims. If we were required to pay a significant amount on account of these liabilities for which we self-insure, our business, financial condition and results of operations could be seriously harmed.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.