Overview

Vishay Intertechnology, Inc. is an international manufacturer and supplier of discrete semiconductors and passive electronic components, including power MOSFETs, power conversion and motor control integrated circuits, transistors, diodes, optoelectronic components, resistors, capacitors, inductors, strain gages, load cells, force measurement sensors, displacement sensors, and photoelastic sensors. Semiconductors and passive electronic components manufactured by Vishay are used in virtually all types of electronic products, including those in the industrial, computer, automotive, consumer electronic products, telecommunications, military/aerospace, and medical industries.

Vishay operates in two segments, Semiconductors and Passive Components. Semiconductors segment products include transistors, diodes, rectifiers, certain types of integrated circuits, and optoelectronic products. Passive Components segment products include resistors, capacitors, and inductors. We include in the Passive Components segment our Measurements Group, which manufactures and markets strain gages, load cells, transducers, instruments, and weighing systems whose core components are resistors that are sensitive to various types of mechanical stress. While the passive components business had historically predominated at Vishay, following several acquisitions of semiconductor businesses, revenues from our Semiconductors and Passive Components segments were essentially split evenly from 2003 through the first quarter of 2007. On April 1, 2007, Vishay acquired the Power Control Systems ("PCS") business of International Rectifier Corporation, which has been included in the Semiconductors segment. Going forward, revenues from our Semiconductors segment are expected to represent slightly more than half of our total revenues.

Net revenues for the fiscal quarter ended September 27, 2008 were $739.1 million, compared to $729.6 million for the fiscal quarter ended September 29, 2007.

Vishay reported a loss from continuing operations in the third quarter of 2008 of $312.9 million, or $1.68 per share. The loss includes noncash goodwill and indefinite-lived intangible asset impairment charges, totaling $357.9 million ($328.8 million, net of tax). The amount of the impairment charge is based on a preliminary analysis and may be adjusted in the fourth quarter.

The third quarter 2008 results also include a pretax charge for restructuring and severance costs of $6.8 million, a loss on early extinguishment of debt of $13.6 million, and $4.0 million of costs associated with Vishay's terminated tender offer for all outstanding shares of International Rectifier. On an after tax basis, these items and the impairment charges had a negative $1.86 per share effect on earnings (loss) from continuing operations.

Income from continuing operations for the fiscal quarter ended September 29, 2007 was $37.1 million, or $0.20 per diluted share. Income from continuing operations for the fiscal quarter ended September 29, 2007 was impacted by pretax charges for restructuring and severance costs of $9.9 million. Additionally, reported income tax expense is net of benefits totaling $0.9 million for changes in uncertain tax positions and a change in enacted tax rates. These items, net, had a negative $0.05 per share effect on income from continuing operations.

Net revenues for the nine fiscal months ended September 27, 2008 were $2,246.8 million, compared to $2,103.7 million for the nine fiscal months ended September 29, 2007. The loss from continuing operations for the nine fiscal months ended September 27, 2008 was $1,037.0 million or $5.56 per share, compared to income from continuing operations of $129.1 million or $0.67 per diluted share for the nine fiscal months ended September 29, 2007.

The loss from continuing operations for the nine fiscal months ended September 27, 2008 was impacted by pretax charges for goodwill and indefinite-lived asset impairments of $1,157.9 million, restructuring and severance costs of $34.0 million, related asset write-downs of $4.2 million, a loss on early extinguishment of debt of $13.6 million, $4.0 million of costs associated with Vishay's terminated tender offer for all outstanding shares of International Rectifier, and $9.9 million of tax expense associated with the repatriation of cash from certain non-U.S. subsidiaries. Including the tax effects of the pretax charges, these items had a negative $6.15 per share effect on earnings (loss) from continuing operations.

On April 7, 2008, Vishay sold the automotive modules and subsystems business unit ("ASBU") acquired on April 1, 2007 as part of the acquisition of the PCS business of International Rectifier. The operations of ASBU have been classified as discontinued operations. Including the loss from discontinued operations, the net loss for the fiscal quarter and nine fiscal months ended September 27, 2008 was $312.9 million and $1,079.1 million, respectively, compared to net earnings of $35.2 million and $125.9 million, respectively, for the comparable prior year periods.

During the third quarter of 2008, the electronics industry abruptly experienced the impact of the present macro economic turbulences. Despite results that were below our expectations, we continued to generate strong cash flows. We remain confident for the long-term prospects of our businesses, although we expect further deterioration of market conditions in the short-term.

Financial Metrics

We utilize several financial measures and metrics to evaluate the performance and assess the future direction of our business. These key financial measures and metrics include net revenues, gross profit margin, end-of-period backlog, and the book-to-bill ratio. We also monitor changes in inventory turnover and average selling prices ("ASP").

Gross profit margin is computed as gross profit as a percentage of sales. Gross profit is generally net revenues less costs of products sold, but also deducts certain other period costs, particularly losses on purchase commitments and inventory write-downs. Losses on purchase commitments and inventory write-downs have the impact of reducing gross profit margin in the period of the charge, but result in improved gross profit margins in subsequent periods by reducing costs of products sold as inventory is used. Gross profit margin is clearly a function of net revenues, but also reflects our ability to contain costs.

End-of-period backlog is one indicator of future sales. We include in our backlog only open orders that have been released by the customer for shipment in the next twelve months. If demand falls below customers' forecasts, or if customers do not control their inventory effectively, they may cancel or reschedule the shipments that are included in our backlog, in many instances without the payment of any penalty. Therefore, the backlog is not necessarily indicative of the results to be expected for future periods.

Another important indicator of demand in our industry is the book-to-bill ratio, which is the ratio of the amount of product ordered during a period as compared with the product that we ship during that period. A book-to-bill ratio that is greater than one indicates that our backlog is building and that we are likely to see increasing revenues in future periods. Conversely, a book-to-bill ratio that is less than one is an indicator of declining demand and may foretell declining sales.

We focus on our inventory turnover as a measure of how well we are managing our inventory. We define inventory turnover for a financial reporting period as our costs of products sold for the four quarters ending on the last day of the reporting period divided by our average inventory (computed using each quarter-end balance) for this same period. The inventory balance used for computation of this ratio includes tantalum inventories in excess of one year supply, which are classified as other assets in the consolidated balance sheet. See Note 14 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007. A higher level of inventory turnover reflects more efficient use of our capital.

Pricing in our industry can be volatile. We analyze trends and changes in average selling prices to evaluate likely future pricing. The erosion of average selling prices of established products is typical of the industry. However, we attempt to offset this deterioration with on-going cost reduction activities and new product introductions, as newer products typically yield larger gross margins.

                                3rd Quarter      4th Quarter      1st Quarter      2nd Quarter      3rd Quarter
                                    2007             2007             2008             2008             2008
Net revenues                    $    729,616     $    729,597     $    733,313     $    774,364     $    739,092

Gross profit margin                    24.0%            22.9%            23.5%            23.2%            21.6%

End-of-period backlog           $    678,300     $    646,700     $    696,700     $    695,900     $    619,000

Book-to-bill ratio                      0.98             0.96             1.04             1.00             0.92

Inventory turnover                      3.62             3.76             3.74             3.89             3.85

Change in ASP vs. prior quarter        -1.3%            -1.2%            -0.4%            -0.9%            -1.4%

See "Financial Metrics by Segment" below for net revenues, book-to-bill ratio, and gross profit margin broken out by segment.

Revenues for the third quarter of 2008 were below our expectations. During the quarter, we experienced a substantial slow down in our order-rate, which has continued into fourth quarter. Gross profit margin decreased, principally due to lower volume and decreases in ASPs, particularly in our Semiconductors segment businesses. The book-to-bill ratio decreased to 0.92 from 1.00 in the second quarter of 2008. Orders were particularly weak for Semiconductor segment products from Asian distributors. For the third quarter of 2008, the book-to-bill ratios for distribution customers and original equipment manufacturers ("OEM") were 0.88 and 0.95, respectively, versus ratios of 1.01 and 1.00, respectively, during the second quarter of 2008. We remain confident for the long-term prospects of the electronics industry, but it is difficult in the current environment to make precise short term projections. We expect revenues between $640 million and $670 million for the fourth quarter of 2008, at flat gross margins. The expected revenues have been negatively impacted by the strengthening of the U.S. dollar compared to other currencies, principally the Euro.

We have continued to see relatively modest pricing pressure in 2008, continuing the trend experienced in 2006 and 2007, although we have experienced accelerating price declines for our Semiconductors segment products, and expect increasing pricing pressure for the remainder of the year.

Financial Metrics by Segment

The following table shows net revenues, book-to-bill ratio, and gross profit
margin broken out by segment for the five quarters beginning with the third
quarter of 2007 through the third quarter of 2008 (dollars in thousands):

                    3rd Quarter      4th Quarter      1st Quarter      2nd Quarter      3rd Quarter
                        2007             2007             2008             2008             2008
Semiconductors

Net revenues        $    400,967     $    386,013     $    387,780     $    407,443     $    392,934

Book-to-bill ratio          0.95             0.94             1.03             1.01             0.85

Gross profit margin        23.3%            22.5%            22.9%            22.5%            21.8%

Passive Components

Net revenues        $    328,649     $    343,584     $    345,533     $    366,921     $    346,158

Book-to-bill ratio          1.02             0.99             1.05             0.99             0.98

Gross profit margin        24.9%            23.3%            24.3%            24.1%            21.4%

Acquisition and Divestiture Activity

As part of our growth strategy, we seek to expand through the acquisition of other manufacturers of electronic components that have established positions in major markets, reputations for product quality and reliability, and product lines with which we have substantial marketing and technical expertise. This includes exploring opportunities to acquire smaller targets to gain market share, effectively penetrate different geographic markets, enhance new product development, round out our product lines, or grow our high margin niche market businesses. Also as part of this growth strategy, we seek to explore opportunities with privately held developers of electronic components, whether through acquisition, investment in non-controlling interests, or strategic alliances.

During the third quarter of 2008, Vishay made three acquisitions. On June 30, 2008, Vishay acquired its partner's 51% interest in a transducer manufacturing joint venture in India for approximately $9.6 million. On July 23, 2008, Vishay acquired Powertron GmbH, a manufacturer of specialty precision resistors, for approximately $14.3 million, including the repayment of certain debt of Powertron. On September 15, 2008, Vishay acquired the wet tantalum capacitor business of KEMET Corporation for $35.2 million and other consideration in the form of a three-year term loan of $15 million. Terms of the secured loan of $15 million to KEMET from Vishay include a three-year non-amortizing maturity, an interest rate of LIBOR plus four percent, and security consisting of accounts receivable.

As further described in Note 13 to our consolidated condensed financial statements, during the third quarter, Vishay made an unsolicited offer to acquire all outstanding shares of International Rectifier. This tender offer was terminated on October 13, 2008. Vishay incurred $4 million of costs associated with the International Rectifier tender offer, which are presented as a separate line item in the consolidated condensed statements of operations.

In April 2007, Vishay acquired the PCS business of International Rectifier. On April 7, 2008, Vishay sold the automotive modules and subsystems business unit ("ASBU") it had acquired as part of the acquisition of the PCS business. During the first quarter of 2008, we recorded an impairment charge of $32.3 million to reduce the carrying value of the net assets of ASBU to the selling price.

Vishay has notified International Rectifier of damage claims concerning forecasts provided to Vishay regarding ASBU in advance of the PCS business acquisition that Vishay believes International Rectifier knew to be unsupportable. Vishay has also notified International Rectifier of certain other claims that it has regarding the sale of the PCS business to Vishay. International Rectifier has stated that it does not believe that Vishay's claims have merit and that it intends to vigorously defend its position.

We place a strong emphasis on reducing our costs. Since 2001, we have been implementing aggressive cost reduction programs to enhance our competitiveness, particularly in light of the erosion of average selling prices of established products that is typical of the industry.

One way we have reduced costs is by moving production to the extent possible from high-labor-cost markets, such as the United States and Western Europe, to lower-labor-cost markets, such as the Czech Republic, Israel, India, Malaysia, Mexico, the People's Republic of China, and the Philippines. The percentage of our total headcount in lower-labor-cost countries is a measure of the extent to which we are successful in implementing this program. This percentage was 75.6% at the end of the third quarter of 2008, compared to 74.0% at the end of 2007, 74.2% at the end of 2006, and 57% when this program began in 2001. Our target is to have between 75% and 80% of our headcount in lower-labor-cost countries.

These production transfers and other long-term cost cutting measures require us to initially incur significant severance and other exit costs and to record losses on excess buildings and equipment. We anticipate that we will realize the benefits of our restructuring through lower labor costs and other operating expenses in future periods. Since 2001, we recorded over $225 million of restructuring and severance costs and recorded related asset write-downs of over $80 million in order to reduce our cost structure going forward. We have realized, and expect to continue to realize, annual net cost savings associated with these restructuring activities.

Restructuring and severance costs, as presented on the consolidated condensed statement of operations, are separate from plant closure, employee termination and similar integration costs we incur in connection with our acquisition activities. These plant closure and employee termination costs subsequent to acquisitions are also integral to our cost reduction program. These amounts, which were not significant in recent years, are included in the costs of our acquisitions and do not affect earnings or losses on our statement of operations.

We evaluate potential restructuring projects based on an expected payback period. The payback period represents the number of years of annual cost savings necessary to recover the initial cash outlay for severance and other exit costs. In general, a restructuring project must have a payback of less than 3 years to be considered beneficial. On average, our restructuring projects have a payback of between 1 and 1.5 years.

During 2005 and the first quarter of 2006, we completed a broad-based fixed cost reduction program. In April 2005, we began evaluating additional restructuring initiatives to improve the results of underperforming divisions. Annual pretax savings resulting from restructuring projects initiated under these programs were expected to be approximately $50 million, of which approximately 70% of the savings would reduce costs of products sold, and approximately 30% of the savings would result in reduced selling, general, and administrative costs. Our actual costs savings from these programs in 2007 were approximately $40 million. Of this $40 million of annualized savings, approximately $20 million began to be realized in 2006, and $20 million began to be realized in 2007. We expect to realize an additional $10 million of savings from these programs in 2008. The expected and actual savings quantified above are net of additional costs incurred after production was transferred to lower-labor-cost regions.

We expect these restructuring programs to result in higher profitability through better gross margins and lower selling, general, and administrative expenses. However, these programs to improve our profitability also involve certain risks which could materially impact our future operating results, as further detailed in Item 1A, "Risk Factors," included in our Annual Report on Form 10-K for the year ended December 31, 2007.

While streamlining and reducing fixed overhead, we are exercising caution so that we will not negatively impact our customer service or our ability to further develop products and processes. Our cost management plans also include expansion of certain critical capacities, which we hope will reduce average materials and processing costs.

Foreign Currency Translation

We are exposed to foreign currency exchange rate risks, particularly due to transactions in currencies other than the functional currencies of certain subsidiaries. While we have in the past used forward exchange contracts to hedge a portion of our projected cash flows from these exposures, we generally have not done so in recent periods.

Statement of Financial Accounting Standards ("SFAS") No. 52 requires that entities identify the "functional currency" of each of their subsidiaries and measure all elements of the financial statements in that functional currency. A subsidary's functional currency is the currency of the primary economic environment in which it operates. In cases where a subsidiary is relatively self-contained within a particular country, the local currency is generally deemed to be the functional currency. However, a foreign subsidiary that is a direct and integral component or extension of the parent company's operations generally would have the parent company's currency as its functional currency. Vishay has both situations among its subsidiaries.

Foreign Subsidiaries which use the Local Currency as the Functional Currency

We finance our operations in Europe and certain locations in Asia in local currencies, and accordingly, these subsidiaries utilize the local currency as their functional currency. For those subsidiaries where the local currency is the functional currency, assets and liabilities in the consolidated balance sheets have been translated at the rate of exchange as of the balance sheet date. Translation adjustments do not impact the results of operations and are reported as a separate component of stockholders' equity. With the general weakening of the U.S. dollar over the past year, this translation of these subsidiaries' financial statements into U.S. dollars has resulted in a significant increase in the translation adjustment recorded in accumulated other comprehensive income on our balance sheet. As the U.S. dollar modestly strengthened in the third quarter, we saw a moderate decrease in the translation adjustment recorded in accumulated other comprehensive income on our balance sheet. See Note 7 to our consolidated condensed financial statements.

For those subsidiaries where the local currency is the functional currency, revenues and expenses are translated at the average exchange rate for the year. While the translation of revenues and expenses into U.S. dollars does not directly impact the statement of operations, the translation effectively increases or decreases the U.S. dollar equivalent of revenues generated and expenses incurred in those foreign currencies. As a result of the general weakening of the U.S. dollar versus several foreign currencies, the translation of foreign currency revenues and expenses into U.S. dollars has significantly increased reported revenues and expenses during the nine fiscal months ended September 27, 2008. Expected general strengthening of the U.S. dollar during the fourth quarter of 2008, as experienced in October, is expected to reduce the U.S. dollar equivalent of revenues generated and expenses incurred in foreign currencies, particularly the Euro.

Our operations in Israel and most significant locations in Asia are largely financed in U.S. dollars, and accordingly, these subsidiaries utilize the U.S. dollar as their functional currency. For those foreign subsidiaries where the U.S. dollar is the functional currency, all foreign currency financial statement amounts are remeasured into U.S. dollars. Exchange gains and losses arising from remeasurement of foreign currency-denominated monetary assets and liabilities are included in the results of operations. While these subsidiaries transact most business in U.S. dollars, they may have significant costs, particularly payroll-related, which are incurred in the local currency. The cost of products sold and selling, general, and administrative expense for the nine fiscal months ended September 27, 2008 have been significantly increased by local currency transactions of subsidiaries which use the U.S. dollar as their functional currency, particularly our subsidiaries in Israel.

Critical Accounting Policies and Estimates

We supplement our discussion of critical accounting policies and estimates, which appears in Item 7 of our Annual Report on Form 10-K, as follows.

Goodwill

Goodwill represents the excess of the cost of businesses acquired over the fair value of the related net assets at the date of acquisition. Goodwill is not amortized but rather tested for impairment at least annually. We perform our annual impairment test as of the first day of the fiscal fourth quarter. These impairment tests must be performed more frequently if there are triggering events.

SFAS No. 142, Goodwill and Other Intangible Assets, prescribes a two-step method for determining goodwill impairment. In the first step, we determine the fair value of the reporting unit using a comparable companies market multiple approach. The comparable companies utilized in our evaluation are generally the members of our peer group included in the presentation of our stock performance graph in Item 5 of our Annual Report on Form 10-K. We also utilized other valuation techniques, including a discounted cash flow analysis, to evaluate the reasonableness of the fair value determined using the market multiple approach.

If the net book value of the reporting unit exceeds the fair value, we would then perform the second step of the impairment test, which requires allocation of the reporting unit's fair value to all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. An impairment charge will be recognized only when the implied fair value of a reporting unit's goodwill is less than its carrying amount.

In light of a sustained decline in market capitalization for Vishay and its peer group companies, and other factors, Vishay determined that an interim impairment . . .