UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)

OF THE SECURITIES EXCHANGE ACT OF 1934 o

OR

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934 x

For the fiscal year ended September 30, 2006

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________to ____________. o

OR

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934 o

Date of event requiring this shell company report ____________.

Commission file number: 1-15000

Infineon Technologies AG

(Exact name of Registrant as specified in its charter)

Federal Republic of Germany

(Jurisdiction of incorporation or organization)

Am Campeon 1-12,

D-85579 Neubiberg

Federal Republic of Germany

(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

     Securities registered or to be registered pursuant to Section 12(g) of the Act: None

     Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

     Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.    747,609,294 ordinary shares, notional value €2.00 per share

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x No o

     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

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     Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

     Indicate by check mark which financial statement item the registrant has elected to follow.

Item 17 o Item 18 x

     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

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     (APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

     Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yes o No o

INFINEON TECHNOLOGIES AG

ANNUAL REPORT ON FORM 20-F

FOR THE FINANCIAL YEAR ENDED

SEPTEMBER 30, 2006

      

CROSS REFERENCES TO FORM 20-F

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

        Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Our consolidated financial statements are expressed in euro. In this annual report, references to “euro” or “€” are to euro and references to “U.S. dollars” or “$” are to United States dollars. For convenience, this annual report contains translations of euro amounts into U.S. dollars at the rate of €1.00 = $1.2687, the noon buying rate of the Federal Reserve Bank of New York for euro on September 29, 2006. The noon buying rate for euro on November 28, 2006 was €1.00 = $1.3162. Our financial year ends on September 30 of each year. References to any financial year refer to the year ended September 30 of the calendar year specified. In this annual report, references to:

      This annual report contains market data that has been prepared or reported by Gartner Inc. and its unit Dataquest, Inc. (together “Gartner Dataquest”), Frost & Sullivan, IC Insights, Inc. (“IC Insights”), IMS Research Ltd. (“IMS Research”), iSuppli Corporation (“iSuppli”), Strategy Analytics, Inc. (“Strategy Analytics”), and World Semiconductor Trade Statistics (“WSTS”).

      Figures presented in tabular format may not add up due to rounding.

      Special terms used in the semiconductor industry are defined in the glossary.

Forward-Looking Statements

      This annual report contains forward-looking statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections, and you should not place too much reliance on them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update any of them in light of new information or future events. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement. These factors include those identified under the heading “Risk Factors” and elsewhere in this annual report.

Use of Non-U.S. GAAP Financial Measures

      This document contains non-U.S. GAAP financial measures. Non-U.S. GAAP financial measures are measures of our historical or future performance, financial position or cash flows that contain adjustments that exclude or include amounts that are included or excluded, as the case may be, from the most directly comparable measure calculated and presented in accordance with U.S. GAAP in our consolidated financial statements. Earnings before interest and taxes (“EBIT”) is an example of a non-U.S. GAAP financial measure. For descriptions of these non-U.S. GAAP financial measures and the adjustments made to the most directly comparable U.S. GAAP financial measures to obtain them, please refer to “Operating and Financial Review”.

Principal Business Address

      Our principal business address is Am Campeon 1-12, D-85579 Neubiberg, Federal Republic of Germany

SELECTED CONSOLIDATED FINANCIAL DATA

        You should read the following selected consolidated financial data in conjunction with our consolidated financial statements, the related notes and “Operating and Financial Review”, all of which appear elsewhere in this annual report.

      We have derived the selected consolidated statement of operations and cash flow data for the 2002 through 2006 financial years and the selected consolidated balance sheet data at September 30, 2002 through 2006 from our consolidated financial statements, which have been prepared in accordance with U.S. GAAP and audited by KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, an independent registered public accounting firm.

Notes

OPERATING AND FINANCIAL REVIEW

        This discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and other financial information included elsewhere in this annual report. Our audited consolidated financial statements have been prepared on the basis of a number of assumptions more fully explained in Note 1 (Description of Business, Formation and Basis of Presentation) and Note 2 (Summary of Significant Accounting Policies) to our audited consolidated financial statements appearing elsewhere in this annual report.

Overview of the 2006 Financial Year

        In our 2006 financial year, which ended September 30, both the global economy and the semiconductor market were slightly stronger than in the prior year. As a global player in the semiconductor market, we were influenced by these more favorable macroeconomic and market conditions. In spite of these improved market conditions, we were also impacted by ongoing strong pricing pressure in all of our operating segments.

      The following were the key developments in our business during the 2006 financial year:

Our Business

        We design, develop, manufacture and market a broad range of semiconductors and complete system solutions used in a wide variety of microelectronic applications, including computer systems, telecommunications systems, consumer goods, automotive products, industrial automation and control systems, and chip card applications. Our products include standard commodity components, full-custom devices, semi-custom devices, and application-specific components for memory, analog, digital, and mixed-signal applications. We have operations, investments, and customers located mainly in Europe, Asia and North America.

      Our business is organized into three principal operating segments serving various markets in the semiconductor industry:

      We have two additional segments for reporting purposes, our Other Operating Segments, which includes remaining activities for certain product lines that have been disposed of, as well as other business activities, and our Corporate and Eliminations segment, which contains items not allocated to our operating segments, such as certain corporate headquarters’ costs, strategic investments, unabsorbed excess capacity and restructuring costs.

The Semiconductor Industry and Factors that Impact Our Business

        Our business and the semiconductor industry are highly cyclical and are characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life-cycles and wide fluctuations in product supply and demand. Although these factors affect all segments of our business, they are especially pronounced for Qimonda, are increasingly true for our Communication Solutions segment, and have the least impact on our Automotive, Industrial & Multimarket segment.

          Cyclicality

      The industry’s cyclicality results from a complex set of factors, including, in particular, fluctuations in demand for the end products that use semiconductors and fluctuations in the manufacturing capacity available to produce semiconductors. This cyclicality is especially pronounced in the memory portion of the industry. Semiconductor manufacturing facilities (so-called fabrication facilities, or “fabs”) can take several years to plan, construct, and begin operations. Semiconductor manufacturers have in the past made capital investments in plant and equipment during periods of favorable market conditions, in

      We and Qimonda attempt to mitigate the impact of cyclicality by investing in manufacturing capacities throughout the cycle and entering into alliances and foundry manufacturing arrangements that provide flexibility in responding to changes in the cycle. We believe that Qimonda, in particular, can improve its gross margin by focusing on two key areas: the continuous improvement of cost structure and productivity through the introduction of advanced memory process technologies and the development and marketing of a broader range of memory products, focusing particularly on higher margin and less volatile applications such as infrastructure, high-end graphics, consumer and mobile applications.

          Substantial Capital and R&D Expenditures

      Semiconductor manufacturing is very capital-intensive. The manufacturing capacities that are essential to maintain a competitive cost position require large investments in manufacturing assets. The top 10 capital spenders in the industry, of which we rank number 8 according to IC Insights, account for nearly 50% of the industry’s projected 2006 capital spending budgets. Manufacturing processes and product designs are based on leading-edge technologies that require considerable research and development expenditures. A high percentage of the cost of operating a fab is fixed; therefore, increases or decreases in capacity utilization can have a significant effect on profitability.

      Because pricing, for DRAM products in particular, is market-driven and largely beyond our control, a key factor for us in achieving and maintaining profitability is to continually lower our per-unit costs by reducing our total costs and by increasing unit production output, particularly at Qimonda.

      To reduce our total costs, we also aim to share the costs of research and development and manufacturing facilities with third parties, either by establishing alliances or through the use of foundry facilities for manufacturing. We believe that cooperation in alliances for R&D and manufacturing and foundry partnerships provide us with a number of important benefits, including the sharing of risks and costs, reducing our own capital requirements, allowing us to develop a broader range of products, acquiring technical know-how, and gaining access to additional production capacities. Qimonda, for example, is developing future DRAM technologies with feature sizes of 58-nanometer together with Nanya. In addition, Qimonda has established foundry relationships with partners in Asia, including Semiconductor Manufacturing International Corporation, Shanghai, China (“SMIC”), and Winbond Electronics Corp., Hsinchu, Taiwan (“Winbond”), to increase its manufacturing capacities, and therefore its potential revenues, without investing in additional manufacturing assets. In our logic area, our principal alliances are with International Business Machines Corporation (“IBM”), New York, United States of America, Chartered Semiconductor Manufacturing Ltd., Singapore (“Chartered Semiconductor”) and Samsung Electronics Co. Ltd., Seoul, Korea (“Samsung”) for CMOS development and manufacturing at 65-nanometer and 45-nanometer process technologies, with United Microelectronics Corporation, Taipei, Taiwan (“UMC”) for 90-nanometer manufacturing, and with IBM through our manufacturing joint venture ALTIS Semiconductor S.N.C. (“ALTIS”) in Essonnes, France.

      We expect to increase unit production output through improvements in manufacturing, which is achieved by producing chips with smaller structure sizes (more bits per chip) and by producing more chips per silicon wafer (by using larger wafers). For DRAM process technology, the majority of Qimonda’s capacity is based on 110-nanometer structure sizes. In addition, 90-nanometer technology is currently in ramp-up and Qimonda has already started commercial production based on 75-nanome-

      With our planned investment of approximately $1 billion in the Kulim power manufacturing facility, we will increase our manufacturing capacity mainly for automotive and industrial power products by up to 100,000 wafer starts per month using 200-millimeter wafers. At full capacity, this manufacturing facility is expected to employ about 1,700 people.

          Technological Development and Competition

      Sales prices per unit are volatile and generally decline over time due to technological developments and competitive pressure. Memories in particular are commodity-type products. Since most specifications are standardized, customers can switch between suppliers on short notice. This leads to strong competition within the market, and causes manufacturers to pass cost savings on to their customers in an effort to gain market share. Logic products are generally not commodities, but rather have a certain degree of application specification. Although generally less volatile than those for commodity memory products, unit sales prices for logic products typically decline over time as technological developments occur.

      We aim to offset the effects of declining unit sales prices on total net sales by optimizing product mix, by increasing unit sales volume and by continually reducing per-unit production costs. The growth in volumes depends in part on productivity improvements in manufacturing. By moving to ever-smaller structure sizes, the number of functional elements has historically doubled approximately every two years. This trend, often called Moore’s Law, has led to an average growth rate of bit-volumes of between 40% and 45% per year and, assuming constant costs per square inch of silicon, to an approximately 30% cost reduction per bit per year.

          Seasonality

      Our business is affected by seasonality, with sales historically strongest in our fourth financial quarter and weakest in our first financial quarter. The seasonality of our sales reflects the seasonal demand fluctuations for the products that incorporate our semiconductors. If anticipated sales or shipments do not occur when expected, expenses and inventory levels in that quarter can be disproportionately high, and our results of operations for that quarter, and potentially for future quarters, may be adversely affected.

          Product Development Cycles

      For logic products, the cycle for test, evaluation and adoption of our products by customers before the start of volume production can range from several months to more than one year. Due to this lengthy cycle, we may experience significant delays from the time we incur expenses for research and development, marketing efforts, and investments in inventory, to the time we generate corresponding revenue, if

          Acquisition and Divestiture Strategy

      A key element of our business strategy involves the acquisition and divestiture of businesses, assets, products, or technologies to reduce the time required to develop new technologies and products and bring them to market, and to optimize our existing product offerings, market coverage, engineering workforce, or technological capabilities. We plan to continue to evaluate strategic opportunities as they arise, including business combination transactions, strategic relationships, capital investments, and the purchase or sale of assets.

          Intellectual Property

      Due to the high-technology nature of the semiconductor industry, intellectual property (IP), meaning intangible assets relating to proprietary technology, is of significant importance. We do not record assets in our balance sheet for self-developed IP. Only IP licensed from others or acquired through a business acquisition is reflected on our balance sheet, and reduced through amortization over its expected useful life. The value of such acquired IP is often complex and difficult to estimate. We also derive modest revenues from the licensing of our IP, generally pursuant to cross licensing arrangements.

          Challenges that lie Ahead

      Going forward, our success will remain highly dependent on our ability to stay at the leading edge of technology development, and to continue to optimize our product portfolio. We must achieve both objectives to ensure that we have the flexibility to react to fluctuations in market demand for different types of semiconductor products. We believe that the ability to offer and the flexibility to manufacture a broad portfolio of products will be increasingly important to our long-term success in many markets within the semiconductor industry. Establishing and maintaining advantageous technology, development and manufacturing alliances, including the use of third-party foundries, and continuing our efforts to broaden our product portfolio will make it easier for us to respond to changes in market conditions and to improve our financial performance.

          Semiconductor Market Conditions in the 2006 Financial Year

      The growth of the semiconductor market accelerated only slightly through the first three quarters of the 2006 calendar year following growth of 7% in the 2005 calendar year, according to WSTS (World Semiconductor Trade Statistics). In October 2006, WSTS predicted a growth rate of 8% for the full 2006 calendar year. According to WSTS, sales in North America are expected to increase by 11% in the 2006 calendar year. The semiconductor market in Asia-Pacific is expected to increase by 11%; the Japanese market is expected to grow by 7%; the European market is expected to increase slightly by 1%. Sales of non-memory products (logic chips, analog, discrete and optical components), which accounted for 78% of the entire market in the first half of the 2006 calendar year, are predicted to grow by 6% compared with the 2005 calendar year. Sales of memory products are predicted to grow by 17% compared with the 2005 calendar year.

      Gartner Dataquest predicts worldwide growth in the 2006 calendar year of 12% for semiconductors in the communications business (wireless and wireline). Sales of semiconductors for industrial electronics are predicted to grow by 15%, for automotive electronics by 6%, for data processing by 8% and for consumer electronics by 17%.

Results of Operations

Results of Operations as a Percentage of Net Sales

      The following table presents the various line items in our consolidated statements of operations expressed as percentages of net sales.

Reorganization

      Our new organizational structure became effective on May 1, 2006, following the legal separation of our memory products business into the stand-alone legal company Qimonda. The results of prior periods have been reclassified to conform to the current period presentation, as well as to facilitate analysis of current and future operating segment information. As a result of the reorganization, certain corporate overhead expenses are no longer apportioned to Qimonda and are instead allocated to Infineon’s logic segments.

      We operate primarily in three major operating segments, two of which are application focused: Automotive, Industrial & Multimarket, and Communication Solutions; and one of which is product focused: Qimonda. Further, certain of our remaining activities for product lines sold, for which there are no continuing contractual commitments subsequent to the divestiture date, as well as new business activities also meet the FASB Statement of Financial Accounting Standards (“SFAS”) No. 131 definition of an operating segment, but do not meet the requirements of a reportable segment as specified in SFAS No. 131. Accordingly, these segments are combined and disclosed in the “Other Operating Segments” category pursuant to SFAS No. 131.

      Effective May 1, 2006, with the completion of the Qimonda carve-out, the Other Operating Segments also include revenues and earnings that Infineon’s 200-millimeter production facility in Dresden records from the sale of wafers to Qimonda under foundry agreements. The Corporate and Eliminations segment reflects the elimination of these intra-group revenues and earnings.

      We generate our revenues primarily from the sale of our semiconductor products and systems solutions. In addition, on average we generated more than 1% of the last three years of our sales from activities such as foundry services for divested businesses and the licensing of our intellectual property. Our semiconductor products include two main categories of semiconductors:

      We made the vast majority of our product sales in the 2006 financial year through our direct sales force, with approximately 24% of net sales from our logic segments and approximately 13% of Qimonda’s net sales derived from sales made through distributors.

      We derive our license revenue from royalties and license fees earned on technology that we own and license to third parties. This enables us to recover a portion of our research and development expenses, and also often allows us to gain access to manufacturing capacity at foundries through joint licensing and capacity reservation arrangements. We recognize license income, primarily in Qimonda, resulting from the transfer of technology to our current and former alliance partners, such as Winbond, Nanya and ProMOS.

      Our net sales fluctuate in response to a mix of factors, including the following:

      In the 2005 financial year, net sales decreased primarily due to lower demand for products of the wireless business and declining prices for DRAM products. The increase in net sales in the 2006 financial year was mainly driven by higher demand for memory products, especially for graphics, mobile and consumer DRAMs, as well as healthy growth in the Automotive, Industrial & Multimarket segment, particularly in the automotive and industrial power applications businesses. In the 2005 financial year, license income increased primarily due to the settlement reached with ProMOS, whereby €118 million in license income was recognized. The decrease in license income in the 2006 financial year was mainly driven by the non-recurring license fees from ProMOS recognized in the prior financial year. The strength of major foreign currencies (primarily the U.S. dollar) relative to the euro during the 2006 financial year positively impacted reported net sales, whereas the net sales of the 2004 and 2005

Net Sales by Segment

DRAM Price Development

      DRAM prices were under substantial pressure during the first quarter of our 2006 financial year after which they recovered over the remaining three quarters. Our average per-megabit selling prices for DRAM products (expressed in U.S. dollars) were approximately 20% less in 2006 financial year compared with the 2005 financial year. The per-megabit selling prices in U.S. dollars at the spot market of our major products with DDR2 interfaces declined sharply at the start of our financial year, declining around 26% over the first three months. During this quarter, we produced an excess of DDR2 chips because the corresponding DDR2 logic chipsets, which are produced by logic semiconductor manufacturers, were not available in quantities sufficient for PC manufacturers to absorb the supply of DDR2s in the market. A portion of the DDR2 chips that we produced remained unsold and in our inventory until supply of appropriate logic chipsets caught up. Starting January 2006 prices recovered quickly for DDR2 chips, gaining around 26% in the next three months. After a period of strong and stable pricing until May 2006, DDR2 pricing experienced some modest short-lived price erosion until July 2006 before again rising through to financial year end due to tight market supply. DDR recovered steadily, albeit more slowly from the December 2005 low points, continuing to increase through to the end of our financial year.

      Our net sales decreased in the 2005 financial year in all major regions, primarily due to pricing pressure and lower demand for semiconductor products, especially for baseband components in the wireless business in Germany. In the 2006 financial year, our net sales increased in nearly every region, primarily due to higher demand for semiconductor products, in particular for specialty memory products in the consumer electronics and game-console businesses in North America.

      The number of customers of our Automotive, Industrial & Multimarket segment remained stable. In the 2006 financial year, the top 20 customers of this segment accounted for approximately 65% of the segment’s sales. The net sales of this segment increased in all regions, with a particularly strong increase in Asia.

      In the Communication Solutions segment, we have seen a further shift of net sales to the Asia/Pacific region. Our top 20 customers in this segment accounted for over 80% of its net sales. The four largest customers of that segment in the 2006 financial year were BenQ, Ericsson, Nokia and Siemens. In the financial years 2005 and 2006, the wireless business saw net sales drop significantly as a result of the loss in market share experienced by BenQ. The Communication Solutions segment responded to these developments by putting in place much leaner internal structures to reduce fixed costs, and by systematically broadening its customer base. This strategy has made good progress. During financial year 2006, in the face of strong competition, our company won two new major customers, LG Electronics Inc., Seoul, Korea (“LG”), and Samsung.

      In the 2006 financial year Qimonda’s top 20 customers accounted for nearly 80% of its net sales. The net sales of Qimonda improved in all regions, with a particularly strong increase in North America and Japan due to increased net sales of specialty memory products to consumer electronics and game-console manufacturers.

      The Siemens group accounted for 13 percent, 13 percent and 7 percent of our net sales in the 2004, 2005 and 2006 financial years, respectively. Sales to the Siemens group are made primarily by our logic segments. No other single customer accounted for 10 percent or more of our net sales in the 2004, 2005 or 2006 financial years. On April 3, 2006, Siemens disposed of its remaining shareholding in our company. Transactions between us and Siemens subsequent to this date are no longer reflected as related party transactions.

Cost of Goods Sold and Gross Margin

      Our cost of goods sold consists principally of:

      In addition to factors that affect our revenue, our gross margin is impacted by:

      We report as cost of goods sold the cost of inventory purchased from our joint ventures and other associated and related companies such as ALTIS (consolidated since December 31, 2005) and Inotera. Our purchases from these associated and related companies amounted to €575 million in the 2006 financial year, €615 million in the 2005 financial year and €357 million in the 2004 financial year.

      Our gross margin deteriorated in the 2005 financial year, primarily as a result of higher idle capacity costs and strong pricing pressure in most of our operating segments, as well as the unfavorable U.S. dollar/ Euro exchange rate, which could not be entirely offset by productivity measures. In the 2006 financial year our gross margin decreased slightly compared to the 2005 financial year due to decreased gross margin of Qimonda primarily as a result of lower level of license income and strong pricing pressure for DDR2 memories in the first quarter of the 2006 financial year. This effect was almost entirely offset by the improved gross margin in the Automotive, Industrial & Multimarket and the Communication Solutions segments, particularly due to lower idle costs.

Research and Development (R&D) Expenses

      Research and development expenses consist primarily of salaries and fringe benefits for research and development personnel, materials costs, depreciation and maintenance of equipment used in our research and development efforts, and contracted technology development costs. Materials costs include expenses for development wafers and costs relating to pilot production activities prior to the commencement of commercial production. R&D expenses also include our joint technology development arrangements with partners such as Nanya and IBM.

      We continue to focus our investments on the development of leading-edge manufacturing technologies and products with high potential for growth and profitability.

      Some of our R&D projects qualify for subsidies from local and regional governments where we do business. If the criteria to receive a grant are met, the subsidies received reduce R&D expenses over the project term as expenses are incurred.

      Selling expenses consist primarily of salaries and fringe benefits for personnel engaged in sales and marketing activities, costs of customer samples, costs related to prototyping activities, other marketing incentives, and related marketing expenses.

      General and administrative expenses consist primarily of salaries and benefits for administrative personnel, non-manufacturing related overhead costs, consultancy, legal and other fees for professional services, recruitment and training expenses.

      Selling and administrative expenses increased primarily due to charges of €28 million incurred in connection with the insolvency of BenQ’s German subsidiary, expenses of €16 million related to the Qimonda formation, as well as stock-based compensation costs of €12 million.

Other Items Affecting Earnings

      Restructuring Charges. In connection with our decision to close down various development centers in the 2004 financial year, we recorded restructuring charges, mainly for severance payments. In the 2005 financial year, we continued our restructuring and cost-saving efforts aimed at reducing costs, including downsizing our workforce and consolidating certain functions and operations. We agreed upon plans to terminate employees, primarily in connection with the close down of fiber optics operations in Germany and the United States, as well as measures taken to restructure our chip manufacturing in the front-end area within the manufacturing cluster Perlach, Regensburg and Villach. Production activities at Munich-Perlach will be transferred principally to Regensburg and, to a lesser extent, to Villach. In the 2006 financial year, we continued our restructuring measures to downsize the workforce at ALTIS and our chip card back-end activities in order to maintain competitiveness and reduce cost. As part of the restructurings, it is expected that a total of 450 employees will be terminated.

      Other Operating Expense, Net. Other operating expense, net in the 2004 financial year related principally to charges from our settlement of an antitrust investigation by the U.S. Department of Justice, related settlements with customers and a similar ongoing investigation in Europe, as well as a goodwill impairment charge of €71 million related to our 2001 acquisition of Catamaran. In the 2005 financial

      Equity in (Losses) Earnings of Associated Companies. Our principal associated company is currently Inotera, as ALTIS has been fully consolidated as of December 31, 2005. Inotera is a DRAM manufacturer and is reflected in the results of Qimonda; our equity in its earnings has been sensitive to fluctuations in the price of DRAM and is reflected in the results of Qimonda.

      Start-up losses at Inotera during the ramp-up phase of production contributed to the losses incurred in the 2004 financial year. In the 2005 and 2006 financial years, Inotera contributed the majority of our equity in earnings from associated companies, reflecting the start of volume production by that joint venture in the 2005 financial year.

      Gain on subsidiaries and associated company share issuance, net — In August 2006, Qimonda successfully completed an initial public offering on the New York Stock Exchange of 42 million new ordinary shares, together with 6.3 million ordinary shares from Infineon in an over-allotment option, at a price of $13 per share. We realized a non-operating loss of €53 million from the dilution of our interest in Qimonda following its initial public offering.

      In March and May 2006, our joint venture Inotera successfully completed an initial public offering on the Taiwanese Stock Exchange of 200 million ordinary shares and a public offering on the Luxembourg Stock Exchange of 40 million global depositary shares (representing 400 million common shares), each at an issuance price of NT$33 per ordinary share. As a result of these transactions, we recognized a non-operating gain of €72 million.

      Other Non-Operating (Expense) Income, Net. Other non-operating income and expense consists of various items in different periods not directly related to our principal operations, including gains and losses on sales of marketable securities. Other non-operating expense, net in the 2004 financial year mainly consisted of €65 million of investment-related impairment charges. In the 2005 financial year, non-operating income, net included €40 million related to net gains from foreign currency derivatives and foreign currency transactions and a gain of €13 million realized on the sale of our venture capital activities, partially offset by investment-related impairment charges of €29 million. In the 2006 financial year, the non-operating expenses consisted mainly of €31 million related to net losses from foreign currency derivatives and foreign currency transactions and investment-related impairment charges of €13 million.

Earnings Before Interest and Taxes (EBIT)

      We define EBIT as earnings (loss) before interest and taxes. Our management uses EBIT as a measure to establish budgets and operational goals, to manage our business and to evaluate its performance. We report EBIT information because we believe that it provides investors with meaningful

      The EBIT amounts of our separate reporting segments were as follows:

     The EBIT results reflect the combined effects of the following EBIT movements of our reporting segments:

Interest Expense, Net

      We derive interest income primarily from cash and cash equivalents and marketable securities. Interest expense is primarily attributable to bank loans and convertible notes, and is net of interest capitalized on manufacturing facilities under construction.

      Interest expense in the 2004, 2005 and 2006 financial years relates principally to the convertible bonds that we issued in February 2002 and in June 2003. In addition, interest expense in the 2004 financial year included €21 million, paid upon redemption of the other investors’ ownership interests in the Infineon Technologies SC300 GmbH & Co. OHG (“SC300”) venture in Dresden. These effects were partially reduced in the 2004 and 2005 financial years as a result of the redemption of a portion of our convertible bonds in 2004 and increased interest capitalization related to facilities under construction, as well as interest income from financial derivatives. The increase of the interest expense, net in the 2006 financial year is mainly due to the drawdown of $345 million under our $400/€400 million syndicated credit facility to finance the expansion of our Richmond manufacturing facility and a reduction in income from interest rate swaps resulting from increased variable interest rates, and to a lesser extent, interest on outstanding tax obligations and a reduction in capitalized interest.

Income Taxes

      Pursuant to U.S. GAAP, deferred tax assets in tax jurisdictions that have a three-year cumulative loss are subject to a valuation allowance excluding the impact of forecasted future taxable income. In the 2004 financial year, our effective tax rate increased because we recorded additional valuation allowances of €54 million related to tax jurisdictions that continue to have a three-year cumulative loss, and also had more non-deductible expenditures. In the 2005 and 2006 financial years we continued to have a three-year cumulative loss in certain tax jurisdictions and we recorded increases to the valuation allowance of €192 million and €292 million, respectively. We assess our deferred tax asset position on a regular basis. Our ability to realize benefits from our deferred tax assets is dependent on our ability to generate future taxable income sufficient to utilize tax loss carry-forwards or tax credits before expira-

Net Income (Loss)

      In the 2004 financial year, we were profitable due to sales volume growth, manufacturing efficiencies and cost reduction efforts, although the impact was reduced through increased charges for impairments, antitrust-related matters and tax expense. In the 2005 financial year, the net loss incurred resulted primarily from the combination of lower revenues and gross margin, long-term asset impairments, restructuring measures and tax expense. In the 2006 financial year, the net loss incurred was primarily due to charges resulting from the insolvency of BenQ’s German subsidiary, the initial public offering of Qimonda, as well as the settlement of litigation. In addition, in the 2006 financial year our company began to recognize the fair value of employee stock options in earnings, which further contributed to the net loss incurred.

Financial Condition

      As of September 30, 2006, our total assets and current assets increased in comparison to the prior year due to increased cash and cash equivalents. The increase of cash and cash equivalents resulted from the net proceeds of €464 million from the initial public offering of Qimonda and the sale of Qimonda shares upon exercise of the underwriters’ over-allotment option, as well as proceeds from a drawdown under our $400/€400 million syndicated credit facility in the amount of $345 million to finance the expansion of our Richmond manufacturing facility.

      Non-current assets decreased slightly at the end of the 2006 financial year as capital expenditures mostly offset depreciation, amortization and impairment charges during the year.

      Total liabilities increased as of the end of the 2006 financial year, mainly due to the drawdown under the $400/€400 million syndicated credit facility in the amount of $345 million to finance the expansion of our Richmond manufacturing facility. The increase in current liabilities resulted primarily from the reclassification of €638 million related to subordinated convertible notes due 2007 from non current liabilities into current liabilities. The decrease of non-current liabilities due to that reclassification was partly offset by the $345 million drawdown under the syndicated credit facility. The increase of the minority interests resulted primarily from the initial public offering of Qimonda and the initial consolidation of ALTIS as of December 31, 2005.

Financial Ratios

The aforementioned ratios of the financial condition are calculated as follows:

     In the 2006 financial year our equity ratio decreased principally due to the net loss during the year. At September 30, 2006, our equity ratio was 48%, a 7% decrease from September 30, 2005.

      The return on equity amounted to negative 5% and the return on assets amounted to negative 3% due to the net loss in the 2005 financial year, compared to positive 1% for both financial ratios in the 2004 financial year. In the 2006 financial year, the return on equity remained unchanged at negative 5% and the return on assets improved to negative 2% due to a smaller net loss and increased total assets compared to the 2005 financial year.

      The equity-to-fixed-assets ratio decreased to 150% in the 2005 financial year from 167% in the prior year as a result of the net loss and capital expenditures which exceeded depreciation expense during the year. In the 2006 financial year, the equity-to-fixed-assets ratio further decreased to 141% mainly as a result of the net loss and nearly unchanged fixed assets.

      The decrease of the debt-to-equity ratio to 30%, compared to 33% in the 2004 financial year, was mainly attributable to the repayment of the €450 million loan entered into in connection with the build-out of our plant in Dresden during the 2005 financial year. In the 2006 financial year, the debt-to-equity ratio

Liquidity

Cash Flow

      Our consolidated statement of cash flows shows the sources and uses of cash during the reported periods. It is of key importance for the evaluation of our financial position.

      Cash flows from investing and financing activities are both indirectly determined based on payments and receipts. Cash flows from operating activities are determined indirectly from net income (loss). The changes in balance sheet items have been adjusted for the effects of foreign currency exchange fluctuations and for changes in the scope of consolidation. Therefore, they do not conform to the corresponding changes in the respective balance sheet line items.

      Cash provided by operating activities in the 2006 financial year resulted mainly from the net loss of €268 million, which is net of non cash charges for depreciation of €1,405 million, impairment charges of €57 million and equity in earnings of associated companies of €78 million. Cash provided by operating activities was positively impacted by an increase of trade accounts payable, accrued liabilities and other current liabilities of €359 million, and negatively impacted by an increase in inventories and trade accounts receivable of €479 million.

      Cash used in investing activities in the 2006 financial year mainly reflects capital expenditures of €1,253 million, principally to equip our manufacturing facilities in Richmond and Kulim, as well as net proceeds from net sales of marketable securities of €238 million and cash used for purchases of intangible assets of €44 million.

      Cash provided by financing activities in the 2006 financial year principally relates to the net proceeds of €406 million from the initial public offering of Qimonda and proceeds from the issuance of long-term debt of €400 million, in particular from a drawdown of $345 million under our $400/€400 million syndicated credit facility to finance the expansion of our Richmond manufacturing facility.

Free Cash Flow

      We define free cash flow as cash from operating and investing activities excluding purchases or sales of marketable securities. Since we hold a substantial portion of our available monetary resources in the form of readily available marketable securities, and operate in a capital-intensive industry, we report free cash flow to provide investors with a measure that can be used to evaluate changes in liquidity after taking capital expenditures into account. It is not intended to represent the residual cash flow available for discretionary expenditures, since debt service requirements or other non-discretionary