2003 that related to sales of our Xbox related processors. In addition, during fiscal 2005 we realized a lower average sales price on our sales of Xbox processors.



Consolidated Gross Margin



The improvement in our gross margin reflects our continuing focus on delivering cost effective product architectures, enhancing business processes and delivering profitable growth.  We expect gross margin to improve by approximately 0.5% to 1.0% during the first quarter of fiscal 2007.



Operating Expenses



Research and Development 

Research and development expenses increased by $17.0 million, or 5%, from fiscal 2005 to fiscal 2006 primarily due to a $32.4 million increase in salaries and benefits related to 423 additional personnel and a $5.3 million increase in computer software and equipment primarily due to increased allocation of information technology expenses. Other expenses increased $3.9 million primarily due to travel and other employee related expenses associated with the expansion of our international sites. Depreciation and amortization increased $2.1 million due to increased purchases of hardware and software equipment and facilities increased $0.6 million due to increased facilities expense allocation, both of which were based on the growth in headcount. These increases were offset by an increase of $26.9 million in license and development project costs, primarily related to increased development costs related to our collaboration with SCE and other engineering costs related to a different development contract. As a portion of our personnel who usually devote their time to research and development efforts have been focusing their efforts on these development projects, the costs associated with these individuals are not charged to research and development, but were charged to cost of revenue in our consolidated statements of income, or were capitalized on our consolidated balance sheets and will be recognized as cost of revenue, on a percentage of completion basis.



Research and development expenses increased by $65.1 million, or 24%, from fiscal 2004 to fiscal 2005 primarily due to a $36.0 million increase in salaries and benefits related to 174 additional personnel and a $10.4 million increase in new product development costs related to an overall increase in the number of product tape-outs and in prototype materials. Depreciation and amortization increased $11.5 million due to emulation hardware and software programs that were purchased during fiscal 2004, resulting in a full year of depreciation in fiscal 2005 compared to a partial year of depreciation in fiscal 2004. Computer software and equipment increased $4.2 million primarily due to increased allocation of information technology expenses and facilities increased $3.1 million due to increased facilities expense allocation, both of which were based on the growth in headcount. Other expenses increased $1.9 million primarily due to travel and other employee related expenses associated with the expansion of our international sites. These increases were offset by an increase of $2.0 million in license and development project costs related to our collaboration with SCE that