General

We are a national distributor of electronic components, primarily focused on transistors, diodes and other discrete semiconductors, optoelectronic devices and passive components with a reputation of in-depth inventories and knowledge of the products it markets. Our "superstore" strategy consists of carrying a large quantity and variety of components in inventory to meet the rapid delivery requirements of our customers. To differentiate from other distributors, we also manufacture electronic components based on our engineering specifications under the brands "TCI" or "PSD" through outsourcing. At December 31, 2005, our inventory consisted of over 14,000 different products manufactured by more than 100 different suppliers. We are incorporated in California, and were originally formed in 1989. We maintain a majority-owned subsidiary in Mexico and three divisions in each of Taiwan, Brazil and China. Our Mexico and Brazil locations are for regional distribution, sales and marketing purposes and our Taiwan and China locations for supporting our purchasing of components and manufactured products.

Discrete semiconductors are basic electronic building blocks. One or more different types of discrete semiconductors generally are found in the electronic or power supply circuitry of products as diverse as automobiles, televisions, radios, telephones, computers, medical equipment, airplanes, industrial robotics and household appliances. The term "discrete" is used to differentiate those single function semiconductor products which are packaged alone, such as transistors or diodes, from those which are "integrated" into microchips and other integrated circuit devices.

The U.S. electronics distribution industry is composed of national distributors (and international distributors), as well as regional and local distributors. Electronics distributors market numerous products, including active components (such as transistors, microprocessors and integrated circuits), passive components (such as capacitors and resistors) and electromechanical, interconnect and computer products. We focus our efforts almost exclusively on the distribution of discrete semiconductors, optoelectronic devices and passive components, a small subset of the electronic components market.

We continue to be impacted by the severe decline in demand from the U.S. market, which began in late 2000. As a result, we have experienced declining sales since early 2001. In response to this declining demand, we expect to increase our sales to existing customers through further expansion of the number of different types of discrete components and other integrated circuits in our inventory and by attracting additional contract electronic manufacturers (CEMs), original equipment manufacturers (OEMs) and electronics distributor customers. In addition to traditional component fulfillment, we are continuing to develop our market role into value-added engineering services for existing OEM and CEM customers through partnership agreements with offshore solution providers.

Discrete Semiconductors

Semiconductors can be broadly divided into two categories - discrete semiconductors, including transistors, diodes, rectifiers and bridges, which are packaged individually to perform a single or limited function, and integrated circuits, such as

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microprocessors and other "chips," which can contain from a few to several million transistors and other elements in a single package, and usually are designed to perform complex tasks.

While integrated circuits may garner more public exposure, discrete semiconductors, the ancestral root of integrated circuits, have been a core element of electric equipment for more than 35 years. Discrete semiconductors are found in most consumer, industrial and military electrical and electronic applications.

Discrete semiconductors represent only a small subset of the different types of semiconductors currently available. Discrete semiconductors are generally more mature products with a more predictable demand, more stable pricing and more constant sourcing than other products in the semiconductor industry, and are thus less susceptible to technological obsolescence than integrated circuits.

Optoelectronic Devices and Passive Components

In addition to discrete semiconductors, we offer optoelectronic devices such as LED's, infrared sensors and opto couplers, along with passive devices, such as resistors, capacitors and inductors which are electronic components manufactured with non-semiconductor materials. We market these optoelectronic devices and passive components through the same channels, as the discrete semiconductors. Sales of these optoelectronic devices and passive components were 45% and 41% of our total sales for the years ended December 31, 2005 and 2004, respectively. During 2005, we purchased $2,240,000 of inventory for these components, to facilitate our market for these products.

Electronic Distribution Channels

Electronic component manufacturers, which we refer to as suppliers, sell components directly to CEMs and OEMs, as well as to distributors. The practice among the major suppliers is generally to focus their direct selling efforts on larger volume customers, while utilizing distributors to reach small and medium-sized CEMs and OEMs, as well as smaller distributors. Many suppliers consider electronic distributors to be an integral part of their businesses. As a stocking, marketing and financial intermediary, the distributor relieves its suppliers of a portion of their costs and personnel associated with stocking and selling products, including otherwise sizable investments in finished goods inventories and accounts receivable. By having geographically dispersed selling and delivery capabilities, distributors are often able to serve small and medium-sized companies more effectively and economically than can the supplier.

Electronic distributors are also important to CEMs and OEMs. CEMs and OEMs frequently place orders which are of insufficient size to be placed directly with the suppliers or require delivery schedules not available from suppliers. Distributors offer product availability, selection and more rapid and flexible delivery schedules keyed to meet the requirements of their CEMs and OEM customers. Also, they often rely upon electronic distributors to provide timely, knowledgeable access to electronic components.

There is also pressure on the suppliers, CEMs and OEMs to maintain small inventories. Inventory is costly to maintain and thus suppliers desire to ship finished goods as soon as the goods are manufactured. CEMs and OEMs typically demand "just in time" delivery -- receipt of their requirements immediately prior to the time when the components are to be used. Distributors fill this niche.

Strategy

Our preliminary goal was to become one of the leading distributors of discrete semiconductors in North America. In 2004, we began providing design and engineering services to support our existing OEM and CEM customers by outsourcing their product design and manufacturing assembly work offshore. Sales of these products were $440,000 and $985,000 in 2004 and 2005. In order to facilitate this outsourcing program, in 2005, we opened an engineering design center in Shanghai, China. Strategic allies such as Princeton Technology Corporation, a company controlled by one of our directors, and Teamforce Co. Ltd., both Taiwan-based companies, will assist us with this program. Our goal is to have 50% component sales and 50% design and manufacturing sales within 3 years.

We initially gained market share by concentrating on selling discrete semiconductors at competitive prices. Since 1997, we have marketed ourselves as the "discrete components superstore," with an in-depth focus on discrete semiconductors, passive and optoelectronic components and extensive inventory of a wide variety of these products. In creating the "superstore" strategy, we have attempted to develop a more efficient link between suppliers and the small and medium-sized customers which generally do not have direct access to large suppliers and must purchase exclusively through distributors. The primary aspects of our strategy include:

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Inventory. Our core strategy includes maintaining a substantial inventory of discrete and passive components purchased at prices generally lower than those commonly available to its competitors. This strategy allows us to fill customer orders immediately from stock held in inventory. We believe that our most important competitive advantage is the depth of our inventory. Unlike other distributors who carry only the best-selling discretes, our entire inventory consists of a wide range of discrete semiconductors, optoelectronic devices and passive components. However, we are also focusing on lowering our inventory levels to balance with the weakened demand experienced throughout 2005. With immediate availability of a wide selection of products and brands, we believe that sales may grow if the market rebounds. See Part II, Item 6 - "Management's Discussion and Analysis - Liquidity and Capital Resources".

Private brands and custom made parts. To assure the best quality of the product with the most competitive price, we choose the best product lines among existing suppliers and market them under the "TCI" or "PSD" brand. These private label products are manufactured according to our specification under a special contract agreement with certain manufacturers. Custom made parts are also available by following either customer's specification or specially made engineering specification. We believe custom made parts business is more stable and profitable than the traditional commodity type business.

Strategic Purchasing. When the opportunity presented itself, we made opportunistic purchases of a supplier's uncommitted inventory in order to take advantage of favorable pricing. We also made significant purchases in advance in an attempt to maintain consistent inventory levels and meet anticipated orders. When possible, we attempt to control our inventory risks by matching large customer orders with simultaneous purchases from suppliers. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Need to Maintain Large Inventory; Price Fluctuations".

Support Small Distributors, CEMs and OEMs. We focus our marketing efforts on small contract manufacturers, distributors, CEMs and OEMs who generally do not have direct access to suppliers because of their limited purchasing volumes and, therefore, usually have to purchase their requirements from large distributors, often with substantial markups. During the last few years, there have been substantial consolidations within the electronics distribution industry creating very large distributors. This trend to consolidate creates opportunities for us since suppliers do not usually direct sales efforts toward small and medium-sized CEMs and OEMs and often the larger distributors no longer adequately service small customers. We believe that our strategic purchasing policies enable us to provide small and medium-sized CEMs and OEMs and distributors competitive prices while maintaining adequate profit margins. We generally do not impose minimum order limitations on our customers, which enables smaller customers to avoid the costs of carrying large inventories. We also offer our customers a limited range of value-added services such as cutting and forming, quality monitoring and product source tracing. We intend to grow by developing our market role into value-added design and engineering services for the small OEMs and CEMs.

Master Distributor. We distribute electronic components to other distributors, including nationwide distributors, when their inventory cannot fulfill immediate customer orders. With its higher volume, lower cost inventory, we act as a master distributor for certain of its component suppliers. We estimate that approximately 35% of our sales are a direct result of being a master distributor.

Preferred Distributors. We developed a Preferred Distributor Agreement with certain selective distributor customers to promote a much stronger business relationship. Under these agreements, our preferred distributors provide point of sales (POS) reports which identify the distributor's customers and we provide the preferred distributors with limited price protection, limited stock rotations and return privileges among other benefits. As of the date of this Report, we maintain Preferred Distributor Agreements with 9 selected distributors. We intend to maintain only a few preferred distributors in each geographical region.

Relationships with Suppliers. Stock rotation and price protection privileges are beneficial to distributors because they enable distributors to reduce inventory cost or rotate inventory they are unable to sell, thus reducing the risks and costs associated with over-purchasing or obsolescence. Price protection mitigates the risks of falling prices of components held in inventory. Since 2001, we have been aggressively pursuing new distribution agreements that provide us with stock rotation and price protection privileges. These distribution agreements also provide stock buy back terms where suppliers will buy back inventory from the distributor if either the supplier or distributor terminates the distribution agreement. We also believe that we have been able to gain a competitive advantage over other distributors by sometimes foregoing or not demanding these privileges (and thus assuming the risk for over-purchasing, product obsolescence and price fluctuations) in order to obtain better pricing. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Need to Maintain Large Inventory; Price Fluctuations" and "Business - Suppliers".

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Reliable One Stop Shopping. We offer a large selection of different name-brand discrete semiconductors, optoelectronic devices and passive components at competitive prices which reduce the number of suppliers a buyer must use to purchase these devices and components. We provide customers with catalogs that are specially designed to aid customers in quickly locating the types and brands of products that they need. Because of our large inventory, we often can fill a significant portion, or all, of a customer's order from stock. Historically, we have been able to fill most of our customers' orders within 24 hours and in compliance with their requested delivery schedules. See Part II Item 6 - "Management's Discussion and Analysis - Results of Operations", "Business - Customers" and "Business - Sales and Marketing Channels".

Broken Package Sales. From time to time, we have broken the minimum package for specific customers who demanded only a partial reel or bag for their prototype or pilot run. With the new development of web order entry system (WOE) and the completion of warehouse management system (WMS), we are able to perform the broken package sales more economically and efficiently. We will target local distributors, OEMs and CEMs to release their financial burden of carrying unwanted parts in their stock.

Web Order Entry (WOE) and Customer Drop Shipment (CDS). The demand of web purchasing from buyers around the world is growing rapidly. We have developed a web order entry system for existing customers to access our inventory and to place purchase orders in real time. Not only they will get the sales order and shipment confirmation on the same day, but also be able to assign the drop shipments to their customers directly. We believe this is a new trend to many local distributors and brokers who want to serve their customers more effectively and efficiently without material handling costs.

Vendor Managed Inventory (VMI). A special VMI contract is available for our major OEM customers who often release their purchase orders based on short notice, usually within 24 hours. Based on their non-cancelable and non-returnable purchase orders, we allocate these products in advance within a separate VMI storage area in our warehouse to ensure we cover any short term demand. Our VMI system is fully operational from web by mangers who could be our customers, sales representatives or employees.

Products

We market a wide variety of discrete semiconductors, including rectifiers (or power diodes), diodes, transistors, optoelectronic devices and passive components, to other electronic distributors, contract electronic manufacturers and original equipment manufacturers, who incorporate them in their products. At December 31, 2005, our inventory consisted of over 14,000 different products manufactured by more than 100 different suppliers.

In 2005, we purchased products from over 50 suppliers, including Everlight Electronics Co, Ltd., KEC America Corporation, Samsung Electro-Mechanics Co., Vishay Americas Inc. and Zowie Technology Corporation. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Suppliers", "Business - Customers" and "Business - Suppliers".

Discretes are categorized based on various factors, including capacity, construction, fabrication and function. The products we sell include:

Rectifiers. Rectifiers generally are utilized in power supply and other high power applications to convert alternating current to direct current. We sell a wide variety of rectifiers, including silicon rectifiers, fast efficient rectifiers, schottky rectifiers, glass passivated rectifiers, fast efficient glass passivated rectifiers, silicon bridge rectifiers, fast recovery, glass passivated bridge rectifiers and controlled avalanche bridge rectifiers.

Diodes. Diodes are two-lead semiconductors that only allow electric current to flow in one direction. They are used in a variety of electronic applications, including signal processing and direction of current. Diodes sold by us include switching diodes, varistor diodes, germanium diodes and zener diodes.

Transistors. Transistors are used in, among other applications, the processing or amplification of electric current and electronic signals, including data, television, sound and power. We currently sell many types of transistors, including small signal transistors, power transistors and power MOSFETS.

Optoelectronic Devices. Optoelectronic devices are solid state products which provide light displays (such as LEDs), optical links and fiber-optic signal coupling. Applications vary from digital displays on consumer video equipment to fiber optic transmission of computer signals to pattern sensing for regulation, such as is found in automobile cruise controls. Optoelectronic devices generally are not classified as discrete semiconductors or integrated circuits, although they incorporate semiconductor materials.

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Passive Components. Passive components are a type of electronic component manufactured with non-semiconductor materials. Passive components such as resistors, capacitors and inductors are used in electronic circuitry but they do not provide amplification. Passive components are basic electronic components found in virtually all electronic products.

The products distributed by us are mature products that are used in a wide range of commercial and industrial products and industries. We believe that a majority of the products we distribute are used in applications where integrated circuits are not viable alternatives. As a result, we have not experienced any material amount of product obsolescence, and do not expect to experience any material amount of product obsolescence in the foreseeable future. However, we cannot assure you that over time the functions for which discretes are used will not eventually be displaced by integrated circuits.

We purchase products from reliable manufacturers who provide warranties for their products that are common in the industry and therefore we conduct limited quality monitoring of our products. We are certified according to the International Standardization Organization (ISO) and we maintain our Certificate under the quality standard ISO 9001:2000.

Our distribution originates from our 55,000 square-foot facility located in Santa Clarita, California. We utilize a computerized inventory control/tracking system which enables us to quickly access inventory levels and trace product shipments. See Item 2 - "Properties."

Customers

We market our products to distributors, CEMs and OEMs. We believe that our strategic purchasing policies allow us to provide smaller and medium-sized distributors, CEMs and OEMs competitive prices while maintaining an adequate profit margin. As a rule, we do not impose minimum order limitations, which enable customers to avoid the cost of carrying large inventories. See "Business - Strategy."

During 2005, we distributed our products to approximately 750 customers. For the years ended December 31, 2005 and 2004, no one customer accounted for more than 8.5% and 6.2%, respectively, of our net sales. We do not believe that the loss of any one customer would have a material adverse effect on our business.

In 2005, distributors represented approximately 35% and both CEMs and OEMs together represented approximately 50% of our net sales. The remaining 15% sales represented other brokers, exporters and overseas customers.

We historically have not required our distributor customers to provide any point of sale reporting and therefore we do not know the different industries in which our products are sold by our distributor customers. However, based on our sales to CEMs and OEMs, we believe that no single industry accounted for a majority of the applications of the products sold in 2005 or 2004.

We offer customers inventory support which includes carrying inventory for their specific needs and providing free samples of our products. We also offer customers a limited range of value-added services, such as lead cutting and bending for specific applications, enhanced quality monitoring and product source tracing, but, to date, these value-added services have not been material to our business or results of operations.

We believe that exceptional customer service and customer relations are key elements of our success, and train our sales force to provide prompt, efficient and courteous service to all customers. See "Business - Sales and Marketing Channels." We have the ability to ship most orders the same day they are placed and, historically, most of our customers' orders have been shipped within the requested delivery schedule.

As our customers grow in size, we may lose our larger customers to our own suppliers and as the electronics distribution industry consolidates, some of our customers may be acquired by competitors. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Competition".

Sales and Marketing Channels

As of March 1, 2006, our sales and marketing department consisted of 11 employees. We have centralized our sales order processing and customer service department into our headquarters at Santa Clarita, California. However, we retained outside sales account managers in the states of Massachusetts and Georgia. Our inside sales and customer service departments are divided into regional sales territories throughout North America. The outside sales account managers are also responsible for developing new CEM and OEM accounts, as well as working locally with our independent sales representatives and preferred distributors.

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We also supply products to national distributors who share our franchised lines. These national distributors usually have many office locations throughout the United States and are larger than us. We serve the national distributors by providing easy access to discrete products that they choose not to stock, as well as supporting their needs in inventory shortage situations. Sales to national distributors were $51,000 in 2005 and $100,000 in 2004.

We have sales channels into Central America through our majority-owned subsidiary in Mexico City, Mexico. Central American sales were $626,000 and $514,000 in 2005 and 2004, respectively.

We have sales channels into Asia through our branch office in Taipei, Taiwan. Sales to Asian customers were $439,000 and $507,000 in 2005 and 2004, respectively.

We also have sales channels into South America through our branch office in Sao Paulo, Brazil. South American sales were $351,000 and $322,000 in 2005 and 2004, respectively.

Independent sales representatives have played an important role in developing our client base, especially with respect to OEMs. Many OEMs want their suppliers to have a local presence and our network of independent sales representatives is responsive to those needs. Independent sales representatives are primarily responsible for face-to-face meetings with our customers, and for developing new customers. Independent sales representatives are each given responsibility for a specific geographic territory. Typically, sales representatives are only compensated for sales made to CEMs, OEMs and preferred distributors. We believe that this commission policy directs independent sales representatives' attention to those end users with potential to increase market share. Along with our independent sales representatives, we jointly advertise and participate in trade shows. We utilized 7 independent sales representatives during 2005.

We provide customers with catalogs that are specially designed to aid them to quickly find the types and brands of discrete semiconductors and passive and optoelectronic devices that they need.

Suppliers

We believe that it's important to develop and maintain good relationships with our suppliers. We do not typically enter into long-term supply, distribution or franchise agreements with our suppliers, but instead cultivate strong working relationships with each of our suppliers. However, we have entered into certain franchise agreements with some of our suppliers. The franchise agreements have terms from one to two years with inventory and price protection programs. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Relationship with Suppliers".

In order to facilitate good relationships with our suppliers, we typically will carry a complete line of each supplier's discrete products. We also support our suppliers by increasing their visibility through advertising and participation in regional and national trade shows. We generally order components far in advance, helping suppliers plan their production. Outstanding commitments to purchase inventory from suppliers as of March 1, 2006 were approximately $2,054,000. In addition, we have distribution agreements with certain suppliers which provide stock-rotation, price protection and stock buy back terms. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Need to Maintain Large Inventory; Price Fluctuations" and "Business - Strategy".

In 2005, we purchased components from over 50 different suppliers, including Everlight Electronics Co, Ltd., Samsung Electro-Mechanics Co. and Vishay Americas Inc. We are continually attempting to build relationships with suppliers and from time to time add new suppliers in an attempt to provide our customers with a better product mix. Also, our relationships with suppliers have been terminated from time to time. The possibility exists that the loss of one or more distribution relationships with a supplier might have a material adverse effect on us and our results of operations. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Relationship with Suppliers".

For the year ended December 31, 2005, Samsung Electro-Mechanics Co. and Everlight Electronics Co, Ltd., together accounted for approximately 31% of our net purchases. However, we do not regard any one supplier as essential to our operations, since equivalent replacements for most of the products we market are either available from one or more of our other suppliers or are available from various other sources at competitive prices. We believes that, even if we lose a direct relationship with a supplier, there exist alternative sources for another supplier's products. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Relationship with Suppliers."

In design and engineering services, we have built relationships with few selected system integration vendors in China providing quality service and warranty of the finished products. Most of our current projects involve multiple year cooperation

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among components suppliers, overseas vendors and our end customers in the U.S.A., therefore, we believe such arrangements may increase the business stability and reduce the financial risk of excess inventory.

Competition

We operate in a highly competitive environment and face competition from numerous local, regional and national distributors (both in purchasing and selling inventory) and electronic component manufacturers, including some of our own suppliers. Many of our competitors are more established and have greater name recognition and financial and marketing resources than us. We believe that competition in the electronic industry is based on breadth of product lines, product availability, choice of brand name, customer service, response time, competitive pricing and product knowledge, as well as value-added services. We believe we compete effectively with respect to breadth and availability of inventory, response time, pricing and product knowledge. Generally, large component manufacturers and large distributors do not focus their internal selling efforts on small and medium-sized OEMs, CEMs and distributors, which constitute the vast majority of our customers. However, should our customers increase in size, component manufacturers may find it cost effective to focus direct sales efforts on those customers, which could result in the loss of customers or decreased selling prices. See Part II, Item 6 - "Management's Discussion and Analysis - Cautionary Statements and Risk Factors - Competition" and "Business - Electronic Distribution Channels".

Management Information Systems

We have made a significant investment in computer hardware, software and personnel. The Management Information Systems (MIS) department is responsible for software and hardware upgrades, maintenance of current software and related databases, and designing custom systems. We believe that our MIS department is crucial to our success and believe in continually upgrading our hardware and software. We also developed a vendor management inventory software program which allows participating customers to access and manage their own inventory through the internet. The web site also provides users with other current information about us.

Warehouse Management System

We utilize a wireless, fully bar-coded warehouse tracking system that greatly enhances the processing speed, accuracy of product quantity and location control within the warehouse. It also reduces potential errors and accelerates the delivery of components to our customers. We continuously improve our warehouse management system with custom programming features.

Foreign Trade Regulation

A large portion of the products we distribute are manufactured in Asia, including Taiwan, Hong Kong, Japan, China, South Korea, Thailand and the Philippines. The purchase of goods manufactured in foreign countries is subject to a number of risks, including economic disruptions, transportation delays and interruptions, foreign exchange rate fluctuations, imposition of tariffs and import and export controls, and changes in governmental policies, any of which could have a material adverse effect on our business and results of operations.

Sales to Asian customers were 5.2% and 5.4% of our total sales in 2005 and 2004, respectively.

From time to time, protectionist pressures have influenced U.S. trade policy concerning the imposition of significant duties or other trade restrictions upon foreign products. We cannot predict whether additional U.S. customs quotas, duties, taxes or other charges or restrictions will be imposed upon the importation of foreign components in the future or what effect any of these actions would have on our business, financial condition or results of operations.

The ability to remain competitive with respect to the pricing of imported components could be adversely affected by increases in tariffs or duties, changes in trade treaties, strikes in air or sea transportation, and possible future U.S. legislation with respect to pricing and import quotas on products from foreign countries. For example, it is possible that political or economic developments in China, or with respect to the United States' relationship with China, could have an adverse effect on our business. Our ability to remain competitive also could be affected by other governmental actions related to, among other things, anti-dumping legislation and international currency fluctuations. While we do not believe that any of these factors adversely impact our business at present, we cannot assure you that these factors will not materially adversely affect us in the future. Any significant disruption in the delivery of merchandise from our suppliers, substantially all of whom are foreign, could have a material adverse impact on our business and results of operations. See Part II, Item 6 - "Management's Discussion and Analysis - - Cautionary Statements and Risk Factors - Foreign Trade Regulation."

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Employees

At March 1, 2006, we had 27 employees, all of whom are employed on a full time basis. None of our employees are covered by a collective bargaining agreement and we consider our relations with employees to be good.

Website Availability of Our Reports Filed with the Securities and Exchange Commission

We maintain a website with the address www.taitroncomponents.com. We are not including the information contained on this website as a part of, or incorporating it by reference into, this annual report on Form 10-KSB. We make available free of charge through this website our annual reports, quarterly reports and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after it electronically files that material with, or furnish the material to, the Securities and Exchange Commission.