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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

or

Commission file number: 0-23576

CELERITEK, INC.

(408) 986-5060
(Registrant’s telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)

     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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

     Indicate the number of shares outstanding of each of the issuer’s classes of stock, as of the latest practicable date.

     Common Stock, No Par Value: 12,396,210 shares as of October 24, 2003

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CELERITEK, INC.

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PART I FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

CELERITEK, INC.

Note:

The balance sheet at March 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

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CELERITEK, INC.

See accompanying notes.

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CELERITEK, INC.

See accompanying notes.

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Celeritek, Inc.

Notes to Condensed Consolidated Financial Statements
(Unaudited)

September 30, 2003

1.		Basis of Presentation
		The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.
		The Company’s reporting period consisted of a thirteen-week period ending on the Sunday closest to the calendar month end. The second quarters of fiscal 2004 and fiscal 2003 ended September 28, 2003 and September 29, 2002, respectively. For convenience, the accompanying financial statements have been shown as ending on the last day of the calendar month.
		Operating results for the three and six months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2004. This financial information should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended March 31, 2003 as filed with the Securities and Exchange Commission.
		Certain amounts reported in previous years have been reclassified to conform to the current year presentation.
2.		Stock Based Compensation
		The Company generally grants stock options to its employees for a fixed number of shares with an exercise price equal to the fair value of the shares on the date of grant. The Company records compensation related to employees stock awards under the intrinsic value method and accordingly, no compensation expense is recognized in the Company’s financial statements in connection with stock options granted to employees with exercise prices not less than fair value.
		Pro forma information regarding net loss and net loss per share under the fair value method is presented below (in thousands, except per share amounts):

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Pro forma information regarding net loss and net loss per share is required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-based Compensation (SFAS 123), as amended by SFAS 148, and has been determined as if the Company had accounted for its stock options granted subsequent to December 31, 1994 under the fair value method of SFAS 123. The fair market value for options granted prior to December 1995, the date of the initial public offering of the Company’s common stock, was estimated at the date of grant using the Minimum Value Method. The fair market value for options granted subsequent to December 1995 was estimated at the date of grant using the Black-Scholes option-pricing model. The Company valued its employee stock options using the following weighted-average assumptions:

		The Black-Scholes option valuation model was developed for use in estimating the fair market value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair market value estimate, in management’s opinion, the existing models do not necessarily provide a reliable measure of the fair market value of its options.
		The weighted average grant date fair value of options granted during the three months ended September 30, 2003 and 2002 was $5.12 and $5.26, respectively. The weighted average grant date

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		fair value of Employee Stock Purchases shares granted during the three months ended September 30, 2003 and 2002 was $2.61 and $3.24, respectively.
3.		Inventories
		Inventories, stated at the lower of standard cost (which approximates actual cost on a first-in, first-out method) or market, consists of the following components (in thousands):

4.		Loss Per Share
		Basic loss per common share is computed using the weighted average common shares outstanding during the period. The effect of outstanding stock options is excluded from the calculation of diluted net loss per share, as their inclusion would be antidilutive.
		The following table sets forth the computation of basic and diluted loss per share (in thousands, except per share data):

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5.		Comprehensive Loss
		The components of comprehensive loss for the three and six month periods ended September 30, 2003 and 2002 are as follows (in thousands):

6.		Strategic Investments
		The Company regularly reviews its investments for circumstances of impairment and assesses the carrying value of the assets against market value. When an impairment exists, the Company records an expense to the extent that the carrying value exceeds fair market value in the period the assessment was made. The fair value of strategic investments is dependent on the performance of the companies invested in, as well as the marketability of these investments. In assessing potential impairment of these investments, management considers these factors as well as forecasted financial performance of the investees. If these forecasts are not met or if market conditions change, the Company may have to record additional impairment charges.
		Handset Design Company
		In December 2001, the Company invested $0.5 million in a Korean handset design company. On April 1, 2002, the Company invested an additional $2.0 million in the handset design company. The Company does not have significant influence over the management of the handset design company and accordingly has accounted for the investment on a cost basis in all reported periods. The Company reviewed the investment as of September 30, 2003 and determined no indicators of impairment were present that would indicate the current carrying value of the investment was impaired.
		GaAs Foundry
		In December 2000, the Company invested approximately $2.4 million in a GaAs foundry under construction in Taiwan in exchange for a strategic interest in the foundry. The Company has accounted for this investment using the cost basis in all reported periods.
		During the fourth quarter of fiscal 2002 and the first and fourth quarter of fiscal 2003, the Company recorded impairment charges of approximately $1.7 million, $0.3 million and $0.1 million, respectively, against its strategic investment in the Taiwanese foundry, which was deemed, in those respective periods, to have an other than temporary decline in value. The Company reviewed the

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		investment as of September 30, 2003 and determined no indicators of further impairment were present that would indicate the current carrying value of the investment was impaired.
7.		Intangible Assets
		Intangible assets consist of the following (in thousands):

		In late September 2003, the Company exited the wireless handset power amplifier market and was in final negotiations to sell certain tangible assets and all of its intangible assets. As a result, the Company reclassified certain tangible and intangible assets to be sold, as “Assets Held for Sale” as part of “prepaid expenses and other current assets” (note 8).
8.		Assets Held for Sale
		Assets held for sale are intangible and tangible assets actively being marketed for disposal at September 30, 2003. The assets are stated at the lower of their carrying amounts and estimated fair value, net of selling costs, and are classified as current assets. The Company completed the sale of the identified assets on October 15, 2003. See Note 13 – Subsequent Events. The following table summarizes the assets classified as held-for-sale and the assessment of their carrying value (in thousands):

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9.		Special Charges
		The special charges of $2.6 million recorded during the second quarter of fiscal 2004 were due to the Company’s restructuring activities at its Belfast facility in July 2003, and the Company’s decision to exit the wireless handset power amplifier market in September 2003. The special charges of $2.6 million are comprised of approximately $0.2 million of impairment charges related to the writedown of carrying values for certain tangible and intangible assets to be sold, $1.8 million of equipment impairment charges related to exiting the wireless handset power amplifier market, and $0.6 million of equipment impairment charges related to restructuring at the Belfast facility.
		The following table summarizes the Company’s special charges activity (in thousands):

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10.		Product Warranty
		The Company warrants its products against defects in design, materials, and workmanship, generally for one year from the date of shipment for all of its products. The actual term could vary depending on the specific customers. An accrual for estimated future costs relating to warranty expense is recorded, as a percentage of revenue based on prior experience, when revenue is recorded and is included in cost of goods sold. Factors that affect the Company’s warranty liability include historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
		Changes in the Company’s product liability during the three and six months ended September 30, 2003 and 2002 were as follows (in thousands):

11.		Cost Related to Shareholder and Strategic Actions
		In the fourth quarter of fiscal 2003, a group of shareholders (the “Shareholder Committee”) called a special meeting to remove the Company’s Board of Directors from office and replace them with a different slate of candidates. In May 2003 the Company’s Board of Directors entered into an agreement with the Shareholder Committee. Under the terms of the agreement, the Company has expanded its Board of Directors from six directors to seven. The new Board is now composed of three of the Company’s directors who were directors prior to the agreement, three directors nominated by the Shareholder Committee and one member who is not affiliated with either the Company or the Shareholder Committee.
		The four new directors were each automatically granted options to purchase 6,000 shares of common stock.
		In the first six months of fiscal 2004, expenses of $1.4 million related to the special meeting of shareholders and $1.4 million in investment banking fees were incurred and reported in loss from operations under the caption “Cost related to shareholder and strategic actions.”
12.		Recent Accounting Pronouncements
		In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to

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		support its activities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period ending after December 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company will adopt FIN 46 in the third quarter of fiscal 2004 and this does not expect that this will have a material impact on its financial position or results of operations.
		In December 2002, the FASB issued Statement Number 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148). SFAS 148 amends Statement Number 123, “Accounting for Stock-Based Compensation,” (SFAS 123) to provide alternative methods of transition to the SFAS 123 fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The transition provisions of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The transition provisions do not currently have an impact on our consolidated financial position and results of operations as we have not elected to adopt the fair value based method of accounting for stock-based employee compensation under SFAS No. 123. We adopted the disclosure provisions of SFAS No. 148 and, accordingly, have included such disclosures in the financial statements for the three and six month periods ended September 30, 2003.
		In May 2003, the FASB issued Statement Number 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). This Statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 generally requires liability classification for two broad classes of financial instruments: (1) instruments that represent, or are indexed to, an obligation to buy back the issuer’s shares, and (2) obligations that can be settled in shares, but are subject to certain conditions. SFAS 150 applies to all financial instruments created or modified after May 31, 2003, and to other instruments at the beginning of the first interim period beginning after July 1, 2003. As we have not created or modified any financial instruments since the effective date of SFAS 150, we do not believe this Statement will have a material impact on our financial statements.
		In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21 Accounting for Revenue Arrangements with Multiple Deliverables. The EITF concluded that revenue arrangements with multiple elements should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and as long as there are no rights of return or additional performance guarantees by the Company. The provisions of EITF Issue No. 00-21 are applicable to agreements entered into in fiscal periods beginning after June 15, 2003. Management adopted the consensus in the second quarter of fiscal 2004 and it did not have a material effect on the Company’s results of operations or financial condition.
13.		Rights Plan Termination
		On June 6, 2003, the Company amended its shareholder rights plan (the “Rights Plan”) to accelerate the final expiration date of the Preferred Share Purchase Rights issued thereunder from April 8, 2009

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		to June 13, 2003. The Company terminated the Rights Plan upon expiration of the purchase rights on June 13, 2003.
14.		Subsequent Events
		In late September 2003, the Company exited the wireless handset power amplifier market and subsequently in early October 2003, reduced its headcount by 39 persons in the United States and 3 persons in Korea and is in the process of closing its Korean subsidiary and consolidating its Santa Clara operations into one building. The Company expects to incur approximately $2.4 million in special charges in the next several quarters related to employee termination expenses, building lease termination and facilities consolidation costs.
		On October 15, 2003, the Company sold the intangible and certain tangible assets used to develop products for the wireless handset power amplifier market to Anadigics, Inc. for approximately $1.0 million.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

     This report contains forward-looking statements, which are identified by words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend” and other similar expressions. In addition, forward looking statements in this report include, but are not limited to, those regarding: focusing our resources on market areas where we believe our core competencies will allow us the greatest opportunity of success in our goal of returning to profitability; our consolidation of operations into one building in Santa Clara and the closing of our Korean subsidiary; expected special charges as a result of existing the wireless handset power amplifier market; our gross margins; research and development expenses; investment banking fees and selling, general and administrative expenses; and our belief that our cash and borrowings from equipment financing should be sufficient to meet our liquidity needs through at least the next twelve months. These forward-looking statements are subject to business and economic risks and uncertainties, and our actual results of operations may differ materially from those contained in the forward-looking statements. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. However, readers should carefully review the risk factors set forth in this Form 10-Q and other reports or documents we file from time to time with the Securities and Exchange Commission.

Critical Accounting Policies

     The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires us to make estimates and assumptions that affect the reported amounts. Some of the estimation processes affect current assets and liabilities and are therefore critical in assessing our financial and operating status. These estimates involve certain assumptions that, if incorrect, could have a material adverse impact on our operations and financial position.

     We review our estimates, including, but not limited to, allowance for doubtful accounts, inventory write-downs, and impairments of long-lived assets and investments on a regular basis and make adjustments based on historical experiences and existing and expected future conditions. These evaluations are performed

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regularly and adjustments are made, as information is available. We believe that these estimates are reasonable; however, actual results could differ from these estimates. The following paragraphs describe the methodology we use in making some of our principal accounting estimates, in evaluating some of the uncertainties inherent in accounting estimates and in evaluating some of the ways that our estimates may impact our financial condition.

     Revenue Recognition. Revenue related to product sales is recognized when the products are shipped to the customer, title has transferred and no obligations remain. In circumstances where the collection of payment is not probable at the time of shipment, we defer recognition of the revenue until payment is collected. We provide for expected returns based on past experience as well as current customer activities. Our customers do not have rights of return outside of products returned under warranty and, to date, returns have not been material. Shipping and handling costs are included in costs of goods sold for all periods presented.

     Allowance for Doubtful Accounts. We establish an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We evaluate our customers’ financial position and order level to determine if an allowance should be established. Any change in the allowance from our assessment of the likelihood of receiving payment is reflected in the selling, general, and administrative costs in the period the change in assessment is made.

     Inventory Write-downs. We record inventory write-downs for estimated obsolescence or unmarketable inventory. Our write-downs for excess and obsolete inventory are primarily based upon forecasted demand and our backlog of orders for the product. Any inventory write-downs are reflected in cost of sales in the period the write-downs are made.

     Long-lived Assets and Strategic Investments. We regularly review our long-lived assets and strategic investments for indicators of impairment and assess the carrying value of the assets against market values. When impairment exists, we record an expense to the extent that the carrying value exceeds fair market value in the period the assessment is made.

     We record impairment losses on long-lived assets used in operations or expected to be disposed of when events and circumstances indicate that the undiscounted cash flow estimated to be generated by these assets is less than the carrying amounts of those assets. We consider sensitivities to capacity, utilization and technological developments in making related assumptions.

     The fair value of strategic investments is dependent on the performance of the companies in which we have invested, as well as the marketability of these investments. In assessing potential impairment of these investments, we consider these factors as well as forecasted financial performance of the investees. If these forecasts are not met or if market conditions change, we may assess the value of the strategic investment to be other than temporarily impaired and accordingly record an impairment charge.

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     Intangible Assets. We recorded intangible assets at fair value. Intangible assets with finite useful lives were amortized over their estimated useful life and amortization expense was classified as part of operating expenses. To date, we have only had intangible assets with finite useful lives. We regularly performed reviews to determine if the carrying values of our intangible assets were impaired. We looked for facts, circumstances, either internal or external, that may have indicated we may not have recovered the carrying value of the assets. We recorded impairment losses based on the amount by which the carrying amounts of such assets exceeded their fair values.

Overview

     In late September 2003, we exited the wireless handset power amplifier market. This decision was the result of severe pricing pressure and other adverse market conditions in the wireless handset industry that we believe would have prevented our handset related business from achieving acceptable gross margins. This decision will allow us to focus our resources on market areas where we believe our core competencies will allow us the greatest opportunity of success in our goal of returning to profitability. As a result of this action, we face increased reliance on the sales of our defense products and semiconductor products for commercial communications, both of which markets may have lower growth potential than the wireless handset market.

     As a result of this action, we incurred $2.6 million in special charges in the second quarter of fiscal 2004 for fixed and intangible asset impairment charges. The special charges of $2.6 million are comprised of approximately $0.2 million of impairment charges related to the reassessment of carrying values for certain tangible and intangible assets to be sold, $1.8 million of equipment impairment charges related to exiting the wireless handset power amplifier market, and $0.6 million of equipment impairment charges related to restructuring at the Belfast facility.

     On October 15, 2003, we sold all the intangible and certain tangible assets related to the wireless handset power amplifier market for $1.0 million to Anadigics, Inc. We also terminated 42 employees in early October 2003, and are in the process of consolidating our Santa Clara operations into one building and closing our Korean subsidiary. We expect to incur special charges of approximately $2.4 million over the next several quarters related to employee termination expenses, a building lease termination and facilities consolidation costs.

     We anticipate realizing annual cost savings in the range of $9.0 to $10.0 million compared to our expense rate before these actions were taken.

Result of Operations – Second Quarter of Fiscal 2004 Compared to Second Quarter of Fiscal 2003:

     Total net sales were $7.1 million for the second quarter of fiscal 2004, compared to $15.5 million for the second quarter of fiscal 2003, a decrease of 54%.

     Semiconductor sales were $2.2 million in the second quarter of fiscal 2004, compared to $11.4 million in the second quarter of fiscal 2003, a decrease of 81%. Sales in the second quarter of fiscal 2004 did not include any sales of power amplifier modules for handsets, while sales in the second quarter of fiscal 2003 included $10.4 million of sales of power amplifier modules for handsets. Motorola, which was our largest customer for this product, transitioned from the handset platform on which we were the sole source for power amplifier modules, to new handset platforms for which we are not supplying modules. While sales of infrastructure products almost doubled in the second quarter of fiscal 2004 as compared to the second quarter of fiscal 2003, they were not significant enough to offset the loss of the handset related sales. Based on our decision to exit the wireless handset market, we do not expect any future sales for handset related products.

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     Subsystem sales in the second quarter of fiscal 2004 were $4.9 million, compared to $4.1 million in the second quarter of fiscal 2003, an increase of 20%. The increase in sales of subsystems products to defense customers is primarily the result of many defense customers making purchases for specific programs, and therefore product demand fluctuates from quarter to quarter.

     Gross margin was 19% of net sales in the second quarter of fiscal 2004, compared to 25% of net sales in the second quarter of fiscal 2003. The decrease in gross margin was primarily due to decreased semiconductor sales volume. We do not expect significant improvement in gross margin until sales volumes increase because of fixed costs related to our fabrication facility.

     Research and development expenses were $2.9 million, or 41% of net sales, in the second quarter of fiscal 2004, compared to $2.7 million, or 18% of net sales, in the second quarter of fiscal 2003, an increase of 6%. Research and development expenses increased due to our acquisition of Tavanza. A significant part of our research and development efforts were focused on developing handset products for the market in South Korea. We expect research and development expenses to decrease because we exited the wireless handset power amplifier market and reduced our headcount accordingly.

     Selling, general and administrative expenses were $2.2 million, or 32% of net sales, in the second quarter of fiscal 2004, compared to $2.3 million, or 15% of net sales, in the second quarter of fiscal 2003, a decrease of 1%. The decrease was primarily due to lower selling costs driven by the decrease in revenues. We expect selling, general and administrative expenses to be fairly consistent with this quarter, absent any special charges.

     The $0.2 million in costs related to shareholder and strategic actions in the second quarter of fiscal 2004 was for investment banking fees. The $0.5 million in costs related to shareholder and strategic actions in the second quarter of fiscal 2003 was for legal and investment advisors in response to an unsolicited offer from Anaren Microwave, Inc. We expect to incur additional investment banking fees of at least $0.6 million through March 2004

     The special charges of $2.6 million in the second quarter of fiscal 2004 are comprised of approximately $0.2 million of impairment charges related to the reassessment of carrying values for certain tangible and intangible assets to be sold, $1.8 million of equipment impairment charges related to exiting the wireless handset power amplifier market, and $0.6 million of equipment impairment charges related to restructuring at the Belfast facility.

     Amortization of intangibles was $0.1 million during the second quarter of fiscal 2004. The intangible assets were acquired as part of the purchase of Tavanza’s assets during the third quarter of fiscal 2003. At the end of the second quarter of fiscal 2004, the intangible assets were reclassified to assets held for sale based on our decision in September 2003 to exit the wireless handset power amplifier market. These assets were subsequently sold on October 15, 2003; accordingly, no amortization expense will be recorded in future periods.

     Interest income and other, net was $1.0 million in the second quarter of fiscal 2004 compared to $0.5 million in the second quarter of fiscal 2003. The increase in interest income and other, net, was due to the collection of a customer’s order cancellation charge of $0.8 million, offset by lower interest rates on lower cash balances.

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Result of Operations – First Six Months of Fiscal 2004 Compared to the First Six Months of Fiscal 2003:

     Total net sales were $13.7 million for the first six months of fiscal 2004, compared to $30.8 million for the first six months of fiscal 2003, a decrease of 56%.

     Semiconductor sales were $3.8 million in the first six months of fiscal 2004, compared to $20.8 million in the first six months of fiscal 2003, a decrease of 82%. Sales in the first six months of fiscal 2004 did not include any sales of power amplifier modules for handsets, while sales in the first six months of fiscal 2003 included $18.9 million of sales of power amplifier modules for handsets. Motorola, which was our largest customer for this product, transitioned from the handset platform on which we were the sole source for power amplifier modules, to new handset platforms for which we are not supplying modules. While sales of infrastructure products doubled in the first six months of fiscal 2004 as compared to the first six months of fiscal 2003, they were not significant enough to offset the loss of the handset related sales. Based on our decision to exit the wireless handset market, we do not expect any future sales for handset related products.

     Subsystem sales in the first six months of fiscal 2004 were $9.9 million, compared to $10.0 million in the first six months of fiscal 2003, a decrease of 1%.

     Gross margin was 14% of net sales in the first six months of fiscal 2004, compared to 25% of net sales in the first six months of fiscal 2003. The decrease in gross margin was primarily due to decreased semiconductor sales volume. We do not expect significant improvement in gross margin until sales volumes increase because of fixed costs related to our fabrication facility.

     Research and development expenses were $5.8 million, or 43% of net sales, in the first six months of fiscal 2004, compared to $5.4 million, or 18% of net sales, in the first six months of fiscal 2003, an increase of 9%. Research and development expenses increased due to our acquisition of Tavanza. A significant part of our research and development efforts were focused on developing handset products for the market in South Korea. We expect research and development expenses to decrease because we exited the wireless handset power amplifier market and reduced our headcount accordingly.

     Selling, general and administrative expenses were $4.4 million, or 32% of net sales, in the first six months of fiscal 2004, compared to $4.9 million, or 16% of net sales, in the first six months of fiscal 2003, a decrease of 11%. The decrease was primarily due to lower selling costs driven by the decrease in revenues and lower personnel costs. In addition, we incurred management information systems consulting costs of approximately $0.2 million in the first six months of fiscal 2003. We expect selling, general and administrative expenses to be fairly consistent with this quarter, absent any special charges.

     The $2.7 million in costs related to shareholder and strategic actions in the first six months of fiscal 2004 consisted of approximately $1.4 million in expense related to the special meeting of shareholders and $1.3 million in investment banking fees. The $.5 million in costs related to shareholder actions in the first six months of fiscal 2003 was for legal and investment advisors in response to an unsolicited offer from Anaren Microwave, Inc. We expect to incur additional investment banking fees of at least $0.6 million through March 2004.

     The special charges of $2.6 million are comprised of approximately $0.2 million of impairment charges related to the reassessment of carrying values for certain tangible and intangible assets to be sold, $1.8 million of equipment impairment charges related to exiting the wireless handset power amplifier market, and $0.6 million of equipment impairment charges related to restructuring at the Belfast facility.

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     The $0.3 million impairment of strategic investment included in the first quarter of fiscal 2003 was the result of a further impairment of our investment in a Taiwanese foundry. The additional impairment charge was determined after analysis of changes in the market values of public companies in the GaAs market from March 2002 to June 2002. We reviewed the investment as of September 30, 2003 and determined no indicators of further impairment were present that would indicate the current carrying value of the investment was impaired.

     The following table summarizes our special charges activity (in thousands):

     Amortization of intangibles was $0.2 million during the first six months of fiscal 2004. The intangible assets were acquired as part of the purchase of Tavanza’s assets during the third quarter of fiscal 2003. At the end of the second quarter of fiscal 2004, the intangible assets were reclassified to assets held for sale based on our decision in September 2003 to exit the wireless handset power amplifier market. These assets were subsequently sold on October 15, 2003; accordingly, no amortization expense will be recorded in future periods.

     Interest income and other, net was $1.2 million in the first six months of fiscal 2004 compared to $0.9 million in the first six months of fiscal 2003. The increase in interest income and other, net, was due to the collection of a customer’s order cancellation charge of $0.8 million, offset by lower interest rates on lower cash balances.

     Liquidity and Capital Resources

     We have funded our operations to date primarily through cash flows from operations and sales of equity securities. As of September 30, 2003, we had $13.5 million in cash and cash equivalents, $73.3 million in short-term investments and $84.2 million in working capital.

     Net cash used by operating activities was $7.0 million in the first six months of fiscal 2004 and was due primarily to the quarterly net losses partially offset by non-cash impairment charges and decreases in accounts receivable and inventory. Net cash provided by operating activities was $8.6 million in the first six months of fiscal 2003 and was due mainly to decreases in accounts receivable and inventory and increases in accounts payable and other current liabilities.

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     Net cash used by investing activities was $7.0 million in the first six months of fiscal 2004 and was due to the net purchases, sales and maturities of short-term investments of approximately $6.7 million and the purchase of property and equipment of approximately $0.4 million. Net cash used by investing activities was $5.6 million in the first six months of fiscal 2003 and was due to the net purchases, sales and maturities of short-term investments of approximately $2.4 million, the purchase of property and equipment of approximately $1.2 million, and further investment of approximately $2.0 million in a Korean handset design company.

     Net cash used by financing activities was $1.4 million in the first six months of fiscal 2004 and was due to principal payments on long-term debt of approximately $1.4 million and payments on capital leases of approximately $0.3 million offset by cash proceeds of $0.3 million from the issuance of common stock. Net cash used by financing activities was approximately $1.0 million in the first six months of fiscal 2003 and was due to principal payments on long-term debt of approximately $1.1 million and payments on capital leases of approximately $0.3 million off set by cash proceeds of $0.5 million from the issuance of common stock. As of September 30, 2003, we had $0.5 million in outstanding letters of credit, which are secured by certificates of deposits. Given our cash position, we currently do not have a line of credit.

     We believe that our current cash resources and borrowings available from our equipment financing sources should be sufficient to meet our liquidity requirements through at least the next twelve months.

Commitments

     We do not have any special purpose entities. We have no commercial commitments with related parties, except for employee loans. We have outstanding loans to certain current and former employees totaling approximately $1.4 million at September 30, 2003. The notes are relocation loans collateralized by certain real property assets, bear no interest and have maturities through 2019. The principal will be repaid at various dates. If an employee voluntarily ceases being employed by us, the principal outstanding will be due and payable within 90 days.

     We have various equipment notes outstanding with lenders, which are secured by the equipment. Several of these notes have covenants pertaining to liquidity levels and minimum tangible net worth. As of September 30, 2003 we were in compliance with all covenants.

     We have contractual obligations in the form of operating and capital leases, debt and purchase order commitments. The following table sets forth our future contractual obligations as of September 30, 2003 (in thousands):

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     The table records cash obligations, including future interest repayments, and includes operating lease obligations for equipment that no longer has economic value for us, for which a special charge of $1.3 million was recorded in the third quarter of fiscal 2003 in the statement of operations.

     In addition, we have contractual commitments as of September 30, 2003, relating to our engagement of financial advisory firms pursuant to which we will be required to incur aggregate minimum future costs of approximately $0.6 million through March 2004. However, as is customary for contracts of this type, these commitments may increase above the minimum depending on the value of any strategic transaction we may complete, or the value of our common stock in the event that there is no strategic transaction.

     We have outstanding letters of credit, secured by certificates of deposits, of approximately $0.5 million as security for capital leases for equipment.

RISK FACTORS

     You should carefully consider the risks described below. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, results of operations or cash flows could be adversely affected. In those cases, the trading price of our common stock could decline, and you may lose all or part of your investment.

Because many of our expenses are fixed, we will not achieve profitability until our revenues significantly increase.

     Our business requires us to maintain manufacturing equipment and related support infrastructure that we must pay for regardless of our level of sales. To support our manufacturing capacity we also incur costs for maintenance and repairs and employ personnel for manufacturing and process engineering functions. These expenses, along with depreciation costs, are fixed and do not vary greatly, if at all, when our net sales decrease. In addition, the lead time for developing and manufacturing our products often requires us to invest in manufacturing capacity in anticipation of future demand. The recent decline in market demand has resulted in infrastructure costs in excess of current needs and has resulted in lower earnings. Although we recently exited the wireless handset power amplifier market – which we believe will result in reduced expenses — we are nevertheless still relying on increased sales to manufacturers of commercial communications equipment

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and defense contractors in order to realize a significant increase in revenues. If these sales do not materialize, and if our revenues do not significantly increase to a level commensurate with our installed capacity, we will be unable to achieve profitability.

As a result of our recent exit from the wireless handset power amplifier business, we face risks relating to our increased reliance on sales of our defense products and semiconductor products for commercial communications.

     In late September 2003, we exited the wireless handset power amplifier business in order to focus our resources on market areas where we believe our core competencies will allow us the greatest opportunity of success in our goal of returning to profitability. There is, however, no guarantee that our exit from the wireless handset power amplifier business will enable us to reach profitability on a more expedited basis, or at all. In particular, we now face increased reliance on the sales of our defense products and semiconductor products for commercial communications, both of which markets may have lower growth potential than the wireless handset market. In addition, we may fail to manage successfully our exit from the wireless handset power amplifier business. If we do not properly manage our exit from the handset business, or if our projections with respect to the sales of our defense products and semiconductors products for commercial communications are incorrect, we may fail to achieve profitability and our business may suffer.

Our operating results have fluctuated significantly in the past, and we expect these fluctuations to continue. If our results are worse than expected, our stock price could fall.

     Our operating results have fluctuated in the past, and may continue to fluctuate in the future. These fluctuations may cause our stock price to decline. Some of the factors that may cause our operating results to fluctuate include:

	•		the timing, cancellation or delay of customer orders or shipments, particularly from our largest customers;
	•		fluctuating demand from our defense customers;
	•		the timing of our introduction of new products and the introduction of new products by our competitors;
	•		variations in average selling prices of our products;
	•		the mix of products that we sell;
	•		our ability to secure manufacturing capacity and effectively utilize the capacity;
	•		the availability and cost of components;
	•		GaAs semiconductor component and GaAs-based subsystem failures and associated support costs;
	•		variations in our manufacturing yields related to our GaAs semiconductor components;
	•		market acceptance of our products; and
	•		changes in our inventory levels.

     Any unfavorable changes in the factors listed above or general industry and global economic conditions could significantly harm our business, operating results and financial condition. For example, during the third quarter of fiscal 2003, Motorola, our largest customer, began transitioning to new handset platforms for which we were not the selected supplier of power amplifier modules and our sales were negatively impacted. In addition, in late September 2003, we exited the wireless handset power amplifier market entirely. Due to fluctuations in our net sales and operating expenses, we believe that period to period comparisons of our results of operations are not good indications of our future performance. It is possible that in some future quarter or quarters, our operating results will be below the expectations of securities analysts or investors. In that case, our stock price could decline.

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We depend on a small number of original equipment manufacturers as customers. If we lose one or more of our significant customers, or if purchases by any one of our key customers decrease, our net sales will decline and our business will be harmed.

     We expect that sales to a limited number of customers will account for a large percentage of our net sales in the future and will be a very important component in our plans for returning to profitability.

     If we lose any of our existing major customers, our operating results and business would be harmed. In the first six months of fiscal year 2004, sales to our top ten customers accounted for approximately 65% of our net sales, with one customer making up approximately 15% and another customer making up approximately 12% of those net sales. In fiscal year 2003, sales to our top ten customers accounted for approximately 75% of our net sales, with Motorola making up approximately 41% of those net sales. In fiscal year 2002, sales to our top ten customers accounted for approximately 76% of our net sales, with Motorola making up approximately 43% of those net sales. We had been a sole source supplier of power amplifier modules to Motorola for its model 120v handset platform. However, Motorola transitioned to new platforms, and it selected a sole source supplier other than us for its new platforms. We did not receive any revenue from products for the handset market in the first six months of fiscal 2004 nor do we expect revenue sufficient to replace the Motorola revenue in the next several quarters. Furthermore, as discussed above, we have exited the wireless handset power amplifier market entirely. If we were to lose a major customer, or if orders by any of our major customers were to otherwise decrease or be delayed, our business, operating results and financial condition would be seriously harmed.

We need to keep pace with rapid product and process development and technological changes to be competitive.

     We compete in markets with rapidly changing technologies, evolving industry standards and continuous improvements in products. To be competitive we will need to continually improve our products and keep abreast of new technology and our ability to grow will depend substantially on our ability to continue to apply our GaAs semiconductor components expertise to existing and emerging wireless communications markets. New process technologies could be developed that have characteristics that are superior to our current processes. If we are unable to develop and maintain competitive processes or design products using new technologies, and if we are unable to secure production orders for these products, we will not achieve the significant increase in revenues necessary to achieve profitability, and our business and operating results will suffer. We cannot assure you that we will be able to respond to technological advances, changes in customer requirements or changes in regulatory requirements or industry standards. Any significant delays in our development, introduction or shipment of products could seriously harm our business, operating results and financial condition.

Consolidation of our Santa Clara operations into one facility involves a number of different risks that could adversely affect our business.

     In connection with our exit from the wireless handset power amplifier business, we are in the process of consolidating our Santa Clara operations, which are currently housed into two separate facilities, into one facility. We face a number of risks resulting from this consolidation, including, among other things: possible disruptions in our ability to manufacture our products in a timely fashion; unanticipated costs related to the move; the possible inability to obtain a permit for some of our equipment on a timely basis (which would prohibit our ability to move); and damage to our equipment as a result of our move. If any of the foregoing occur, we may be unable to manufacture and deliver our products in time to meet our customers’ demand and the costs of the move could be greater than anticipated, either of which would adversely affect our business and our ability to regain profitability.

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We are exposed to general economic, market and, additionally, industry conditions.

     Our business is subject to the effects of general economic conditions in the United States and globally, and, in particular, market conditions in the wireless communications and defense industries. In recent quarters, our operating results have been adversely affected as a result of unfavorable economic conditions and reduced capital spending in the United States, Europe and Asia. In particular, sales to customers who supply equipment to service providers of voice and data services have been adversely affected due to significant decline in demand in the wireless infrastructure markets. If the economic conditions in the United States and globally do not improve, if we experience a worsening in the global economic slowdown or if the wireless infrastructure markets do not recover, we may continue to experience material adverse impacts on our business, operating results and financial condition.

We expect our products to experience rapidly declining average sales prices, and if we do not decrease costs or develop new or enhanced products, our margins will suffer.

     In each of the markets where we compete, average sales prices of established products have been significantly declining, and we anticipate that prices will continue to decline and negatively impact our gross profit margins. There is currently over capacity in the markets we serve, which could lead to additional pricing pressure as our competitors seek to improve their asset utilization. Accordingly, to remain competitive, we believe that we must continue to develop product enhancements and new technologies that will either slow the price declines of our products or reduce the cost of producing and delivering our products. If we fail to do so, our results of operations would be seriously harmed.

Our sales to international customers expose us to risks that may harm our business