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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 1-10981

SBS Technologies, Inc.

(505) 875-0600

Securities registered pursuant to Section 12(b) of the Act: None

Title of each class

     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 þ         No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o

     The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on September 3, 2002 as reported on The Nasdaq Stock Market® was $62,255,867. Shares of Common Stock held by each officer and director as of September 3, 2002 and by each person who owns 5% or more of the outstanding Common Stock according to filings with the Securities and Exchange Commission dated June 30, 2002 have been excluded because these persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

     As of September 03, 2002, Registrant had 14,602,935 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Parts of the following document are incorporated by reference into Part III of this Form 10-K Report: (1) Definitive Proxy Statement for Registrant’s 2002 Annual Meeting of Shareholders to be held November 14, 2002.

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SBS TECHNOLOGIES, INC. AND SUBSIDIARIES

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      All statements in this Form 10-K, other than statements of historical fact, that address future financial performance, activities, events or developments that SBS or management intends, expects, projects, believes or anticipates will or may occur in the future are forward-looking statements. These statements include, but are not limited to, expected sales, gross margin, expectations of internally-generated cash flows, new product introductions, and expectations of SG&A and R&D costs. These statements and other forward-looking statements are based upon certain assumptions and assessments made by management of SBS in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes to be appropriate. These assumptions and assessments include the volume and product mix of sales, estimates of costs and inventory and receivable levels, defense spending levels, and other items. The forward-looking statements included in this report are also subject to a number of risks and uncertainties, including but not limited to economic, competitive, supply and demand, governmental and technological factors affecting SBS’ operations, markets, products, services and prices. These forward-looking statements are not guarantees of future performance, and actual results, developments, and business decisions may differ from those expressed or implied by these forward-looking statements.

PART I

Item 1.     Business

     Introduction

      SBS Technologies, Inc. (“SBS”) designs and builds open-architecture embedded computer products that enable original equipment manufacturers (“OEM”) to serve the commercial, communications, enterprise and government markets. SBS’ products are integrated into a variety of applications, including communications networking, medical imaging, industrial automation and military systems. The portfolio includes an extensive line of CPU boards, computer interconnections, avionics, telemetry, and fully integrated systems and enclosures that system designers can easily utilize to create a custom solution specific to the user’s unique application. SBS’ objective is to continue to capitalize on its design expertise and customer service capabilities to enhance product quality and reduce time to market for OEM customers. SBS has grown, and intends to continue to do so, through a combination of internal growth and acquisitions. SBS completed ten acquisitions between 1992 and June 30, 2002 that broadened SBS’ product offerings and customer base. SBS achieves internal growth by expanding its existing product lines through new product development, through increasing penetration of its existing customer base, and by adding new customers.

      SBS was incorporated in New Mexico in November 1986 and began operations in September 1987. SBS’ executive office is located at 2400 Louisiana Boulevard, NE, AFC Building 5, Suite 600, Albuquerque, New Mexico, 87110, telephone number (505) 875-0600. References to “SBS” are to SBS Technologies, Inc. and its consolidated subsidiaries. As of June 30, 2002, SBS had six subsidiaries: SBS Technologies, Inc., Commercial Group (“SBS Commercial”), formerly SBS Technologies, Inc., Modular I/O and SBS Technologies, Inc., Connectivity Products, which merged in May 2002, SBS Technologies, Inc., Government Group (“SBS Government”), formerly SBS Technologies, Inc., Embedded Computers, SBS Technologies, Inc., Industrial Computers (“Industrial Computers”), SBS Technologies, Inc., Communications Products (“Communications Products”), SDL Communications, Inc. (“SDL”) and SBS Technologies, Inc. Foreign Holding Company (“Foreign Holding”). Effective July 1, 2002, the Avionics Products division of SBS was combined with SBS Government. In September 2002, Industrial Computers and SDL merged into Communications Products, at which point the name was changed to SBS Technologies, Inc., Communications and Enterprise Group. SBS Technologies Holding GmbH (“Holding GmbH”) is a subsidiary of Foreign Holding. ortec Electronic Assembly GmbH (“ortec”) is a subsidiary of Holding GmbH. A partnership exists between Holding GmbH, SBS Technologies GmbH & Co. KG (“or”), and the general partner, SBS or Computers Verwaltungs GmbH.

      SBS Technologies®, IndustryPack®, Omnispan® and Denali® are registered trademarks of SBS. PC•MIP® is a registered trademark of MEN Micro, Inc. of Carrollton, Texas, and SBS. SBS has filed

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      The following narrative should be read in conjunction with the Section entitled “Risk Factors.”

     SBS’ Operating Segments and Products

      SBS operates internationally through two operating segments: the Communications and Enterprise Group, and the Commercial and Government Group. These segments were defined during the fourth quarter of fiscal year 2002, in conjunction with the change in the Chief Executive Officer and management’s realignment of operations and market development efforts. To better align similar technologies and selling channels, the former Commercial Group and the former Government Group were combined. The combined group consists of SBS Commercial, SBS Government, or, ortec, and SBS’ Avionics Product division. The Communications and Enterprise Group consists of Communications Products, SDL, and Industrial Computers. These segments are based on the markets that are served and the products that are provided to those markets. Each segment has its own sales and distribution channels and has a manager who reports directly to the President and Chief Operating Officer. The Commercial and Government Group’s primary focus is to serve customers in the medical, semiconductor, aerospace, defense and other commercial markets. The Communications and Enterprise Group serves major telecommunications OEM’s and OEM’s that manufacture and distribute business computing equipment.

     Communications and Enterprise Group Products

      The Communications and Enterprise Group designs and builds high performance embedded system products to serve the needs of communications and enterprise OEM customers. SBS provides a comprehensive portfolio of communication products, which include single board computers, input/ output modules, and fully integrated systems. These products are designed to meet the evolving requirements of communications customers while reducing cost and expediting time to market. These products are based on standard form factor hardware designs such as CompactPCI, PMC, PCI with open standard operating support such as VxWorks and Linux, and consistent driver development kits for ATM, frame relay and other software protocols. SBS’ approach to product engineering and manufacture allows its OEM customers to quickly and efficiently integrate these products using advanced components and software. Typical OEM products in which SBS products are used are optical switches, routers, wireless base stations and access systems, radio network controllers, ATM switches, media gateways, network access servers, test and monitoring equipment, and firewall and security appliances. In fiscal years 2002, 2001 and 2000, sales of these products comprised approximately 30.8%, 49.2%, and 34.3%, respectively, of SBS’ total sales. As of September 1, 2002, 2001, and 2000, backlog orders expected to be filled within the current fiscal year were $6.4 million, $17.7 million, and $40.0 million, respectively. However, SBS has recently experienced order cancellations and requests for extensions of product shipments and may continue to experience these cancellations and extensions, and as a result, shipments of the Communications and Enterprise Group’s current backlog may be delayed or canceled.

     Commercial and Government Group Products

      The Commercial and Government Group designs and builds open-architecture computer components and systems for CompactPCI, PCI, PMC, VME, and PC/104 standard bus architectures. The Group’s product lines include Intel and PowerPC architecture CPU boards, serial and networking modules, analog and digital I/O modules, computer interconnection and expansion units, MIL-STD-1553, ARINC 429, telemetry, and complete computer systems. These products support OEM and end-user applications in semiconductor manufacturing equipment, industrial automation, medical imaging, military and aerospace, and entertainment applications. Standard commercial level products are sold in these segments as well as ruggedized products in the military and aerospace markets. In fiscal years 2002, 2001, and 2000, sales of these products comprised approximately 69.2%, 50.8%, and 65.7%, respectively, of SBS’ total sales. As of September 1, 2002, 2001, and 2000, backlog orders expected to be filled within the current fiscal year were $24.1 million, $16.3 million, and $24.5 million, respectively. However, SBS has in the past experienced order cancellations and requests for

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     Segment Financial Data

      See Notes 13 and 14 to SBS’ Consolidated Financial Statements for information about SBS’ industry segments, geographic areas, and major customers.

     Customers and Applications

      SBS’ broad range of products are used by a diversified OEM customer base in a variety of applications including communications networking, medical imaging, industrial automation and military systems. In fiscal 2002, 2001, and 2000, no one customer equaled or exceeded 10% of SBS’ sales. Most of the Communications and Enterprise Group’s customers are OEM’s serving the telecommunications or business computing markets. They use SBS’ products in applications such as wireless base station controllers, optical switches, routers and network monitoring and security applications. The Commercial and Government Group’s customers are primarily OEM’s building products that are used in semiconductor manufacturing, industrial automation, medical imaging, military and aerospace, and entertainment applications, or customers using SBS’ products in applications such as mission critical components in fighter aircraft and ground vehicles, flight and ground simulation, electronic system test solutions, and data link and command and control applications. Examples of these products include semiconductor manufacturing equipment, CT scan and MRI equipment, automotive manufacturing and test equipment, test and measurement equipment, industrial automation equipment, aircraft flight simulators, and audio mixing and video authoring equipment, systems and equipment for military aircraft, military ground vehicles, telemetry equipment, and space exploration applications.

     Sales and Marketing

      SBS markets its products both domestically and internationally utilizing a combination of direct employee sales personnel, independent manufacturers’ representatives, and distributors. As of September 1, 2002, SBS had 104 employees, who typically hold engineering degrees, in sales, marketing and customer relations, 16 U.S.-based independent manufacturers’ representatives and 44 distributors located outside the U.S. Domestically, SBS’ direct employee sales personnel are deployed regionally throughout the U.S. as sales specialists representing their respective operating segments. Internationally, as of September 1, 2002, SBS had three direct sales employees, located in the United Kingdom, Sweden and France. Also, SBS had one direct sales employee located in the United States who supports SBS’ sales and distribution channels in the Far East. Domestically and internationally, the direct employee sales personnel are supported by field application engineers who provide pre-sale technical support to SBS’ customers. All direct employee sales personnel refer opportunities to appropriate product line managers within their respective operating segments. Sales methods vary between SBS’ operating segments. The Commercial and Government Group serves a diverse set of large and small customers. In order to gain access to this diverse customer base, all available selling channels are used. Domestically, the direct employee sales personnel generally sell to the larger OEM opportunities, while manufactures’ representatives sell to the smaller accounts. Internationally, the direct employee sales personnel sell to the larger OEM opportunities, although all quoting, pricing and final order acceptance of international sales of U.S.-built products is controlled domestically. Independent distributors sell to the smaller accounts. The Communications & Enterprise Group sells to a more cohesive customer set generally made up exclusively of large OEM customers. Selling activities to this customer group generally consist of sales by the direct employee sales personnel associated with this Group. All quoting, pricing and final order acceptance for all sales are controlled by the responsible operating Group.

      SBS maintains its primary sales offices in Albuquerque, New Mexico, Raleigh, North Carolina, Carlsbad, California, St. Paul, Minnesota, and Augsburg, Germany. Sales and sales leads are generated through a range of activities, including direct sales calls, identification of participants in key defense and government related programs, participation in numerous trade shows, direct mail catalogs, advertisements in leading trade publications, and SBS’ web site.

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     Research and Development

      SBS invests in research and development programs to develop new products in related markets and to integrate state of the art technology into existing products. As of September 1, 2002, SBS had approximately 144 employees engaged in research and development activities. Of these employees, 73 have technical degrees and 25 have advanced degrees. SBS seeks to combine special-purpose hardware, firmware and software in its products to provide its customers with the desired functionality. SBS’ research and development expense was $18.5 million, $20.1 million and $15.9 million in fiscal 2002, 2001 and 2000, respectively, corresponding to 15.6%, 10.7% and 12.5% of sales, respectively.

      SBS has several trademarks and has filed applications for other trademarks as described in the Introduction above. However, SBS has generally sought only limited patent protection for its technology. Currently, SBS has only one patent issued, expiring in November 2016, and three patents pending. SBS primarily relies on trade secrets for protection of its intellectual property and believes that future financial performance is much more dependent on the timely introduction of new products and technology and on its customer relationships than protection of its intellectual property.

      During fiscal 2002, the Communications and Enterprise Group responded to definite shifts in market demand and technology trends. The Group’s research and development efforts concentrated on improving the breadth of products available as well as the quality of engineering designs. The Group expanded its PowerPC processor portfolio to include several PPC 750FX products (Palomar 1000) with emphasis on high performance, low footprint technologies. Also, the Group introduced a dual processor PMC supporting 512MB of SDRAM and a multi-function bridge. In addition, the Group developed two compliant PICMG 2.16 compatible Compact PCI single processor blades, one based on the IBM 750FX technology (Olympus 2100) and one based on the mobile Pentium III processor (CT8). The Olympus 2100 is unique in its capability to host two PMC sites, supporting basic packet switching functions through on-board packet memory. The Group also expanded its systems capabilities with the development of a PICMIG 2.16 compatible chassis supporting multiple products, including a system controller (Olympus 1000), a multi-port broadband switch (Sabre 2000) and additional processing blades (Olympus 2100). New technologies continue to be designed for launch in the coming year. SBS expects these to increase the ease in which the broad selection of SBS WAN I/O and processor PMC technology can be embedded in communication equipment based on PIGMG 2.16 and PICMG 3 standards. During 2002, the Group moved into the packet processing market with the development of a voice-over ATM Compact PCI product currently supporting voice and message inter-connect in the wireless market. An announced partnership with Spectrum Signal Processing Inc., a vocoder supplier, will enable deployment of voice-over IP capabilities ranging from DS-3 to products to include support for the WAN portfolio in a common framework, making these products easier and cheaper to integrate with customer’s applications.

      During fiscal 2002, the Commercial and Government Group’s research and development efforts concentrated on improvement of existing technology, as well as the introduction of new products and technology. In the avionics product line, four new versions of MILSTD 1553 products were introduced in PMC, VME and CompactPCI formats, along with a new graphical interface for the PASS 1553 software. By adding these new 1553 products, SBS increased its product line targeted at the avionics test marketplace. The Group also developed conduction-cooled versions of the 1553 and ARINC 429 PMC boards as well as the CompactPCI 1553 board. These conduction-cooled versions of the product are used in the Group’s systems offerings for not only avionics based platforms, but ground based platforms as well. In addition, two new DSP based industrial I/O products were developed, also for use in systems applications. The Group also expanded its single board computer products with a new release of the VG4, RL4 and CK3 PowerPC based products. All of these products are used in military systems as well as commercial applications. The Group continued to expand the Ethernet and Fibre Channel product offerings with faster Fibre Channel interfaces and by introducing multiple (4) channel gigabit Ethernet PMC boards. The Group extended the breadth of the Ethernet and Fibre Channel product line by adding PMC and CompactPCI board formats. Fibre Channel and the Ethernet products are used in both commercial and government applications. New technology products added by the Group during fiscal 2002 include the addition of HIPPI (high performance parallel interface) products for high performance computer interconnection and the introduction of new InfiniBand® products.

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     Suppliers

      SBS uses contract manufacturing to produce substantially all of its U.S.-built board-level products. SBS obtains parts from large electronics parts suppliers and printed circuit boards from printed circuit board manufacturers and provides these parts and boards as kits to contract manufacturing companies that fabricate SBS’ products. Following manufacturing, SBS performs test, packaging and support functions for its products. During fiscal year 2002, SBS moved and consolidated the majority of its test, packaging and support functions previously performed at the Newark, California facility, the Albuquerque, New Mexico facility, and the Raleigh, North Carolina facility to the St. Paul, Minnesota facility. In addition, these same functions previously performed at the Mansfield, Massachusetts facility were moved and consolidated into the Carlsbad, California facility. SBS has begun complete turnkey outsourcing to contract manufacturers, although it is for a small portion of its total production. SBS reduces dependence on a particular contract manufacturer by using multiple contract manufacturers for many of SBS’ products.

      SBS’ German operation manufactures approximately 70% of its board-level products at its Mindelheim facility, using contract manufacturers for its OEM production business and certain ruggedized and military applications.

     Competition

      The embedded computer industry is highly competitive and fragmented, and SBS’ competitors differ depending on product type, company size, geographic market and application type. Consolidation within the communications, capital equipment and defense industries has resulted in increased competition and may result in an increase in pricing pressure across SBS’ product lines. SBS believes it differentiates itself from its competition based on the following:

	•	broad product line,
	•	willingness to adapt products to customer needs (customization),
	•	after sale support, and
	•	maintaining long-term customer relationships.

      SBS’ competition in each of its operating segments is described below.

      The Communications and Enterprise Group’s CPU product line competes against other suppliers of CPU boards based on PowerPC and Intel microprocessor technology, including Motorola, Inc., Force Computers, Inc. (a wholly-owned subsidiary of Solectron Corporation), RadiSys Corporation, Artesyn Technologies, Inc., Ziatech Corporation (a wholly-owned subsidiary of Intel Corporation) and others. The WAN I/O products compete with other suppliers of similar products supplying the telecommunications and data communications segment of the embedded computer market. They include companies such as Performance Technologies, Incorporated, Digi International, Inc., and Dialogic Corporation (a subsidiary of Intel Corporation). The systems and enclosure products compete with other suppliers of special purpose PC and CompactPCI platforms, enclosures and turnkey systems, such as Force Computers, Inc., RadiSys Corporation and Motorola, Inc.

      The Commercial and Government Group’s IP, PMC and PC•MIP I/O modules have two classes of competition. The first class includes companies that compete directly by selling these products. The second class includes companies that compete with these products using a different implementation to provide functionally equivalent products. Competitors in each of these classes include Acromag, Inc., Systran, Inc., VMIC, Inc., and a few small companies. Companies that directly compete in the PMC Ethernet market

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      As of September 1, 2002, SBS had approximately 446 employees at its eight locations: Albuquerque, New Mexico; Carlsbad, California; Newark, California; Raleigh, North Carolina; St. Paul, Minnesota; Mansfield, Massachusetts; and Augsburg and Mindelheim, Germany. Of these employees, 63 were in executive and administrative positions; 104 were in sales, marketing and customer relations; 144 were in research and development; 124 were employed in support of ongoing production, and 11 were employed on a part-time basis.

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Risk Factors

      Statements in this Report about SBS’ outlook for its business and markets, such as projections of future performance, statements of management’s plans and objectives, and forecasts of market trends and other matters, are forward-looking statements that involve risks and uncertainties. SBS’ actual results may differ materially from the results discussed in the forward-looking statements. Factors that may cause such a difference include, but are not limited to, those discussed below:

      SBS’ period to period sales and operating results have fluctuated, and may continue to fluctuate significantly, which has caused, and may continue to cause, volatility in the market price for its common stock. SBS has experienced fluctuations in its period to period sales and operating results in the past, and management expects that fluctuations will occur in the future. SBS’ sales, on both an annual and a quarterly basis, can fluctuate as a result of a variety of factors, many of which are beyond its control and which it may not be able to predict. These factors include:

	•	the timing and volume of customer orders and delays,
	•	success in achieving design wins in which SBS’ products are designed into those of SBS’ customers,
	•	manufacturing delays,
	•	delays in shipment due to component shortages,
	•	cancellations of orders,
	•	changes in the mix of products sold,
	•	the rate of introduction of new products,
	•	ability to maintain appropriate inventory levels,
	•	excess or obsolete inventory and changes in valuation of inventory,
	•	cyclicality or downturns in the markets served by SBS’ customers, including significant reductions in defense, communications and capital equipment expenditures,
	•	political, legal, regulatory and economic conditions and developments in the areas of the world in which SBS operates or into which SBS might expand its operations,
	•	competition from new technologies and other companies,
	•	variations in sales channels, product costs and the mix of products sold, and
	•	economic disruptions due to terrorist activity.

      Because fluctuations in operating results have happened in the past, and may continue to happen in the future, SBS believes that comparisons of the results of its operations for preceding quarters and fiscal years are not necessarily meaningful, and that investors should not rely on the results for any one quarter or year as an indication of how SBS will perform in the future. Investors should also understand that, if SBS’ sales or earnings for any quarter or year are less than the level expected by securities analysts or the market in general, the market price for SBS’ common stock has been in the past, and may be, in the future, subject to an immediate and significant decline.

      SBS’ sales have been, and may to continue to be, significantly reduced due to the currently depressed communications and capital equipment markets and may be further limited if anticipated increases in defense spending do not occur or if defense spending is reduced. SBS has derived a significant portion of its sales from products for communications and capital equipment applications and directly or indirectly from the U.S. Department of Defense. The communications and capital equipment markets are characterized by intense competition and rapid technological change. The communications market grew rapidly in the late 1990’s, but is currently experiencing significantly depressed conditions as to which management has no immediate expectations of recovery. After over a decade of downward trends, the current defense budget outlook is one of growth. However, Congress may not approve increased defense funding. Any increased

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      If SBS’ sales do not increase, or if they continue to decline, SBS could experience difficulty in obtaining debt or equity financing. Contraction and declines in the markets SBS serves has had and may continue to have an adverse impact on SBS’ sales and income. During fiscal 2002, and at June 30, 2002, SBS incurred losses that caused it to be in default of its bank credit facility covenants, resulting in the inability to borrow under the facility. On September 20, 2002, SBS canceled its bank credit facility. SBS may require external financing in the future, and that financing may not be available on terms acceptable to SBS or at all. In addition, continuing losses would likely impede SBS’ ability to raise funds through the sale of debt or equity securities.

      If SBS does not persuade OEM’s to use its products instead of those of other suppliers, SBS’ sales could be harmed. SBS’ sales depend, in part, on its ability to obtain and maintain design wins for its components from OEM’s. OEM’s that do not currently integrate SBS’ components into their products may not be willing to purchase components from SBS because the cost of integrating new components into their products may be more expensive than continuing to use existing components. OEM’s currently using SBS’ components may elect to use another supplier’s components if the other supplier’s designs are superior to SBS’ designs. Also, OEM’s currently integrating SBS’ components may redesign their products in a manner that no longer requires SBS’ components. If SBS fails to maintain existing design wins or to achieve new design wins, SBS’ sales could be reduced.

      SBS might have to expend substantial funds to redesign its technology because of changes in industry standards, customer preferences or technology. Most of SBS’ products are developed to meet industry standards that define the basis of compatibility in operation and communication of a system supported by different vendors. These standards are continuing to develop. If these standards are eliminated or changed, the design of SBS’ products could be inappropriate or obsolete, and SBS could be required to undertake costly redesign and research and development efforts. SBS’ sales also depend in part on the ability to develop state of the art products that comport with changing customer preferences. SBS may, or may not, be successful in developing these products in a timely manner, or in selling the products it develops. SBS’ sales could significantly decrease, and its products could become obsolete, if SBS fails to adapt timely to changing industry standards, advances in technology, or customer preferences.

      SBS’ business depends upon continually introducing new and enhanced products and solutions for business needs. The development or adaptation of products and technologies requires SBS to commit financial resources, personnel and time well in advance of sales. In order to compete, SBS’ decisions with respect to those commitments must accurately anticipate both future demand and the technology that will be available to meet that demand.

      To grow, SBS must persuade customers to outsource their component needs. Many of SBS’ potential customers design and manufacture embedded computer components internally, which they may view as a cost-savings over purchasing these components from suppliers like SBS. To increase its sales, SBS needs to persuade them that use of SBS’ components and services is cost-effective.

      Increased market acceptance of SBS’ products also depends on a number of other factors, including:

	•	the quality of its design and production expertise,
	•	the increasing use and complexity of embedded computer systems in new and traditional products,

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	•	the expansion of markets that are served by embedded computers,
	•	time to market requirements of SBS’ products,
	•	the assessment by SBS’ customers of direct and indirect cost savings, and
	•	SBS’ customers’ willingness to rely on SBS for mission-critical applications.

      SBS faces significant competition. The embedded computer industry is highly competitive and fragmented. SBS’ competitors differ depending on product and market type, company size, geographic market and application type. SBS faces competition in each of its operating segments.

      Competition in all of SBS’ operating segments is based on:

	•	performance,
	•	time-to-market,
	•	customer support,
	•	product longevity,
	•	existing customer relationships,
	•	supplier stability,
	•	price,
	•	breadth of product offerings, and
	•	reliability.

      Many of SBS’ existing and potential competitors are bigger companies that have a number of significant advantages over SBS, including:

	•	significantly greater financial, technological and marketing resources, giving them the ability to respond more quickly to new or changing opportunities, technologies and customer requirements,
	•	established relationships with customers or potential customers, which can make it harder for SBS to sell its products to those customers,
	•	a longer operating history, and
	•	more extensive name recognition and marketing capability.

      In addition, existing or potential competitors may establish cooperative relationships with each other or with third parties, or adopt aggressive pricing policies to gain market share.

      Because of increased competition, SBS might encounter significant pricing pressures across its product lines. These pricing pressures could result in significantly lower average selling prices and reduced profit margins for SBS’ products. SBS may not be able to offset the effects of any price reductions with an increase in the number of its customers, cost reductions or otherwise. SBS cannot assure investors that it will be able to compete effectively in its current or future markets.

      SBS purchases many of the components it uses from third party suppliers who may discontinue or change their products or have insufficient supply. Many of SBS’ products contain state-of-the-art electronic components. SBS depends upon third parties for its supply of many of these components. SBS obtains some of these components from a sole supplier or a limited number of suppliers, for which alternate sources may be difficult to locate. SBS has experienced, and may continue to experience, component part shortages, and has in the past built, and may in the future build, inventory of these components. Moreover, suppliers may discontinue or upgrade some of the products incorporated into SBS’ products, which could require SBS to redesign a product to incorporate newer or alternative technology. SBS’ inventory of component parts may become obsolete, which has in the past and may in the future result in cost write-downs. Although SBS believes that it has arranged for an adequate supply of components to meet its short-term requirements, SBS

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      SBS uses contract manufacturers to produce substantially all of its U.S-built board-level products and so is dependent on their timeliness, quality, and availability. SBS obtains parts from large electronics parts suppliers and printed circuit boards from printed circuit board manufacturers and provides these parts and boards as kits to contract manufacturing companies that fabricate SBS’ products. Many of the contract manufacturers utilized by SBS are small companies with limited capital resources. SBS reduces dependence on a particular contract manufacturer by using multiple contract manufacturers for many of its products, although there is no assurance that SBS will not experience delays in obtaining product from contract manufacturers. If it becomes necessary for SBS to move its production to new contract manufacturers due to non-performance by current contract manufacturers, additional delays in obtaining product could be incurred, as qualifying new contract manufacturers is costly and time-consuming. If SBS is unable to meet its customer’s delivery requirements due to delays in obtaining product from contract manufacturers, SBS’ sales and results of operations could be materially reduced.

      SBS’ products have lengthy sales cycles that require SBS to expend resources in advance of receiving revenue. SBS’ customers typically require several months to test and evaluate SBS’ products before designing their products to incorporate SBS’ components. Once SBS’ customers have determined to use SBS’ components, they may require several more months to begin volume production of products incorporating these components. Because of this lengthy sales cycle, SBS may experience delays from the time it increases its operating expenses and its investments in inventory until the time that SBS generates sales from these components. SBS may never generate sales from components after incurring development expenses if SBS’ customers decide not to purchase them. Even if SBS’ customers select SBS’ components to incorporate into their products, SBS’ customers may not market or sell their products successfully.

      SBS is subject to order and shipment uncertainties that could harm its operating results. SBS typically sells its products pursuant to purchase orders that customers can cancel or defer on short notice without incurring a significant penalty. Cancellations or deferrals could cause SBS to hold excess inventory that may not be salable to other customers at commercially reasonable terms, which could reduce its profit margins and restrict its ability to fund its operations.

      SBS has limited patent protection covering its technology, and SBS may not be able to protect its intellectual property. Disputes could be expensive. SBS’ success depends, in part, on its ability to develop and protect its intellectual property. SBS has sought only limited patent protection for its technology. SBS currently has one patent issued and three patents pending. SBS cannot guarantee that its pending patents will be issued, or that if issued, its pending or existing patents will be enforced in a court of law if challenged. Patent applications in the United States are not publicly disclosed until the patents are issued. Therefore, undisclosed U.S. patent applications that relate to SBS’ products and technology may have been filed. Also, SBS cannot be certain that foreign patents have not or will not be issued that would harm its ability to commercialize its current and future products. Even as SBS obtains patent protection for its intellectual property, third parties could independently develop and patent equivalent or superior products or technology, in which case SBS may be required to obtain licenses to that technology from those parties.

      In addition to patent rights, SBS relies upon trade secret laws, industrial know-how and employee confidentiality agreements to protect its intellectual property. Third parties or employees may breach SBS’ agreements with them or otherwise attempt to disclose, obtain or use SBS’ products and technologies. Further, if consultants, employees and other parties apply technological information developed independently, by them or others, to SBS’ projects, disputes may arise as to the proprietary rights to that information. Those disputes may not be resolved in SBS’ favor.

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      SBS may not be able to obtain court enforcement of its agreements, which would leave SBS with inadequate remedies to protect its intellectual property rights. This is particularly true in foreign countries, where laws or law enforcement practices often do not protect intellectual property as fully as in the United States.

      SBS enters into contracts with OEM’s which typically provide for broad indemnification of the OEM’s against allegations of infringements of intellectual property rights arising from SBS’ products, including costs of defense. SBS does not carry insurance covering any such claims. Any such claim or claims could materially affect the financial condition of SBS.

      SBS may have to litigate to enforce or defend its intellectual proprietary rights. In addition, companies frequently sue other companies as a means of delaying the introduction of a competitor’s products or technologies. Any litigation, regardless of outcome, including any interference proceeding to determine priority of inventions, oppositions to patents in foreign countries, or litigation against SBS or any SBS indemnified OEM, may be costly and time consuming. Further, if it were ultimately determined that SBS’ claimed intellectual property rights are unenforceable, or that its products infringe on the rights of others, SBS may be required to pay past royalties or obtain licenses to use technologies. SBS may not be able to obtain licenses for these technologies on commercially reasonable terms, or at all.

      SBS’ success depends, in part, on its ability to identify and to acquire and successfully integrate new businesses. A major element of SBS’ business strategy is to pursue acquisitions that either expand or complement its business. SBS has increased the scope of its operations through the acquisition of ten businesses and product lines since 1992. Where business conditions permit, SBS intends to continue to pursue actively acquisition opportunities, including some that could be material and that may become available in the near future. This acquisition strategy may pose additional risks to SBS, including:

	•	SBS might not be able to identify or acquire acceptable acquisition candidates on terms favorable to it, and in a timely manner.
	•	SBS’ management and financial controls, personnel, and other corporate support systems might not be adequate to manage the increase in the size and the diversity of scope of its operations as a result of acquisitions and to integrate effectively acquired businesses.
	•	SBS’ acquisitions might not increase its revenue or earnings and the companies acquired might not continue to perform at their historical levels.
	•	SBS may use cash for acquisitions that would otherwise be available to fund SBS’ operations or to use for other corporate purposes.
	•	SBS’ shareholders may experience dilution if SBS uses its capital stock to pay for acquisitions, and
	•	SBS’ debt burden will increase as a result of any borrowings SBS may make to pay for acquisitions.

      SBS may need to raise additional capital to fund its operations and to complete acquisitions. SBS depends on cash flow from operations to fund its operations and pay for its acquisitions. If SBS experiences decreased sales, increased expenses, or a combination of the two, it may need to raise additional capital to fund its operations or acquire other businesses. If SBS decides to do so, SBS could attempt to issue debt securities or capital stock. SBS may not be able to sell these securities, particularly under the current market conditions. Even if SBS were successful in finding buyers for its securities, the buyers could demand commercially unreasonable terms. For example, if SBS had to sell debt securities, it might be forced to pay high interest rates or agree to onerous operating covenants, which could in turn harm SBS’ ability to operate its business by reducing its cash flow and increasing restrictions on its operating activities. If SBS were to sell its capital stock, SBS might be forced to sell shares at a depressed market price, which could result in substantial dilution to its existing shareholders. In addition, any shares of capital stock SBS may issue may have rights, privileges, and preferences superior to those of SBS’ common shareholders. If SBS is unable to raise additional capital on commercially reasonable terms, it may be required to reduce its operations and delay or terminate any potential acquisitions plans, which would harm SBS’ ability to grow.

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      SBS’ earnings have been, and could continue to be, adversely affected because of charges resulting from acquisitions, or an acquisition could reduce shareholder value. As part of SBS’ strategy for growth, SBS acquires compatible businesses. In accounting for a newly acquired business, SBS is, in many cases, required to amortize, over a period of years, certain identifiable intangible assets. Although usually the acquired business’ current operating profit offsets the amortization expense, a decrease in the acquired business’ operating profit could reduce SBS’ overall net income and earnings per share. Changes in future markets or technologies may require SBS to amortize intangible assets faster and in such a way that SBS’ overall financial condition or results of operations are harmed. During fiscal year 2002, changes in economic and/or business conditions caused impairment of goodwill and other intangibles acquired in an acquisition, resulting in a significant charge against SBS’ earnings. If economic and/or business conditions do not improve, SBS may incur additional impairment charges against earnings in the future. SBS may also be required, under generally accepted accounting principles, to charge against earnings upon consummation of an acquisition the value of an acquired business’ technology that does not meet the accounting definition of “completed technology.” An acquired business could reduce shareholder value if it should generate a net loss or require invested capital.

      SBS may expend resources without receiving benefit from strategic alliances with third parties. From time to time, SBS may enter into strategic alliances to deliver solutions to its customers. These alliances are typically formed to provide products or services that SBS does not provide in its core businesses. SBS may expend capital and resources on these alliances but may not receive any immediate or long-term return or economic benefit from them.

      SBS depends on its employees for success. SBS’ ability to maintain its competitive position and to develop and market new products depends, in part, upon its ability to retain key employees and to recruit and retain additional qualified personnel, particularly engineers. Competition for qualified employees in the computer industry is intense. If SBS is unable to retain and recruit key employees, SBS’ product development and marketing and sales could be harmed.

      SBS is subject to significant product liability risk. SBS’ products and services could subject SBS to product liability or government or commercial warranty claims. SBS maintains primary product liability insurance for its non-aviation products with a general aggregate limit of $1.0/$2.0 million per occurrence and a $50.0 million excess umbrella policy. SBS maintains, for its aviation products, a $100.0 million liability insurance policy, per occurrence. SBS’ products are widely used in a variety of applications. If a claim is made against SBS, SBS’ insurance coverage might not be adequate to pay for SBS’ defense or to pay for any award, in which case SBS would have to pay for it. Also, as a result of the terrorist attacks of September 11, 2001, the cost of insurance coverage has significantly increased. In the future, SBS might not be able to continue its insurance coverage at desired levels, for premiums acceptable to SBS. If a litigant were successful against SBS, a lack or insufficiency of insurance coverage could significantly harm SBS’ financial condition.

      SBS faces political, economic and regulatory risks associated with its international sales and operations not faced by businesses operating only in the United States. SBS sells its products in countries throughout the world from its United States and German based operations. SBS intends to continue to expand its operations and sales outside the United States. SBS’ international operations and sales subject SBS to risks not experienced by companies operating only in the United States, including:

	•	increased governmental regulations,
	•	export and import controls,
	•	political, economic and other uncertainties, including, risk of war, revolution, expropriation, renegotiation or modification of existing contracts, standards and tariffs, and taxation policies,
	•	international monetary fluctuations that may make payment more expensive for foreign customers who may, as a result, limit or reduce purchases,
	•	exposure to different legal standards, particularly with respect to intellectual property,
	•	longer accounts receivable collection cycles,

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	•	trade disputes or new trading policies that could limit, reduce, disrupt or eliminate SBS’ sales and business prospects outside the United States, and
	•	unexpected changes in regulatory requirements that impose multiple conflicting tax laws and regulations.

      Exchange rate fluctuations could reduce SBS’ earnings when stated in U.S. Dollars. Substantially all of SBS’ U.S. export sales to date have been denominated in United States dollars and substantially all sales generated by SBS’ subsidiary based in Germany have been denominated in Euros. However, some sales in the future may be denominated in other currencies. Any decline in the value of other currencies in which SBS makes sales against the United States dollar or Euro will have the effect of decreasing SBS’ consolidated earnings when stated in United States dollars. SBS has not in the past, but may in the future, engage in hedging transactions that could have the effect of minimizing the risks associated with these types of currency fluctuations but could have adverse consequences to SBS.

      SBS’ common stock price can be volatile because of several factors, including a limited public float. During the twelve-month period ended June 30, 2002, the sale price of SBS’ common stock fluctuated from $9.94 to $20.05 per share. SBS believes that its common stock is subject to wide price fluctuations because of several factors, including:

	•	quarterly and annual fluctuations in SBS’ operating results,
	•	a relatively thin trading market for SBS’ common stock, which causes trades of small blocks of stock to have a significant impact on SBS’ stock price,
	•	announcements of new technologies by SBS, its competitors or customers,
	•	general conditions in the markets served by SBS,
	•	fluctuations in earnings of SBS’ competitors,
	•	changes in earnings estimates or investment recommendations by securities analysts,
	•	general volatility of the stock markets and the market prices of other publicly traded companies,
	•	economic disruptions due to terrorist activity, and
	•	investor sentiment regarding equity markets generally, including public perception of corporate ethics and governance and the accuracy and transparency of financial reporting.

      SBS is subject to credit risk. Credit risk is inherent in SBS’ commercial activities. Credit risk relates to the risk of loss resulting from a customers failure to pay in accordance with contractual obligations. The majority of SBS’ sales are on open account, typically with 30 to 60 day payment terms without any down payment or security. Many of SBS’ customers and potential customers in various markets, including the communications market, have had the credit ratings of their debt reduced. As a result, some of SBS’ customer’s creditworthiness may be reduced, which could pose a heightened risk of bankruptcy or delayed payment that could affect SBS’ earnings and cash flow.

      SBS may be subject to liquidity concerns. For a discussion of factors affecting SBS’ sources of cash and liquidity, please read the Liquidity and Financial Condition section of Item #7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

      SBS is subject to the effects of terrorist attacks and acts of war. SBS is currently unable to measure the ultimate impact of the terrorist attacks of September 11, 2001 on its industry and the United States economy as a whole. The uncertainty associated with the retaliatory military response of the United States and other nations and the risk of future terrorist activity may impact SBS’ results of operations and financial condition in unpredictable ways. The occurrence or risk of occurrence of future terrorist attacks or related acts of war could adversely affect the economy of the United States and other countries. A lower level of economic activity could result in a decline in demand for SBS’ products that could adversely affect SBS’ sales and earnings and limit SBS’ future growth prospects. The terrorist attacks and the associated uncertainties have caused, and

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Item 2.     Properties

      SBS leases office and manufacturing space in Albuquerque, New Mexico, Carlsbad, California, Newark, California, Raleigh, North Carolina, St. Paul, Minnesota, Mansfield, Massachusetts, Madison, Wisconsin, and Augsburg and Mindelheim, Germany. SBS’ standard practice is to obtain all of its facilities through operating leases. SBS maintains an insurance plan covering all its facilities and contents.

      The Albuquerque, New Mexico leased facility consists of approximately 42,500 square feet located in a multi-floor office building. This facility houses the sales and engineering functions of SBS’ Commercial and Government Group’s avionics interface and telemetry product lines, as well as certain test, packaging and support function for these product lines. The Albuquerque facility also serves as SBS’ corporate headquarters. The lease term for approximately 39,000 square feet of the Albuquerque, New Mexico facility runs through June 30, 2005, with an option to extend the term for an additional five years, and the lease term for approximately 3,500 square feet terminates on January 31, 2004. Management believes that this facility will be sufficient to serve SBS’ needs through the term of the lease.

      SBS’ general purpose I/ O engineering team, which supports the Commercial and Government Group, is located in Newark, California. The approximate 27,000 square foot facility, which is leased for a five-year term expiring November 30, 2004, is a one story, multi-tenant building in a business park. It consists of approximately 18,000 square feet of office space and approximately 9,000 square feet of manufacturing space. In August 2001, SBS moved and consolidated this facility’s test, packaging and support functions with the SBS St. Paul, Minnesota facility, creating excess capacity at this facility. SBS is actively attempting to sub-lease this facility, and if successful, will move the general purpose I/ O engineering team to a smaller facility in the immediate Newark, California area.

      SBS’ Commercial and Government Group Intel and PowerPC CPU sales and engineering functions are located in Raleigh, North Carolina which leases an 11,000 square foot one story multi-tenant facility. The lease expires on November 30, 2002. Management is currently negotiating a renewal of this lease.

      SBS’ St. Paul, Minnesota facility consists of approximately 43,650 square feet, located in a business park. This facility consists of approximately 18,850 square feet of office space occupied by the Commercial and Government Group’s sales and engineering functions for its connectivity, expansion and general purpose I/ O products, and 24,800 square feet of production and warehouse space utilized by SBS as its production center for its computer connectivity and expansion unit products, general purpose I/ O products, avionics interface products, and all U.S. built Intel based CPU products. The lease expires on January 31, 2006. Management believes that this facility will be sufficient to serve its needs through the term of the lease.

      SBS’ Communications and Enterprise Group WAN I/ O engineering team is located in Mansfield, Massachusetts. The approximate 31,200 square foot facility, which is leased for a five-year term expiring on June 14, 2005, is a one-story multi-tenant building in a business park. In August 2001, SBS moved and consolidated the test, packaging and support functions for its WAN I/ O products from the Mansfield facility to its Carlsbad, CA facility, creating excess capacity in Mansfield. Currently, management intends to occupy this facility through the term of the lease.

      SBS’ Communications and Enterprise Group leases, in Carlsbad, California, an approximate 75,200 square foot facility, located in a business park, consisting of approximately 32,000 square feet of office space and approximately 43,200 square feet of test, packaging and support space. The lease term is for seven years expiring in April 2006, plus one option to extend the lease for three additional years. Management believes that this facility will be sufficient to serve the needs of these operations through the term of the lease. The Group also leases, in Madison, Wisconsin, approximately 7,200 square feet of a 90,000 square foot multi-floor

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      SBS leases, in Augsburg, Germany, a six floor building, consisting of approximately 30,000 square feet of office, test, packaging and support areas for its or operations. The lease has a term of ten years expiring December 31, 2005. Management believes that the facility is sufficient to serve the needs of the or operations through the term of the lease. In addition, SBS leases, on a month-to-month basis, approximately 5,000 square feet of manufacturing space in a multi-use facility in Mindelheim, Germany for its ortec operations. Management believes that the facility is sufficient to serve the needs of ortec for the foreseeable future.

      Subsequent to June 30, 2002, SBS received notice of a claim for patent infringement regarding the sale of SBS’ PCMCIA product line. Management is currently evaluating the claim. Due to the uncertainty regarding the ultimate outcome of this matter, SBS is currently unable to determine an estimate of the amount or range, if any, of potential loss. However, management believes the outcome of this matter will not have a material impact on SBS’ financial position.

      SBS is subject to various claims that arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position, results of operations, or liquidity of SBS. SBS is not a party to, and none of its property is subject to, any material pending legal proceedings. SBS knows of no material proceedings contemplated by governmental authorities.

      Not applicable.

      The following table sets forth the price range (adjusted for two-for-one stock split declared August 18, 2000) of trading in SBS’ Common Stock as reported on The Nasdaq Stock Market for each full fiscal quarter within the last two fiscal years:

      SBS’ Common Stock is traded on The Nasdaq Stock Market using the symbol SBSE.

      Based on data provided by SBS’ transfer agent and The Depository Trust Company, management believes that as of September 3, 2002, the number of share owner accounts of record, as defined by Rule 12g5-1 of the Exchange Act, was approximately 230, at which date the closing market price of SBS’ common stock was $7.23 per share.

      SBS has not paid any cash dividends on its Common Stock. Management’s current policy is to retain earnings, if any, for use in SBS’ operations and for expansion of the business. No dividend payments are anticipated in the foreseeable future (see “Management’s Discussion and Analysis: Liquidity and Financial Condition”). In addition, under the terms of SBS’ Credit Agreement with Bank of America, N.A., (“Bank”) as amended, SBS is prohibited from declaring dividends without the Bank’s permission.

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      The following selected financial data for the years ended June 30, 1998 through June 30, 2002 have been derived from the audited consolidated financial statements of SBS. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements and related notes thereto included elsewhere herein.

Notes: SBS has not declared any dividends during the periods presented. No dividend payments are expected in the foreseeable future.

      On August 18, 2000, SBS declared a two-for-one stock split for stockholders of record on September 5, 2000, distributed on September 20, 2000. All references to net income per common share, net income per common share — assuming dilution, common stock, and stockholders’ equity have been restated as if the stock split had occurred as of the earliest period presented.

      On April 12, 2000, SBS completed the purchase of SDL. In connection with the acquisition, SBS recorded a $4.0 million acquired in-process research and development (“IPR&D”) charge in the fourth quarter of fiscal 2000.

      On December 20, 1999, SBS completed a pooling of interests transaction with SciTech Inc. (“SciTech”). SciTech was subsequently merged into Communications Products. SciTech’s historical results did not have a material effect on combined financial position or results of operations, therefore the financial position and results of operations of SBS and SciTech are combined from October 1, 1999 on a prospective basis.

      On August 12, 1998, SBS completed the purchase of Communications Products.

      On July 1, 1998, SBS acquired, through its subsidiary Holding GmbH, a 50.1% interest in or and a 50.2% interest in ortec. SBS also acquired, through its subsidiary, Government Group, a 100% interest in or Computers, Inc. On December 9, 1998, SBS completed the purchases of the minority interest in or and ortec.

      On November 24, 1997, SBS completed the purchase of Industrial Computers.

      The following discussion and analysis should be read in conjunction with “Selected Financial Data” and SBS’ Financial Statements and Notes thereto. Statements, other than statements of historical fact, that address activities, events or developments that SBS or management intends, expects, projects, believes or anticipates will or may occur in the future are forward-looking statements. These statements include, but are not limited to, expected sales, gross margin, expectations of internally-generated cash flows, new product introductions, and expectations of SG&A and R&D costs. These statements and other forward-looking statements are based upon certain assumptions and assessments made by management of SBS in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes to be appropriate. These assumptions and assessments include the volume and product mix of sales, estimates of costs and inventory and receivable levels, defense spending levels, and other items. The forward-looking

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      SBS designs and builds open-architecture embedded computer products that enable OEM’s to serve the commercial, communications, enterprise and government markets. SBS’ products are integrated into a variety of applications including communications networking, medical imaging, industrial automation and military systems. The portfolio includes an extensive line of CPU boards, computer interconnections, avionics, telemetry, and fully integrated systems and enclosures that system designers can easily utilize to create a custom solution specific to the user’s unique application. SBS’ objective is to continue to capitalize on its design expertise and customer service capabilities to enhance product quality and reduce time to market for OEM customers. SBS has grown, and intends to continue to do so, through a combination of internal growth and acquisitions. SBS completed ten acquisitions between 1992 and June 30, 2002 that broadened SBS’ product offerings and customer base. SBS achieves internal growth by expanding its existing product lines through new product development, through increasing penetration of its existing customer base, and by adding new customers.

      Sales for the year ended June 30, 2002 were $118.9 million, a 36.5% decrease from the $187.2 for fiscal year 2001. Net loss for the year ended June 30, 2002 was $(24.4) million, or net loss per common share — assuming dilution of $(1.67). This compares to net income for the year ended June 30, 2001 of $17.2 million, or net income per common share — assuming dilution of $1.14. SBS’ performance during fiscal 2002 was affected by external factors, including dramatic changes in the markets that SBS serves, and internal factors, including changes in senior management and overall corporate strategy. The net loss for fiscal 2002 includes $15.1 million of inventory write-downs, $13.0 million of goodwill and identifiable intangible impairment charges, and $3.2 million of severance and other employee termination costs. See further discussion regarding these items below.

      During the fourth quarter of fiscal year 2002, in conjunction with the change in the Chief Executive Officer and management’s realignment of operations and market development efforts, SBS segment structure was redefined. To better align similar technologies and selling channels, the former Commercial Group and the former Government Group were combined. The combined group consists of SBS Commercial, SBS Government, or, ortec, and SBS’ Avionics Products division. The Communications and Enterprise Group consists of Communications Products, SDL, and Industrial Computers. Reportable segments for all periods presented have been restated to conform to the current segment reporting structure.

      The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used when accounting for items such as inventory, allowances for doubtful accounts, depreciation and amortization periods, income taxes, and intangible assets. These estimates and assumptions are evaluated on an on-going basis and may require adjustment. Actual results could differ from the estimates under different assumptions or conditions. The policies discussed below are considered by management to be critical to an understanding of SBS’ consolidated financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. For additional accounting policies, see Note 1 to the consolidated financial statements, “Summary of Significant Accounting Policies.”

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	•	Revenue Recognition. Revenue is generally recognized when goods are shipped to the customer, provided that SBS has received a valid purchase order, the price is fixed, title has transferred, collection of the associated receivable is reasonably assured, and there are no remaining significant obligations. Where customer acceptance provisions exist, revenue is recognized only when SBS is certain that the products meet all of the specified criteria for customer acceptance and all other revenue recognition criteria have been met.
	•	Inventory Valuation. SBS records inventory write-downs based on estimates of obsolescence or unmarketable inventory, taking into account historical usage, forecasted future demand, and general market conditions. Write-downs may also be recorded based on SBS’ decisions to discontinue the marketing of certain products or product lines. If SBS’ forecasts are incorrect, market conditions deteriorate, or SBS decides to exit other product lines, additional inventory write-downs may be required. If market conditions or demand are better than expected, SBS may sell inventories that have been previously written down.
	•	Allowances for Doubtful Accounts. SBS maintains allowances for doubtful accounts receivable resulting from the failure of its customers to make required payments. The estimate is based on the aging of SBS’ accounts receivable, SBS’ historical write-off experience, and the current and projected financial condition of customers. If SBS misinterprets the financial condition of customers or if the financial condition of customers deteriorates, additional allowances for doubtful accounts may be required.
	•	Long-Lived and Intangible Assets. SBS evaluates the carrying value of long-lived and intangible assets whenever certain events or changes in circumstances indicate that the carrying amount may not be recoverable. Such events or circumstances include, but are not limited to, a prolonged industry or economic downturn, a significant decline in SBS’ market value, or significant reductions in projected future cash flows. The asset would be considered to be impaired if future undiscounted cash flows, without consideration of interest, are insufficient to recover the carrying amount of the asset. Once deemed impaired, a charge to expense is recognized to the extent that the carrying amount of the asset exceeds fair value. Fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon SBS weighted average cost of capital. Estimates of future cash flows require significant judgement, and any change in these estimates may result in additional impairment charges.
	•	Income Taxes. SBS’ estimates of current and deferred income taxes reflect SBS’ assessment of current and future taxes to be paid or received on items reflected in the financial statements, giving consideration to both timing and probability of realization. Estimates of current income taxes include estimates for items such as general business credits and benefits from foreign sales. Actual income taxes could vary from these estimates due to future changes in income tax laws or review of SBS’ tax returns by taxing authorities.

      On March 4, 2002, SBS completed the acquisition of certain assets and assumed certain liabilities of Essential Communications, a division of publicly held Intrusion, Inc., for approximately $1.0 million. Founded in 1992, Essential develops and delivers early stage InfiniBand products. SBS utilizes Essential’s InfiniBand product expertise and industry relationships to build on its current InfiniBand efforts in the enterprise server and storage markets. As required under the purchase method of accounting, Essential’s results of operations have been combined with SBS’ since the date of acquisition. The purchase price has been allocated to the underlying assets acquired and liabilities assumed based on their estimated fair values. In conjunction with the purchase price allocation, SBS recorded approximately $364,000 of identifiable intangibles, principally core-technology assets, which are being amortized over a two-year period. No goodwill was recorded. Proforma results of operations are not presented as Essential’s results of operations in fiscal 2002 and 2001 were not material to SBS’ consolidated results of operations.

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      On April 12, 2000, SBS completed the acquisition of SDL. Located in Mansfield, Massachusetts, SDL specializes in the design, manufacture and sale of WAN I/ O for the telecommunications and data communications markets. SDL designs, manufactures, and markets T1/ EI, T3/ E3, HSSI and OC3 products based on the PCI, CompactPCI, and PMC form factors, and supporting protocols such as Frame Relay, HDLC, PPP, X.25 and ATM. In addition, SDL’s products support the operating systems most commonly used in communications, including Windows NT, Solaris, and VxWorks. SBS acquired all of the outstanding stock of SDL for $25.6 million in cash. Acquisition costs associated with the purchase were $0.6 million. The purchase price included $1.2 million for the fair value of SBS options issued in exchange for unvested SDL options. The acquisition was funded with existing cash and a $20.0 million borrowing under SBS’ Credit Agreement with Bank of America, N.A. The acquisition was accounted for under the purchase method, whereby the purchase price was allocated to the underlying assets and liabilities based upon their estimated fair values. Identifiable intangibles are being amortized over four to eight years and goodwill is being amortized over ten years. In connection with the acquisition, SBS recorded a $4.0 million earnings charge, based on an assessment of purchased technology of SDL. The assessment determined that $4.0 million of SDL’s purchase price represented technology that did not meet the accounting definitions of “completed technology,” and thus should be charged to earnings under generally accepted accounting principles. The assessment analyzed certain products that were in various stages of completion ranging from 35% of completion to 85% of completion, with estimated completion dates ranging from the third quarter of calendar 2000 to the second quarter of calendar 2001. The value assigned to acquired IPR&D was determined based on estimates of the resulting net cash flows from the evaluated technology of SDL and the discounting of those cash flows to present value. In projecting net cash flows resulting from those products, management estimated revenues, cost of sales, selling expenses, research and development expenses, and income taxes for those products. These estimates were based on the following assumptions:

	•	Estimated revenues projected a compound annual growth rate over seven years of 18%. Projections of revenue growth were based on management’s estimates of market size and growth, supported by analyst’s estimates and by the nature and expected timing of the development of the products by SBS and its competitors.
	•	The estimated cost of sales as a percentage of revenue, initially at 64% declining to 50%, was consistent with the historical rates for SDL’s business as well as historical results of companies operating within the industry.
	•	Estimated selling expenses were expected to remain consistent as a percentage of sales, with an average of 14% to 15%.
	•	The estimated research and development costs were expected to remain consistent as a percentage of sales at 3.5% as most research and development efforts are in the maintenance phase.
	•	An effective tax rate of 40% was estimated.

      The projected net cash flows for the in-process projects were discounted using a 30% weighted-average cost of capital (“WACC”). The calculation produces the average required rate of return of an investment in an operating enterprise. The WACC selected was based upon the risk/return characteristics of the subject asset class. A WACC of 25% or 26% was used to determine the value of the return of the core developed technology, the customer list and all other intangibles acquired as part of the purchase of SDL. The fair value of the purchased technology was determined in accordance with the views expressed by the staff of the Securities and Exchange Commission. The financial results of SDL have been included in SBS’ Consolidated Financial Statements from April 12, 2000.

      In fiscal 2002, SDL’s test, packaging and support functions were consolidated into Communications Products. In addition, during the fourth quarter of fiscal 2002, due to recent order cancellations and a continued decline in sales and bookings, SBS recorded a $10.3 million write-down of goodwill and core-developed technology associated with the acquisition of SDL. This write-down was based on SBS’ projection of undiscounted future operating cash flows of SDL over the remaining useful lives of the goodwill and core-technology, which indicated that these cash flows were not sufficient to recover the carrying amounts of the

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      On December 20, 1999, SBS acquired SciTech, a Madison, Wisconsin based designer and manufacturer of communications network I/ O products based on PMC and PCI form factors. The acquisition qualified as a pooling of interests for accounting purposes and constituted a tax-free reorganization for federal income tax purposes. Under the terms of the agreement, SciTech’s shareholders exchanged all outstanding shares of SciTech stock for 349,726 shares of SBS’ stock. SciTech was subsequently merged into Communications Products. SciTech’s historical results do not have a material effect on combined financial position or results of operations, and as such, the financial position and results of operations of SBS and SciTech are combined from October 1, 1999 on a prospective basis.

     Results of Operations

      The following table sets forth for the periods indicated certain operating data as a percentage of sales:

      Sales. In fiscal 2002, sales decreased 36.5%, or $68.3 million, from $187.2 million in fiscal 2001, to $118.9 million. Unit shipments declined within the Communications and Enterprise Group, primarily due to depressed market and economic conditions, customer order cancellations, and delays of shipment dates by several of the Group’s telecommunications infrastructure customers. Unit shipments of the Commercial and Government Group’s avionics, telemetry and computer processor products increased. Unit shipments of the Group’s general purpose I/ O products and computer connectivity and expansion unit products declined, due to unfavorable economic and market conditions and delays of shipment dates by several customers. Management does not expect significant improvement in the communications and commercial markets in fiscal 2003. Management expects some growth in sales to government customers in fiscal 2003 due to an expected increase in Department of Defense development and field deployment expenditures. Actual results may vary materially.

      Gross Profit. In fiscal 2002, gross profit decreased 51.9%, or $46.0 million, from $88.6 million in fiscal 2001, to $42.6 million. This decrease was primarily due to the decrease in sales combined with $0.2 million of expenditures associated with the SBS’ manufacturing consolidation and cost reduction efforts, a $12.4 million

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      Selling, General and Administrative Expense. In fiscal 2002, selling, general and administrative expense increased 17.5%, or $5.8 million from $33.0 million in fiscal 2001, to $38.8 million. This increase was primarily due to an increase in SBS’ sales personnel associated with the realignment of its business, additional corporate personnel, increases in executive compensation, relocation expenses for recently hired employees, additional information technology department personnel, depreciation and consulting expenses associated with the implementation of SBS’ customer relationship management system, additional reserves for accounts receivable due to collection issues, and costs associated with the termination of SBS’ proposed acquisition of Interactive Circuit Systems (“ICS”) in the quarter ended December 31, 2001. This increase, combined with the decrease in sales, resulted in an increase in SG&A expense as a percentage of sales to 32.7% in fiscal 2002 from 17.6% in fiscal 2001.

      Research and Development Expense. In fiscal 2002, research and development expense decreased by 7.9%, or $1.6 million, from $20.1 million in fiscal 2001, to $18.5 million, primarily due to cost reductions in the Communications and Enterprise Group, resulting from depressed business conditions. In fiscal 2002, research and development expense as a percentage of sales increased to 15.6% from 10.7% in fiscal 2001, primarily due to the decrease in sales volume. In July 2002, the Communications and Enterprise Group’s Madison, Wisconsin facility was closed, resulting in the termination of 7 full-time employees and 11 part-time employees.

      Severance and Other Employee Termination Costs. In fiscal 2002, SBS recorded severance and other employee termination charges as follows:

	•	On April 28, 2002, SBS announced the resignation of its Chairman of the Board and Chief Executive Officer, Grahame E. Rance. During the quarter ended June 30, 2002, SBS recorded approximately $2.0 million of severance and other employee termination costs related to the Separation Agreement between SBS and Mr. Rance.
	•	During the year ended June 30, 2002, based on unfavorable economic and market conditions, facility consolidation actions, and the decision to exit the legacy PCI Chassis product line, SBS reduced its employee base, resulting in elimination of 159 positions in manufacturing, R&D, administration, and sales and marketing. On August 14, 2001, SBS notified 58 employees that their positions would be eliminated by the end of September 2001. On December 26, 2001, the SBS Board of Directors approved additional reductions, to be completed through March 31, 2002 and 54 employees were notified that their jobs would be eliminated. On May 21, 2002, SBS announced further reductions, which were effective immediately, and 47 employees were notified that their jobs had been eliminated. As a result, for the year ended June 30, 2002, employee severance and other termination charges of approximately $1,253,000 were recorded. As of June 30, 2002, cash payments of $963,000 had been

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		made, $21,000 of the original charge was reversed as a result of the decision not to terminate certain originally notified employees, and the remaining $269,000 will be paid through the quarter ending December 31, 2002.

      Impairment of Assets. For fiscal 2002, $2.7 million of the $13.0 million asset impairment charge represented the write-off of the remaining goodwill recorded in connection with the acquisition of Industrial Computers (formerly Micro Alliance) in November 1997. This write-off was the result of SBS’ decision in the quarter ended December 31, 2001 to exit the PCI chassis business. The remaining $10.3 million represented the write-down of goodwill and other identifiable intangible assets associated with the acquisition of SDL in April of 2000. The write-down, which occurred in the fourth quarter, was based on SBS’ projection of undiscounted future operating cash flows. This evaluation indicated that these cash flows were not sufficient to recover the carrying amounts of the goodwill and other identifiable intangible assets. As a result, the impairment charge was recorded to the extent that the carrying value exceeded fair value of the assets. The evaluation was performed as a result of continued order cancellations and a continued decline in sales and bookings in the fourth quarter.

      Interest and Other Income, Net. In fiscal 2002, net interest and other income of $646,000 consisted primarily of a recovery from insurance of $307,000, and interest income associated with surplus cash, partially offset by the fiscal 2002 second quarter $323,000 write-down related to an other-than-temporary decline in the fair value of SBS’ investment in an unrelated software company. The investment in the software company is currently valued at approximately $177,000. In fiscal 2001, interest income of $410,000 consisted primarily of interest associated with SBS’ surplus cash.

      Income Taxes. For fiscal 2002 and fiscal 2001, income taxes represented effective income tax rates of 35.6% and 36.1%, respectively. A tax benefit related to the loss from operations was recorded in fiscal 2002 primarily due to SBS’ ability to realize the benefit through tax loss carrybacks to prior periods.

      Earnings per Share. For fiscal 2002, net loss per common share was $(1.67) compared to net income per share of $1.23 for fiscal 2001. For fiscal 2002, net loss per common share-assuming dilution was $(1.67) compared to net income per common share-assuming dilution of $1.14 for fiscal 2001.

      SBS operates internationally through two operating segments: the Communications and Enterprise Group, and the Commercial and Government Group. These segments were defined during the fourth quarter of fiscal year 2002, in conjunction with the change in the Chief Executive Officer, and management’s realignment of operations and market development efforts. To better align similar technologies and selling channels, the former Commercial Group and the former Government Group were combined. The combined group consists of SBS Commercial, SBS Government, or, ortec, and SBS’ Avionics Products division. The Communications and Enterprise Group consists of Communications Products, SDL, and Industrial Computers. These segments are based on the markets that are served and the products that are provided to those markets. Each segment has its own sales and distribution channels and has a manager who reports directly to the President and Chief Operating Officer. Reportable segments for all periods have been reclassified to conform to the new segment reporting structure.

      The following is a discussion of sales to external customers and segment profit (loss) for each reportable segment. In the measure of segment profit or loss, SBS does not allocate the following to these segments:

	•	Substantially all of the amortization expense associated with acquisitions,
	•	asset impairment charges,
	•	substantially all interest income earned on cash balances,
	•	interest expense associated with SBS borrowing facilities,
	•	acquired in-process research and development charges, and
	•	corporate overhead costs, excluding sales and marketing costs.

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      Communications and Enterprise Group sales to external customers in fiscal 2002 decreased 60.2%, or $55.4 million, from $92.0 million in fiscal 2001, to $36.6 million. This decrease was primarily due to depressed market and economic conditions, customer order cancellations and delays of shipment dates by several of the Group’s telecommunications infrastructure customers. As of the date of this report, Communications and Enterprise Group orders remain at severely reduced levels. Management does not expect improvement during the remainder of fiscal 2003. Actual results may vary materially.

      For fiscal 2002, Communications and Enterprise Group segment loss was $(14.4) million, compared to segment profit of $22.1 million for fiscal 2001. This decrease was primarily due to the decrease in sales, severance and other employee termination costs, reserves for accounts receivable, a second quarter $9.0 million inventory write-down and a fourth quarter $2.7 million inventory write-down. The second quarter inventory write-down was associated with programs that were not anticipated to come back to their previous forecasts and with SBS’ decision to exit its legacy PCI chassis product line. The fourth quarter inventory write-down was due to additional order cancellations and the continued decline in sales and bookings. This decrease was partially offset by a reduction in R&D expenditures resulting from depressed business conditions. In July 2002, the Group’s Madison, Wisconsin facility was closed, resulting in the termination of 7 full-time employees and 11 part-time employees.

      Commercial and Government Group sales to external customers in fiscal 2002 decreased 13.5%, or $12.9 million from $95.2 million in fiscal 2001, to $82.3 million. Sales of the Group’s general purpose I/ O products and computer connectivity and expansion unit products decreased 33.0%, primarily as a result of unfavorable economic and market conditions and several customer delays of shipment dates. Unit shipments of the Group’s computer processor products increased 6.2%, primarily due to the focus on high volume production business in the quarter ended September 30, 2001, and an increase in shipments to a customer in the quarter ended June 30, 2002, partially offset by weak demand in the quarters ended December 31, 2001 and March 31, 2002. Unit shipments of the Group’s avionics and telemetry products increased 3.0%, primarily due to the release of the conduction-cooled PMC design, an increase in sales of the PMC2 board, and an increase in sales of integrated products. SBS does not expect significant improvement in the commercial market in fiscal 2003. Management expects some growth in sales to government customers in fiscal 2003 due to an expected increase in Department of Defense development and field deployment expenditures. Actual results may vary materially.

      Commercial and Government Group segment profit decreased 45.3%, or $9.7 million, from $21.4 million in fiscal 2001 to $11.7 million. This decrease was primarily due to the decrease in sales, $0.2 million of expenditures associated with SBS’ manufacturing consolidation and cost reduction efforts, severance and other employee termination costs, a second quarter $3.4 million inventory write-down, and an increase in SG&A expenses. The inventory write-down consisted of inventory associated with products that will no longer be marketed and with the implementation of a new inventory management methodology associated with the consolidation of manufacturing operations. The increase in SG&A expense was primarily due to an increase in sales and marketing costs due to SBS’ pro-rata allocation of certain corporate SG&A expenses among segments, based on sales. For the same reasons, segment profit as a percentage of sales decreased from 22.5% in fiscal 2001 to 14.2% in fiscal 2002.

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      Sales. In fiscal 2001, sales increased 46.0%, or $59.0 million, from $128.2 million in fiscal 2000, to $187.2 million. Of this 46.0% increase, sales contributed by SDL, which was acquired on April 12, 2000, comprised 14.3%, and 31.7% was attributable to SBS’ other product lines. Unit shipments increased among all product lines within the Communications and Enterprise Group segment. Unit shipments increased within the Commercial and Government Group, with the exception of the Group’s avionics and telemetry product line, which decreased, primarily due to the decline in commercial satellite and military markets and in major new aircraft development programs.

      Gross Profit. In fiscal 2001, gross profit increased 32.2%, or $21.6 million, from $67.0 million in fiscal 2000, to $88.6 million. Of this 32.2% increase, 13.3% was due to the acquisition of SDL on April 12, 2000, and 18.9% was attributable to SBS’ other product lines. As expected, gross profit as a percentage of sales decreased to 47.3% in fiscal 2001 from 52.3% in fiscal 2000, primarily due to the significant sales mix change that occurred, as SBS continued to transition to higher volume, lower margin OEM production orders, and became less dependent on its high-margin legacy products.

      Selling, General and Administrative Expense. In fiscal 2001, selling, general and administrative expense increased 25.5%, or $6.7 million from $26.3 million in fiscal 2000, to $33.0 million. Of this 25.5% increase, 5.4% resulted from the acquisition of SDL on April 12, 2000, and 20.1% was primarily due to an increase in costs commensurate with the growth of the Communications and Enterprise Group and to the strengthening of SBS’ sales and marketing efforts, partially offset by cost reductions within the Commercial and Government Group. In fiscal 2001, selling, general and administrative expense as a percentage of sales decreased to 17.6% from 20.5% in fiscal 2000, as the increase in sales volume more than offset the increase in expense.

      Research and Development Expense. In fiscal 2001, research and development expense increased by 25.8%, or $4.2 million, from $15.9 million in fiscal 2000, to $20.1 million. Of this 25.8% increase, 22.2% resulted from the acquisition of SDL on April 12, 2000, and 3.6% was primarily due to increased investment in product development within the Communications and Enterprise Group commensurate with the growth of the segment, partially offset by cost reductions within the Commercial and Government Group. In fiscal 2001, research and development expense as a percentage of sales decreased to 10.7% from 12.5% in fiscal 2000, as the increase in sales volume more than offset the increase in expense.

      Amortization of Intangible Assets. In fiscal 2001, amortization of intangible assets increased 54.6%, or $2.7 million from $5.0 million in fiscal 2000, to $7.7 million. This increase was the result of the amortization of goodwill and identifiable intangibles associated with the acquisition of SDL on April 12, 2000 and the amortization of SBS’ license agreement for fibre channel technology purchased in the fourth quarter of fiscal 2000.

      Interest Income. In fiscal 2001, interest income of $410,000 consisted primarily of interest associated with SBS’ surplus cash.

      Interest Expense. In fiscal 2001, interest expense of $1.1 million consisted primarily of interest associated with the $20.0 million of borrowings used to fund the acquisition of SDL on April 12, 2000.

      Foreign Exchange Losses. In fiscal 2001, the $201,000 of foreign exchange losses were primarily attributable to the change in exchange rates relating to interest payable on debt from SBS’ foreign subsidiary, partially offset by a foreign exchange gain attributable to the change in exchange rates relating to payments by SBS’ U.S. subsidiaries to an SBS foreign subsidiary for commissions accrued at June 30, 2000.

      Income Taxes. For fiscal 2001 and fiscal 2000, income taxes represented effective income tax rates of 36.1% and 42.9%, respectively. For fiscal 2000, the effective income tax rate, excluding the non-deductible acquired in-process research and development charge, would have been 34.1%.

      Earnings per Share. For fiscal 2001, net income per common share was $1.23 compared to $0.71 for fiscal 2000. Net income per common share-assuming dilution was $1.14 for fiscal 2001 compared to $0.66 for fiscal 2000. For fiscal 2000, net income per common share-assuming dilution, excluding the acquired IPR&D

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      SBS operates internationally through two operating segments: the Communications and Enterprise Group, and the Commercial and Government Group. These segments were defined during the fourth quarter of fiscal year 2002, in conjunction with the change in the Chief Executive Officer, and management’s realignment of operations and market development efforts. To better align similar technologies and selling channels, the former Commercial Group and the former Government Group were combined. The combined group consists of SBS Commercial, SBS Government, or, ortec, and SBS’ Avionics Products division. The Communications and Enterprise Group consists of Communications Products, SDL, and Industrial Computers. These segments are based on the markets that are served and the products that are provided to those markets. Each segment has its own sales and distribution channels and has a manager who reports directly to the President and Chief Operating Officer. Reportable segments for all periods have been reclassified to conform to the new segment reporting structure.

      The following is a discussion of sales to external customers and segment profit for each reportable segment. In the measure of segment profit or loss, SBS does not allocate the following to these segments:

	•	Substantially all of the amortization expense associated with acquisitions,
	•	asset impairment charges,
	•	substantially all interest income earned on cash balances,
	•	interest expense associated with SBS borrowing facilities,
	•	acquired in-process research and development charges, and
	•	corporate overhead costs, excluding sales and marketing costs.

      Communications and Enterprise Group sales to external customers in fiscal 2001 increased 109.5%, or $48.1 million, from $43.9 million in fiscal 2000, to $92.0 million. Of this 109.5% increase, sales contributed from the acquisition of SDL on April 12, 2000 accounted for 41.8% of the increase. The balance of the increase was primarily attributable to a 102.1% increase in sales of the Group’s PowerPC based processor products, I/ O products, and high availability systems products, resulting from growth in sales to wireless internet access, high speed router, optical switch, wide area network monitoring, and IP routing application customers.

      Communications and Enterprise Group segment profit in fiscal 2001 increased 116.7%, or $11.9 million, from $10.2 million in fiscal 2000, to $22.1 million. This increase was primarily due to earnings contributed by the acquisition of SDL on April 12, 2000 and an increase in sales among the Group’s PowerPC based processor products, I/ O products and high availability systems products, partially offset by an increase in selling, general and administrative and research and development expenses commensurate with the growth of the segment. Segment profit as a percentage of sales increased from 23.2% in fiscal 2000 to 24.0% in fiscal 2001, as the increase in sales volume more than offset the increase in expense.

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     Commercial and Government Group

      Commercial and Government Group sales to external customers in fiscal 2001 increased 12.9%, or $10.9 million from $84.3 million in fiscal 2000, to $95.2 million. Sales of the Group’s general purpose I/O and computer connectivity and expansion unit products, and computer processor products increased 28.8% and 13.8%, respectively, as compared to fiscal 2000. This increase was primarily the result of the Group’s focus on OEM production business, as well as an increase in sales to semiconductor equipment manufacturers, and an increase in sales to entertainment production equipment and defense and aerospace customers. The increase in sales volume of the Group’s computer processor products was partially offset by the approximate $1.5 million negative impact of changes in exchange rates on sales, as the U.S. dollar strengthened against the Deutsche mark during fiscal 2001. Sales of the Group’s avionics and telemetry products decreased 3.8%, primarily the result of declines in the commercial satellite and military markets and the decline in major new aircraft development programs.

      Commercial and Government Group segment profit increased 13.6%, or $2.6 million, from $18.8 million in fiscal 2000 to $21.4 million. This increase was primarily due to the gross profit contributed by the increase in sales and R&D and SG&A cost reductions, partially offset by the amortization of the Group’s license agreement for fibre channel technology purchased in the fourth quarter of fiscal 2000. Segment profit as a percentage of sales was 22.5% in fiscal 2001, consistent with fiscal 2000.

      SBS uses a combination of the sale of equity securities, internally generated funds and bank borrowings to finance its acquisitions, working capital requirements, capital expenditures and operations.

      Cash totaled $24.8 million at June 30, 2002, an increase of $15.1 million from June 30, 2001. This increase was the result of $20.6 million of cash provided by operating activities and $1.6 million from the exercise of stock options, partially offset by $3.3 million for the acquisition of property and equipment, $2.5 million of payments on SBS’ line of credit, $1.0 million expended for the Essential Communications asset purchase, and $0.5 million paid to repurchase shares of SBS’ common stock pursuant to a repurchase plan adopted by the Board of Directors on September 14, 2001 and implemented from September 20 to September 26, 2001. Accounts receivable declined, consistent with the decline in sales. Inventory declined $23.5 million, $15.1 million of which was due to inventory write-downs (see “Gross Profit” above). The remaining decline in inventory was consistent with the decline in sales volume. Liabilities were in line with the current level of business.

      Between June 30, 2002 and September 17, 2002, SBS repurchased 46,000 shares of its common stock for approximately $324,000.

      Effective June 30, 2002, SBS executed the fourth amendment to its $30.0 million Credit Agreement (“Agreement”) with Bank of America, N.A. (“Bank”). At December 31, 2001 and March 31, 2002, SBS was out of compliance with the fixed charge coverage ratio covenant of the Agreement, primarily due to losses incurred by SBS during the quarter ended December 31, 2001, but obtained waivers from the Bank. SBS and the Bank began negotiations to amend the Agreement on terms acceptable to both parties, finalizing these negotiations on June 30, 2002. This fourth amendment lowered the maximum amount available to be borrowed from $30.0 million to $20.0 million and modified the compliance covenants of the Agreement.

      At June 30, 2002, there were no borrowings drawn on the Agreement. At June 30, 2002, SBS was out of compliance with the cash flow coverage ratio covenant of the amended Agreement, primarily due to the inventory write-down and the charges for impairment of identifiable intangibles and goodwill recorded in the fourth quarter of fiscal 2002. On September 20, 2002, SBS canceled the Agreement.

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      Management believes that its internally generated funds will be sufficient to finance SBS’ current operations and capital expenditures, excluding acquisitions, for at least the next twelve months. Because long-term cash flow cannot be predicted with certainty, it is possible that SBS could require external financing in the future, and that such financing may not be available on terms acceptable to SBS or at all.

      As of the date of this report, SBS does not have any material capital expenditure commitments. As of June 30, 2002, SBS had $269,000 in remaining severance payments to employees, due at various dates through the quarter ending December 31, 2002 (see “Severance and Other Employee Termination Costs” above). SBS is also committed under noncancelable operating leases that expire at various dates through fiscal 2006. The following is a five-year schedule of future minimum lease payments:

      For the periods ended June 30, 2002, 2001 and 2000, there was no significant impact from inflation.

      In June 2001, the FASB issued SFAS 141, “Business Combinations,” and SFAS 142, “Goodwill and Other Intangible Assets.” SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Any purchase price allocable to an assembled workforce may not be accounted for separately. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, if any, and reviewed for impairment in accordance with SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.”

      SBS adopted the provisions of SFAS 141 and SFAS 142 on July 1, 2002. SFAS 141 requires that SBS evaluate its existing intangible assets and goodwill that were acquired in prior purchase business combinations, and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. SFAS 142 requires SBS to reassess the useful lives and residual values of all intangible assets acquired, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, SBS is required to test the intangible asset for impairment in accordance with the provisions of SFAS 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period.

      In connection with SFAS 142’s transitional goodwill impairment evaluation, SBS is required to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. To accomplish this, the Company must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. The Company will then have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit’s carrying amount. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and SBS must perform the second step of the transitional impairment test. In the second step, SBS must compare the implied fair value of the reporting unit’s goodwill,

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      Because of the extensive effort needed to comply with the adoption of SFAS 141 and SFAS 142, it is not practicable to reasonably estimate the impact of adoption of these standards of SBS’ financial statements at the date of this report, including whether it will be required to recognize any transitional impairment losses as the cumulative effect of a change in accounting principle. At June 30, 2002, the amount of unamortized goodwill was approximately $20.0 million. Goodwill amortization for the years ended June 30, 2002, 2001, and 2000 was approximately $4.5 million, $4.6 million, and $4.4 million, respectively.

      In June 2001, the FASB issued SFAS 143 “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the asset. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, SBS will recognize a gain or loss on settlement. The adoption of SFAS 143, effective July 1, 2002, did not have a material impact on SBS’ financial statements or results of operations.

      In August 2001, the FASB issued SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” but retains many of the fundamental provisions of SFAS 121. SFAS 144 also supersedes APB Opinion No. 30, “Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS 144 retains the requirement in Opinion 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. The adoption of SFAS 144, effective July 1, 2002 did not have a material impact on SBS’ financial statements or results of operations.

      In June 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between SFAS 146 and EITF 94-3 relates to SFAS 146’s requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability be recognized when the liability is incurred. Under 94-3, a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002, but early application is encouraged. SBS does not expect the adoption of SFAS 146 to have a material impact on its financial statements or results of operations.

      As of the date of this report, Communications and Enterprise Group orders remain at severely reduced levels. Management does not expect significant improvement in the communications or commercial markets in fiscal 2003. Management expects some growth in sales to government customers in fiscal 2003 due to an expected increase in Department of Defense development and field deployment expenditures. Management

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      SBS’ liquid investment is cash invested either in money market accounts or in overnight repurchase agreements. Due to the nature of these investments, SBS believes that the market risk related to these investments is minimal. SBS’ revolving credit facility provides for interest on borrowings based on the prime rate or LIBOR in accordance with the LIBOR margin defined in the Agreement. As a result, increases or decreases in these rates will have the effect of reducing or increasing net income during the period these notes remain outstanding. There are no outstanding borrowings under the facility at the date of this report.

      SBS, as a result of its German operating and financing activities, is exposed to market risk from changes in foreign currency exchange rates. To date, SBS has not entered into any foreign exchange forward contracts to reduce its exposure to changes in foreign currency exchange rates.

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INDEPENDENT AUDITORS’ REPORT

The Board of Directors

      We have audited the accompanying consolidated balance sheets of SBS Technologies, Inc. and subsidiaries as of June 30, 2002 and 2001, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended June 30, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SBS Technologies, Inc. and subsidiaries as of June 30, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2002 in conformity with accounting principles generally accepted in the United States of America.

	KPMG LLP

Albuquerque, New Mexico

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SBS Technologies, Inc. and Subsidiaries

Consolidated Balance Sheets

See accompanying notes to consolidated financial statements

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SBS Technologies, Inc. and Subsidiaries

Consolidated Statements of Operations

See accompanying notes to consolidated financial statements

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SBS Technologies, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity