SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

        For the quarterly period ended June 30, 2004

or

        For the transition period from _________________ to _______________________

Commission file number: 0-23576

CELERITEK, INC.

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

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

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

     Yesx Noo

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yeso Nox

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

     Common Stock, No Par Value: 12,855,962 shares as of July 25, 2004

CELERITEK, INC.

Table of Contents

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PART I            FINANCIAL INFORMATION

Item 1.             FINANCIAL STATEMENTS

CELERITEK, INC.

     Note: The balance sheet at March 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

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CELERITEK, INC.

See accompanying notes.

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CELERITEK, INC.

See accompanying notes.

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Celeritek, Inc.

Notes to Condensed Consolidated Financial Statements
(Unaudited)

June 30, 2004

1.		Basis of Presentation
		The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.
		The Company’s reporting period consists of a thirteen-week period ending on the Sunday closest to the calendar month end. The first quarters of fiscal 2005 and fiscal 2004 ended June 27, 2004 and June 29, 2003, respectively. For convenience, the accompanying financial statements have been shown as ending on the last day of the calendar month.
		Operating results for the three months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2005. This financial information should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended March 31, 2004 as filed with the Securities and Exchange Commission.
		On July 8, 2004, the Company announced it had entered into an asset purchase agreement with Teledyne Wireless, Inc. pursuant to which Teledyne will acquire the Company’s defense subsystems business for $33.0 million in cash (subject to a working capital adjustment). The Company’s defense subsystems business had sales of $19.7 million for the fiscal year ended March 31, 2004. The asset sale is subject to the approval of the Company’s shareholders, as well as other customary closing conditions. If the proposed transaction is completed, the Company intends to distribute a substantial portion of the after-tax proceeds from the proposed transaction to its shareholders through an extraordinary cash dividend, although the amount of the dividend has not yet been determined, since the Company has not completed its analysis of the cash it will need to continue its operations and otherwise pay its liabilities and expenses.
		Certain amounts reported in previous years and interim periods have been reclassified to conform to the current year presentation.

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2.		Stock Based Compensation
		The Company generally grants stock options to its employees for a fixed number of shares with an exercise price equal to the fair value of the shares on the date of grant. The Company records compensation related to employees stock awards under the intrinsic value method and accordingly, no compensation expense is recognized in the Company’s financial statements in connection with stock options granted to employees with exercise prices not less than fair value.
		Pro forma information regarding net loss and net loss per share under the fair value method is presented below (in thousands, except per share amounts):

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

The Black-Scholes option valuation model was developed for use in estimating the fair market value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect

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		the fair market value estimate, in management’s opinion, the existing models do not necessarily provide a reliable measure of the fair market value of its options.
		The weighted average grant date fair value of options granted during the three months ended June 30, 2004 and 2003 was $2.49 and $5.25, respectively. There were no purchases made under the Employee Stock Purchase Plan during the three months ended June 30, 2004 and 2003.
		We declared an extraordinary cash dividend of $4.50 per share payable to shareholders of record as of February 5, 2004, payable on March 11, 2004. The total dividend paid was $57.8 million. Under the intrinsic value method of accounting for stock options, we were required to adjust our stock option exercise price by the dividend amount, or $4.50 per share, because the dividend was a return of capital. Since our stock option plan does not allow us to reprice options, we were required to change to the variable method of accounting for our outstanding stock options. Under variable accounting, compensation expense is recognized over the life of the option (until exercised, forfeited, or cancelled) generally to the extent that there are any increases in the per share market price of the company’s common stock. It is difficult to estimate the impact that expensing stock options will have on our statement of operations as this expense is dependent upon future events that are difficult to predict, such as the number of options to be granted during a period, the price of our common stock at the time of grant, the stock price volatility, the risk free interest rate during the period and the expected average life of the option. A slight change in any one of these variables can materially affect the amount of compensation expense to be recorded. This change to the variable method of accounting on March 12, 2004 had no financial impact on the fiscal 2005 first quarter financial statements.
3.		Inventories
		Inventories, stated at the lower of standard cost (which approximates actual cost on a first-in, first-out method) or market, consists of the following components (in thousands):

4.		Loss Per Share
		Basic loss per common share is computed using the weighted average common shares outstanding during the period. The effect of outstanding stock options is excluded from the calculation of diluted net loss per share, as their inclusion would be antidilutive.

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5.		Comprehensive Loss
		The components of comprehensive loss for the three month periods ended June 30, 2004 and 2003 are as follows (in thousands):

6.		Strategic Investments
		The Company regularly reviews its investments for circumstances of other than temporary impairment and assesses the carrying value of the assets against market value. When an other than temporary impairment exists, the Company records an expense to the extent that the carrying value exceeds fair market value in the period the assessment was made. The fair value of strategic investments is dependent on the performance of the companies invested in, as well as the marketability of these investments. In assessing potential other than temporary impairment of these investments, management considers these factors as well as forecasted financial performance of the investees. If these forecasts are not met or if market conditions change, the Company may have to record additional impairment charges.
		Handset Design Company
		In December 2001, the Company invested $0.5 million in a Korean handset design company. On April 1, 2002, the Company invested an additional $2.0 million in the handset design company. The Company does not have significant influence over the management of the handset design company and accordingly has accounted for the investment on a cost basis in all reported periods. The Company reviewed the investment as of June 30, 2004 and determined no indicators of impairment were present that would indicate the current carrying value of the investment was impaired.
		GaAs Foundry
		In December 2000, the Company invested approximately $2.4 million in a GaAs foundry under construction in Taiwan in exchange for a strategic interest in the foundry. The Company does not

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		have significant influence over the management of the GaAs foundry and accordingly has accounted for the investment on a cost basis in all reported periods.
		During the fourth quarter of fiscal 2002, first and fourth quarter of fiscal 2003 and first quarter of fiscal 2005, the Company recorded impairment charges of approximately $1.7 million, $0.3 million, $0.1 million and $0.3 million, respectively, against its strategic investment in the Taiwanese foundry, which was deemed, in those respective periods, to have an other than temporary decline in value. The current carrying value of this investment at the end of the first quarter of fiscal 2005 is zero. The Company has completely written off its investment in the GaAs foundry due to the insolvency of its parent company, which the Company believes was the foundry’s main source of funding.
7.		Special Charges
		At March 31, 2004, the Company held an accrual for $1.1 million relating to the fiscal 2003 and fiscal 2004 restructuring activities. Lease termination cost accrual of $0.4 million represented the present value of future minimum payments under operating leases covering unused equipment in fiscal 2003. Such amounts will be paid through to lease expiry in fiscal 2005. Relocation cost accrual of $0.7 million represented the present value of future minimum payments under a building lease agreement for a building the Company vacated in fiscal 2004. Such amounts will be paid through to lease expiry in fiscal 2006.
		The following table summarizes the Company’s special charges activity (in thousands):

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

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Changes in the Company’s product liability during the three months ended June 30, 2004 and 2003 were as follows (in thousands):

9.		Cost Related to Shareholder and Strategic Actions
		In the fourth quarter of fiscal 2003, a group of shareholders (the “Shareholder Committee”) called a special meeting to remove the Company’s Board of Directors from office and replace them with a different slate of candidates. In May 2003 the Company’s Board of Directors entered into an agreement with the Shareholder Committee. Under the terms of the agreement, the Company has expanded its Board of Directors from six directors to seven. The new Board is now composed of three of the Company’s directors who were directors prior to the agreement, three directors nominated by the Shareholder Committee and one member who is not affiliated with either the Company or the Shareholder Committee. In fiscal 2004, expenses of $1.4 million related to the special meeting of shareholders and $1.7 million in investment banking fees were incurred and reported in loss from operations under the caption “Cost related to shareholder and strategic actions.” The Company did not incur any cost related to shareholder and strategic actions during the first three months of fiscal 2005.
10.		Recent Accounting Pronouncements
		In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period ending after December 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company adopted FIN 46 in the third quarter of fiscal 2004 and its adoption did not have a material impact on the Company’s financial position or results of operations.

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		In May 2003, the FASB issued Statement Number 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 generally requires liability classification for two broad classes of financial instruments: (1) instruments that represent, or are indexed to, an obligation to buy back the issuer’s shares, and (2) obligations that can be settled in shares, but are subject to certain conditions. SFAS 150 applies to all financial instruments created or modified after May 31, 2003, and to other instruments at the beginning of the first interim period beginning after July 1, 2003. As the Company has not created or modified any financial instruments since the effective date of SFAS 150, it did not have a material impact on the Company’s financial statements.
		In November 2002, the Emerging Issues Task Force (the “EITF”) reached a consensus on Issue No. 00-21 Accounting for Revenue Arrangements with Multiple Deliverables. The EITF concluded that revenue arrangements with multiple elements should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and as long as there are no rights of return or additional performance guarantees by the Company. The provisions of EITF Issue No. 00-21 are applicable to agreements entered into in fiscal periods beginning after June 15, 2003. Management adopted the consensus in the second quarter of fiscal 2004, and it did not have a material effect on the Company’s results of operations or financial condition.
		In November 2003, the EITF issued EITF No. 03-6 “Participating Securities and the Two-Class Method under FASB Statement No. 128,” which provides for a two-class method of calculating earnings per share computations that relate to certain securities that would be considered to be participating in conjunction with certain common stock rights. This guidance would be applicable to the Company starting with the second quarter beginning July 1, 2004. The Company is currently evaluating the potential impact of this pronouncement on its financial statements.
11.		Subsequent Events
		On July 8, 2004, the Company announced it had entered into an asset purchase agreement with Teledyne Wireless, Inc. pursuant to which Teledyne will acquire the Company’s defense subsystems business for $33.0 million in cash (subject to a working capital adjustment). The Company’s defense subsystems business had sales of $19.7 million for the fiscal year ended March 31, 2004. The asset sale is subject to the approval of the Company’s shareholders, as well as other customary closing conditions. If the proposed transaction is completed, the Company intends to distribute a substantial portion of the after-tax proceeds from the proposed transaction to its shareholders through an extraordinary cash dividend, although the amount of the dividend has not yet been determined, since the Company has not completed its analysis of the cash it will need to continue its operations and otherwise pay its liabilities and expenses.

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

Forward-Looking Statements

     This report contains forward-looking statements, which are identified by words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend” and other similar expressions. In addition, forward-looking statements in this report include, but are not limited to, those regarding: our intention to distribute a cash dividend from the proceeds of the proposed asset sale, our focus on market areas where we believe our resources and core competencies will give us the greatest opportunity for success in our goal of returning to profitability; our future gross margins; our expected research and development expenses and selling, general and administrative expenses; and our belief that our cash resources will be sufficient to meet our liquidity needs through at least the next twelve months. These forward-looking statements are subject to business and economic risks and uncertainties, and our actual results of operations may differ materially from those contained in the forward-looking statements. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. However, readers should carefully review the risk factors set forth in this Form 10-Q and other reports or documents we file from time to time with the Securities and Exchange Commission.

Critical Accounting Policies

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

     We review our estimates, including, but not limited to, allowance for doubtful accounts, inventory write-downs, and impairments of long-lived assets and investments, on a regular basis and make adjustments based on historical experiences and existing and expected future conditions. These evaluations are performed regularly and adjustments are made as information is available. We believe that these estimates are reasonable; however, actual results could differ from these estimates. The following paragraphs describe the methodology we use in making some of our principal accounting estimates, in evaluating some of the uncertainties inherent in accounting estimates and in evaluating some of the ways that our estimates may impact our financial condition.

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

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

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

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

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

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

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

Recent Events

     On July 8, 2004, we announced we had entered into an asset purchase agreement with Teledyne Wireless, Inc. pursuant to which Teledyne will acquire our defense subsystems business for $33.0 million in cash (subject to a working capital adjustment). Our defense subsystems business had sales of $19.7 million for the fiscal year ended March 31, 2004. The asset sale is subject to the approval of our shareholders, as well as other customary closing conditions. If the proposed transaction is completed, the Company intends to distribute a substantial portion of the after-tax proceeds from the proposed transaction to its shareholders through an extraordinary cash dividend, although the amount of the dividend has not yet been determined, since the Company has not completed its analysis of the cash it will need to continue its operations and otherwise pay its liabilities and expenses.

Result of Operations — First Quarter of Fiscal 2005 Compared to First Quarter of Fiscal 2004

     Total net sales were $8.0 million for the first quarter of fiscal 2005, compared to $6.6 million for the first quarter of fiscal 2004, an increase of 22%.

     Semiconductor sales were $3.3 million in the first quarter of fiscal 2005, compared to $1.6 million in the first quarter of fiscal 2004, an increase of 106%. Sales in the first quarter of fiscal 2004 did not include any sales of power amplifier modules for handsets while sales in the first quarter of fiscal 2005 included $1.0

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     million of sales of power amplifier modules for handsets and $0.4 million of revenue for a development contract for power amplifier modules for satellite handsets.

     Subsystem sales in the first quarter of fiscal 2005 were $4.7 million compared to $5.0 million in the first quarter of fiscal 2004, a decrease of 6%. The decrease in sales of subsystems products to defense customers is primarily the result of design issues causing delays in the transition of products from an engineering phase into production.

     Gross margin was 38% of net sales in the first quarter of fiscal 2005 compared to 8% of net sales in the first quarter of fiscal 2004. The increase in gross margin was due to the unanticipated sale of approximately $1.0 million of power amplifier modules for handsets where the corresponding costs were written off in prior periods as obsolete inventory and $0.4 million of sales for a milestone achievement in a contract to develop power amplifier modules for satellite handsets with the corresponding costs recorded in research and development expense. The increased revenue without a corresponding cost of sales contributed 14% to the gross margin improvement. The remaining improvement in gross margin is due to reduced overhead expenses, which are the result of headcount reductions and asset and lease impairments. We do not expect significant improvement in gross margin until sales volumes increase because of fixed costs related to our fabrication facility.

     Research and development expenses were $1.8 million, or 22% of net sales, in the first quarter of fiscal 2005 compared to $2.9 million, or 44% of net sales, in the first quarter of fiscal 2004, a decrease of 38%. Research and development expenses decreased from the prior year due to our decision to exit the wireless handset market. A significant part of our research and development efforts were focused on developing wireless handset power amplifier products for the market in South Korea. These decreases in spending were somewhat offset by increased spending on the development of defense products.

     Selling, general and administrative expenses were $2.0 million, or 25% of net sales, in the first quarter of fiscal 2005 compared to $2.2 million, or 33% of net sales, in the first quarter of fiscal 2004, a decrease of 6%. The decrease was primarily due to lower selling costs driven by the decrease in revenues and lower personnel costs.

     The $2.5 million of costs related to shareholder actions in the first quarter of fiscal 2004 consisted of approximately $1.4 million in expense related to the special meeting of shareholders and $1.1 million in investment banking fees, including fees related to the special meeting.

     During the first quarter of fiscal 2005, we recorded an impairment charge of approximately $0.3 million against our strategic investment in the Taiwanese foundry, which was deemed to have an other than temporary decline in value. The current carrying value of this investment at the end of the first quarter of fiscal 2005 is zero. We have completely written off our investment in the Taiwanese foundry due to the insolvency of its parent company, which we believe was the foundry’s main source of funding. During the fourth quarter of fiscal 2002 and first and fourth quarter of fiscal 2003, we recorded impairment charges of approximately $1.7 million, $0.3 million and $0.1 million, respectively, against our strategic investment in the Taiwanese foundry, which was deemed, in those respective periods, to have an other than temporary decline in value.

     We incurred no special charges during the first quarter of fiscal 2005. During fiscal 2004, we incurred $4.5 million in special charges due to our exit of the wireless handset power amplifier market, offset by $0.2 million in proceeds from the sale of equipment impaired in fiscal 2002, for a net expense of $4.3 million for fiscal 2004. The special charges of $4.5 million in fiscal 2004 are comprised of approximately $0.2 million of impairment charges related to the reassessment of carrying values for certain tangible and intangible assets to

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be sold, $1.8 million of equipment impairment charges related to exiting the wireless handset power amplifier market, $0.6 million of equipment impairment charges related to restructuring at the Belfast facility, $0.7 million in employee termination charges, $0.9 million for building lease termination costs, $0.2 million of facilities consolidation costs, and $0.1 million to close our Korean sales office.

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

     There was no amortization of intangibles during the first quarter of fiscal 2005. Amortization of intangibles was $0.1 million during the first quarter of fiscal 2004. In the second quarter of fiscal 2004, we exited the wireless handset power amplifier market and during the third quarter of fiscal 2004 sold all the intangible and certain tangible assets related to the wireless handset power amplifier market for $1.0 million to Anadigics, Inc.

     Interest income and other, net was $0.1 million in the first quarter of fiscal 2005 compared to $0.2 million in the first quarter of fiscal 2004. The decrease in interest income and other, net, was primarily due to decreased interest income on a lower cash and short-term investments balances.

Liquidity and Capital Resources

     We have funded our operations to date primarily through cash flows from operations and sales of equity securities. As of June 30, 2004, we had $8.1 million in cash and cash equivalents, $15.4 million in short-term investments and $25.0 million in working capital.

     Net cash used by operating activities was $1.7 million in the first three months of fiscal 2005 and was due primarily to the payment of accrued liabilities. Net cash used by operating activities was $3.9 million in the first three months of fiscal 2004 and was due primarily to the quarterly net loss partially offset by decreases in accounts receivable and inventory and increases in accounts payable and accrued liabilities.

     Net cash provided by investing activities was $8.0 million in the first three months of fiscal 2005 and was due to the net sales and maturities of short-term investments of $8.6 million, offset by the purchase of property and equipment of $0.6 million. Net cash used by investing activities was $18.4 million in the first three months of fiscal 2004 and was due to the net purchases of short-term investments of $18.1 million and the purchase of property and equipment of $0.3 million.

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     Net cash used by financing activities was $1.3 million in the first three months of fiscal 2005 and was due primarily to the principal payments on long-term debt of $1.2 million. Net cash used by financing activities was $0.7 million in the first three months of fiscal 2004 and was due primarily to principal payments on long-term debt of $0.6 million. As a result of the extraordinary cash dividend in the fourth quarter of fiscal 2004, we violated certain lending covenants, based on current agreements in place. Therefore, we decided to repay certain lending agreements in full.

     As of June 30, 2004, we had $0.9 million in outstanding letters of credit, which are secured by certificates of deposits.

     Given our cash position, we currently do not have a line of credit. We have various equipment notes outstanding with other lenders, which are secured by the equipment. Several of these notes have covenants attached pertaining to liquidity levels and minimum tangible net worth.

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

Commitments

     We do not have any special purpose entities. We have no commercial commitments with related parties, except for employee loans. We have outstanding loans to certain former officers and employees totaling approximately $0.6 million at June 30, 2004. The notes are relocation loans collateralized by certain real property assets, bear no interest and have maturities through 2019. The principal will be repaid at various dates. If an employee voluntarily ceases being employed by us, the principal outstanding will be due and payable within 90 days.

     We have contractual obligations in the form of operating and capital leases, debt and purchase order commitments. The following table sets forth our future contractual obligations as of June 30, 2004 (in thousands):

Contractual Obligations

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

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     We have outstanding letters of credit of approximately $0.9 million as security for capital leases for equipment and pending supplier cancellation charges.

RISK FACTORS

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

If the proposed sale of our defense subsystems business to Teledyne is consummated, our success will depend on our semiconductor business alone.

     Our defense business constitutes a substantial portion of our assets. As such, our asset base and revenues following the proposed asset sale will change significantly from those existing currently. Following the proposed asset sale, we expect to generate substantially all of our sales from our semiconductor business. To date, our semiconductor business has never generated a profit and has incurred significant operating losses. As a result, we must grow our semiconductor business rapidly and substantially in order to achieve profitability, and economic and other factors may prevent us from growing the business at a sustainable rate, if at all. If we fail to grow our semiconductor operations, we may be unable to afford to continue to do business, and we may have to cease operations altogether.

If the proposed sale of our defense subsystems business to Teledyne is not consummated, our business and results of operations may suffer.

     The proposed asset sale is conditioned upon a number of factors, including approval by our shareholders and the receipt of certain third-party consents from our most significant defense business customers. If the asset sale is not consummated for any reason, our business may be harmed because our customers may question our commitment to our defense business and cease doing business with us. Similarly, our employees may believe we are not committed to our defense business and look for employment elsewhere. The potential loss of customers and employees if we are unable to consummate the proposed asset sale would seriously harm our results of operations and financial condition.

Certain terms of the proposed sale of our defense business to Teledyne are unfavorable to us and could cause our business to be harmed.

     Pursuant to the terms of the asset purchase agreement, we will be responsible for substantially all preclosing liabilities of our defense business, except for current liabilities that will be assumed by Teledyne. If any of these preclosing defense business liabilities arise in the future, we may lack the cash required to satisfy them. In addition, we have agreed to indemnify Teledyne against certain losses it may suffer arising out of the acquisition of our defense business. If we are required to indemnify Teledyne for any matter, it could have a material adverse impact on our business by draining our available cash reserves.

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

     Our business requires us to maintain manufacturing equipment and related support infrastructure that we must pay for regardless of our level of sales. To support our manufacturing capacity we also incur costs for

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maintenance and repairs and employ personnel for manufacturing and process engineering functions. These expenses, along with depreciation costs, are fixed and do not vary greatly, if at all, when our net sales decrease. In addition, the lead time for developing and manufacturing our products often requires us to invest in manufacturing capacity in anticipation of future demand. The recent decline in market demand has resulted in infrastructure costs in excess of current needs and has resulted in lower earnings. Although we recently exited the wireless handset power amplifier market — which we believe will result in reduced expenses — we are nevertheless still relying on increased sales to manufacturers of commercial communications equipment and defense contractors in order to realize a significant increase in revenues. If these sales do not materialize, and if our revenues do not significantly increase to a level commensurate with our installed capacity, we will be unable to achieve profitability.

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

     In late September 2003, we exited the wireless handset power amplifier business in order to focus our resources on market areas where we believe our core competencies will allow us the greatest opportunity of success in our goal of returning to profitability. There is, however, no guarantee that our exit from the wireless handset power amplifier business will enable us to reach profitability on a more expedited basis, or at all. In particular, we now face increased reliance on the sales of our semiconductor products for wireless infrastructure, satellite communications and defense applications, which markets may have lower growth potential than the wireless handset market. In addition, we may fail to manage successfully our exit from the wireless handset power amplifier business. If our projections with respect to the sales of our semiconductors products for wireless infrastructure, satellite communications and defense applications are incorrect, we may fail to achieve profitability and our business may suffer.

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

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

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

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

Variable accounting related to past stock option grants may impact our future earnings.

     We declared an extraordinary cash dividend of $4.50 per share payable to shareholders of record as of February 5, 2004, payable on March 11, 2004. The total dividend paid was $57.8 million. Pursuant to the Nasdaq Marketplace Rules, the ex-dividend date with respect to the cash dividend was set as March 12, 2004. Accordingly, prior to the commencement of trading on March 12, 2004, our opening bid price was reduced by $4.50 per share to reflect the payment of the cash dividend. Under the intrinsic value method of accounting for stock options, we were required to adjust our stock option exercise price by the dividend amount or $4.50 per share because the dividend was a return of capital. Since our stock option plan does not currently allow us to reprice options, we were required to change to the variable method of accounting for our outstanding stock options. Under variable accounting, compensation expense is recognized over the life of the option (until exercised, forfeited, or cancelled) generally to the extent that there are any increases in the per share market price of our common stock. It is difficult to estimate the impact that expensing stock options will have on our statement of operations as this expense is dependent upon future events that are difficult to predict, such as the number of options to be granted during a period, the price of our common stock at the time of grant, the stock price volatility, the risk free interest rate during the period and the expected average life of the option. A slight change in any one of these variables can materially affect the amount of compensation expense to be recorded.

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

     We expect that sales to a limited number of customers will account for a large percentage of our net sales in the future and will be a very important component in our plans for returning to profitability. If we lose any of our existing major customers, our operating results and business would be harmed. In the first three months of fiscal year 2005, sales to our top ten customers accounted for approximately 63% of our net sales, with Motorola and Raytheon making up approximately 12% each. In fiscal year 2004, sales to our top ten customers accounted for approximately 62% of our net sales, with Raytheon making up approximately 16% and BAE Systems making up approximately 10% of those net sales. In fiscal year 2003, sales to our top ten customers accounted for approximately 75% of our net sales, with Motorola making up approximately 41% of those net sales. We had been a sole source supplier of power amplifier modules to Motorola for its model 120v handset platform. However, Motorola transitioned to new platforms, and it selected a sole source supplier other than us for its new platforms. As discussed above, we have exited the wireless handset power amplifier market entirely. If we were to lose a major customer, or if orders by any of our major customers were to otherwise decrease or be delayed, our business, operating results and financial condition would be seriously harmed.

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

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

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

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

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

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

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

     Sales to international customers accounted for 45% of our net sales in the first three months of fiscal 2005, 35% of our net sales in fiscal 2004 and 67% of our net sales in fiscal 2003. The increase in the percentage of sales to international customers in fiscal 2005, as compared to fiscal 2004, is the result of sales of power amplifiers to Motorola, which we do not expect to continue shipping in significant quantities. The decline in the percentage of sales to international customers in fiscal 2004, as compared to fiscal 2003, is the result of the decline in sales of power amplifiers to Motorola. Almost all of our wireless handset power amplifier products were sold to Motorola’s foreign subsidiaries and contractors. We expect that international sales will continue to account for a significant portion of our net sales in the future. In addition, many of our domestic customers sell their products outside of the United States. These sales expose us to a number of inherent risks, including:

•

the need for export licenses;

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•		unexpected changes in regulatory requirements;
•		tariffs and other potential trade barriers and restrictions;
•		reduced protection for intellectual property rights in some countries;
•		fluctuations in foreign currency exchange rates;
•		the burdens of complying with a variety of foreign laws;
•		the impact of recessionary or inflationary environments in economies outside the United States; and
•		generally longer accounts receivable collection periods.

     We are also subject to general geopolitical risks, such as political and economic instability and changes in diplomatic and trade relationships, in connection with our international operations. Potential markets for our products exist in developing countries that may deploy wireless communications networks. These countries may decline to construct wireless communications networks, experience delays in the construction of these networks or use the products of one of our competitors to construct their networks. As a result, any demand for our products in these countries will be similarly limited or delayed. If we experience significant disruptions to our international sales, our business, operating results and financial condition could be harmed.

     Additionally, all of our circuit assembly and test vendors are located outside of the United States. Consequently, our ability to secure products from these vendors is subject to most of the same risks described in the above paragraphs, including: unexpected changes in regulatory requirements; tariffs and other potential trade barriers and restrictions; reduced protection for intellectual property rights in some countries; fluctuations in foreign currency exchange rates; the burdens of complying with a variety of foreign laws; and general geopolitical risks. In the event that any of our international vendors is unable to fulfill our requirements in a timely manner, we may experience an interruption in production until we locate alternative sources of supply. If we encounter shortages in component supply, we may be forced to adjust our product designs and production schedules. The failure of one or more of our key suppliers or vendors to fulfill our orders in a timely manner and with acceptable quality and yields could cause us to not meet our contractual obligations, could damage our customer relationships (including relationships with major customers) and could harm our business.

Our backlog may not result in sales.

     Our backlog primarily represents signed purchase orders for products due to ship within 18 months. As of June 30, 2004, our backlog was approximately $19.1 million, of which 79% was from subsystem customers and 21% was from semiconductor customers. Backlog is not necessarily indicative of future sales as our customers may cancel or defer orders without penalty. Nevertheless, we make a number of management decisions based on our backlog, including purchasing materials, hiring personnel and other matters that may increase our production capabilities and costs. Cancellation of pending purchase orders or termination or reduction of purchase orders in progress could significantly harm our business. We do not believe that our backlog as of any particular date is representative of actual sales for any succeeding period, and we do not know whether our current order backlog will necessarily lead to sales in any future period.

     Generally, purchase orders in our backlog are subject to cancellation without penalty at the option of the customer, and from time to time we have experienced cancellation of orders in backlog. In fact, in fiscal 2002, a significant portion of our backlog was cancelled due to changing market conditions. Certain of our customers in the wireless infrastructure market delayed and cancelled long-standing contracts in response to declining market demand.

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     The variability of our manufacturing yields may affect our gross margins.

     The success of our business depends largely on our ability to make our products efficiently through a manufacturing process that results in a large number of usable products, or yields, from any particular production run. In the past we have experienced significant delays in our product shipments due to lower than expected production yields. Due to the rigid technical requirements for our products and manufacturing processes, our production yields can be negatively affected for a variety of reasons, some of which are beyond our control. For instance, yields may be reduced by:

•		lack of experience in producing a new product;
•		defects in masks that are used to transfer circuit patterns onto wafers;
•		impurities in materials used;
•		contamination of the manufacturing environment; and
•		equipment failures.

     Our manufacturing yields also vary significantly among our products due to product complexity and the depth of our experience in manufacturing a particular product. We cannot assure you that we will not experience problems with our production yields in the future. Decreases in our yields can result in substantially higher costs for our products. If we cannot maintain acceptable yields in the future, our business, operating results and financial condition will suffer.

Decreases in our customers’ sales volumes could result in decreases in our sales volumes.

     Our current semiconductor product strategy is to design standard products that can be used by different customers for a variety of applications. Any significant increase in our sales volume is dependent on our achieving a considerable number of design wins. Additionally, where our products are designed into an original equipment manufacturer’s product, our sales volumes will be dependent upon the commercial success of the original equipment manufacturer’s product. Sales of our major customers’ products can vary significantly from quarter to quarter. Accordingly, our sales could be adversely affected by a reduction in demand for wireless and defense communications systems. Our operating results have been significantly harmed in the past by the failure of anticipated orders to be realized and by deferrals or cancellations of orders as a result of changes in demand for our customers’ products.

We depend on single and limited sources for key components. If we lose one or more of these sources, delivery of our products could be delayed or prevented and our business could suffer.

     We acquire some of the components for our existing products from single sources, and some of the other components for our products are presently available or acquired only from a limited number of suppliers. Our single-sourced components include substrates, millimeter wave components and semiconductor packages. Some of these components are critical to the products we sell to our major customers. In the event that any of these suppliers are unable to fulfill our requirements in a timely manner, we may experience an interruption in production until we locate alternative sources of supply. If we encounter shortages in component supply, we may be forced to adjust our product designs and production schedules. The failure of one or more of our key suppliers or vendors to fulfill our orders in a timely manner and with acceptable quality and yields could cause us to not meet our contractual obligations, could damage our customer relationships (including relationships with major customers) and could harm our business.

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Intense competition in our industry could result in the loss of customers or an inability to attract new customers.

     We compete in an intensely competitive industry and we expect our competition to increase. A number of companies produce products that compete with ours or could enter into competition with us. These competitors, or potential future competitors, include CTT, M/A-COM, Miteq, and REMEC. In addition, a number of smaller companies may introduce competing products. Many of our current and potential competitors have significantly greater financial, technical, manufacturing and marketing resources than we have and have achieved market acceptance of their existing technologies. Our ability to compete successfully depends upon a number of factors, including:

•		the willingness of our customers to incorporate our products into their products;
•		product quality, performance and price;
•		the effectiveness of our sales and marketing personnel;
•		the ability to rapidly develop new products with desirable features;
•		the ability to produce and deliver products that meet our customers’ requested shipment dates;
•		the capability to evolve as industry standards change; and
•		the number and nature of our competitors.

     We cannot assure you that we will be able to compete successfully with our existing or new competitors. If we are unable to compete successfully in the future, our business, operating results and financial condition will be harmed.

Our business will be harmed if potential customers do not use gallium arsenide components.

     Silicon semiconductor technologies are the dominant process technologies for integrated circuits, and the performance of silicon integrated circuits continues to improve. Our prospective customers may be systems designers and manufacturers who are evaluating these silicon technologies and, in particular, silicon germanium versus gallium arsenide integrated circuits for use in their next generation high performance systems. Customers may be reluctant to adopt our gallium arsenide products because of:

•

unfamiliarity with designing systems with gallium arsenide products;

•

concerns related to relatively higher manufacturing costs and lower yields; and

•

uncertainties about the relative cost effectiveness of our products compared to high performance silicon components.

     In addition, potential customers may be reluctant to rely on a smaller company like us for critical components. We cannot be certain that prospective customers will design our products into their systems, that current customers will continue to integrate our components into their systems or that gallium arsenide technology will continue to achieve widespread market acceptance.

Our products may not perform as designed and may have errors or defects that could result in a decrease in net sales or liability claims against us.

     Our customers establish demanding specifications for product performance and reliability. Our standard product warranty period is one year. Problems may occur in the future with respect to the performance and reliability of our products in conforming to customer specifications. If these problems do occur, we could experience increased costs, delays in or reductions, cancellations or rescheduling of orders and shipments, product returns and discounts and product redesigns, any of which would have a negative impact on our

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business, operating results and financial condition. In addition, errors or defects in our products may result in legal claims that could damage our reputation and our business, increase our expenses and impair our operating results.

The sales cycle of our products is lengthy and the life cycle of our products is short, making it difficult to manage our inventory efficiently.

     Most of our products are components in commercial or defense communications systems. The sales cycle associated with our products is typically lengthy, and can be as long as two years, due to the fact that our customers conduct significant technical evaluations of our products before making purchase commitments. This qualification process involves a significant investment of time and resources from us and our customers to ensure that our product designs are fully qualified to perform with the customers’ equipment. The qualification process may result in the cancellation or delay of anticipated product shipments, thereby harming our operating results.

     In addition, our inventory can rapidly become outdated due to the short life cycle of the end products that incorporate our products. In fiscal 2003, we wrote off outdated inventory when one of our customers stopped producing the mobile handsets that incorporated our power amplifier. Our business, operating results and financial condition could be harmed by excess or outdated inventory levels if our customers’ products evolve more rapidly than anticipated or if demand for a product does not materialize.

We are subject to stringent environmental regulations that could negatively impact our business.

     We are subject to a variety of federal, state and local laws, rules and regulations related to the discharge and disposal of toxic, volatile and other hazardous chemicals used in our manufacturing process. Our failure to comply with present or future regulations could result in fines being imposed on us, suspension of our production or a cessation of our operations. The regulations could require us to acquire significant equipment or to incur substantial other expenses in order to comply with environmental regulations. Any past or future failure by us to control the use of or to restrict adequately the discharge of hazardous substances could subject us to future liabilities and could cause our business, operating results and financial condition to suffer. In addition, under some environmental laws and regulations we could be held financially responsible for remedial measures if our properties are contaminated, even if we did not cause the contamination.

If we are unable to effectively protect our intellectual property, or if it were determined that we infringed the intellectual property rights of others, our ability to compete in the market may be impaired.

     Our success depends in part on our ability to obtain patents, trademarks and copyrights, maintain trade secret protection and operate our business without infringing the intellectual property rights of other parties. Although there are no pending lawsuits against us, from time to time we have been notified in the past and may be notified in the future that we are infringing another party’s intellectual property rights.

     In the event of any adverse determination of litigation alleging that our products infringe the intellectual property rights of others, we may be unable to obtain licenses on commercially reasonable terms, if at all. If we were unable to obtain necessary licenses, we could incur substantial liabilities and be forced to suspend manufacture of our products. Litigation arising out of infringement claims could be costly and divert the effort of our management and technical personnel.

     In addition to patent and copyright protection, we also rely on trade secrets, technical know-how and other unpatented proprietary information relating to our product development and manufacturing activities. We try

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to protect this information with confidentiality agreements with our employees and other parties. We cannot be sure that these agreements will not be breached, that we would have adequate remedies for any breach or that our trade secrets and proprietary know-how will not otherwise become known or independently discovered by others.

     In addition, to retain our intellectual property rights we may be required to seek legal action against infringing parties. This legal action may be costly and may result in a negative outcome. An adverse outcome in litigation could subject us to significant liability to third parties, could put our patents at risk of being invalidated or narrowly interpreted and could put our patent applications at risk of not issuing. The steps taken by us may be inadequate to deter misappropriation or impede third party development of our technology. In addition, the laws of some foreign countries in which our products are or may be sold do not protect our intellectual property rights to the same extent, as do the laws on the United States. If we are not successful in protecting our intellectual property our business will suffer.

Our manufacturing capacity and our ability to maintain sales volume is dependent on the successful retention of qualified design, assembly and test personnel and our ability to install critical assembly and test equipment on a timely basis.

     Our ability to satisfy our current backlog and any additional orders we may receive in the future will depend on our ability to successfully retain qualified design engineers, assembly and test personnel. Our design engineers reside at our headquarters in Santa Clara, California and at our design center in the United Kingdom. We contract with third parties located primarily in Asia for many of our assembly and test requirements. Our need to successfully manage and retain these personnel will intensify if in the future our production volumes are required to increase significantly from expected levels. Demand for people with these skills is intense and we cannot assure you that we will be successful in retaining sufficient personnel with these critical skills. Our business has been harmed in the past by our inability to hire and retain people with these critical skills, and we cannot assure you that similar problems will not reoccur.

We depend heavily on our key managerial and technical personnel. If we cannot attract and retain persons for our critical management and technical functions we may be unable to compete effectively.

     Our success depends in significant part upon the continued service of our key technical, marketing, sales and senior management personnel and our continuing ability to attract and retain highly qualified technical, marketing, sales and managerial personnel. In particular, we have experienced and continue to experience difficulty attracting and retaining qualified engineers, which has harmed our ability to develop a wider range of handset products in a timely manner. Competition for these kinds of experienced personnel is intense. In addition, as discussed above, uncertainties resulting from potential business restructurings may hamper our ability to retain our executives or key personnel in our engineering and other departments. We cannot assure you that we can retain our key technical and managerial employees or that we can attract, assimilate or retain other highly qualified technical and managerial personnel in the future. Our failure to attract, assimilate or retain key personnel could significantly harm our business, operating results and financial condition.

Our customers’ failure to adhere to governmental regulations could harm our business.

     A significant portion of our products are integrated into the wireless communications subsystems of our clients. These subsystems are regulated domestically by the Federal Communications Commission and internationally by other government agencies. With regard to equipment in which our products are integrated, it is typically our customers’ responsibility, and not ours, to ensure compliance with governmental regulations. Our net sales will be harmed if our customers’ products fail to comply with all applicable domestic and international regulations.

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A disaster could severely damage our operations.

     A disaster could severely damage our ability to deliver our products to our customers. Our products depend on our ability to maintain and protect our computer systems, which are primarily located in or near our principal headquarters in Santa Clara, California. Santa Clara exists on or near a known earthquake fault zone. Although the facilities in which we host our computer systems are designed to be fault tolerant, the systems are susceptible to damage from fire, floods, earthquakes, power loss, telecommunications failures, and similar events. Although we maintain general business insurance against fires, floods and some general business interruptions, there can be no assurance that the amount of coverage will be adequate in any particular case.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

     Our exposure to market risk is principally confined to our cash, cash equivalents and investments which have maturities of less than two years. We maintain a non-trading investment portfolio of investment grade, liquid, debt securities that limits the amount of credit exposure to any one issue, issuer or type of instrument. At June 30, 2004, our investment portfolio comprised approximately $10.0 million in money market funds and certificate of deposits and $14.6 million of money market auction rate preferred stocks, corporate debt securities and municipal bonds. The securities in our investment portfolio are not leveraged, are classified as available for sale and are therefore subject to interest rate risk. We currently do not hedge interest rate exposure. If market interest rates were to increase by 100 basis points, or 1%, from June 30, 2004 levels, the fair value of our portfolio would decline by approximately $27,000. The modeling technique used measures the change in fair values arising from an immediate hypothetical shift in market interest rates.

Foreign Currency Exchange Risk

     The current foreign exchange exposure in all international operations is deemed to be immaterial since all of our net sales and the majority of liabilities are receivable and payable in U.S. dollars. A 10% change in exchange rates would not be material to our financial condition and results from operations. Accordingly, we do not use derivative financial instruments to hedge against foreign exchange exposure.

Item 4. CONTROLS AND PROCEDURES

     Our management evaluated, with the participation of our chief executive officer and our chief financial officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

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There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II            OTHER INFORMATION

Item 6.             EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

(b)

Reports on Form 8-K.

We filed one report on Form 8-K with the Securities and Exchange Commission during the period covered by this report, as follows:

1.

Report on Form 8-K filed on May 5, 2004 under Item 12 (Results of Operations and Financial Condition), regarding our fiscal 2004 fourth quarter and year end financial results.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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INDEX TO EXHIBITS

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