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UNITED STATES

FORM 10-Q

Commission file number 0-22799

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

Yes   [X]     No   [  ]

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

Common Stock: $.001 Par Value, 14,538,906 shares issued and outstanding as of June 28, 2003.

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BEI TECHNOLOGIES, INC. AND SUBSIDIARIES

INDEX

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PART I. FINANCIAL INFORMATION

Item 1.     FINANCIAL STATEMENTS (UNAUDITED)

BEI TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

Note: The balance sheet at September 28, 2002 has been derived from the audited consolidated balance sheet at that date.

See notes to condensed consolidated financial statements.

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BEI TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

See notes to condensed consolidated financial statements.

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BEI TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See notes to condensed consolidated financial statements.

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BEI TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending September 27, 2003. For further information, refer to the consolidated financial statements and footnotes thereto in the Company’s annual report on Forms 10-K and 10-K/A for the year ended September 28, 2002.

BEI Technologies, Inc. (“the Company” or “Technologies”) is an established manufacturer of electronic sensors, motors, actuators and motion control products used for factory and office automation, medical equipment, military, aviation and space systems. In addition, sales to manufacturers of transportation equipment including automobiles, trucks and off-road equipment have become a significant addition to the Company’s business in recent years. The Company’s micromachined quartz yaw rate sensors are being used in advanced vehicle stability control systems and a significant increase in the production of those sensors had been in progress from the middle of 1998 through fiscal 2001. The Company encountered a decrease in production in fiscal 2002 due to increased competition, however production in the current quarter has exceeded the fiscal 2001 run rate. The Company is currently transitioning to its next generation of automotive inertial quartz based sensor products, remotely mounted multi-sensor clusters with can bus and a multi rate sensor package suitable for incorporation into electronic systems modules. The Company also manufactures electronic steering wheel position sensors, seat-memory modules, throttle position sensors, pressure sensors, and other devices used in transportation systems. GyroChip and MotionPak are registered trademarks of the Company.

The Company has received customer funding for product development in prior years and in the fiscal quarter ended June 28, 2003. This revenue is negotiated to fund past or future projects and is recognized as noted in “Item 2. Management’s Discussion and Analysis — Significant Accounting Policies.” These projects are dependent upon successful negotiations that can be concluded at any time.

Technologies was incorporated in Delaware in June 1997 and became publicly held on September 27, 1997 as a result of the distribution of shares in Technologies to all the stockholders of BEI Electronics, Inc. on September 24, 1997.

At the close of business on October 30, 2000, Technologies declared a distribution to its stockholders of approximately 42% of the outstanding securities of OpticNet, Inc. (“OpticNet”), a formerly controlled subsidiary of Technologies. In the distribution, each holder of record of Technologies common stock as of the close of business on October 30, 2000 received one share of OpticNet common stock for every two shares of Technologies common stock held, and cash in lieu of any fractional share of OpticNet common stock.

Since inception, all operating capital for OpticNet has been provided by the Company as debt or equity financing. The Company accounted for its investment in OpticNet under the equity method of accounting until March 31, 2002, when the Company deemed its investment impaired. Since that date, the Company has recognized OpticNet’s entire net loss reflecting Technologies being the sole provider of operating capital to OpticNet. As of March 30, 2002, the Company recognized as impaired the carrying value of its initial $1.0 million investment in OpticNet and reduced the investment to zero and fully reserved as uncollectable its $2.7 million loan to OpticNet.

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Use of Estimates

The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. These estimates are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. On an ongoing basis, the Company evaluates its estimates. Results may differ from these estimates due to actual outcomes being different from those on which the Company based its assumptions.

Recent Accounting Pronouncements

The Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE (the “primary beneficiary”). This new model for consolidation applies to an entity in which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 will be effective beginning with the Company’s fiscal quarter ended September 27, 2003 with transitional disclosure required beginning with the consolidated financial statements for the quarter ended March 29, 2003.

The Company plans to adopt FIN 46 during the fiscal quarter ended September 27, 2003. FIN 46’s consolidation criteria are based on analysis of risks and rewards, not control, and represent a significant and complex modification of previous accounting principles. FIN 46 represents an accounting change, not a change in the underlying economics of legally independent businesses. Under the provisions of FIN 46 it is possible that the activities of OpticNet may need to be consolidated by the Company. The Company is in the process of determining whether OpticNet meets the definition of a VIE under the criteria outlined in FIN 46 and, if it does, whether Technologies would be deemed to be the Primary Beneficiary which would require Technologies to consolidate OpticNet’s activities. In the event that consolidation of OpticNet is deemed to be appropriate under the provisions of FIN 46, the Company would not be deemed to have any additional legal ownership, the Company’s legal rights and obligations would not change, and the Company would not become legally obligated for OpticNet’s liabilities. If consolidation by the Company of OpticNet’s activities is required, the Company currently believes that adoption of FIN 46 will not have a material impact on the Company’s financial position or its results of operations. See Note 5 for a further description of OpticNet and its relationship with the Company.

In December 2002, the FASB issued FAS No. 148, “Accounting for Stock-Based Compensation: Transition and Disclosure” (“FAS No. 148”). FAS No.148 amends FAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation (“transition provisions”). In addition, FAS No. 148 amends the disclosure requirements of Accounting Principals Board (“APB”) Opinion No. 28, “Interim Financial Reporting,” to require pro forma disclosure in interim financial statements by companies that elect to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 (“disclosure provisions”). The transition methods of FAS No. 148 are effective for the Company’s September 27, 2003 Form 10-K. The Company continues to use the intrinsic value method of accounting for stock-based compensation. As a result, the transition provisions will not have an effect on the Company’s consolidated financial statements. The Company has elected adoption of the interim disclosure requirements as presented below - - “Stock Based Compensation.”

In May 2003, the FASB issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“FAS No. 150”). FAS No. 150 establishes standards for how

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an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. FAS No. 150 applies specifically to a number of financial instruments that companies have historically presented within their financial statements as either equity or between the liabilities section and the equity section, rather than as liabilities. FAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not believe that FAS No. 150 will have a material impact on its financial statements.

Product Warranty

The Company offers limited warranties for its products for a period that lasts generally from one to four years. The specific terms and conditions of those warranties vary depending upon the products sold that are specific to different industries and customers. The Company estimates the costs that may be incurred under its limited warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of installed units, historical and anticipated rates of warranty claims, and cost per claim. The Company assesses the adequacy of its recorded warranty liabilities on a minimum of a quarterly basis and adjusts that amount as necessary. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and the Use of Estimates” for a further description of product warranty.

Changes in the Company’s product warranty liability during the period are as follows (in thousands):

Stock Based Compensation

The Company’s 1997 Equity Incentive Plan provides for the granting of incentive stock options to employees and stock or options to consultants, employees and directors. The Company accounts for stock based compensation using the intrinsic value method prescribed in APB Opinion No. 25 whereby the options are granted at market price, and therefore no compensation costs are recognized. The Company has elected to retain its current method of accounting as described above and has adopted the disclosure requirements of FAS Nos. 123 and 148. If compensation expense for the Company’s stock option plan had been determined based upon fair values at the grant dates for awards under those plans in accordance with FAS No. 123, the Company’s pro forma net earnings, basic and diluted earnings (loss) per common share would have been as follows:

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NOTE 2. INVENTORIES

Inventories are carried principally at the lower of cost or fair value and do not exceed their net realizable value. Cost is determined by the first-in, first-out (FIFO) method, including material, labor and factory overhead.

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NOTE 3. EARNINGS (LOSS) PER COMMON SHARE

The following table sets forth the computation of basic and diluted earnings (loss) per common share:

NOTE 4. LONG-TERM DEBT

On November 16, 1998, the Company sold $35.0 million of senior notes in a private placement. The notes have an interest rate of 6.7% and mature in annual installments of $7.0 million beginning November 16, 2001 up to and including November 16, 2005. The note agreement contains covenants regarding certain operating ratios, limitations on debt, dividend payments and minimum net worth.

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As of the quarter ended March 30, 2002, the Company completed an amendment with its senior note holders, which provided that the net impact of the provisions for excess capacity, uncollectables from a related party and product line move recognized in the second quarter of fiscal 2002 would not cause an event of default. The Company’s operating results for the quarter ended March 30, 2002, excluding these provisions from the calculation of debt covenants, result in the Company maintaining compliance as of that date.

On August 14, 2002, the Company established a $25.0 million line of credit, which matures on August 15, 2004, with a bank and terminated the $25.0 million facility in place at the end of fiscal 2001 with another bank. No borrowings were outstanding under the new line of credit at September 28, 2002. As of June 28, 2003 the Company had an outstanding balance of $3.0 million.

During December 2002, the Company received a waiver of one of its financial covenants of its senior notes for the fiscal quarter ended September 28, 2002. Additionally, the Company completed an amendment reducing the coverage level required with its senior note holders, related to the same financial covenant discussed above, for the fiscal quarter ended December 28, 2002. The Company’s operating results for the quarter ended December 28, 2002 resulted in the Company maintaining compliance as of that date based on the reduced coverage levels.

NOTE 5. RELATED PARTY TRANSACTIONS

During fiscal 2001, the Company agreed to provide OpticNet with a line of credit originally established for up to $2.0 million, amended in March 2002 to allow for borrowings by OpticNet of up to $3.0 million and in October 2002 to extend the maturity date to December 31, 2002. The outstanding principal on the note evidencing the line of credit bears interest at prime plus 1.5% per annum. The parties intend to extend the maturity date of the line of credit. The final terms of such an extension would be determined when, and if, such an extension is consummated. During the fiscal quarter ended June 29, 2002, the Company suspended the availability of advances to OpticNet under the line of credit, as the Company concluded that the note receivable totaling $2.7 million in principal amount at such time was uncollectable and the Company’s original investment in OpticNet was impaired. This determination was a result of OpticNet’s inability to attract significant strategic partners or third party financing necessary to sustain operations. Therefore, a charge of $3.1 million was recorded in the Company’s statement of operations in fiscal 2002 as the note receivable was deemed uncollectable and the carrying value of the original investment in OpticNet was deemed impaired.

On September 28, 2001, the Company completed the leasing of research and development equipment placed in service during the quarter ended September 29, 2001, which had been previously purchased by the Company for $0.7 million. In addition, on December 20, 2001 and March 28, 2002, the Company executed additional equipment lease schedules under this agreement to lease equipment similar to that described above valued at approximately $3.5 million and $2.8 million, respectively. Under the terms of the lease transaction, the Company sold the equipment and then immediately leased the equipment from the sole purchaser under a non-cancelable operating lease with a lease term of three years and an interest rate of approximately 6.9%.

The Company has entered into an agreement with OpticNet to rent capacity on this equipment to OpticNet from month to month based on OpticNet’s usage of the equipment beginning in October 2001. In March 2002, OpticNet significantly reduced operations to support only its current customer base, resulting in lower use of this equipment.

The Company also leases 15,571 square feet of office and manufacturing facilities used for research and development and manufacturing activities in Hayward, California, which it originally subleased entirely to OpticNet under an agreement entered into in October 2001, for an initial term expiring December 2005. During March 2002, OpticNet concluded it was necessary to reduce operating costs due to its inability to obtain significant strategic partners or third party financing. The companies both agreed that a reduction in operations would lower usage of the subleased facilities described above. Beginning March 31, 2002, the Company agreed to prorate the annual lease payments for the space and equipment from OpticNet, based on the portion of the facilities OpticNet requires to support its current customers.

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The Company is party to an intercompany services agreement with OpticNet, entered into in October 2000, under which the company provides certain administrative services to OpticNet at a cost of $25,000 per fiscal quarter. During the third quarter of fiscal 2002, the Company agreed to suspend current and future charges under the agreement, in light of the inability of OpticNet to obtain outside financing to such date.

In the quarter ended March 30, 2002, the Company concluded that portions of the assets held under leases were in excess to the Company’s requirements. As discussed above, these assets had been primarily used by OpticNet. This determination was a result of OpticNet’s lack of success in attracting strategic partners or third party financing. In March 2002, the Company recorded a charge of $10.3 million for expected future losses on the leases of the facility and production assets noted above. A portion of the facility and equipment will continue to be used by the Company for its ongoing silicon MEMS research and development effort.

In the six months ending September 28, 2002, the Company provided an additional $1.8 million of financing to OpticNet, which was advanced with the intent to convert such cash advances into additional equity in OpticNet, upon terms to be decided. The $1.8 million advanced was expensed during the third and fourth quarters of fiscal 2002, reflecting OpticNet’s net loss for the six-month period from March 31, 2002 through September 28, 2002. Effective September 28, 2002, the Company and OpticNet had determined that OpticNet would authorize and issue to the Company a series of nonvoting preferred stock. In November 2002, OpticNet issued a total of 18,146,420 shares of nonvoting and nonconvertible Series B Preferred Stock to Technologies, in consideration of the $1.8 million advanced during the third and fourth quarters of fiscal 2002.

In the three and nine months ended June 28, 2003, the Company provided approximately $0.3 million and $0.8 million, respectively, of additional funding to OpticNet for general operating expenses.

During the fiscal quarter ended March 29, 2003, the Company sent a letter to OpticNet’s Board of Directors stating that the Company is interested in acquiring those shares of OpticNet’s common stock that are not currently owned by the Company. See Schedule 13D as filed by the Company on March 24, 2003.

If this transaction is approved, the Company expects the aggregate purchase price for all common stock not already owned by the Company will not exceed $250,000 for the stock. Upon acquisition of these securities, the Company would fully reserve their value in the period that the transaction is finalized. Management does not expect that the additional cost to accomplish this transaction to be material. However, if the transaction is completed, the Company will recognize significant savings on a consolidated basis as the ongoing cost of maintaining OpticNet as a public entity will be eliminated.

The detail of the Company’s provision for excess capacity is as follows (in thousands):

NOTE 6. PROVISION FOR PRODUCT LINE MOVE AND OTHER

In March 2002, the Company approved a plan to close a facility and relocate manufacturing activities to a more cost effective location. As a result, the Company accrued $2.2 million related primarily to the closure of manufacturing facilities and administrative functions including the accrual of remaining payments on the

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facility operations lease, less future anticipated sublease payments. Other costs included write-downs of fixed assets and inventories to their fair value. The facility closure and relocation was completed within the 12 month period ending March 29, 2003. The Company continues to incur costs related to the facility closure and these costs are charged to the remaining balance of the provision.

The detail of the Company’s provision for product line move and other is as follows (in thousands):

NOTE 7. CONTINGENCIES AND LITIGATION

Claim against U.S. Government

The Company believes that BEI Defense Systems Company (“Defense Systems”), a subsidiary of the Company with discontinued operations, suffered substantial monetary damages due to actions of the U.S. Government in connection with the parties’ H70 contract in effect during the 1992-1996 timeframe. As a result, Defense Systems filed a substantial claim against the U.S. Government in 1996. Following attempts to negotiate a settlement, Defense Systems filed an appeal of its claim that has been heard before an Administrative Judge at the Armed Services Board of Contract Appeals (“ASBCA”). In fiscal 2002, the Judge ruled that Defense Systems is entitled to an “equitable reformation” of the prices on certain rockets and motors in the H70 contract. The decision was remanded to the parties to negotiate the amount. The parties were unable to negotiate an amount on their own, so the parties then agreed to enter a non-binding mediation of Alternate Dispute Resolution process with the same Administrative Judge from the ASBCA who had rendered the original entitlement decision. Effective December 2002, the parties finalized mediation that resulted in a settlement, net of expenses, of $5.4 million. This amount was recorded in other income for the quarter ended December 28, 2002.

Other

During fiscal 2002, Defense Systems was subject to litigation with a former landlord regarding damages to real property formerly leased. The United States District Court for the Western District of Arkansas entered a judgment, including attorney’s fees, of approximately $0.7 million against the Company. The Company is in the process of contesting the award and has filed an appeal of the judgment. Due to the uncertainty of success in the appeal, the Company reserved $0.7 million for this judgment during the fiscal quarter ended June 29, 2002.

During fiscal 2002, the Company initiated litigation against a competitor alleging patent infringement of certain quartz technologies. Because the lawsuit is currently pending, the duration and outcome of this litigation are uncertain. The Company believes the lawsuit is meritorious and intends to vigorously pursue prosecution of the claims of infringement. The Company, however, can provide no guarantee of the eventual outcome of the litigation. As of June 28, 2003, this litigation has resulted in legal costs of approximately $2.9 million, of which $0.5 million and $2.1 million were incurred in the three and nine months ending June 28, 2003, respectively.

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The Company has various other pending legal actions arising in the normal course of business. Management believes that none of the legal actions not already recognized in the financial statements as material, individually or in the aggregate, will have a material impact on the Company’s business, financial condition or operating results.

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Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from those expressed in, or implied by, such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, and those discussed in the Company’s Forms 10-K and 10-K/A for the year ended September 28, 2002, in particular, within the “Risk Factors” section thereof.

See “Critical Accounting Policies and the Use of Estimates” for a description of the Company’s critical accounting policies.

Results of Operations

The following table sets forth, for the fiscal periods indicated, the percentage of net sales represented by certain items in the Company’s Condensed Consolidated Statements of Operations.

Quarters Ended June 28, 2003 and June 29, 2002

Net sales for the third quarter of fiscal 2003 increased $9.3 million, or 19%, to $57.1 million from $47.8 million during the same period in fiscal 2002.

The sales volume increase was primarily due to commercial sales to domestic and foreign automotive customers, and to a lesser extent government sales. Automotive sensor sales increased by $8.7 million to $32.4 million in the third quarter of fiscal 2003 from $23.7 million in the comparable period of fiscal 2002 due to an increase in quantities shipped and engineering development billings of $2.3 million to our largest customer. Sales under government contracts increased by $1.5 million from the same period of fiscal 2002, while sales of non-automotive commercial products decreased by $0.9 million from the same period of fiscal 2002. Although the Company’s sales have historically been to many customers in a variety of markets,

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during the third quarter of fiscal 2003 and fiscal 2002, one automotive customer accounted for approximately 44% and 37%, respectively, of the Company’s net sales. Sales to that one customer are subject to the usage of the Company’s sensors in their end user antilock braking or stability control systems that are impacted by trends in the automotive industry.

Cost of sales as a percentage of net sales in the third quarter of fiscal 2003 increased 4.3 percentage points to 75.1% from 70.8% in the comparable period of fiscal 2002 due primarily to a higher automotive mix with lower associated margins, higher overhead spending associated with GyroChip capacity expansion not yet fully absorbed and additional inventory reserves at the Company’s facilities and other commercial operations. There may be additional margin rate variability in future quarters due to the introduction of new products and related changes in average prices, changes in manufacturing processes and volumes, changes in supplier costs, and product life cycles.

Selling, general and administrative expenses as a percentage of net sales decreased in the third quarter of fiscal 2003 versus the comparable period of fiscal 2002 due to modestly higher spending on a higher revenue base. Actual selling, general and administrative expenses increased $0.7 million from the prior fiscal year period primarily due to the legal costs associated with the Company’s allegation of patent infringement against a competitor of approximately $0.5 million.

Research, development and related expenses as a percentage of net sales for the third quarter of fiscal 2003 decreased by 0.6 percentage points over the comparable period of fiscal 2002 primarily as a result of a higher revenue base. Actual research, development and related expenses increased $0.4 million over the prior fiscal year period primarily to support silicon gyro and accelerometer developments.

Interest expense as a percentage of sales decreased slightly from the same period of the prior fiscal year. This decrease is primarily due to reduced debt levels and lower interest rates on the Company’s line of credit as compared to the senior notes.

Nine Months Ended June 28, 2003 and June 29, 2002

Net sales for the first nine months of fiscal 2003 increased $16.7 million, or 12%, to $158.9 million from $142.2 million during the same period in fiscal 2002.

The sales volume increase was primarily due to commercial sales to domestic and foreign automotive customers, and to a lesser extent government sales. Automotive sensor sales increased by $14.4 million to $87.5 million in the first nine months of fiscal 2003 from $73.1 million in the comparable period of fiscal 2002 due to the launch of new platforms into the North American and European markets, an increase in quantities shipped and engineering development billings of $2.3 million to our largest customer. Although the Company’s sales have historically been to many customers in a variety of markets, during the first nine months of fiscal 2003 and fiscal 2002, one automotive customer accounted for approximately 41% and 40%, respectively, of the Company’s net sales. Sales under government contracts increased $4.8 million from the same period of fiscal 2002 due primarily to customer demand. Sales of non-automotive commercial products decreased by $2.6 million from the same period of fiscal 2002 due primarily to weakness in the manufacturing sector.

Cost of sales as a percentage of net sales in the first nine months of fiscal 2003 increased 2.3 percentage points to 75.3% from 73.0% in the comparable period of fiscal 2002 due primarily to a higher automotive mix with lower associated margins, higher overhead spending associated with GyroChip capacity expansion not yet fully absorbed, additional inventory reserves at the Company’s facilities and other commercial operations and the impact of yield loss associated with model launches. There may be additional margin rate variability in future quarters due to the introduction of new products, changes in manufacturing processes and volumes, changes in supplier costs, and product life cycles.

Selling, general and administrative expenses as a percentage of net sales increased in the first nine months of

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fiscal 2003 versus the comparable period of fiscal 2002 due primarily to significant spending on legal proceedings associated with the Company’s allegation of patent infringement by a competitor. Actual selling, general and administrative expenses increased $3.5 million from the prior fiscal year period primarily due to the legal costs noted above of approximately $2.1 million and to support increased automotive sales.

Research, development and related expenses as a percentage of net sales for the first nine months of fiscal 2003 remained constant over the comparable period of fiscal 2002 primarily due to increased spending related to the support of silicon gyro and accelerometer developments on increased sales. Research, development and related expenses increased $1.2 million in the first nine months of fiscal 2003 versus the prior fiscal year period. The higher research and development spending reflects management’s dedication to the development of new products, such as the next generation of automotive sensors, and improvements to existing product families.

Provisions for excess capacity, uncollectables from a related party and product line move in the first nine months of fiscal 2002 consisted of approximately $10.3 million related to the expected future losses on operating lease payments on facility and production assets that partially supported OpticNet, as well as $3.1 million to reserve for the note receivable due from OpticNet and the Company’s initial investment in OpticNet. Additionally, the Company recognized a product line move charge of approximately $2.2 million for a plan to close a facility and relocate manufacturing activities to a more cost-effective location.

Interest expense as a percentage of sales decreased slightly from the same period of the prior fiscal year. This decrease is primarily due to reduced debt levels and lower interest rates on the Company’s line of credit as compared to the senior notes.

Liquidity and Capital Resources

During the first nine months of fiscal 2003, total cash provided by operations was $12.9 million. Cash provided by operations included the positive impact of non-cash charges from depreciation and amortization of $6.0 million and $1.8 million, respectively. In addition, positive impacts to cash resulted from net income of $3.3 million, decreases in inventories, prepaid income taxes and assets held for sale of $5.2 million, $1.5 million and $1.5 million, respectively, as well as collection of an income tax receivable recognized in the second quarter of $3.0 million and a favorable settlement with the U.S. Government of $5.4 million, net of expenses. These items were offset by an increase in accounts receivable of $5.4 million, and decreases in accounts payable, accrued liabilities and other liabilities of $0.6 million, $1.6 million and $1.7 million, respectively.

Cash used by investing activities included equipment purchases of $5.1 million primarily to expand production capacity and an increase in other assets of $3.0 million. The increase in other assets is primarily due to an equity investment of $2.5 million into a strategic manufacturing partner finalized during the second quarter of fiscal 2003.

Cash used by financing activities included debt payments of $36.6 million, which consisted of $29.6 million in payments on the Company’s line of credit. Other cash used by financing activities included cash purchases of the Company’s stock for $0.9 million and dividend payments of $0.4 million. These items were partially offset by proceeds from borrowings on the Company’s line of credit of $32.6 million and proceeds from the issuance of common stock of $0.1 million.

While the Company believes that its available credit line and cash derived from operations will be sufficient to meet the Company’s capital requirements for the next twelve months, the Company may need to raise additional funds through public or private financings or other arrangements. Revenue and profitability may be negatively affected until there is clear evidence of an upswing in the industrial economy. There can be no assurance that the Company will not require additional funding, or that such additional funding, if needed, will be available on terms attractive to the Company, or at all. Any additional equity financing may be dilutive to the stockholders, and debt financing, if available, may involve restrictive covenants.

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The Company had no material capital commitments at June 28, 2003.

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Effects of Inflation

Management believes that, for the periods presented, inflation has not had a material effect on the Company’s operations.

Critical Accounting Policies and the Use of Estimates

Management’s discussion and analysis of financial condition and results of operations is based upon the Company’s unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company reviews the accounting policies used in reporting its financial results on a regular basis. The preparation of these unaudited condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The estimates are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. On an ongoing basis, the Company evaluates its estimates. Actual results may differ from these estimates due to actual outcomes being different from those on which the Company based its assumptions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Product Warranty

The Company records a warranty liability on its products at the time of revenue recognition based on historical experience and any specific warranty issues that the Company has identified. Although historical warranty costs have been within expectations, there can be no assurance that future warranty costs will not exceed historical amounts. If actual future warranty costs exceed historical amounts, additional allowances may be required, which could have a material adverse impact on the Company’s operating results in future periods. See Note 1 to the condensed consolidated financial statements for product warranty disclosure.

Allowance for Doubtful Accounts

The Company continuously monitors collections and payments from its customers and maintains allowances for doubtful accounts based upon historical experience and any specific customer collection issues that the Company has identified. While such credit losses have historically been within management’s expectations, there can be no assurance that the Company will continue to experience the same relative level of credit losses that it has in the past. In addition, although the Company’s sales have historically been to many customers in a variety of markets, in recent periods, one automotive customer accounted for a significant portion of the Company’s net sales. A significant change in the liquidity or financial position of that customer or a further deterioration in the economic environment in general could have a material adverse impact on the collectability of the Company’s accounts receivable and future operating results, including a reduction in future revenues and additional allowances for doubtful accounts. If, at the time of shipment, the Company determines that collection of a receivable is not reasonably assured, the revenue is deferred and recognized at the time collection becomes reasonably assured, which is generally upon receipt of payment.

Inventories

The Company writes down its inventory for estimated obsolescence for the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Inventories are carried principally at the lower of cost or fair value and do not exceed net realizable value. Cost is determined by the first-in, first-out (FIFO) method, including material, labor and factory overhead.

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Long-Lived and Intangible Assets and Goodwill

Management reviews goodwill and intangible assets with indefinite useful lives for impairment either on an annual basis or quarterly if an event occurs that might reduce the fair value of the long-lived asset below its carrying value. All other long-lived and intangible assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the asset may not be recoverable. An impairment loss would be recognized based on the difference between the carrying value of the asset and its estimated fair value, which would be determined based on either discounted future cash flows or other appropriate fair value methods. The evaluation of goodwill and intangibles with indefinite useful lives for impairment requires management to use significant judgments and estimates including, but not limited to, projected future revenue, operating results, and cash flows.

Although management currently believes that the estimates used in the evaluation of goodwill and intangibles with indefinite lives are reasonable, differences between actual and expected revenue, operating results, and cash flow could cause these assets to be deemed impaired. If this were to occur, the Company would be required to charge to earnings the write-down in value of such assets, which could have a material adverse effect on the Company’s results of operations and financial position.

Provision for Excess Capacity, Uncollectables from a Related Party and Product Line Move and Other

During the quarter ended March 30, 2002, the Company established reserves for portions of assets held under leases in excess of requirements, receivables from a related party and the closure of a specific manufacturing facility, as discussed in Note 5. These reserves required the use of significant estimates. Though the Company believes that these estimates accurately reflect the costs of these plans, they relate to matters that are inherently uncertain and actual results may be different.

Income Taxes

The Company has significant amounts of deferred tax assets that are reviewed periodically for recoverability and valued accordingly. These assets are evaluated by using the four sources of taxable income that may be considered under Financial Accounting Standards (“FAS”) No. 109: (1) Future reversals of existing temporary differences; (2) Taxable income in prior carryback years, if carryback is permitted under the tax law; (3) Tax planning strategies and; (4) Future taxable income exclusive of reversing temporary differences and carryforwards. In the event it is determined more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance would be recorded with a corresponding charge to income in the period such determination occurs.

Litigation

The Company reserves for legal claims when payments associated with the claims become probable and can be reasonably estimated. Due to the difficulty in estimating costs of resolving legal claims, actual costs may be substantially different than the amounts reserved.

Environmental Matters

The Company reserves for known environmental claims, of which there are none as of June 28, 2003, when payments associated with the claims become probable and the costs can be reasonably estimated. The Company’s environmental reserves, for all periods presented, are recorded at the expected payment amount. The actual cost of resolving environmental issues may be higher than that reserved primarily due to difficulty in estimating such costs and potential changes in the status of government regulations.

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Significant Accounting Policies

Revenue Recognition

Revenues are primarily generated from the sale of electronic devices to our customers, typically the end-user.

The Company recognizes revenue using the guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements.” Under these guidelines, revenue recognition is deferred on transactions where (i) persuasive evidence of an arrangement does not exist, (ii) revenue recognition is contingent upon performance of one or more obligations of the Company, (iii) the price is not fixed or determinable or (iv) payment is not reasonably assured.

Property, Plant and Equipment and Related Depreciation

The Company records property, plant and equipment at cost, which is depreciated using the straight-line method for structures and equipment over their estimated useful lives. Leasehold improvements and assets acquired under capital leases are amortized over the shorter of the lease term or their estimated useful lives. Management reviews the estimated useful lives of property, plant and equipment to verify that the assets are being depreciated in accordance with their usage and all assets no longer in service are fully depreciated.

Accrued Expenses and Other Liabilities

The Company records liabilities for services or products received in the period in which the benefit was recognized. Due to the difficulty in estimating costs of these services or products received, actual costs may be substantially different than the amounts recorded.

Item 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company believes that there have been no material changes in the reported market risks faced by the Company since those discussed in the Company’s Forms 10-K and 10-K/A for the fiscal year ended September 28, 2002 under the heading corresponding to that set forth above. The Company’s exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, as a portion of the Company’s investments are in short-term debt securities issued by corporations. The Company’s investments are placed with high-quality issuers and the Company attempts to limit the amount of credit exposure to any one issuer. Due to the nature of the Company’s short-term investments, the Company believes that it is not subject to any material market risk exposure. The Company does not have any foreign currency or other derivative financial instruments.

Item 4.       CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation within 90 days of the filing date of this report, that the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) are effective for gathering, analyzing and disclosing the information the Company is required to disclose in its reports filed under the Securities Exchange Act. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the previously mentioned evaluation.

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Item 6.       EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

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