SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended April 3, 2005

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to               

 

Commission file number 000-31337

 

WJ COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE		94-1402710
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
401 River Oaks Parkway, San Jose, California		95134
(Address of principal executive offices)		(Zip Code)

 

(408) 577-6200

(Registrant’s telephone number, including area code)

 

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, and (2) has been subject to such filing requirements for the past 90 days. Yes  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  ý  No  o

 

As of May 13, 2005 there were 64,012,240 shares outstanding of the registrant’s common stock, $0.01 par value.

 

 

SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q, the Annual Report on Form 10-K, the shareholders’ annual report, press releases and certain information provided periodically in writing or orally by the Company’s officers, directors or agents contain certain forward-looking statements within the meaning of the federal securities laws that also involve substantial uncertainties and risks. These forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our industry, our beliefs and our assumptions. Words such as “may,” “will,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks” and “estimates” and variations of these words and similar expressions, are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed, implied or forecasted in the forward-looking statements. In addition, the forward-looking events discussed in this annual report might not occur. These risks and uncertainties include, among others, those described in the section of this report entitled “Risk Factors.”  Readers should also carefully review the risk factors described in the other documents that we file from time to time with the Securities and Exchange Commission. We assume no obligation to update or revise the forward-looking statements or risks and uncertainties to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

 

 

WJ COMMUNICATIONS, INC.

QUARTERLY REPORT ON FORM 10-Q

THREE MONTHS ENDED APRIL 3, 2005

TABLE OF CONTENTS

 

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Statements of Operations for the Three months ended April 3, 2005 and March 28, 2004
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three months ended April 3, 2005 and March 28, 2004
	Condensed Consolidated Balance Sheets at April 3, 2005 and December 31, 2004
	Condensed Consolidated Statements of Cash Flows for the Three months Ended April 3, 2005 and March 28, 2004
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosure About Market Risks
Item 4.	Controls and Procedures
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes In Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
	Signatures

 

 

PART I — FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
Sales:
Semiconductor and RFID		$	7,514		$	6,638
Wireless integrated assemblies		260			433
Total sales		7,774			7,071
Cost of goods sold		4,348			3,195
Gross profit		3,426			3,876
Operating expenses:
Research and development		4,743			4,103
Selling and administrative		3,189			2,846
Acquired in-process research and development		3,400			—
Total operating expenses		11,332			6,949
Loss from operations		(7,906		)	(3,073		)
Interest income		240			166
Interest expense		(23		)	(25		)
Other income—net		5			—
Loss before income taxes		(7,684		)	(2,932		)
Income tax benefit		—			(6,542		)
Net income (loss)		$	(7,684	)	$	3,610
Basic net income (loss) per share		$	(0.12	)	$	0.06
Basic average shares		63,027			59,396
Diluted net income (loss) per share		$	(0.12	)	$	0.05
Diluted average shares		63,027			67,476

 

See notes to condensed consolidated financial statements.

 

2

 

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
Net income (loss)		$	(7,684	)	$	3,610
Other comprehensive gain:
Unrealized holding gains on securities arising during the period net of reclassification adjustments		6			—
Comprehensive income (loss)		$	(7,678	)	$	3,610

 

See notes to condensed consolidated financial statements.

 

3

 

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

		April 3,			December 31,
		2005			2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	24,705		$	24,392
Short-term investments		13,908			18,732
Receivables, net		5,445			6,841
Inventories		5,017			5,148
Net assets held for sale		648			—
Other		2,166			3,183
Total current assets		51,889			58,296
PROPERTY, PLANT AND EQUIPMENT, net		8,387			9,679
Goodwill		6,835			1,368
Intangible assets		2,155			180
Other assets		211			210
		$	69,477		$	69,733
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	2,140		$	2,633
Accrued liabilities		3,635			5,589
Income taxes payable		1,940			—
Restructuring accrual		3,373			3,350
Total current liabilities		11,088			11,572
Restructuring accrual		15,340			16,069
Other long-term obligations		804			795
Total liabilities		27,232			28,436
STOCKHOLDERS’ EQUITY:
Common stock		655			629
Treasury stock		(18		)	(18		)
Additional paid-in capital		202,762			194,262
Accumulated deficit		(160,883		)	(153,199		)
Deferred stock compensation		(265		)	(365		)
Other comprehensive loss		(6		)	(12		)
Total stockholders’ equity		42,245			41,297
		$	69,477		$	69,733

 

See notes to condensed consolidated financial statements.

 

4

 

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
OPERATING ACTIVITIES:
Net income (loss)		$	(7,684	)	$	3,610
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		968			746
Acquired in-process research and development		3,400			—
Amortization of deferred financing costs		10			11
Net gain on disposal of property, plant and equipment		(15		)	—
Amortization of deferred stock compensation		90			67
Provision for (reduction in) allowance for doubtful accounts		(41		)	29
Amortization of net premiums on short-term investments		101			21
Net changes in:
Receivables		1,702			(1,153		)
Inventories		325			(254		)
Other assets		843			384
Restructuring liabilities		(705		)	(580		)
Income tax contingency liability		(6		)	(6,542		)
Accruals and accounts payable		(646		)	40
Net cash used in operating activities		(1,658		)	(3,621		)
INVESTING ACTIVITIES:
Purchase of short-term investments		(8,443		)	(13,454		)
Proceeds from sale and maturities of short-term investments		13,370			24,477
Purchases of property, plant and equipment		(191		)	(102		)
Acquisition of Telenexus and related costs		(3,119		)	—
Proceeds on disposal of property, plant and equipment		51			—
Net cash provided by investing activities		1,668			10,921
FINANCING ACTIVITIES:
Payments on long-term borrowings		(43		)	(20		)
Net proceeds from issuances of common stock		346			10,552
Net cash provided by financing activities		303			10,532
Net increase in cash and cash equivalents		313			17,832
Cash and cash equivalents at beginning of period		24,392			10,900
Cash and cash equivalents at end of period		$	24,705		$	28,732
Other cash flow information:
Income taxes paid		$	6		$	—
Interest paid		13			15
Issuance of common stock for Telenexus acquisition		8,190			—

 

See notes to condensed consolidated financial statements.

 

5

 

WJ COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 of America 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 considered necessary for a fair presentation have been included. Operating results for the three month period ended April 3, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

 

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of WJ Communications, Inc. (the “Company”) for the fiscal year ended December 31, 2004, which are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2005.

 

The balance sheet at December 31, 2004 has been derived from the audited consolidated 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.

 

RECLASSIFICATIONS — Certain amounts for 2004 have been reclassified to conform with the 2005 presentation. Such reclassifications did not have any impact on net income (loss) or stockholders’ equity.

 

STOCK-BASED COMPENSATION — The Company accounts for stock-based compensation granted to employees and directors under the intrinsic value method as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”

 

As required under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure,” the pro forma effects of stock-based compensation on net income (loss) and net income (loss) per common share have been estimated at the date of grant as if the Company had accounted for such awards under the fair value method of SFAS No. 123 using the Black-Scholes option-pricing model.

 

The following table illustrates the effect on net income (loss) and net income (loss) per share had compensation cost for all of the Company’s stock option plans been determined based upon the fair value at the grant date for awards under these plans, and amortized to expense over the vesting period of the awards consistent with the methodology prescribed under SFAS No. 123 (in thousands, except per share amounts):

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
Reported net income (loss)		$	(7,684	)	$	3,610
Add: Total stock-based employee compensation expense included in reported net income (loss)		90			67
Deduct: Total stock-based employee  compensation expense under fair value based method for all awards		(1,018		)	(831		)
Pro forma net income (loss)		$	(8,612	)	$	2,846
Net income (loss) per basic share
As reported		$	(0.12	)	$	0.06
Pro forma		$	(0.14	)	$	0.05
Net income (loss) per diluted share
As reported		$	(0.12	)	$	0.05
Pro forma		$	(0.14	)	$	0.04

 

6

 

2.              ORGANIZATION AND OPERATIONS OF THE COMPANY

 

WJ Communications, Inc. (formerly Watkins-Johnson Company, the “Company”) was founded in 1957 in Palo Alto, California. The Company was originally incorporated in California and reincorporated in Delaware in August 2000. For more than 45 years, the Company developed and manufactured radio frequency (“RF”) microwave devices for government electronics and space communications systems used for intelligence gathering and communication. In 1996, the Company began to develop commercial applications for its military technologies. The Company’s current operations design, develop and market innovative, high-performance products for both current and next generation wireless and broadband cable networks, defense and homeland security systems and radio frequency identification (“RFID”) systems worldwide. The Company’s products are comprised of advanced, highly functional RF semiconductors, components and integrated assemblies which seek to address the RF requirements of these various systems.

 

3.              ACQUISITIONS

 

EiC Acquisition

 

On June 18, 2004, the Company completed its acquisition of the wireless infrastructure business and associated assets from EiC. The aggregate purchase price was $13.2 million which included payments of cash of $10.0 million, the issuance of 737,000 shares of the Company’s common stock valued at $2.5 million, acquisition costs of $1.2 million (including $700,000 paid to a related party for investment banking services in connection with the acquisition) and $126,000 registration statement related expenses reduced by $576,000 related to the termination settlement of the associated supply agreement with EiC recognized during our quarter ended December 31, 2004. In connection with the acquisition, $1.5 million in cash and 294,118 shares of common stock have been held in escrow as security against certain financial contingencies. On March 30, 2005, the Company made a claim against the escrow account for unpaid invoices issued under the supply agreement.  The Company received those funds on May 4, 2005.  The uncontested amount was released to EiC on April 5, 2005 per the escrow agreement and the residual balance of the $1.5 million was released to EiC on May 4, 2005. The outstanding escrow shares balance in the escrow account less any properly noticed unpaid or contested amounts will be distributed within five days after March 31, 2006. On November 23, 2004 the Company filed a registration statement registering for resale by the seller of up to 442,882 shares of the Company’s common stock issued in the acquisition. In addition to the closing consideration, EiC may be entitled to further consideration of up to $14.0 million in cash and shares of the Company’s common stock if certain revenue and gross margin targets are achieved by March 31, 2005 and March 31, 2006. The Company has calculated that the revenue and gross margin targets were not met for the nine month period ending March 31, 2005.  EiC has thirty days to review and possibly contest the Company’s calculation.  EiC may be entitled to further consideration of up to $7.0 million in cash and shares of the Company’s common stock if certain revenue targets are achieved by March 31, 2006.  The Company shall pay EiC this additional consideration, if earned, ninety percent (90%) in its common stock and ten percent (10%) in cash. The number of shares of its common stock to be delivered shall be determined by dividing the value in dollars of the portion payable in its common stock by the average closing price of its common stock, as quoted on the NASDAQ National Market, during the ten consecutive trading days ending one trading day before the end of the period covered by the payment, provided, however, that in the event that the calculation of the average closing price results in a price for the first payment that would be less than $5.00 or for the second payment that would be less than $6.00, then the Company, at its option, in its sole discretion, may elect to make the payment part or all in cash and the balance, if any, in shares of its common stock.  If EiC receives such consideration, the amounts will be recorded as an increase to goodwill. The fair value of the Company’s common stock was determined based on the average closing price per share of the Company’s common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (June 21, 2004). The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and accordingly the Company’s consolidated financial statements from June 18, 2004 include the impact of the acquisition. The allocation of the purchase price for this acquisition, as of the date of the acquisition, is as follows (in thousands):

 

7

 

Property and equipment		$	1,124
Inventory		2,038
In-process research and development		8,500
Developed technology		200
Goodwill		1,371
Total purchase price		$	13,233

 

The acquisition was accounted for as a purchase transaction, and accordingly, the assets of EiC were recorded at their estimated fair values at the date of the acquisition. With the exception of the goodwill and acquired in-process research and development (“IPRD”), the identified intangible assets will be amortized on a straight-line basis over their estimated useful lives, with a weighted average life of approximately five years.

 

A portion of the purchase price, $8.7 million, was allocated to developed and core technology and in-process research and development (“IPRD”). Developed and core technology and IPRD were identified and valued through extensive interviews, analysis of data provided by EiC Corporation concerning developmental products, their stage of development, the time and resources needed to complete them, their expected income generating ability, target markets and associated risks. The income approach method was the primary technique utilized in valuing the developed and core technology and IPRD. Under the income approach, fair value reflects the present value of the projected cash flows that are expected to be generated by the products incorporating the current technologies.

 

Developmental projects that reached technological feasibility were classified as developed and core technology, and the $200,000 value assigned to developed technology was capitalized to be amortized using the straight-line method over a weighted-average period of five years. Developmental projects that had not reached technological feasibility, and had no future alternative uses were classified as IPRD. The $8.5 million value allocated to projects that were identified as IPRD was charged to acquired in-process research and development in 2004. The value assigned to IPRD comprises the following projects:  12V heterojunction bipolar transistor (“HBT”) power amplifiers ($1.5 million) and 28V HBT high power amplifiers ($7.0 million).

 

The nature of the efforts required to develop the acquired IPRD into commercially viable products principally relate to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the products can be produced to meet their design specifications, including functions, features and technical performance requirements.

 

In valuing the IPRD, the Company considered, among other factors, the importance of each project to the overall development plan, the projected incremental cash flows from the projects when completed and any associated risks. The projected incremental cash flows were discounted back to their present value using an after-tax discount rate of 25%. This discount rate was determined after consideration of the Company’s weighted average cost of capital and the weighted average return on assets. Associated risks include the inherent difficulties and uncertainties in completing each project and thereby achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets.

 

As part of the acquisition, the Company entered into a sublease with EiC Corporation for 28,160 square feet of space at their facility in Fremont, California. This sublease expired in December 2004 and converted into a month to month lease thereafter.  At the end of January 2005 the Company moved the wafer fabrication facility from the Fremont location to its facility in Milpitas, California and ended this sublease.

 

8

 

Telenexus Acquisition

 

On January 28, 2005, the Company completed its acquisition of Telenexus, Inc. (“Telenexus”).  Pursuant to an Agreement and Plan of Merger, dated January 19, 2005, by and between the Company, WJ Newco, LLC (the “WJ Sub”), Telenexus and Richard J. Swanson, Wilfred K. Lau, David Fried, Kurt Christensen and Mark Sutton (collectively the “Shareholders”), Telenexus merged with and into the WJ Sub effective on January 29, 2005.  The WJ Sub was the survivor in the merger and is a wholly-owned subsidiary of the Company. Telenexus designs, develops, manufactures and markets radio frequency identification (“RFID”) reader products for a broad range of industries and markets.  By virtue of the merger, the Company purchased through the WJ Sub all of the assets necessary for the conduct of the RFID business of Telenexus, consisting primarily of, and including, but not limited to RFID modules, baseband processing algorithm technology, applications software and realizations of several reader product designs.  The consideration paid by the Company on the closing date in connection with the merger consisted of cash in the amount of $3.0 million, which was paid out of the Company’s cash reserves on the closing date, and 2,333,333 shares of the Company’s common stock valued at $8.2 million at the closing date.  Including acquisition costs of $218,000, the aggregate purchase price for the net assets of Telenexus totaled $11.4 million.  Of the closing consideration, cash in the amount of $500,000 and 333,333 shares of the Company’s common stock are being held in escrow with respect to any indemnification matter under the merger agreement. The outstanding balance of the escrow account less any properly noticed unpaid or contested amounts will be distributed within two days after October 28, 2005.  The fair value of the Company’s common stock was determined based on the average closing price per share of the Company’s common stock over a 5-day period beginning two trading days before and ending two trading days after the amended terms of the acquisition were agreed to and announced (January 31, 2005). In addition to the closing consideration, the sellers may be entitled to further compensation of up to $2.5 million in cash and up to 833,333 shares of the Company’s common stock if the Company achieves certain revenue targets by July 28, 2006.  Any change in the fair value of the net assets of Telenexus or any additional consideration to the Shareholders will change the amount of the purchase price allocable to goodwill.  Two of the Shareholders, Richard J. Swanson and Wilred K. Lau also entered into three-year employment agreements with the Company.

 

In accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”), the total purchase price was preliminarily allocated to the tangible and intangible assets acquired and liabilities assumed based upon their respective estimated fair values at the acquisition date with the excess purchase price allocated to goodwill. The valuation of the identifiable intangible assets acquired reflects management’s estimates based on, among other factors, a valuation of the intangible assets prepared by an independent third party.  The following table summarizes the components of the total purchase price and the preliminary allocation (in thousands):

 

Net tangible assets		$	504
In-process research and development		3,400
Amortizable intangible assets:
Developed technology		40
Customer relationships		900
Trademarks and trade names		700
Non-competition agreements		400
Goodwill		5,464
Total purchase price		$	11,408

 

9

 

With the exception of the goodwill and acquired in-process research and development (“IPRD”), the identified intangible assets consisting of existing technology, customer relationships, trademarks and trade names and non-competition agreements will be amortized on a straight-line basis over their estimated useful lives, with a weighted average life of approximately eight years. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), goodwill of $5.5 million will not be amortized and will be tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable in accordance with the Company’s policy on impairment analysis. The amounts contained in the purchase price allocation may change as more detailed analysis is completed, additional information on the fair values of Telenexus’ tangible and intangible assets and liabilities becomes available and all direct acquisition costs are finalized. The preliminary purchase price allocations are expected to be finalized in the second quarter of 2005.

 

Prior to the acquisition, the Company and Telenexus had entered into an agreement to jointly design, develop and produce a Personal Computer Memory Card International Association (“PCMCIA”) Type II Multi-Protocol RFID reader. The Company has evaluated the effective settlement of this preexisting executory contract and the associated reacquired right to the use of its technology in accordance with Emerging Issues Task Force (“EITF”) 04-1 “Accounting for Preexisting Relationships between the Parties to a Business Combination.”  The Company has determined that the effective settlement of the executory contract and the associated reacquired right to use its technology was neither favorable or unfavorable as the agreement represented fair value when compared to similar market transactions and there were no stated settlement provisions in the contract.

 

A portion of the purchase price, $3.4 million, was allocated to developed and core technology and in-process research and development (“IPRD”). Developed and core technology and IPRD were identified and valued through extensive interviews, analysis of data provided by Telenexus concerning developmental products, their stage of development, the time and resources needed to complete them, their expected income generating ability, target markets and associated risks. The income approach method was the primary technique utilized in valuing the developed and core technology and IPRD. Under the income approach, fair value reflects the present value of the projected cash flows that are expected to be generated by the products incorporating the current technologies.

 

Developmental projects that reached technological feasibility were classified as developed and core technology, and the $40,000 value assigned to developed technology was capitalized to be amortized using the straight-line method over a weighted-average period of fourteen months. Developmental projects that had not reached technological feasibility, and had no future alternative uses were classified as IPRD.  The $3.4 million value allocated to projects that were identified as IPRD was charged to acquired in-process research and development in the accompanying condensed consolidated statements of operations for the three months ended April 3, 2005.   The value assigned to IPRD comprises the following projects:  multi-protocol readers ($1.3 million), Smart readers ($900,000) and Class 3 readers ($1.2 million).  The value of these projects was determined by estimating the discounted net cash flows from the sale of the products resulting from the completion of the projects, reduced by the portion of the revenue attributable to developed technology and the percentage of completion of the project.

 

Products based on multi-protocol reader (‘MPR”) technology are capable of reading tags of different classes (e.g., Class 0, Class 0+, Class 1, and Gen 2 tags) with a single reader.  The hardware realization of the MPR products is based on a hardware stack consisting of an interface board, a control board, a radio frequency (“RF”) board and an antenna.  A modular construction technique is employed such that differing combinations of boards can be used to produce different products.  For example, the same antenna, RF board, and control board can be used with one interface board to provide an Ethernet connection to the host computer, or a different interface board to provide a serial interface to the host.  Similarly, different RF boards can be used to provide one, two or four antenna ports for reading tags without changing the control board or interface board.  This novel modular construction technique is a part of the MPR technology approach.

 

10

 

Smart reader technology is an extension of the MPR Technology.  This technology provides an operating system (e.g., Linux, Windows® CE) in the embedded microprocessor on the interface board.  With the previous RFID technologies, the host computer provided virtually every command to the reader.  With Smart reader technology, the embedded controller can host middleware applications.  These applications can take high-level commands from the host and then provide most of the lower-level commands internal to the reader.  Thus relieving much of the command and processing burden from the host computer.

 

Class 3 tags are fundamentally different from the Class 0, 0+ and 1 tags in that they are battery assisted.  This makes them more powerful and capable, and provides longer read range, but at the expense of battery life and cost.  They are more appropriate for tracking higher-value assets.  The air-interface protocol is different for the Class 3 readers and tags, and to date is not standardized (as is the case for Class 0 and 1 tags).

 

The nature of the efforts required to develop the acquired IPRD into commercially viable products principally relate to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the products can be produced to meet their design specifications, including functions, features and technical performance requirements.

 

In valuing the IPRD, the Company considered, among other factors, the importance of each project to the overall development plan, the projected incremental cash flows from the projects when completed and any associated risks. The projected incremental cash flows were discounted back to their present value using an after-tax discount rate of 25%. This discount rate was determined after consideration of the Company’s weighted average cost of capital and the weighted average return on assets. Associated risks include the inherent difficulties and uncertainties in completing each project and thereby achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets.

 

The Company has currently not identified any pre-acquisition contingencies where a liability is probable and the amount of the liability can be reasonably estimated.  If information becomes available to us prior to the end of the purchase price allocation period, which would indicate that a liability is probable and the amount can be reasonably estimated, such items will be included in the purchase price allocation.

 

4.              GOODWILL AND INTANGIBLE ASSETS

 

In connection with the acquisition of the wireless infrastructure business and associated assets from EiC on June 18, 2004, the Company recorded $1.8 million of goodwill. Adjustments to goodwill in 2004, subsequent to the EiC acquisition date, resulted primarily from $576,000 related to the termination settlement of the associated supply agreement with EiC and partially offset by $126,000 of additional registration statement related expenses.  In connection with the acquisition of Telenexus acquisition on January 28, 2005, the Company recorded $5.5 million of goodwill.  This goodwill was based upon the values assigned to the transactions at the time they were announced in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). The changes in the carrying value of goodwill as of April 3, 2005 are as follows (in thousands):

 

		Three Months Ended April 3, 2005
		EiC			Telenexus			Total
Balance as of December 31, 2004		$	1,368		$	—		$	1,368
Purchased goodwill		—			5,464			5,464
Adjustments to goodwill		3			—			3
Balance as of April 3, 2005		$	1,371		$	5,464		$	6,835

 

11

 

In addition to the closing consideration, EiC may be entitled to further consideration of up to $7.0 million in cash and shares of the Company’s common stock if certain revenue targets are achieved by March 31, 2006. The selling shareholders of Telenexus may be entitled to further consideration of up to $2.5 million in cash and up to 833,333 shares of the Company’s common stock if certain revenue targets are achieved by July 28, 2006.  If either party receives such consideration, the amounts will be recorded as an increase to goodwill.

 

Intangible assets are recorded at cost, less accumulated amortization. The following tables present details of the Company’s purchased intangible assets (in thousands):

 

As of April 3, 2005:

 

		Useful					Accumulated
Description		Life		Gross			Amortization			Net
EiC acquisition
Purchased developed technology		5 years		$	200		$	30		$	170
Telenexus acquisition
Purchased developed technology		1.2 years		40			6			34
Customer relationships		7 years		900			22			878
Trademarks and trade names		12 years		700			10			690
Non-competition agreements		4 years		400			17			383
Total identified intangible assets				$	2,240		$	85		$	2,155

 

As of December 31, 2004:

 

Useful

Accumulated

Description

Life

Gross

Amortization

Net

EiC acquisition

Purchased developed technology

5 years

$

200

$

20

$

180

 

In the three months ended April 3, 2005 amortization of purchased intangible assets included in cost of goods sold was approximately $16,000. In the three months ended April 3, 2005, amortization of purchased intangible assets included in operating expense was approximately $49,000. No comparable amounts were included in the three months ended March 28, 2004. Amortization is computed using the straight-line method over the estimated useful life of the intangible asset. The Company expects that annual amortization of acquired intangible assets to be as follows (in thousands):

 

		Three Months Ended April 3, 2005
		EiC			Telenexus			Total
Fiscal year:
2005 (remaining nine months)		$	30		$	241		$	271
2006		40			295			335
2007		40			287			327
2008		40			287			327
2009		20			195			215
2010 and beyond		—			680			680
Total amortization		$	170		$	1,985		$	2,155

 

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5.              UNAUDITED PRO FORMA RESULTS OF OPERATIONS

 

The following unaudited pro forma consolidated financial data represents the combined results of operations as if Telenexus’ business had been combined with the Company at the beginning of the respective period. This pro forma financial data includes the straight line amortization of intangibles over their respective estimated useful lives and excludes the write-off of IPRD of $3.4 million (in thousands, except per share amounts):

 

		Three Months Ended
		April 3, 2005			March 28, 2004
Net sales		$	7,852		$	7,817
Loss from operations		$	(4,591	)	$	(3,036	)
Net income (loss)		$	(4,385	)	$	3,639
Basic net income (loss) per share		$	(0.07	)	$	0.06
Basic average shares		63,704			61,729
Diluted net income (loss) per share		$	(0.07	)	$	0.05
Diluted average shares		63,704			69,810

 

The unaudited pro forma results of operations is presented for illustrative purposes only and is not intended to represent what the Company’s results of operations would have been if the acquisition had occurred on those dates or to project the Company’s results of operations for any future period. Since the Company and Telenexus were not under common control or management for any period presented prior to the acquisition, the unaudited pro forma results of operations may not be comparable to, or indicative of, future performance. These results do not reflect any additional costs or cost savings resulting from the acquisition.

 

6.              RECENT ACCOUNTING PRONOUNCEMENTS

 

In March 2004, the Financial Accounting Standards Board (“FASB”) approved the consensus reached on the Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The Issue’s objective is to provide guidance for identifying other-than-temporarily impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB issued a FASB Staff Position (FSP) EITF 03-1-1 that delays the effective date of the measurement and recognition guidance in EITF 03-1 until further notice. The disclosure requirements of EITF 03-1 were effective with this annual report for fiscal 2003. Once the FASB reaches a final decision on the measurement and recognition provisions, the Company will evaluate the impact of the adoption of the accounting provisions of EITF 03-1. Disclosures for cost method investments are required in annual financial statements for fiscal years ending after June 15, 2004.

 

In September 2004, the EITF reached a consensus regarding Issue No. 04-1, “Accounting for Preexisting Relationships Between the Parties to a Business Combination” (“EITF 04-1”). EITF 04-1 requires an acquirer in a business combination to evaluate any preexisting relationship with the acquiree to determine if the business combination in effect contains a settlement of the preexisting relationship. A business combination between parties with a preexisting relationship should be viewed as a multiple element transaction. EITF 04-1 is effective for business combinations after October 13, 2004, but requires goodwill resulting from prior business combinations involving parties with a preexisting relationship to be tested for impairment by applying the guidance in the consensus. The Company applied EITF 04-1 to its Telenexus acquisition which was subsequent to the effective date and will apply it in our future goodwill impairment testing.

 

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In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs – an amendment of ARB No. 43, Chapter 4.” This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “. under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges.” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  SFAS No. 151 is effective for fiscal years beginning after June 15, 2005, and is required to be adopted by the Company effective January 1, 2006. The Company is currently determining what effect, if any, the provisions of SFAS No. 151 will have on its operating results or financial condition.

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (FSP) 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP FAS 109-1). In accordance with FSP FAS 109-1, the Company will treat the deduction for qualified domestic manufacturing activities as a reduction of the income tax provision in future years as realized. The deduction for qualified domestic manufacturing activities did not impact the Company’s Consolidated Financial Statements in 2004, and this deduction is not expected to have a material impact on the Company’s effective tax rate in 2005.

 

On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”).  SFAS 123R eliminates the alternative of applying the intrinsic value measurement provisions of Opinion 25 to stock compensation awards issued to employees.  Rather, the new standard requires enterprises to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award.  That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).

 

The Company has not yet quantified the effects of the adoption of SFAS 123R, but it is expected that the new standard may result in significant stock-based compensation expense.  The pro forma effects on net income and earnings per share if the Company had applied the fair value recognition provisions of original SFAS 123 on stock compensation awards (rather than applying the intrinsic value measurement provisions of Opinion 25) are disclosed above.  Although such pro forma effects of applying original SFAS 123 may be indicative of the effects of adopting SFAS 123R, the provisions of these two statements differ in some important respects.  The actual effects of adopting SFAS 123R will be dependent on numerous factors including, but not limited to, the valuation model chosen by the Company to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the requisite service period; and the transition method (as described below) chosen for adopting SFAS 123R.

 

SFAS 123R will be effective for the Company’s fiscal quarter beginning January 1, 2006, and requires the use of the Modified Prospective Application Method.  Under this method SFAS 123R is applied to new awards and to awards modified, repurchased or cancelled after the effective date.  Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (such as unvested options) that are outstanding as of the date of adoption shall be recognized as the remaining requisite services are rendered.  The compensation cost relating to unvested awards at the date of adoption shall be based on the grant-date fair value of those awards as calculated for pro forma disclosures under the original SFAS 123.  In addition, companies may use the Modified Retrospective Application Method.  This method may be applied to all prior years for which the original SFAS 123 was effective or only to prior interim periods in the year of initial adoption.  If the Modified Retrospective Application Method is applied, financial statements for prior periods shall be adjusted to give effect to the fair-value-based method of accounting for awards on a consistent basis with the pro forma disclosures required for those periods under the original SFAS 123.

 

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7.              BORROWING ARRANGEMENTS

 

In December of 2000, the Company entered into a revolving credit facility (“Revolving Facility”) with a bank the terms of which were amended and restated in September 2003. Under the new terms, the Revolving Facility provides for a maximum credit extension of $20.0 million with a $15.0 million sub-limit to support letters of credit and matures on September 22, 2005. Interest rates on outstanding borrowings are periodically adjusted based on certain financial ratios and are initially set, at the Company’s option, at LIBOR plus 1.0% or Prime minus 0.5%. The Revolving Facility requires the Company to maintain certain financial ratios and contains limitations on, among other things, the Company’s ability to incur indebtedness, pay dividends and make acquisitions without the bank’s permission. The Company was in compliance with the covenants as of April 3, 2005. The Revolving Facility is secured by substantially all of the Company’s assets. As of April 3, 2005 and December 31, 2004, there were no outstanding borrowings under the Revolving Facility. The Company has letters of credit of $3.2 million outstanding as of April 3, 2005 against which no amounts have been drawn.

 

8.              INVENTORIES

 

Inventories are stated at the lower of cost, using average-cost basis, or market. Cost of inventory items is based on purchase and production cost including labor and overhead. Write-downs, when required, are made to reduce excess inventories to their estimated net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. If actual conditions become less favorable than the assumptions used, an additional inventory write-down may be required. Inventories at April 3, 2005 and December 31, 2004 consisted of the following (in thousands):

 

		April 3,			December 31,
		2005			2004
Finished goods		$	2,253		$	1,944
Work in progress		1,956			2,338
Raw materials and parts		808			866
		$	5,017		$	5,148

 

9.              CONCENTRATION OF CREDIT RISK

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments and trade receivables. The Company maintains cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company invests in a variety of financial instruments such as money market funds, commercial paper and high quality corporate bonds, and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. At April 3, 2005, Richardson Electronics, Premier Devices Inc. and Celestica represented 25%, 19% and 16%  of the total accounts receivable balance, respectively. At December 31, 2004, Richardson Electronics and Celestica represented 46% and 10% of total accounts receivable balance, respectively. The Company performs ongoing credit evaluations and maintains an allowance for doubtful accounts based upon the expected collectibility of receivables.

 

10.       STOCKHOLDERS’ EQUITY

 

On January 28, 2004, the Company completed a secondary underwritten public offering of 2,000,000 shares of common stock at $5.75 per share, resulting in net proceeds of $10.1 million.

 

15

 

In March 2003, the Company’s Board of Directors (the “Board”) authorized the repurchase of up to $2.0 million of the Company’s common stock. In October 2003, the Board approved an additional $2.0 million to expand its existing share repurchase program increasing the total amount authorized to $4.0 million. Purchases under the stock repurchase program may be made in the open market, through block trades or otherwise. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time-to-time without prior notice. During the year ended December 31, 2003, $2.8 million was utilized to purchase 1,340,719 shares of the Company’s common stock at a weighted average purchase price of $2.08 per share. All of the purchases were made on the Nasdaq National Market at prevailing open market prices using general corporate funds. The repurchases reduced the Company’s cash and interest income during the period and correspondingly reduced the number of the Company’s outstanding shares of common stock. This stock repurchase program ended as of the annual shareholder meeting on July 22, 2004. On July 27, 2004 the Company announced that its Board of Directors has authorized a new repurchase program of up to $2.0 million of the Company’s common stock. This new program was effective July 27, 2004 and replaces all previous repurchase programs. Under the new program, $920,000 was utilized to purchase 429,053 shares of the Company’s common stock at a weighted average purchase price of $2.12 per share.

 

During the year ended December 31, 2004, the Company modified two option agreements (to extend the option exercise period) resulting in $594,000 of severance expense which was recorded as selling and administrative expense for the year ended December 31, 2004 and an increase to additional paid-in capital in the accompanying consolidated balance sheet.

 

STOCK OPTION PLANS — During 2000, the Company’s “2000 Stock Incentive Plan” and “2000 Non-Employee Director Stock Compensation Plan” (collectively the “Plans”) were adopted and approved by the Board and the Company’s stockholders. Under the Plans, the Company may grant incentive awards in the form of options to purchase shares of the Company’s common stock, restricted shares, common stock and stock appreciation rights to participants, which include non-employee directors, officers and employees of and consultants to the Company and its affiliates. On May 22, 2002, the Board approved the adoption of an amendment to the Company’s “2000 Stock Incentive Plan” to increase the number of shares of common stock authorized for issuance from 16,500,000 to 19,000,000 shares. This plan amendment did not affect any other terms of the “2000 Stock Incentive Plan.” On May 29, 2003, the Board approved the adoption of an amendment to the Company’s “2000 Non-Employee Director Compensation Plan” to increase the number of shares of common stock authorized for issuance from 570,000 to 800,000, which was approved by the Company’s stockholders on July 15, 2003 at the Company’s Annual Meeting of Stockholders. Also on May 29, 2003, the Board approved the adoption of a second amendment to the Company’s “2000 Stock Incentive Plan” so that options granted to employees under the “2000 Stock Incentive Plan” will qualify as performance-based compensation under Internal Revenue Code Section 162(m) and thereby not be subject to a deduction limitation. Particularly, the amendment to the “2000 Stock Incentive Plan” provides that no employee or prospective employee shall be granted one or more options within any fiscal year which in the aggregate are for the purchase of more than 3,000,000 shares. The total number of shares of common stock authorized for issuance pursuant to the Plans is 19,800,000 shares.

 

On May 23, 2001, the Company’s 2001 Employee Stock Incentive Plan (the “Plan”) was adopted and approved by the Board and the Company’s stockholders. The Plan may grant incentive awards in the form of options to purchase shares of the Company’s common stock, restricted shares, common stock and stock appreciation rights to participants, which include employees which are not officers and directors of the Company and its affiliates and consultants to the Company and its affiliates. The total number of shares of common stock reserved and available for grant under the Plan is 2,000,000 shares. Shares subject to award under the Plan may be authorized and unissued shares or may be treasury shares. Stock options may include incentive stock options, nonqualified stock options or both, in each case, with or without stock appreciation rights.

 

16

 

The Company’s stock option plans (“Plans”) provide that options granted under the Plans will have a term of no more than 10 years. Options granted under the Plans have vesting periods ranging from two to four years. The provisions of the Plans provide that under certain circumstances, such as a change in control, the achievement of certain performance objectives, or certain liquidity events, the outstanding option may be subject to accelerated vesting.  As of April 3, 2005 the number of shares available for future grants under the above plans was 3,856,050 Stock options may include incentive stock options, nonqualified stock options or both, in each case, with or without stock appreciation rights.

 

11.       NET INCOME (LOSS) PER SHARE CALCULATION

 

Per share amounts are computed based on the weighted average number of basic and diluted (dilutive stock options) common and common equivalent shares outstanding during the respective periods. The net income (loss) per share calculation is as follows (in thousands, except per share amounts):

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
Net income (loss)		$	(7,684	)	$	3,610
Denominator for basic net income (loss) per share:
Weighted average shares outstanding		63,027			59,396
Denominator for diluted net income (loss) per share:
Weighted average shares outstanding		63,027			59,396
Effect of dilutive stock options		—			8,080
Diluted weighted average common shares		63,027			67,476
Basic income (loss) per share		$	(0.12	)	$	0.06
Diluted income (loss) per share		$	(0.12	)	$	0.05

 

For the three months ended April 3, 2005, the incremental shares from the assumed exercise of 13,482,702 of the Company’s stock options outstanding and 119,700 shares as of April 3, 2005 related to contributions under the Employee Stock Purchase Plan for pending purchases were excluded from the calculation of diluted earnings per share because operations resulted in a loss and the effect of such assumed conversion would be anti-dilutive. For the three months ended March 28, 2004, the incremental shares from the assumed exercise of 703,550 of the Company’s stock options outstanding were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than or equal to the average share price for the quarter, and therefore their inclusion would have been anti-dilutive. These options could be dilutive in the future if the average share price increases and is greater than the exercise price of these options.

 

12.       RESTRUCTURING CHARGES

 

Fourth Quarter 2002 Restructuring Plan

 

Over the course of 2002, the Company began to design and manufacture semiconductors utilizing other manufacturing technologies. The Company believed that this approach was required in order to continue to offer competitive products and expected that a greater number of its future products would be developed in this fashion. The Company at that time believed that this business strategy offered considerable other advantages such as allowing it to focus its resources on product development and marketing, minimizing capital expenditures, reducing operating expenses, allowing it to continue to offer competitive pricing, reducing time to market, reducing technology and product risks and facilitating the migration of the Company’s products to new process technologies, which reduce costs and optimize performance. On December 17, 2002, the Company’s Board of Directors approved a plan to completely outsource the Company’s internal wafer fabrication within one year and close its own wafer fabrication facility (the “fab closure”).

 

17

 

Lease Loss –  The fab closure would have resulted in additional excess space of approximately 35,000 square feet for which the Company would have had a remaining two year commitment after the anticipated fab closure. The original decision resulted in a lease loss of $4.3 million, comprised of future lease payments net of broker commissions and other facility costs. In determining this estimate, the Company made certain assumptions with regards to its ability to sublease the space in line with the Company’s best estimate of current market conditions.

 

During the fourth quarter of 2003 the Company decided that additional time would be needed to effect the complete outsourcing of its internal wafer fabrication due to an unplanned increase in near-term product demand and additional qualification procedures associated with outsourced wafer fabrication. The Company planned to continue to operate its fab through April 2004. As such, the additional four months of rent and facility costs would be incurred as an operating expense resulting in an approximate $364,000 reduction in the lease loss accrual.

 

During the second quarter of 2004, the Company delayed the closure of its internal wafer fabrication facility (“fab”) for a minimum of three additional months to assess the integration of the EiC acquisition (see Note 3) into its existing operations which resulted in an approximate $430,000 reduction in its lease loss accrual.  During the third quarter of 2004, the Company decided to not close its fab as the Company believes that integrating the newly acquired fab from EiC with its pre-existing fab will offer the Company certain benefits over outsourcing the pre-existing fab. As such, the Company reversed the remainder of this lease loss accrual of $3.6 million.

 

Workforce reduction – As a result of the originally planned fab closure, approximately 10% of the Company’s workforce (20 employees) would have been eliminated, which would have resulted in severance payments of $279,000 during 2004.  The Company ultimately paid out $194,000 of the accrued severance to terminated employees.  The remaining accrual of $85,000 was reversed upon the Company’s decision not to close the fab.

 

Impairment of Long Lived Assets –  Assets to be held and used – The decision to utilize the Company’s internal wafer fabrication equipment and related leasehold improvements for only one more year triggered an impairment under SFAS No. 144. Management measured the recoverability of these assets through a comparison of the carrying amount of these assets to future undiscounted cash flows expected to be generated by these assets over their remaining year of life. As such, the carrying value of these assets were written down to the estimated future cash flows that are directly associated with and that were expected to arise as a direct result of the use and eventual disposition of these assets. Management estimated the future cash flows using a traditional present value approach based on management’s assumptions regarding the intended use of these assets consistent with the Company’s budget and projections as well as the planned eventual disposition of the asset group through sale. Management estimated the disposition value of these assets after consideration of several factors including the condition and management’s intended use of the equipment, offers made for similar equipment the Company intended to sell and the results of an independent third party appraisal.  Management employed a risk-free interest rate commensurate with the Company’s size, capital structure and stock volatility in relation to the overall market. This action resulted in a $4.2 million asset impairment charge in 2002.

 

Third Quarter 2002 Restructuring Plan

 

As a result of the prolonged downturn in the telecommunications industry and the uncertainty as to when the telecommunications equipment market will recover, in July 2002 the Company announced a workforce reduction and its second restructuring program in the previous two years.

 

Workforce reduction – Approximately 22% of the Company’s workforce (50 employees) was eliminated, which resulted in severance payments of $507,000 during the third quarter of 2002.

 

During first quarter of 2003, it was determined that one of the employees slated to be terminated would instead be retained for another position. As such, $21,000 of the third quarter 2002 restructuring charge was reversed in 2003.

 

18

 

Lease Loss – In the third quarter of 2002, the Company decided to abandon a portion of its leased facility based on revised anticipated demand for its products and current market conditions. This excess space, for which the Company had a remaining eight year commitment, is located on the first floor of the Company’s current corporate headquarters and originally housed a portion of the Company’s optics and integrated assemblies manufacturing operations. This decision resulted in a lease loss of $10.6 million, comprised of future lease payments net of anticipated sublease income, broker commissions and other facility costs, and an asset impairment charge of $3.2 million for tenant improvements deemed no longer realizable. In determining this estimate, the Company made certain assumptions with regards to its ability to sublease the space and reflected offsetting assumed sublease income in line with the Company’s best estimate of current market conditions.

 

During the fourth quarter of 2002, based on a continuing deterioration in the real estate market and difficulties subleasing its available space, the Company revised its assumptions regarding sublease occupancy rates and market rates downward resulting in an additional lease loss of $674,000.

 

During the fourth quarter of 2003, after reviewing current information regarding continuing deterioration in the real estate market, difficulties subleasing its available space and facility costs, the Company revised its lease loss assumptions. $23,000 of the lease loss was reversed as reduced facility costs (mainly property taxes and utilities) were largely offset by reductions in estimated sublease occupancy and market rates.

 

During the third quarter of 2004, after reviewing current information regarding reduced facility operating costs (predominantly building maintenance costs), the Company revised its lease loss assumptions resulting in a reversal of $377,000 of the lease loss.

 

As of April 3, 2005, the maximum potential amount of the lease loss for this property is $8.2 million which is partially offset by $81,000 of estimated net sublease income.

 

Impairment of Long Lived Assets:

 

Assets held for sale – Due to the prolonged downturn in the telecommunications industry, especially related to the Company’s fiber optics products, management made a decision during the third quarter of 2002 to exit the fiber optics business after current contractual obligations have been satisfied. This decision resulted in a significant overcapacity of certain manufacturing equipment and the Company initiated a plan to sell this equipment. The Company’s excess capacity resulted in a total charge of $3.9 million related to these assets. Assets to be held for sale were measured at the lower of carrying amount or fair value less cost to sell. Management determined fair market value after consideration of several factors including the condition of the equipment, offers made by potential buyers of the equipment and the results of an independent third party appraisal. The majority of these impaired assets were sold in the fourth quarter of 2002.

 

During the fourth quarter of 2003, management determined that the remaining assets held for sale could not be sold. As such, the assets were scrapped resulting in an additional charge of $151,000.

 

Assets to be held and used – During the third quarter of 2002, management identified manufacturing equipment exclusively supporting certain in-warranty optics and fixed wireless products as well as manufacturing equipment supporting final orders for certain other optics and fixed wireless products and determined that the estimated future undiscounted cash flows did not support the carrying value of these assets. As such, the carrying value of these assets was written down to the estimated future cash flows that are directly associated with and that are expected to arise as a direct result of the use and eventual disposition of these assets, which management determined after consideration of several factors including the condition and management’s intended use of the equipment, offers made for similar equipment the Company intended to sell and the results of an independent third party appraisal. This action resulted in a $200,000 asset impairment charge.

 

19

 

Third Quarter 2001 Restructuring Plan

 

Lease Loss and Leasehold Impairment –  In September 2001, the Company decided to abandon a leased facility based on revised anticipated demand for its products and current market conditions. This excess facility, for which the Company had a ten year commitment, is located adjacent to the Company’s current corporate headquarters and was originally developed to house additional administrative and corporate offices to accommodate planned expansion. This decision resulted in a lease loss of $7.2 million, comprised of future lease payments net of anticipated sublease income, broker commissions and other facility costs, and an asset impairment charge of $2.6 million on tenant improvements deemed no longer realizable. In determining this estimate, the Company made certain assumptions with regards to its ability to sublease the space and reflected offsetting assumed sublease income in line with the Company’s best estimate of current market conditions.

 

During the third and fourth quarters of 2002, based on an overall deteriorating real estate market and difficulties subleasing its available space, the Company revised its assumptions regarding sublease occupancy rates and market rates downward resulting in additional lease loss accruals of $4.5 million and $1.8 million, respectively.

 

During the fourth quarter of 2003, after reviewing current information regarding continuing deterioration in the real estate market, difficulties subleasing its available space and facility costs, the Company revised its lease loss assumptions. $203,000 of additional lease loss was accrued as reductions in estimated sublease occupancy and market rates were partially offset by reduced facility costs (mainly property taxes and utilities).

 

During the third quarter of 2004, after reviewing current information regarding continuing deterioration in the real estate market, difficulties subleasing its available space and increasing facility operating costs, the Company revised its lease loss assumptions resulting in $538,000 of additional lease loss.

 

20

 

As of April 3, 2005, the maximum potential amount of the lease loss for this property is $12.3 million which is partially offset by $690,000 of minimum sublease income commitments under noncancellable sublease rental agreements and $916,000 of estimated net sublease income.  The following table summarizes restructuring accrual activity recorded during the years 2001 though April 3, 2005 (in thousands):

 

		Q3 2001
		Restructuring
		Plan			Q3 2002 Restructuring Plan									Q4 2002 Restructuring Plan
					Workforce						Asset			Workforce						Asset
		Lease Loss			Reduction			Lease Loss			Impairment			Reduction			Lease Loss			Impairment			Total
Q3 2001 charge to expense		$	9,797		$	—		$	—		$	—		$	—		$	—		$	—		$	9,797
Non-cash charges (1)		(2,503		)	—			—			—			—			—			—			(2,503		)
Cash payments		(463		)	—			—			—			—			—			—			(463		)
Balance at December 31, 2001		6,831			—			—			—			—			—			—			6,831
Q3 2002 charge to expense		—			507			13,841			4,087			—			—			—			18,435
Q4 2002 charge to expense		—			—			—			—			279			4,285			4,277			8,841
2002 additional charge		6,283			—			674			—			—			—			—			6,957
Non-cash charges (2)		(22		)	—			(2,930		)	(4,087		)	—			—			(4,277		)	(11,316		)
Cash payments		(1,002		)	(437		)	(290		)	—			—			—			—			(1,729		)
Balance at December 31, 2002		12,090			70			11,295			—			279			4,285			—			28,019
2003 additional charge (credit)		203			(21		)	(23		)	151			—			(364		)	—			(54		)
Non-cash charges		—			—			(15		)	(151		)	—			—			—			(166		)
Cash payments		(782		)	(49		)	(1,316		)	—			(26		)	—			—			(2,173		)
Balance at December 31, 2003		11,511			—			9,941			—			253			3,921			—			25,626
2004 additional charge (credit)		538			—			(377		)	—			(85		)	(3,921		)	—			(3,845		)
Non-cash charges		12			—			30			—			—			—			—			42
Cash payments		(1,003		)	—			(1,233		)	—			(168		)	—			—			(2,404		)
Balance at December 31, 2004		11,058			—			8,361			—			—			—			—			19,419
2005 additional charge (credit)		—			—			—			—			—			—			—			—
Non-cash charges		—			—			12			—			—			—			—			12
Cash payments		(402		)	—			(316		)	—			—			—			—			(718		)
Balance at April 3, 2005		$	10,656		$	—		$	8,057		$	—		$	—		$	—		$	—		$	18,713

 

(1)          Non-cash charges related to the Q3 2001 Restructuring Plan lease loss represents $2.5 million of tenant improvements deemed no longer realizable.

 

(2)          Non-cash charges related to the Q3 2002 Restructuring Plan lease loss represents $3.2 million of tenant improvements deemed no longer realizable net of a $310,000 write-off of accrued deferred rent.

 

Of the accrued restructuring charge at April 3, 2005, the Company expects $3.4 million of the lease loss to be paid out over the next twelve months. As such, this amount is recorded as a current liability and the remaining $15.3 million to be paid out over the remaining life of the lease of approximately six years is recorded as a long-term liability.

 

13.       BUSINESS SEGMENT REPORTING

 

In 1997, the Company adopted SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” As an integrated products provider, the Company currently has one reportable segment. The Company’s Chief Operating Decision Maker (“CODM”) is the CEO. While the Company’s CODM monitors the sales of various products, operations are managed and financial performance evaluated based upon the sales and production of multiple products employing common manufacturing and research and development resources; sales and administrative support; and facilities. This allows the Company to leverage its costs in an effort to maximize return. Management believes that any allocation of such shared expenses to various products would be impractical, and currently does not make such allocations internally.

 

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The CODM does, however, monitor sales by products at a more detailed level than those depicted in the Company’s historical general purpose financial statements as follows (in thousands):

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
Semiconductor and RFID		$	7,514		$	6,638
Wireless Integrated Assemblies		260			433
Total		$	7,774		$	7,071

 

The Company believes it is more meaningful in terms of concentration of risk to combine the sales to manufacturing subcontractors with the end customer who ultimately controls product demand. Sales to individual customers representing greater than 10% of Company consolidated sales during at least one of the past three years are as follows (in thousands):

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
Richardson Electronics Ltd (1)		$	3,529		$	3,795
Celestica		1,054			1,094

 

(1)          Richardson Electronics Ltd. is the sole worldwide distributor of the Company’s complete line of RF semiconductor products.

 

Sales to unaffiliated customers by geographic area are as follows (in thousands):

 

		Three Months Ended
		April 3,			March 28,
		2005			2004
United States		$	4,791		$	4,527
Export sales from United States:
Europe		308			712
China		1,631			765
Other		1,044			1,067
Total		$	7,774		$	7,071

 

Long-lived assets located outside of the United States are insignificant.

 

14.       INCOME TAXES

 

The tax benefit for the period ended March 28, 2004 of $6.5 million resulted from a revision of the Company’s estimated income tax contingency liability due to the receipt of the final assessment from the Internal Revenue Service related to the audit of the Company’s 1996 through 2000 tax returns.

 

15.       NET ASSETS HELD FOR SALE

 

During the three months ended April 3, 2005, the Company combined its two wafer fabrication facilities resulting in excess manufacturing equipment.  Management has initiated a plan to sell this equipment over the course of the next six months. Assets to be held for sale were measured at the lower of carrying amount or fair value less cost to sell.

 

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