Back to GetFilings.com

Table of Contents

Index to Financial Statements

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

- OR -

For the Fiscal Year Ended August 31, 2003

Commission File No. 0-24414

RF Monolithics, Inc.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (972) 233-2903

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK .001 PAR VALUE

(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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

The aggregate market value of RF Monolithics, Inc. Common Stock held by nonaffiliates as of October 31, 2003, based on the last reported sale price on the NASDAQ Stock Market composite tape on February 28, 2003 (the last trading date of the registrant’s most recently completed second fiscal quarter), was $13,969,441. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock of the Company have been excluded because such persons may be deemed to be affiliates.

Common Stock outstanding at October 31, 2003: 7,262,224 shares, par value $0.001.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, which will be filed with the Commission on or about December 9, 2003, is incorporated by reference into Part III of this report.

Table of Contents

Index to Financial Statements

RF MONOLITHICS, INC.

FORM 10-K

YEAR ENDED AUGUST 31, 2003

TABLE OF CONTENTS

1

Table of Contents

Index to Financial Statements

PART I.

RF Monolithics, Inc., or the Company, was organized in 1979 as a Texas corporation and converted to a Delaware corporation in 1994. We design, develop, manufacture and market a broad range of radio frequency, or RF, component and module products in two groups: (a) low-power products, which include low-power components and Virtual Wire^® Short-range Radio products, and (b) communications products, which include frequency control modules and filters. Most of our products are based on surface acoustic wave, or SAW, technology and are manufactured as discrete devices to perform specific functions and as integrated modules to meet system performance requirements.

We focus our product development in the frequency range of 50 megahertz, or MHz, to 2.4 gigahertz, or GHz. We market our line of more than 300 active resonators, filters, clocks, oscillators, transmitters and receivers to distributors, electronic manufacturing service companies and original equipment manufacturers world-wide. Our customers include Acal Electronics, Delco Electronics, Flextronics International, Insight Electronics, Motorola, Nokia Telecommunications, Schrader Electronics and Solectron Corporation.

Advantages of SAW Technology / Our Solutions

We believe that a significant market opportunity for more widespread adoption of SAW technology is emerging. As electronic products move into additional wireless applications, there will be an increasing demand for lower power consumption, reduced size, improved performance, greater precision, and greater reliability.

We believe that our SAW-based products, coupled with our RF design and manufacturing expertise, offer potential customers certain fundamental advantages over alternative technologies. As electronic applications ranging from automated meter reading to satellite radio migrate to lower power consumption and reduced size, we think demand for RF modules and SAW discrete components will increase.

Our product offerings combine a complex mix of application assistance, design technology, wafer fabrication capability, hybrid assembly and packaging processes to meet stringent customer performance requirements. The unique features of SAW technology provide flexible solutions to system designers defining tomorrow’s emerging applications in various market segments.

Markets and Applications

We focus on specific market opportunities where we believe that our SAW technology solutions coupled with our RF design expertise address the application requirements. Our products are incorporated into application designs in five markets: automotive, consumer, distribution, industrial and telecommunications.

Automotive

The automotive industry utilizes SAW-based components in transmitter and receiver designs for remote keyless entry, tire pressure monitoring and satellite radio applications. The automotive industry continues to develop new and improved safety features. The Tread Act that phases in tire pressure monitoring through 2006 in the United States presents an opportunity in the RF-type direct method of tire pressure monitoring. We believe that SAW devices are stable and resistant to shock, vibration and moisture, all characteristics required for this application.

2

Table of Contents

Index to Financial Statements

Satellite Radio is emerging because the digital modulation used in satellite radio systems is more efficient than traditional analog AM or FM. Current proposed digital standards, within the same bandwidth, are achieving near CD quality audio. Published reports say that in ten years there could be as many as 48 million subscribers to satellite radio services. Automotive electronic applications continue to grow with the ongoing drive toward smaller size, reduced cost and improved system performance. Our low-power components, Virtual Wire^® Short-range Radio products and filters meet many of the requirements of this automotive market. This market currently is characterized by fierce competition due to commodity pricing by competitors.

Consumer

The consumer market is currently a relatively small market for our products. However, we believe that there is significant growth potential in the areas of global positioning systems, sports applications, such as Smartcast^™ Wireless Fish Finder, home security, internet appliances, garage doors, cable TV and a wide variety of wireless applications. Both low-power components and Virtual Wire^® Short-range Radio products may be designed into consumer applications.

Distribution

Several of our products, particularly in the low-power product group, have widespread potential uses and standardized characteristics that make them ideal for sales through distribution. Two of the top applications serviced by distribution are (a) wireless computer connectivity and (b) wireless medical applications. Our distributors have the technical expertise and experienced personnel required to help potential customers design their products using our products. Distributors also provide service to customers with special delivery and lead-time requirements. Standard distribution contracts govern sales to distributors and substantially limit the amounts that distributors may return to us for stock rotation. Our largest distributors are Insight Electronics Inc., in North and South America, and Acal Electronics and Equipements Scientifiques S.A. in Europe. In the first quarter of fiscal year 2004, we announced that Richardson Electronics had been added as a distributor.

Industrial

The industrial market includes applications such as automated meter reading, medical systems, security systems, RF ID tags, bar code reading devices, and custom data link equipment. We believe that the automated utility meter reading, medical systems and industrial security market segments have the potential for significant growth. As the deregulation of utility companies gains momentum, the HR6 Act concerning real time cost and consumption monitoring creates the need to access data remotely critical to utility providers. Published reports say that the automated meter reading market may grow 15% to 20% annually for the next five years. The need to transfer more and more data with low power consumption is ideally suited for our Virtual Wire^® Short-range Radio products. We were selected as the transceiver of choice for the communication protocol network of StatSignal Systems, Inc. Our low-power components, Virtual Wire^® Short-range Radio products and filters are used in industrial security applications.

Telecommunications

We believe that a number of dynamics within the telecommunication and wireless communications market are opening new applications for SAW technology. The deployment of digital cellular telephone standards, such as Global System for Mobile Communications, Code Division Multiple Access, Enhanced Digital Global Evolution, Wideband Code Division Multiple Access and Wireless Local Area Network has been initiated worldwide. All of these digital cellular telephone standards entail digital modulation, which requires SAW filters that minimize distortion and conform to international cellular telephone standards.

3

Table of Contents

Index to Financial Statements

Other markets, such as wireless Internet access and broadband multimedia, will continue to use SAW-based filter and timing products. We believe that as broadband wireless communication systems demand more performance to support Internet requirements, bandwidth will become the key element that allows information to flow efficiently. This will create a requirement to minimize systems noise present in broadband wireless communication and provide clean timing to maximize throughput around the system’s backbone. Analog communications, test instrumentation, computer timing and military applications also create markets for SAW-based frequency control products. Timing integrity and elimination of system noise in circuits are critical for these applications. We have introduced optical timing products based upon our patented technology that we believe are well suited for the Dense Wave Division Multiplex internet application.

Our SAW filters are designed to operate at a frequency range of 50 MHz to 2.4 GHz. We face a threat of direct conversion technology and other competitor alternatives that do not operate in the frequency range suitable for SAW filters. Such alternative technologies may negatively affect our ability to penetrate new filter applications.

Products

Our products are organized into two groups: (a) the Low-power Products Group, which includes low-power components and Virtual Wire^® Short-range Radio Products, and (b) the Communications Products Group, which includes frequency control modules and filters.

Low-power Products Group

Low-power Components:

Resonators. Our resonators are used in low-power wireless transmitter and receiver applications, including automotive remote-keyless-entry systems, tire pressure monitoring systems, and wireless security systems and related products. We offer SAW resonators in volume, and they are supplied in both three-lead metal packages and various surface mount packages. We accelerated the development of smaller package styles for these products in the current year. The market for low-power resonators is intensely competitive and has experienced price erosion, rapid technological change and product obsolescence.

Coupled-Resonator Filters. Coupled-resonator filters are well suited for certain frequency stabilization applications, such as the receiver portion of remote-keyless-entry systems, and input and output filter for module products manufactured by us. We provide coupled-resonator filters in both three-lead metal packages and surface mount packages.

Virtual Wire^® Short-range Radio Products:

Our second-generation hybrid transmitter, receiver and transceiver modules are the primary products included in Virtual Wire^® Short-range Radio products. Our transceiver module, based on its patented Amplifier Sequenced Hybrid, or ASH, technology, offers two-way data communication in a single small module, with performance identical to the separate transmitter and receiver modules, at a lower total cost.

These products feature small size, very low-power consumption, excellent RF performance, and provide the system designer flexibility and fast time-to-market for emerging applications. The breadth of frequency ranges cover both North American and international frequency bands for low-power data transmission. The receiver’s ASH architecture provides exceptional performance with extremely low harmonic radiation and exceptional resistance to electromagnetic interference. This helps facilitate international standards certification for our customer’s products.

4

Table of Contents

Index to Financial Statements

The Virtual Wire^® Short-range Radio product offerings also include complete transceiver design and development kits that provide the system designer with minimal RF experience the ability to easily incorporate wireless data transfer for emerging applications. We also provide software protocols for key applications. The markets for Virtual Wire^® Short-range Radio products include remote bar code data entry, automated meter reading, point of sale terminals, medical monitoring systems, home automation, consumer sports, data link equipment and wireless thermostats.

We believe that markets for wireless products will continue to expand. We also believe that ASH technology has all the characteristics required to become an industry standard for short-range wireless applications. We have begun development of our third generation Virtual Wire^® products. This next generation will capitalize on the low power consumption of the base Virtual Wire^® technology and expand the product’s capabilities with new features. We believe the new features will fill additional needs in current wireless applications and support a variety of emerging applications.

Communications Products Group

Frequency Control Modules:

Our frequency control modules consist of frequency source products for both analog and digital applications. These products provide added value to the SAW components we manufacture. Each module incorporates one or more discrete SAW devices with standard and custom integrated circuits and passive components. Specialized SAW devices are incorporated in voltage-controlled sources to allow frequency variability along with very low phase noise for both analog and digital applications.

High-frequency clocks. Our high-frequency clock modules are used in high-bandwidth, high-performance computer systems. Our “Diff Sine” clocks allow network applications to realize improved performance by providing a highly stable frequency source, which results in very low timing variations from one cycle to the next (commonly referred to as “jitter”) and good symmetry across each cycle.

Oscillators. We produce commercial and military fixed-frequency and voltage-controlled SAW oscillators. These products are supplied in surface mount or leaded metal packages and are used in applications such as microwave radios, identification-friend-or-foe transponders for commercial and military avionics and precision instrumentation.

Optical timing products. We have introduced a line of oscillators that uses our patented technology to target the Optical Dense Wave Division market. These products are targeted for customers in the optical network market, including high-speed routers and the OC768 backbone system.

Filters:

We pioneered the development of several SAW technologies related to the implementation of high performance band-pass filters having low insertion loss. World-class filter design capabilities are provided by our team of filter design employees and consultants located in Dallas, Texas and Moscow, Russia. Their state-of-the-art filter designs are transformed into highly manufacturable product configurations by our design engineering staff in Dallas, Texas. Our filter products are primarily intended for emerging satellite radio, GPS and various telecommunications applications, particularly cellular telephone base stations.

In response to the demand from manufacturers of wireless communications products, we have focused on intermediate frequency SAW filters based on new SAW structures that provide the best performance. However, we also offer a variety of RF filters.

5

Table of Contents

Index to Financial Statements

Manufacturing

We have manufacturing operations in Dallas, Texas and have contractual relationships with (a) two manufacturers in the Philippines, Automated Technology (Phil.) Inc. and Cirtek Electronics Corporation; (b) one manufacturer in Taiwan, Tai-Saw Technology Co., Ltd.; and (c) one manufacturer in Japan, Morioka Seiko Instruments, Inc., a division of Seiko Instruments, Inc. These multiple sites provide original source and back-up capability for products and operations.

The manufacturing of our products is a highly complex and precise process that is sensitive to a wide variety of factors. The level of contaminants in the manufacturing environment, variations in the materials used and the performance of manufacturing personnel and production equipment are all factors. Each of the devices we manufacture is subject to contamination until it is enclosed or sealed within its final package Therefore, all operations, prior to enclosure, are performed in controlled clean-room environments.

In the past, we have occasionally experienced temporary product shipment delays and lower-than-expected production yields. Similar events could occur in the future. Certain other acts-of-God or events of a political nature could also temporarily delay product shipment.

We have experienced sudden increases in demand, which have put pressure on our manufacturing facilities to rapidly increase capacity to meet this demand. We have been aggressive in securing increased manufacturing capacity through offshore manufacturing alliances. Capacity currently exists to meet any reasonably anticipated potential demand within a short time. However, we do not maintain large amounts of raw material and wafer inventories and may occasionally experience temporary shipment delays due to the unavailability of these parts in the face of rapidly increasing customer demands.

Our transition to offshore assembly has created additional complexities in logistics. However, we are working to reduce these complexities, and have developed the capability to ship directly to our customers from offshore locations to reduce our lead times.

We divide our manufacturing operations into three key areas: (a) wafer fabrication, (b) domestic pilot line assembly, and (c) offshore assembly.

Wafer Fabrication

Fabrication of deposited and patterned wafers takes place in a clean-room environment. Thin aluminum films are precisely deposited onto four-inch diameter piezoelectric wafers. These films are subsequently etched to create multiple, patterned structures with very small (micron and submicron) features on the surface of the wafers. Each patterned structure is called a die, and there may be from 40 to 3,000 die on a single wafer. These die are subsequently assembled and sealed into a hermetic enclosure to become a product that is sold to customers. The majority of wafer fabrication currently takes place at our Dallas, Texas location. We have secured a backup source of supply at one of our offshore locations that also provides added capability for new products.

Domestic Pilot Assembly

The domestic pilot line assembly is primarily focused on frequency control products, but can manufacture a limited quantity of all product types as required. This manufacturing capability supports customers’ short-term delivery requirements, engineering requirements and new product development. Because of its flexibility, this line also provides additional backup production capability in case of offshore manufacturing disruption.

6

Table of Contents

Index to Financial Statements

Offshore Assembly

As noted above, we have manufacturing arrangements with Automated Technology (Phil) Inc., Cirtek Electronics Corporation, Morioka Seiko Instruments, Inc. and Tai-Saw Technology Co., Ltd. Each of these organizations has hermetic packaging capability, which is essential to the manufacture of SAW devices. Each one also possesses an understanding of the unique aspects of SAW component assembly and test. Assembly and test of all our products except clocks and oscillators occurs at more than one of these locations.

Source of Components/Labor

While we use standard components whenever possible, some components used in the SAW devices and modules are made to our specifications by specialized manufacturers. For example, we purchase several RF integrated circuits and ceramic arrays from Maxim Integrated Products or Kyocera America, Inc. We have experienced delays and quality control problems with certain of our single-source suppliers in the past. Although we are attempting to obtain second-source suppliers, we think we will continue to be somewhat dependent upon single-source suppliers for the foreseeable future. As part of our agreement with offshore manufacturers, the responsibility for securing certain raw materials has been transferred to them.

Quality

Our customers demand an ever-increasing level of quality in our products. We, as well as our partners in the Philippines and Taiwan, have achieved QS 9000 and ISO 9001 certification. We are working toward certification to the new TS 16949 Quality Standard. In addition to continually improving the efficiency and effectiveness of all of our functions, including manufacturing, we strive to assure that the features and benefits of our products meet or exceed customer expectations for performance and reliability. We have achieved significant operating improvements from these activities. Improvement of quality levels remains a high priority for us.

Sales and Marketing

International sales in foreign markets, as well as North American sales are as follows:

We distribute our products in the United States through manufacturers’ representatives managed by our area sales management team (internal sales force). During the current year we authorized one major North American distributor (Insight Electronics) to stock and sell all of our products. Since that time we have added Richardson Electronics as a distributor. International sales are handled on a nonexclusive basis through manufacturers’ representatives, manufacturers’ representatives acting as distributors and direct sales management.

Our international sales are currently denominated in U.S. currency. We have set up a limited capability to allow customers to buy products at prices denominated in Euros. An increase in the value of the

7

Table of Contents

Index to Financial Statements

U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, potentially less competitive in those markets. Additional risks inherent in international business activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, costs and risks of localizing international operations, potentially adverse tax consequences, repatriation of earnings and the burdens of complying with a wide variety of foreign laws. These factors could have a material adverse effect on our sales prospects.

A number of factors may slow down or prevent customers from using our products. We help customers design in our existing products through applications assistance. We sometimes work with our customers under custom product development programs. Both types of assistance can last from 6 months to 18 months. We cannot predict when or whether a particular customer’s product will be designed and reach volume production status. We cannot predict whether a particular customer will be commercially successful in selling its product. In addition, customers may require their products to be certified with various regulatory agencies. We offer them various types of assistance in obtaining certification. However, those customers may not obtain required certifications in a timely manner or at all. Any one of these factors could result in significant losses of potential sales.

Competition

The markets for our products are intensely competitive and are characterized by price erosion, rapid technological change and product obsolescence. In most of the markets for our products, we compete with very large, vertically integrated, international companies, including AVX, EPCOS Electronic Parts and Components, Murata Manufacturing Co., and Triquint Semiconductor Inc. These competitors have substantially greater financial, technical, sales, marketing, distribution and other resources, as well as broader product lines, than we do. Our competitors who have greater financial resources or broader product lines may be able to engage in sustained price reductions in our markets to gain market share.

We expect increased competition from existing competitors as well as competition from a number of companies that currently use SAW expertise largely for internal requirements. We also experience increased competition from companies that offer alternative solutions such as phase locked loop technology, which combines a semiconductor with a traditional crystal. We think competitors may duplicate our products, which would cause additional pressure on selling prices and which could adversely affect market share.

We believe that our ability to compete in our target markets depends on factors both within and outside our control. These include (a) the timing and success of new product introductions by us and our competitors, (b) our ability to support decreases in selling price through reduction in cost of sales, (c) the pace at which our customers incorporate our products into their end-user products, and (d) factors that are listed under the heading “Forward-Looking Statements”.

Research and Development

Our research and development efforts are primarily aimed at creating new, proprietary, innovative SAW device structures and SAW-based hybrid modules that uniquely address market needs. An example is the work currently being conducted to develop a third generation of Virtual Wire^® Short-range Radio products. These developments also include process improvements in wafer fabrication involving better line width and metal thickness control as well as improvements in device packaging.

We employ a number of highly qualified individuals in engineering and product and process development, including technicians, design engineers and scientists. These individuals are responsible for new products and new processes from inception to the commencement of volume manufacturing. We think that the efforts of this group help to ensure that our products provide an optimum system solution for the customer and are manufacturable at a competitive cost.

8

Table of Contents

Index to Financial Statements

From time to time we have entered into agreements with customers to develop specific SAW devices for inclusion in the customer’s end product. In addition, we have participated in government sponsored research and development programs. We treat sales derived from engineering design services as technology development sales and their associated costs are included in cost of sales. Total technology development sales during fiscal years 2003, 2002 and 2001 were $801,000, $723,000 and $759,000 respectively. Costs related to these sales were included in our cost of sales during these years. We consider the development of new products essential to maintaining and increasing sales.

Proprietary Rights

We rely on a combination of patents, copyrights and nondisclosure agreements in order to establish and protect our proprietary rights. We have received 40 patents for various inventions that include both SAW devices and innovative RF circuits that employ SAW devices. We have applied for an additional seven patents. Our policy is to file patent applications to protect technology, inventions and improvements that are important to our business.

We believe that our patents provide us competitive advantages. Reliance upon proprietary or patented technology is subject to a number of risks, however. Patents may not be issued from any of the pending applications. In addition, claims that are allowed from existing or pending patents may not be sufficiently broad to protect our technology. While we intend to protect our intellectual property rights vigorously, patents may be challenged, invalidated or circumvented.

We also seek to protect our trade secrets and proprietary technology through confidentiality agreements with employees, consultants and other parties. However, these agreements could be breached and we may not have adequate remedies. Further, our trade secrets could otherwise become known to or independently developed by others. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States.

The electronics industry is characterized by uncertainty and conflicting intellectual property claims that represents a risk to us. We may be notified that one of our products is infringing on patents and/or intellectual property rights of third parties. In the event of such alleged infringement, a license to the technology in question may not be available on commercially reasonable terms, if at all. Litigation could occur and the outcome of such litigation might be adverse to us. The cost of defending ourselves from such litigation could have a material adverse effect on our business, regardless of its outcome.

Regulations

We are subject to a variety of federal, state and local laws and regulations related to the use, storage, emission, treatment, disposal, transportation and exposure to certain toxic, volatile and other hazardous chemicals used in our manufacturing process. The failure to comply with present or future regulations could result in fines, suspension of production or a cessation of operations. Such regulations could also require us to acquire costly equipment, to make changes to our manufacturing process, or to incur substantial other expenses to comply with environmental regulations. Any past or future failure by us to control the use of, or to restrict adequately the discharge of, hazardous substances could subject us to future liabilities. Any of these situations could have a material adverse effect on our business, operating results and financial condition.

Employees

As of August 31, 2003, we had a total of 195 employees. With the exception of one employee located in each of the sales locations in Georgia, Minnesota and California and two supporting sales consultants in Europe, all of our employees are based at our headquarters in Dallas, Texas. Our future success depends to a significant degree upon the continued service of our key technical and senior management personnel and our

9

Table of Contents

Index to Financial Statements

continuing ability to attract and retain highly qualified technical and managerial personnel. Competition for such personnel can be intense. We may not be able to retain or continue to attract key managerial and technical employees. Failure to retain or continue to attract key managerial and technical employees could have a material adverse effect on our business, operating results and financial condition. None of our employees are represented by a labor union. We have not experienced any work stoppages and we consider our relations with our employees to be good. The availability of offshore production tends to mitigate the impact of labor shortages in Dallas, Texas.

Potential Fluctuations in Results of Operations; Order Trends and Backlog

Our quarterly and annual results have been and will continue to be affected by a wide variety of factors that could have a material adverse effect on our sales and results of operations. These factors include: (a) the level of orders that are received and can be shipped in a quarter, (b) the rescheduling or cancellation of orders by our customers, (c) competitive pressures on selling prices, (d) changes in product or customer mix, (e) loss of a strategic relationship, (f) the ability to introduce new products on a timely and cost-effective basis, (g) new product introductions by our competitors, (h) market acceptance of products of both us and our customers, and (i) other factors that are listed under the heading “Forward-Looking Statements”.

Historically, the electronics industry has experienced sudden and unexpected economic downturns. Our results of operations are subject to such downturns. In addition, our operating expenses are largely fixed and difficult to change quickly should sales not meet our expectations. This magnifies the adverse effect of any such sales shortfall. Period-to-period comparisons of our financial results should not be relied upon as a guarantee of future performance.

Our backlog at August 31, 2003 was approximately $13.7 million as compared to $13.9 million as of August 31, 2002. Our backlog includes all purchase orders scheduled for delivery within the subsequent 12 months. We think the level of backlog is a reflection of a general economic uncertainty. This reflects the reluctance of our customers to commit to purchase products when they have limited visibility of their own requirements. Our backlog, although useful for scheduling production, does not represent actual sales and should not be used as a measure of future sales. All orders in backlog are subject to cancellation prior to 30 days before shipment without penalty at the option of the customer and to changes in delivery schedules.

Our principal administrative, sales, marketing, research and development and manufacturing facilities are located in Dallas, Texas, in two adjacent buildings totaling 58,000 square feet. One building, containing 27,000 square feet, is leased through October 2008. The second building, containing 31,000 square feet (which we had previously leased), was purchased by us in February 2003. The purchase, including the surrounding parking lots, consists of 2.1 acres. We believe that our existing facilities are adequate for our current requirements and that the current properties are suitable and productive for the currently intended purposes. Due to our flexible offshore manufacturing capabilities, we do not expect to require significant additions to our assembly facilities or equipment.

None.

None.

10

Table of Contents

Index to Financial Statements

PART II.

Our common stock (symbol RFMI) is quoted on the NASDAQ Stock Market. The following table sets forth the high and low sales prices of our common stock during each quarter of fiscal 2003 and 2002 as furnished by NASDAQ. These prices reflect prices between dealers, without retail markups, markdowns or commissions, and may not necessarily represent actual transactions.

We have not paid dividends on our common stock during the past two most recent fiscal years and presently intend to continue this policy in order to retain earnings for use in our business.

The number of record holders of our common stock as of October 31, 2003 was approximately 200 (which number does not include the number of stockholders whose shares are held of record by a brokerage house or clearing agency, but rather includes such brokerage house or clearing agency as one record holder). The last sales price for our common stock, as reported by NASDAQ on October 31, 2003, was $5.43.

Equity Compensation Plan Information

The following table summarizes our equity compensation plans as of the fiscal year ended August 31, 2003:

11

Table of Contents

Index to Financial Statements

12

Table of Contents

Index to Financial Statements

In fiscal 2002, we recorded an impairment expense of approximately $229,000 to write down or write off specific fixed assets that were determined at that time to be of no further use.

In fiscal 2001, we recorded an impairment expense of approximately $1.0 million to write down or write off specific fixed assets that were no longer required due to the move of certain manufacturing lines overseas. We also incurred approximately $399,000 restructuring costs related to the severance of 238 employees. This reduction occurred mostly in the manufacturing and manufacturing support departments of operations moving overseas.

Business

We design, develop, manufacture and market a broad range of radio frequency components and modules. Our products are organized into two groups: (a) the Low-power Products Group and (b) the Communications Products Group. The Low-power Products Group includes low-power components, as well as Virtual Wire^® Short-range Radio products. The Communications Products Group includes frequency control modules and filter products. Our products generally utilize the SAW technology explained in Item 1 “Business” of this document.

Our strategy is to leverage our radio frequency design skills and our packaging technology to provide SAW-based solutions to the current and emerging requirements of the electronics industry. Our products include approximately 300 active individual products, also described in Item 1 “Business”. Our average selling prices generally range from $.35 to $10 for low-power products and from $1 to $100 for communications products.

13

Table of Contents

Index to Financial Statements

Critical Accounting Policies and Estimates

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgements and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the periods presented. Listed below are our most significant accounting policies and estimates, which we think are the most critical to fully understand and evaluate our reported financial results. Please keep the following policies and estimates in mind when reading the accompanying financial statements and related footnotes.

Accounts Receivable

We perform credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness. We continuously monitor collections and payments from customers and maintain a provision for estimated credit losses based upon historical experience and specific customer information. We maintain credit insurance on major customer balances and have a relatively diversified customer base.

In the current year, our losses due to credit issues were very small. However, there is no guarantee that we will continue to experience the same low rates in the future. A significant change in the liquidity or financial condition of a large customer or group of customers could have a material adverse effect on our ability to collect our receivables and we may incur losses as a result.

Inventory

We value inventory at the lower of the actual cost to purchase or manufacture the inventory (on a first-in, first-out basis) or the current estimated market value of the inventory. We use a standard cost system to estimate the actual costs of inventory and regularly review actual costs and the estimated market value of inventory to standard costs. Significant changes to our purchasing or manufacturing costs (either an increase or a decrease) could cause material changes to the valuation of our inventory when we adjust standard costs to reflect the change.

We estimate the market value of inventory based upon existing and forecasted demand for end products for the next twelve months and estimated amounts of inventory that would be consumed. We reduce the valuation of inventory items that are in excess supply compared to demand, items that have had limited usage over time, items that may no longer be usable due to product obsolescence and items that we decide to discontinue selling. We have a product rationalization process that involves key management personnel to identify and evaluate products and related inventory that fall into those situations.

In recent years we have written off significant amounts of inventory. In the current year we wrote down $2.6 million of inventory to reflect changes that occurred in our marketing strategy to accelerate the migration of our products to smaller packages. This was done in response to an abrupt shift in market requirements toward smaller packages.

If the facts and circumstances require it, we may have to write down inventory again in future periods. Our electronics industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could make such write downs necessary. Also, estimates of future product demand may prove to be inaccurate, in which case the valuation adjustments for obsolete and slow moving inventory may be understated or overstated. If we change our estimate of future demand, we may have to increase or decrease our inventory valuation reserves for excess inventory, with a corresponding impact on cost of sales. We continually review our inventory valuations for all of these factors. However,

14

Table of Contents

Index to Financial Statements

significant changes in manufacturing costs, unanticipated changes in product demand or technological developments could have a significant impact on the value of inventory and reported operating results.

Impairment of long-lived assets

In accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets, we regularly review our long-lived assets for changes in circumstances indicating that their carrying values may not be recoverable. We recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows. We measure an impairment loss as the difference between the carrying amount and fair value of the asset. As an example, we have moved assembly production offshore and consolidated our Dallas operations. This change in circumstances caused us to test for an impairment loss and ultimately record a $1.2 million charge in fiscal 2003 related to fixed assets.

Deferred Tax Assets

In fiscal year 2001 we recorded a full asset valuation allowance against tax loss carryforwards and other tax benefits according to the SFAS 109 “Accounting for Income Taxes” guidelines. Since then we have recorded no additional net federal tax benefits or expenses, since they were offset by the valuation allowance. The only exception to this was in fiscal year 2002 when a change in tax law allowed us to collect a significant tax refund, which was recorded in the period in which the change in tax law occurred. We still retain a large amount of potential tax benefits for tax loss carryforwards and other factors, as explained in the notes to the financial statements. These benefits may be realized in future periods. As a result, we do not expect to record significant federal income tax expense for some time.

Accrued Medical Benefits

We largely self-insure the payment of medical benefits to our employees. Consequently we regularly estimate the value of unpaid benefits based upon historical trends and use that information to record our liability for benefits that have been incurred but not yet paid. We have stop loss insurance protection to cover the costs of medical claims over certain deductible amounts for any given plan year for an individual claimant or in the aggregate. However, medical claims may significantly and unexpectedly increase or decrease over a short period of time, in which case our liability for unpaid claims may no longer be accurate. This could cause us to either increase or decrease medical expense in a material way in the period in which the change occurred.

Revenue Recognition

We recognize revenue for the most part when we ship the product to the customer. Less than 5% of fiscal 2003 sales were recognized under programs in which inventory is consigned to a customer. We recognize sales from consigned products when the customer pulls the product for use from the consigned inventory. In all cases, we recognize sales at the point at which legal title passes to the customer. Our standard terms and conditions are FOB our factory. We permit the return of defective products and accept limited amounts of product returns in other instances. Accordingly, we provide allowances for the estimated amounts of these returns based on historical experience when we recognize revenue.

15

Table of Contents

Index to Financial Statements

Results of Operations

In this next section we will discuss our financial statements. In doing this, we will make comparisons between the following periods, which we believe are relevant to understanding trends in our business:

The following table displays, for the years ended August 31, (a) the percentage relationship of certain items from our statements of operations to total sales and (b) the percentage change in these items from year to year:

16

Table of Contents

Index to Financial Statements

Sales

The following table displays sales for our different product lines and the percentage relationship of those product lines to total sales for the periods indicated:

Overall Sales Trends in Fiscal Year 2003 Compared to Fiscal Year 2002

Our total sales were approximately the same in fiscal 2003 as they were in fiscal 2002. However, our individual product lines showed very different trends year over year. Our base business has been the low-power components product line. These products have accounted for well over half of our sales for many years. The primary market for these products is the automotive market for keyless entry and tire pressure monitoring applications. The automotive market is very price competitive and we have had to reduce average selling prices significantly this year to maintain our market position. This is the primary reason why sales for this base business declined almost 12% this year.

We expect the trend for lower average selling prices for low-power components to continue, and may result in lower sales for these products in the future. We have anticipated this potential trend for some time. As a result, for several years we have focused our product and market development efforts on higher-value products with technical content to allow them to be sold at higher average selling prices. We had some success in increasing sales for these higher-value product lines this year. Sales increased more than 16% for these products, as we sold almost 60% more units, including several new products that we will discuss below. In the current year the decrease in our base business sales was just about equal to the increase in sales of higher-value products, resulting in overall sales slightly less than the prior year.

We compete in very price competitive markets in which customers require decreased prices over time to maintain their business. In addition, we understand that as new products ramp up in volume our customers expect ‘economy of scale’ to result in lower pricing. As a result, each of our product lines experienced a decline in average selling prices this year of 7% or more. This is a change from the prior year in which we did not experience significant decreases in average selling prices. A decline in average selling prices adversely impacts gross margin, as well as sales. Therefore, offsetting this impact is an important part of our

17

Table of Contents

Index to Financial Statements

strategic plan. We have achieved significant market position in most of the markets on which we focus. However, we believe that price competition from much larger and better financed competitors represents a significant risk in maintaining our sales levels and gross margins, particularly the automotive market.

One of the biggest factors in determining what happens to total sales in the future will be whether or not the anticipated growth in higher-value product line sales will be greater than or less than the anticipated decline in sales for our base low-power components business. We expect sales for our first quarter of fiscal 2004 to remain relatively flat. This would be an improvement over the trend we have seen for the last two years of approximately 6% fourth quarter to first quarter sales declines.

Our sales success is highly dependent on the following factors: (1) achieving technological advances in our product design and manufacturing capabilities; (2) our ability to sell our products in a competitive marketplace that can be influenced by outside factors, such as economic and regulatory conditions; (3) competition from alternative technologies or from competitors duplicating the Company’s technologies; and (4) the impact of competitive pricing. These and other factors may adversely affect our ability to grow or even maintain our sales levels.

We have experienced sudden increases in demand in the past, which have put pressure on our manufacturing facilities and those of our offshore contractors to increase capacity to meet this demand. In addition, new products sometimes require different manufacturing processes than we currently possess. We may not be able to increase our manufacturing capacity, the manufacturing capacity of our assembly contractors, or improve our manufacturing processes in a timely manner so as to take advantage of increased market demand. Failure to do this could result in a material loss of potential sales.

Overall Sales Trends in Fiscal Year 2002 compared to Fiscal Year 2001

Total sales decreased 16% in fiscal 2002 as compared to fiscal 2001. The decrease was primarily due to a 16% decrease in the number of units sold, which occurred in most of our product lines. The decrease in the number of units sold was primarily due to the general economic slowdown, which occurred in most of our markets. An economic downturn occurred in our largest market, the automotive market, although to a lesser extent than some other markets, such as the telecommunications market. We believe that although progress was made in market acceptance of some of our newer products, overall sales for even some of those products was adversely impacted by adverse economic conditions for existing or potential customers in their markets.

Despite participating in very price competitive markets, we did not experience a decrease in the average selling prices for our products within our various product lines. In most cases, we were able to secure new business from new customers to replace business that was lost due to competitive pricing pressures.

Product Line Sales Trends

Sales for low-power components products decreased 12% in fiscal 2003 and 17% in fiscal 2002. The decrease in sales for the current year was primarily due to a 7% decrease in average selling prices in the very competitive automotive market, together with a 4% decrease in the number of units sold. The decrease in the number of units sold was mainly related to our older style TO-39 packaged products, which continue a trend of applications for those products either converting to surface mount versions or being lost to lower- priced competitors. The number of units sold of surface mount products was similar to the prior year, as sales for keyless entry applications decreased due to loss of some sales to alternative technologies, but that was offset by increased sales for tire pressure monitoring applications. The decrease in fiscal 2002 sales was primarily due to a 17% decrease in the number of units sold, mostly to automotive customers that were adversely affected by the general economic slowdown. During the year, sales of low-power components products

18

Table of Contents

Index to Financial Statements

fluctuated in accordance with changing production schedules for automotive customers. We expect this fluctuation of low-power components products sales with automotive production schedules to continue.

Competitive pressures and consumer preferences in the low-power components and filter markets caused us to change our marketing strategy in the third quarter. We significantly accelerated the migration of these older version products to new smaller packages. In addition, we modified our product line strategy by reallocating resources to support products in newer, smaller packages and discontinue selected products. Discontinued products resulted in a projected 1% reduction in future sales. We believe we have the package sizes available to meet or exceed competitive offerings and meet customer expectations.

We expect that the trend of lower average selling prices for low-power component products to continue. In addition, the trend toward lower TO-39 product sales is expected to continue. We believe the number of units sold for tire pressure monitoring applications will continue to increase, partially offsetting these events. We also believe the Tread Act, which mandates a growing number of new vehicles in the United States to have some form of tire pressure monitoring will continue to increase market demand. Our products support the direct conversion method of tire pressure monitoring. There are competing technologies for meeting this requirement, which may impact our ability to benefit from the Tread Act legislation.

In addition, during fiscal 2003 we introduced more than 50 new products in smaller packages which we expect will have increasing market acceptance in fiscal 2004. As a result of these various factors, we think low-power components sales may decrease somewhat in the next fiscal year, despite the fact that the number of units sold may increase.

Sales for Virtual Wire^® Short-range Radio products increased 22% in the current year, although they decreased 16% in fiscal 2002. The increase in the current year was primarily due to a 32% increase in the number of units sold for these products. For several years we have devoted considerable resources developing and marketing new Virtual Wire^® Short-range Radio products. We believe these products offer potential for significant growth in sales in numerous new applications, particularly for applications that require small size and low power consumption. In the current year automated meter reading applications and consumer sports applications showed large increases. In the prior year the reduction in sales was primarily due to an almost complete elimination of sales of the first generation of these products, which were discontinued during fiscal 2001. Sales of second generation products in fiscal 2002 were similar to fiscal 2001.

We intend to continue working with our customers to develop new applications using Virtual Wire^® Short-range Radio products and we expect future sales increases for these products. However, the timing of any sales resulting from new applications is dependent upon the customers’ product development and product introduction cycles. It is difficult for us to predict when, or if, new applications of products will have a significant impact on our sales. We have seen that consumer applications are often part of special promotional programs by our customers, so sales to those customers will tend to fluctuate with the timing of those programs.

Filter sales increased 12% in fiscal 2003, compared to a decrease of 8% in fiscal 2002. In both years we sold an increased number of units, particularly for newer products in smaller packages that have lower average selling prices. The unit increase was more than 90% in fiscal 2003 and more than 40% in fiscal 2002. In the current year, the increased number of units sold was mostly for a Global Positioning Satellite consumer application and a new satellite radio application for the automotive market. We have sold more than 1 million satellite radio filters as of July 2003 and expect to sell our second million units by the end of the calendar year. Most of those sales were for the Sirius Satellite Radio Inc. (NASDAQ:SIRI) applications. We are working with both Sirius and XM Satellite Radio Holdings, Inc. (NASDAQ:XMSR) on next generation products. We expect sales for the satellite radio application will continue to increase.

19

Table of Contents

Index to Financial Statements

In the prior year our filter sales declined due to a decrease in average selling prices as a result of changes in product mix. In fiscal 2002 the number of units sold of relatively high-priced filters for telecommunications applications declined due to a severe downturn in economic conditions in that market. The number of units sold of newer products in smaller packages increased, but not enough to offset the impact of a lower number of units sold for older telecommunications applications. In recent years we have devoted a considerable portion of our engineering resources to filters and have developed many new products. However, the product development and introduction cycle for filter products is largely under customers’ control. As a result, it is difficult to predict whether or not the focus on filter products will continue to result in increased sales. We believe the telecommunications market is currently very unpredictable due to the uncertain economic condition of that industry, and it is impossible to predict sales in that market with any precision.

Frequency control module sales increased 5% in fiscal 2003, as compared to a decrease of 36% in fiscal 2002. The increase in the current year was primarily due to an increased number of units sold to customers in high-end computer markets. The decrease in fiscal 2002 resulted from a decrease in the number of units sold of a line of optical timing products based upon patented technology that targets the Optical Dense Wave Division Multiplex marketplace. That segment of the telecommunications market was particularly hard hit by economic conditions. While there were sales increases in these markets in fiscal 2003, it is not known when, or if, a general economic recovery will occur for increases in sales for frequency control module products in other markets that have been very depressed in recent periods.

Other Sales Trends

The following table provides additional data concerning our sales:

Our strategy is to seek diversification in our sales. We believe we have achieved a significant level of diversification in our customers, markets, products and geographic areas. However, due to the very competitive nature of the markets in which we compete, we may not always be able to achieve such diversification.

We consider all product sales with a delivery destination outside North America to be international sales. These sales are denominated primarily in U.S. currency, although some European customers require that we sell in Euros. We have not entered into any hedging activities to mitigate the exchange risk associated with sales in foreign currency. We intend to continue our focus on international sales. We anticipate that international sales will continue to represent a significant portion of our business. However, international sales are subject to fluctuations as a result of local economic conditions and competition. Therefore, we cannot predict whether we will be able to continue to derive similar levels of our business from international sales.

Gross Profit Trends in Fiscal Year 2003 Compared to Fiscal Year 2002

Gross profit margin decreased to 21.3% in fiscal 2003, compared to 24.5% in fiscal 2002 and 11.9% in fiscal 2001. Our current year cost of sales was $33.8 million. This included a $2.6 million non-cash charge (6.1% of sales) for obsolescence and write-down of inventory, as explained below. The decrease in

20

Table of Contents

Index to Financial Statements

gross profit due to the inventory write-down was partially offset by the continuation of cost reduction achieved as a result of our restructuring program. We have moved most of our assembly production offshore and we have reduced our Dallas, Texas workforce as a result. This has resulted in significantly lower ongoing production costs.

In the third quarter we changed our marketing strategy to significantly accelerate the migration of low-power component and filter products to new, smaller packages. We did this in response to an abrupt shift in market requirements toward smaller packages. We experienced significant decreases in average selling prices for older-style products in our second and third quarters and saw significant acceptance by customers of new products in smaller packages. As a result, we modified our product line strategy by reallocating resources to support those newer products and by discontinuing selected products. Discontinued products resulted in a reduction of approximately 50% in the number of products offered, with a projected reduction in future sales of less then 1%. The change in strategy and reduction in the number of products offered, as well as other factors, resulted in a $2.6 million non-cash charge related to the write-down of inventory recorded as cost of sales on our condensed consolidated statements of operations. We disposed of approximately $2.0 million of written-down inventory in the fourth quarter.

Gross Profit Trends in Fiscal Year 2002 Compared to Fiscal Year 2001

The gross margin increase in fiscal 2002 resulted from the gradual impact of our program to reduce manufacturing costs. We transitioned volume assembly operations offshore to contract manufacturing companies over a two-year period. By the end of fiscal 2002, this process was essentially complete. As a result of the move of assembly operations offshore, we were able to reduce costs in our Dallas, Texas operations and our labor and overhead costs were considerably reduced from prior periods. Cost of sales for fiscal 2001 included $1.2 million in special inventory charges related to elimination of product lines and transition to offshore manufacturing.

We also reduced cost by transitioning customers for our Virtual Wire^® Short-range Radio products to more cost-effective second-generation products. This was largely completed by the fourth quarter of fiscal 2001. The fiscal 2002 results represent purely second-generation results, which were much improved over the prior fiscal year. We realized additional cost savings through purchasing savings, process improvements and yield enhancements. We devote considerable resources to improving both our remaining operations in Dallas, Texas and our offshore contractors.

Factors Influencing Gross Margins

Our gross margin continues to be influenced by several factors, some of which were unfavorable and some of which were favorable. The most important unfavorable factors, some of which are outside our control, are as follows:

21

Table of Contents

Index to Financial Statements

Offsetting these unfavorable factors were other favorable factors that represent our long-term efforts to improve gross margins and respond to these unfavorable factors. The most important favorable factors are as follows:

The discussion above indicates that there are numerous factors that may have a material impact on our gross margins. Any one of them could cause a significant change in gross margin in either a favorable or unfavorable way, depending on the circumstances. This makes long-term estimates of our gross margin very difficult. However, we believe that gross margins in the coming first quarter will remain at approximately 28% of sales.

Research and Development

Research and development expense was approximately $3.3 million, $3.1 million and $3.9 million in fiscal 2003, 2002 and 2001 respectively. Research and development expense in fiscal 2003 increased approximately 4% compared to a decrease of approximately 19% in fiscal 2002. The slight increase in the current year was due to planned increases in design activities, including costs related to the development of a third generation of Virtual Wire^® Short-range Radio products. The prior year’s decrease was primarily a result of our cost reduction program and reallocations from engineering design functions to manufacturing functions to improve manufacturing efficiency and to support the offshore transition.

We believe that the continued development of our technology and new products is essential to our success and we are committed to continuing our investment in research and development. We expect our investments in research and development to remain approximately the same or increase in absolute dollars over the next several quarters.

Sales and Marketing

Sales and marketing expense was $4.9 million, $4.8 million and $5.7 million in fiscal 2003, 2002 and 2001 respectively. In fiscal 2003, sales and marketing expenses increased approximately 2%. The slight increase in the current year was due to planned increases in sales activities, including additional sales application support for our customers. In fiscal 2002, sales and marketing expenses decreased approximately 17% from the prior year, due primarily to decreased sales commissions resulting from decreased sales and a

22

Table of Contents

Index to Financial Statements

change in our program to reduce commission rates. Sales and marketing expenses were 11% of sales in fiscal 2003 and fiscal year 2002. We expect to incur comparable or slightly higher sales and marketing expenses in absolute dollars over the next several quarters, with the exception of sales commission expenses that will fluctuate in line with sales levels.

General and Administrative

General and administrative expense was $2.6 million, $2.8 million and $3.2 million in fiscal 2003, 2002 and 2001 respectively. General and administrative expenses decreased approximately 7% in fiscal 2003, compared to a 11% decrease in fiscal year 2002. The decreases were part of our restructuring program. We expect general and administrative expenses to remain approximately the same in absolute dollars over the next several quarters.

Restructuring and Impairment Expense

In the current year, we identified additional opportunities to create efficiencies in our Dallas, Texas operations by consolidating our pilot line and wafer fabrication facilities into a recently purchased building that we had formerly leased. For this and other reasons, we incurred non-cash charges of $1.2 million, which was primarily for equipment and other assets that will no longer be usable in our operations. Included in this charge was $33,000 in costs related to severance of employees. The $1.2 million charge was recorded as restructuring and impairment in our condensed consolidated statements of operations. We expect to dispose of these assets over the next year. Restructuring and impairment expenses were approximately $229,000 in the prior year, which consisted of fixed asset write downs resulting from transfer of additional operations offshore. We believe the restructuring and consolidation of our assembly operations is now complete and do not anticipate significant additional restructuring or impairment expense.

Total Operating Expenses

Our operating expenses were $12.0 million for the current year, compared to $11.0 million in the prior year. The increase was almost entirely due to the increase in restructuring and impairment expense as explained above. Total operating expenses had decreased $3.2 million in the prior year. While some of the decrease in the prior year was due to lower sales commissions resulting from lower sales, most of the decrease was a result of our cost reduction efforts. We intend to continue our program to control operating expenses. Therefore, we do not expect operating expenses to change materially over the next several quarters, other than making a small amount of strategic product and market development investments intended to help increase sales. In addition, we expect sales commission expense to fluctuate in line with sales.

Other Income (Expense)

Other income (expense), primarily interest expense on our bank debt, decreased $605,000 (57%) in the current year and $492,000 (32%) in the prior year. This was primarily due in both years to a lower amount borrowed, as well lower interest rates. We have paid down net bank debt by approximately $2.3 million in the current year and $4.9 million in the prior year. We expect to continue to pay down our bank debt, and expect these expenses to continue to decrease next year.

Loss Before Income Taxes

Loss before income taxes increased to $3.3 million in the current year, compared to a $1.4 million loss for the prior year and a $9.6 million loss in fiscal 2001. The increased current year loss was primarily due to $3.8 million in non-cash charges to cost of sales for obsolescence and write-down of inventory and to operating expenses for restructuring and impairment expenses as explained above. The improvement in fiscal year 2002 compared to fiscal 2001 was primarily a result of improved gross profit and reduced operating expenses and reflects the positive impact of our restructuring program.

23

Table of Contents

Index to Financial Statements

Income Tax Expense (Benefit)

In the current year we recorded a small provision for state income tax and expect to record relatively small state income tax provisions in future periods. In the prior year we benefited from a change in legislation that allowed us to obtain tax refunds for taxes paid in additional prior periods and additional categories of taxes. As a result, we recorded a $991,000 income tax benefit in fiscal 2002, which was subsequently received. In fiscal 2001, we fully reserved, in a non-cash charge, all tax benefits that had been recorded prior to that point in accordance with FAS 109. This resulted in $3.7 million in income tax expense for fiscal 2001.

We continue to maintain a full valuation allowance on our deferred tax assets due to prior period losses, as well as the general economic environment. However, we retain the tax benefits involved and we will realize the benefit in future periods to the extent we are profitable. As of the end of the current year, we have income tax carry forwards and other potential tax benefits available to reduce future federal taxable income by approximately $16.8 million as explained in footnote 13 to our financial statements. The net operating loss carry forward begins to expire August 31, 2023.

We do not expect to receive any additional tax refunds from recent legislation and do not expect to record any future federal income tax benefits or expense until the recovery of deferred tax assets is more likely than not.

Loss per Share

The net loss for the current year was $3.3 million, compared to a $442,000 loss in the prior year and a $13.2 million loss for fiscal 2001. Our basic and diluted loss per share was $.47 for fiscal 2003, compared to $.06 per share for fiscal 2002 and $1.97 per share for fiscal 2001. The increased loss in the current year was primarily due to $3.8 million in non-cash charges to cost of sales for obsolescence and write-down of inventory and to operating expenses for restructuring and impairment expenses as explained above. The improvement in loss per share in fiscal 2002 was due to both (a) an improvement in gross margins and operating expenses as a result of our restructuring efforts, as well as (b) a $1 million tax refund in fiscal 2002, compared to a $3.7 million expense for a FAS 109 special charge in fiscal 2001.

Fourth Quarter of Fiscal 2003

Unaudited quarterly financial data is presented in Note 16 to the accompanying financial statements.

Sales for the fourth quarter of $11.1 million decreased approximately 2%, compared to $11.3 million in the comparable quarter of the prior year. Sales increased approximately 2% compared to the previous third quarter. The sales decrease in the current quarter compared to the comparable quarter of the prior year was primarily due to a decrease in the average selling prices of our products, despite a slight increase in the number of units sold. See the above discussion under the heading “Product Line Sales Trends” for more details on the impact of average selling prices on our sales and gross margins. Our sales increase from the previous quarter was primarily due to a strong increase in the number of units sold, particularly to automotive customers for tire pressure monitoring and satellite radio applications.

For the last two years, our sales have declined an average of 6% in our first quarter compared to the previous fourth quarter. We expect that sales for tire pressure monitoring and satellite radio applications to offset this decline and overall sales for the next quarter will remain relatively flat with the current quarter. We currently cannot make any estimate of sales beyond the next quarter, due to the uncertain economic environment and the lack of visibility from customers in terms of backlog. We feel the diversity of our product offering and customer base moderates to a great extent the impact of economic changes on any particular industry or market.

24

Table of Contents

Index to Financial Statements

Gross profit margin was 28.3% in the fourth quarter, compared to 28.8% for the comparable quarter of the prior year and 3.7% for the previous quarter. The primary reason for the decrease in gross margin from the comparable quarter of the prior year was our product mix within the low-power components line was not quite as favorable as it was last year. The primary reason for the increase in gross margin from the previous quarter was our third quarter $2.6 million non-cash charge (24.3% of sales) for obsolescence and write-down of inventory, as explained above under the heading “ Gross Profit Trends in Fiscal Year 2003 Compared to Fiscal Year 2002”. We expect that gross margin in the first quarter of fiscal 2004 will remain at approximately 28% of sales.

Operating expenses for the fiscal 2003 fourth quarter were approximately $2.8 million, compared to approximately $3.0 million for the comparable quarter of the prior year and $4.0 million for the previous quarter. Most of the variations in operating expenses were due to fluctuations in restructuring and impairment expense. The current quarter had no restructuring and impairment expense, compared to $229,000 in the prior year and $1.2 million in the previous quarter. These charges were described above. Without restructuring and impairment expense, operating expenses for the fourth quarter were not significantly changed from either the comparable quarter of the prior year or the previous quarter. We expect that operating expenses will remain stable over the next several quarters, except for sales commission expenses, which will change in line with sales levels.

Other expense was $78,000 in the fiscal 2003 fourth quarter, compared to $158,000 in the comparable quarter of the prior year and $132,000 in the previous quarter. This was primarily due to a lower amount borrowed, as well as due to lower interest rates. The decrease from the previous quarter was magnified by the fact that the current quarter also included a small amount of gains on sales of fixed assets, while the previous quarter included a small loss on sales of fixed assets. We expect that projected positive cash flow may allow us to continue to pay down debt, so interest expense may continue to decrease in the next year.

Pre-tax income for the fiscal 2003 fourth quarter was $255,000 compared to $52,000 in the comparable quarter of the prior year and a loss of $3.7 million in the previous quarter. The current quarter increase from the comparable quarter of the prior year resulted from lower operating and non operating expenses as explained in the previous two paragraphs. This was the highest pretax income we have reported in four years and we feel represents the favorable impact of our restructuring program. The increase from the previous quarter primarily results from the fact that the previous quarter included $3.8 million in non-cash charges to cost of sales for obsolescence and write-down of inventory and to operating expenses for restructuring and impairment expenses that did not recur.

Income tax expense was nearly the same for the current quarter, the comparable quarter of the prior year and the previous quarter. Diluted net income per share was $0.03 in the fourth quarter, compared to $0.01 for the comparable quarter of the prior year and a loss of $0.52 for the previous quarter. Net income followed the same pattern as pre-tax income (see discussion above). The number of shares outstanding increased in the current quarter due to an increase in stock price that put more stock options “in the money”.

25

Table of Contents

Index to Financial Statements

Liquidity

Financing Arrangements

On February 3, 2003, our banking agreement was amended and restated. As of May 31, 2003, the banking agreement was further amended to adjust loan covenants to allow the inventory write off and asset impairment charge recorded in the third quarter of fiscal 2003. The bank agreement consists of:

The banking agreement calls for an interest rate of bank prime plus 1.5%. Substantially all our assets, tangible and intangible, are pledged as collateral. The banking agreement contains financial covenants relating to various matters, including but not limited to (a) minimum net worth, (b) quarterly and monthly earnings, (c) limitations on changes in corporate structure and (d) restrictions on dividends and capital spending. We were in compliance with all covenants as of August 31, 2003. Although we believe that we will be able to continue compliance with the covenants, there is no assurance that this will occur. Should there be a covenant violation and we are unable to negotiate a waiver or amendment, the maturity of our debt could be accelerated. In that case, other sources of cash would be needed to support our operations. The banking agreement will expire in December 2005.

As part of the May 2003 amendment, we entered into a warrant purchase agreement with the lender. We issued warrants to purchase 30,000 shares of our common stock at an exercise price of $3.75 per share. The closing price of our common stock as of May 31, 2003 was $3.10 per share. The warrants expire 3 years from date of issuance. We accounted for the fair value assigned to these warrants of $42,000 as a debt issuance cost and we are amortizing it over the remaining period of the banking agreement.

Cash Flows

Liquidity at August 31, 2003 consisted primarily of $216,000 of cash and approximately $4.9 million available under the banking agreement. Net cash provided by our operating activities was $4.5 million in the current year, the same as the prior year. While net income was $2.9 million lower in fiscal 2003, the non-cash items included in net income were $2.4 million higher. Working capital used in operations declined by approximately $553,000, primarily because the reduction (pay down) in accounts payables was approximately $2 million lower. We continued to be within payment terms with our vendors in fiscal 2003.

We reduced both inventory and receivables in both years. Collection of our receivables improved on a days-sales outstanding measurement to the low to mid 50-day range in the current year. Receivables declined more last year due to lower sales. Inventory decreased more last year as offshore contractors took over a portion of the responsibility for raw materials.

There are some unusual factors included in the cash flows over the last two years. Both net income and non-cash items included in net income in the current year incorporate the effect of the $3.8 million non-cash charges to cost of sales for obsolescence and write-down of inventory and to operating expenses for

26

Table of Contents

Index to Financial Statements

restructuring and impairment expenses that were mentioned above. The prior year included the benefit of a $991,000 tax refund. Depreciation was approximately $1 million lower in fiscal year 2003 as a result of assets reaching the end of their lives and the various fixed asset write downs we have reported. We expect depreciation will decrease another $1 million next year for the same reasons.

We expect to maintain a positive cash flow from operations for fiscal 2004, as we did in the last two years. We have classified all of our bank debt, except for the long-term portion of the mortgage, as current on our year-end balance sheet. This reflects our plan to pay down more bank debt in fiscal 2004 than required under the loan’s repayment terms. We believe continued positive cash flow, as well as access to our credit facilities, will be sufficient to maintain normal operations for the next fiscal year. However, we cannot guarantee this will be achieved.

Cash used in investing activities was $2.7 million in the current year, compared to cash provided from investing activities of $0.4 million for the prior year. This was primarily due to capital spending of approximately $2.9 million in the current year. The bulk of our capital spending was for the purchase of a building for $1.4 million that we had formerly leased and improvements to that building that allowed us to consolidate a substantial part of our Dallas operations into our acquired building. We had cash provided from investing activities resulting from the proceeds of sales of fixed assets in both years. We will continue our efforts to sell fixed assets that were idled in recent years. We expect to acquire up to $1.5 million of capital equipment by the end of fiscal 2004, primarily related to the development of new products and new manufacturing processes. Due to our offshore manufacturing initiative, we do not expect to need significant additions to our assembly facilities or equipment in the next year.

We used $1.9 million in net cash in financing activities in 2003, compared to $4.9 million in fiscal 2002. In fiscal 2003 approximately $2.3 million was used to reduce bank borrowings, compared to $4.9 million in the prior year. In the current year we used a $1.1 million mortgage to help finance the building we purchased. Under our banking agreement, all receipts are applied to loans that are outstanding and we borrow funds to support all of our activities. As a result, repayments on debt and borrowings are large relative to our sales. We raised $452,000 from sales of stock to employees under various stock programs in fiscal 2003.

As of August 31, 2003, we had approximately $4.9 million of cash availability under our banking agreement based upon the borrowing base. In addition, approximately $5.9 million more may become available under the banking agreement if our borrowing base were to increase sufficiently to support increased borrowing. We are not able to say when or if that will happen because of our inability to see very far into the future due to limited lead times on orders placed with us by our customers.

While we reported positive operating cash flows for the last nine quarters, a reduction in sales or gross margins could occur due to economic or other factors. We believe that cash generated from operations, our cash balances and the amounts available under our credit facility will be sufficient to meet our cash requirements for the next twelve months. If for any reason these sources of funds are not sufficient to meet our requirements, we may be required to raise additional funds. We cannot guarantee that we would be able to obtain additional financing or, if available, that it would be available to us on acceptable terms. Should that happen, there could be a significant adverse impact on our operations.

27

Table of Contents

Index to Financial Statements

Contractual Obligations

The following represent our known contractual obligations as of August 31, 2003 (in thousands):

Stock Options

(a) Stock Option Program Description

Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented personnel and align stockholder and employee interests. We currently have four plans (1999 Plan, 1997 Plan, 1986 Plan and Director Plan) under which we grant stock options to employees, directors and consultants. The options generally vest at a rate of one forty-eighth each month beginning the first day of the month following the date of grant. The exercise price of each option equals the market price of our stock on the date of grant and each option generally expires ten years after the date of grant. The 1986 Plan expired for future grants according to its terms in November 2002. The Director Plan will expire as well in April 2004. In the near future we plan to grant most options and restricted stock to employees and directors from our 1997 Plan.

We currently account for our option plans under APB 25 and, accordingly, do not recognize compensation expense for options granted to employees and directors. Options granted to consultants are accounted for under SFAS 123 and are valued using the Black-Scholes model. Compensation expense of those options is recognized over the vesting life of the options, which is aligned with the consulting service life.

We also use the 1997 Plan to grant restricted stock. The grants are considered issued stock when granted and certificates are presented to the grantee as vesting occurs. We record unearned compensation, valued using the Black-Scholes model based on the share price on the date of grant, and expense that compensation over the vesting period.

28

Table of Contents

Index to Financial Statements

(b) Distribution and Dilutive Effect of Options

Employee and Executive Option Grants

The following table summarizes the options granted to (a) our employees and (b) our chief executive officer and other four most highly compensated executive officers at August 31, 2003, whose total annual salary and bonus exceeded $100,000 during the fiscal year ended August 31, 2003. This and other information will be reported in our Proxy Statement filed with the Securities and Exchange Commission in connection with our 2004 annual meeting of stockholders. The individuals in category (b) above are referred to in the table below as our Named Executive Officers.

(c) General Option Information

Summary of Option Activity

The following is a summary of stock option activity for the fiscal years ended August 31, 2003 and 2002:

29

Table of Contents

Index to Financial Statements

In-the-Money and Out-of-the-Money Option Information

The following table compares the number of shares subject to option grants with exercise prices below the closing price of our common stock at August 31, 2003 (referred to as “In-the-Money”) with the number of shares subject to option grants with exercise prices equal to or greater than the closing price of our common stock at August 31, 2003 (referred to as “Out-of-the-Money”). The closing price of our common stock at August 31, 2003 was $7.50 per share.

(d) Executive Options

Options Granted to Named Executive Officers

The following table sets forth a summary of the stock options granted to our Named Executive Officers during the fiscal year ended August 31, 2003. Named Executive Officers are those executive officers described in the table above under the heading “Employee and Executive Option Grants”. The following table does not contemplate status of granted options relative to our current stock price.

30

Table of Contents

Index to Financial Statements

The percentage of total options granted to employees is based on an aggregate of 338,500 options granted to our employees, consultants and directors during the year ended August 31, 2003, including our Named Executive Officers. The exercise price per share of each option is equal to the fair market value of the common stock on the date of grant.

The potential realizable value is calculated based on the term of the option at its time of grant (ten years). It is calculated by assuming that the stock price on the date of grant appreciates at the indicated annual rate compounded annually for the entire term of the option, and that the option is exercised and sold on the last day of its term for the appreciated stock price. No gain to the optionee is possible unless the stock price increases over the option term, which will benefit the stockholder.

Options Exercises and Remaining Holdings of Named Executive Officers

The following table sets forth information concerning stock options exercised during the fiscal year ended August 31, 2003 and the number of shares of our common stock subject to both exercisable and unexercisable stock options as of August 31, 2003 for each of our Named Executive Officers described in the table above under the heading “Employee Executive Option Grants”. The value of unexercised in-the-money options is based on the fair market value of our common stock as of August 31, 2003, of $7.50 per share, minus the exercise price, multiplied by the number of shares underlying the option.