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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

OR

For the transition period from              to             

Commission file number 0-02287

SYMMETRICOM, INC.

(Exact name of registrant as specified in our charter)

2300 Orchard Parkway, San Jose, California 95131-1017

(Address of principal executive offices)

Registrant’s telephone number: (408) 433-0910

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

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

SYMMETRICOM, INC.

FORM 10-Q

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SYMMETRICOM, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(Unaudited)

See notes to the consolidated financial statements.

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SYMMETRICOM, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See notes to the consolidated financial statements.

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SYMMETRICOM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See notes to the consolidated financial statements.

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SYMMETRICOM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The consolidated financial statements included herein are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of the management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Symmetricom’s Annual Report on Form 10-K for the year ended June 30, 2004. The results of operations for the three months ended September 30, 2004 are not necessarily indicative of the results to be anticipated for the entire fiscal year ending June 30, 2005.

The consolidated balance sheet at June 30, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Note 2. Summary of Significant Accounting Policies

Fiscal Period

Symmetricom’s fiscal period ends on the Sunday closest to month end. For ease of presentation, all periods are presented as if they ended on month end. All references to the quarter refer to Symmetricom’s fiscal quarter. Our fiscal quarter, covered by this report ended on October 3, 2004.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, our price is fixed or determinable and collectibility is reasonably assured. Our standard arrangement for our domestic and international customers includes a signed purchase order or contract and no right of return of delivered products.

We assess collectibility based on the creditworthiness of the customer and past transaction history. We perform on-going credit evaluations of our customers and do not require collateral from our customers. For many of our international customers, we require an irrevocable letter of credit to be issued for the account of the customer before the purchase order is accepted. If we determine that collection of a fee is not reasonably assured, we recognize the revenue at the time that collection becomes reasonably assured, which is generally upon the receipt of cash. We commonly have transactions that involve sales of both product and services to our customers. Product revenue is generated from the sale of synchronization and timing equipment with embedded software that is essential to product functionality. We account for these transactions in accordance with the rules applicable to software revenue recognition. Service revenue is recognized as the services are performed, provided collection of the related receivable is probable. Our sales to distributors are made under agreements allowing for returns or credits under certain circumstances. Accordingly, we defer an estimate of returns from distributors based on a historical average of distributor returns. We record commission expense when orders are shipped, at which time the commission is both earned and payable.

Revenue from contracts that require development and manufacture in accordance with customer specifications and have a lengthy development period is recognized under the percentage of completion method of accounting. Under this method, revenue recognition is principally based upon the costs incurred relative to the total estimated costs to complete the individual contracts. Revenue from long-term contracts is reviewed periodically, with adjustments recorded in the period in which the revisions are made. A contract is determined to be substantially complete when the physical deliverables are completed, shipped and accepted. Unbilled receivables totaled $1.8 million as of September 30, 2004, of which $1.4 million is expected to be collected by the end of fiscal 2005 and the remainder in subsequent years. Any anticipated losses on contracts are fully charged to operations as soon as they are determinable.

Use of Estimates

The preparation of financial statements is in conformity with the generally accepted accounting principles in the United States of America. This requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates include allowances for doubtful accounts receivable, valuation of goodwill and intangible assets, and valuation of deferred tax assets.

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Stock-Based Compensation

We account for employee stock-based compensation using the intrinsic-value-based method of accounting as defined under Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” and its related interpretations. Accordingly, we recognize no compensation expense in our consolidated statements of operations with respect to options awarded to our employees with exercise prices greater than or equal to the fair value of the underlying common stock at the date of grant. However, we recognize compensation expense in our consolidated statements of operations with respect to restricted stock awarded to our employees. The following table illustrates the effect on net earnings (loss) and earnings (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123 “Accounting for Stock-Based Compensation” to stock-based employee compensation.

The weighted average estimated fair value of options granted was $4.87 per share in the first quarter of fiscal 2005 and $3.38 per share in the corresponding quarter of fiscal 2004. Our calculations were made using the Black-Scholes option-pricing model. The fair value of Symmetricom’s stock-based awards to employees was estimated assuming no expected dividend and the following weighted-average assumptions for the first quarter of fiscal 2005 and 2004, respectively: expected volatility of 81.1% and 84.7%, risk-free interest rate of 3.2% and 2.6% and expected life after vesting of 2.4 years and 1.7 years.

Note 3. Discontinued Operations

In June 2003, we discontinued the operation of the Trusted Time Division as part of our post-acquisition consolidation process. The division was acquired as part of the acquisition of Datum in October 2002. The division has been accounted for as a discontinued operation and, accordingly, the results of operations have been excluded from continuing operations in the consolidated statements of operations. During the three months ended September 30, 2004, we did not recognize any gain or loss from the discontinued operation.

Note 4. Integration and restructuring charges

In connection with the acquisitions of Datum and TrueTime in fiscal 2003, we initiated an integration plan to consolidate and restructure certain functions of the pre-acquisition Datum and TrueTime operations. During fiscal 2004, a majority of our manufacturing operations were consolidated into our facility in Aguadilla, Puerto Rico and we integrated our Irvine, California manufacturing into our Beverly, Massachusetts facility. Internally, we have consolidated the Broadband Networking Division, which is now part of our Wireless /OEM Products segment, into the Telecom Solutions Division and discontinued the Trusted Time Division. Related to the acquisitions, we accrued approximately $8.3 million of restructuring costs in connection with loss on several facility leases and employee terminations. These costs have been recognized as a liability assumed in the purchase business combination in accordance with Emerging Issues Task Force (EITF) Issue No. 95-3 “Recognition of Liabilities in Connection with Purchase Business Combinations” and reflected as an increase to goodwill. In addition, we expensed $1.2 million for additional lease loss accrual during the fourth quarter of fiscal 2003.

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The facilities accruals from the integration plan represent the lease loss accruals for the Toledo Way facility in Irvine, California, the Westwind Boulevard facility in Santa Rosa, California and the Via Del Oro facility in San Jose, California. These accruals are presented net of expected sublease income. The employee terminations were for personnel from manufacturing, engineering, sales, marketing and administration from the Datum and TrueTime sites in Beverly, Massachusetts; Austin, Texas; Santa Rosa, California and Irvine, California.

As of September 30, 2004, all of the accrued severance expenses from the integration plan have been paid out. The balance of the $1.4 million lease loss accrual as of September 30, 2004 will be paid over the next seven years.

During fiscal 2004, we had a restructuring plan to reduce headcount primarily in the Telecom Solution Division and to exit our Parker facility in Irvine, California; the Lindbergh Avenue facility in Livermore, California and the Brighton facility in the United Kingdom. The balance of $293,000 lease loss accrual and $15,000 severance accrual as of September 30, 2004 will be substantially paid out by the end of fiscal 2005.

During the first quarter of fiscal 2005, we did not have any integration and restructuring charges. During the corresponding quarter of fiscal 2004, we recorded integration and restructuring charges of $0.8 million in acquisition-related costs, $0.5 million of which was recorded as cost of sales and the remaining $0.3 million as operating expenses. These include merger related costs incurred for employee travel, consulting services, legal fees and moving expense related to the relocation of the Irvine, California operation to Beverly, Massachusetts and Aguadilla, Puerto Rico.

The following tables show the details of the restructuring cost accruals, which consist of facilities and severance costs, for the three-month period ended September 30, 2004 and year ended June 30, 2004. The adjustments are for reclassifications of facility and benefit accruals:

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Note 5. New Accounting Pronouncements

The FASB issued Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities,” in January 2003, and a revised interpretation of FIN 46, or FIN 46R, in December 2003. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The adoption of FIN 46R in the second quarter of fiscal year 2004 did not have an impact on our financial position, results of operations or cash flows.

In December 2003, the Securities Exchange Commission or the SEC issued Staff Accounting Bulletin No. 104, Revenue Recognition, or SAB 104, which codifies, revises and rescinds certain sections of SAB 101, Revenue Recognition in Financial Statements, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The adoption did not have a material effect on our operating results or financial condition.

In March 2004, the EITF reached a final consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”, to provide additional guidance in determining whether investment securities have an impairment which should be considered other-than-temporary. The adoption of Issue 03-01 did not have an effect on our operating results or financial condition.

Note 6. Net Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during the period less unvested shares of restricted common stock. For the three months ended September 30, 2004, the weighted average numbers of common shares outstanding and unvested restricted common stock were 45,055,317 and 282,428 shares, respectively. For the corresponding period ended September 30, 2003, the weighted average numbers of common shares outstanding and unvested shares of restricted common stock were 42,767,274 and 252,428 shares, respectively.

Diluted earnings (loss) per share is calculated by dividing net earnings (loss) by the weighted average number of common shares outstanding and common equivalent shares from dilutive stock options, warrants and unvested restricted stock using the treasury method, except when anti-dilutive. During the three-month period ended September 30, 2004, diluted net earnings per share included 1,413,274 weighted dilutive common equivalent shares outstanding and excluded 1,222,957 weighted anti-dilutive common equivalent shares outstanding. During the three-month period ended September 30, 2003, diluted net loss per share excluded 6,463,568 weighted common equivalent shares outstanding, as their effect was anti-dilutive. The following table reconciles the number of shares utilized in the earnings (loss) per share calculations.

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Note 7. Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories consist of:

Note 8. Goodwill and Other Intangible Assets

There are no changes in the carrying value of goodwill for the three months ended September 30, 2004. Other intangible assets are recorded at cost, less accumulated amortization. Other intangible assets as of September 30, 2004 consist of:

The estimated future amortization expense is as follows:

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Note 9. Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of two components: net earnings (loss) and other comprehensive income (loss). Other comprehensive income (loss) refers to revenue, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of stockholders’ equity but are excluded from net earnings (loss). Other comprehensive income (loss) is comprised of unrealized gains and losses, net of taxes, on marketable securities categorized as available-for-sale and foreign currency translation adjustments. The components of comprehensive income (loss), net of tax, are as follows:

Note 10. Stock Repurchase Program

During the first quarter of fiscal 2002, the Board of Directors approved the repurchase of our common stock. During the three months ended September 30, 2004, we did not repurchase any shares. As of September 30, 2004, we have the authorization to repurchase an additional 0.7 million shares of common stock.

Note 11. Long-term Obligations

In connection with the Datum acquisition, we assumed Datum’s liability relating to the $2.7 million industrial development bond that was issued by the Massachusetts Development Finance Agency on June 1, 2001, to finance the expansion by Datum of its manufacturing facility in Beverly, Massachusetts. The bond matures on May 1, 2021. Interest on the bond is payable monthly at an adjustable rate of interest as determined by the remarketing agent for each rate period to be the lowest rate which in its judgment would permit the sale of the bonds at par. The bond is collateralized by a $2.7 million letter of credit issued under our credit facility with Wells Fargo Bank.

Long-term obligations consist of:

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Note 12. Contingencies

In late 1996, Datum (which we acquired in October 2002) received notice of potential environmental contamination from the owner of a premises in Austin, Texas that had previously been occupied by Austron, Inc., a Datum subsidiary for its wireline operation (“Austron”), prior to Datum’s acquisition of Austron in 1988. Although Austron had remediated the site pursuant to then-existing environmental regulations in connection with vacating the site in 1983, the applicable environmental regulations were modified after 1983, providing the basis for the property owner’s claim that the soil at the site contains the same contaminants that were the focus of Austron’s previous remediation efforts. In compliance with current law, Datum had established the extent of the site contamination, which extends to adjoining properties owned by third parties. In May 2004, we received a demand from the owner of several adjoining lots for damages, as well as seeking an indemnity for the contamination and a promise to remediate the contamination. The adjacent property owner has not filed suit but, if a suit is filed, we will contest it vigorously. We believe that we will continue to incur monitoring costs for the next several years in connection with the site contamination and may be subject to demands and claims from other adjoining landowners in addition to the claim for remediation discussed above, and the amount of such costs and the extent of the our exposure to such claims cannot be determined at this time. Although there can be no assurance that the costs of remediation efforts, the property owners’ claims or any related governmental action will not singly or in the aggregate have a material adverse effect on our financial condition or results of operations, we do not believe our ultimate aggregate liability will have such an effect. We currently have an accrual of $0.8 million for remediation costs, appraisal fees and other ongoing monitoring costs. This site is currently available for sale.

We are also a party to certain other claims in the normal course of our operations. While the results of these claims cannot be predicted with any certainty, we believe that the final outcome of these matters will not have a material adverse effect on our financial position and results of operations.

Note 13. Business Segment Information

Subsequent to the acquisitions of Datum and TrueTime, we reorganized our structure and we now have a total of five reportable segments. There are four reportable segments within the Telecom Solutions Division: Wireline Products, Wireless/OEM Products, Global Services and Specialty Manufacturing/Other. The fifth reportable segment is the Timing, Test and Measurement Division. Wireline Products consist principally of Digital Clock Distributors, or DCDs, based on quartz, rubidium and Global Positioning System (GPS) technologies. Our Wireline Products provide highly accurate and uninterruptible timing to meet the synchronization requirements of telecommunication networks. Our Wireless/OEM base station timing products are designed to deliver stable timing to cellular/PCS base stations through a GPS receiver to capture cesium-based time signals produced by GPS satellites. Also included in our Wireless/OEM segment are Broadband Networking products, which include GoWide, a product that provides a high-bandwidth solution for medium-sized businesses without access to optical networks, was reported as a segment in prior periods and now is included in Wireless/OEM Products due to changes in the management reporting structure. Through our Global Services division, we offer a broad portfolio of services for our customers around the world. The services we offer include system planning, network audits, network monitoring, maintenance, logistics, and installation. Transmission Products and Contract Manufacturing were reported as segments in prior periods, and are now included in Specialty Manufacturing/Other within the Telecom Solutions Division.

The Timing, Test and Measurement products are precision time and frequency systems that are important to communications systems of wireline, wireless, satellite and computer network technologies, for government, power utilities, aerospace, defense, and enterprise markets.

For each of our segments, we have separate financial information, including gross profit amounts, which are evaluated regularly by management in deciding how to allocate resources and in assessing performance. We do not allocate assets or specific operating expenses to these individual operating segments. Therefore, the segment information reported here includes only net revenue and gross profit.

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Note 14. Warranties

Our standard warranty agreement is one year upon shipment. However, our warranty agreements are contract and component specific and can range to twenty years for selected components. We offer extended warranty contracts to our customers. The extended warranty is offered on products that are less than eight years old. The extended warranty contract is applicable for a maximum of nine years after the expiration of the standard one-year warranty. We accrue for anticipated warranty costs upon shipment. Our warranty reserve is based on the number of installed units, historical analysis of the volume of product returned to us under the warranty program, management’s judgment regarding anticipated rates of warranty claims and associated repair costs. We use the historical data to forecast our anticipated future warranty obligations. This analysis is updated on a quarterly basis.

Changes in our accrued warranty liability during the three-month periods are as follows:

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read together with the consolidated financial statements and related notes included elsewhere in this report.

When used in this discussion, the words “expects,” “anticipates,” “estimates,” “believes,” “plans,” “will,” “intend,” “can” and similar expressions are intended to identify forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as risks relating to general economic conditions in the markets we address and the telecommunications market in general, risks related to the development of our new products and services including our entry into the Broadband Access market and the Professional Services market, the effects of competition and competitive pricing pressure, uncertainties associated with changing intellectual property laws, developments in and expenses related to litigation, increased competition in our markets, inability to obtain sufficient amounts of key components, the rescheduling or cancellations of a key customer order, the loss of a key customer, the effects of new and emerging technologies, the risk that excess inventory may result in write-offs, the risk that unprofitability in future quarters may result in write downs of our deferred tax assets, price erosion and decreased demand, fluctuations in the rate of exchange of foreign currency, changes in our effective tax rate, market acceptance of our new products and services, technological advancements, undetected errors or defects in our products, the risks associated with our international sales, the risks associated with attempting to integrate companies we acquire, and the matters discussed in “Factors That May Affect Results.” These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Overview

Symmetricom is a leading supplier of precise timing standards to industry, telecommunications, government, utilities, research centers and aerospace markets. We supply scientific and business solutions for customers who demand reliable products and engineering expertise in a variety of applications including timing, testing, verification and/or the measurement of a time and frequency-based signal. We are a recognized technology and market leader for rubidium clocks, cesium clocks and hydrogen masers. Our products include timing elements and business broadband access devices for wireline and wireless networks as well as professional services. Our products play an important role in the operation, bandwidth optimization, and quality of service of wireline, wireless and broadband communications networks. Our products enable our customers to increase both performance and efficiency in today’s evolving communications environment.

Symmetricom’s customers include worldwide public network providers, incumbent local exchange carriers (ILECs), public telephone and telegraph companies (PTTs), competitive local exchange carriers (CLECs), other telephone companies, wireless service providers, cable television operators, distributors and systems integrators, internet service providers (ISPs), and communications original equipment manufacturers (OEMs). With the addition of customers from TrueTime and Datum, we have entered into the government, defense and industry sectors.

Discontinued Operations

In June 2003, we discontinued the operation of the Trusted Time Division. The Trusted Time Division was acquired as part of the acquisition of Datum Inc. in October 2002. The division has been accounted for as a discontinued operation and, accordingly, the results of operations have been excluded from continuing operations in the consolidated statements of operations.

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Critical Accounting Policies, Significant Judgments and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure at the date of our financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, intangible assets, income taxes, and warranty obligations. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Symmetricom considers certain accounting policies related to revenue recognition and allowance for doubtful accounts, reserve for warranty, inventory valuation, capitalized acquisition costs, accounting for income taxes, valuation of investments and valuation of intangible assets and goodwill to be critical policies due to the estimates and judgments involved in each.

Business Combinations

We allocated the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as in-process research and development based on their estimated fair values. We engaged an independent third-party appraisal firm to assist us in determining the fair values of the assets acquired and the liabilities assumed. Such valuations require management to make significant estimations and assumptions, especially with respect to intangible assets.

Critical estimates in valuing certain intangible assets include but are not limited to: future expected cash flows from customer contracts, customer lists, distribution agreements, acquired developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimating cash flows from the projects when completed; also the brand awareness and the market position of the acquired products and assumptions about the period of time the brand will continue to be used in the combined company’s product portfolio. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable.

Revenue Recognition

Our standard arrangement for our domestic and international customers includes a signed purchase order or contract and no right of return of delivered products. Revenue from sales of product and software licenses is recognized when: (1) we enter into a legally binding arrangement with a customer; (2) we deliver the products; (3) customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collection is probable. Revenue from post-sale customer support is deferred and recognized ratably over the term of the support contract. Revenue from consulting and training services is recognized as the services are performed.

We assess collectibility based on the creditworthiness of the customer and past transaction history. We perform on-going credit evaluations of our customers and do not require collateral from our customers. For many of our international customers, we require an irrevocable letter of credit to be issued by the customer before the purchase order is accepted. If we determine that collection of a fee is not reasonably assured, we recognize the revenue at the time that collection becomes reasonably assured, which is generally upon the receipt of cash. We commonly have transactions that involve sales of both product and services to our customers. Product revenue is generated from the sale of synchronization and timing equipment with embedded software that is essential to product functionality. We account for these transactions in accordance with the rules applicable to software revenue recognition. Service revenue is recognized as the services are performed, provided collection of the related receivable is probable. Our sales to distributors are made under agreements allowing for returns or credits under certain circumstances. Accordingly, we defer an estimate of returns from distributors based on a historical average of distributor returns. We record commission expense when orders are shipped, at which time the commission is both earned and payable.

Revenue from contracts that require development and manufacture in accordance with customer specifications and have a lengthy development period is recognized under the percentage of completion method of accounting, principally based upon the costs incurred relative to the total estimated costs to complete the individual contracts. Revenue from long-term contracts is reviewed periodically, with adjustments recorded in the period in which any revisions are made. Any anticipated losses on contracts are fully charged to operations as soon as they are determinable.

Warranty Reserve

Our standard warranty agreement is one year upon shipment. However, our warranty agreements are contract and component specific and can range to twenty years for selected components. We accrue for anticipated warranty costs upon shipment. Our warranty reserve is based on the number of installed units, historical analysis of the volume of product returned to us under the warranty program, management’s judgment regarding anticipated rates of warranty claims and associated repair costs. We use the historical data to forecast our anticipated future warranty obligations. This analysis is updated on a quarterly basis. We offer extended warranty contracts on products that are less than eight years old. The extended warranty contract is applicable for a maximum of nine years after the expiration of the standard one-year warranty.

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Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts based on a periodic review of customer accounts, payment patterns and specific collection issues. Where specific collection issues are identified, we record a specific allowance based on the amount that we believe will be uncollected. For accounts where specific collection issues are not identified, we record a reserve based on the age of the receivable and historical collection patterns.

Valuation of Inventory

Inventories are valued at the lower of cost or market, cost being determined on a first-in, first-out basis. We assess the valuation of all inventories, including raw materials, work-in-process, finished goods and spare parts on a periodic basis. Obsolete inventory or inventory in excess of management’s estimated usage is written down to its estimated market value less costs to sell, if less than its cost. Inherent in the estimates of market value are management’s estimates related to current economic trends, future demand, and technological obsolescence. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. If the inventory value is written down to its net realizable value, and subsequently there is an increased demand for the inventory at a higher value, the increased value of the inventory is not realized until the inventory is sold.

Valuation of Intangible Assets and Goodwill

We periodically evaluate our intangible assets and goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our annual assessment date is June 30. Intangible assets include goodwill, purchased technology, trademarks, and other. Factors we consider important that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, or significant negative industry or economic trends. If these criteria indicate that the value of the intangible asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset over its remaining useful life is made. If this evaluation indicates that the intangible asset is not recoverable, the net carrying value of the related intangible asset will be reduced to fair value, and the remaining amortization period may be adjusted. Any such impairment charge could be significant and could have a material adverse effect on our reported financial statements if and when an impairment charge is recorded. If an impairment charge is recognized, the amortization related to intangible assets would decrease during the remainder of the fiscal year. Based on these evaluations, no impairment losses were recorded during the first quarter of fiscal 2005 and the corresponding quarter in fiscal 2004.

Accounting for Income Taxes

The determination of our tax provision is subject to judgments and estimates due to our operations outside the United States, primarily in Puerto Rico. Net earnings of our Puerto Rico subsidiary are taxed under Internal Revenue Code Section 936, which exempts qualified Puerto Rico earnings from federal income tax. Section 936 limits the amount of qualified Puerto Rico earnings and expires at the end of fiscal year 2006. The change in tax law may affect our future tax rate.

The carrying value of our net deferred tax assets, which are made up primarily of tax deductions and net operating loss carryforwards, assumes we will be able to generate sufficient future income to fully realize these deferred tax assets. We evaluate the weight of all available evidence in determining whether it is more likely than not that some portion of the deferred tax assets will not be realized. If we do not generate sufficient future income, the realization of these deferred tax assets may be impaired, resulting in an additional income tax expense. A portion of our tax credits is related to stock options and has a valuation allowance because of uncertainty regarding realization. If these tax credits are realized, the benefit will be credited to common stock.

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Results of Operations

The following table presents selected items in our consolidated statements of operations as a percentage of total revenues for the three months ended September 30, 2004 and 2003.

Net Revenue:

Net revenue consists of sales of product, software licenses and services. In the first quarter of fiscal 2005, net revenue increased by $13.5 million from $38.5 million in the corresponding quarter of fiscal 2004 to $52.0 million. The increase in net revenue was attributable to a $10.6 million increase in the Telecom Solutions Division primarily from the Wireline Products and a $2.9 million increase in the Timing, Test and Measurement Division primarily due to increased sales of instrumentation products.

Of the $52.0 million in net revenue for the first quarter of fiscal 2005, $38.2 million was from our Telecom Solutions Division, which was made up of $23.1 million from our wireline products, $9.4 million from our Wireless/OEM products, $2.4 million from global services and $3.2 million from Specialty Manufacturing, and the remaining revenue of $13.8 million was from the Timing, Test and Measurement Division. For the corresponding quarter of fiscal 2004, $27.5 million was from the Telecom Solutions Division, which was made up of $17.3 million from our wireline products, $7.0 million from our Wireless/OEM products, $2.1 million from global services, $1.1 million from Specialty Manufacturing, and the remaining revenue of $10.9 million was from the Timing, Test and Measurement Division.

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Gross Profit:

Gross profit as a percentage of net revenue was 44.9% in the first quarter of fiscal 2005 compared to 35.9% in the corresponding quarter of fiscal 2004. Of the 9.0% increase in gross profit, 7.2% was attributable primarily to the cost improvements as a result of the completion of the acquisitions and related synergies, impact of higher sales volume on manufacturing costs and selling price increases on older products effective in the fourth quarter of fiscal 2004.

Operating Expenses:

Research and development:

Research and development expenses consist primarily of salaries and benefits, prototype expenses and fees paid to outside consultants. Research and development expenses were $4.1 million during the first quarter of fiscal 2005 compared to $4.8 million for the corresponding quarter of fiscal 2004. The overall decrease in the research and development expense was primarily due to the reduction in force after the acquisition of TrueTime and Datum.

We expect to continue to support research and development efforts in order to enhance existing products and to design and develop new technologies and products.

Selling, general and administrative, including amortization of intangible assets:

Selling, general and administrative expense, including the amortization of intangibles, consists primarily of salaries, benefits, sales commissions and travel related expenses for our sales and services, finance, human resources, information technology and facilities departments and part of the amortization expenses of our intangible assets. These expenses increased 14.4% to $13.3 million for the first quarter of fiscal 2005 compared to $11.7 million for the corresponding quarter of fiscal 2004. The increase in selling, general and administrative expenses was attributable primarily to salary increases effective July 2004, recruiting fees and salary expenses for three newly-hired senior sales and marketing executives and compensation expense for anticipated accelerated vesting of restricted stock to employees.

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Integration and restructuring charges:

During the first quarter of fiscal 2005, we did not record any integration and restructuring charges. During the corresponding quarter of fiscal 2004, we recorded integration and restructuring charges of $0.3 million primarily for product-line consolidation after the acquisition of TrueTime and Datum.

Interest Income:

Interest income increased to $145,000 during the first quarter of fiscal 2005 compared to $74,000 during the corresponding quarter of fiscal 2004 due to a higher cash investments balance and higher average interest rates.

Interest Expense:

Interest expense consists primarily of interest on our bond payable and the capital lease for our headquarters building in San Jose, California. Interest expense remained fairly consistent at $0.1 million and at $0.2 million in the first quarter of fiscal 2005 and fiscal 2004.

Income Taxes:

Our income tax provision from continuing operations was $1.4 million in the first quarter of fiscal 2005, compared to a tax benefit of $0.8 million in the corresponding quarter of fiscal 2004. Our effective tax rate (our income tax benefit as a percentage of our pre-tax loss) for the first three months of fiscal 2005 was 23.4% compared to an annual rate of 48.5% for fiscal 2004. Our fiscal 2005 effective tax rate is also affected by the percentage of qualified Puerto Rico earnings compared to total earnings, because most of our Puerto Rico earnings is taxed under Section 936 of the U.S. Internal Revenue Code, which exempts qualified Puerto Rico earnings from regular federal income taxes. The federal 936 exemption is subject to various limitations and is scheduled to expire at the end of fiscal 2006.

As a result of the factors discussed above, we had net earnings of $4.5 million, or $0.10 per share, in the first quarter of fiscal 2005 compared to a net loss of $2.3 million, or $0.05 per share, during the corresponding quarter of fiscal 2004.

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Key Operating Metrics:

Key operating metrics for measuring our performance include sales backlog, contract revenue, headcount and deferred revenue. These metrics, which compare as of the end of the first quarter of fiscal 2005 with the end of the fiscal 2004, are listed below.

Sales Backlog:

Our backlog consists of firm orders that have yet to be shipped to the customer, or may not be shippable to a customer until a future period. Most orders included in backlog can be rescheduled or canceled by customers without significant penalty. Historically, a substantial portion of net sales in any fiscal period has been derived from orders received during that fiscal period. Our total backlog amounted to $39.6 million as of September 30, 2004, compared to $41.8 million as of June 30, 2004. Our backlog which is shippable within the next six months was $27.5 million as of September 30, 2004, compared to $27.9 million as of June 30, 2004.

Contract Revenue:

Revenue from contracts that require development and manufacture in accordance with customer specifications and have a lengthy development period is recognized under the percentage of completion method of accounting, principally based upon the costs incurred relative to the total estimated costs to complete the individual contracts. Revenue from long-term contracts is reviewed periodically, with adjustments recorded in the period in which the revisions are made. Any anticipated losses on contracts are fully charged to operations as soon as they are determinable. As of September 30, 2004, we have approximately $3.1 million in contract revenue to be performed and recognized within the next 36 months, compared to approximately $3.4 million in contract revenue that was to be performed and recognized within the following 36 months as of June 30, 2004. These amounts have been accounted for as part of our sales backlog discussed above.

Headcount:

Our consolidated headcount as of September 30, 2004 consisted of 754 regular employees and 130 temporary employees, compared to 754 regular employees and 125 temporary employees as of June 30, 2004.