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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE PERIOD ENDED September 30, 2004

OR

FOR THE PERIOD From              to             .

Commission file number 000-31223

PEMSTAR INC.

(Exact name of registrant as specified in its charter)

3535 TECHNOLOGY DRIVE N.W.

ROCHESTER, MN 55901

(Address of principal executive officers)

(Zip Code)

(507) 288-6720

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods 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 Exchange Act).

    Yes  x    No  ¨

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

Common Stock, $0.01 Par Value — 45,152,579 shares as of October 31, 2004.

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Index

Pemstar Inc.

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Part I. Financial Information

Pemstar Inc.

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

See notes to consolidated financial statements.

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Pemstar Inc.

Consolidated Statements of Operations (Unaudited)

(In thousands, except per share data)

See notes to consolidated financial statements.

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Pemstar Inc.

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

See notes to consolidated financial statements.

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Pemstar Inc.

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2004

(Dollars and share amounts in thousands, except per share data)

Note A—Basis of Presentation and Accounting Policies

The accompanying unaudited condensed consolidated financial statements of Pemstar Inc. (the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending March 31, 2005.

The balance sheet at March 31, 2004 has been derived from the restated 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.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Pemstar Inc. Annual Report on Form 10-K for the year ended March 31, 2004, as amended, filed with the Securities and Exchange Commission.

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Stock-Based Compensation

During the three and six months ended September 30, 2004, employees exercised stock options to acquire 6 and 16 shares at an average exercise price of $0.75 and $1.01 per share, respectively.

The Company has adopted the pro forma disclosure only requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”, and accordingly, accounts for stock options issued to employees using the intrinsic value method of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.” Compensation expense is recorded on the date stock options are granted only if the current fair market value of the underlying stock exceeds the exercise price of the option. Accordingly, no compensation cost has been recognized for grants under these stock option plans since the exercise price equaled the fair market value of the stock on the date of grant. Had compensation cost for stock option grants been based on the grant date fair values of awards (the method described in SFAS No. 123), reported net loss would have been changed to the pro forma amounts reported below. The additional compensation expense, net of tax for the three and six months ended September 30, 2003 has been restated to reflect a full valuation allowance against the deferred tax benefit of the pro forma deduction. The additional compensation expense, net of tax was previously disclosed as $433 and $1,218 for the three and six months ended September 30, 2003, respectively.

Recently Issued Accounting Pronouncements

Accounting for Share-Based Payment

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123 (revised 2004), Share-Based Payment. This Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement requires that the compensation cost relating to share-based payment transactions be measured on the fair value of the equity or liability instruments issued. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement is effective in the first interim or annual reporting period that begins after June 15, 2005. Management believes adoption of the pronouncement will have a significant impact due to the Company’s use of stock options as employee incentives but has not yet determined the impact on earnings.

Accounting for Inventory Costs

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS 151, Inventory Costs—an amendment of ARB No. 43, Chapter 4. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. . . .” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not believe the adoption of this Statement will have any immediate material impact on the Company.

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Note B—Inventories

The components of inventories consist of the following:

Note C—Other Income and Comprehensive Loss

Other income for the six months ended September 30, 2004 includes gains on the sale of property, plant and equipment of $1,575, consisting principally from sales of real estate at the Company’s headquarters facility during the first quarter of fiscal 2005.

Total comprehensive loss was $6,002 and $6,652 for the three months ended September 30, 2004 and 2003, respectively, and $6,104 and $18,012 for the six months ended September 30, 2004 and 2003, respectively. Comprehensive loss differs from net loss due to foreign currency translation gains and losses.

Note D—Financing Arrangements

At September 30, 2004, the Company had available borrowing capacity under its domestic revolving credit facilities of $25.6 million in excess of outstanding borrowings under the facility. In April 2004, the Company entered into financing agreements with Krung Thai Bank Public Company limited, which provide various term and revolving credit loans for up to $26,600. Within these facilities, $19,370 was borrowed in the six months ended September 30, 2004, with $4,951 of the proceeds used to pay off outstanding notes payable with the predecessor institution.

In October 2004, the Company entered a revolving credit arrangement with ABN AMRO Bank N.V. to provide borrowing capacity for its European business requirements. The facility provides for up to Euro 5 million of borrowings, secured by accounts receivable and inventories of the Company’s Netherlands operation and bears interest at Euro Rate plus .9% (effective rate of 2.1% at September 30, 2004). The agreement requires maintenance of minimum tangible net worth and debt to equity ratios.

In October 2004, the term of the domestic revolving credit facilities was extended by one year, concurrent with a .75% reduction in interest rate and a reduction of the minimum cash flow level. The minimum cash flow level is required only in the event that sufficient liquidity, measured by amounts available to borrow for the current collateral base less amounts actually borrowed, is not maintained.

Note E—Earnings Per Share Data

Common stock equivalents and their impact on net loss have been excluded from the diluted per share calculation for all periods presented, since the Company incurred net losses and the inclusion of common stock equivalents would have had an anti-dilutive impact. Potentially dilutive securities, which have been excluded, consist of i) unexercised stock options and warrants to purchase 6,052 and 6,135 shares of the Company’s Common Stock as of September 30, 2004 and 2003, respectively, and ii) 2,193 shares of the Company’s Common Stock issuable upon conversion of convertible debt as of September 30, 2004 and 2003.

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Note F—Restructuring and Impairment Charges

A rollforward of restructuring provisions is as follows:

During fiscal 2003, the Company incurred restructuring costs of $4,249. Of this, $1,037 of lease continuation costs, related to the decision to consolidate separate manufacturing facilities in San Jose, California, into a single facility, which decision resulted from the prolonged under utilization of capacity across the two sites. As a result of this consolidation the Company incurred accelerated amortization of leasehold improvements of $773, as well. Additionally, $2,439 of severance costs were incurred, primarily in The Netherlands and in the United States’ locations, responding to reductions in local business requirements.

During fiscal 2004, the Company recorded charges of $6,737 for restructuring related costs as a result of a Company initiative based upon a strategic review of the Company’s primary products and business aimed at optimizing and aligning its manufacturing capacity with customer demand, while positioning the Company for stronger operating results. The charges consisted of $1,066 for employee termination and severance costs related to approximately 100 salaried and hourly employees located primarily at three domestic operating sites and $5,671 for adjustment of expected future lease costs, associated with the closing of one California facility in fiscal 2003 and one additional California facility in fiscal 2004. In connection with this consolidation the Company incurred asset write-downs of $1,224 for machinery and equipment to the Company’s fair value assessment. The fiscal 2004 restructuring actions taken pertain to operations for those businesses and locations experiencing negligible or negative growth due to continued market declines in the Communications and Optical business sectors. Certain machinery and equipment were written down to their estimated fair values as a direct result of the continued decline in the optical business sector, which has resulted in excess capacity and under-utilized machinery and equipment.

During fiscal 2005, the Company recorded charges of $390 for restructuring related personnel costs, responding to the reduction in local business requirements of our Mexico operations and centralization of business process for Midwest domestic sites. These charges were for employee termination and severance costs related to 103 salaried and hourly employees in Mexico and 30 primarily salaried support personnel in the West Coast and Midwest domestic sites.

As of September 30, 2004, approximately $4,185, $3,385 and $190 of cash payments had been made against the accrual associated with the fiscal 2003, 2004, and 2005 charges, respectively.

Reserve balances of $879, $722 and $729 are included in accrued expenses and other and $0, $3,355 and $2,278 are included in other liabilities and deferred credits at March 31, 2003, March 31, 2004 and September 30, 2004. The Company does not expect to record any additional expense from these restructuring activities and the impact on future cash flows is expected to be $3,007.

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Note G—Liquidity

The domestic revolving credit facilities were replaced during fiscal 2004 to provide expanded capacity for funding business growth and to extend arrangements approaching the expiration of their term. In the event that the Company does not maintain sufficient liquidity, measured by amounts available to borrow for the current collateral base less amounts actually borrowed, these facilities require the maintenance of certain minimum cash flow levels. These minimum cash flow levels were reduced during fiscal 2005 with the amendment to the facility agreement and the extension of the agreement. The Company’s operating plan includes an expectation of maintaining this liquidity, as well as initiatives to reduce specific cash expenditures related to general and administrative expenses.

Maintaining liquidity within its domestic credit facility is dependent upon the Company achieving certain cash flow objectives. The Company expects to meet its cash flow requirements through the term of the lending agreement. The Company also believes that, if necessary, it would be able to secure additional financing from its lenders or sell additional Company equity securities; however, there can be no assurance that such funding can be obtained or that future credit facility violations will be waived.

During fiscal 2004 and 2005, the Company obtained significant funding locally for its foreign operations and has obtained commitments for further increases to suit business requirements. As such, it has become substantially less reliant on domestic lines of credit for needs outside of domestic operations.

Management believes that, as a result of the restructuring actions it has taken to reduce cash expenditures, the efforts it continues to make to increase revenues from continuing customers and to generate new customers in various industry sectors and the new agreements it has reached to provide additional borrowing capacity, it will meet the liquidity requirements of its lending agreements. However, there can be no assurance that the financial plan will be met.

Note H—Contingencies

We are currently a defendant, along with several current and former officers and directors, in a consolidated putative class action captioned in re PEMSTAR Securities Litigation, alleging violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Sections 11 and 12 of the Securities Act of 1933. The lawsuit is a consolidation of several lawsuits, the first of which was commenced in United States District Court for the District of Minnesota on July 24, 2002. The plaintiffs, several individual shareholders, allege, in essence, that the defendants defrauded our shareholders by making optimistic statements during a time when they should have known that business prospects were less promising and allege that the registration statement filed by us in connection with a secondary offering contained false, material misrepresentations. An Amended Consolidated Complaint was filed January 9, 2003. The securities class action is pending and discovery is ongoing. On August 23, 2002 and October 2, 2002 two different individual shareholders also commenced virtually identical shareholder derivative actions against us as nominal defendant and our Board. Those actions have been consolidated and are currently pending in United States District Court for the District of Minnesota, Third Judicial District, County of Olmsted. The allegations in the consolidated derivative action are based on many of the same facts that gave rise to the securities action. The derivative action alleges that our Board breached its fiduciary duties by allegedly allowing the violations of the securities to occur.

It is too early to predict the likelihood of prevailing on the various lawsuits described above. We believe the securities action is wholly without merit and we have moved to dismiss the derivative action based on the plaintiffs’ failure to make a demand that the Board consider the merits of the claims in that action. We are vigorously defending against both of these claims.

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

Results of Operations

Net sales - Net sales for the second quarter of fiscal 2005 increased 10.5% to $166.4 million from $150.6 million for the comparable three months of the prior fiscal year. These amounts include proceeds from the return of excess inventory to customers under the terms of the sales contracts of $4.1 million and $3.9 million, respectively. Under the terms of the contracts with the customers, inventory returns are priced at cost of those materials, which therefore serves to reduce the gross margin apparent from total net sales. The increase in net sales was due to the expansion of the Company’s industrial equipment manufacturing operations. Specifically, industrial sales were up $28.4 million, offset by a decrease in sales of $6.0 million to our communications customers, $5.3 million in our computing and data storage business and $1.2 million to medical customers. The majority of the sales gains in the industrial business were sales to existing and new customers in the semiconductor capital equipment industry. Sales to communications customers declined due to product transitions in wireless handsets and continued soft demand in system infrastructure business. Computing and data storages sales declined resulting from the phase out of unprofitable business with certain customers in the computing peripheral market. Net sales for the six months ended September 30, 2004 increased 22.6% to $363.1 million compared to $296.1 million for the same period last year. These totals include sales of excess inventory of $7.4 million and $4.9 million for first half of fiscal 2005 and fiscal 2004, respectively. Again, the majority of the six-month sales growth was due to increased industrial sales. The Company’s five largest customers in the second quarter and first half of fiscal 2005 accounted for approximately 46.4% and 47.7%, respectively. Customers comprising greater than 10% of net sales in the second quarter of fiscal 2005 included IBM at 21.9% of net sales and Applied Materials at 12.6% of net sales.

Gross profit - Gross profit increased $0.7 million in the second quarter of fiscal 2005 to $12.0 million (7.2% of net sales) from $11.2 million (7.5% of net sales) in the same quarter of fiscal 2004. Slightly higher gross

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profit stemmed primarily from the strong higher margin industrial sales with increased gross profit of $0.8 million, offset by $0.4 million of gross profit from lower product development sales and inventory write-offs of $1.0 million associated with the phase out of unprofitable customers. Gross profit increased $11.5 million during the first six months of fiscal 2005 to $28.1 million (7.7% of sales) from $16.6 million (5.6% of sales) in the same period of fiscal 2004. Higher gross profit in the six-month period resulted from higher industrial sales with increased gross profit of $6.9 million, and improved performance in our communications, medical and computing and data storage business with increased gross profit of $3.8, $0.5 and $0.3 million respectively. This fiscal 2005 first half improvement in gross profit includes cost savings estimated at $3.6 million from prior fiscal year restructuring actions offset by $1.2 million of first half inventory write-offs from customer losses, of which $0.7 million was in our computing and data storage business. We incurred inventory write-downs primarily as a result of a customer bankruptcy and the phase out of unprofitable business, which compares to no significant write-downs of inventory during the first half of fiscal 2004.

Selling, general and administrative expenses - Selling, general and administrative expenses were $15.5 million (9.3% of net sales) in the second quarter of fiscal 2005, an increase of $3.4 million from $12.1 million (8.0% of net sales) for the same quarter of fiscal 2004. Selling, general and administrative expenses were $30.3 million (8.3% of sales) during the first six months of fiscal 2005, an increase of $5.7 million from $24.6 million (8.3% of sales) for the same period of fiscal 2004. The increase during the six-month period ended September 30, 2004, was the result of expanded infrastructure expenses in Asia of $1.7 million, increased bad debt expense, staffing our corporate industry organization of $1.2 million, new expenses associated with the Austin, Texas operations of $0.7 million, increased depreciation expense incurred due to worldwide IT implementations of $0.3 million, and increased sales commissions associated with higher sales of $0.2 million We incurred bad debt expense of $1.6 million for the first half of fiscal 2005 primarily as a result of a customer bankruptcy and customers experiencing financial difficulty, which compares to no significant write-downs of bad debt expense during the first half of fiscal 2004.

Restructuring costs - Restructuring costs of $0.4 million, consisting of employee termination and severance costs, were recognized in the second quarter of fiscal 2005 compared to $4.7 million, consisting of $4.6 million for future lease costs and $0.1 million for employee termination and severance costs for the second quarter of fiscal 2004. Such costs were reduced from the $8.2 million recorded for the six months ended September 30, 2003, which consisted of $.8 million of employee termination and severance costs, $6.0 million of future lease costs and $1.4 million for write downs of machinery and equipment, primarily related to closure of California facilities and personnel reductions there and in other domestic sites.

Interest expense - Our interest expense for the three and six months ended September 30 was virtually unchanged at $2.0 and $4.1 million for fiscal 2005 compared to $2.1 and $4.2 million for fiscal 2004.

Other expense (income) - Other expense (income) net was $0.3 million expense for the second quarter of fiscal 2005 compared to ($0.4) million income for the second quarter of fiscal 2004. The change consists primarily of exchange losses in certain international operations in fiscal 2005. Other expense (income) net was ($1.2) million income, compared to ($0.7) million income for the six months ended September 30, 2004 and September 30, 2003 respectively. The increase in other income for fiscal 2005 included gain from the sale of surplus real estate at the Company’s headquarters facility offset partially by exchange losses in certain international operations in fiscal 2005.

Income tax (benefit) expense - Income tax (benefit) was ($0.2) million (2.5% effective tax benefit rate) for the second quarter of fiscal 2005, compared to income tax expense of $.2 million (2.7% effective tax rate) for the second quarter of fiscal 2004. For the first half of fiscal 2005, the income tax (benefit) was ($0.1) million (1.0% effective tax benefit rate) compared to income tax expense $0.3 million (1.4% effective tax rate) for the first half of fiscal 2004. The effective rates remain very low, consistent with prior year results, given the current operating loss and the carryforward of prior net operating losses, primarily in the United States, and the inability to recognize the benefit of carryforward losses and the low or zero incentive income tax rates in most profitable foreign operations. The benefits in fiscal 2005 relate to the deferred tax benefits of $0.3 million recorded as our Singapore operations exited the tax free pioneer status period.

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Liquidity and Capital Resources

The Company has historically funded its operations from the proceeds of bank debt, private offerings of debt, private and public offerings of equity, cash generated from operations and lease financing of capital equipment. Our principal uses of cash have been to finance working capital, acquisitions, new operations, capital expenditures and to fulfill debt service requirements. We anticipate these uses will continue to be our principal uses of cash in the future.

As of September 30, 2004, the Company had cash and cash equivalent balances of $18.3 million and total bank, other interest bearing debt and capital lease obligations totaling $107.4 million. Included therein, we had approximately $36.9 million outstanding under our domestic revolving credit facility, $28.4 million outstanding in short-term facilities for our China operation, $18.9 million outstanding under our Thailand credit facility and $5.1 million outstanding under our Singapore credit facility. Each credit facility bears interest on outstanding borrowings at variable interest rates, which as of September 30, 2004 were 5.06% for the domestic revolving credit facility, 1.8% - 5.0% for the China facilities, 2.8% - 3.9% for the Thailand facility and 3.6% for the Singapore facility. In October 2004, the Company expanded its credit network with the addition of a European working capital facility, which makes an additional $6.1 million available. These credit facilities are secured by substantially all of our assets.

The domestic revolving credit facility includes a covenant to attain minimum earnings before interest expense, income taxes, depreciation and amortization (EBITDA), for domestic and worldwide operations. These covenants do not apply however, if we maintain at least $10.0 million in available domestic borrowing capacity. As of September 30, 2004 we had $25.6 million of available domestic borrowing capacity. We are required under certain foreign credit facilities to meet various financial covenants, including minimum location net worth, maximum debt to equity ratios, and minimum location net income, all of which we were in compliance with at September 30, 2004.

Net cash provided by operating activities for the first six months of fiscal 2005 was $4.6 million compared to net cash used of ($13.3) million for the comparable period of the prior fiscal year. Increased net cash from operating activities in fiscal 2005 was attributable primarily to decreased balances in accounts receivable, inventories and prepaid expenses, offset by decreased accounts payable balances.

Net cash (used in) investing activities for the six months ended September 30, 2004 was ($6.0) million compared to net cash used of ($5.5) million for the comparable period of the prior fiscal year. This increase in cash used resulted primarily from the increase in capital expenditures in our Asian operations, offset in part by $2.4 million of proceeds from the sale of surplus real estate at the corporate headquarters and other property, plant and equipment.

Net cash provided by financing activities for the six months ended September 30, 2004 was $10.3 million compared to $3.3 million for the comparable period of the prior fiscal year. Debt borrowings net of repayments were $16.9 million for the first six months of fiscal 2005, compared to ($15.4) million for the comparable prior year period. The repayments in the prior year were made possible with proceeds of $20.1 million from the sale of 7.5 million shares of common stock, pending their expected use to fund working capital and potential acquisitions.

Our ability to maintain sufficient liquidity depends, in part, on our achieving anticipated revenue targets and intended expense reductions from our restructuring activities. We believe that as a result of: i) the restructuring actions taken in fiscal 2004 and further actions completed in fiscal 2005 to reduce cash expenditures, ii) the efforts we continue to make to increase revenues from continuing customers, as well as efforts to generate new customers in various industry sectors, and iii) our new revolving credit facility, which provides additional borrowing capacity, we have sufficient cash flow to meet our needs for the remainder of fiscal 2005. We may not achieve these targets or realize the intended expense reductions. If our operating goals are not met, we may be required to secure additional waivers of any resulting covenant violations under existing lending facilities, secure additional financing from lenders or sell additional securities.

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We regularly review acquisition and additional facilities expansion or joint venture opportunities, as well as major new program opportunities with new or existing customers, any of which may require us to sell additional equity or secure additional financing in order to fund the requirement. The sale of additional equity could result in additional dilution to our shareholders. We cannot be assured that financing arrangements will be available in amounts or on terms acceptable to us.

Recently Issued Accounting Pronouncements

Accounting for Share-Based Payment

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123 (revised 2004), Share-Based Payment. This Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement requires that the compensation cost relating to share-based payment transactions be measured on the fair value of the equity or liability instruments issued. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement is effective in the first interim or annual reporting period that begins after June 15, 2005. Management believes adoption of the pronouncement will have a significant impact due to the Company’s use of stock options as employee incentives but has not yet determined the impact on earnings.

Accounting for Inventory Costs

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS 151, Inventory Costs—an amendment of ARB No. 43, Chapter 4. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. . . .” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not believe the adoption of this Statement will have any immediate material impact on the Company.

CAUTIONARY STATEMENTS

This report contains forward-looking statements within the meaning of federal securities laws that may include statements regarding intent, belief or current expectations of Pemstar Inc. and our management. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information without fear of litigation so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. We desire to take advantage of these “safe harbor” provisions. Accordingly, we hereby identify the following important factors which could cause our actual results to differ materially from any such results which may be projected, forecast, estimated or budgeted by us in forward-looking statements made by us from time to time in reports, proxy statements, registration statements and other written communications, or in oral forward-looking statements made from time to time by our officers and agents. The following list is not exhaustive and we disclaim any obligation to subsequently revise any forward-looking statements to reflect events or circumstances after the date of such statements.

Risks Relating to Our Business and Industry

Failure to maintain an effective system of internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could inhibit our ability to accurately report our financial results and have a material adverse impact on our business and stock price.

Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports our operating results could be harmed. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. We are in the process of documenting and testing our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our Independent Auditors addressing these assessments. During the course of our testing we may identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. Failure to achieve and maintain an effective internal control environment could have a material adverse effect on our stock price.

Reductions in demand and other factors have caused net losses.

The continuing reduction in capital spending by businesses for new technologies, the remaining effects of the recent recession and the market disruptions caused by the September 2001 terrorist attacks in the United States and threats of hostilities in the Middle East and Asia have reduced demand in many of the technology markets we serve. As a result of these market conditions, we experienced a significant reduction in demand for our services during fiscal 2002, continuing through fiscal 2003, which caused us to have net losses of $38.8 million in fiscal 2003. The losses continued into fiscal 2004, totaling $25.3 million by year end. Although the majority of these losses occurred in the first half of fiscal 2004, there is on-going uncertainty in the demand for our services, which may rapidly and significantly fluctuate. A return to the recession, outbreak of hostilities or any other event leading to excess capacity or a continued or increased downturn in the markets we serve would likely negatively affect our net sales. In addition, the communications, computing and data storage, industrial and medical equipment markets of the electronics manufacturing services industry are characterized by intense competition, relatively short product life-cycles and significant fluctuations in product demand. These markets are also subject to rapid technological change and product obsolescence. If any of these factors or other factors reduce demand for specific products or components that we design or manufacture for our customers, our net sales would likely be negatively affected. Due to these market conditions and factors, we may experience net losses in future periods.

We depend on a small number of customers for a significant portion of our net sales and the loss of any of our major customers would harm us.

We depend on a relatively small number of customers for a significant portion of our net sales. Our two largest customers in fiscal 2004 were IBM and Motorola, which represented approximately 30% of our total net sales. In addition, our ten largest customers in fiscal 2004 accounted for approximately 62% of our net sales. We expect to continue to depend upon a relatively small number of customers for a significant percentage of our net sales. Because our major customers represent such a large part of our business, the loss of any of our major customers could negatively impact our business.

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Our major customers may not continue to purchase products and services from us at current levels or at all. In the past, we have lost customers due to the acquisition of our customers, product discontinuation and customers’ shifting production of products to internal facilities. We may lose customers in the future for similar reasons. We may not be able to expand our customer base to make up any sales shortfalls if we lose a major customer. Our attempts to diversify our customer base and reduce our reliance on particular customers may not be successful.

Our business has been adversely affected by reductions or delays in customer orders.

We do not typically obtain firm long-term purchase orders or commitments from our customers. We work closely with our customers to develop forecasts for future orders, but these forecasts are not binding. Customers may cancel their orders, change production quantities from forecast volumes or delay production for a number of reasons beyond our control. Any material delay, cancellation or reduction of orders from our largest customers could cause our net sales to decline significantly and could result in us holding excess inventories of components and materials. In fiscal 2004, these and similar factors caused us to recognize charges for inventory reserves and adjustments of $0.8 million. We may be required to recognize similar charges in future periods.

Many of our costs and operating expenses are relatively fixed. As a result, a reduction in customer demand can decrease our gross profit and adversely affect our business, financial condition and results of operations.

If we are unable to satisfy the financial covenants under our credit facility, our availability may be limited or we may have to obtain alternative sources of financing.

We have historically experienced violations of covenants under our revolving credit facilities and have been required to seek waivers for such violations. If we do not comply with these covenants or if we default on our payment obligations under other debt obligations, our availability under our credit facility could be reduced or our lenders could declare a default under the credit facility. In the event of a default or a substantial reduction of availability, we would be required to obtain alternative financing, which could be more expensive than our current arrangement, be dilutive to existing shareholders and divert management’s time and attention. Moreover, we cannot assure that we would be able to obtain alternative financing on favorable terms and on a timely basis, if at all. Our failure to meet any of our covenants under our credit facility could significantly harm our liquidity and financial position.

We require additional sources of funds for working capital.

Our continued viability depends on our ability to generate additional cash from operations or obtain additional sources of funds for working capital. Our ability to maintain sufficient liquidity depends, in part, on our achieving anticipated revenue targets and intended expense reductions from our restructuring activities. We may not achieve these targets or realize the intended expense reductions. If our operating goals are not met, we will be required to secure additional financing from lenders or sell additional securities. We may not be able to obtain additional capital when we want or need it, and capital may not be available on satisfactory terms. If we issue additional equity securities or convertible debt to raise capital, it may be dilutive to your ownership interest. In addition, any additional capital may have terms and conditions that adversely affect our business, such as financial or operating covenants.

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We have been unable to collect all our accounts receivable.

Falling demand for the products of our technology customers and liquidity difficulties for these companies have forced us to reach accommodations with a portion of our customers and have limited our ability to collect fully our accounts receivable from these customers in fiscal 2002 and 2003. In addition, several significant customers have filed for bankruptcy protection, which limits our recovery of accounts receivable from these customers. In fiscal 2004, these and similar factors caused us to recognize charges for accounts receivable adjustments of $1.0 million. We may be required to recognize similar charges in future periods.

Our acquisition strategy may not succeed.

As part of our business strategy, we have acquired other companies, assets or product lines that complement or expand our existing business. These acquisitions have not been entirely successful, and in the fourth quarter of fiscal 2002, we incurred approximately $24.2 million of goodwill impairment charges related to facilities acquired by us in the past three years. As a result of implementing new accounting pronouncements in fiscal 2003, we recorded an additional goodwill impairment charge of $5.3 million. Although we anticipate seeking further acquisition opportunities, we cannot assure you that we will be able to identify suitable acquisition candidates or finance and complete transactions that we select. We may incorrectly judge the value or worth of an acquired company or business. In addition, its key personnel may decide not to work for us. We may also have difficulty in integrating acquired businesses, products, services and technologies into our operations. These difficulties could disrupt our ongoing business, distract our management and workforce, increase our expenses and adversely affect our operating results. Furthermore, we may incur significant debt or be required to issue equity securities to pay for future acquisitions or investments. The issuance of equity securities could be dilutive to our shareholders. Failure to execute our acquisition strategy may adversely affect our business, financial condition and results of operations.

During periods of significant growth we may have trouble managing our expanded operations.

Rapid growth can place a significant strain on our management, financial resources and on our information, operations and financial systems. We face risks associated with coordinating multinational operations and reporting systems, diverse technologies and multiple products and services. In addition, our growth has increased our expenses and working capital requirements. If we are unable to manage our growth effectively, it may have an adverse effect on our business, financial condition and results of operations. We cannot assure you that we will manage our growth effectively

Our financial condition could suffer if we fail to successfully defend pending lawsuits.

We are currently a defendant, along with several current and former officers and directors, in a consolidated putative class action captioned: In re PEMSTAR Securities Litigation. We and our Board are also defendants in a consolidated shareholder derivative action that is based on many of the same facts that gave rise to the securities class action. For further information about the nature of these actions see Item 3 in our Annual Report on Form 10-K for the year ended March 31, 2004. We believe the securities action is wholly without merit and we have moved to dismiss the derivative action based on the plaintiffs’ failure to make a demand that the Board consider the merits of the claims in that action. Although we are vigorously defending against both of these claims, these actions are in their early stages and we cannot predict their outcomes. If we are not able to successfully defend these actions, our business and financial condition could suffer.

Increased competition may result in decreased demand or prices for our services.

The electronics manufacturing services industry is highly competitive and characterized by low margins. We compete against numerous U.S. and foreign service providers with global operations, as well as

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those who operate on a local or regional basis. In addition, current and prospective customers continually evaluate the merits of manufacturing products internally. Consolidation in the electronics manufacturing services industry results in a continually changing competitive landscape. The consolidation trend in the industry also results in larger and more geographically diverse competitors who have significant combined resources with which to compete against us. Some of our competitors have substantially greater managerial, manufacturing, engineering, technical, financial, systems, sales and marketing resources than we do. These competitors may:

We also may be operating at a cost disadvantage as compared to competitors who have greater direct buying power from component suppliers, distributors and raw material suppliers or who have lower cost structures. Increased competition from existing or potential competitors could result in price reductions, reduced margins or loss of market share.

We anticipate that our net sales and operating results will fluctuate which could affect the price of our common stock.

Our net sales and operating results have fluctuated and may continue to fluctuate significantly from quarter to quarter. A substantial portion of our net sales in any given quarter may depend on obtaining and fulfilling orders for assemblies to be manufactured and shipped in the same quarter in which those orders are received. Further, a significant portion of our net sales in a given quarter may depend on assemblies configured, completed, packaged and shipped in the final weeks of such quarter. Our operating results may fluctuate in the future as a result of many factors, including:

Our operating expenses are based on anticipated revenue levels and a high percentage of our operating expenses are relatively fixed in the short term. As a result, any unanticipated shortfall in revenue in

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a quarter would likely adversely affect our operating results for that quarter. Also, changes in our product assembly mix may cause our margins to fluctuate, which could negatively impact our results of operations for that period. Results in any period should not be considered indicative of the results to be expected in any future period. It is possible that in one or more future periods our results of operations will fail to meet the expectations of securities analysts or investors, and the price of our common stock could decline significantly.

Our predictions of future operating results may not be achieved.

From time to time in earnings releases and otherwise, we may publish forecasts or other forward-looking statements, or comment on the estimates of financial analysts, regarding our future results, including estimated revenues or net earnings. Any forecast of, or comment on, our future performance reflects various assumptions. These assumptions are subject to significant uncertainties, and as a matter of course, any number of them may prove to be incorrect. Further, the achievement of any forecast depends on numerous risks and other factors (including those described in this discussion), many of which are beyond our control. As a result, we cannot assure you that our performance will be consistent with any management forecasts or comments or that the variation from such forecasts or comments will not be material and adverse. You are cautioned not to base your entire analysis of our business and prospects upon isolated predictions, but instead are encouraged to utilize our entire publicly available mix of historical and forward-looking information, as well as other available information affecting us and our services, when evaluating our prospective results of operations.

Shortages or price fluctuations in component parts specified by our customers could delay product shipments and adversely affect our profitability.

Many of the products we manufacture require one or more components that we order from sole-source suppliers. Supply shortages for a particular component can delay production of all products using that component or cause cost increases in the services we provide. In the past, some of the materials we use, such as capacitors and memory and logic devices, have been subject to industry-wide shortages. As a result, suppliers have been forced to allocate available quantities among their customers and we have not been able to obtain all of the materials desired. Our inability to obtain these needed materials could slow production or assembly, delay shipments to our customers, increase costs and reduce operating income. In certain circumstances, we may bear the risk of periodic component price increases. Accordingly, some component price increases could increase costs and reduce our operating income.

In addition, if we fail to manage our inventory effectively, we may bear the risk of fluctuations in materials costs, scrap and excess inventory, all of which adversely affect our business, financial condition and results of operations. We are required to forecast our future inventory needs based upon the anticipated demand of our customers. Inaccuracies in making these forecasts or estimates could result in a shortage or an excess of materials. A shortage of materials could lengthen production schedules and increase costs. An excess of materials may increase the costs of maintaining inventory and may increase the risk of inventory obsolescence, both of which may increase expenses and decrease our profit margins and operating income.

If we are unable to respond to rapidly changing technologies and process developments, we may not be able to compete effectively.

The market for our products and services is characterized by rapidly changing technologies and continuing process developments. The future success of our business will depend in large part upon our ability to maintain and enhance our technological capabilities, to develop and market products and services that meet changing customer needs and to successfully anticipate or respond to technological changes on a cost-effective and timely basis. Our core technologies could in the future encounter competition from new or revised technologies that render existing technology less competitive or obsolete or that reduce the demand for our services. We cannot assure you that we will effectively respond to the technological requirements of

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the changing market. If we determine that new technologies and equipment are required to remain competitive, the development, acquisition and implementation of these technologies may require us to make significant capital investments. We cannot assure you that we will be able to obtain capital for these purposes in the future or that investments in new technologies will result in commercially viable technological processes. The loss of revenue and earnings to us from these changing technologies and process developments could adversely affect us.

Operating in foreign countries exposes us to increased risks, which could adversely affect our results of operations.

We currently have foreign operations in Brazil, China, Ireland, Israel, Japan, Mexico, the Netherlands, Romania, Singapore and Thailand. We may in the future expand into other international regions. We have limited experience in managing geographically dispersed operations and in operating in foreign countries. We also purchase a significant number of components manufactured in foreign countries. Because of the scope of our international operations, we are subject to the following risks, which could adversely impact our results of operations:

In addition, changes in policies by the United States or foreign governments could negatively affect our operating results due to increased duties, increased regulatory requirements, higher taxation, currency conversion limitations, restrictions on the transfer of funds, the imposition of or increase in tariffs and limitations on imports or exports. Also, we could be negatively affected if our host countries revise their policies away from encouraging foreign investment or foreign trade, including tax holidays.

We may be unable to protect our intellectual property, or we may be deemed to be infringing the intellectual property rights of others, either of which would negatively affect our ability to compete and our results.

We rely on our proprietary technology, and we expect that future technological advances made by us will be critical to remain competitive. Therefore, we believe that the protection of our intellectual property rights is, and will continue to be, important to the success of our business. We rely on a combination of patent, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Despite the steps we have taken to protect our intellectual property, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology. We cannot be certain that patents we have or that may be issued as a result of our pending patent applications will protect or benefit us or give us adequate protection from competing technologies. We also cannot be certain that others will not develop our unpatented proprietary technology or effective competing technologies on their own.

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From time to time, third parties including our customers and competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to us. In this regard, in August 2002, we were named as defendant in one of a number of actions currently being pursued by the Lemelson Foundation Partnership based on alleged infringements of patent rights it claims in certain imaging analysis technology. The litigation has been stayed pending the resolution of other litigation, to which we are not a party, asserting the invalidity and/or unenforceability of certain Lemelson patents. Patents held by other companies, including Lemelson, may be determined to be valid, and some of our products may ultimately be determined to infringe the patents or other intellectual property of other companies. The results of any litigation are inherently uncertain. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to our products, we could be required to obtain licenses to the infringing technology, to pay substantial damages under applicable law, to cease the manufacture, use and sale of infringing products or to expend significant resources to develop non-infringing technology. Licenses may not be available from third parties, either on commercially reasonable terms or at all. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. Accordingly, any infringement claim or litigation against us could significantly harm our business, operating results and financial condition.

Our inability to expand our Web-based supply chain management system could negatively impact our future competitiveness.

Our future success depends in part on our ability to rapidly respond to changing customer needs by scaling operations to meet customers’ requirements, shift capacity in response to product demand fluctuations, procure materials at advantageous prices, manage inventory and effectively distribute products to our customers. In order to continue to meet these customer requirements, we have developed a Web-based supply chain management system that enables us to collaborate with our customers on product content and to process engineering changes. We are currently implementing an enhanced version of our existing system, which will include real-time communications between our customers across all of our facilities. Our inability to expand this Web-based system, or delays or defects in such expansion could negatively impact our ability to manage our supply chain in an efficient and timely manner to meet customer demands, which could adversely affect our competitive position and negatively affect our ability to be competitive in the electronics manufacturing services industry.

Our business could suffer if we lose the services of, or fail to attract, key personnel.

Our future success largely depends on the skills and efforts of our executive management and our engineering, manufacturing and sales employees. We do not have employment contracts or non-competition agreements with any of our executive management or other key employees. The loss of services of any of our executives or other key personnel could negatively affect our business. Our continued growth will also require us to attract, motivate, train and retain additional skilled and experienced managerial, engineering, manufacturing and sales personnel. We face intense competition for such personnel. We may not be able to attract, motivate and retain personnel with the skills and experience needed to successfully manage our business and operations.

We are subject to a variety of environmental laws, which expose us to potential financial liability.

Our operations are regulated under a number of federal, state, provincial, local and foreign environmental laws and regulations, which govern, among other things, the discharge of hazardous materials into the air and water as well as the handling, storage and disposal of such materials. Compliance with these environmental laws is a significant consideration for us because we use metals and other hazardous materials in our manufacturing processes. We may be liable under environmental laws for the cost of cleaning up

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properties we own or operate if they are or become contaminated by the release of hazardous materials, regardless of whether we caused the release. In addition, we, along with any other person who arranges for the disposal of our wastes, may be liable for costs associated with an investigation and remediation of sites at which we have arranged for the disposal of hazardous wastes, if such sites become contaminated, even if we fully comply with applicable environmental laws. In the event of contamination or violation of environmental laws, we could be held liable for damages including fines, penalties and the costs of remedial actions and could also be subject to revocation of our discharge permits. Any such penalties or revocations could require us to cease or limit production at one or more of our facilities, thereby harming our business.

Risks Relating to Our Common Stock

The market price of our common stock could fluctuate in response to quarterly operating results and other factors.

The market price of our common stock has fluctuated significantly in the past and may fluctuate significantly in the future in response to quarterly operating results and other factors, including many over which we have no control and that may not be directly related to us. The stock market has from time to time experienced extreme price and volume fluctuations, which have often been unrelated or disproportionate to the operating performance of particular companies. Fluctuations or decreases in the trading price of our common stock may adversely affect your ability to trade your shares and you may lose all or part of your investment. In addition, these fluctuations could adversely affect our ability to raise capital through future equity financings.

Future sales of our common stock may cause our stock price to decline and may cause dilution to our existing shareholders.

As of May 31, 2004, our directors, executive officers and largest shareholder beneficially owned an aggregate of 6,952,387 shares, or 13.3%, of our common stock. In addition, substantially all of our outstanding shares of common stock are freely tradable without restriction or further registration. Sales of substantial amounts of common stock by our shareholders or even the potential for such sales, may cause the market price of our common stock to decline and could impair our ability to raise capital through the sale of our equity securities.

As noted above, we may need additional funding, which may be raised through issuances of equity securities and securities convertible into equity securities, to provide us with the capital to reach our objectives. We also have the right to issue, at the discretion of our board of directors, shares upon such terms and conditions and at such prices as our board of directors may establish. In addition, we may in the future issue preferred stock that might have priority over our common stock as to distributions and liquidation proceeds. Such offerings would dilute the ownership interest of existing shareholders and could cause a dilution of the net tangible book value of such shares.

Provisions in our charter documents and Minnesota law may delay or prevent an unsolicited takeover effort to acquire our company, which could inhibit your ability to receive an acquisition premium for your shares.

Provisions of our amended articles of incorporation and our amended and restated bylaws and provisions of Minnesota law may delay or prevent an unsolicited takeover effort to acquire our company on terms that you may consider to be favorable. These provisions include the following:

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Item 3—Quantitative and Qualitative Disclosure about Market Risk

The Company realized unrecognized (losses) gains of $(628) and $30 for the first three and six months of fiscal 2005, respectively, resulting in a net accumulated unrecognized other comprehensive gain of $2,484 as of September 30, 2004. These gains resulted primarily from changes in the exchange rate of the Thai Baht and the Euro in relationship to the United States dollar applied to our net invested asset currency exposure in the Thailand and Netherlands ($3,865 and $15,270, respectively, at September 30, 2004). Additional credit facilities denominated in local currencies of foreign locations are designed to limit risks.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and its Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Company’s Chief Executive Officer along with the Company’s Executive Vice President and Chief Financial Officer concluded that, except for the disclosure controls and procedures with respect to its Guadalajara, Mexico operation which are discussed below, the Company’s disclosure controls and procedures were effective as of September 30, 2004 in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

In October 2004, the Company’s management became aware of certain accounting discrepancies related to its Guadalajara, Mexico operation. Based on an investigation of these discrepancies conducted at the direction of management by an independent third party, the Company determined that these discrepancies resulted from various improper accounting practices engaged in by its accounting staff in Mexico, including not properly posting transactions, standard costing errors and improper account reconciliations. As a result of these discrepancies the Company restated its previously reported financial statements for the fiscal year ended March 31, 2004 and quarter ended June 30, 2004 (see Note 17 to the Company’s Consolidated Financial Statements (audited) for the fiscal year ended March 31, 2004 and Note H to the Company’s Consolidated Financial Statements (unaudited) for the fiscal quarter ended June 30, 2004 for more information concerning the nature and scope of the restated items in each period). The Company also determined that the errors in its Consolidated Financial Statements were due in part to material weaknesses in its disclosure controls and procedures with respect to its Mexico operations which prevented the necessary information from being accumulated and communicated to the Company’s management as appropriate to allow for timely decisions regarding required disclosure.

In December 2004, the Company’s management became aware of certain sales transactions at its Tianjin, China operation which were not properly accounted for in accordance with U.S. GAAP due to a significant deficiency in its internal control over financial reporting. The Company determined that this adjustment was not detected on a timely basis due to a significant deficiency in its disclosure controls and procedures with respect to its China operation which prevented the necessary information from being accumulated and communicated to the Company’s management as appropriate to allow for timely decisions regarding required disclosure.

Prior to the filing of this report, the Company, under the direction of its Chief Executive Officer and Executive Vice President and Chief Financial Officer, implemented revised disclosure controls and procedures as part of its remediation efforts after the Pemstar Mexico investigation and restatement of financial statements. The revised controls and procedures include expanded supervisory activities and monitoring procedures with respect to Pemstar Mexico. In addition, in response to the significant deficiency with respect to its China operation, management implemented improved transaction approval processes and reconciliation procedures as part of its disclosure controls. Based on these changes and improvements, management believes that, as of the date of filing of this Form 10-Q for the fiscal quarter ended September 30, 2004, the Company’s disclosure controls and procedures are effective to ensure that material information relating to the Company is recorded, processed, summarized and reported to our Chief Executive Officer and Executive Vice President and Chief Financial Officer within the time periods specified in the SEC’s rules and forms.

Internal Control Over Financial Reporting

During the fiscal quarter ended September 30, 2004, there were no changes made in our internal control over financial reporting (as defined in Rule 13a - 15(f) under the Securities and Exchange Act of 1934, as amended) that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In the light of restatement of the Company’s previously issued financial statements for the fiscal year ended March 31, 2004 and fiscal quarter ended June 30, 2004, the Company’s management has concluded that there were significant deficiencies in the design or operation of its internal control over financial reporting in its Guadalajara, Mexico operation which did adversely affect the Company’s ability to record, process, summarize and report financial data. Management believes that such deficiencies represented material weaknesses in its internal control over financial reporting that resulted in misstatements in its financial statements for fiscal year ended March 31, 2004 and quarter ended June 30, 2004. The Company has implemented corrective actions to address these internal control weaknesses including improved supervision and approval of journal entries, timely account reconciliation and review, redefined separation of duties, relocation of certain accounting activities to its Corporate Headquarters, and replacement of key management personnel in its Mexico operation.

Prior to filing this Form 10-Q, management also identified a significant deficiency in its internal controls related to certain sales transactions at its Tianjin, China operation and corrected the impact of this deficiency during the consolidation process. Management has implemented corrective actions to address the significant deficiency in China including improved transaction approval processes and reconciliation procedures. In addition, management will continue to assess the control environment at this location to determine if additional controls will be needed.

The Company believes that these corrective actions will remediate the identified material weaknesses and significant deficiencies in its internal control over financial reporting.

Section 404 Assessment

Section 404 of the Sarbanes-Oxley Act requires management’s annual review and evaluation of our internal control over financial reporting, and an attestation of the effectiveness of these controls by our independent registered public accountants beginning with the Form 10-K for the fiscal year ending March 31, 2005. The Company has dedicated significant resources, including management time and effort, and incurred substantial costs in connection with its ongoing Section 404 assessment. The Company is currently documenting and testing its internal controls and evaluating necessary improvements for maintaining an effective control environment. The evaluation of the internal controls is being conducted under the direction of senior management. In addition, the Company’s management is regularly discussing the results of the testing and any proposed improvements to the control environment with the Audit Committee of the Company’s Board of Directors. Nevertheless, because of the requirement that all corrective actions and procedure changes relative to period end financial reporting must be in place for one full calendar quarter prior to attestation of the effectiveness by our independent registered public accountants, the Company expects that it is likely that it will report the existence of material weaknesses in its internal control over financial reporting as of the end of its fiscal year ending March 31, 2005.

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Part II. Other Information

Item 1—Legal Proceedings

Not applicable.

Item 2—Unregistered Sale of Equity Securities and Use of Proceeds

Not applicable.

Item 3—Default on Senior Securities

Not applicable.

Item 4—Submission of Matters to a Vote of Security Holders

The Annual Meeting of Stockholders was held on July 29, 2004 at the main offices of the Company at 3535 Technology Drive NW, Rochester, Minnesota. The stockholders took the following actions (with voting tallies, from eligible voting shares, as noted):

Item 5—Other Information

Not applicable.

Item 6—Exhibits

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Signatures

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

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EXHIBIT INDEX

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