##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-K [X]
    
    Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended October 2,
2004[  ]
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 Commission file number 0-22799 BEI TECHNOLOGIES, INC.
  Delaware
    
    94-3274498(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 One Post Street, Suite 2500
San Francisco, California 94104 
  (415) 956-4477 
  Securities registered pursuant to Section 12(b) of the Act:
None 
 Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value 
 Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrants knowledge, in proxy or information statements incorporated
by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[  ] Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [X] No [  ] The approximate aggregate market value of the voting stock held by
non-affiliates of the Registrant as of April 3, 2004 was $258,676,000 (A). The number of shares outstanding of the Registrants common stock as of
December 9, 2004 was 14,814,862. (A) Based upon the closing sale price of the common stock on April 3, 2004 as
reported on the NASDAQ National Market System. Excludes 3,504,400 shares of
common stock held by directors, executive officers and stockholders whose
ownership exceeds ten percent of common stock outstanding on April 3, 2004.
Exclusion of shares held by any person should not be construed to indicate that
such person possesses the power, direct or indirect, to direct or cause the
direction of the management or policies of Registrant, or that such person is
controlled by or under common control with Registrant. DOCUMENTS INCORPORATED BY REFERENCE Registrants Proxy Statement with respect to its 2005 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission is
incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this
report.




---



TABLE OF CONTENTS  
 PagePART IItem 1. Business
    
    
    3Item 2. Properties
    
    
    21Item 3. Legal Proceedings
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    23Item 6. Selected Financial Data
    
    
    26Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    27Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    34Item 8. Financial Statements and Supplementary Data
    
    
    36Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    59Item 9A. Controls and Procedures
    
    
    59Item 9B Other Information
    
    
    59PART IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    59Item 11. Executive Compensation
    
    
    60Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    60Item 13. Certain Relationships and Related Transactions
    
    
    60Item 14. Principal Accountant Fees and Services
    
    
    60PART IVItem 15. Exhibits and Financial Statement Schedules
    
    
    61Signatures
    
    
    65EXHIBIT 10.15EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




---



##### Table of Contents



Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. When used herein, the words intend, anticipate, believe,
estimate and expect and similar expressions as they relate to the Company
are intended to identify such forward-looking statements. The Companys actual
results, performance or achievements could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in Item 1, Business as well
as Item 7, Managements Discussion and Analysis of Financial Condition and
Results of Operations. Unless the context otherwise requires, all references
in this Annual Report to we, us, our, Technologies or Company refer
to BEI Technologies, Inc. and all of its subsidiaries. The following product or
technology designations are registered trademarks of BEI Technologies, Inc.:
BEI, GyroChip, NCAPS, DIGISINE, ServoReady and ServoSmart. 
 PART I 
 ITEM 1. BUSINESS Overview We are a global leader in the design, development, engineering,
manufacture and marketing of intelligent sensors, sensor-based systems,
actuators and motors for use in precision motion control applications. Most of
our sensors measure physical motion and provide information that is essential
to logical, safe and efficient operation of sophisticated machinery. We
believe that we have competitive advantages through our proprietary
technologies and processes, manufacturing capabilities, brand recognition and
highly skilled employees. We are recognized for our applications engineering
expertise and our ability to design and manufacture sophisticated sensors and
sensor based systems in high volume with superior quality. We believe we are a
leader in the commercialization of advanced sensor products and emerging
technologies such as our quartz micromachined inertial sensors. We sell our highly engineered products to leading manufacturers in the
automotive and transportation, industrial, and aerospace and defense
industries. For example, our broad range of products are used for applications
that include computerized control of automobile stability, factory automation,
and commercial and military aircraft. We generally sell our automotive
products to Tier I suppliers; most of our other products are sold directly to
original equipment manufacturers (OEMs), in the transportation and aerospace
and defense markets, and we are frequently a sole-source supplier. In our
industrial and commercial applications, we sell both through direct sales and
representative sales organizations, where we rely upon our differentiated
products and strong brand recognition. Since our separation from BEI Medical Systems Co. in 1997, our revenues
have grown at a compounded annual rate of 13.6%, from $101.5 million in 1997,
to $281.3 million in 2004. Our basic earnings per share for fiscal 2004 were
$0.81 compared with $0.39 for fiscal 2003. The Sensor Market The sensor market is broadly defined and encompasses a large number of
products with a wide variety of applications. A sensor is an
electro-mechanical device that responds to a physical stimulus, such as
electromagnetic energy, magnetic field, or motion, by producing an output
signal that is typically electrical. Examples of properties that our sensors
measure include position, acceleration and angular rate-of-change. Typical
technologies used to sense these properties include optical, magnetic,
potentiometric and piezoelectric. We believe we are well positioned to capitalize on the major trends in the
sensor market which we believe include miniaturization, increased precision,
increased functionality and lower cost. The advent of micro-technology has significantly advanced electronics and
has led to the development of MEMS based applications and products. MEMS
(micro-electromechanical systems) technology utilizes semiconductor industry
processing techniques to create miniaturized structures for sensing and
actuation. Over the past 10 years, our MEMS technology has achieved increased
acceptance in the inertial sensing market. Given the unit volume demands and
performance requirements, we believe the automotive and aerospace markets will
have the greatest potential for incremental unit demand for MEMS sensors over
the next several years. 3




---



##### Table of Contents



Automotive and Transportation Sensor Market The automotive sensor market is benefiting from the increased use of
electronics in vehicles. A significant impetus to sensor growth has been the
increasing awareness of and corresponding adoption of safety and efficiency
enhancing systems such as electronic stability control ESC systems, advanced
roll stability control RSC systems, anti-lock braking systems, airbags,
seat-belt tensioners, and steering and throttle positioning systems. Stricter
emissions laws are also driving demand for engine diagnostic sensors. We
believe that technological and manufacturing advances are enabling the
development and commercialization of higher performance, lower cost sensors,
which in turn are increasing the opportunities for adoption of these sensors in
automotive applications. Industrial and Commercial Sensor Market The industrial and commercial marketplace uses motion control sensors in a
wide array of applications, including factory automation, office automation and
medical equipment to enable higher levels of performance for their systems.
Growth in the industrial sensor market is being driven by the increasing demand
for factory floor automation, increasing production volumes and the resulting
need to improve the efficiency and accuracy of manufacturing processes. Growth
in the commercial sensor, actuator and motor markets is being driven by demand
for sensors, actuators and motors in diverse products, including semiconductor
capital equipment, medical devices, printers and copiers. Aerospace and Defense Sensor Market The aerospace and defense market uses sensors for a variety of
applications, including systems for inertial navigation, global positioning,
satellite tracking, platform stabilization and attitude heading and reference,
and related applications. Sensors used in navigation control systems for
aircraft provide heading and position information. They also are used for yaw
damping, back-up attitude-heading and reference instruments. End-markets
include both commercial and military aircraft as well as missiles and smart
munitions. Similar to the automotive and transportation market, aerospace and defense
manufacturers are increasingly incorporating sensors into their products as
they seek to improve accuracy, lower costs, enhance reliability, increase
functionality and decrease weight. We believe the same factors are driving the
increase in the aerospace and defense market demand for MEMS technology
products such as guidance and control applications in unmanned air vehicles
UAV, guided munitions and aircraft flight control systems (such as for the
F-22 Raptor). Competitive Strengths We believe that the following key competitive strengths will contribute to
our continued growth: Extensive Expertise and Experience in Sensor Technology:We have been
active in developing new sensor technologies for over 50 years. We believe our
advanced technical expertise and ability to successfully commercialize emerging
technologies provide us with a competitive advantage in responding to our
customers evolving demands for miniaturization, precision, increased
functionality and lower cost. Sophisticated Application Engineering:We derive applications for our
products from customer motion control problems that our experienced application
engineers solve by using our portfolio of technologies. We rely on our
application engineers and sales force to interface with potential customers and
expertly assess and solve the specific motion control problems. These
important relationships build confidence and loyalty within our customer base
and provide us with competitive advantages for our customers next generation
systems and new applications. We believe our ability to custom engineer
sophisticated sensor packaging represents a substantial advantage to our
customers. Strong Intellectual Property Portfolio:Our investment in research,
process and product development over the past several decades has given us a
strong portfolio of commercially relevant intellectual property. We currently
hold in excess of 80 U.S. patents and 40 foreign patents with expiration dates
ranging from October 2004 to November 2024. Some of our key patents relate to
our quartz MEMS technology, mixed signal processing, optoelectronics and
magnetics. We will continue to invest in research and development to further
strengthen our intellectual property and improve our competitive position. Strong Products and Brands with Diverse Market Applications:We offer a
wide range of products including linear and rotary position sensors, optical
encoders, brushless DC motors, magnetic actuators, accelerometers, angular rate
sensors, 4




---



##### Table of Contents



inertial measurement units, inertial navigation systems and sensor-based
systems and sub-systems. We market our products under strong brand names,
including GyroChip, BEI Encoder, Kimco Actuator and Duncan Position Sensor. We
believe that our customers associate these brand names with superior quality,
reliability and performance. In addition, we have been successful in
leveraging our products and technologies developed for one market into other
markets. For example, we were successful in introducing the quartz MEMS sensor
initially developed for the military market into the GyroChip we use in the
automotive market. We are also leveraging the advancements made to the
GyroChip from our automotive efforts into current opportunities for the
aerospace and defense markets. Advanced, Cost-Effective Manufacturing:We use complex proprietary
processes, software and equipment in our manufacturing. The fabrication of
certain of our products requires a highly controlled and clean room
environment. We have also implemented flexible continuous flow manufacturing,
and have automated and continue to automate our volume manufacturing processes
which also allows us to meet the needs of our customers for shorter lead-times
in a cost-effective manner. In addition, we increasingly utilize low cost
manufacturing options and outsource non-core content. Long-Term Relationships with Large and Diverse Customer Base:We supply
over 6,000 customers globally across diverse industries and markets. Our
reputation for superior technology, quality service, and expertise in
recommending advanced technical solutions for diverse end-market applications
has helped us to develop strong, long-term relationships with our customers.
In 2004, 49% of our sales were to Continental Teves (CT). We have had a
business relationship with CT, our largest customer for nearly a decade. We
have sold to the government and government contractors for several years. In
fiscal 2004, 9% of our sales were to government and government contractors. We
have multi-year contracts with certain automotive, aerospace and defense
customers. Experienced Management Team:Our senior management team has an average of
over 30 years experience in the sensor and sensor-based industries. We believe
our management team has a longstanding track record of working together to
produce superior operating performance, even in challenging environments, and
the skills and experience necessary to grow our business. Our Strategy Our objective is to be recognized worldwide as the most capable source for
the sensor, motor and actuator categories targeted by our products. Our
strategy is to provide our customers with superior technical solutions and
service that, together with the products themselves, create value and give the
customer confidence that the products have been expertly engineered and
manufactured. Key elements of our strategy include: Increase global penetration of the quartz MEMS technology for the automotive
industry We intend to capitalize on our innovation in quartz MEMS technology and
our relationships with our automotive customers to increase our global market
penetration. Since 1998, the market for ESC has grown substantially. We
estimate that the overall penetration rates for ESC are in the 30%-40% range in
Europe, and as high as 50% in Germany, compared to less than 10% in North
America and Asia. We believe that safety concerns among consumers,
manufacturers and regulatory agencies will increase penetration of ESC and
advanced RSC systems worldwide, particularly in North America and Asia. We
believe there is an opportunity to grow our business as the market for ESC
products continues to penetrate automotive platforms. Leverage existing technologies and products into other markets and applications We are leveraging advancements made in our existing products into new
opportunities across all of our markets. For example, the high volume
manufacturing processes and techniques related to the GyroChip developed for
the automotive industry are now being implemented in navigation and stability
applications in non-automotive markets such as commercial aviation. We also
seek to use our complementary proprietary sensor capabilities to create
value-added systems and products. For example, we can provide position feedback
inside a magnetic actuator, creating a smart actuator. Continue to develop and commercialize proprietary technologies with potentially
large market opportunities We intend to continue the development and commercialization of proprietary
technologies that have broad industrial and commercial applications for motion
control. Our strategy of focusing on leading edge technology through internal
innovation and external investments has enabled us to target technology-based
markets for sub-systems and end products in which our 5




---



##### Table of Contents



sensors, motors and actuators play an enabling role. For example, we are
commercializing the non-contact angular position sensors (NCAPS) and developing
non-contacting torque sensors. We believe these products could potentially
address large emerging markets, including electronic steering. Additionally,
commercialization efforts are underway for a belt tension sensor (BTS),
intended to address the need for smart air-bag products as mandated by the
National Highway Traffic Safety Administration. Expand product lines through acquisitions and strategic relationships We plan to continue to expand our business through acquisitions of or
investments in companies, product lines or technologies with an emphasis on
increasing our military and industrial revenue. We have established a
strategic relationship with Athena Technologies Inc., a provider of advanced
flight controls systems for the UAV market. Subsequent to fiscal year-end we
acquired Newall Measurement Systems, Ltd. (UK) to add linear encoders and
digital readout product lines to our offerings. In addition, we are sponsoring
research with a number of universities to provide us with prospective
technologies. We intend to continue these efforts to expand our market
position and technology portfolio. Our Customer Markets Our products are utilized extensively in the automotive and
transportation, industrial and commercial, and aerospace and defense markets.
Our primary product offerings are for ESC in the automotive market, military
application of quartz MEMS, potentiometric sensors in automotive and
transportation, and actuators and encoders in industrial automation. All of
our target markets generally are concerned with the detection, interpretation
and control of motion. The following is a list of significant applications by
end market: Automotive and Transportation
    
    Industrial and Commercial
    
    Aerospace and DefenseApplications
    
    Applications
    
    ApplicationsFarm
implement position sensors
Hand controls for fork lift operations
Hydraulic and fuel pump motors
Memory seat position sensors
Pedal position sensors
Pedal sensors for drive by wire
Rollover sensing for vehicle dynamic control
Seat belt tension sensors
Smart actuator for autonomous cruise control and
other applications
Steering sensors for drive by wire
Steering sensors for vehicle dynamic control
Throttle position sensors
Yaw sensing for vehicle ESC
    
    Bar code scanner motors
Copier drive motors
Crane control encoders
Elevator positioning encoders
Industrial motor speed and position encoders
Machine tool positioning encoders
Medical scanner motors, trackballs and encoders
Mill control encoders
Petrochemical draw works position encoders
Petrochemical Encoders for wireline depth measurement
Printing registration and packaging encoders
Pump and centrifuge motors
Respiratory therapy blower motors and actuator
valve. Semiconductor and electronics assembly
machine motors, actuators and encoders
Surgical instrument and drill motors
    
    Aircraft attitude, heading, and reference
instrumentation rate sensors
Aircraft electro-optical targeting system encoders
Aircraft flight control rate sensors. Inertial
measurement units (IMUs) and navigation subsystems
Aircraft instrumentation position sensors,
encoders and rate sensors
Antenna stabilization rate sensors
Infrared scanner drives
Mars Rover navigation rate sensor
Missile guidance rate sensors
Missile launcher position encoders
Missile seeker gimbal position and stabilization sensors and actuators
Munitions guidance rate sensors
Radar position encoders
Satellite stabilization rate sensors
Satellite tracking, pointing and rate control
encoders and servos for antennas, instruments,
and solar arrays
 6




---



##### Table of Contents



Automotive and Transportation
    
    Industrial and Commercial
    
    Aerospace and DefenseApplications
    
    Applications
    
    ApplicationsTape drive encoders
    
    Spacecraft robotic encoders
Tank turret position encodersUAV flight control, IMUs and navigation subsystems
 Our Products MEMS Quartz Rate Sensors We believe we are a world leader in the design, development and
manufacture of MEMS quartz rate sensors. MEMS technology utilizes standard
semiconductor industry processing techniques to create miniaturized structures
that form the mechanical basis of sensors. Our significant investment over
many years has yielded a substantial understanding of the properties of quartz
as they apply to inertial sensors. Our GyroChip angular rate sensor and the Vibrating Quartz Accelerometer
(VQA) are examples of products manufactured utilizing MEMS technology. These
sensors rely on the piezoelectric proprieties of the base crystalline quartz
material. Our extensive knowledge includes crystalline orientations of quartz
for maximum performance, miniaturized patented fork designs for maximum signal
to noise ratios, low cost, high reliability packaging to withstand high
g-forces and minimize the effect of vibration, and proprietary signal
processing techniques for temperature compensation, enhanced sensor performance
and continuous built-in test capability. Since the inception of our automotive
GyroChip production in 1994, we have shipped in excess of 10 million units.
Our GyroChips are now the leading brand of yaw rate sensors employed in ESC
systems. In addition, modified GyroChips can be found in Boeing, Airbus,
Sikorsky and Lockheed Martin aircraft, numerous types of missiles, and in a
number of space applications such as the heading control sensor on the
Sojourner rover on Mars. Optical Encoders Our encoders translate rotational motion directly into a digitally coded
electronic signal that is proportionate to angular position using
non-contacting optical means. We have been an active technology developer
within the encoder market for decades and we believe we have established brand
leadership through continuous innovation in technology and quality of our
products. We also pioneered the use of LED illumination technology for use in
encoder products. Our design strengths in lenses, masks and gratings produce
robust signals within our products. We utilize a variety of detector schemes
to sense the optical modulation signal. We employ optical application specific
integrated circuits (ASICs) combined with signal processing for an encoder on a
chip. We have sophisticated, proprietary optoelectronic production machines to
master our code disks and test our final products. Our optical encoders are
used in a wide array of factory and office automation and aerospace and defense
applications, ranging from elevator systems to material handling applications
to the Hubble space telescope. Potentiometric Sensors A potentiometric sensor provides an analog output proportionate to a
linear or rotary position. Unlike our optical encoders, these are contacting
devices that use resistive technologies. Our Duncan potentiometric position
sensor utilizes proprietary conductive ink printed onto a substrate which is
then placed into a configuration that includes a mechanical wiper contact.
These small, light and low cost sensors were first applied to missile fins and
missile seeker head position control, and are now used in a wide range of
industrial and automotive applications. 7




---



##### Table of Contents



Today, the Duncan position sensor is found in a substantial number of
automotive platforms for memory seat, adjustable pedal and steering sensor
applications. We believe our sensors are the preferred position sensors in
heavy equipment applications. These sensors continue to find increasing usage
/ acceptance in missiles and the aerospace markets. We believe the Duncan
position sensor brand is renowned in its markets for outstanding durability and
reliability. Voice Coil Actuators and Brushless DC Motors Voice coil actuators are direct drive linear motion motors consisting of a
light moving coil assembly placed in the field of a permanent magnet. We were
the first company to integrate high-energy rare earth magnets into voice coils.
The integration of high-energy magnets enables the actuators to achieve high
speed, high accuracy and dynamic response. Our voice coil actuators are known
for superior acceleration and position control capability and are used in a
wide variety of applications including wire bonding used in semiconductor
manufacturing, controlling valves of medical ventilators and adjusting
missile(s) fins. Our voice coil actuators are being integrated with position
sensors to create intelligent actuators, called ServoReady and ServoSmart
products. Besides actuators, we believe we have unique skills and knowledge of high
performance magnetics as applied to brushless DC motors. We manufacture low
horsepower, high torque, brushless DC motors for motion control applications.
We differentiate ourselves by our ability to customize our products to meet our
specific customer applications. Our products are used in medical applications,
instrumentation, and factory and office automation applications. Signal Processing Common to all of our products is our strong technical capabilities in
analog circuits, digital electronics, digital signal processing, ASIC
development and network broadcast and unknown server (BUS) communication. We
incorporate these skills into our products in several ways. Specialized analog
circuits are often necessary to develop initial sensor signals. Proprietary
charge amplifiers to read minute piezo charge are an example of this
capability. Intelligent functions such as sensor self-check, self-calibration,
electronic multiplication and network BUS communication are enabled by our
expertise in digital signal processing. To address the needs of volume
production we have refined our skills in ASIC design, to reduce a set of
electronics to a single cost effective chip. Relationship With Continental Teves We are the primary source to Continental Teves (CT) for angular rate
sensors used in ESC systems. CT is a leading global supplier of braking and
ESC systems for the automotive industry. Our relationship with CT began in
1994. In 1999, we signed a long-term contract with CT for the supply of 9.3
million GyroChips. In fiscal year 2004 we shipped approximately 3.3 million
units under the CT contract. In March 2004, we entered into a new agreement with CT that substantially
extended our existing business arrangements. Under the new agreement, we will
supply all of CTs rate sensor product requirements for brake-related systems
for new automotive platforms starting in 2004. Under the new agreement, final
assembly will be transferred to CT. We will supply only the sensor module
(i.e. circuit board with the nugget). The nugget is the housing structure
that contains our GyroChip. Our current plan is to transition to supplying
only the nugget by mid-2006. As part of this new agreement, we have also
granted CT an exclusive license to use the GyroChip, or any of our other rate
sensor products, in brake-related applications for light vehicles such as cars,
vans, SUVs and light trucks. We also agreed not to supply certain rate sensor
products to any third party for use in brake-related applications for light
vehicles. These provisions do not preclude us from supplying these products to
our existing customers who have previously purchased rate sensor products from
us. By transferring to CT responsibility for the production and packaging of
ancillary parts of the GyroChip nuggets, we are better able to focus on our
core-competitive advantage, which is the design, development and manufacture of
GyroChips. We believe that it will result in reduced infrastructure
requirements, working capital, program management, technology and manufacturing
risk. Manufacturing Our manufacturing operations provide a mix of standard and custom products
designed to meet the specialized requirements of particular customers. Our
products, whether standard or custom, are normally manufactured in response to
customers orders and are in general not held as finished goods. Most are
assembled from parts or subassemblies that are 8




---



##### Table of Contents



proprietary to us. We rely on various sources for our raw material
components. See Risk factorsWe depend on a limited source of suppliers and
any interruption in our supply of components could cause manufacturing delays,
increased costs and a loss of sales. Specialized or proprietary equipment is often used to produce our
products. For example, a code pattern generator designed by and proprietary to
us is used to produce some shaft encoder parts. Specialized quartz
micromachining equipment is used for the production of GyroChip units. High
throughput automated or semi-automated equipment is used for the production of
GyroChip assemblies, brushless motors and potentiometers. Some parts are
fabricated under clean room conditions. Customer demand for automotive quartz rate sensors required scaling-up our
production to support broader introduction of our products in the automobile
market. We are continuing to refine manufacturing and industrial engineering
measures to support the fabrication, assembly, and testing of new sensors in
the appropriate quantities. There can be no assurance that we will be able to
produce the required quantities on time or in sufficient amounts to satisfy
demand. Failure to do so would have a material adverse effect on our business,
financial condition and results of operations. See Risk factorsOur failure
to increase manufacturing capacity in a timely and efficient manner will have a
material negative impact on our sales. Research And Development Our research and development focus has included improving performance and
yields of existing products, with special emphasis on the quartz rate sensors
used in high accuracy IMUs and high volume yaw rate sensors for the automotive
industry. Substantial effort has also been devoted to the development of
efficient manufacturing methods necessary for competitive pricing of our
products while maintaining the required quality for the automotive market. We
have transitioned to a smaller next generation quartz fork sensor, resulting in
more forks per wafer. The new patented fork design also offers the opportunity
to migrate to larger wafers. We also continued research on fork design to
upgrade performance for military applications, introduced overall new packaged
configurations and continued to upgrade accelerometer performance for military
use. We have also set up study contracts with multiple educational institutions
to study selected motion control projects. During the 2004 fiscal year, we continued development and
commercialization of NCAPS. The development was driven by our perception of
market demand for a technology usable in high volume applications (e.g.,
steering sensors, medium resolution absolute angular position measurement
sensors) that would overcome the limitations of contacting sensors as well as
the limitations of currently available non-contacting sensors. The design and
architecture of NCAPS (essentially a digitally processed proprietary
transceiver sensor unit), when combined with our existing manufacturing
expertise, may lend itself to high volume production. We believe applications
for this technology may cover a wide spectrum within the automotive and
industrial market sectors. Design of a customized ASIC for the NCAPS sensor is
near completion with production capable devices in test at several customers.
We have also developed and patented a capacitive torque sensor for
complementary applications with NCAPS. Our management believes that our future success will depend in part on our
ability to continue to enhance our existing products, and to develop and
introduce new products that maintain technological leadership, meet a wider
range of customer needs and achieve market acceptance. Accordingly, our
internally funded research, development and related engineering expenditures
were approximately $14.6 million, $15.3 million and $15.4 million in fiscal
2004, 2003 and 2002, respectively. In addition, customer-funded research and
development expenditures charged to cost of sales were $0, $0.5 million and
$0.5 million, respectively, for the same periods. Development of our portfolio
of rate sensors, including NCAPS, comprised most of the prior years
customer-funded research and development expenditures. Employees As of October 2, 2004, we had 1,024 employees, including 138 in research,
development and engineering, 144 in administration, 40 in marketing and sales,
and 702 in operations. We believe that our continued success depends on our
ability to attract and retain highly qualified personnel. Our employees are
not covered by collective bargaining agreements. We have not experienced any
work stoppages and consider our relationships with our employees to be good. 9




---



##### Table of Contents



Competition Competitors for various products offered by us are found among certain
divisions or product lines of large, diversified companies such as Robert Bosch
GmbH, Siemens AG, Denso Corporation, Analogue Devices, Danaher Corporation,
Northrop Grumman Corporation, BAE Systems PLC, Panasonic/Matsushita Electric
Industrial Co. Inc., and Rockwell Automation Inc. There are smaller or
product-specific companies, some of whose products compete with ours, including
CTS Corporation, Dr. Johannes Heidenhain GmbH, Silicon Sensor International AG,
Servo Magnetics Inc., Bourns, Inc. and BI Technologies of TT Electronics PLC. In our principal markets, we believe that competition is based primarily
on design, performance, reliability, price, delivery, service and support. We
believe that we compete favorably with respect to these factors. Intellectual Property We rely primarily upon trade secrets and know-how to develop and maintain
our competitive position. We and our subsidiaries currently hold in excess of
80 U.S. patents and 40 foreign patents with expiration dates ranging from
October 2004 to November 2024. Because many of these patents relate to
technology that is important to certain of our products, we consider these
patents to be significant to our business. In addition, we have acquired
various licenses for externally developed technology and have incorporated the
licensed technology in certain of our current products. We expect to
incorporate similar licensed technology in future products. While management believes that our intellectual property rights are
important, management also believes that because of the rapid pace of
technological change in the industries in which we compete, factors such as
innovative skills, technical expertise, development and utilization of
customized ASICs, the ability to adapt quickly to technological change and
evolving customer requirements, product support and customer relations are of
equal competitive significance. Major Customers and Foreign Sales CT, located in Germany, accounted for approximately 49%, 41% and 39% of
our net sales in fiscal year 2004, 2003 and 2002, respectively. Sales to all
customers located outside the United States accounted for approximately 53%,
54% and 50% of our net sales in fiscal 2004, 2003, and 2002, respectively. Backlog Our backlog at October 2, 2004 and at September 27, 2003 was approximately
$137 million and $112 million, respectively. Our commercial operations typically ship standard products within 3 to 90
days after receipt of a purchase authorization. Our management believes that
our competitive position depends in part on minimizing the time that elapses
between receipt and shipment of an order. Products that require special
analysis, design or testing, such as those produced for customers in the
aviation or space technology markets, are generally shipped from 6 to 18 months
after receipt of the purchase authorization. Our backlog includes aggregate contract revenues remaining to be earned
principally over the next twelve months for scheduled deliveries under existing
contracts. A small number of contracts undertaken by us extend beyond one
year. Accordingly, portions of certain contracts are carried forward from one
year to the next as part of backlog. All orders considered as backlog as of
October 2, 2004 are scheduled for shipment during fiscal 2005. There can be no
assurance that all existing contract backlog will eventually result in revenue
and, accordingly, the amount of backlog at any date is not necessarily a
reliable indicator of future revenue or profitability trends. In the
case of U.S. Government contracts, backlog includes only the applicable portion
of contracts that are fully funded by a procuring Government agency. All U.S.
Government contracts and subcontracts are subject to termination by the U.S.
Government at-will, traditionally with compensation for work completed and
costs incurred. 10




---



##### Table of Contents



Environmental Matters We use certain controlled or hazardous materials in our research and
manufacturing operations and, as a result, we are subject to federal, state and
local regulations governing the storage, use and disposal of such materials.
Our management believes that we are currently in compliance with such laws and
regulations, and that the cost of such compliance has not had a material effect
on our capital expenditures, earnings or competitive position, and is not
expected to have a material adverse effect in the foreseeable future. Available Information We file with the Securities and Exchange Commission (SEC), pursuant to
Section 13(a) or 15(d) of the Exchange Act, annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished. These reports may be accessed at the SECs
Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549.
Information on the operation of the Public Reference Room is available by
calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information about
the Company. The SECs Internet address is http://www.sec.gov. Our Internet address is http://www.bei-tech.com. We make available, free
of charge through our Internet website, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements
and amendments to those reports, as soon as reasonably practicable after we
electronically file such material with, or furnishes it to, the SEC. We have adopted a code of ethics that applies to all officers, directors
and employees regarding their obligations in the conduct of Company affairs.
This code of ethics is available free of charge upon written request to BEI
Technologies, Inc., One Post Street, Suite 2500, San Francisco, California,
94104, Attention: Secretary. RISK FACTORS Before you invest in our Common Stock, you should be aware
of various risks to which we are subject, including those described below. The
following risks and uncertainties may have a material and adverse effect on our
business, financial condition and results of operations, or on the trading
price of our Common Stock. You should carefully consider these risks and
uncertainties, together with all of the other information included or
incorporated by reference in this Annual Report on Form 10-K, before you decide
whether to purchase any of our Common Stock. If any of the risks or
uncertainties we face were to occur, the trading price of our Common Stock
could decline, and you may lose all or part of your investment. We depend on one key customer for a substantial portion of our revenue and the
loss of, or a reduction in, orders from that customer would significantly
reduce our revenue. Approximately 49% of our net sales in fiscal 2004 were to CT for the
automotive quartz rate sensor product used in advanced vehicle stability
control systems. This concentration of sales is expected to expand in fiscal
2005 and beyond. The loss of sales to CT would have a significant negative
impact on our business. CT integrates our sensor product into independently developed products and
markets the integrated systems to various customers in the automobile industry.
In March 2004, we executed a new long-term contract with CT. Under the
contract, we will supply all of CTs new rate sensor product requirements for
brake-related electronic stability control (ESC) systems. The impact of the
contract on long-term revenue and gross margin depends upon negotiated pricing,
customer supplied content, successful development of an enhanced product,
projected cost reductions and market acceptance of ESC, among other factors.
Under certain circumstances, primarily related to our remaining competitive
with our pricing and delivery, CT has the option to terminate the contract. If
they choose to discontinue use of our product in their products or lose
business for their products, it would have a significant negative impact on our
revenue and operating results. Our failure to increase manufacturing capacity in a timely and efficient manner
would have a material negative impact on our sales. We are continuing the process of adding production capacity for our
automotive yaw rate sensors to respond to the expected future demand for
quantities required by the automobile market. In fiscal 2004, we manufactured
approximately 3.8 million units of our automotive quartz rate sensor in our
Concord, California facility, which supplied sensors to new automobiles sold in
the North American, European and Asian markets. In years prior to fiscal 2001,
we encountered difficulties in scaling up production of the GyroChip sensors,
including problems involving production yields, component 11




---



##### Table of Contents



supplies and shortages of qualified personnel. Although many of these
issues were resolved in fiscal 2001, we did incur some yield loss from our
continued ramp-up of unit shipments in 2004. Management expects to continue to increase
manufacturing capacity in fiscal 2005 and beyond. A failure by us to
manufacture and deliver products in a timely fashion could harm our reputation
and cause the loss of potential future sales and we could be liable for
penalties to customers in the event of contract breach for delivery failures.
These types of manufacturing delays can occur for various reasons, including a
lack of manufacturing capacity, the failure of a supplier to provide components
in a timely fashion or with acceptable quality, or an inability by us to
attract and retain qualified manufacturing personnel. There can be no
assurance that future manufacturing difficulties which could have a material
adverse effect on our business, financial condition and results of operations,
will not occur. Any defects in our products may lead to product recalls or significant
liability claims, which could seriously harm our business and our reputation. We have experienced manufacturing quality problems in the past and could
experience similar problems in the future. Certain of our products are
designed for use in critical safety and mission critical systems. During our
continuing efforts to increase manufacturing and production capabilities to
meet market demand, high quality standards for our products must be maintained,
or we risk customer dissatisfaction, damage to our reputation, or significant
liability claims if our products contain undetected errors or inaccuracies. We
attempt to contractually limit exposure to liability claims by customers, but
this may be insufficient in the face of very large claims and does not preclude
all potential claims. As a result, product recalls or significant liability
claims, whether or not successful, could harm our reputation and business. We rely on our primary manufacturing facility to produce a substantial portion
of our products and any disruption of production at that facility would have a
material adverse effect on our business. We manufacture certain products such as quartz rate sensors,
potentiometers and certain shaft encoders using extremely complex proprietary
processes and equipment. The fabrication of these products requires
manufacturing efforts to occur in a highly-controlled and ultra-clean
environment, and accordingly these products are extremely sensitive to changes
in manufacturing conditions. We are largely dependent on our Concord,
California facility to meet the volume of manufacturing required by the
automotive market. In the event of a production disruption, equipment could be
damaged or process disciplines and controls could be temporarily lost, which
would cause us to experience problems achieving acceptable manufacturing rates
and yields. Our corporate headquarters and most of our manufacturing
facilities are located in California. The risk of losses due to an earthquake
in California is significant due to the proximity to major earthquake fault
lines. Any disruption of production could delay product shipments, delay or
decrease our revenues, hurt our customer relationships and harm our reputation
and ability to win future customer agreements. We do not maintain insurance
against earthquake damage. We depend on a limited source of suppliers and any interruption in our supply
of components could cause manufacturing delays, increased costs and a loss of
sales. Although the majority of the components used in our products are available
from multiple sources, several components are built or provided to our
specifications. Such components include quartz, supplied by Sawyer Research
Products, Inc.; Control Area Network (CAN) BUS and microprocessor chip sets,
supplied by Texas Instruments; housings, supplied by C&H Casting and ZSNP as
gold pellets, supplied by Vacuum Engineering & Material Co., Inc.; PWB/case
assemblies, supplied by Kimball Electronics Group; injection molding, supplied
by L. W. Reinhold, Inc.; substrates, supplied by Aurora Circuits, LLC; various
types of ASICs, supplied by National Semiconductor Corporation, Flextronics
Semiconductor, Inc., American Megatrends, Inc. and AMI Semi Conductor, Inc.;
and two types of light emitting diodes (LEDs), supplied by Optek Technology,
Inc. and Opto Diode Corp. Any increase in the cost of the components used in
our products could make our products less competitive and lower our gross
margin. Additionally, our single source suppliers could enter into exclusive
agreements with or be acquired by one of our competitors, increase their
prices, refuse to sell their products to us, discontinue products or go out of
business. To the extent acceptable alternative suppliers are available to us,
identifying them and entering into arrangements with them is difficult and time
consuming, requiring validation of quality standards. Additionally,
consolidations among our suppliers could result in other sole source suppliers.
There can be no assurance that there will not be a significant disruption in
the supply of such components in the future, or in the event of such
disruption, that we will be able to locate alternative suppliers of the
components with the same quality at an acceptable price. An interruption in
the supply of components used in the manufacture of our products, particularly
as we scale up our manufacturing activities could have a material adverse
effect on our business, financial condition and results of operations. 12




---



##### Table of Contents



If we lose key management or technical personnel, we may not be able to
successfully manage our business. We depend, to a significant degree, on the continued contribution of key
management and technical personnel. The loss of the services of one or more
key employees could have a material adverse effect on us. Our success also
depends on our ability to attract and retain additional highly qualified
management and technical personnel. Skilled technical personnel in our
industry are typically in short supply. As a result, competition for these
people is intense and they are often subject to offers from competing
employers, particularly in northern California where certain of our facilities
are located and there is a high concentration of technology companies. There
can be no assurance that we will be able to retain our key employees, or that
we will be able to attract or retain additional skilled personnel as needed.
We do not currently maintain key person insurance on any employee. See
BusinessEmployees. We face significant competition and increased competition could reduce our
sales or cause us to lose market share. The principal competitive factors affecting the market for our products
include product functionality, performance, quality, reliability, price,
compatibility and conformance with industry standards, and changing customer
systems requiring product customization. Several of our existing and potential
competitors, including those noted under Business  Competition, have
substantially greater financial, engineering, manufacturing and marketing
resources than we do. Further, the technologies offered by us may compete for
customer acceptance with technologies offered by other manufacturers, such as
resolvers, inductosyns, magnetic encoders, laser gyros, fiber optic gyros and
silicon gyros. There can be no assurance that other companies will not develop
more sophisticated, more cost-effective or otherwise superior products which
could have a material adverse effect on our business, financial condition and
results of operations. Our future growth depends on our ability to develop new and enhanced products
at competitive prices. The market for our products is affected by rapidly changing technology and
evolving industry standards and the emergence of new technologies and
protocols. We believe that our future success will depend upon our ability to
enhance our existing products and to further develop and introduce new products
that meet a wide range of evolving customer needs and achieve market
acceptance. In particular, we are required to develop an enhanced version of
our automotive quartz rate sensor as part of our agreement to supply product to
CT. Our failure to develop new and enhanced products will negatively impact
our revenue and our business. We have incurred, and we expect to continue to
incur, substantial expenses associated with the introduction and promotion of
new products. We cannot assure you that we will be successful in our efforts
to develop new and enhanced products, or that any new and enhanced products
will achieve market acceptance. Our failure to protect our proprietary technology could result in increased
competition and downward price pressure resulting in a loss of revenues and
profits. Success for us depends, in part, on our ability to protect our
intellectual property. We rely on a combination of patent, copyright,
trademark and trade secret laws to protect our proprietary technologies and
processes. Nevertheless, such measures may not be adequate to safeguard the
proprietary technology underlying our products. In addition, our existing and
future patents could be challenged, invalidated or circumvented, and any right
granted thereunder may not provide meaningful protection to us. The failure of
any patents to provide protection to our technology might make it easier for
competitors to offer similar products and use similar manufacturing techniques.
Despite precautions, it may be possible for a third party to copy or otherwise
obtain and use our products or technology without authorization, develop
similar technology independently or design around those patents issued to us.
In addition, effective patent, copyright, trademark and trade secret protection
may be unavailable or limited outside of the United States, Europe and Japan.
We may not be able to obtain any meaningful intellectual property protection in
such countries and territories. Additionally, we may, for a variety of
reasons, decide not to file for patent, copyright, or trademark protection
outside of the United States. Further, at the request of customers, we
occasionally incorporate a customers intellectual property into designs, in
which case we will have obligations with respect to the non-use and
non-disclosure of that intellectual property. However, the steps taken by us
to prevent misappropriation or infringement of our intellectual property or
that of customers may not be successful. Moreover, costly and time intensive
litigation could be necessary to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of proprietary
rights of others, including customers. 13




---



##### Table of Contents



Our failure to avoid litigation for infringement or misappropriation of
proprietary rights of third parties could result in costly, time-consuming
litigation or even the inability to offer certain products. The industries in which we operate can be characterized by their vigorous
protection and pursuit of intellectual property rights. In this regard, the
invalidity of our patents could be asserted and claims made against us.
Furthermore, in a patent or trade secret action, we could be required to
withdraw certain products from the market or redesign products offered for sale
or under development. We have also entered into certain indemnification
obligations in favor of customers and strategic partners that could be
triggered upon an allegation or finding of infringement of other parties
proprietary rights. Irrespective of the validity or successful assertion of
such claims, we would likely incur significant costs and diversion of resources
with respect to the defense of such claims. To address any potential claims or
actions asserted in opposition, we may seek to obtain a license under a third
partys intellectual property rights. Under such circumstances, a license may
not be available on commercially reasonable terms, if at all. Changes to or failure to comply with government regulations could require us to
redesign our products or cause us to be unable to sell into certain countries
or to certain customers, which could result in a substantial decrease in our
revenue. Certain aspects of the industry in which our products are sold are
regulated both in the United States and in foreign countries. Imposition of
public carrier tariffs, foreign taxation and the necessity of incurring
substantial costs and the expenditure of managerial resources to obtain
regulatory approvals, particularly in foreign countries where safety standards
differ from those in the United States, or the inability to obtain regulatory
approvals within a reasonable period of time, could have a material, adverse
effect on our business, operating results and financial condition. Our
products must comply with a variety of equipment, interface and installation
standards promulgated by regulatory authorities in different countries.
Changes in government policies, regulations and interface standards could
require the redesign of products and result in product shipment delays which
could have a material, adverse impact on our business, operating results and
financial condition. Certain of our exports, such as our GyroChip quartz rate sensors, are
subject to restrictions contained in the State Departments International
Traffic in Arms Regulations and require export licenses in order to be sold
abroad. Non-defense related foreign sales are generally governed by the Bureau
of Export Administration of the U.S. Commerce Department, which also frequently
requires export licenses. We can give no assurance that we will be successful
in obtaining these necessary licenses in order to conduct business abroad. For example, in July 2003, the State Department contacted us, our
customers and other companies in the aviation industry concerning exports and
re-exports of our QRS11 GyroChip quartz rate sensors, which are controlled
under the International Traffic in Arms Regulations. The QRS11 sensors are
used in military and commercial aircraft, among other applications.
Noncompliance with the International Traffic in Arms Regulations could subject
us, our customers and other companies in the aviation industry to criminal,
civil and administrative sanctions. Delays associated with obtaining export
licenses and other approvals, and the inability to obtain export licenses and
other approvals in some cases, could subject us, our customers and other
companies in the aviation industry to financial losses. Although we were able
to work with the appropriate regulatory entities and ensure that exports of
those sensors complied with relevant regulations, the delay in product
shipments as well as the cost of dealing with the regulatory authorities had a
negative impact on our business. We cannot assure you that we will not have
similar issues in the future. Any such regulatory issues may have a material
adverse effect on our business, financial condition and results of operations. We sell a significant portion of our products to U.S. government entities and
the terms of such contracts expose us to greater financial risks. Approximately 9%, 10% and 9% of our net sales in fiscal 2004, 2003 and
2002, respectively, were derived from contracts with the U.S. Government or
under subcontract to other prime contractors to the U.S. Government. Because a
significant portion of our business is derived from contracts with the
Department of Defense or other agencies of the U.S. Government, our business is
sensitive to changes in U.S. Government spending policies that can have
significant variations from year to year. At various times, our results have
been adversely affected by contract cutbacks and there can be no assurance that
our results of operations will not in the future be materially and adversely
affected by changes in U.S. Government procurement policies or reductions in
U.S. Government expenditures for products furnished by us. 14




---



##### Table of Contents



Under applicable regulations, various audit agencies of the U.S.
Government conduct regular audits of contractors compliance with a variety of
U.S. Government regulations. The U.S. Government also has the right to review
retroactively the cost records under most U.S. Government contracts. Contract
prices may be adjusted in the event the U.S. Government determines that we
submitted incomplete, inaccurate or obsolete cost or pricing data. Government
contracts and subcontracts generally provide for either a fixed price,
negotiated fixed price or cost-plus-fixed-fee basis for remuneration. The
majority of our contracts with the U.S. Government are competitive fixed price
or negotiated fixed price contracts, although cost-plus-fixed-fee contracts
provided approximately 2% of our net sales in fiscal 2004. For fixed price
contracts, we bear the risk of cost overruns and derive the benefits from cost
savings. As a result, greater risks are involved under fixed price contracts
than under cost-plus contracts because failure to anticipate technical
problems, estimate costs accurately or control costs during contract
performance may reduce or eliminate the contemplated profit or may result in a
loss. All U.S. Government contracts contain termination clauses that allow the
contract to be terminated either for contractor default or for the convenience
of the U.S. Government. In the event of termination for the convenience of the
Government, the clause typically provides that the contractor will receive
payment for work-in-progress, including profit. To date, termination of our
contracts by the U.S. Government has not had any significant effect on our
financial results. However, no assurance can be given that such terminations
will not have a materially adverse effect on our results of operations in the
future. A high percentage of our sales are overseas and exchange rate fluctuations may
affect our competitiveness or a failure by us to comply with foreign laws may
have a material negative impact on our business. Sales to customers located outside the United States accounted for
approximately 53%, 54% and 50% of our net sales in fiscal 2004, 2003 and 2002,
respectively. Most of these sales were to CT locations in Europe and Japan.
We expect that international sales will continue to represent a significant
portion of our product revenues and that we will be subject to the normal risks
of international sales, such as export laws, currency fluctuations, longer
payment cycles, greater difficulties in accounts receivable collections and
complying with a wide variety of foreign laws. Although we have not previously
experienced significant difficulties under foreign law in exporting our
products, there can be no assurance that we will not experience such
difficulties in the future. In addition, because we primarily invoice our
foreign sales in U.S. dollars, fluctuations in exchange rates could affect
demand for our products by causing our prices to be out of line with products
priced in the local currency. Such difficulties could have a material adverse
effect on our international sales and a resulting material adverse effect on
our business, operating results and financial condition. We rely on our Tijuana, Mexico manufacturing facility to produce some of our
product. If we are unable to produce product in sufficient quantities or with
adequate quality due to risks inherent in operating a facility outside the
United States, we may not be able to fulfill our production commitments to our
customers, which could cause us to lose sales and would harm our reputation. As part of our operating strategy, we manufacture some of our products in
our Tijuana, Mexico facility. In order to continue to lower our costs of
production and increase our gross margins, we plan to increase manufacturing at
this facility. Factors that could result in an interruption of supply from our
Mexican facility or prevent us from increasing our production at the facility
include, but may not be limited to:  
    
    changes in local regulations and government policy;  
    
    inability of third party agencies to provide appropriate individuals to work in our facility;  
    
    inability to expand the size of our facility;  
    
    labor disputes;  
    
    changes in import/export regulations  
    
    infrastructure failures; and  
    
    political instability. 15




---



##### Table of Contents



In the event of an interruption of supply from our Mexican facility, our
reputation may be harmed and we may lose future sales. If our insurance coverage is insufficient to cover possible future property and
casualty loss events, we could suffer a material adverse effect to our
business. It is our policy to insure for certain property and casualty risks
consisting primarily of physical loss to property, business interruptions
resulting from property losses, workers compensation, comprehensive general
liability and auto liability. Insurance coverage is obtained for catastrophic
property and casualty exposures as well as those risks required to be insured
by law or contract. Although we believe that our insurance coverage is
reasonable, significant events such as judicial decisions, legislation,
economic conditions and large losses could materially affect our insurance
obligations and future expense. We do not maintain insurance coverage against
earthquake damage. If we fail to correct certain significant deficiencies in our internal
controls, our ability to provide accurate financial statements could be
impaired and any failure to maintain our internal controls and provide accurate
financial statements would cause our stock price to decrease substantially and
potentially subject us to litigation. We are in the process of instituting changes to our internal control
procedures to satisfy the requirements of the Sarbanes-Oxley Act of 2002, when
and as such requirements become applicable to us. In connection with this
process, we have identified certain significant deficiencies in our internal
controls. (See Item 9A Controls and Procedures for a further discussion of
these deficiencies.) We are devoting substantial resources to improve and
enhance our written policies and procedures and internal controls to remedy
these significant deficiencies. If we fail to correct these significant
deficiencies and maintain adequate internal controls, we may not be able to
provide accurate financial statements and comply with the Sarbanes-Oxley Act of
2002. Any failure to maintain the adequacy of our internal controls and
provide accurate financial statements may subject us to litigation and would
cause the trading price of our Common Stock to decrease substantially. Our stock price has in the past and may continue in the future to
fluctuate, which could result in substantial losses for investors and
significant costs related to litigation. The market price for our Common Stock fluctuated widely in the past. We
anticipate that the market for our Common Stock will continue to be volatile.
This could result in substantial losses for investors. The market price of our
Common Stock may fluctuate significantly in response to a number of factors,
some of which are beyond our control. These factors include:  
    
    quarterly variations in operating results;  
    
    changes in financial estimates by securities analysts;  
    
    announcements by us or our competitors of new product and
service offerings, significant contracts, acquisitions or strategic
relationships;  
    
    publicity about our company, our products and services, our
competitors or the markets in which we compete in general;  
    
    additions or departures of key personnel;  
    
    any future sales of our Common Stock or other securities;  
    
    international political instability, including, for example,
instability associated with military action in Afghanistan and Iraq,
strained relations with North Korea and other conflicts; and  
    
    stock market price and volume fluctuations of publicly-traded
companies in general and in our industry in particular. 16




---



##### Table of Contents



In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may be the target of similar litigation in the future.
Securities litigation could result in significant costs and divert managements
attention and resources, which could seriously harm our business and operating
results. Anti-takeover provisions of our charter documents, Delaware law and our
stockholder rights plan could prevent or delay transactions resulting in a
change in control. Provisions of our certificate of incorporation and bylaws and applicable
provisions of Delaware law may make it more difficult for or prevent a third
party from acquiring control of us without the approval of our board of
directors. These provisions:  
    
    establish a classified board of directors, so that not all members of our board may be elected at one time;  
    
    set limitations on the removal of directors;  
    
    limit who may call a special meeting of stockholders;  
    
    establish advance notice requirements for nominations for
election to our board of directors or for proposing matters that can
be acted upon at stockholder meetings;  
    
    prohibit stockholder action by written consent, thereby
requiring all stockholder actions to be taken at a meeting of our
stockholders;  
    
    provide our board of directors the ability to designate the
terms of and issue new series of preferred stock without stockholder
approval; and  
    
    require holders of at least 80% of our voting power to approve
a business combination between us and a holder of more than 10% of
our voting power. Our board of directors adopted a stockholder rights agreement in September
1997. The terms of this agreement provide for a dividend distribution of one
preferred share purchase right for each outstanding share of our Common Stock,
and each preferred share purchase right entitles the holder to purchase
one-hundredth of a share of our Series A Junior Participating Preferred Stock.
If a person or group acquires, or announces a tender or exchange offer that
would result in the acquisition of, a certain percentage of our assets or
earning power, unless the rights are redeemed by us for $0.001 per right
subject to adjustment as provided in the rights agreement, the rights will
become exercisable by all rights holders, except the acquiring person or group,
for the number of shares of Common Stock equal to the market book value of
twice the purchase price. These rights will cause substantial dilution to a
person or group that attempts to acquire us on terms not approved by our Board
of Directors. These provisions may have the effect of entrenching our management team
and may deprive you of the opportunity to sell your shares to potential
acquirors at a premium over prevailing prices. This potential inability to
obtain a control premium could reduce the price of our Common Stock. Geopolitical military conditions, including terrorist attacks and other acts of
war, may materially and adversely affect the markets in which we operate, our
operations and our profitability. International conflicts such as the war in Iraq and the political turmoil
in the Middle East cause significant uncertainty with respect to U.S. and other
business and financial markets and may adversely affect our business. Although
our military and aerospace business may experience greater demand for products
as a result of increased government defense spending, factors arising (directly
or indirectly) from international conflicts have adversely affected our
business in the past, and may in the future adversely affect our business. 17




---



##### Table of Contents



DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY Our directors and executive officers and their ages as of December 1, 2004
are as follows: Name
    
    Age
    
    PositionCharles Crocker
    
    
    65
    
    
    Chief Executive Officer and Chairman of the
Board of DirectorsDr. Asad Madni
    
    
    57
    
    
    President, Chief Operating Officer and DirectorJohn LaBoskey
    
    
    51
    
    
    Senior Vice President and Chief Financial OfficerRobert R. Corr
    
    
    58
    
    
    Vice President, Treasurer,
Controller and SecretaryDavid Pike
    
    
    51
    
    
    Vice President and General Manager,
Systron Donner Automotive Division.Richard M. Brooks (1)(2)
    
    
    76
    
    
    DirectorC. Joseph Giroir, Jr. (1)(2)(3)
    
    
    65
    
    
    DirectorDr. William G. Howard, Jr. (1)(2)(3)
    
    
    63
    
    
    DirectorJ. Lavon Morton (1)(3)
    
    
    54
    
    
    DirectorGary D. Wrench
    
    
    71
    
    
    Director
   (1)
    
    Member of the Audit Committee(2)
    
    Member of the Compensation Committee(3)
    
    Member of the Nominating & Corporate Governance Committee Directors & Executive Officers Mr. Crocker began serving as a Director in June 1997 prior to the
distribution of our shares of Common Stock (the Distribution) to all
stockholders of our former parent, BEI Electronics, Inc.(Electronics) and
resulting spin-off of the Company from Electronics in September 1997
(Spin-Off). He was a founder of Electronics and was named Chairman of the
Board of Directors of Electronics in October 1974. He continued to serve as a
Director of BEI Medical Systems, Inc. (formerly Electronics prior to September
1997) until the sale of BEI Medical Systems, Inc. in June 2002. Mr. Crocker
has served as Chairman of the Board of Directors since October 1997. Mr.
Crocker assumed the positions of President (in which position he served until
May 2000) and Chief Executive Officer, effective October 1, 1997, after
resigning as President and CEO of Electronics as a result of the Distribution.
Mr. Crocker served as President of Crocker Capital Corporation, a Small
Business Investment Company, from 1970 to 1985, and as General Partner of
Crocker Associates, a venture capital investment partnership, from 1970 to
1990. He currently serves as a director of Franklin Resources, Inc. and its
subsidiary Fiduciary Trust International, Pope & Talbot, Inc. and Teledyne
Technologies, Inc. Mr. Crocker holds a B.S. from Stanford University and a
M.B.A. from the University of California, Berkeley. Dr. Madni was appointed our President and Chief Operating Officer in May
2000. He began serving as a Director and as a Vice President of ours in June
1997 prior to the Distribution and resulting Spin-Off. Dr. Madni was
appointed President of BEI Sensors & Systems Company, Inc. in October 1993,
which was formed by the consolidation of BEI Motion Systems Company and the
BEI Sensors & Controls Group, of which Dr. Madni had been President since
October 1992. Prior to joining Electronics in 1992, he served over 17 years
in various senior level technical and executive positions with Systron Donner
Corporation, a manufacturer of avionics and aerospace sensors and subsystems.
He was most recently Chairman, President and CEO of Systron Donner Corporation,
a subsidiary of Thorn/EMI. Dr. Madnis degrees include a B.S. and M.S. in
Engineering from the University of California, Los Angeles, and a Ph.D. in
Engineering from California Coast University. He is also a graduate of the
Engineering Management Program from the California Institute of Technology, the
AEA/Stanford Executive Institute from Stanford University, and the Program for
Senior Executives from the Massachusetts Institute of Technology, Sloan School
of Management. He is a Chartered Engineer and Fellow of the Institute of
Electrical and Electronics Engineers, Institution of Electrical Engineers,
Institute for the Advancement of Engineering, New York Academy of Sciences,
American Association for the Advancement of Science, American Institute of
Aeronautics and Astronautics, and the International Biographical Association. 18




---



##### Table of Contents



Mr. LaBoskey serves as our Senior Vice President and Chief Financial
Officer. He was appointed Vice President and Chief Financial Officer of BEI
Sensors & Systems Company Inc., in October 1993, which was formed by the
consolidation of BEI Motion Systems Company and the BEI Sensors & Controls
Group, of which Mr. LaBoskey had served as Vice President and Controller since
1992. Prior to joining Electronics in 1992, he served for 7 years as
Controller for Systron Donner Corporation, Microwave Division, a manufacturer
of avionics and aerospace sensors and subsystems. Mr. LaBoskeys degrees
include a Bachelor of Arts from the University of California, Irvine, and a
Masters in Business Administration from the University of Colorado. He is also
a graduate of the Executive Program from the University of California, Los
Angeles, Anderson School of Management. He is a Certified Management
Accountant (CMA) through the Institute of Management Accountants (IMA), and
Certified in Production and Inventory Management (CPIM) through the American
Production and Inventory Control Society (APICS). Mr. Corr was named a Vice President of ours in March 2000. He has served
as our Treasurer, Controller and Secretary since September 1997 and held these
same positions with Electronics prior to the Distribution in September 1997.
Mr. Corr resigned from his positions with Electronics immediately prior to the
Distribution. Mr. Corr served as Secretary of Electronics from February 1995,
served as Controller from November 1989 and served as Treasurer from November
1987 until his resignation immediately prior to the Distribution. From 1978
to 1987, he was employed by AMPEX Corporation, an electronics and magnetic
media company, in various financial positions. From 1975 to 1978, he was an
auditor with Arthur Andersen LLP. Mr. Corr received a B.B.A. from Loyola
University in 1968 and his CPA in 1978 from the State of California. Mr. Pike serves as our Vice President and General Manager, Systron Donner
Automotive Division. Mr. Pike joined Electronics in 1983, and prior to his
present position served in various operational, administrative and financial
positions with BEI Sensors & Systems Company, a subsidiary of ours. Prior to
joining Electronics, he was employed by Coastal Oil & Gas and AFCO Metals in
their respective financial departments. He received a B.A. from Ouachita
Baptist University in 1973 and his CPA in 1979 from the State of Arkansas. Mr. Brooks began serving as a Director in June 1997 prior to the
Distribution and resulting spin-off of the Company from BEI Electronics in
September 1997. From 1987 until his resignation as a result of the
Distribution, he served as a director of Electronics. He is currently an
independent financial consultant. Mr. Brooks holds a B.S. from Yale University
and a M.B.A. from the University of California, Berkeley. Mr. Giroir began serving as a Director in June 1997 prior to the
Distribution and resulting Spin-Off. He was a director of Electronics from
1978 until his resignation as a result of the Distribution. He served as the
Secretary of Electronics from 1974 to early 1995. Mr. Giroir is the sole
member of the law firm Giroir, PLLC. Mr. Giroir is also Chairman of the Board
of the Centennial Bank and Two JJ Ranch, LLC. Mr. Giroir holds a B.A. and a
L.L.B. from the University of Arkansas and a L.L.M. from Georgetown University. Dr. Howard began serving as a Director in June 1997 prior to the
Distribution and resulting Spin-Off. He was a director of Electronics from
December 1992 until his resignation as a result of the Distribution. He is
currently an independent consulting engineer in microelectronics and
technology-based business planning. From 1987 to 1990, Dr. Howard served as
Senior Fellow of the National Academy of Engineering and, prior to that time,
held various technical and management positions with Motorola, Inc., most
recently as Senior Vice President and Director of Research and Development. He
currently serves as director of RAMTRON International Corp., Credence Systems,
Inc., Thunderbird Technologies, Inc., Xilinx, Inc., and Innovative Micro
Technology, Inc. Dr. Howard holds a B.S.E.E. and a M.S. from Cornell
University and a Ph.D. in electrical engineering and computer sciences from the
University of California, Berkeley. Mr. Morton began serving as a Director in
January 2003. He is Vice President Tax and Chief Internal Auditor for Arkansas
Best Corporation, a transportation company. Mr. Morton has been responsible
for the Audit and Tax Departments of that company since January 1, 2000. From
1997 to 1999, Mr. Morton was Vice-President Financial Reporting of Arkansas
Best Corporation. His responsibilities in that position included financial
statements contained in annual and quarterly SEC filings. From 1984 to 1996,
Mr. Morton served as a Partner in Ernst & Young LLP or its predecessors.
During that time, Mr. Morton served as engagement partner on a number of SEC
registrants, including manufacturing companies. Mr. Morton served as
engagement partner on the audit of Electronics from 1984 to 1990 and from 1994
to 1996. Mr. Morton received a B.B.A. from the University of Central Arkansas
in 1972 and his CPA in 1974 from the State of Arkansas. Mr. Wrench began serving as a Director in June 1997 prior to the
Distribution and resulting Spin-Off. He was Senior Vice President and Chief
Financial Officer of Electronics from July 1993 until his resignation as a
result of the Distribution, and held these same positions with us until his
retirement in May 2000. Mr. Wrench was named a Director of Electronics in 19




---



##### Table of Contents



February 1986. He continued to serve as a Director of BEI Medical
Systems, Inc. (formerly Electronics prior to September 1997) until the sale of
BEI Medical Systems, Inc. in June 2002. From April 1985 to July 1993, he
served as Vice President of Electronics and President and Chief Executive
Officer of BEI Motion Systems Company, Inc., then a wholly owned subsidiary of
Electronics that is now a part of the Company. Mr. Wrench holds a B.A. from
Pomona College and a M.B.A. from the University of California, Los Angeles. Staggered Board of Directors We have a staggered Board of Directors, which may have the effect of
deterring hostile takeovers or delaying changes in control of our management.
For purposes of determining their term of office, directors are divided into
three classes, with the term of office of the Class I directors to expire at
the 2007 annual meeting of stockholders, the term of office of the Class II
directors to expire at the 2005 annual meeting of stockholders and the term of
office of the Class III directors to expire at the 2006 annual meeting of
stockholders. Class I consists of Mr. Crocker and Mr. Morton; Class II
consists of Mr. Giroir, Dr. Madni and Mr. Wrench; and Class III consists of Mr.
Brooks and Dr. Howard. Directors elected to succeed those directors whose
terms expire will be elected to a three-year term of office. All directors
hold office until the next annual meetings of stockholders at which their terms
expire and until their successors have been duly elected and qualified.
Executive officers serve at the discretion of the Board. There are no family
relationships between any of the officers and directors. 20




---



##### Table of Contents



ITEM 2. PROPERTIES Our principal executive offices are located in leased office space in San
Francisco, California under a lease that expires in 2006. We own or operate
ten other facilities that relate to our business and maintain office space in
various locations throughout the United States and in Europe for sales and
technical support. None of the owned principal properties is subject to any
encumbrance material to our consolidated operations. Management believes that
its existing owned or leased facilities are adequate to meet our needs for the
foreseeable future. We have identified a property as excess space. See Note 14 to the
consolidated financial statements. In addition to our executive offices, our principal facilities are as
follows: Location
    
    Description of FacilityConcord, California
    
    Own approximately 101,000 square foot
manufacturing, engineering and administrative
facilities.Maumelle, Arkansas
    
    Own approximately 54,000 square foot
manufacturing, engineering, administrative and
research and development facility.Goleta, California
    
    Own approximately 33,000 square foot
manufacturing, engineering and administrative
facility.Tustin, California
    
    Lease approximately 80,000 square foot
manufacturing, engineering and administrative
facility.Sylmar, California
    
    Lease approximately 74,000 square foot facility
of which approximately 6,000 square feet is used
for engineering and administrative facility; the
remainder is subleased to third parties.Tijuana, Baja California
    
    Lease approximately 52,000 square foot
manufacturing, and administrative space.Irvine, California
    
    Lease approximately 42,000 square foot
manufacturing, engineering and administrative
facility.Strasbourg, France
    
    Lease approximately 19,000 square foot
manufacturing, engineering and administrative
facility.Hayward, California
    
    Lease approximately 15,000 square foot
manufacturing, research and development facility.Vista, California
    
    Lease approximately 29,000 square foot
manufacturing, engineering and administrative
facility.
 21




---



##### Table of Contents



ITEM 3. LEGAL PROCEEDINGS During fiscal 2002, BEI Defense Systems, a subsidiary of ours with
discontinued operations, was subject to litigation with a former landlord
regarding damages to real property formerly leased. The United States District
Court for the Western District of Arkansas entered a judgment, including
attorneys fees, of approximately $0.7 million against us. We filed an appeal
of the judgment in the United States Court of Appeals for the Eighth Circuit.
Due to the uncertainty of success in the appeal, we reserved $0.7 million for
this judgment during the fiscal quarter ended June 29, 2002. In early February
2004, the appeals court issued an opinion reversing the district courts
judgment in part and remanding one of the claims to the district court for
further consideration consistent with the appeals courts opinion. In March
2004, the United States Court of Appeals for the Eighth Circuit denied a motion
for rehearing. We recorded the reduced judgment against us reflected in the
Appeals Court ruling and the reserve was adjusted to approximately $0.1 million
for the anticipated final liability and related legal fees. At the end of fiscal 2004, we were added as a party to several currently
pending lawsuits relating to an explosion, in 2000 at a third partys
facilities, of hazardous materials allegedly provided by us. We have notified
our insurance carrier of these lawsuits and the carrier has agreed to assume
our defense in these matters. We have not recorded any reserves for these
matters due to their early stage and our insurance coverage. We have other various pending legal actions arising in the normal course
of business. Management believes that none of the legal actions not already
recognized in the financial statements as material, individually or in the
aggregate, will have a material impact on our business, financial condition or
operating results. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 22




---



##### Table of Contents



PART II 
  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES Our common stock commenced regular way trading on the NASDAQ National
Market System under the symbol BEIQ on October 8, 1997. Set forth below are
the high and low closing sale prices on the National Market System for the
periods indicated. Such quotations do not reflect retail mark-ups, markdowns
or commissions. 2004 Fiscal Year
    
    
    
    
    
    
    
    
    
    Cash Dividend(ended 10/02/04)
    
    High
    
    Low
    
    DeclaredFourth Quarter
    
    $
    30.00
    
    
    $
    21.82
    
    
    $
    0.01Third Quarter
    
    $
    29.62
    
    
    $
    20.20
    
    
    $
    0.01Second Quarter
    
    $
    24.75
    
    
    $
    18.80
    
    
    $
    0.01First Quarter
    
    $
    20.94
    
    
    $
    15.15
    
    
    $
    0.02
 2003 Fiscal Year
    
    
    
    
    
    
    
    
    
    Cash Dividend(ended 9/27/03)
    
    High
    
    Low
    
    DeclaredFourth Quarter
    
    $
    16.68
    
    
    $
    11.55
    
    
    $
    0.01Third Quarter
    
    $
    12.34
    
    
    $
    8.27
    
    
    $
    0.01Second Quarter
    
    $
    12.15
    
    
    $
    8.83
    
    
    $
    0.01First Quarter
    
    $
    15.00
    
    
    $
    9.16
    
    
    $
    0.01
 As of December 8, 2004, there were approximately 5,200 participants in
security position listings of our common stock. The Board of Directors
declared, and we paid, cash dividends per share of common stock noted above in
fiscal 2004 and 2003. Payment of dividends is within the discretion of our
Board of Directors, will be subject to periodic review and will depend, among
other factors, upon our earnings, capital requirements, operating results and
financial condition from time to time. There are no restrictions on our
ability to pay dividends provided the covenants set forth in our bank credit
agreement and Senior Note Agreement are met (see Managements Discussion and
Analysis of Financial Condition and Results of Operations  Liquidity and
Capital Resources and Note 4 to the Consolidated Financial Statements). The
covenants primarily concern certain operating ratios and minimum balances of
tangible net worth. We were in compliance with these covenants in fiscal 2004. A regular quarterly dividend of $0.01 per share was declared November 17, 2004
to stockholders of record on December 1, 2004. On August 14, 2002, the Company publicly announced that its Board of
Directors had approved the repurchase by the Company, in the open market or in
privately negotiated transactions, of an additional 300,000 shares of the
Companys Common Stock. The repurchases may be made either from the Companys
cash funds or from other available sources. The program has no expiration date
but may be terminated at any time at the Boards discretion. 41,087 shares
were purchased in fiscal 2004, bringing the balance of shares available for
purchase under the program to 283,821. Since the program was announced, a total
of 1,216,179 shares have been repurchased at an aggregate cost of $12,661,021. In accordance with the Companys 1997 Equity Incentive Plan (1997 Plan),
any employee, director or consultant to whom a stock award is granted may
satisfy any federal, state or local tax obligation relating to the exercise or
acquisition of stock under a stock award by authorizing the Company to withhold
shares from the shares of common stock otherwise issuable as a result of the
exercise or acquisition of stock under the stock award. Accordingly, the
following shares have been repurchased by the Company to satisfy employee,
director or consultant tax obligations relating to the exercise or acquisition
of stock under a stock award: 23




---



##### Table of Contents



(d)Maximum(c) Total number
    
    number ofof shares
    
    shares thatpurchased as
    
    may yet be(a) Total
    
    
    
    
    
    part of a
    
    purchasednumber of
    
    (b) Average
    
    publicly
    
    under theshares
    
    price paid per
    
    announced plan
    
    plan orpurchased
    
    share ($)
    
    or program
    
    programJuly 4, 2004  August 2, 2004
    
    
    0
    
    
    
    0.00
    
    
    
    
    
    
    
    August 3, 2004  September 1, 2004
    
    
    7,536
    
    
    $
    24.42
    
    
    
    
    
    
    
    September 2, 2004  October 2, 2004
    
    
    9,913
    
    
    $
    26.91Total
    
    
    17,449
    
    
    $
    25.58
    
    
    
    
    
    
    
    
 24




---



##### Table of Contents



SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS Number of securitiesremaining available forNumber of securities to be
    
    
    
    
    
    future issuance under equityissued upon exercise of
    
    Weighted-average exercise
    
    compensation plansoutstanding options, warrants
    
    price of outstanding options,
    
    (excluding securitiesPlan Category
    
    and rights
    
    warrants and rights
    
    reflected in column (a))(a)
    
    (b)
    
    (c)Equity compensation plans
approved by security
holders:1997 Equity Incentive Plan
    
    
    374,310
    
    
    
    11.47
    
    
    
    695,639Equity compensation plans
not approved by security
holders:None
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    374,310
    
    
    $
    11.47
    
    
    
    695,639
 25




---



##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The selected financial data for the five fiscal years presented below is
derived from our audited Consolidated Financial Statements. The data should be
read in conjunction with the Consolidated Financial Statements and their
related Notes, and the other financial information included therein. Years EndedOctober 2,
    
    September 27,
    
    September 28,
    
    September 29,
    
    September 30,2004
    
    2003
    
    2002
    
    2001
    
    2000(amounts in thousands
except per share amounts)Statement of Operations Data:Net sales
    
    $
    281,300
    
    
    $
    213,674
    
    
    $
    185,638
    
    
    $
    238,985
    
    
    $
    219,216Income (loss) from
continuing operations
    
    
    11,643
    
    
    
    5,565
    
    
    
    (8,806
    )
    
    
    11,717
    
    
    
    9,607Diluted income (loss) from
continuing operations per
share
    
    
    0.80
    
    
    
    0.39
    
    
    
    (0.63
    )
    
    
    0.81
    
    
    
    0.65Shares used in computing
diluted income (loss) per
share
    
    
    14,638
    
    
    
    14,291
    
    
    
    13,993
    
    
    
    14,444
    
    
    
    14,807Dividends per common share
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.04
    
    
    
    0.075
    
    
    
    0.04Balance Sheet Data:Working capital
    
    $
    38,632
    
    
    $
    37,783
    
    
    $
    36,551
    
    
    $
    43,764
    
    
    $
    41,808Total assets
    
    
    152,568
    
    
    
    133,453
    
    
    
    127,166
    
    
    
    146,357
    
    
    
    138,288Long-term debt (excluding
current portion)
    
    
    10,639
    
    
    
    17,494
    
    
    
    22,500
    
    
    
    29,556
    
    
    
    36,614Stockholders equity
    
    
    72,735
    
    
    
    58,641
    
    
    
    52,359
    
    
    
    60,320
    
    
    
    49,096
 26




---



##### Table of Contents



ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those discussed
in, or implied by, these forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in this section and in the BusinessRisk Factors section of this
Report. See Critical Accounting Policies and the Use of Estimates for a
description of our critical accounting policies. Overview We are a global leader in the design, development, engineering,
manufacture and marketing of intelligent sensors, sensor-based systems,
actuators and motors for use in precision motion control applications. Most of
our sensors measure physical motion and provide information that is essential
to logical, safe and efficient operation of sophisticated machinery. We
believe that we have competitive advantages through our proprietary
technologies and processes, manufacturing capabilities, brand recognition and
highly skilled employees. We are recognized for our applications engineering
expertise and our ability to design and manufacture sophisticated sensors and
sensor based systems in high volume with superior quality. We believe we are a
leader in the commercialization of advanced sensor products and emerging
technologies such as our quartz micromachined inertial sensors. Our products include gyroscopes, position sensors, optical encoders,
brushless DC motors, magnetic actuators, accelerometers, rate sensors, inertial
measurement units and sensor-based systems and sub-systems. Our brand names
are well recognized in their respective markets, and we have a portfolio of
unique technological capabilities that we strive to renew and expand through
ongoing research and development. As the worldwide demand for automotive
sensors for advanced safety applications has grown significantly, we continue
to increase production of our MEMS quartz rate sensor, the GyroChip.
Currently, the annual production rate of the GyroChip exceeds 3.8 million
units. Since 1994, we have supplied in excess of 10 million units. These
sensors are employed in vehicle dynamic control systems that help prevent
spinout and reduce the chance for rollover in a growing number of automotive
platforms. We generate revenue through operations that design, manufacture and sell
electronic devices for the commercial automotive, industrial and government
industries. The percentage of sales to major industries are as follows: Fiscal Year EndedOctober 2, 2004
    
    September 27, 2003
    
    September 28, 2002Automotive and transportation
    
    
    61
    %
    
    
    56
    %
    
    
    51
    %Industrial and commercial
    
    
    30
    %
    
    
    34
    %
    
    
    40
    %Aerospace and defense
    
    
    9
    %
    
    
    10
    %
    
    
    9
    %
 During March 2004, we executed a long-term contract for automotive rate
sensor products with our largest customer, CT. Under the new contract, we have
agreed with CT on a substantial extension of our strategic business
relationship. We will supply all of CTs rate sensor product requirements for
brake-related ESC systems. The impact of the contract on long-term revenue and
gross margin depends upon negotiated pricing, customer supplied content,
projected cost reductions and market acceptance of ESC, among other factors.
CT will continue to take delivery on the prior contract for an aggregate of 9.3
million units for the sensor module assembly to complete the contract, which
expires in 2006. As we are shifting emphasis to high volume sensor and package
production, we will sell and transfer our cluster final assembly and test line
to CT to enable them to perform those functions. At the point when the shift
occurs, revenue and related costs will decrease; however, net margins will not
be significantly impacted. We are actively expanding our business through organic growth,
acquisitions of, or investments in, companies, product lines or technologies,
with an emphasis on increasing our military and industrial revenue. For
example, in 2002, we formed a strategic relationship and made an investment in
Athena Technologies, Inc., a provider of advanced flight controls systems for
the UAV market. This relationship allows us to provide advanced competitive
solutions in emerging markets including commercial avionics, attitude heading
and reference systems, aerial targets and unmanned vehicles, guided munitions,
automotive control systems, and industrial control systems. This is part of
our strategy to use our low cost, high volume 27




---



##### Table of Contents



automotive sensor expertise in developing sophisticated applications for
the aerospace, defense, industrial and commercial markets. Net sales outside North America represented approximately 53% of total net
sales for the fiscal year period ending October 2, 2004. The majority of those
sales were to CT and accounted for 49% of total net sales for the fiscal year
ending October 2, 2004. We have derived and expect to continue to derive a
majority of sales from products outside the United States. The vast majority
of these sales are denominated in U.S. dollars. In fiscal 2004, we generated record revenue levels. During this period,
automotive and transportation sensor sales increased 44%, industrial and
commercial sales increased 18% and aerospace and defense sales increased 10%
over the prior year. We plan to focus on lowering costs and increasing gross
margin by a continued increase in manufacturing offshore. We also plan to
strengthen our existing business by continuing to negotiate long-term
contracts, adding long-term business by securing production contracts for new
products (such as a NCAPS and BTS) and developing strategic relationships with
larger corporate partners for long-term sales of multiple sensor product
offerings. Results of Operations The following table sets forth, for the fiscal periods indicated, the
percentage of net sales represented by certain items in our Consolidated
Statements of Operations. Years Ended2004
    
    2003
    
    2002Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    76.4
    
    
    
    75.4
    
    
    
    72.4Gross margin
    
    
    23.6
    
    
    
    24.6
    
    
    
    27.6Operating expenses:Selling, general and administrative expenses
    
    
    12.0
    
    
    
    14.7
    
    
    
    16.6Research, development and related expenses
    
    
    5.2
    
    
    
    7.2
    
    
    
    8.3Provision for excess capacity
    
    
    (0.1
    )
    
    
    0.6
    
    
    
    5.5Provision for uncollectables from a related party
    
    
    0.0
    
    
    
    0.0
    
    
    
    1.7Provision for product line move and other
    
    
    0.0
    
    
    
    0.0
    
    
    
    1.2Income (loss) from operations
    
    
    6.5
    
    
    
    2.1
    
    
    
    (5.7
    )Other income (expense)
    
    
    0.3
    
    
    
    2.7
    
    
    
    (0.9
    )Interest expense
    
    
    (0.5
    )
    
    
    (0.9
    )
    
    
    (1.2
    )Income (loss) before income taxes
    
    
    6.3
    
    
    
    3.9
    
    
    
    (7.8
    )Provision (benefit) for income taxes
    
    
    2.2
    
    
    
    1.4
    
    
    
    (3.1
    )Net income (loss)
    
    
    4.1
    %
    
    
    2.5
    %
    
    
    (4.7
    )%
 Net Sales During fiscal 2004 our net sales increased 31.6% to $281.3 million from
$213.7 million in fiscal 2003. The sales volume increase was primarily due to a
44.0% increase in automotive revenue to $171.5 million compared with $119.1
million in fiscal 2003. Automotive revenue increased due to larger GyroChip
sensor shipments to CT due to improved consumer acceptance of stability control
systems and the launch of new platforms with an increasing amount of multi axis
roll stability control systems. Future revenue from automotive customers is
dependent on demand for stability control systems, and on our ability to supply
a cost competitive product in volume. Industrial revenue increased by 18% to
$85.8 million from the prior year level of $72.7 million due largely to
stronger demand for potentiometers used in heavy equipment, industrial encoders
and quartz products for commercial aviation. Government aerospace and defense
sales increased 10% to $24.0 million from $21.8 million due to higher sensor
sales to space and military programs and inertial sensor applications. During fiscal 2003 our net sales increased 15.1% to $213.7 million from
$185.6 million in fiscal 2002. The sales volume increase was primarily due to
increased commercial sales to domestic and foreign automotive customers, and to
a lesser extent 28




---



##### Table of Contents



government sales. Sales to the automotive industry, including sales of
our GyroChip sensors, increased 25.8% to $119.2 million from $94.7 million in
fiscal 2002 due to the launch of new platforms into the North American and
European markets and an increase in quantities shipped and engineering
development billings of $3.0 million to our largest customer. Sales to other
industrial customers decreased $1.3 million to $72.7 million from $74.0 million
during fiscal 2003 resulting primarily from continued weakness in factory
automation. Government related sales increased $4.9 million in fiscal 2003 to
$21.8 million from $16.9 million during fiscal 2002 primarily from increased
military based sensor shipments. Our sales to international customers were approximately 53%, 54% and 50%
of our net sales for fiscal 2004, 2003 and 2002, respectively. The slight
change in international sales in fiscal 2004 is the result of domestic customer
demand growing faster than international customer demand for GyroChips. The
increase in international sales in fiscal 2003 is attributable to the launch of
new automotive platforms with stability control systems and an increase in
quantities shipped for older platforms. Cost of Sales and Gross Margin In
fiscal 2004 cost of sales as a percentage of net sales increased 1.0%
primarily due to a settlement with a customer of $1.6 million recorded in the
fourth quarter and a higher automotive product mix with its continued lower
associated average margins. The average cost of sales for Gyrochip automotive products,
which doubled from 1.9 million units shipped in fiscal 2002 to 3.8 million
units shipped in fiscal 2003, was impacted by yield losses from this
significant ramp-up. This was offset by the recovery of previously expensed
scrap costs from two vendors in the second quarter of fiscal 2004 and to lower
cost of sales as more industrial products were manufactured offshore. There
may be additional margin rate variability in future years due to the
introduction of new products, changes in product pricing, negotiation of
development revenues and changes in manufacturing processes, volumes and
product life cycles. Management continues to undertake technological
initiatives designed to increase manufacturing and production efficiencies and
attempts to maintain close relationships with vendors and customers in an
effort to reduce costs and increase margins. In fiscal 2003 cost of sales as a percentage of net sales increased 3.0%
due to a higher automotive product mix with lower associated margins, higher
overhead spending associated with GyroChip capacity expansion not yet fully
absorbed, additional inventory reserves at our facilities, the impact of low
yields associated with model launches and scrap issues with two automotive
vendors. Selling, General and Administrative Expenses Selling,
general and administrative expenses in fiscal 2004 increased $2.3
million from $31.4 million in fiscal 2003 to $33.7 million due primarily to
costs related to the support of the higher revenue base across all product
lines and costs associated with preparing for the new reporting requirements of
the Sarbanes-Oxley Act of 2002. Partially offsetting these increases was a
reduction in spending on legal proceedings in the current fiscal year.
Management believes that the cost to comply with the Sarbanes-Oxley Act of 2002
will be greater in fiscal 2005 than in fiscal 2004. Selling, general and administrative expenses in fiscal 2003 increased $0.5
million from $30.9 million in fiscal 2002 to $31.4 million. Included in
selling, general and administrative expense was the legal expense recovery of
$3.5 million associated with the favorable settlement of our patent
infringement litigation against a competitor. More than offsetting this
recovery was increased spending primarily due to the legal costs associated
with the patent infringement litigation settlement of $2.7 million and other
spending of $1.3 million to support higher revenue. As a percentage of sales,
selling, general and administrative expenses decreased 2.7 percentage points to
12.0% in fiscal 2004 from 14.7% in fiscal 2003 primarily due to increased sales
revenue. Research, Development and Related Expenses Research and development expenses in fiscal 2004 decreased $0.7 million to
$14.6 million from $15.3 million in fiscal 2003 due to our reduced silicon
development efforts in 2004. Research and development expenses in fiscal 2003 decreased $0.1 million to
$15.3 million from $15.4 million in fiscal 2002. Research and development
expenditures were constant due to managements dedication to the development of
new and enhanced products, such as the next generation quartz automotive gyro
sensor, NCAPS torque sensors and improvements to other existing product
families. 29




---



##### Table of Contents



Management remains dedicated to the development of new and enhanced
products. We believe that the continued timely development of new products and
enhancements to our existing products is essential to maintaining our
competitive position. Accordingly, we anticipate that expenses associated with
such efforts will increase in absolute amount, but may fluctuate as a
percentage of sales depending on our success in acquiring customers or, in some
cases, U.S. Government contracts funding research and development efforts. Related Party Expense and Financing In August 2003, we entered into a tender offer (the Tender Offer) to
purchase the outstanding common shares of OpticNet, Inc. (OpticNet) at $0.04
per share (at an aggregate cost of approximately $0.2 million). Upon
completion in December 2003, we terminated the registration of OpticNets
common stock under the Securities Exchange Act of 1934, as amended (the
Exchange Act). See Note 11 for a further description of our relationship with
OpticNet. Provisions In fiscal 2004, the reserve for the impairment of silicon gyro and
development equipment was adjusted by $0.2 million. The reserve was reevaluated
based on managements updated analysis related to the
anticipated net proceeds from the sale of the equipment. In fiscal 2003,
we recognized a provision for the impairment of silicon gyro research and
development equipment of approximately $1.2 million related to excess capacity.
Silicon gyro designs will continue to be evaluated, but we will not continue
to operate our silicon fabrication facility in Hayward, California. We believe
that continuing progress with quartz technology will remain competitive in
future years. Interest Expense and Other Income Interest expense was $1.3 million, $1.9 million and $2.3 million in fiscal
2004, 2003 and 2002, respectively. Interest expense as a percentage of sales
decreased in fiscal 2004 as compared to fiscal 2003 due to reduced debt levels
and lower interest rates on our line of credit as compared to the senior notes.
Our fixed interest rate debt decreased in fiscal 2004 due to a principal
payment on long-term debt in November 2003. In addition, during fiscal 2004 we
borrowed on, and fully repaid, our line of credit as described under Liquidity
and Capital Resources below. Other
income decreased $5.1 million in fiscal 2004 due to several events
that occurred in fiscal 2003 but did not recur in fiscal 2004. These events
included the favorable settlement in fiscal 2003 of litigation with the U.S.
Government regarding the H70 contract of $5.4 million, the favorable settlement
of litigation with a competitor regarding patent infringement of certain quartz
technologies of $2.1 million, net of legal recovery, partially offset by the
uncollectability write off of $1.0 million for funding provided to OpticNet and
the $1.5 million impairment charge of our investment in Athena Technologies. 30




---



##### Table of Contents



Income Taxes Our effective tax rate was 34.7%, 35.1 and 39.6% for fiscal 2004, 2003 and
2002, respectively. The effective tax rate primarily reflects the statutory
U.S. federal tax rate and the weighted average tax rate of the states in which
we conduct business. The net decrease of 0.4% in fiscal 2004 from fiscal 2003
results from many factors including: the relative proportion of tax credits
generated to pre-tax book income for 2004, the true-up of estimator
prior year items, decreased export sales benefit
generated in the current year, and a decrease in the valuation allowance. Other
factors may have favorable and unfavorable effects upon our effective tax rate
in 2005 and subsequent years. These factors include, but are not limited to,
interpretations of existing tax law, certain provisions of the American Jobs
Creation Act, which was passed into law on October 22, 2004, and future levels
of research and development spending. Deferred Income Taxes At October 2, 2004, we had net deferred income tax assets of $10.4 million.
Realization of the net deferred tax assets is dependent upon our ability to
either carry back the reversal of the underlying temporary differences and
obtain a refund of taxes previously paid, or generate sufficient taxable income
in future years to benefit from the reversal of the underlying temporary
differences. Based on our historical information and all currently available
information about future years, we believe there exists a sufficient amount of
present or future taxable income to realize the tax benefit of these deferred
assets. We generated approximately $12.7 million of taxable income in fiscal
2004 and $7.1 million in fiscal 2003. Liquidity and Capital Resources During fiscal 2004, our operations provided $16.2 million in cash. Cash
provided by operations included net income of $11.6 million plus non-cash
charges for depreciation, amortization, and impairment of investments of $8.2
million, $1.9 million, and $0.3 million, respectively. Cash was used to
increase inventory by $6.8 million, primarily in the support of increased sales volumes to some
customers. Cash used by operations also included an increase in trade
receivables of $8.5 million and an increase in other current assets of $2.7
million related to increased operational activities. Offsetting these negative
impacts were increases in trade accounts payable, accrued expenses and other
liabilities of $11.9 million, also to support the increased business activity
levels. Our investing activities in fiscal 2004 consisted primarily of the
purchase of $11.9 million in capital equipment used mainly to expand production
capacity of our GyroChip automotive product line. This cash outflow was offset
by the receipt of $1.5 million in cash from the disposal of equipment and the
sale of a product line, resulting in net cash used by investing activities of
$10.4 million. Fiscal 2004 financing activities primarily consisted of debt payments of
$13.4 million, which consisted of $7.0 million in principal paid on senior
notes payable, $1.8 million paid to refinance an existing mortgage note payable
and $4.6 million paid on our line of credit. Other cash used by financing
activities included cash purchases of our stock at open market prices for $0.9
million and dividend payments of $0.7 million. These cash outflows were
primarily offset by proceeds from recurring borrowing on our line of credit of
$4.6 million, $1.6 million from refinancing the mortgage note payable and
proceeds of $1.3 million from stock issuances related to the exercise of
options granted under our 1997 Equity Incentive Plan, resulting in net cash
used for financing activities of $6.8 million. While we believe that our available credit line and cash derived from
operations will be sufficient to meet our capital requirements for the next
twelve months, we may need to raise additional funds through public or private
financings or other arrangements. See Note 17 Subsequent Events for detail
on our acquisition of Newall Measurement Systems, Ltd. Revenue and
profitability may be negatively impacted if there is a decline in the
industrial economy. There can be no assurance that we will not require
additional funding, or that such additional funding, if needed, will be
available on terms attractive to us, or at all. Any additional equity
financing may be dilutive to our stockholders, and debt financing, if
available, may involve restrictive covenants. 31




---



##### Table of Contents



We
had the following contractual obligations as of October 2, 2004: Payments due by periodLess than
    
    1-3
    
    
    
    
    
    More than 5Contractual Obligations
    
    Total
    
    1 year
    
    years
    
    3-5 years
    
    yearsLong-term debt obligations
    
    $
    15,477
    
    
    $
    7,104
    
    
    $
    7,104
    
    
    $
    1,269
    
    
    $
    Capital lease obligations
    
    
    2,855
    *
    
    
    230
    
    
    
    458
    
    
    
    456
    
    
    
    1,711Operating lease obligations
    
    
    6,238
    
    
    
    3,530
    
    
    
    1,452
    
    
    
    1,024
    
    
    
    232Other long term
liabilities reflected on
the consolidated balance
sheet under GAAP
    
    
    2,783
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Purchase
Obligations
    
    
    6,500Total
    
    $
    33,853
    
    
    $
    10,864
    
    
    $
    9,014
    
    
    $
    2,749
    
    
    $
    1,943
 * The amount disclosed
includes amounts representing interest of $0.4 million as
at October 2, 2004. See Note #9 to the consolidated financial
statements for details. Effects of Inflation Management believes that, for the periods presented, inflation has not had
a material effect on our operations. Critical Accounting Policies And The Use Of Estimates Managements discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. We review the accounting policies used in reporting
its financial results on a regular basis. The preparation of these consolidated
financial statements requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses and
related disclosure of contingent assets and liabilities. The estimates are
based on historical experience and on various other assumptions that management
believes to be reasonable under the circumstances. On an ongoing basis, we
evaluate our estimates. Results may differ from these estimates due to actual
outcomes being different from those on which we based our assumptions. The United States Securities and Exchange Commission (SEC) has defined
critical accounting policies as those that are most important to the portrayal
of an issuers financial condition and results of operations and require
management to make the most difficult and subjective judgments, often as a
result of the need to make estimates on matters that are inherently uncertain.
Based upon this definition, we believe the following critical accounting
policies affect its more significant judgments and estimates used in the
preparation of our consolidated financial statements. Allowance for Doubtful Accounts We continuously monitor collections and payments from our customers and
maintain allowances for doubtful accounts based upon historical experience and
any specific customer collection issues that we have identified. While such
credit losses have historically been within managements expectations, there
can be no assurance that we will continue to experience the same relative level
of credit losses as in the past. In addition, although our sales have
historically been to many customers in a variety of markets, in recent periods,
one automotive customer accounted for a significant portion of our net sales.
A significant change in the liquidity or financial position of that customer or
a further deterioration in the economic environment in general could have a
material adverse impact on the collectability of our accounts receivable and
future operating results, including a reduction in future revenues and
additional allowances for doubtful accounts. If, at the time of shipment, we
determine that collection of a receivable is not reasonably assured, the
revenue is deferred and recognized at the time collection becomes reasonably
assured, which is generally upon receipt of payment. 32




---



##### Table of Contents



Inventories Inventories are carried principally at the lower of cost or fair value and
does not exceed net realizable value. Cost is determined by the first-in,
first-out (FIFO) method, including material, labor and factory overhead. We
provide a reserve against our inventory for estimated obsolescence for the
difference between the cost of inventory and the estimated market value based
upon assumptions about future demand and market conditions. If actual future
demand or market conditions are less favorable than those projected by
management, additional inventory write-downs may be required. Our inventories are evaluated for obsolescence and excess quantity at
least annually, with quarterly updates for the most significant operations. Long-Lived and Intangible Assets and Goodwill Management reviews goodwill and intangible assets with indefinite useful
lives for impairment on an annual basis or more regularly if an event occurs
that represents an indicator of possible impairment. All other long-lived and
intangible assets are reviewed for impairment whenever events or circumstances
indicate that the carrying amount of the asset may not be recoverable. An
impairment loss would be recognized based on the difference between the
carrying value of the asset and its estimated fair value, which would be
determined based on undiscounted cash flows estimated to be generated by those
assets. The evaluation of goodwill and intangibles with indefinite useful
lives for impairment requires management to use significant judgments and
estimates including, but not limited to, projected future revenue, operating
results and cash flows. Although management currently believes that the estimates used in the
evaluation of goodwill and intangibles with indefinite lives are reasonable,
differences between actual and expected revenue, operating results and cash
flow could cause these assets to be deemed impaired. If this were to occur, we
would be required to charge to earnings the write-down in value of such assets,
which could have a material adverse effect on our results of operations and
financial position. Equity Investments We record our equity investments in private companies on the cost basis if
we own less than 20% of the outstanding equity of the investee company and no
other control factors are present. We periodically evaluate the fair market
value of our equity investment to determine if an other-than-temporary
impairment in the value of our investment has taken place. Litigation We reserve for legal claims when payments associated with the claims
become probable and can be reasonably estimated. Due to the difficulty in
estimating costs of resolving legal claims, actual costs may be substantially
different than the amounts reserved. Provision for Excess Capacity, Uncollectables from a Related Party and Product
Line Move and Other During the quarter ended March 30, 2002, we established reserves for portions
of assets held under leases and owned in excess of requirements, receivables
from a related party and the closure of a specific manufacturing facility, as
discussed in Note 14 to our consolidated financial statements. These reserves
required the use of significant estimates. Though we believe that these
estimates accurately reflect the costs of these plans, they relate to matters
that are inherently uncertain and actual results may be different. Income Taxes We have significant amounts of deferred tax assets that are reviewed
periodically for recoverability and valued accordingly. These assets are
evaluated by using the four sources of taxable income that may be considered
under Financial Accounting Standards (FAS) No. 109: (1) future reversals of
existing temporary differences; (2) taxable income in prior carryback years, if
carryback is permitted under the tax law; (3) tax planning strategies and; (4)
future taxable income exclusive of reversing temporary differences and
carryforwards. In the event it is determined more likely than not that some
portion or all of the deferred tax assets will not be realized, a valuation
allowance would be recorded with a corresponding charge to income in the period
such determination occurs. 33




---



##### Table of Contents



Environmental Matters We reserve for known environmental claims, of which there are none as of
October 2, 2004, when payments associated with the claims become probable and
the costs can be reasonably estimated. Our environmental reserves, for all
periods presented, are recorded at the expected payment amount. The actual cost
of resolving environmental issues may be higher than that reserved primarily
due to difficulty in estimating such costs and potential changes in the status
of government regulations. Significant Accounting Policies Revenue Recognition Revenues are primarily generated from the sale of electronic devices to
our customers, typically the end-user. Revenues also include other items such
as negotiated development billings, licensing fees or royalties that may not
occur on a regular basis. Revenue from product sales is generally recognized
upon shipment provided that a purchase order has been received or a contract
has been executed, there are no uncertainties regarding customer acceptance,
any fee is fixed or determinable and collectibility is deemed probable. If
uncertainties regarding customer acceptance exist, revenue is recognized when
such uncertainties are resolved. Generally, shipments are made F.O.B. point of
origin, with variations due to contract specific agreements. We recognize revenue using the guidance from SEC Staff Accounting Bulletin
No. 104 Revenue Recognition in Financial Statements. Under these guidelines,
revenue recognition is deferred on transactions where: (1) persuasive evidence
of an arrangement does not exist; (2) revenue recognition is contingent upon
performance of one or more obligations of the Company; (3) the price is not
fixed or determinable or (4) payment is not reasonably assured. Product Warranty We record a warranty liability on our products at the time of revenue
recognition based on historical experience and any specific warranty issues
that we have identified. Although historical warranty costs have been within
expectations, there can be no assurance that future warranty costs will not
exceed historical amounts. If actual future warranty costs exceed historical
amounts, additional allowances may be required, which could have a material
adverse impact on our operating results in future periods. See Note 1 to the
consolidated financial statements for product warranty disclosure. Property, Plant and Equipment and Related Depreciation We record property, plant and equipment at cost, which is depreciated
using the straight-line method for structures and equipment over their
estimated useful lives. Leasehold improvements and assets acquired under
capital leases are amortized over the shorter of the lease term or their
estimated useful lives. Management reviews the estimated useful lives of
property, plant and equipment to verify that the assets are being depreciated
in accordance with their usage and all assets no longer in service are fully
depreciated. Accrued Expenses and Other Liabilities We record liabilities for services or products received in the period in
which the benefit was recognized. Due to normal variations in estimating costs
of these services or products received, actual costs may be different than the
amounts recorded. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk in the form of changes in foreign exchange
rates, changes in the prices of marketable equity securities held as part of a
deferred compensation plan (a Rabbi trust) and changes in interest rates. We have approximately $3,400,000 (calculated based on the conversion rate
for Euros at October 2, 2004) permanently invested in the assets of Ideacod,
S.A.S., located in Strasbourg, France. The potential loss in fair value
resulting from a hypothetical 10% adverse change in the foreign currency
exchange rate amounts to $340,000, which would not be material to the
consolidated financial statements. 34




---



##### Table of Contents



The Rabbi trust assets, consisting of cash equivalents and debt and equity
securities, are offset by an equivalent deferred compensation liability to the
trust participants. The liability fluctuates equally with changes in the value
of the assets. Because the liability completely offsets the assets of the
trust, changes in asset value have no effect on the results of operations or
financial position. We are affected by changes in the general level of U.S. interest rates as
a portion of our investments, when we have excess cash balances, are in
short-term debt securities issued by corporations. Our investments are placed
with high-quality issuers and we attempt to limit the amount of credit exposure
to any one issuer. Due to the nature of our short-term investments, we believe
that we are not subject to any material market risk exposure. We do not have
any foreign currency or other derivative financial instruments. Our long-term notes payable and line of credit have fixed rates of 6.7%
and 4.9%, respectively. Our capital lease has a fixed portion at 5.1% and a
variable portion at 3.4% at the end of fiscal 2004. 35




---



##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEETS
BEI Technologies, Inc. and Subsidiaries October 2,
    
    September 27,dollars in thousands except per share amounts
    
    2004
    
    2003ASSETSCurrent assetsCash and cash equivalents
    
    $
    8,218
    
    
    $
    9,211Restricted investments
    
    
    4,299
    
    
    
    5,185Trade receivables:Commercial customers, less allowance for doubtful accounts (2004-$813; 2003-$783)
    
    
    44,721
    
    
    
    36,243United States Government
    
    
    761
    
    
    
    1,02845,482
    
    
    
    37,271Inventories, net
    
    
    29,897
    
    
    
    24,190Deferred income taxes
    
    
    7,567
    
    
    
    8,372Assets held for sale
    
    
    1,065
    
    
    
    Other current assets
    
    
    8,515
    
    
    
    4,543Total current assets
    
    
    105,043
    
    
    
    88,772Property, plant and equipmentLand
    
    
    4,111
    
    
    
    4,466Structures
    
    
    16,168
    
    
    
    15,977Equipment
    
    
    70,467
    
    
    
    65,250Leasehold improvements
    
    
    2,280
    
    
    
    2,16293,026
    
    
    
    87,855Less allowances for depreciation and amortization
    
    
    53,121
    
    
    
    50,73239,905
    
    
    
    37,123Other assetsTradenames, patents and related assets, less amortization (2004-$3,655; 2003-$3,594)
    
    
    217
    
    
    
    223Technology acquired under license agreements, less amortization
(2004-$10,311; 2003-10,066)
    
    
    297
    
    
    
    542Goodwill
    
    
    1,612
    
    
    
    1,612Deferred income taxes, non-current
    
    
    2,879
    
    
    
    2,235Other
    
    
    2,615
    
    
    
    2,9467,620
    
    
    
    7,558$
    152,568
    
    
    $
    133,453
 See notes to consolidated financial statements 36




---



##### Table of Contents



CONSOLIDATED BALANCE SHEETS
BEI Technologies, Inc. and Subsidiaries October 2,
    
    September 27,dollars in thousands except per share amounts
    
    2004
    
    2003LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesTrade accounts payable
    
    $
    33,698
    
    
    $
    15,680Accrued expenses and other liabilities
    
    
    21,151
    
    
    
    22,318Income tax payable
    
    
    
    
    
    
    689Deferred compensation liability
    
    
    4,299
    
    
    
    5,185Current portion of capital lease obligation
    
    
    159
    
    
    
    93Current portion of long-term notes payable
    
    
    7,104
    
    
    
    7,024Total current liabilities
    
    
    66,411
    
    
    
    50,989Capital lease obligation, less current portion
    
    
    2,266
    
    
    
    1,958Long-term notes payable, less current portion
    
    
    8,373
    
    
    
    15,536Other liabilities
    
    
    2,783
    
    
    
    6,329Total liabilities
    
    
    79,833
    
    
    
    74,812Stockholders equityPreferred stock($.001 par value; authorized 2,000,000 shares; none issued)
    
    
    
    
    
    
    Common stock($.001 par value; authorized 35,000,000 shares; issued
and outstanding; 200414,822,983; 200314,524,910)
    
    
    13,019
    
    
    
    7,931Retained earnings
    
    
    64,925
    
    
    
    54,466Accumulated other comprehensive income
    
    
    297
    
    
    
    5978,241
    
    
    
    62,456Less: Unearned restricted stock
    
    
    (5,506
    )
    
    
    (3,815
    )Total stockholders equity
    
    
    72,735
    
    
    
    58,641$
    152,568
    
    
    $
    133,453
 See notes to consolidated financial statements 37




---



##### Table of Contents



CONSOLIDATED STATEMENTS OF OPERATIONS
BEI Technologies, Inc. and Subsidiaries Years EndedSeptember 27,
    
    September 28,dollars in thousands except per share amounts
    
    October 2, 2004
    
    2003
    
    2002Net sales
    
    $
    281,300
    
    
    $
    213,674
    
    
    $
    185,638Cost of sales
    
    
    214,848
    
    
    
    161,215
    
    
    
    134,311Gross margin
    
    
    66,452
    
    
    
    52,459
    
    
    
    51,327Selling, general and administrative expenses
    
    
    33,667
    
    
    
    31,383
    
    
    
    30,912Research, development and related expenses
    
    
    14,607
    
    
    
    15,288
    
    
    
    15,397Provision for excess capacity
    
    
    (238
    )
    
    
    1,222
    
    
    
    10,275Provision for uncollectables from a related party
    
    
    
    
    
    
    
    
    
    
    3,072Provision for product line move and other
    
    
    
    
    
    
    
    
    
    
    2,230Income (loss) from operations
    
    
    18,416
    
    
    
    4,566
    
    
    
    (10,559
    )Other income (expense)
    
    
    745
    
    
    
    5,862
    
    
    
    (1,760
    )Interest expense
    
    
    (1,326
    )
    
    
    (1,855
    )
    
    
    (2,270
    )Income (loss) before income taxes
    
    
    17,835
    
    
    
    8,573
    
    
    
    (14,589
    )Provision (benefit) for income taxes
    
    
    6,192
    
    
    
    3,008
    
    
    
    (5,783
    )Net income (loss)
    
    $
    11,643
    
    
    $
    5,565
    
    
    $
    (8,806
    )Basic Earnings (Loss) Per Common ShareNet income (loss) per common share
    
    $
    0.81
    
    
    $
    0.39
    
    
    $
    (0.63
    )Shares used in computing basic income
(loss) per common share
    
    
    14,295,410
    
    
    
    14,118,731
    
    
    
    13,993,013Diluted Earnings (Loss) Per Common ShareNet income (loss) per common and common equivalent share
    
    $
    0.80
    
    
    $
    0.39
    
    
    $
    (0.63
    )Shares used in computing diluted income (loss) per
common and common equivalent share
    
    
    14,638,406
    
    
    
    14,290,603
    
    
    
    13,993,013
 38




---



##### Table of Contents



CONSOLIDATED STATEMENTS OF CASH FLOWS
BEI Technologies, Inc. and Subsidiaries Years EndedOctober 2,
    
    September 27,
    
    September 28,dollars in thousands
    
    2004
    
    2003
    
    2002Cash flows from operating activities:Net income (loss)
    
    $
    11,643
    
    
    $
    5,565
    
    
    $
    (8,806
    )Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Depreciation
    
    
    8,162
    
    
    
    8,474
    
    
    
    6,926Amortization
    
    
    1,940
    
    
    
    2,359
    
    
    
    2,172Impairment
of investments in equity securities
    
    
    250
    
    
    
    1,500
    
    
    
    Deferred income taxes
    
    
    
    
    
    
    313
    
    
    
    (1,669
    )Loss (gain) on disposition of assets
    
    
    227
    
    
    
    (37
    )
    
    
    (397
    )Foreign currency translation
    
    
    398
    
    
    
    298
    
    
    
    219Provision for excess capacity
    
    
    (238
    )
    
    
    1,222
    
    
    
    10,275Provision for uncollectables from a related party
    
    
    
    
    
    
    
    
    
    
    3,072Provision for product line move and other
    
    
    
    
    
    
    
    
    
    
    2,230Changes in operating assets and liabilities:Trade receivables
    
    
    (8,521
    )
    
    
    (12,071
    )
    
    
    1,569Inventories
    
    
    (6,770
    )
    
    
    4,348
    
    
    
    2,270Assets held for sale
    
    
    
    
    
    
    2,011
    
    
    
    2,411Other current assets
    
    
    (3,183
    )
    
    
    789
    
    
    
    (4,093
    )Trade accounts payable, accrued expenses and other liabilities
    
    
    12,291
    
    
    
    7,723
    
    
    
    (13,418
    )Net cash provided by operating activities
    
    
    16,199
    
    
    
    22,494
    
    
    
    2,761Cash flows used by investing activities:Investment in equity securities  Athena
    
    
    
    
    
    
    (2,000
    )
    
    
    (500
    )Purchase of property, plant and equipment
    
    
    (11,865
    )
    
    
    (6,427
    )
    
    
    (7,596
    )Disposition of property, plant and equipment
    
    
    1,500
    
    
    
    624
    
    
    
    400Other assets
    
    
    5
    
    
    
    (1,471
    )
    
    
    1,585Net cash used by investing activities
    
    
    (10,360
    )
    
    
    (9,274
    )
    
    
    (6,111
    )Cash flows used by financing activities:Proceeds from debt borrowings
    
    
    6,164
    
    
    
    32,576
    
    
    
    44,966Principal payments on debt and other liabilities
    
    
    (13,362
    )
    
    
    (39,613
    )
    
    
    (52,017
    )Proceeds from issuance of common stock
    
    
    1,344
    
    
    
    176
    
    
    
    160Tax benefit from exercised stock options
    
    
    705
    
    
    
    35
    
    
    
    433Repurchase of common stock
    
    
    (944
    )
    
    
    (1,021
    )
    
    
    (1,636
    )Payment of cash dividends
    
    
    (739
    )
    
    
    (580
    )
    
    
    (576
    )Net cash used by financing activities
    
    
    (6,832
    )
    
    
    (8,427
    )
    
    
    (8,670
    )Net increase (decrease) in cash and cash equivalents
    
    
    (993
    )
    
    
    4,793
    
    
    
    (12,020
    )Cash and cash equivalents at beginning of period
    
    
    9,211
    
    
    
    4,418
    
    
    
    16,438Cash and cash equivalents at end of period
    
    $
    8,218
    
    
    $
    9,211
    
    
    $
    4,418
 See notes to consolidated financial statements 39




---



##### Table of Contents



CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
BEI Technologies, Inc. and Subsidiaries Years EndedOctober 2,
    
    September 27,
    
    September 28,dollars in thousands
    
    2004
    
    2003
    
    2002Supplemental disclosures of non cash
investing and financing activities:Grants of restricted stock
    
    $
    3,452
    
    
    $
    9
    
    
    $
    3,808Cancellations of restricted stock
    
    
    177
    
    
    
    225
    
    
    
    323Tax benefit from restricted stock
    

    
    200
    
    
    
    874
    
    
    
    269Capital lease obligation incurred
    
    
    993
    
    
    
    2,051
    
    
    
    Disposal of fully depreciated equipment
    
    
    4,186
    
    
    
    
    
    
    
    12,450Cash paid during the period for:Income Taxes
    
    
    5,375
    
    
    
    410
    
    
    
    428Interest
    
    
    1,300
    
    
    
    1,900
    
    
    
    2,400
 See notes to consolidated financial statements 40




---



##### Table of Contents



CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE
INCOME (LOSS)
BEI Technologies, Inc. and Subsidiaries CommonStock
    
    Retained
    
    AccumulatedOtherComprehensive
    
    Comprehensive
    
    UnearnedRestrictedIn thousand except shares
    
    Shares
    
    Amount
    
    Earnings
    
    Income (Loss)
    
    Income (Loss)
    
    Stock
    
    TotalBalances at September 29, 2001
    
    
    14,326,272
    
    
    
    4,025
    
    
    
    59,434
    
    
    
    (458
    )
    
    
    
    
    
    
    (2,681
    )
    
    
    60,320Net loss for 2002
    
    
    
    
    
    
    
    
    
    
    (8,806
    )
    
    
    
    
    
    
    (8,806
    )
    
    
    
    
    
    
    (8,806
    )Other comprehensive incomeForeign currency translation gain,
net of income tax of $144
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    219
    
    
    
    219
    
    
    
    
    
    
    
    219Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,587
    )Restricted stock plan
    
    
    282,714
    
    
    
    3,485
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,510
    )
    
    
    975Stock options exercised
    
    
    31,471
    
    
    
    160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    160Tax benefit from exercised stock options
    
    
    
    
    
    
    433
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    433Tax benefit from restricted stock
    
    
    
    
    
    
    269
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    269Repurchase of stock
    
    
    (41,320
    )
    
    
    (253
    )
    
    
    (382
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (635
    )Cash dividends
    
    
    
    
    
    
    
    
    
    
    (576
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (576
    )Balances at September 28, 2002
    
    
    14,599,137
    
    
    
    8,119
    
    
    
    49,670
    
    
    
    (239
    )
    
    
    
    
    
    
    (5,191
    )
    
    
    52,359Net income for 2003
    
    
    
    
    
    
    
    
    
    
    5,565
    
    
    
    
    
    
    
    5,565
    
    
    
    
    
    
    
    5,565Other comprehensive incomeForeign currency translation gain,
net of income tax of $160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    298
    
    
    
    298
    
    
    
    
    
    
    
    298Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,863Restricted stock plan
    
    
    (21,412
    )
    
    
    (228
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,376
    
    
    
    1,148Stock options exercised
    
    
    37,601
    
    
    
    176
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    176Tax benefit from exercised stock options
    
    
    
    
    
    
    35
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Tax benefit from restricted stock
    
    
    
    
    
    
    874
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    874Repurchase of stock
    
    
    (90,416
    )
    
    
    (832
    )
    
    
    (189
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,021
    )Cash dividends
    
    
    
    
    
    
    
    
    
    
    (580
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (580
    )Contributed capital and other
    
    
    
    
    
    
    (213
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (213
    )Balances at September 27, 2003
    
    
    14,524,910
    
    
    
    7,931
    
    
    
    54,466
    
    
    
    59
    
    
    
    
    
    
    
    (3,815
    )
    
    
    58,641Net income for 2004
    
    
    
    
    
    
    
    
    
    
    11,643
    
    
    
    
    
    
    
    11,643
    
    
    
    
    
    
    
    11,643Other comprehensive incomeForeign currency translation gain,
net of income tax of $160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    238
    
    
    
    238
    
    
    
    
    
    
    
    238Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,881Restricted stock plan
    
    
    203,323
    
    
    
    3,293
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,692
    )
    
    
    1,601Stock options exercised
    
    
    135,837
    
    
    
    1,344
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,344Tax benefit from exercised stock options
    
    
    
    
    
    
    705
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    705Tax benefit from restricted stock
    
    
    
    
    
    
    200
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200Repurchase of stock
    
    
    (41,087
    )
    
    
    (449
    )
    
    
    (445
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (894
    )Cash dividends
    
    
    
    
    
    
    
    
    
    
    (739
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (739
    )Contributed capital and other
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    (4
    )Balance at October 2, 2004
    
    
    14,822,983
    
    
    
    13,019
    
    
    
    64,925
    
    
    
    297
    
    
    
    
    
    
    
    (5,506
    )
    
    
    72,735
 See notes to consolidated financial statements 41




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Note 1 Summary of Significant Accounting Policies Basis of Presentation: BEI Technologies (Technologies or the Company)
was incorporated in Delaware in June 1997 and became publicly held on September
27, 1997 as a result of the distribution of shares in Technologies (the
Distribution) to all the stockholders of BEI Electronics, Inc.,
(Electronics) on September 24, 1997. Electronics was subsequently renamed
BEI Medical Systems Company, Inc. and was acquired by Boston Scientific
Corporation in 2002. The accompanying financial statements present the consolidated financial
position and results of operations of the Company and its wholly owned
subsidiaries. All intercompany accounts and transactions have been eliminated. The Companys business is the design, development, engineering,
manufacture and marketing of intelligent sensors, sensor-based systems,
actuators and motors for use in precision motion control applications for the
commercial, automotive, industrial and government industries. Fiscal Year:The Companys fiscal year ends on the Saturday nearest
September 30. Fiscal years 2004, 2003 and 2002 contained 53 weeks, 52 weeks
and 52 weeks, respectively. Use of Estimates:The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the amounts reported in the consolidated financial statements and the
accompanying notes. Actual results could differ from these estimates. Cash and Cash Equivalents:The Company considers all highly liquid
investments with maturity of three months or less when purchased to be cash
equivalents. Accounts Receivable:The Companys products are primarily sold to
commercial customers throughout the United States, various foreign countries
and to the United States Government. Substantially all foreign sales are
denominated in U.S. dollars. The Company continuously monitors collections and
payments from its customers and maintains allowances for doubtful accounts based
upon historical experience and any specific customer collection issues that the
Company has identified. The Company maintains reserves for potential credit
losses. Historically, such losses have been within the expectations of
management. Restricted Investments:The Companys restricted investments consist of
investments in debt and equity securities that are held in a Rabbi Trust and
are restricted for payment to the participants of the Companys deferred
compensation plan. As the Company has identified the Rabbi Trust as a variable
interest entity, it has consolidated the Rabbi Trusts assets and liabilities
in the balance sheet. The Company accounts for its restricted investments in
accordance with FAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities. As required by FAS No. 115, the Company determines the
proper classification of its investments at the time of purchase and reassesses
such designations at each balance sheet date. At October 2, 2004 and September
27, 2003, the Companys restricted investments were classified as trading
securities and were recorded in restricted investments in the accompanying
consolidated balance sheets. Inventories:Inventories are carried principally at the lower of cost or
fair value and do not exceed net realizable value. Cost is determined by the
first-in, first-out (FIFO) method, including material, labor and factory
overhead. The Company provides a reserve against its inventory for estimated
obsolescence for the difference between the cost of inventory and the estimated
market value based upon assumptions about future demand and market conditions.
If actual future demand or market conditions are less favorable than those
projected by management, additional inventory write-downs may be required. Depreciation and Amortization:Property, plant and equipment are recorded
at cost. Depreciation and amortization are provided in amounts sufficient to
amortize the cost of such assets over their estimated useful lives, which range
from 3 to 30 years, using the straight-line method for structures and
equipment. Leasehold improvements and assets acquired under capital leases are
amortized using the straight-line method over the shorter of the lease term or their estimated useful lives. 42




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Other Assets:Tradenames, patents and related assets are being amortized
over their remaining lives at the date of acquisition up to a period of 17
years. Technology acquired under license agreements consists primarily of the
cost of exclusive rights to make, use and sell products utilizing quartz rate
sensing technology. Technology acquired is being amortized over 13 years,
which approximates its estimated useful life from the date of acquisition. The
amortization expense relating to intangible assets for fiscal year 2004 totaled
approximately $0.3 million. The estimated aggregate amortization expense for
each of the five succeeding years is $0.15 million, $.13 million, $.12
million, $.12 million and $0.12 million, respectively. Equity Investments: The Company records its equity investments in private
companies at cost as the Company owns less than 20% of the
outstanding equity of the investee companies and no other control factors are
present. Net equity investments totaling approximately $1.2 million at October
2, 2004, and $1.0 million at September 27, 2003, were included in other assets
in the accompanying consolidated balance sheets. The Company periodically evaluates the fair market value of its equity
investments to determine if an other-than-temporary impairment in the value of
its investment has taken place. Impairment charges of $0.25 million and $1.5
million for the years ended October 2, 2004 and September 27, 2003,
respectively, were taken to reduce the Companys equity investments to their
estimated fair value. Goodwill:Goodwill consists of the excess of cost over fair value of net
tangible assets acquired in purchase acquisitions. In accordance with the
provisions of Statement of Financial Accounting Standard (FAS) No. 142,
Goodwill and Other Intangible Assets, the Company evaluates the carrying
value of goodwill annually as of the first day of the fourth quarter of each
fiscal year, or more often if certain indicators arise. In evaluating
goodwill, as the Company operates in one reportable unit, the Company compares
the total carrying value of goodwill to the Companys fair value as determined
by its market capitalization. To date, there has been no impairment of this
asset. Long-Lived Assets:The Company recognizes impairment losses in accordance
with FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. Long-lived assets, including property, plant and equipment and other
assets, are reviewed and impairment recognized when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of the assets. Assets to be disposed
of are reclassified as assets held for sale at the lower of their carrying
amount or fair value less costs to sell. Product Warranty:The Company offers limited warranties for its products
for a period that lasts generally from one to four years. The specific terms
and conditions of those warranties vary depending upon the products sold that
are specific to different industries and customers. The Company estimates the
costs that may be incurred under its limited warranty and records a liability
in the amount of such costs at the time product revenue is recognized. Factors
that affect the Companys warranty liability include the number of installed
units, historical and anticipated rates of warranty claims, and cost per claim.
The Company assesses the adequacy of its recorded warranty
liabilities at least quarterly and adjusts that amount as necessary. Changes in
the Companys product warranty liability during the period are as follows (in
thousands): Balance, September 28, 2002
    
    $
    603Warranties issued during the period
    
    
    1,185Settlements made during the period
    
    
    (1,190
    )Changes in liability for pre-existing warrantiesduring the period, including expirations
    
    
    569Balance, September 27, 2003
    
    $
    1,167Warranties issued during the period
    
    
    816Settlements made during the period
    
    
    (687
    )Changes in liability for pre-existing warranties
during the period, including expirations
    
    
    149Balance, October 2, 2004
    
    $
    1,445
 Revenue Recognition:Revenue from product sales is generally recognized
upon shipment provided that a purchase order has been received or a contract
has been executed, there are no uncertainties regarding customer acceptance,
any fee is fixed or determinable and collectibility is deemed probable. If
uncertainties regarding customer acceptance exist, revenue is 43




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 recognized when such uncertainties are resolved. Generally, shipments are
made F.O.B. point of origin, with variations due to contract specific
agreements. The Company records an estimated warranty liability on its
products at the time of revenue recognition. Costs associated with shipping
and handling are primarily included in cost of sales. Revenues also include other items such as negotiated development billings,
licensing fees or royalties that may not occur on a regular basis. Research and Development:Costs to develop the Companys products are
expensed as incurred. Stock Based Compensation:The Companys 1997 Equity Incentive Plan
provides for the granting of incentive stock options to employees and stock or
options to consultants, employees and directors. The Company accounts for
stock based compensation using the intrinsic value method prescribed in
Accounting Principles Board (APB) Opinion No. 25 whereby the options are
granted at market price, and therefore no compensation costs are recognized.
The Company has elected to retain its current method of accounting as described
above and has adopted the disclosure requirements of FAS Nos. 123 and 148. If
compensation expense for the Companys stock option plan had been determined
based upon fair values at the grant dates for awards under those plans in
accordance with FAS No. 123, the Companys pro forma net earnings, basic and
diluted earnings (loss) per common share would have been as follows (in
thousands except per share amounts): Years EndedOctober 2,2004
    
    September 27,2003
    
    September 28,2002Net income (loss), as reported
    
    $
    11,643
    
    
    $
    5,565
    
    
    $
    (8,806
    )Deduct: Total stock based
employee compensation
expense determined under fair
value based method
for all awards, net of related tax
effects
    
    
    (293
    )
    
    
    (727
    )
    
    
    (783
    )Pro forma net income (loss)
    
    $
    11,350
    
    
    $
    4,838
    
    
    $
    (9,589
    )Earnings (Loss) per Common Share:Basic-as reported
    
    $
    0.81
    
    
    $
    0.39
    
    
    $
    (0.63
    )Basic-pro forma
    
    $
    0.79
    
    
    $
    0.34
    
    
    $
    (0.69
    )Diluted-as reported
    
    $
    0.80
    
    
    $
    0.39
    
    
    $
    (0.63
    )Diluted-pro forma
    
    $
    0.78
    
    
    $
    0.34
    
    
    $
    (0.69
    )
 The fair value of options at date of grant was estimated using the
Black-Scholes option valuation model with the following weighted average
assumptions: Years EndedOctober 2,2004
    
    September 27,2003
    
    September 28,2002Expected life (years)
    
    
    5
    
    
    
    5
    
    
    
    5Risk-free interest rate
    
    
    3.29
    %
    
    
    2.51
    %
    
    
    4.13
    %Expected volatility
    
    
    73.00
    %
    
    
    50.00
    %
    
    
    80.46
    %Expected dividend yield
    
    
    0.20
    %
    
    
    0.40
    %
    
    
    0.30
    %
 The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Companys employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
managements opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options. The effects of
applying FAS 123 in the pro forma disclosures may not be indicative of the
valuations for future awards because the Black-Scholes option valuation model
involves subjective assumptions. In addition to incentive stock options, the Company issues restricted
stock to its employees. The fair value of a share of restricted stock awarded
to an employee is measured at the market price of a share of nonrestricted
stock on the grant date. The value of a grant is amortized as expense over its
term. 44




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Net Income (Loss) Per Common Share:Basic income (loss) per common share
is computed using the weighted average number of common shares outstanding
during the period. Diluted income (loss) per common share is computed using
the weighted average number of common shares outstanding during the period,
adjusted for the incremental shares attributed to unvested stock and
outstanding options to purchase common stock calculated using the treasury
stock method, if dilutive. Foreign Subsidiary: The financial statements of Ideacod, S.A.S., a wholly
owned subsidiary, have been translated into U.S. dollars at fiscal year-end,
using the exchange rates on those dates for assets and liabilities and the
average exchange rates during the period for income and expenses. The
resulting unrealized translation adjustments are recorded as a component of
other comprehensive income (loss). The Company has approximately $3,400,000
(calculated based on the conversion rate for Euros at October 2, 2004)
permanently invested in the assets of Ideacod, S.A.S., located in Strasbourg,
France. Related Party Financing and Arrangements: During fiscal 2000, Technologies
made a $1.0 million equity investment in OpticNet, Inc. (OpticNet), the
Companys then majority owned subsidiary. Following the
distribution of OpticNet stock by the Company, BEI Technologies, Inc. accounted for its investment in OpticNet under the equity method of
accounting until March 31, 2002, when the Company deemed its investment
impaired. As of March 30, 2002, the Company recognized as impaired the
carrying value of its initial $1.0 million investment in OpticNet and reduced
the investment to zero and fully reserved as uncollectable its $2.7 million
loan to OpticNet. The Company recognized OpticNets entire net loss for all of
fiscal year 2003. In August 2003, the Company entered into a tender offer to purchase the
outstanding common shares of OpticNet at $0.04 per share (an aggregate cost of
approximately $0.2 million). Upon completion in December 2003, the Company
terminated the registration of OpticNets common stock under the Securities
Exchange Act of 1934, as amended (the Exchange Act). OpticNets results of
operations for the fiscal year ended October 2, 2004, have been consolidated by
the Company. Reclassification:Certain reclassifications have been made to the 2003 and
2002 consolidated financial statements to conform to current year
presentations. Recent Accounting Pronouncement: In March 2004, the Emerging Issues Task
Force (EITF) reached a consensus on Issue No. 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments.
EITF 03-01 provides guidance on other-than-temporary impairment models for
marketable debt and equity securities accounted for under SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, and SFAS
No. 124, Accounting for Certain Investments Held by Not-for-Profit
Organizations, and non-marketable equity securities accounted for under the
cost method. The EITF developed a basic three-step model to evaluate whether an
investment is other-than-temporarily impaired. On September 30, 2004, the FASB
issued FSP 03-1-1, Effective Date of Paragraphs 10-20 of EITF 03-1, The
Meaning of Other Than Temporary Impairment, delaying the effective date for
the recognition and measurement guidance of EITF 03-1, as contained in
paragraphs 10-20, until certain implementation issues are addressed and a final
FSP providing implementation guidance is issued. The disclosure requirements of
the consensus remain in effect. We do not expect the adoption of EITF 03-01s
three-step model to have a material affect on our results of operations and
financial condition. Quantitative and qualitative disclosures for investments
accounted for under SFAS 115 are effective for the Companys fiscal year ended
October 2, 2004. Note 2 Inventories October 2,
    
    September 27,2004
    
    2003(in thousands)Finished products
    
    $
    4,220
    
    
    $
    3,503Work in process
    
    
    6,726
    
    
    
    5,284Materials
    
    
    18,951
    
    
    
    15,403Total inventories
    
    $
    29,897
    
    
    $
    24,190
 45




---



##### Table of Contents



Note 3 Accrued Expenses and Other Liabilities October 2,
    
    September 27,2004
    
    2003(in thousands)Employee compensation and benefits
    
    $
    5,218
    
    
    $
    4,572Accrued
payroll and other taxes
    
    
    1,145
    
    
    
    728Contract costs
    
    
    140
    
    
    
    75Accrued professional fees
    
    
    922
    
    
    
    1,785Insurance
    
    
    359
    
    
    
    675Royalties and related costs
    
    
    2,417
    
    
    
    4,583Customer advances / Deferred income
    
    
    2,127
    
    
    
    3,013Commissions
    
    
    306
    
    
    
    360Interest
    
    
    377
    
    
    
    538Warranty
    
    
    1,445
    
    
    
    1,167Provision for excess capacity
    
    
    1,945
    
    
    
    2,534Reserve for product line move and other
    
    
    34
    
    
    
    238Reserve for settlement with customer
    
    
    1,600
    
    
    
    Other
    
    
    3,116
    
    
    
    2,050Total accrued expenses and other liabilities
    
    $
    21,151
    
    
    $
    22,318
 46




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Note 4 Long-Term Debt October 2,
    
    September 27,2004
    
    2003(in thousands)6.70% Senior Notes; due in annual
installments of $7,000 from November 16,
2001 through November 16, 2005
    
    $
    14,000
    
    
    $
    21,000Mortgage note payable with interest at
1.625% per annum in excess of the LIBOR rate
(3.33% at October 2, 2004); due in monthly
installments in addition to quarterly
principal payments of $26 until December
2008 when the remaining balance of
approximately $958 is due; collateralized by
certain real property
    
    
    1,477
    
    
    
    1,56015,477
    
    
    
    22,560Less current portion
    
    
    7,104
    
    
    
    7,024$
    8,373
    
    
    $
    15,536
 On November 16, 1998, the Company sold $35.0 million of senior notes in a
private placement. The notes have an interest rate of 6.7% and mature in
annual installments of $7.0 million beginning November 16, 2001 up to and
including November 16, 2005. The note agreement contains covenants regarding
certain operating ratios, limitations on debt, dividend payments and minimum
net worth. The proceeds from the senior notes were used to repay the
pre-existing senior notes and pay down outstanding borrowings on the Companys
line of credit as they matured. On December 15, 2003, the mortgage note payable was refinanced with a new
lender and the due date extended from fiscal 2004 to fiscal 2009. As such, the
amount of $1,373,000 has been excluded from current liabilities in the
accompanying consolidated balance sheet at October 2, 2004. The Company has a $25.0 million line of credit, which had an interest rate
of 4.12% at October 2, 2004, maturing on November 14, 2004. No borrowings were
outstanding under the line of credit at October 2, 2004. See Note 17
Subsequent Events for more detail on the line of credit. Maturities of long-term debt including the senior notes and the mortgage note
payable are approximately as follows: fiscal 2005 $7.1 million; fiscal 2006
$7.1 million; thereafter $1.2 million. Note 5 Research and Development The Companys internally funded research, development and related
engineering expenditures were approximately $14.6 million, $15.3 million and
$15.4 million in fiscal 2004, 2003 and 2002, respectively. In addition,
customer-funded research and development expenditures charged to cost of sales
were $0, $0.5 million and $0.5 million, respectively, for the same periods. 47




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Note 6 Income Taxes The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes. Under this
standard, deferred tax liabilities and assets are recognized for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax bases of assets and liabilities. Deferred tax assets and
liabilities are determined based on the differences between financial reporting
and the tax bases of assets and liabilities and are measured using the enacted
tax rates and laws known at this time and that will be in effect when the
differences are expected to reverse. The provision (benefit) for income tax consists of the following (in
thousands): Year EndedOctober 2,
    
    September 27,
    
    September 28,2004
    
    2003
    
    2002CurrentForeign
    
    $
    
    
    
    $
    850
    
    
    $
    Federal
    
    
    5,684
    
    
    
    1,029
    
    
    
    (3,987
    )State
    
    
    507
    
    
    
    816
    
    
    
    (127
    )Total Current
    
    
    6,191
    
    
    
    2,695
    
    
    
    (4,114
    )DeferredForeign
    
    
    
    
    
    
    
    
    
    
    Federal
    
    
    (318
    )
    
    
    886
    
    
    
    (865
    )State
    
    
    319
    
    
    
    (573
    )
    
    
    (804
    )Total Deferred
    
    
    1
    
    
    
    313
    
    
    
    (1,669
    )Total income tax provision (benefit)
    
    $
    6,192
    
    
    $
    3,008
    
    
    $
    (5,783
    )
 Tax benefits of $905,000, $909,000 and $702,000 related to the 1997 Equity
Incentive Plan were credited to stockholders equity and decreased the amount
of taxes payable or increased the amount of taxes currently refundable during
fiscal year 2004, 2003 and 2002, respectively. Significant components of the Companys net deferred tax assets are as
follows (in thousands): October 2,
    
    September 27,2004
    
    2003Deferred tax assetsNet operating loss carryforwards
    
    $
    125
    
    
    $
    125Tax credits
    
    
    675
    
    
    
    996Accrued expenses
    
    
    5,548
    
    
    
    5,278Asset impairment reserves
    
    
    4,569
    
    
    
    5,351Inventory valuation
    
    
    1,688
    
    
    
    1,491Contract reserves
    
    
    337
    
    
    
    1,264Intangibles
    
    
    1,013
    
    
    
    1,026Restricted stock
    
    
    766
    
    
    
    532Other
    
    
    138
    
    
    
    1,031Total deferred tax assets
    
    
    14,859
    
    
    
    16,069Valuation allowance against deferred tax assets
    
    
    (838
    )
    
    
    (972
    )14,021
    
    
    
    15,097Deferred tax liabilitiesDepreciation and property basis difference
    
    
    2,229
    
    
    
    3,098Goodwill
    
    
    239
    
    
    
    204Other
    
    
    1,107
    
    
    
    1,188Total deferred tax liabilities
    
    
    3,575
    
    
    
    4,490Net deferred tax assets
    
    $
    10,446
    
    
    $
    10,607
 48




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 In
compliance with FAS 52, the Company recognized $160,000 of deferred
foreign tax liabilities related to foreign currency translation adjustment for the Companys
foreign subsidiary. The differences between the provision for income taxes and the income tax
determined by applying the statutory federal income tax rate of 35% for 2004,
and 34% for 2003 and 2002 (in thousands) are as follows: October 2,
    
    September 27,
    
    September 28,2004
    
    2003
    
    2002Income tax at the statutory rate
    
    $
    6,242
    
    
    $
    2,915
    
    
    $
    (4,960
    )State income tax, net of federal income tax effect
    
    
    728
    
    
    
    519
    
    
    
    (585
    )Increase / decrease in valuation allowance
    
    
    (134
    )
    
    
    972
    
    
    
    Prior years items
    
    
    (200
    )
    
    
    (743
    )
    
    
    Tax credits
    
    
    (184
    )
    
    
    (463
    )
    
    
    (292
    )Export sales benefit
    
    
    (328
    )
    
    
    (216
    )
    
    
    (163
    )Other
    
    
    68
    
    
    
    24
    
    
    
    217Total income taxes
    
    $
    6,192
    
    
    $
    3,008
    
    
    $
    (5,783
    )
 Prior year items relate principally to changes in estimates resulting from
events occurring in the current year that provided greater certainty as to the expected
outcome of matters for which an estimate was provided. The valuation allowance was $838,000 for the year ended October 2, 2004
and $972,000 for the year ended September 27, 2003. The decrease is mainly due
to an updated evaluation of the realization of capital loss carry-over. As of October 2, 2004, the Company has state net operating loss
carryforwards of $2 million, which begin to expire in the year 2012. The
Company had California research and development credits and Manufacturers
Investment Credit carryforwards of $724,000 and $350,000 respectively. These
credits do not expire under California statute. Note 7 Equity Incentive Plans The Companys 1997 Equity Incentive Plan (the Incentive Plan) was
adopted by the Board of Directors in September 1997. The Incentive Plan
provides for the granting of incentive stock options to employees and
nonstatutory stock options, restricted stock purchase awards, and stock bonuses
(collectively, Stock Awards) to consultants, employees and directors. The
Company has reserved 2,878,890 shares of common stock for issuance under the
Incentive Plan, which included shares for substitute options granted to the
option holders of Electronics in connection with the Distribution. 49




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Option and restricted stock activity under the Technologies Incentive
Plan is summarized below: Restricted SharesCommon stock
    
    Outstanding
    
    Options Outstandingavailable for
    
    Number of common
    
    
    
    
    
    Weighted averagegrant
    
    shares
    
    Number of common shares
    
    exercise price per shareBalances, September 29, 2001
    
    
    757,723
    
    
    
    1,256,683
    
    
    
    381,760
    
    
    $
    8.98Restricted stock
granted
    
    
    (305,500
    )
    
    
    305,500
    
    
    
    
    
    
    
    Restricted stock
terminated
    
    
    22,786
    
    
    
    (22,786
    )
    
    
    
    
    
    
    Restricted stock
retired
    
    
    
    
    
    
    (41,320
    )
    
    
    
    
    
    
    Options Granted
    
    
    (262,000
    )
    
    
    
    
    
    
    262,000
    
    
    
    13.19Options Exercised

    
    
    
    
    
    
    
    
    
    
    (31,471
    )
    
    
    5.09Options Cancelled
    
    
    29,940
    
    
    
    
    
    
    
    (29,940
    )
    
    
    13.40Balances, September 28, 2002
    
    
    242,949
    
    
    
    1,498,077
    
    
    
    582,349
    
    
    
    10.84Restricted stock
granted
    
    
    (6,000
    )
    
    
    6,000
    
    
    
    
    
    
    
    Restricted stock
terminated
    
    
    27,412
    
    
    
    (27,412
    )
    
    
    
    
    
    
    Restricted stock
retired
    
    
    
    
    
    
    (40,271
    )
    
    
    
    
    
    
    Additional shares
authorized
    
    
    600,000
    
    
    
    
    
    
    
    
    
    
    
    Options Granted
    
    
    (15,700
    )
    
    
    
    
    
    
    15,700
    
    
    
    12.90Options Exercised
    
    
    
    
    
    
    
    
    
    
    (37,601
    )
    
    
    4.74Options
Cancelled
    
    
    32,802
    
    
    
    
    
    
    
    (32,802
    )
    
    
    15.21Balances, September 27, 2003
    
    
    881,463
    
    
    
    1,436,394
    
    
    
    527,646
    
    
    
    11.11Restricted stock
granted
    
    
    (221,750
    )
    
    
    221,750
    
    
    
    
    
    
    
    Restricted stock
terminated
    
    
    18,427
    
    
    
    (18,427
    )
    
    
    
    
    
    
    Restricted stock
retired
    
    
    
    
    
    
    (41,087
    )
    
    
    
    
    
    
    Options Granted
    
    
    (11,000
    )
    
    
    
    
    
    
    11,000
    
    
    
    15.35Options Exercised
    
    
    
    
    
    
    
    
    
    
    (135,837
    )
    
    
    9.92Options
Cancelled
    
    
    28,499
    
    
    
    
    
    
    
    (28,499
    )
    
    
    14.53Balances, October 2, 2004
    
    
    695,639
    
    
    
    1,598,630
    
    
    
    374,310
    
    
    $
    11.47
 50




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Weighted Average
    
    WeightedNumber
    
    Remaining Contractual
    
    Average ExerciseRange of Exercise Prices
    
    Outstanding
    
    Life (Years)
    
    Price Per Share$3.50
    
    
    30,338
    
    
    
    4.01
    
    
    $
    3.50$5.56
    
    
    1,336
    
    
    
    4.83
    
    
    $
    5.56$6.00 - $8.34
    
    
    66,486
    
    
    
    5.16
    
    
    $
    6.36$8.50
    
    
    2,334
    
    
    
    5.20
    
    
    $
    8.50$8.59 - $16.21
    
    
    252,082
    
    
    
    7.02
    
    
    $
    13.06$16.87 - $21.00
    
    
    14,734
    
    
    
    3.58
    
    
    $
    18.35$23.00 - $28.60
    
    
    7000
    
    
    
    6.80
    
    
    $
    24.95$3.50 - $28.60
    
    
    374,310
    
    
    
    6.29
    
    
    $
    11.47
 As of October 2, 2004, options for 290,751 shares were vested and
exercisable at a weighted average exercise price of $10.93. Under both the 1992 Plan and the Incentive Plan, as of October 2, 2004,
2,016,123 restricted shares have been granted, of which 1,598,630 shares are
outstanding, and 1,184,706 shares have fully vested. Compensation expense of
approximately $1,600,000, $1,148,000, and $975,000 for the amortization of
restricted stock was recorded in fiscal years 2004, 2003 and 2002,
respectively. During fiscal years 2004 and 2003, options to acquire 11,000 and 15,700
shares were granted with a weighted average fair value of $15.35 and $12.90 per
share, respectively. In addition to options, during fiscal years 2004 and 2003, 221,750 and
6,000 shares of nonvested stock were granted with a weighted average fair value
of $15.34 and $13.84 per share, respectively. The fair value at date of grant
of nonvested stock is amortized to compensation expense over its related
vesting period. Note 8 Employee Benefit Plans The Company has a defined contribution retirement plan for the benefit of
all eligible employees of BEI Technologies, Inc. and subsidiaries. Matching
non-discretionary contributions are based on a percentage of employee
contributions. Contributions to the plan by the Company for the benefit of its
employees expensed in fiscal years 2004, 2003 and 2002 were approximately
$1,422,000, $1,285,000 and $1,290,000, respectively. The Company has a grantor trust to fund deferred compensation for certain
employees (a Rabbi Trust or trust). The assets in the Rabbi Trust,
consisting of cash equivalents and debt and equity securities, are recorded at
current market prices principally based upon national exchange and
over-the-counter markets. The trust assets are available to satisfy claims of
the Companys general creditors in the event of its bankruptcy. The trusts
assets, included in restricted investments, and the corresponding deferred
compensation liability of approximately $4.3 million at October 2, 2004 and
$5.2 million at September 27, 2003, are included in the accompanying
consolidated balance sheets. 51




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Note 9 Lease Commitments Operating leases consist principally of leases for real properties,
manufacturing equipment and land. Certain of the operating leases contain
various options for renewal and/or purchase of the related assets for amounts
approximating their fair market value at the date of exercise of the option.
At October 2, 2004 and September 27, 2003, assets recorded under capital leases
consist of land, buildings and equipment of approximately $2.7 million and
$2.0 million net of accumulated amortization of $0.1 million and $0,
respectively. The future minimum payments for operating and capital leases, net
of future minimum rentals to be received under noncancelable subleases, consist
of the following at October 2, 2004 (in thousands): Capital
    
    OperatingFiscal Year
    
    Leases
    
    Leases2005
    
    $
    230
    
    
    $
    3,5302006
    
    
    229
    
    
    
    8542007
    
    
    229
    
    
    
    5982008
    
    
    228
    
    
    
    5452009
    
    
    228
    
    
    
    479Thereafter
    
    
    1,711
    
    
    
    232Total minimum lease payments, net
of future minimum rental income
    
    
    2,855
    
    
    $
    6,238Less amounts representing interest
    
    
    (430
    )Less current portion
    
    
    (159
    )Amounts included in long-term debt
    
    $
    2,266
 On September 28, 2001, the Company completed the leasing of research and
development equipment placed in service during the quarter ended September 29,
2001, which had been previously purchased by the Company for $700,000. In
addition, on December 20, 2001 and March 28, 2002, the Company executed
additional equipment lease schedules under this agreement to lease equipment
similar to that described above valued at approximately $3.5 million and $2.8
million, respectively. Under the terms of the lease transaction, the Company
sold the equipment and then immediately leased the equipment from the sole
purchaser under a non-cancelable operating lease with a lease term of three
years and an interest rate of approximately 6.9%. Total rent expense,
including interest is included in the table of future minimum annual rental
commitments under operating leases. In March 2003 and September 2003, the
Company recognized an impairment of these assets. See Note 14 for a further
discussion of this impairment. Total rental expense amounted to approximately $1,910,000, $2,320,000 and
$2,342,000 for fiscal years 2004, 2003 and 2002, respectively. Note 10 Contingencies and Litigation Claim against U.S. Government The Company believed that BEI Defense Systems Company (Defense Systems),
a subsidiary of the Company with discontinued operations, suffered substantial
monetary damages due to actions of the U.S. Government in connection with the
parties H70 contract in effect during the 1992-1996 timeframe. As a result,
Defense Systems filed a substantial claim against the U.S. Government in 1996.
Following attempts to negotiate a settlement, Defense Systems filed an appeal
of its claim that was heard before an Administrative Judge at the Armed
Services Board of Contract Appeals (ASBCA). In fiscal 2002, the Judge ruled
that Defense Systems was entitled to an equitable reformation of the prices
on certain rockets and motors in the H70 contract. The decision was remanded
to the parties to negotiate the amount. The parties were unable to negotiate
an amount on their own, so the parties then agreed to enter a non-binding
mediation of Alternate Dispute Resolution process with the same Administrative
Judge from the ASBCA who had rendered the original entitlement decision.
Effective December 2002, the parties finalized mediation that resulted in a
settlement, net of expenses, of $5.4 million. This amount was recorded in
other income during the fiscal year ended September 27, 2003. 52




---



##### Table of Contents



Other During fiscal 2004 management had ongoing discussions with a customer to review
a claim that certain BEI industrial products did not perform properly in a
specific hostile environment. Upon completion of a thorough review in November
2004 management reached a settlement agreement with this customer, subject to
confidentiality provisions, and the Company has taken a charge to cost of sales
of $1.6 million, or $0.07 per share, in the fiscal year ended October 2, 2004.
This amount represented managements best estimate of its liability under the
tentative agreement. The agreement is subject to final approval of
documentation by both parties. During fiscal 2002, BEI Defense Systems, a subsidiary of the Company with
discontinued operations, was subject to litigation with a former landlord
regarding damages to real property formerly leased. The United States District
Court for the Western District of Arkansas entered a judgment, including
attorneys fees, of approximately $0.7 million against the Company. The
Company filed an appeal of the judgment in the United States Court of Appeals
for the Eighth Circuit. Due to the uncertainty of success in the appeal, the
Company reserved $0.7 million for this judgment during the fiscal quarter ended
June 29, 2002. In early February 2004, the appeals court issued an opinion
reversing the district courts judgment in part, remanding one of the claims to
the district court for further consideration consistent with the appeals
courts opinion. In March 2004, the United States Court of Appeals for the
Eighth Circuit denied a motion for rehearing. The Company recorded the reduced
judgment against the Company reflected in the Appeals Court ruling. The
reserve related to this matter is $0.1 million at October 2, 2004 for the final
anticipated liability and related legal fees. During fiscal 2002, the Company initiated litigation against a competitor
alleging patent infringement of certain quartz technologies. Effective
September 2003, the parties finalized mediation that resulted in a cash
settlement in favor of BEI Technologies, Inc., net of expenses, of $7.6
million. This settlement included legal expense recovery which was recorded as
an offset to selling, general and administrative expense in the fiscal quarter
ended September 27, 2003. This legal expense recovery amounted to
approximately $3.5 million, of which $2.7 million and $0.8 were incurred in
fiscal 2003 and 2002, respectively. An additional amount of $2.1 million was recorded
in other income, net of other direct costs associated with the settlement, in
the quarter ended September 27, 2003. An additional favorable impact of
approximately $1.1 million was recognized in other income during fiscal 2004,
with the balance to be recognized in fiscal 2005. At the end of fiscal 2004, BEI Technologies, Inc. was added as a party to
a currently pending lawsuit, involving several defendants regarding an
explosion originating from hazardous material in 2000. Due to the nature of the
issue it is covered by insurance and the underwriter is providing a defense for
BEI Technologies. Since the litigation with respect to BEI Technologies, Inc.
is in its early stages and is insured for, no reserve has been recorded as of
October 2, 2004. The Company has various other pending legal actions arising in the normal
course of business. Management believes that none of the legal actions not
already recognized in the financial statements, individually or in the
aggregate, will have a material impact on the Companys business, financial
condition or operating results. Note 11 Related Party Transactions During fiscal 2001, the Company agreed to provide OpticNet with a line of
credit originally established for up to $2.0 million, amended in March 2002 to
allow for borrowings by OpticNet of up to $3.0 million and in October 2002 to
extend the maturity date to December 31, 2002. The interest rate on the line
of credit was at prime plus 1.5% per annum. During the fiscal quarter ended
June 29, 2002, the Company suspended the availability of advances to OpticNet
under the line of credit, as the Company concluded that the note receivable
totaling $2.7 million in principal amount at such time was uncollectable and
the Companys original investment in OpticNet was impaired. This determination
was a result of OpticNets inability to attract significant strategic partners
or third party financing necessary to sustain operations. Therefore, a charge

of $3.1 million was recorded in the Companys statement of operations in fiscal
2002 as the note receivable was deemed uncollectable and the carrying value of
the original investment in OpticNet was deemed impaired. On September 28, 2001, the Company completed the leasing of research and
development equipment placed in service during the quarter ended September 29,
2001, which had been previously purchased by the Company for $0.7 million. In
addition, on December 20, 2001 and March 28, 2002, the Company executed
additional equipment lease schedules under this agreement to lease equipment
similar to that described above valued at approximately $3.5 million and $2.8
million, 53




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 respectively. Under the terms of the lease transaction, the Company sold
the equipment and then immediately leased the equipment from the sole purchaser
under a non-cancelable operating lease with a lease term of three years and an
interest rate of approximately 6.9%. The Company entered into an agreement with OpticNet to rent capacity on
this equipment to OpticNet from month to month based on OpticNets usage of the
equipment beginning in October 2001. In March 2002, OpticNet significantly
reduced operations to support only its current customer base and by December
2003 had ceased operations, resulting in lower use of this equipment. In the
six months ending September 28, 2002, the Company provided an additional $1.8
million of financing to OpticNet, which was advanced with the intent to convert
such cash advances into additional equity in OpticNet, upon terms to be
decided. The $1.8 million advanced was expensed during the third and fourth
quarters of fiscal 2002, reflecting OpticNets net loss for the six-month
period from March 31, 2002 through September 28, 2002. Effective September 28,
2002, the Company and OpticNet had determined that OpticNet would authorize and
issue to the Company a series of nonvoting preferred stock. In November 2002,
OpticNet issued a total of 18,146,420 shares of nonvoting and nonconvertible
Series B preferred stock to Technologies, in consideration of the $1.8 million
advanced during the third and fourth quarters of fiscal 2002. In fiscal 2003 the Company provided approximately $1.0 million of
additional funding to OpticNet for general operating expenses. This funding
was expensed during fiscal year 2003 and is included in other expense. In August 2003, the Company entered into a Tender Offer to purchase the
outstanding common shares of OpticNet at $0.04 per share. The board of
directors of both companies approved the proposed transaction in December 2003.
The Tender Offer enabled the Company to purchase the 6.1 million outstanding
common shares of OpticNet it did not already own at an aggregate cost of
approximately $0.2 million. Upon acquisition of these securities, the Company
fully reserved their value. The Company subsequently terminated the
registration of OpticNets common stock under the Exchange Act. Note 12 Fair Value of Financial Instruments FAS No. 107 (FAS 107), Disclosures about Fair Value of Financial
Instruments, requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. Whenever possible, quoted market prices
were used to develop fair values. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets, and, in many cases, could
not be realized in immediate settlement of the instrument. FAS 107 excludes
certain financial instruments and all non-financial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company. The following
methods and assumptions were used by the Company in estimating its fair value
disclosures for financial instruments as of October 2, 2004 and as of September
27, 2003. Cash, Cash Equivalents and Investments:The carrying amounts reported in
the balance sheet for cash, cash equivalents and investments approximate those
assets fair values. Long-Term Debt:The fair value of long-term debt has been estimated based
upon discounted future cash flows. The discount rate used included a risk free
rate derived from the Treasury yield curve plus a risk weighting commensurate
with the Companys borrowing position. The fair value of
long-term debt, including capital lease, is
approximately $10.1 million and $15.9 million compared with the carrying
amounts of $10.6 million and $17.5 million at October 2, 2004, and September 27,
2003, respectively. 54




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and SubsidiariesOctober 2, 2004 Note 13 Earnings (Loss) Per Common Share The following table sets forth the computation of basic and diluted
earnings (loss) per common share: Year EndedOctober 2
    
    September 27,
    
    September 28,2004
    
    2003
    
    2002(in thousands, except per share amounts)NumeratorNet income (loss)
    
    $
    11,643
    
    
    $
    5,565
    
    
    $
    (8,806
    )DenominatorDenominator for basic earnings (loss) per common share 
Weighted average shares, net of nonvested shares
(fiscal 2004698 shares; fiscal 2003593 shares;
fiscal 2002699 shares)
    
    
    14,295
    
    
    
    14,119
    
    
    
    13,993Effect of dilutive securities:Nonvested shares
    
    
    108
    
    
    
    62
    
    
    
    Employee stock options
    
    
    235
    
    
    
    110
    
    
    
    Denominator for diluted earnings (loss) per share
    
    
    14,638
    
    
    
    14,291
    
    
    
    13,993Basic income (loss) per common share
    
    $
    0.81
    
    
    $
    0.39
    
    
    $
    (0.63
    )Diluted income (loss) per common and common equivalent share
    
    $
    0.80
    
    
    $
    0.39
    
    
    $
    (0.63
    )
 If the Company had reported net income in fiscal 2002, the calculation of
diluted earnings (loss) per share would have included the shares used in the
computation of historical net loss per share as well as an additional 232,000
common equivalent shares related to outstanding stock options and nonvested
restricted stock (determined using the treasury stock method) for the year
ended September 28, 2002. Note 14 Restructuring Charges In March 2002, the Company approved a plan to close a facility and
relocate manufacturing activities to a more cost effective location. As a
result, the Company accrued $2.2 million related primarily to the closure of
manufacturing facilities and administrative functions, including the accrual of
remaining payments on the facility operating lease, less future anticipated
sublease payments. Other costs included write-downs of fixed assets and
inventories to their fair value. The facility closure and relocation was
completed within the 12-month period ending March 29, 2003. The Company
continues to make payments related to the facility closure and these payments
are charged to the remaining balance of the provision. Future revenues and
operating income are not expected to be impacted by the facilitys closure. The detail of the Companys provision for product line move and other is
as follows (in thousands): Facility Closure ChargesBalance, September 28, 2002
    
    $
    1,583Charges
    
    
    Amounts utilized
    
    
    (1,345
    )Balance, September 27, 2003
    
    
    238Amounts utilized
    
    
    (204
    )Balance, October 2, 2004
    
    $
    34
 In the quarter ended March 30, 2002, the Company concluded that portions of the
assets held under leases were in excess to the Companys requirements. These
assets had been primarily used by OpticNet. This determination was a result of
OpticNets lack of 55




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and Subsidiaries
October 2, 2004 success in attracting strategic partners or third party financing. In March
2002, the Company recorded a charge of $10.3 million for expected future losses
on the leases of the facility and production assets in the provision for excess
capacity. In September 2003, the Company approved a plan to cease operation of its
silicon fabrication facility. To date, the Company had made significant
investments in designing a silicon rate sensor, including related equipment and
facilities. The Companys assessment is that its continuing progress with
quartz technology will remain competitive and therefore it will not continue to
operate its silicon fabrication facility. The Company recognized an impairment
related to the discontinued use of these assets of $1.2 million included in the
provision for excess capacity. Future revenues and operating income are not
expected to be impacted by the facilitys closure. In
2004, the provision for excess capacity was adjusted downward by
$238,000 based on management's updated analysis related to the
anticipated net proceeds from the sale of the equipment. The detail of the Companys provision for excess capacity is as follows (in
thousands): AssetImpairment
    
    Equipment
    
    Facility Lease
    
    OtherCharges
    
    Lease Charges
    
    Impairment Charges
    
    Commitments
    TotalBalance, September 28,
2002
    
    $
    
    
    
    $
    5,235
    
    
    $
    578
    
    
    $
    409
    
    
    $
    6,222Additional charges
    
    
    341
    
    
    
    881
    
    
    
    
    
    
    
    
    
    
    
    1,222Amounts utilized
    
    
    (341
    )
    
    
    (1,694
    )
    
    
    (174
    )
    
    
    (187
    )
    
    
    (2,396
    )Balance, September 27,
2003
    
    $
    
    
    
    
    4,422
    
    
    
    404
    
    
    
    222
    
    
    
    5,048Additional charges
    
    
    
    
    
    
    (327
    )
    
    
    98
    
    
    
    (9
    )
    
    
    (238
    )Amounts utilized
    
    
    
    
    
    
    (2,439
    )
    
    
    (198
    )
    
    
    (13
    )
    
    
    (2,650
    )Balance, October 2, 2004
    
    $
    
    
    
    $
    1,656
    
    
    $
    304
    
    
    $
    200
    
    
    $
    2,160
 Note 15 Sales and Major Customers The principal business and operations of Technologies are conducted within
one business segment and are carried out by operations which design,
manufacture and sell electronic devices that provide vital sensory input and
actuation for the control systems of advanced machinery and automation systems
for the automotive, government and industrial / commercial industries. Net
sales to major industries are as follows (in thousands): October 2,
    
    September 27,
    
    September 28,2004
    
    2003
    
    2002Commercial automotive sensors
    
    $
    171,505
    
    
    $
    119,139
    
    
    $
    94,694Government
    
    
    24,032
    
    
    
    21,814
    
    
    
    16,901Industrial /commercial
    
    
    85,763
    
    
    
    72,721
    
    
    
    74,043Total net sales
    
    $
    281,300
    
    
    $
    213,674
    
    
    $
    185,638
 Although the Company is directly affected by the economic well being of
the above industries, management does not believe significant credit risk
exists at October 2, 2004. The Companys foreign sales are conducted throughout Europe and Asia and
the rest of the world. A summary of foreign and domestic net sales follows (in
thousands): October 2,
    
    September 27,
    
    September 28,2004
    
    2003
    
    2002Domestic
    
    $
    132,977
    
    
    $
    98,323
    
    
    $
    92,558Foreign
    
    
    148,323
    
    
    
    115,351
    
    
    
    93,080Total net sales from operations
    
    $
    281,300
    
    
    $
    213,674
    
    
    $
    185,638
 Foreign net sales accounted for approximately 53%, 54% and 50% of total
net sales for fiscal 2004, 2003 and 2002, respectively. In fiscal 2004, 2003 and 2002, one customer accounted for 49%, 41% and
39%, respectively, of the Companys net sales. 56




---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSBEI Technologies, Inc. and Subsidiaries
October 2, 2004 Note 16 Quarterly Results of Operations (Unaudited) The tables below present quarterly financial information for fiscal 2004
and 2003: OperationsThree months endedJanuary 3,
    
    April 3,
    
    July 3,
    
    October 2,2004
    
    2004
    
    2004
    
    2004(dollars in thousands except per share amounts)Net sales
    
    $
    68,805
    
    
    $
    73,531
    
    
    $
    68,827
    
    
    $
    70,137Gross margin
    
    
    15,147
    
    
    
    18,568
    
    
    
    17,101
    
    
    
    15,636Net income
    
    
    2,003
    
    
    
    3,504
    
    
    
    3,372
    
    
    
    2,764Basic Earnings Per Common ShareBasic net income per common share
    
    $
    0.14
    
    
    $
    0.25
    
    
    $
    0.24
    
    
    $
    0.19Diluted Earnings Per Common ShareDiluted net income per common share
    
    $
    0.14
    
    
    $
    0.24
    
    
    $
    0.23
    
    
    $
    0.19
 December 28,
    
    March 29,
    
    June 28,
    
    September 27,2002
    
    2003
    
    2003
    
    2003Net sales
    
    $
    47,088
    
    
    $
    54,715
    
    
    $
    57,103
    
    
    $
    54,768Gross margin
    
    
    12,315
    
    
    
    12,757
    
    
    
    14,205
    
    
    
    13,182Net income (loss)
    
    
    2,973
    
    
    
    (321
    )
    
    
    663
    
    
    
    2,250Basic Earnings Per Common ShareBasic net income (loss) per common share
    
    $
    0.21
    
    
    $
    (0.02
    )
    
    $
    0.05
    
    
    $
    0.16Diluted Earnings Per Common ShareDiluted net income (loss) per common share
    
    $
    0.21
    
    
    $
    (0.02
    )
    
    $
    0.05
    
    
    $
    0.16
 Note 17 Subsequent Events (Unaudited) On October 8, 2004 the Company amended its line of credit agreement and
increased its available credit from $25 million to $35 million and extended the
maturity date from January 2006 to January 2007. The interest rate on the line
of credit is 1.5% per annum in excess of the Banks LIBOR rate. The Company
utilizes the line of credit to supplement general working capital and other
general corporate purposes. There was no outstanding amount on the line of
credit as of October 2, 2004. Concurrent with the increase in the line of credit availability the
Company executed a promissory note with its bank. The four year note
with an average life of three years is for $12 million and bears a fixed interest rate
of 5.9%. The terms of the note include monthly interest payments in addition
to annual principal payments of $4 million each. On October 12, 2004, the Company acquired the assets of Newall Measurement
Systems, Ltd., a manufacturer of proprietary products including high quality
digital readout systems (DRO) and digital linear encoders. The acquisition cost
was $11 million. Newall, which is based in the United Kingdom, serves machine
tool and process automation markets in North America, Asia and Europe. 57




---



##### Table of Contents



Report of Ernst & Young LLP, Independent Registered Public Accounting Firm The Board of Directors and Stockholders BEI Technologies, Inc. We have audited the accompanying consolidated balance sheets of BEI
Technologies, Inc. and subsidiaries as of October 2, 2004 and September 27,
2003, and the related consolidated statements of operations, stockholders
equity and comprehensive income (loss) and cash flows for each of the three
years in the period ended October 2, 2004. These financial statements are the
responsibility of the Companys management. Our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of BEI
Technologies, Inc. and subsidiaries at October 2, 2004, and September 27, 2003,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended October 2, 2004, in conformity with U.S.
generally accepted accounting principles. /s/ Ernst & Young LLP
 San Francisco, California
November 10, 2004 58




---



##### Table of Contents



ITEM 9.
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE None. 
 ITEM 9A. CONTROLS AND PROCEDURES Evaluation and Disclosure Controls and Procedures Based on their evaluation of our disclosure controls and procedures
(as defined in the rules promulgated under the Securities Exchange
Act of 1934), our chief executive officer and our chief financial
officer concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this report. We believe that a controls system, no matter how well designed and
operated, can provide only reasonable, not absolute assurance that
the objectives of the controls system are met. Because of the
inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and
instances of fraud, if any, within a company have been detected.
Our disclosure controls and procedures are designed to provide
reasonable assurance of achieving their objectives, and our chief
executive officer and our chief financial officer have concluded
that these controls and procedures are effective at the reasonable
assurance level. Changes in Internal Controls Our chief executive officer and chief financial officer have
determined that there are significant deficiencies in which the
design or operation of one or more of our internal control
procedures does not reduce to a reasonably low level the risk that
errors or fraud in amounts that would be other than inconsequential
in relation to the financial statements may occur and not be
detected. The deficiencies include the lack of sufficient controls
over inventory management at a major operating unit that resulted in
additional efforts at fiscal year-end by management to validate
reported balances at that date. Management is taking remedial
actions which include scheduling quarterly physical inventories to
insure that quarterly reporting is accurate going forward until the
control improvements are validated. In addition, management and the
audit committee have reviewed other deficiencies that will require
improvements in our system of internal control. We have since
devoted and will continue to devote resources to improve our
controls to remedy these significant deficiencies. Our efforts to
strengthen our financial and internal controls continue, and we
expect to complete remediation of the significant deficiencies
before the end of our fiscal 2005. 
 ITEM 9B. OTHER INFORMATION On
October 8, 2004, we amended our line of credit
agreement with Union Bank of California, N.A. (Union Bank) and increased its available credit from $25 million to
$35 million and extended the maturity date from January 2006 to
January 2007. Concurrent with the line of credit increase we
 executed a promissory note with Union Bank. The four year note with
an average life of three years is for $12 million and
bears a fixed interest rate of 5.9%. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Certain information with respect to directors and executive officers
is set forth in Part I of this Report. Additional information
required by this Item is incorporated herein by reference to the
section entitled Compliance with Section 16(a) of the Securities
and Exchange Act of 1934 of the Proxy Statement related to the
Companys 2005 Annual Meeting of Stockholders to be filed by the
Company with the Securities and Exchange Commission (the Definitive
Proxy Statement). 59




---



##### Table of Contents



ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by
reference to the sections entitled Executive Compensation and
Certain Transactions of the Definitive Proxy Statement. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Certain information with respect to securities authorized for
issuance under equity compensation plans is set forth in Part II,
Item 5 of this Report. Additional information required by this Item
is incorporated herein by reference to the section entitled
Security Ownership of Certain Beneficial Owners and Management of
the Definitive Proxy Statement. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by
reference to the sections entitled Certain Transactions and
Compensation Committee Interlocks and Insider Participation of the
Definitive Proxy Statement. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this Item is incorporated herein to the
section entitled Principal Accountant Fees and Services of the
Definitive Proxy Statement. 60




---



##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES The following documents are filed as part of this Form 10-K. Form 10-KPageNumber(a)(1)
    
    Index to Consolidated Financial StatementsThe following Consolidated Financial Statements of BEI Technologies, Inc. and its
Subsidiaries are filed as part of this Form 10-K:
    
    
    S-2Report of Ernst & Young LLP, Independent Registered Public Accounting FirmConsolidated Balance Sheets - October 2, 2004 and September 27, 2003
    
    
    36Consolidated Statements of Operations -
Years ended October 2, 2004, September 27, 2003
and September 28, 2002
    
    
    38Consolidated Statements of Cash Flows -
Years ended October 2, 2004, September 27, 2003
and September 28, 2002
    
    
    39Consolidated Statement of Changes in Stockholders Equity and Comprehensive
Income (Loss)  Years ended October 2, 2004, September 27, 2003
and September 28, 2002
    
    
    41Notes to Consolidated Financial Statements -
October 2, 2004
    
    
    42(a)(2)
    
    Index to Financial Statement ScheduleThe following Consolidated Financial Statement Schedule of BEI Technologies, Inc. for each of the years in the period
ended October 2, 2004 is filed as part of this Form 10-K:Schedule II Valuation and Qualifying Accounts
    
    
    S-1Report of Ernst & Young LLP, Independent Registered
Public Accounting Firm.
    
    
    S-2
 Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is
included in the Consolidated Financial Statements or Notes thereto.  (a)(3) Listing of Exhibits Exhibit Numbers
    
    Description
    
    Footnote2.1
    
    
    Distribution Agreement between BEI Electronics, Inc.
and BEI Technologies, Inc.
    
    i2.2
    
    
    Corporate Services Agreement between BEI
Technologies, Inc. and BEI Electronics, Inc.
    
    i2.3
    
    
    Tax Allocation and Indemnity Agreement between BEI
Electronics, Inc. and BEI Technologies, Inc.
    
    i
 61




---



##### Table of Contents



Exhibit Numbers
    
    
    Description
    
    Footnote2.4
    
    
    
    
    Assumption of Liabilities and Indemnity Agreement
between BEI Electronics, Inc. and BEI Technologies,
Inc.
    
    i2.5
    
    
    
    
    Technology Transfer and License Agreement by and
between BEI Electronics, Inc. and BEI Technologies,
Inc.
    
    i2.6
    
    
    
    
    Trademark Assignment and Consent Agreement by and
between BEI Electronics, Inc. and BEI Technologies,
Inc.
    
    i2.7
    
    
    
    
    Agreement Regarding Certain Representations and
Covenants by and between BEI Electronics, Inc. and
BEI Technologies, Inc.
    
    i3.1
    
    
    
    
    Certificate of Incorporation of BEI Technologies, Inc.
    
    i3.2
    
    
    
    
    Bylaws of BEI Technologies, Inc.
    
    i3.3
    
    
    
    
    Registrants Certificate of Designation of Series A
Junior Participating Preferred Stock (filed as
Exhibit 99.3 hereto)
    
    i4.1
    
    
    
    
    Specimen Common Share Certificate
    
    i4.2
    
    
    
    
    Certificate of Incorporation of BEI Technologies,
Inc. (filed as Exhibit 3.1 hereto)
    
    i4.3
    
    
    
    
    Bylaws of BEI Technologies, Inc. (filed as Exhibit
3.2 hereto)
    
    i4.4
    
    
    
    
    Registrants Certificate of Designation of Series A
Junior Participating Preferred Stock (filed as
Exhibit 99.3 hereto)
    
    i4.5
    
    
    
    
    Form of Rights Certificate (filed as Exhibit 99.4
hereto)
    
    i10.1
    *
    
    
    
    Registrants 1997 Equity Incentive Plan and forms of
related agreements
    
    i10.2
    *
    
    
    
    Executive Change in Control Benefits Agreement
between BEI Technologies, Inc. and Certain Named
Executive Officers
    
    i10.5
    
    
    
    
    Note Purchase Agreement dated November 16, 1998 by
and between BEI Technologies, Inc., BEI Sensors &
Systems Company, Inc., Connecticut General Life
Insurance Company and Allstate Life Insurance Company
    
    ii10.6
    
    
    
    
    Amendment to Tax Allocation and Indemnity Agreement
between BEI Electronics, Inc. and BEI Technologies,
Inc.
    
    ii
 62




---



##### Table of Contents



Exhibit Numbers
    
    Description
    
    Footnote10.9+
    
    
    Development and Supply Agreement, dated April 26,
2001, by and between Systron Donner Inertial Division
and Continental Teves AG & Co.
    
    iv10.10
    
    
    Amendment to Note Purchase Agreement as amended as of
March 30, 2002, by and between BEI
Technologies, Inc., BEI Sensors & Systems Company, Inc.,
Connecticut General Life Insurance Company and
Allstate Life Insurance Company
    
    v10.11
    
    
    Credit Agreement dated August 14, 2002, by and
between BEI Technologies, Inc., BEI Sensors & Systems
Company, Inc. and Union Bank of California
    
    vi10.12
    
    
    Second amendment to Note Purchase Agreement and
Waiver dated December 20, 2002, by and between BEI
 Technologies, Inc., BEI Sensors & Systems Company,
Inc., Connecticut General Life Insurance Company and
Allstate Life Insurance Company
    
    vi10.13*
    
    
    Employment Agreement between BEI
Technologies, Inc. and Asad M. Madni, renewed as of October 1, 2003.
    
    vii10.14+
    
    
    Supply Agreement, dated
March 2, 2004, by and between Contential Teves AG & Co. and Systron Donner
Automotive Division.
    
    viii10.15
    
    
    Third Amendment to Loan
Agreement dated August 14, 2002, by and between BEI Technologies,
Inc., BEI Sensors & Systems company Inc. and Union Bank of
California21.1
    
    
    Subsidiaries of the Registrant
    
    ii23.1
    
    
    Consent of Independent Registered
Public Accounting Firm.24.1
    
    
    Power of Attorney is included on
the signature pages hereto.31.1
    
    
    CEO Certification Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934 as adopted Pursuant
to Section 302 of the Sarbanes  Oxley Act of 200231.2
    
    
    CFO Certification Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934 as adopted Pursuant
to Section 302 of the Sarbanes  Oxley Act of 200232.1
    
    
    CEO Certification Pursuant to Rule 13a-14(b) of the
Securities Exchange Act of 1934 and 18 U.S.C. 1350 as
adopted Pursuant to Section 906 of the Sarbanes 
Oxley Act of 200232.2
    
    
    CFO Certification Pursuant to Rule 13a-14(b) of the
Securities Exchange Act of 1934 and 18 U.S.C. 1350 as
adopted Pursuant to Section 906 of the Sarbanes 
Oxley Act of 200299.1
    
    
    BEI Technologies, Inc. Information Statement dated
September 24, 1997
    
    ii99.2
    
    
    Rights Agreement dated as of September 11, 1997 among
BEI Technologies, Inc. and ChaseMellon Shareholder
Services, L.L.C.
    
    i99.3
    
    
    Registrants Certificate of Designation of Series A
Junior Participating Preferred Stock
    
    i99.4
    
    
    Form of Rights Certificate
    
    i
 63




---



##### Table of Contents



(i)
    
    Incorporated by reference. Previously filed as an exhibit to the Registrants Information Statement on Form 10 (File No. 0-22799) as filed on
September 22, 1997.(ii)
    
    Incorporated by reference. Previously filed as an exhibit to the Form 10-K (File No. 0-22799) as filed
on December 30, 1998.(iii)
    
    Incorporated by reference. Previously filed as an exhibit to the Form 10-Q (File No. 000-22799) as filed on February 13, 2001.(iv)
    
    Incorporated by reference. Previously filed as an exhibit to the Form 10-Q (File No. 000-22799) as filed on August 14, 2001.(v)
    
    Incorporated by reference. Previously filed as an exhibit to the Form 10-Q (File No. 000-22799) as filed on May 13, 2002.(vi)
    
    Incorporated by reference. Previously filed as an exhibit to the Form 10-K (File No. 000-22799) as filed on December 23, 2002.(vii)
    
    Incorporated by reference. Previously filed as an exhibit to the From-10Q (File No. 000-22794) as filed on February 12, 2004.(viii)
    
    Incorporated by reference. Previously filed as an exhibit to the Form-10Q (File No. 000-22799) as filed on May 14, 2004.*
    
    Items which are management contracts or compensatory plans or arrangements required to be filed as an exhibit pursuant to Item 14(c) of Form
10-K.+
    
    Confidential treatment has been requested for a portion of this exhibit.
 64




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 on
December 16, 2004. BEI
TECHNOLOGIES, INCBy:
    /s/ Robert R. CorrRobert R. Corr
Vice President, Treasurer, Controller and Secretary POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Charles Crocker and John LaBoskey, and
each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place, and
stead, in any and all capacities, to sign any and all amendments to this Report
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in connection therewith, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or any of them, or their or his
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ Charles Crocker
    
    Chief Executive Officer and Chairman of
    
    December 15, 2004the Board Of Directors (PrincipalCharles Crocker
    
    Executive Officer)/s/ Dr. Asad M. Madni
    
    President, Chief Operating Officer and
    
    December 15, 2004DirectorDr. Asad M. Madni/s/ John LaBoskey
    
    Senior Vice President and Chief Financial
    
    December 15, 2004OfficerJohn LaBoskey/s/ Robert R. Corr
    
    Vice President, Secretary, Treasurer and
    
    December 15, 2004Controller (Principal Accounting Officer)Robert R. Corr/s/ Richard Brooks
    
    Director
    
    December 15, 2004Richard M. BrooksDirectorC. Joseph Giroir, Jr./s/ Dr. William G. Howard
    
    Director
    
    December 15, 2004Dr. William G. Howard/s/ J. Lavon Morton
    
    Director
    
    December 15, 2004J. Lavon Morton/s/ Gary D. Wrench
    
    Director
    
    December 15, 2004Gary D. Wrench
 65




---



##### Table of Contents



SCHEDULE II BEI TECHNOLOGIES, INC. VALUATION AND QUALIFYING ACCOUNTS Column A
    
    Column B
    
    Column C
    
    Column D
    
    Column EAdditionsBalance at
    
    Charged to
    
    
    
    
    
    
    
    
    
    Balance atBeginning
    
    Costs and
    
    Charged to
    
    
    
    
    
    End ofDescription
    
    of Period
    
    Expenses
    
    Other Accounts
    
    Deductions
    
    Period(in thousands)Year ended October 2, 2004Deducted from asset accounts:Allowance for doubtful accounts
    
    $
    783
    
    
    
    313
    
    
    $
    
    
    
    
    283
    (A)
    
    $
    813Inventory reserve
    
    
    3,400
    
    
    
    3,112
    
    
    
    
    
    
    
    2,452
    (B)
    
    
    4,060Provision for excess capacity
    
    
    5,048
    
    
    
    (238
    )
    
    
    
    
    
    
    2,650
    (C)
    
    
    2,160Total
    
    $
    9,231
    
    
    $
    3,187
    
    
    
    
    
    
    $
    5,385
    
    
    $
    7,033Year ended September 27, 2003:Deducted from asset accounts:Allowance for doubtful accounts
    
    $
    1,365
    
    
    $
    873
    
    
    $
    
    
    
    $
    1,455
    (A)
    
    $
    783Inventory reserve
    
    
    2,427
    
    
    
    3,707
    
    
    
    
    
    
    
    2,734
    (B)
    
    
    3,400Provision for excess capacity
    
    
    6,222
    
    
    
    1,222
    
    
    
    
    
    
    
    2,396
    (C)
    
    
    5,048Total
    
    $
    10,014
    
    
    $
    5,802
    
    
    $
    
    
    
    $
    6,585
    
    
    $
    9,231Year ended September 28, 2002:Deducted from asset accounts:Allowance for doubtful accounts
    
    $
    1,662
    
    
    $
    1,526
    
    
    $
    
    
    
    $
    1,823
    (A)
    
    $
    1,365Inventory reserve
    
    
    3,755
    
    
    
    1,053
    
    
    
    
    
    
    
    2,381
    (B)
    
    
    2,427Provision for excess capacity
    
    
    
    
    
    
    10,275
    
    
    
    
    
    
    
    4,053
    (C)
    
    
    6,222Total
    
    $
    5,417
    
    
    $
    12,854
    
    
    $
    
    
    
    $
    8,257
    
    
    $
    10,014
  (A)
    
    Write-offs of uncollectible accounts(B)
    
    Write-offs of obsolete and scrap items(C)
    
    Provision utilized S-1




---



##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, AS TO  The Board of Directors and Stockholders
BEI Technologies, Inc. We have audited the consolidated financial statements of BEI Technologies,
Inc. and subsidiaries as of October 2, 2004 and September 27, 2003, and for
each of the three years in the period ended October 2, 2004, and have issued
our report thereon dated November 10, 2004. Our audits also included the
financial statement schedule listed in Item 15(a) 2 of this Form 10-K. This
schedule is the responsibility of the Companys management. Our responsibility
is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as
a whole, presents fairly in all material respects, the information set forth
therein. /s/ Ernst & Young LLP San Francisco, California
November 10, 2004 S-2




---



##### Table of Contents



INDEX TO EXHIBITS ExhibitNumber
    
    Description23.1
    
    Consent of Independent Registered Public Accounting Firm31.1
    
    CEO Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934 as adopted Pursuant to Section 302 of the
Sarbanes - Oxley Act of 200231.2
    
    CFO Certification Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934 as adopted Pursuant to Section 302 of the
Sarbanes - Oxley Act of 200232.1
    
    CEO Certification Pursuant to Rule 13a-14(b) of the Securities
Exchange Act of 1934 and 18 U.S.C 1350 as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    CFO Certification Pursuant to Rule 13a-14(b) of the Securities
Exchange Act of 1934 and 18 U.S.C. 1350 as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002