##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2004 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from _________________ to _______________________ Commission file number: 0-23576 CELERITEK, INC. (Exact name of registrant as specified in its charter)
 California
(State or other jurisdiction of
incorporation or organization)
    
    77-0057484
(I.R.S. Employer
Identification Number)3236 Scott Blvd.
Santa Clara, CA
(Address of principal executive offices)
    
    95054
(Zip Code)
 (408) 986-5060
(Registrants telephone number, including area code) NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yesx Noo Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act). Yeso Nox Indicate the number of shares outstanding of each of the issuers classes of stock, as of the latest
practicable date. Common Stock, No Par Value: 12,855,962 shares as of July 25, 2004




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CELERITEK, INC. Table of Contents  
 Page No.PART I: FINANCIAL INFORMATION
    
    
    1Item 1. Financial Statements (Unaudited)
    
    
    1Condensed Consolidated Balance Sheets: June 30, 2004 and
March 31, 2004
    
    
    1Condensed Consolidated Statements of Operations: Three months
ended June 30, 2004 and 2003
    
    
    2Condensed Consolidated Statements of Cash Flows: Three months
ended June 30, 2004 and 2003
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of
operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4. Controls and Procedures
    
    
    25PART II: OTHER INFORMATION
    
    
    26Item 6. Exhibits and Reports on Form 8-K
    
    
    26SIGNATURES
    
    
    27EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  -i-




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##### Table of Contents



PART I            FINANCIAL INFORMATION 
 Item 1.             FINANCIAL STATEMENTS CELERITEK, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 June 30,
    
    March 31,2004
    
    2004(Unaudited)
    
    (Note)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,123
    
    
    $
    3,121Short-term investments
    
    
    15,463
    
    
    
    24,110Accounts receivable, net
    
    
    5,306
    
    
    
    6,048Inventories
    
    
    2,991
    
    
    
    2,739Prepaid expenses and other current assets
    
    
    936
    
    
    
    1,315Total current assets
    
    
    32,819
    
    
    
    37,333Property and equipment, net
    
    
    5,317
    
    
    
    5,430Strategic investments
    
    
    2,504
    
    
    
    2,741Other assets
    
    
    1,254
    
    
    
    1,262Total assets
    
    $
    41,894
    
    
    $
    46,766LIABILITIES & SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,409
    
    
    $
    3,171Accrued payroll
    
    
    1,393
    
    
    
    1,459Accrued liabilities
    
    
    3,119
    
    
    
    4,826Current portion of long-term debt
    
    
    716
    
    
    
    1,866Current obligations under capital leases.
    
    
    168
    
    
    
    328Total current liabilities
    
    
    7,805
    
    
    
    11,650Shareholders equity (12,855,962 common and
no preferred shares outstanding at both
June 30, 2004 and March 31, 2004)
    
    
    34,089
    
    
    
    35,116Total liabilities and shareholders equity
    
    $
    41,894
    
    
    $
    46,766
 Note: The balance sheet at March 31, 2004 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. See accompanying notes. 1




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CELERITEK, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months EndedJune 30,2004
    
    2003Net sales
    
    $
    8,001
    
    
    $
    6,572Cost of goods sold
    
    
    4,991
    
    
    
    6,017Gross profit
    
    
    3,010
    
    
    
    555Operating expenses:Research and development
    
    
    1,793
    
    
    
    2,915Selling, general and administrative
    
    
    2,025
    
    
    
    2,151Cost related to shareholder and
strategic activities
    
    
    
    
    
    
    2,500Intangible asset amortization
    
    
    
    
    
    
    128Total operating expenses
    
    
    3,818
    
    
    
    7,694Loss from operations
    
    
    (808
    )
    
    
    (7,139
    )Impairment of strategic investment
    
    
    (237
    )
    
    
    Interest income and other, net
    
    
    80
    
    
    
    241Loss before income tax
    
    
    (965
    )
    
    
    (6,898
    )Provision for income tax
    
    
    
    
    
    
    Net loss
    
    $
    (965
    )
    
    $
    (6,898
    )Basic and diluted loss per share
    
    $
    (0.08
    )
    
    $
    (0.56
    )Weighted average common shares
outstanding  basic and diluted
    
    
    12,856
    
    
    
    12,343
 See accompanying notes. 2




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##### Table of Contents



CELERITEK, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months EndedJune 30,
    
    June 30,2004
    
    2003Operating activitiesNet loss
    
    $
    (965
    )
    
    $
    (6,898
    )Adjustment to reconcile net loss to net cash (used in)
provided by operating activities:Depreciation, amortization and other
    
    
    982
    
    
    
    1,211Changes in operating assets and liabilities
    
    
    (1,674
    )
    
    
    1,732Net cash (used in) provided by operating activities
    
    
    (1,657
    )
    
    
    (3,955
    )Investing activitiesPurchase of property and equipment
    
    
    (637
    )
    
    
    (260
    )Purchases of short-term investments
    
    
    (5,939
    )
    
    
    (52,875
    )Maturities and sale of short-term investments
    
    
    14,560
    
    
    
    34,755Net cash (used in) provided by investing activities
    
    
    7,984
    
    
    
    (18,380
    )Financing activitiesPayments on long-term debt
    
    
    (1,150
    )
    
    
    (615
    )Payments on obligations under capital leases
    
    
    (160
    )
    
    
    (103
    )Proceeds from issuance of common stock
    
    
    (15
    )
    
    
    14Net cash used in financing activities
    
    
    (1,325
    )
    
    
    (704
    )(Decrease) increase in cash and cash equivalents
    
    
    5,002
    
    
    
    (23,039
    )Cash and cash equivalents at beginning of period
    
    
    3,121
    
    
    
    28,909Cash and cash equivalents at end of period
    
    $
    8,123
    
    
    $
    5,870Supplemental disclosures of cash flow information:Cash paid during the period for:Income taxes
    
    $
    
    
    
    $
    1Interest
    
    
    86
    
    
    
    125Capital lease obligations incurred to acquire equipment
    
    
    
    
    
    
    89
 See accompanying notes. 3




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Celeritek, Inc. 
 Notes to Condensed Consolidated Financial Statements
(Unaudited) June 30, 2004  1.
    
    Basis of PresentationThe accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been
included.The Companys reporting period consists of a thirteen-week period ending
on the Sunday closest to the calendar month end. The first quarters of
fiscal 2005 and fiscal 2004 ended June 27, 2004 and June 29, 2003,
respectively. For convenience, the accompanying financial statements have
been shown as ending on the last day of the calendar month.Operating results for the three months ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the fiscal
year ending March 31, 2005. This financial information should be read in
conjunction with the audited consolidated financial statements and notes
thereto included in the Companys annual report on Form 10-K for the year
ended March 31, 2004 as filed with the Securities and Exchange Commission.On July 8, 2004, the Company announced it had entered into an asset
purchase agreement with Teledyne Wireless, Inc. pursuant to which Teledyne
will acquire the Companys defense subsystems business for $33.0 million
in cash (subject to a working capital adjustment). The Companys defense
subsystems business had sales of $19.7 million for the fiscal year ended
March 31, 2004. The asset sale is subject to the approval of the Companys
shareholders, as well as other customary closing conditions. If the
proposed transaction is completed, the Company intends to distribute a
substantial portion of the after-tax proceeds from the proposed
transaction to its shareholders through an extraordinary cash dividend,
although the amount of the dividend has not yet been determined, since the
Company has not completed its analysis of the cash it will need to
continue its operations and otherwise pay its liabilities and expenses.Certain amounts reported in previous years and interim periods have been
reclassified to conform to the current year presentation. 4




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2.
    
    Stock Based CompensationThe Company generally grants stock options to its employees for a fixed
number of shares with an exercise price equal to the fair value of
the shares on the date of grant. The Company records compensation related to
employees stock awards under the intrinsic value method and accordingly,
no compensation expense is recognized in the Companys financial
statements in connection with stock options granted to employees with
exercise prices not less than fair value.Pro forma information regarding net loss and net loss per share under the
fair value method is presented below (in thousands, except per share
amounts): Three months endedJune 30,2004
    
    2003Net loss
As
reported
    
    $
    (965
    )
    
    $
    (6,898
    )Add: Total stock-based employee
compensation expense determined under
fair value method for all awards, net
of related tax
effects
    
    
    (612
    )
    
    
    (1,156
    )Pro forma net
loss
    
    $
    (1,577
    )
    
    $
    (8,054
    )Basic and diluted net loss per share:As
reported
    
    $
    (0.08
    )
    
    $
    (0.56
    )Pro
forma
    
    $
    (0.12
    )
    
    $
    (0.65
    )
  Pro forma information regarding net loss and net loss per share is
required by Statement of Financial Accounting Standards No. 123,
Accounting for Stock-based Compensation (SFAS 123), as amended by SFAS
148, and has been determined as if the Company had accounted for its stock
options granted subsequent to December 31, 1994 under the fair value
method of SFAS 123. The fair market value for options granted was
estimated at the date of grant using the Black-Scholes option-pricing
model. The Company valued its employee stock options using the following
weighted-average assumptions: Three months endedJune 30,2004
    
    2003Risk-free interest rate
    
    
    3.9
    %
    
    
    2.5
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Volatility
    
    
    86.7
    %
    
    
    87.9
    %Expected life of options
    
    5 years
    
    5 years
  The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options that 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 stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect 5




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the fair market value estimate, in managements opinion, the existing
models do not necessarily provide a reliable measure of the fair market
value of its options.The weighted average grant date fair value of options granted during the
three months ended June 30, 2004 and 2003 was $2.49 and $5.25,
respectively. There were no purchases made under the Employee Stock
Purchase Plan during the three months ended June 30, 2004 and 2003.We declared an extraordinary cash dividend of $4.50 per share payable to
shareholders of record as of February 5, 2004, payable on March 11, 2004.
The total dividend paid was $57.8 million. Under the intrinsic value
method of accounting for stock options, we were required to adjust our
stock option exercise price by the dividend amount, or $4.50 per share,
because the dividend was a return of capital. Since our stock option plan
does not allow us to reprice options, we were required to change to the
variable method of accounting for our outstanding stock options. Under
variable accounting, compensation expense is recognized over the life of
the option (until exercised, forfeited, or cancelled) generally to the
extent that there are any increases in the per share market price of the
companys common stock. It is difficult to estimate the impact that
expensing stock options will have on our statement of operations as this
expense is dependent upon future events that are difficult to predict,
such as the number of options to be granted during a period, the price of
our common stock at the time of grant, the stock price volatility, the
risk free interest rate during the period and the expected average life of
the option. A slight change in any one of these variables can materially
affect the amount of compensation expense to be recorded. This change to
the variable method of accounting on March 12, 2004 had no financial
impact on the fiscal 2005 first quarter financial statements.3.
    
    InventoriesInventories, stated at the lower of standard cost (which approximates
actual cost on a first-in, first-out method) or market, consists of the
following components (in thousands): June 30,
    
    March 31,2004
    
    2004Raw materials
    
    $
    1,025
    
    
    $
    763Work-in-process
    
    
    1,966
    
    
    
    1,976$
    2,991
    
    
    $
    2,739
  4.
    
    Loss Per ShareBasic loss per common share is computed using the weighted
average common shares outstanding during the period. The effect of outstanding stock
options is excluded from the calculation of diluted net loss per share, as
their inclusion would be antidilutive. 6




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5.
    
    Comprehensive LossThe components of comprehensive loss for the three month periods ended
June 30, 2004 and 2003 are as follows (in thousands): Three months endedJune 30,2004
    
    2003Net loss
    
    $
    (965
    )
    
    $
    (6,898
    )Other comprehensive income (loss):Unrealized gains (losses) on
marketable securities
    
    
    (26
    )
    
    
    (17
    )Other comprehensive income (loss)
    
    
    (26
    )
    
    
    (17
    )Comprehensive loss
    
    $
    (991
    )
    
    $
    (6,915
    )
  6.
    
    Strategic InvestmentsThe Company regularly reviews its investments for circumstances of other
than temporary impairment and assesses the carrying value of the assets
against market value. When an other than temporary impairment exists, the
Company records an expense to the extent that the carrying value exceeds
fair market value in the period the assessment was made. The fair value
of strategic investments is dependent on the performance of the companies
invested in, as well as the marketability of these investments. In
assessing potential other than temporary impairment of these investments,
management considers these factors as well as forecasted financial
performance of the investees. If these forecasts are not met or if market
conditions change, the Company may have to record additional impairment
charges.Handset Design CompanyIn December 2001, the Company invested $0.5 million in a Korean handset
design company. On April 1, 2002, the Company invested an additional $2.0
million in the handset design company. The Company does not have
significant influence over the management of the handset design company
and accordingly has accounted for the investment on a cost basis in all
reported periods. The Company reviewed the investment as of June 30, 2004
and determined no indicators of impairment were present that would
indicate the current carrying value of the investment was impaired.GaAs FoundryIn December 2000, the Company invested approximately $2.4 million in a
GaAs foundry under construction in Taiwan in exchange for a strategic
interest in the foundry. The Company does not 7




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have significant influence over the management of the GaAs foundry and
accordingly has accounted for the investment on a cost basis in all
reported periods.During the fourth quarter of fiscal 2002, first and fourth quarter of
fiscal 2003 and first quarter of fiscal 2005, the Company recorded
impairment charges of approximately $1.7 million, $0.3 million, $0.1
million and $0.3 million, respectively, against its strategic investment
in the Taiwanese foundry, which was deemed, in those respective periods,
to have an other than temporary decline in value. The current carrying
value of this investment at the end of the first quarter of fiscal 2005 is
zero. The Company has completely written off its investment in the GaAs
foundry due to the insolvency of its parent company, which the Company
believes was the foundrys main source of funding.7.
    
    Special ChargesAt March 31, 2004, the Company held an accrual for $1.1 million relating
to the fiscal 2003 and fiscal 2004 restructuring activities. Lease
termination cost accrual of $0.4 million represented the present value of
future minimum payments under operating leases covering unused equipment
in fiscal 2003. Such amounts will be paid through to lease expiry in
fiscal 2005. Relocation cost accrual of $0.7 million represented the
present value of future minimum payments under a building lease agreement
for a building the Company vacated in fiscal 2004. Such amounts will be
paid through to lease expiry in fiscal 2006.The following table summarizes the Companys special charges activity (in
thousands): LeaseImpairment
    
    TerminationEmployee
    
    
    
    
    
    of Assets
    
    andTermination
    
    Excess
    
    Held For
    
    RelocationCosts
    
    Equipment
    
    Sale
    
    Costs
    
    TotalAccrual balances, March 31, 2003
    
    $
    123
    
    
    $
    
    
    
    $
    
    
    
    $
    1,050
    
    
    $
    1,173Fiscal 2004 special charges
    
    
    734
    
    
    
    2,618
    
    
    
    183
    
    
    
    1,005
    
    
    
    4,540Cash paid
    
    
    (680
    )
    
    
    
    
    
    
    
    
    
    
    (932
    )
    
    
    (1,612
    )Non-cash activity
    
    
    (100
    )
    
    
    (2,618
    )
    
    
    (183
    )
    
    
    
    
    
    
    (2,901
    )Accrual balances, March 31, 2004
    
    $
    77
    
    
    $
    
    
    
    $
    
    
    
    $
    1,123
    
    
    $
    1,200Cash paid
    
    
    (17
    )
    
    
    
    
    
    
    
    
    
    
    (257
    )
    
    
    (274
    )Accrual balances, June 30, 2004.
    
    $
    60
    
    
    $
    
    
    
    $
    
    
    
    $
    866
    
    
    $
    926
  8.
    
    Product WarrantyThe Company warrants its products against defects in design, materials,
and workmanship, generally for one year from the date of shipment for all
of its products. The actual term could vary depending on the specific
customers. An accrual for estimated future costs relating to warranty
expense is recorded, as a percentage of revenue based on prior experience,
when revenue is recorded and is included in cost of goods sold. Factors
that affect the Companys warranty liability include historical and
anticipated rates of warranty claims and cost per claim. The Company
periodically assesses the adequacy of its recorded warranty liabilities
and adjusts the amounts as necessary. 8




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Changes in the Companys product liability during the three months ended
June 30, 2004 and 2003 were as follows (in thousands): Three months endedJune 30,2004
    
    2003Beginning accrual balance
    
    $
    301
    
    
    $
    400Warranties issued
    
    
    32
    
    
    
    69Charges incurred
    
    
    (33
    )
    
    
    (68
    )Ending accrual balance
    
    $
    300
    
    
    $
    401
  9.
    
    Cost Related to Shareholder and Strategic ActionsIn the fourth quarter of fiscal 2003, a group of shareholders (the
Shareholder Committee) called a special meeting to remove the Companys
Board of Directors from office and replace them with a different slate of
candidates. In May 2003 the Companys Board of Directors entered into an
agreement with the Shareholder Committee. Under the terms of the
agreement, the Company has expanded its Board of Directors from six
directors to seven. The new Board is now composed of three of the
Companys directors who were directors prior to the agreement, three
directors nominated by the Shareholder Committee and one member who is not
affiliated with either the Company or the Shareholder Committee. In
fiscal 2004, expenses of $1.4 million related to the special meeting of
shareholders and $1.7 million in investment banking fees were incurred and
reported in loss from operations under the caption Cost related to
shareholder and strategic actions. The Company did not incur any cost
related to shareholder and strategic actions during the first three months
of fiscal 2005.10.
    
    Recent Accounting PronouncementsIn January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities.In general, a variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its
activities. FIN 46 requires a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss
from the variable interest entitys activities or entitled to receive a
majority of the entitys residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities
created after January 31, 2003. The consolidation requirements apply to
older entities in the first fiscal year or interim period ending after
December 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company adopted FIN 46 in
the third quarter of fiscal 2004 and its adoption did not have a material
impact on the Companys financial position or results of operations. 9




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In May 2003, the FASB issued Statement Number 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS 150 establishes standards for classifying and
measuring as liabilities certain financial instruments that embody
obligations of the issuer and have characteristics of both liabilities and
equity. SFAS 150 generally requires liability classification for two
broad classes of financial instruments: (1) instruments that represent, or
are indexed to, an obligation to buy back the issuers shares, and (2)
obligations that can be settled in shares, but are subject to certain
conditions. SFAS 150 applies to all financial instruments created or
modified after May 31, 2003, and to other instruments at the beginning of
the first interim period beginning after July 1, 2003. As the Company has
not created or modified any financial instruments since the effective date
of SFAS 150, it did not have a material impact on the Companys financial
statements.In November 2002, the Emerging Issues Task Force (the EITF) reached a
consensus on Issue No. 00-21 Accounting for Revenue Arrangements with
Multiple Deliverables. The EITF concluded that revenue arrangements with
multiple elements should be divided into separate units of accounting if
the deliverables in the arrangement have value to the customer on a
standalone basis, if there is objective and reliable evidence of the fair
value of the undelivered elements, and as long as there are no rights of
return or additional performance guarantees by the Company. The provisions
of EITF Issue No. 00-21 are applicable to agreements entered into in
fiscal periods beginning after June 15, 2003. Management adopted the
consensus in the second quarter of fiscal 2004, and it did not have a
material effect on the Companys results of operations or financial
condition.In November 2003, the EITF issued EITF No. 03-6 Participating Securities
and the Two-Class Method under FASB Statement No. 128, which provides for
a two-class method of calculating earnings per share computations that
relate to certain securities that would be considered to be participating
in conjunction with certain common stock rights. This guidance would be
applicable to the Company starting with the second quarter beginning July
1, 2004. The Company is currently evaluating the potential impact of this
pronouncement on its financial statements.11.
    
    Subsequent EventsOn July 8, 2004, the Company announced it had entered into an asset
purchase agreement with Teledyne Wireless, Inc. pursuant to which Teledyne
will acquire the Companys defense subsystems business for $33.0 million
in cash (subject to a working capital adjustment). The Companys defense
subsystems business had sales of $19.7 million for the fiscal year ended
March 31, 2004. The asset sale is subject to the approval of the Companys
shareholders, as well as other customary closing conditions. If the
proposed transaction is completed, the Company intends to distribute a
substantial portion of the after-tax proceeds from the proposed
transaction to its shareholders through an extraordinary cash dividend,
although the amount of the dividend has not yet been determined, since the
Company has not completed its analysis of the cash it will need to
continue its operations and otherwise pay its liabilities and expenses. 10




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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS Forward-Looking Statements This report contains forward-looking statements, which are identified by
words such as anticipate, believe, plan, estimate, expect, intend
and other similar expressions. In addition, forward-looking statements in this
report include, but are not limited to, those regarding: our intention to
distribute a cash dividend from the proceeds of the proposed asset sale, our
focus on market areas where we believe our resources and core competencies will
give us the greatest opportunity for success in our goal of returning to
profitability; our future gross margins; our expected research and development
expenses and selling, general and administrative expenses; and our belief that
our cash resources will be sufficient to meet our liquidity needs through at
least the next twelve months. These forward-looking statements are subject to
business and economic risks and uncertainties, and our actual results of
operations may differ materially from those contained in the forward-looking
statements. Unless required by law, we undertake no obligation to update
publicly any forward-looking statements, whether as a result of new
information, future events, or otherwise. However, readers should carefully
review the risk factors set forth in this Form 10-Q and other reports or
documents we file from time to time with the Securities and Exchange
Commission. Critical Accounting Policies The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires us to make
estimates and assumptions that affect the reported amounts. Some of the
estimation processes affect current assets and liabilities and are therefore
critical in assessing our financial and operating status. These estimates
involve certain assumptions that, if incorrect, could have a material adverse
impact on our operations and financial position. We review our estimates, including, but not limited to, allowance for
doubtful accounts, inventory write-downs, and impairments of long-lived assets
and investments, on a regular basis and make adjustments based on historical
experiences and existing and expected future conditions. These evaluations are
performed regularly and adjustments are made as information is available. We
believe that these estimates are reasonable; however, actual results could
differ from these estimates. The following paragraphs describe the methodology
we use in making some of our principal accounting estimates, in evaluating some
of the uncertainties inherent in accounting estimates and in evaluating some of
the ways that our estimates may impact our financial condition. Revenue Recognition.Revenue related to product sales is recognized when
the products are shipped to the customer, title has transferred and no
obligations remain. In circumstances where the collection of payment is not
probable at the time of shipment, we defer recognition of the revenue until
payment is collected. We provide for expected returns based on past experience
as well as current customer activities. Our customers do not have rights of
return outside of products returned under warranty and, to date, returns have
not been material. Shipping and handling costs are included in costs of goods
sold for all periods presented. Allowance for Doubtful Accounts.We establish an allowance for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. We evaluate our customers financial position and
order level to determine if an allowance should be established. Any change in
the allowance from our assessment of the likelihood of receiving payment is
reflected in the selling, general, and administrative costs in the period the
change in assessment is made. 11




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Inventory Write-downs.We record inventory write-downs for estimated
obsolescence or unmarketable inventory. Our write-downs for excess and obsolete
inventory are primarily based upon forecasted demand and our backlog of orders
for the product. Any inventory write-downs are reflected in cost of sales in
the period the write-downs are made. Long-lived Assets and Strategic Investments.We regularly review our
long-lived assets and strategic investments for indicators of impairment and
assess the carrying value of the assets against market values. When impairment
exists, we record an expense to the extent that the carrying value exceeds fair
market value in the period the assessment is made. We record impairment losses on long-lived assets used in operations or
expected to be disposed of when events and circumstances indicate that the
undiscounted cash flow estimated to be generated by these assets is less than
the carrying amounts of those assets. We consider sensitivities to capacity,
utilization and technological developments in making related assumptions. The fair value of strategic investments is dependent on the performance of
the companies in which we have invested, as well as the marketability of these
investments. In assessing potential impairment of these investments, we
consider these factors as well as forecasted financial performance of the
investees. If these forecasts are not met or if market conditions change, we
may assess the value of the strategic investment to be other than temporarily
impaired and accordingly record an impairment charge. Intangible Assets.We recorded intangible assets at fair value.
Intangible assets with finite useful lives were amortized over their estimated
useful life and amortization expense was classified as part of operating
expenses. To date, we have only had intangible assets with finite useful lives.
We regularly performed reviews to determine if the carrying values of our
intangible assets were impaired. We looked for facts, circumstances, either
internal or external, that may have indicated we may not have recovered the
carrying value of the assets. We recorded impairment losses based on the
amount by which the carrying amounts of such assets exceeded their fair values. Recent Events On July 8, 2004, we announced we had entered into an asset purchase
agreement with Teledyne Wireless, Inc. pursuant to which Teledyne will acquire
our defense subsystems business for $33.0 million in cash (subject to a working
capital adjustment). Our defense subsystems business had sales of $19.7 million
for the fiscal year ended March 31, 2004. The asset sale is subject to the
approval of our shareholders, as well as other customary closing conditions. If
the proposed transaction is completed, the Company intends to distribute a
substantial portion of the after-tax proceeds from the proposed transaction to
its shareholders through an extraordinary cash dividend, although the amount of
the dividend has not yet been determined, since the Company has not completed
its analysis of the cash it will need to continue its operations and otherwise
pay its liabilities and expenses. Result of Operations  First Quarter of Fiscal 2005 Compared to First Quarter
of Fiscal 2004 Total net sales were $8.0 million for the first quarter of fiscal 2005,
compared to $6.6 million for the first quarter of fiscal 2004, an increase of
22%. Semiconductor sales were $3.3 million in the first quarter of fiscal 2005,
compared to $1.6 million in the first quarter of fiscal 2004, an increase of
106%. Sales in the first quarter of fiscal 2004 did not include any sales of
power amplifier modules for handsets while sales in the first quarter of fiscal
2005 included $1.0 12




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million of sales of power amplifier modules for handsets and $0.4 million
of revenue for a development contract for power amplifier modules for satellite
handsets. Subsystem sales in the first quarter of fiscal 2005 were $4.7 million
compared to $5.0 million in the first quarter of fiscal 2004, a decrease of 6%.
The decrease in sales of subsystems products to defense customers is primarily
the result of design issues causing delays in the transition of products from
an engineering phase into production. Gross margin was 38% of net sales in the first quarter of fiscal 2005
compared to 8% of net sales in the first quarter of fiscal 2004. The increase
in gross margin was due to the unanticipated sale of approximately $1.0 million
of power amplifier modules for handsets where the corresponding costs were
written off in prior periods as obsolete inventory and $0.4 million of sales
for a milestone achievement in a contract to develop power amplifier modules
for satellite handsets with the corresponding costs recorded in research and
development expense. The increased revenue without a corresponding cost of
sales contributed 14% to the gross margin improvement. The remaining
improvement in gross margin is due to reduced overhead expenses, which are the
result of headcount reductions and asset and lease impairments. We do not
expect significant improvement in gross margin until sales volumes increase
because of fixed costs related to our fabrication facility. Research and development expenses were $1.8 million, or 22% of net sales,
in the first quarter of fiscal 2005 compared to $2.9 million, or 44% of net
sales, in the first quarter of fiscal 2004, a decrease of 38%. Research and
development expenses decreased from the prior year due to our decision to exit
the wireless handset market. A significant part of our research and
development efforts were focused on developing wireless handset power amplifier
products for the market in South Korea. These decreases in spending were
somewhat offset by increased spending on the development of defense products. Selling, general and administrative expenses were $2.0 million, or 25% of
net sales, in the first quarter of fiscal 2005 compared to $2.2 million, or 33%
of net sales, in the first quarter of fiscal 2004, a decrease of 6%. The
decrease was primarily due to lower selling costs driven by the decrease in
revenues and lower personnel costs. The $2.5 million of costs related to shareholder actions in the first
quarter of fiscal 2004 consisted of approximately $1.4 million in expense
related to the special meeting of shareholders and $1.1 million in investment
banking fees, including fees related to the special meeting. During the first quarter of fiscal 2005, we recorded an impairment charge
of approximately $0.3 million against our strategic investment in the Taiwanese
foundry, which was deemed to have an other than temporary decline in value.
The current carrying value of this investment at the end of the first quarter
of fiscal 2005 is zero. We have completely written off our investment in the
Taiwanese foundry due to the insolvency of its parent company, which we believe
was the foundrys main source of funding. During the fourth quarter of fiscal
2002 and first and fourth quarter of fiscal 2003, we recorded impairment
charges of approximately $1.7 million, $0.3 million and $0.1 million,
respectively, against our strategic investment in the Taiwanese foundry, which
was deemed, in those respective periods, to have an other than temporary
decline in value. We incurred no special charges during the first quarter of fiscal 2005.
During fiscal 2004, we incurred $4.5 million in special charges due to our exit
of the wireless handset power amplifier market, offset by $0.2 million in
proceeds from the sale of equipment impaired in fiscal 2002, for a net expense
of $4.3 million for fiscal 2004. The special charges of $4.5 million in fiscal
2004 are comprised of approximately $0.2 million of impairment charges related
to the reassessment of carrying values for certain tangible and intangible
assets to 13




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be sold, $1.8 million of equipment impairment charges related to exiting
the wireless handset power amplifier market, $0.6 million of equipment
impairment charges related to restructuring at the Belfast facility, $0.7
million in employee termination charges, $0.9 million for building lease
termination costs, $0.2 million of facilities consolidation costs, and $0.1
million to close our Korean sales office. The following table summarizes our special charges activity as follows (in
thousands): LeaseImpairment
    
    TerminationEmployee
    
    
    
    
    
    of Assets
    
    andTermination
    
    Excess
    
    Held For
    
    RelocationCosts
    
    Equipment
    
    Sale
    
    Costs
    
    TotalAccrual balances, March 31, 2003
    
    $
    123
    
    
    $
    
    
    
    $
    
    
    
    $
    1,050
    
    
    $
    1,173Fiscal 2004 special charges
    
    
    734
    
    
    
    2,618
    
    
    
    183
    
    
    
    1,005
    
    
    
    4,540Cash paid
    
    
    (680
    )
    
    
    
    
    
    
    
    
    
    
    (932
    )
    
    
    (1,612
    )Non-cash activity
    
    
    (100
    )
    
    
    (2,618
    )
    
    
    (183
    )
    
    
    
    
    
    
    (2,901
    )Accrual balances, March 31, 2004
    
    $
    77
    
    
    $
    
    
    
    $
    
    
    
    $
    1,123
    
    
    $
    1,200Cash paid
    
    
    (17
    )
    
    
    
    
    
    
    
    
    
    
    (257
    )
    
    
    (274
    )Accrual balances, June 30, 2004.
    
    $
    60
    
    
    $
    
    
    
    $
    
    
    
    $
    866
    
    
    $
    926
 There was no amortization of intangibles during the first quarter of
fiscal 2005. Amortization of intangibles was $0.1 million during the first
quarter of fiscal 2004. In the second quarter of fiscal 2004, we exited the
wireless handset power amplifier market and during the third quarter of fiscal
2004 sold all the intangible and certain tangible assets related to the
wireless handset power amplifier market for $1.0 million to Anadigics, Inc. Interest income and other, net was $0.1 million in the first quarter of
fiscal 2005 compared to $0.2 million in the first quarter of fiscal 2004. The
decrease in interest income and other, net, was primarily due to decreased
interest income on a lower cash and short-term investments balances. Liquidity and Capital Resources We have funded our operations to date primarily through cash flows from
operations and sales of equity securities. As of June 30, 2004, we had $8.1
million in cash and cash equivalents, $15.4 million in short-term investments
and $25.0 million in working capital. Net cash used by operating activities was $1.7 million in the first three
months of fiscal 2005 and was due primarily to the payment of accrued
liabilities. Net cash used by operating activities was $3.9 million in the
first three months of fiscal 2004 and was due primarily to the quarterly net
loss partially offset by decreases in accounts receivable and inventory and
increases in accounts payable and accrued liabilities. Net cash provided by investing activities was $8.0 million in the first
three months of fiscal 2005 and was due to the net sales and maturities of
short-term investments of $8.6 million, offset by the purchase of property and
equipment of $0.6 million. Net cash used by investing activities was $18.4
million in the first three months of fiscal 2004 and was due to the net
purchases of short-term investments of $18.1 million and the purchase of
property and equipment of $0.3 million. 14




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\

Net cash used by financing activities was $1.3 million in the first three
months of fiscal 2005 and was due primarily to the principal payments on
long-term debt of $1.2 million. Net cash used by financing activities was $0.7
million in the first three months of fiscal 2004 and was due primarily to
principal payments on long-term debt of $0.6 million. As a result of the
extraordinary cash dividend in the fourth quarter of fiscal 2004, we violated
certain lending covenants, based on current agreements in place. Therefore, we
decided to repay certain lending agreements in full. As of June 30, 2004, we had $0.9 million in outstanding letters of credit,
which are secured by certificates of deposits. Given our cash position, we currently do not have a line of credit. We
have various equipment notes outstanding with other lenders, which are secured
by the equipment. Several of these notes have covenants attached pertaining to
liquidity levels and minimum tangible net worth. We believe that our current cash resources and borrowings available from
our equipment financing sources should be sufficient to meet our liquidity
requirements through at least the next twelve months. Commitments We do not have any special purpose entities. We have no commercial
commitments with related parties, except for employee loans. We have
outstanding loans to certain former officers and employees totaling
approximately $0.6 million at June 30, 2004. The notes are relocation loans
collateralized by certain real property assets, bear no interest and have
maturities through 2019. The principal will be repaid at various dates. If an
employee voluntarily ceases being employed by us, the principal outstanding
will be due and payable within 90 days. We have contractual obligations in the form of operating and capital
leases, debt and purchase order commitments. The following table sets forth our
future contractual obligations as of June 30, 2004 (in thousands): Contractual Obligations Fiscal YearTotal
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterLong-term debt obligations
    
    $
    716
    
    
    $
    716
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Capital lease obligations
    
    
    163
    
    
    
    163
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating lease obligations
    
    
    3,562
    
    
    
    2,046
    
    
    
    1,226
    
    
    
    260
    
    
    
    30
    
    
    
    Open purchase order commitments
    
    
    1,658
    
    
    
    1,541
    
    
    
    100
    
    
    
    17
    
    
    
    
    
    
    
    Total
    
    $
    6,099
    
    
    $
    4,466
    
    
    $
    1,326
    
    
    $
    277
    
    
    $
    30
    
    
    $
    0
 The table records cash obligations, including future interest repayments,
and includes operating lease obligations for equipment that no longer has
economic value for us, for which a special charge of $1.3 million was recorded
in the third quarter of fiscal 2003 income statement. 15




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We have outstanding letters of credit of approximately $0.9 million as
security for capital leases for equipment and pending supplier cancellation
charges. RISK FACTORS You should carefully consider the risks described below. The risks and
uncertainties described below are not the only ones facing us. Additional risks
and uncertainties not presently known to us or that we currently deem
immaterial may also impair our business operations. If any of the following
risks actually occur, our business, results of operations or cash flows could
be adversely affected. In those cases, the trading price of our common stock
could decline, and you may lose all or part of your investment. If the proposed sale of our defense subsystems business to Teledyne is
consummated, our success will depend on our semiconductor business alone. Our defense business constitutes a substantial portion of our assets. As
such, our asset base and revenues following the proposed asset sale will change
significantly from those existing currently. Following the proposed asset
sale, we expect to generate substantially all of our sales from our
semiconductor business. To date, our semiconductor business has never
generated a profit and has incurred significant operating losses. As a result,
we must grow our semiconductor business rapidly and substantially in order to
achieve profitability, and economic and other factors may prevent us from
growing the business at a sustainable rate, if at all. If we fail to grow our
semiconductor operations, we may be unable to afford to continue to do
business, and we may have to cease operations altogether. If the proposed sale of our defense subsystems business to Teledyne is not
consummated, our business and results of operations may suffer. The proposed asset sale is conditioned upon a number of factors, including
approval by our shareholders and the receipt of certain third-party consents
from our most significant defense business customers. If the asset sale is not
consummated for any reason, our business may be harmed because our customers
may question our commitment to our defense business and cease doing business
with us. Similarly, our employees may believe we are not committed to our
defense business and look for employment elsewhere. The potential loss of
customers and employees if we are unable to consummate the proposed asset sale
would seriously harm our results of operations and financial condition. Certain terms of the proposed sale of our defense business to Teledyne are
unfavorable to us and could cause our business to be harmed. Pursuant to the terms of the asset purchase agreement, we will be
responsible for substantially all preclosing liabilities of our defense
business, except for current liabilities that will be assumed by Teledyne. If
any of these preclosing defense business liabilities arise in the future, we
may lack the cash required to satisfy them. In addition, we have agreed to
indemnify Teledyne against certain losses it may suffer arising out of the
acquisition of our defense business. If we are required to indemnify Teledyne
for any matter, it could have a material adverse impact on our business by
draining our available cash reserves. Because many of our expenses are fixed, we will not achieve profitability until
our revenues significantly increase. Our business requires us to maintain manufacturing equipment and related
support infrastructure that we must pay for regardless of our level of sales.
To support our manufacturing capacity we also incur costs for 16




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maintenance and repairs and employ personnel for manufacturing and process
engineering functions. These expenses, along with depreciation costs, are fixed
and do not vary greatly, if at all, when our net sales decrease. In addition,
the lead time for developing and manufacturing our products often requires us
to invest in manufacturing capacity in anticipation of future demand. The
recent decline in market demand has resulted in infrastructure costs in excess
of current needs and has resulted in lower earnings. Although we recently
exited the wireless handset power amplifier market  which we believe will
result in reduced expenses  we are nevertheless still relying on increased
sales to manufacturers of commercial communications equipment and defense
contractors in order to realize a significant increase in revenues. If these
sales do not materialize, and if our revenues do not significantly increase to
a level commensurate with our installed capacity, we will be unable to achieve
profitability. As a result of our recent exit from the wireless handset power amplifier
business, we face risks relating to our increased reliance on sales of our
semiconductor products for wireless infrastructure, satellite communications
and defense applications. In late September 2003, we exited the wireless handset power amplifier
business in order to focus our resources on market areas where we believe our
core competencies will allow us the greatest opportunity of success in our goal
of returning to profitability. There is, however, no guarantee that our exit
from the wireless handset power amplifier business will enable us to reach
profitability on a more expedited basis, or at all. In particular, we now face
increased reliance on the sales of our semiconductor products for wireless
infrastructure, satellite communications and defense applications, which
markets may have lower growth potential than the wireless handset market. In
addition, we may fail to manage successfully our exit from the wireless handset
power amplifier business. If our projections with respect to the sales of our
semiconductors products for wireless infrastructure, satellite communications
and defense applications are incorrect, we may fail to achieve profitability
and our business may suffer. Our operating results have fluctuated significantly in the past, and we expect
these fluctuations to continue. If our results are worse than expected, our
stock price could fall. Our operating results have fluctuated in the past, and may continue to
fluctuate in the future. These fluctuations may cause our stock price to
decline. Some of the factors that may cause our operating results to fluctuate
include:  
    
    the timing, cancellation or delay of customer orders or
shipments, particularly from our largest customers;
    
    fluctuating demand from our defense customers;
    
    the timing of our introduction of new products and the
introduction of new products by our competitors;
    
    variations in average selling prices of our products;
    
    the mix of products that we sell;
    
    our ability to secure manufacturing capacity and effectively utilize the capacity;
    
    the availability and cost of components;
    
    GaAs semiconductor component and GaAs-based subsystem failures
and associated support costs;
    
    variations in our manufacturing yields related to our GaAs semiconductor components;
    
    market acceptance of our products; and
    
    changes in our inventory levels. 17




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Any unfavorable changes in the factors listed above or general industry
and global economic conditions could significantly harm our business, operating
results and financial condition. For example, during the third quarter of
fiscal 2003, Motorola, our largest customer, began transitioning to new handset
platforms for which we were not the selected supplier of power amplifier
modules and our sales were negatively impacted. In addition, in late September
2003, we exited the wireless handset power amplifier market entirely. Due to
fluctuations in our net sales and operating expenses, we believe that period to
period comparisons of our results of operations are not good indications of our
future performance. It is possible that in some future quarter or quarters, our
operating results will be below the expectations of securities analysts or
investors. In that case, our stock price could decline. Variable accounting related to past stock option grants may impact our future
earnings. We declared an extraordinary cash dividend of $4.50 per share payable to
shareholders of record as of February 5, 2004, payable on March 11, 2004. The
total dividend paid was $57.8 million. Pursuant to the Nasdaq Marketplace
Rules, the ex-dividend date with respect to the cash dividend was set as March
12, 2004. Accordingly, prior to the commencement of trading on March 12, 2004,
our opening bid price was reduced by $4.50 per share to reflect the payment of
the cash dividend. Under the intrinsic value method of accounting for stock
options, we were required to adjust our stock option exercise price by the
dividend amount or $4.50 per share because the dividend was a return of
capital. Since our stock option plan does not currently allow us to reprice
options, we were required to change to the variable method of accounting for
our outstanding stock options. Under variable accounting, compensation expense
is recognized over the life of the option (until exercised, forfeited, or
cancelled) generally to the extent that there are any increases in the per
share market price of our common stock. It is difficult to estimate the impact
that expensing stock options will have on our statement of operations as this
expense is dependent upon future events that are difficult to predict, such as
the number of options to be granted during a period, the price of our common
stock at the time of grant, the stock price volatility, the risk free interest
rate during the period and the expected average life of the option. A slight
change in any one of these variables can materially affect the amount of
compensation expense to be recorded. We depend on a small number of original equipment manufacturers as customers.
If we lose one or more of our significant customers, or if purchases by any one
of our key customers decrease, our net sales will decline and our business will
be harmed. We expect that sales to a limited number of customers will account for a
large percentage of our net sales in the future and will be a very important
component in our plans for returning to profitability. If we lose any of our
existing major customers, our operating results and business would be harmed.
In the first three months of fiscal year 2005, sales to our top ten customers
accounted for approximately 63% of our net sales, with Motorola and Raytheon
making up approximately 12% each. In fiscal year 2004, sales to our top ten
customers accounted for approximately 62% of our net sales, with Raytheon
making up approximately 16% and BAE Systems making up approximately 10% of
those net sales. In fiscal year 2003, sales to our top ten customers accounted
for approximately 75% of our net sales, with Motorola making up approximately
41% of those net sales. We had been a sole source supplier of power amplifier
modules to Motorola for its model 120v handset platform. However, Motorola
transitioned to new platforms, and it selected a sole source supplier other
than us for its new platforms. As discussed above, we have exited the wireless
handset power amplifier market entirely. If we were to lose a major customer,
or if orders by any of our major customers were to otherwise decrease or be
delayed, our business, operating results and financial condition would be
seriously harmed. We need to keep pace with rapid product and process development and
technological changes to be competitive. 18




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We compete in markets with rapidly changing technologies, evolving
industry standards and continuous improvements in products. To be competitive
we will need to continually improve our products and keep abreast of new
technology and our ability to grow will depend substantially on our ability to
continue to apply our GaAs semiconductor components expertise to existing and
emerging wireless communications markets. New process technologies could be
developed that have characteristics that are superior to our current processes.
If we are unable to develop and maintain competitive processes or design
products using new technologies, and if we are unable to secure production
orders for these products, we will not achieve the significant increase in
revenues necessary to achieve profitability, and our business and operating
results will suffer. We cannot assure you that we will be able to respond to
technological advances, changes in customer requirements or changes in
regulatory requirements or industry standards. Any significant delays in our
development, introduction or shipment of products could seriously harm our
business, operating results and financial condition. We are exposed to general economic, market and, additionally, industry
conditions. Our business is subject to the effects of general economic conditions in
the United States and globally, and, in particular, market conditions in the
wireless communications and defense industries. In recent quarters, our
operating results have been adversely affected as a result of unfavorable
economic conditions and reduced capital spending in the United States, Europe
and Asia. In particular, sales to customers who supply equipment to service
providers of voice and data services have been adversely affected due to
significant decline in demand in the wireless infrastructure markets. If the
economic conditions in the United States and globally do not improve, if we
experience a worsening in the global economic slowdown or if the wireless
infrastructure markets do not recover, we may continue to experience material
adverse impacts on our business, operating results and financial condition. We expect our products to experience rapidly declining average sales prices,
and if we do not decrease costs or develop new or enhanced products, our
margins will suffer. In each of the markets where we compete, average sales prices of
established products have been significantly declining, and we anticipate that
prices will continue to decline and negatively impact our gross profit margins.
There is currently over capacity in the markets we serve, which could lead to
additional pricing pressure as our competitors seek to improve their asset
utilization. Accordingly, to remain competitive, we believe that we must
continue to develop product enhancements and new technologies that will either
slow the price declines of our products or reduce the cost of producing and
delivering our products. If we fail to do so, our results of operations would
be seriously harmed. Our sales to international customers expose us to risks that may harm our
business. Sales to international customers accounted for 45% of our net sales in the
first three months of fiscal 2005, 35% of our net sales in fiscal 2004 and 67%
of our net sales in fiscal 2003. The increase in the percentage of sales to
international customers in fiscal 2005, as compared to fiscal 2004, is the
result of sales of power amplifiers to Motorola, which we do not expect to
continue shipping in significant quantities. The decline in the percentage of
sales to international customers in fiscal 2004, as compared to fiscal 2003, is
the result of the decline in sales of power amplifiers to Motorola. Almost all
of our wireless handset power amplifier products were sold to Motorolas
foreign subsidiaries and contractors. We expect that international sales will
continue to account for a significant portion of our net sales in the future.
In addition, many of our domestic customers sell their products outside of the
United States. These sales expose us to a number of inherent risks, including:  
    
    the need for export licenses; 19




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##### Table of Contents




    
    unexpected changes in regulatory requirements;
    
    tariffs and other potential trade barriers and restrictions;
    
    reduced protection for intellectual property rights in some countries;
    
    fluctuations in foreign currency exchange rates;
    
    the burdens of complying with a variety of foreign laws;
    
    the impact of recessionary or inflationary environments in
economies outside the United States; and
    
    generally longer accounts receivable collection periods. We are also subject to general geopolitical risks, such as political and
economic instability and changes in diplomatic and trade relationships, in
connection with our international operations. Potential markets for our
products exist in developing countries that may deploy wireless communications
networks. These countries may decline to construct wireless communications
networks, experience delays in the construction of these networks or use the
products of one of our competitors to construct their networks. As a result,
any demand for our products in these countries will be similarly limited or
delayed. If we experience significant disruptions to our international sales,
our business, operating results and financial condition could be harmed. Additionally, all of our circuit assembly and test vendors are located
outside of the United States. Consequently, our ability to secure products
from these vendors is subject to most of the same risks described in the above
paragraphs, including: unexpected changes in regulatory requirements; tariffs
and other potential trade barriers and restrictions; reduced protection for
intellectual property rights in some countries; fluctuations in foreign
currency exchange rates; the burdens of complying with a variety of foreign
laws; and general geopolitical risks. In the event that any of our
international vendors is unable to fulfill our requirements in a timely manner,
we may experience an interruption in production until we locate alternative
sources of supply. If we encounter shortages in component supply, we may be
forced to adjust our product designs and production schedules. The failure of
one or more of our key suppliers or vendors to fulfill our orders in a timely
manner and with acceptable quality and yields could cause us to not meet our
contractual obligations, could damage our customer relationships (including
relationships with major customers) and could harm our business. Our backlog may not result in sales. Our backlog primarily represents signed purchase orders for products due
to ship within 18 months. As of June 30, 2004, our backlog was approximately
$19.1 million, of which 79% was from subsystem customers and 21% was from
semiconductor customers. Backlog is not necessarily indicative of future sales
as our customers may cancel or defer orders without penalty. Nevertheless, we
make a number of management decisions based on our backlog, including
purchasing materials, hiring personnel and other matters that may increase our
production capabilities and costs. Cancellation of pending purchase orders or
termination or reduction of purchase orders in progress could significantly
harm our business. We do not believe that our backlog as of any particular date
is representative of actual sales for any succeeding period, and we do not know
whether our current order backlog will necessarily lead to sales in any future
period. Generally, purchase orders in our backlog are subject to cancellation
without penalty at the option of the customer, and from time to time we have
experienced cancellation of orders in backlog. In fact, in fiscal 2002, a
significant portion of our backlog was cancelled due to changing market
conditions. Certain of our customers in the wireless infrastructure market
delayed and cancelled long-standing contracts in response to declining market
demand. 20




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The variability of our manufacturing yields may affect our gross margins. The success of our business depends largely on our ability to make our
products efficiently through a manufacturing process that results in a large
number of usable products, or yields, from any particular production run. In
the past we have experienced significant delays in our product shipments due to
lower than expected production yields. Due to the rigid technical requirements
for our products and manufacturing processes, our production yields can be
negatively affected for a variety of reasons, some of which are beyond our
control. For instance, yields may be reduced by:  
    
    lack of experience in producing a new product;
    
    defects in masks that are used to transfer circuit patterns onto wafers;
    
    impurities in materials used;
    
    contamination of the manufacturing environment; and
    
    equipment failures. Our manufacturing yields also vary significantly among our products due to
product complexity and the depth of our experience in manufacturing a
particular product. We cannot assure you that we will not experience problems
with our production yields in the future. Decreases in our yields can result in
substantially higher costs for our products. If we cannot maintain acceptable
yields in the future, our business, operating results and financial condition
will suffer. Decreases in our customers sales volumes could result in decreases in our
sales volumes. Our current semiconductor product strategy is to design standard products
that can be used by different customers for a variety of applications. Any
significant increase in our sales volume is dependent on our achieving a
considerable number of design wins. Additionally, where our products are
designed into an original equipment manufacturers product, our sales volumes
will be dependent upon the commercial success of the original equipment
manufacturers product. Sales of our major customers products can vary
significantly from quarter to quarter. Accordingly, our sales could be
adversely affected by a reduction in demand for wireless and defense
communications systems. Our operating results have been significantly harmed in
the past by the failure of anticipated orders to be realized and by deferrals
or cancellations of orders as a result of changes in demand for our customers
products. We depend on single and limited sources for key components. If we lose one or
more of these sources, delivery of our products could be delayed or prevented
and our business could suffer. We acquire some of the components for our existing products from single
sources, and some of the other components for our products are presently
available or acquired only from a limited number of suppliers. Our
single-sourced components include substrates, millimeter wave components and
semiconductor packages. Some of these components are critical to the products
we sell to our major customers. In the event that any of these suppliers are
unable to fulfill our requirements in a timely manner, we may experience an
interruption in production until we locate alternative sources of supply. If we
encounter shortages in component supply, we may be forced to adjust our product
designs and production schedules. The failure of one or more of our key
suppliers or vendors to fulfill our orders in a timely manner and with
acceptable quality and yields could cause us to not meet our contractual
obligations, could damage our customer relationships (including relationships
with major customers) and could harm our business. 21




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Intense competition in our industry could result in the loss of customers or an
inability to attract new customers. We compete in an intensely competitive industry and we expect our
competition to increase. A number of companies produce products that compete
with ours or could enter into competition with us. These competitors, or
potential future competitors, include CTT, M/A-COM, Miteq, and REMEC. In
addition, a number of smaller companies may introduce competing products. Many
of our current and potential competitors have significantly greater financial,
technical, manufacturing and marketing resources than we have and have achieved
market acceptance of their existing technologies. Our ability to compete
successfully depends upon a number of factors, including:  
    
    the willingness of our customers to incorporate our products into their products;
    
    product quality, performance and price;
    
    the effectiveness of our sales and marketing personnel;
    
    the ability to rapidly develop new products with desirable features;
    
    the ability to produce and deliver products that meet our customers requested shipment dates;
    
    the capability to evolve as industry standards change; and
    
    the number and nature of our competitors. We cannot assure you that we will be able to compete successfully with our
existing or new competitors. If we are unable to compete successfully in the
future, our business, operating results and financial condition will be harmed. Our business will be harmed if potential customers do not use gallium arsenide
components. Silicon semiconductor technologies are the dominant process technologies
for integrated circuits, and the performance of silicon integrated circuits
continues to improve. Our prospective customers may be systems designers and
manufacturers who are evaluating these silicon technologies and, in particular,
silicon germanium versus gallium arsenide integrated circuits for use in their
next generation high performance systems. Customers may be reluctant to adopt
our gallium arsenide products because of:  
    
    unfamiliarity with designing systems with gallium arsenide products;  
    
    concerns related to relatively higher manufacturing costs and lower yields; and  
    
    uncertainties about the relative cost effectiveness of our
products compared to high performance silicon components. In addition, potential customers may be reluctant to rely on a smaller
company like us for critical components. We cannot be certain that prospective
customers will design our products into their systems, that current customers
will continue to integrate our components into their systems or that gallium
arsenide technology will continue to achieve widespread market acceptance. Our products may not perform as designed and may have errors or defects that
could result in a decrease in net sales or liability claims against us. Our customers establish demanding specifications for product performance
and reliability. Our standard product warranty period is one year. Problems may
occur in the future with respect to the performance and reliability of our
products in conforming to customer specifications. If these problems do occur,
we could experience increased costs, delays in or reductions, cancellations or
rescheduling of orders and shipments, product returns and discounts and product
redesigns, any of which would have a negative impact on our 22




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business, operating results and financial condition. In addition, errors
or defects in our products may result in legal claims that could damage our
reputation and our business, increase our expenses and impair our operating
results. The sales cycle of our products is lengthy and the life cycle of our products
is short, making it difficult to manage our inventory efficiently. Most of our products are components in commercial or defense
communications systems. The sales cycle associated with our products is
typically lengthy, and can be as long as two years, due to the fact that our
customers conduct significant technical evaluations of our products before
making purchase commitments. This qualification process involves a significant
investment of time and resources from us and our customers to ensure that our
product designs are fully qualified to perform with the customers equipment.
The qualification process may result in the cancellation or delay of
anticipated product shipments, thereby harming our operating results. In addition, our inventory can rapidly become outdated due to the short
life cycle of the end products that incorporate our products. In fiscal 2003,
we wrote off outdated inventory when one of our customers stopped producing the
mobile handsets that incorporated our power amplifier. Our business, operating
results and financial condition could be harmed by excess or outdated inventory
levels if our customers products evolve more rapidly than anticipated or if
demand for a product does not materialize. We are subject to stringent environmental regulations that could negatively
impact our business. We are subject to a variety of federal, state and local laws, rules and
regulations related to the discharge and disposal of toxic, volatile and other
hazardous chemicals used in our manufacturing process. Our failure to comply
with present or future regulations could result in fines being imposed on us,
suspension of our production or a cessation of our operations. The regulations
could require us to acquire significant equipment or to incur substantial other
expenses in order to comply with environmental regulations. Any past or future
failure by us to control the use of or to restrict adequately the discharge of
hazardous substances could subject us to future liabilities and could cause our
business, operating results and financial condition to suffer. In addition,
under some environmental laws and regulations we could be held financially
responsible for remedial measures if our properties are contaminated, even if
we did not cause the contamination. If we are unable to effectively protect our intellectual property, or if it
were determined that we infringed the intellectual property rights of others,
our ability to compete in the market may be impaired. Our success depends in part on our ability to obtain patents, trademarks
and copyrights, maintain trade secret protection and operate our business
without infringing the intellectual property rights of other parties. Although
there are no pending lawsuits against us, from time to time we have been
notified in the past and may be notified in the future that we are infringing
another partys intellectual property rights. In the event of any adverse determination of litigation alleging that our
products infringe the intellectual property rights of others, we may be unable
to obtain licenses on commercially reasonable terms, if at all. If we were
unable to obtain necessary licenses, we could incur substantial liabilities and
be forced to suspend manufacture of our products. Litigation arising out of
infringement claims could be costly and divert the effort of our management and
technical personnel. In addition to patent and copyright protection, we also rely on trade
secrets, technical know-how and other unpatented proprietary information
relating to our product development and manufacturing activities. We try 23




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to protect this information with confidentiality agreements with our
employees and other parties. We cannot be sure that these agreements will not
be breached, that we would have adequate remedies for any breach or that our
trade secrets and proprietary know-how will not otherwise become known or
independently discovered by others. In addition, to retain our intellectual property rights we may be required
to seek legal action against infringing parties. This legal action may be
costly and may result in a negative outcome. An adverse outcome in litigation
could subject us to significant liability to third parties, could put our
patents at risk of being invalidated or narrowly interpreted and could put our
patent applications at risk of not issuing. The steps taken by us may be
inadequate to deter misappropriation or impede third party development of our
technology. In addition, the laws of some foreign countries in which our
products are or may be sold do not protect our intellectual property rights to
the same extent, as do the laws on the United States. If we are not successful
in protecting our intellectual property our business will suffer. Our manufacturing capacity and our ability to maintain sales volume is
dependent on the successful retention of qualified design, assembly and test
personnel and our ability to install critical assembly and test equipment on a
timely basis. Our ability to satisfy our current backlog and any additional orders we
may receive in the future will depend on our ability to successfully retain
qualified design engineers, assembly and test personnel. Our design engineers
reside at our headquarters in Santa Clara, California and at our design center
in the United Kingdom. We contract with third parties located primarily in Asia
for many of our assembly and test requirements. Our need to successfully manage
and retain these personnel will intensify if in the future our production
volumes are required to increase significantly from expected levels. Demand for
people with these skills is intense and we cannot assure you that we will be
successful in retaining sufficient personnel with these critical skills. Our
business has been harmed in the past by our inability to hire and retain people
with these critical skills, and we cannot assure you that similar problems will
not reoccur. We depend heavily on our key managerial and technical personnel. If we cannot
attract and retain persons for our critical management and technical functions
we may be unable to compete effectively. Our success depends in significant part upon the continued service of our
key technical, marketing, sales and senior management personnel and our
continuing ability to attract and retain highly qualified technical, marketing,
sales and managerial personnel. In particular, we have experienced and continue
to experience difficulty attracting and retaining qualified engineers, which
has harmed our ability to develop a wider range of handset products in a timely
manner. Competition for these kinds of experienced personnel is intense. In
addition, as discussed above, uncertainties resulting from potential business
restructurings may hamper our ability to retain our executives or key personnel
in our engineering and other departments. We cannot assure you that we can
retain our key technical and managerial employees or that we can attract,
assimilate or retain other highly qualified technical and managerial personnel
in the future. Our failure to attract, assimilate or retain key personnel could
significantly harm our business, operating results and financial condition. Our customers failure to adhere to governmental regulations could harm our
business. A significant portion of our products are integrated into the wireless
communications subsystems of our clients. These subsystems are regulated
domestically by the Federal Communications Commission and internationally by
other government agencies. With regard to equipment in which our products are
integrated, it is typically our customers responsibility, and not ours, to
ensure compliance with governmental regulations. Our net sales will be harmed
if our customers products fail to comply with all applicable domestic and
international regulations. 24




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A disaster could severely damage our operations. A disaster could severely damage our ability to deliver our products to
our customers. Our products depend on our ability to maintain and protect our
computer systems, which are primarily located in or near our principal
headquarters in Santa Clara, California. Santa Clara exists on or near a known
earthquake fault zone. Although the facilities in which we host our computer
systems are designed to be fault tolerant, the systems are susceptible to
damage from fire, floods, earthquakes, power loss, telecommunications failures,
and similar events. Although we maintain general business insurance against
fires, floods and some general business interruptions, there can be no
assurance that the amount of coverage will be adequate in any particular case. 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk Our exposure to market risk is principally confined to our cash, cash
equivalents and investments which have maturities of less than two years. We
maintain a non-trading investment portfolio of investment grade, liquid, debt
securities that limits the amount of credit exposure to any one issue, issuer
or type of instrument. At June 30, 2004, our investment portfolio comprised
approximately $10.0 million in money market funds and certificate of deposits
and $14.6 million of money market auction rate preferred stocks, corporate debt
securities and municipal bonds. The securities in our investment portfolio are
not leveraged, are classified as available for sale and are therefore subject
to interest rate risk. We currently do not hedge interest rate exposure. If
market interest rates were to increase by 100 basis points, or 1%, from June
30, 2004 levels, the fair value of our portfolio would decline by approximately
$27,000. The modeling technique used measures the change in fair values arising
from an immediate hypothetical shift in market interest rates. Foreign Currency Exchange Risk The current foreign exchange exposure in all international operations is
deemed to be immaterial since all of our net sales and the majority of
liabilities are receivable and payable in U.S. dollars. A 10% change in
exchange rates would not be material to our financial condition and results
from operations. Accordingly, we do not use derivative financial instruments to
hedge against foreign exchange exposure. 
 Item 4. CONTROLS AND PROCEDURES Our management evaluated, with the participation of our chief executive
officer and our chief financial officer, the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this Quarterly
Report on Form 10-Q. Based on this evaluation, our chief executive officer and
our chief financial officer have concluded that our disclosure controls and
procedures are effective to ensure that information we are required to disclose
in reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. 25




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There was no change in our internal control over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. 
 PART II            OTHER INFORMATION 
 Item 6.             EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. ExhibitNumber
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Securities
Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Securities
Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
  (b)
    
    Reports on Form 8-K. We filed one report on Form 8-K with the Securities and Exchange
Commission during the period covered by this report, as follows:  1.
    
    Report on Form 8-K filed on May 5, 2004 under Item
12 (Results of Operations and Financial Condition), regarding
our fiscal 2004 fourth quarter and year end financial results. 26




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. CELERITEK, INC.Date: August 11, 2004
    
    /s/ MARGARET E. SMITHMargaret E. Smith, Vice President,
Chief Financial Officer and Assistant
Secretary
 27




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INDEX TO EXHIBITS ExhibitNumber
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Securities
Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Securities
Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 28