FORM 10-Q

For the quarterly period ended September 30, 2004

For the transition period from                to                

Radyne ComStream Inc.

Registrant’s telephone number including area code: (602) 437-9620

     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  þ  No  o

     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  o  No  þ

     The number of shares of the registrant’s common stock, which were outstanding as of the close of business on November 1, 2004, was 16,249,733.

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Table of Contents

Part I

Item 1. Financial Statements.

Radyne ComStream Inc.

See Notes to Condensed Consolidated Financial Statements

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Radyne ComStream Inc.

See Notes to Condensed Consolidated Financial Statements

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Radyne ComStream Inc.

See Notes to Condensed Consolidated Financial Statements

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Radyne ComStream Inc.

(1)		Description of Business and Basis of Presentation
		Radyne ComStream Inc. (the Company) is headquartered in Phoenix, Arizona and has manufacturing facilities in Phoenix and in San Diego, California. Additionally, the Company has sales offices in Boca Raton, Florida, Singapore, Beijing, Jakarta, London and Amsterdam. The Company also contracts with representatives that provide sales and/or service centers in Rio de Janeiro, Bangalore, Shanghai and Moscow. The Company designs, manufactures, and sells products, systems and software used for the transmission and reception of data, voice, internet protocol and video over satellite, microwave and cable communication networks.
		The Company operates primarily in North America in the satellite communications industry. The Phoenix facility designs and manufactures satellite and point-to-point modems and allied equipment. The San Diego facility designs and manufactures audio and video encoders, satellite modems and Internet over satellite hardware. The Company sells and distributes its products under the Radyne ComStream, ComStream and Tiernan brands.
		The unaudited condensed consolidated financial statements of the Company for the three and nine month periods ended September 30, 2004 and 2003 have been prepared in accordance with accounting principles generally accepted in the United States of America and the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments necessary, all of which are of a normal recurring nature, to present fairly the Company’s financial position, results of operations and cash flows. Interim results are not necessarily indicative of results for a full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
		The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make a number of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Such estimates and assumptions affect the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates and assumptions based upon historical experience and various other factors and circumstances. The Company believes that its estimates and assumptions are reasonable in the circumstances; however, actual results may differ from these estimates under different future conditions.
		Certain reclassifications have been made to the prior years condensed consolidated financial statements to conform to the current year presentation.
(2)		Employee Stock Options
		The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its employee stock options and to adopt the “disclosure only” alternative treatment under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). Under SFAS 123, deferred compensation is recorded for the fair value of the stock on the date of the option grant. The deferred compensation is amortized over the vesting period of the option.
		The Company applies APB 25 in accounting for its employee stock options. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS 123, the Company’s net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:

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		The pro forma data listed above was calculated by retroactively considering the impact of cancellations of stock options by employees effective January 22, 2003. For a full explanation of the cancelled options, please refer to the section below titled “Non-Executive Employee Stock Option Exchange Offer.”
		The fair value of options granted was estimated on the date of grant with vesting periods ranging from one to three years using the Black-Scholes option-pricing model with the following weighted average assumptions used: no dividend yield, expected volatility of 49 percent – 80 percent, risk free interest rate of 3.0 percent – 3.5 percent and an expected life of five years. The per share weighted average fair value of stock options granted for the three months and nine months ended September 30, 2004 was $4.37 and $4.75, respectively using the Black-Scholes option-pricing model and the assumptions listed above. The share weighted average fair value of stock options granted for the three months and nine months ended September 30, 2003 was $1.03.
		Non-Executive Employee Stock Option Exchange Offer
		On December 23, 2002, the Company offered to exchange certain “out of the money” non-executive employee stock options. As a result of the historic stock market volatility, many employees held stock options with an exercise price that significantly exceeded the market price of the Company’s common stock. Because the Company believed that these options were not providing the appropriate level of performance incentives, it offered a voluntary option exchange program allowing eligible employees to cancel their stock options with exercise prices ranging between $6.00 and $8.25 and between $14.00 and $14.63 per share in exchange for a lesser amount of new options that would be granted six months and one day after the options were accepted for exchange and canceled by the Company. The participating employees were to receive an amount of new options in accordance with the following exchange ratio schedule.

Executive officers, directors, and non-employees were not eligible for the offer. Additionally, employees who received options within six months and a day of the commencement of the exchange offer were not permitted to participate. The offer expired on January 22, 2003. The Company accepted for exchange, options to purchase an aggregate of approximately 999,615 shares of the Company’s common stock, representing approximately 89% of the shares subject to options that were eligible to be exchanged under the offer. On July 23, 2003, the Company granted, in accordance with the Non-Executive Employee Stock Option Exchange Offer, new options to purchase 496,429 shares of common stock at an exercise price of $2.26.

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(3)		Earnings Per Share
		A reconciliation of the numerators and the denominators of the basic and diluted per share computations and a description and amount of potentially dilutive securities follows:

(4)

Inventories

Inventories consist of the following:

(5)		Property and Equipment
Property and equipment consist of the following:

During the nine months ended September 30, 2004 property and equipment totaling $4,447,000 with accumulated depreciation and amortization of $4,188,000 and a remaining net book value of $259,000 was removed from the Company’s consolidated financial statements. The Company received proceeds of $120,000 from the sale of certain of these assets and recorded a leasehold impairment charge of $135,000 and a loss on disposal of assets of $4,000. Substantially all of these assets were no longer in use by the Company.

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(6)

Accrued Expenses

Accrued expenses consist of the following:

Changes to restructuring related liabilities for the nine months ended September 30, 2004 were as follows:

		Lease exit costs will be paid over the lease term expiring in February 2005.
(7)		Income Taxes
		During the three months ended September 30, 2004, the Company reduced the valuation allowance related to the deferred tax assets by $5,740,000 based on management’s belief that it is more likely than not the deferred tax assets will be realized through the generation of future taxable income. As of September 30, 2004, the Company has total net deferred tax assets of $8,285,000 with a corresponding valuation allowance of $2,545,000. The valuation allowance applies to the long-term portion of the deferred tax assets which management believes are limited under Internal Revenue Service Code Section 382. The reduction in the valuation allowance resulted in an income tax benefit of $4,127,000 and an increase in additional paid-in capital of $1,613,000 for the tax benefit related to stock option exercises. The Company has generated taxable income in each of the first three quarters of 2004, the last three quarters of 2003 and projects future taxable income to be able to use the net deferred tax assets. Management believes that past profitable performance and the forecast of future profits supports the recognition of the deferred tax assets and the reduction of the valuation allowance.
		Ultimate realization of any or all of the deferred tax assets is not assured due to significant uncertainties associated with estimates of future taxable income during the carryforward periods and is subject to change depending on the tax laws in effect in the years in which the carryforwards are used. Management will continue to evaluate the recoverability of the deferred tax assets and will adjust the valuation allowance recorded against the deferred tax assets accordingly.
		At September 30, 2004 the effective tax rate for the Company for 2004 is estimated to be 2.08%. At June 30, 2004 the effective tax rate was estimated to be 6.5%. The change in the effective tax rate from 6.5% to 2.08% resulted in an additional tax benefit of $175,000 being recognized in the three months ended September 30, 2004 and an income tax expense of $137,000 for the nine months ended September 30, 2004.
(8)		Common Stock
		On June 4, 2004, the Board of Directors authorized management to purchase up to $10 million of the Company’s outstanding common stock. As of September 30, 2004, the Company has purchased 341,100

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		shares under the program at a total cost of $2,350,000 which has been recorded as a reduction to additional paid-in capital. This program expires on June 3, 2005 and was the only repurchase program outstanding during the third quarter of 2004.
(9)		Concentrations of Risk
		The customer who had the largest accounts receivable balance owed a total of $1,060,000 (12.5% of the total accounts receivable) to the Company at September 30, 2004 compared to the largest outstanding balance of $868,000 (9% of total receivables) at December 31, 2003. The customer who owed the largest amount at September 30, 2004 is not the same customer who owed the largest amount at December 31, 2003.

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

     For a description of the Company’s significant accounting policies and an understanding of the significant factors that influenced the Company’s performance during the three and nine months ended September 30, 2004 and 2003, this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) should be read in conjunction with the Condensed Consolidated Financial Statements, including the related notes, appearing in Item 1 of this Report as well as the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

     Except for the historical information contained herein, the following discussion includes statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) and the Company claims the protection of the safe-harbor for forward-looking statements contained in the Reform Act. These forward-looking statements are often characterized by the terms “may,” “believes,” “projects,” “expects,” or “anticipates,” and do not reflect historical facts. Specific forward-looking statements contained in the following discussion include, but are not limited to, (i) anticipated increases in the levels of business, including, but not limited to, sales of video encoding and other broadcast products, (ii) our ability to maintain higher margins from core products and development of new products in light of scale back in our systems integration business, (iii) the belief that anticipated increases in the current level of research and development expenditures will enhance product development and marketing, (iv) the belief in the recoverability of deferred tax assets, and (v) the belief that existing cash and cash from operations will be sufficient to meet future operational needs and capital requirements.

     Forward-looking statements involve risks, uncertainties and other factors, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include:

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availability of future taxable income to be able to realize the deferred tax assets;

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loss of, and failure to replace, any significant customers;

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timing and success of new product introductions;

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product developments, introductions and pricing of competitors;

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timing of substantial customer orders;

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availability of qualified personnel;

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the impact of local, political and economic conditions and foreign exchange fluctuations on international sales;

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performance of suppliers and subcontractors;

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decreasing or stagnant market demand and industry and general economic or business conditions;

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availability, cost and terms of capital;

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our level of success in effectuating our strategic plan;

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our ability to successfully integrate acquisitions;

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adequacy of our inventory, receivables and other reserves;

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the effects that acts of international terrorism may have on our ability to ship products abroad;

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other factors to which this report refers or to which our 2003 Annual Report on Form 10-K refers; and

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other factors that the Company is currently unable to identify or quantify, but may arise or become known in the future.

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     In addition, the foregoing factors may generally affect our business, results of operations and financial position.

     Forward-looking statements speak only as of the date the statement was made. The Company does not undertake and specifically declines any obligation to update any forward-looking statements.

     A copy of the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available, free of charge, through our website found at www.radn.com, as soon as reasonably practical after such material is electronically filed with the Securities and Exchange Commission (the “Commission”).

Overview

     The Company designs, manufactures, integrates, installs and sells products, systems and software used in the ground-based portion of satellite communication systems to receive, and transmit data, video, audio and Internet over satellite, microwave and cable communications networks. The Company’s products are used in applications for telephone, data, video and audio broadcast communications, private and corporate data networks, Internet applications, and digital television for cable and network broadcast. Through its network of international offices and service centers, the Company serves customers in over 80 count