Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)

For the fiscal year ended January 31, 2004

OR

For the transition period from              to             .

Commission File Number 1-16541

REMEC, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (858) 505-3401

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 Par Value Per Share

(Title of Class)

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 twelve (12) months (or such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past ninety (90) days:    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K.  x

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

The aggregate market value of the registrant’s common stock, $0.01 par value per share, held by non-affiliates of the registrant on July 31, 2003, the last business day of the registrant’s most recently completed second fiscal quarter, was $270,147,123 (based on the closing sales price of the registrant’s common stock on that date). Shares of the registrant’s common stock held by each officer and director and each person who owns 5% or more of the outstanding voting power of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not a determination for other purposes.

The number of outstanding shares of REMEC common stock as of April 8, 2004 was 61,529,674.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for REMEC’s Annual Meeting of Shareholders expected to be held on June 11, 2004, a definitive copy of which will be filed with the SEC within 120 days after the end of the year covered by this Form 10-K, are incorporated by reference herein in Part III of this Form 10-K.

Table of Contents

REMEC, INC.

ANNUAL REPORT ON FORM 10-K

FOR FISCAL YEAR ENDED JANUARY 31, 2004

TABLE OF CONTENTS

i

Table of Contents

ii

Table of Contents

Some of the statements made by us in this Annual Report on Form 10-K are forward-looking in nature, including but not limited to, statements relating to our future revenue, product development, demand, acceptance and market share, gross margins, levels of research and development, our management’s plans and objectives for our current and future operations, and other statements that are not historical facts. Forward-looking statements include, but are not limited to, statements that are not historical facts, and statements including forms of the words “intend,” “believe,” “will,” “may,” “could,” “expect,” “anticipate,” “plan,” “possible,” and similar terms. Actual results could differ materially due to a variety of factors, including the risks described in this Annual Report and the other documents we file from time to time with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

PART I

ITEM 1. BUSINESS

INTRODUCTION

REMEC, Inc. (“REMEC” or the “Company” or “our” or “we”) was incorporated in California in January 1983. Our principal executive offices are located at 3790 Via de la Valle, Del Mar, California 92014, and the telephone number for that location is (858) 505-3401. Our Internet address is www.remec.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other Securities and Exchange Commission, or “SEC,” filings are available free of charge through our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Upon written request, we will provide, without charge, a copy of this annual report on Form 10-K, including the consolidated financial statements, financial statement schedules and any exhibits for our most recent fiscal year. All requests should be sent to: REMEC, Inc., 3790 Via de la Valle, Del Mar, California 92014, Attn: Investor Relations. In addition, the public may read and copy materials filed by REMEC with the SEC at the SEC’s public reference room located at 450 Fifth St., N.W., Washington, D.C. 20549. Our common stock trades on the Nasdaq National Market under the symbol “REMC.”

REMEC designs and manufactures high frequency subsystems used in the transmission of voice, video and data traffic over wireless communications networks in the defense and commercial sectors. Our products are designed to improve the capacity, efficiency, quality and reliability of wireless communications infrastructure equipment. We also develop and manufacture sophisticated wireless communications equipment used in the defense industry, including communications equipment integrated into electronic systems for tactical aircraft, ships, ground systems, satellites, missile systems and smart weapons. We manufacture products that operate at the full range of frequencies currently used in wireless communications transmission, including radio frequencies, or “RF,” microwave frequencies and millimeter wave frequencies. By offering products that cover the entire frequency spectrum for wireless communications, we are able to address opportunities in the worldwide commercial mobile wireless communications and defense markets.

INDUSTRY BACKGROUND

Demand for Mobile Wireless Services Necessitates Expansion of Wireless Infrastructure. Wireless network service providers to date have focused primarily on satisfying the increasing demand for wireless telephony through the transmission of voice and low speed data signals over cellular systems and digital personal communication systems (“PCS”). The demand created by increased minutes of usage and data transmission requires substantial additional capital investment in wireless communications infrastructure equipment.

Advances in Mobile Wireless Communications Network Technology Will Require Additional Wireless Infrastructure Equipment. The capacity and quality of domestic and international mobile wireless communications networks have evolved with advances in technology. In response to capacity and an increase in the level of service demands, service providers are expanding their current infrastructure and are implementing new wireless technologies, including third generation (“3G”) networks.

Demand for High Speed Internet Access and Other Data Services Increases the Need for Broadband Access. Consumers around the world are using the Internet for an ever-increasing range of purposes, including email, high quality audio, streaming video and other multimedia services. Businesses are also using the Internet to enhance their reach to both residential and business consumers with applications such as electronic commerce, global marketing, customer support, web hosting, order fulfillment and supply management. The Internet also permits access to corporate data networks, including intranets and extranets, facilitating communication among corporate sites or with telecommuters or traveling employees. This increased usage requires an expanded capacity for the quick and reliable transmission of voice, video and data, which can be accomplished through broadband access.

1

Table of Contents

Wireless Infrastructure OEMs Rely on Subsystem Providers. In order to meet the demand for mobile wireless and fixed wireless access broadband services, service providers normally utilize systems integrators or original equipment manufacturers (“OEMs”) to build out infrastructure quickly, efficiently and in accordance with exacting performance specifications. In turn, many OEMs are looking to outsource the design and manufacture of highly integrated reliable subsystems in a cost-effective manner. This permits OEMs to accelerate their time to market and allows them to leverage their core competencies of full system design and integration. By outsourcing subsystems, OEMs promote competition among developers and manufacturers, which leads to technological innovations in wireless infrastructure equipment. Concurrently, OEMs are seeking to select a core group of subsystem and component providers in order to reduce the supply and management risks associated with the currently fragmented supplier base.

The Wireless Industry Is Extremely Competitive and Requires a Significant Investment in Up-front Engineering Development. The competitive nature of the wireless industry results from the large number of suppliers at every level, from service providers to OEMs/subsystems and component suppliers. This results in an industry over-capacity condition. In addition, a significant up-front engineering investment is required in order to remain technically competitive.

Consolidation Among Wireless Infrastructure OEMs and Service Providers Increases Competition. A limited number of large OEMs account for a majority of purchases of filter products, antenna line products and amplifier products and subsystems in the wireless equipment market. This requires manufacturers of filter products, antenna line products and amplifier products and subsystems, such as ourselves, to increase efforts to establish and maintain relationships with these important customers. In addition, consolidation among wireless service providers has increased competition for their business, including requiring wireless infrastructure manufacturers to reduce sales prices, pursue manufacturing cost reductions and commit resources to developing new products.

THE REMEC SOLUTION

We market our products to OEMs of wireless communications networks and network service providers, as well as to prime contractors in the defense industry. We provide customers complete product life-cycle management for design, prototyping and mass production of reliable microwave and RF hardware.

We believe that our core competencies enable us to address the existing and emerging opportunities in the wireless communications infrastructure equipment and defense markets. These core competencies include the following:

Components. Our components meet the functionality needs of today’s RF and microwave subsystems, including power dividers, combiners, filters, switches, mixers, amplifiers, oscillators, converters and multipliers. We maintain state-of-the-art capability for performance and cost in key component areas, which are used in our integrated products.

Integration Expertise. We design high performance subsystems over a broad range of RF, microwave and millimeter frequencies, which require sophisticated component integration. By integrating a number of required microwave functions into a single package, we are able to reduce the bill of materials, improve product performance, reduce cost and enhance yields and improve product reliability.

Concurrent Engineering. We streamline and optimize the product development cycle by employing “concurrent engineering,” which includes continuous joint participation with our customers from conceptualization, participation by our suppliers in the design process, and consideration of manufacturing constraints and limitations while developing a product design.

Design for Test and Design for Manufacturability Feedback. Our ability to plan both our internal manufacturing services and design capability reduces product time to market and unit costs. We retain control of each step of the design and manufacturing process while minimizing the use of outside sources and subcontractors for key manufacturing processes and services. This capability also improves quality control, reliability and our ability to implement volume production.

Broad Frequency Range. Our technologies support the range of frequencies utilized for mobile wireless and broadband wireless applications. Our microwave technology expertise covers the frequency spectrum used for existing wireless communications. Many of our subsystem competitors only address select frequency bands in the subsystems they design, which makes them vulnerable to technological advances in products that use frequency bands they do not address. By having the ability to design and manufacture products across the breadth of the wireless communications market, we can better address our customers’ needs and capitalize on our overall design and manufacturing capabilities.

2

Table of Contents

STRATEGY

Our objective is to build on the strength of our core competencies to be the supplier of choice of wireless service providers, OEMs in the wireless infrastructure equipment industry and prime contractors in the defense electronics industry. Our strategy includes the following key elements:

Leverage Technology Experience. Through twenty years of experience in high frequency applications in the defense and commercial industries, we believe that we have an advanced portfolio of products and technologies encompassing RF, microwave and millimeter wave technologies. The skills that we developed in the defense industry, and enhanced for the commercial wireless market, have enabled us to develop solutions to achieve reductions in the size and cost of wireless infrastructure equipment. We intend to continue to integrate additional functions into smaller packaging with fewer parts while meeting the reliability and performance specifications of next-generation wireless infrastructure equipment.

Continue to Develop Strong Strategic Alliances with Customers. By forming lasting customer relationships through working closely with customers, we are better able to develop insight into their system requirements and to design specific products that meet their needs. We intend to continue to expand our key customer alliances with leading infrastructure OEMs. We concentrate our efforts on the commercial customers we believe will be the most successful in selling their systems to service providers that require high volume production.

Supply Integrated Microwave Subsystems to OEMs Worldwide. We believe that we have established significant relationships with global OEMs through the breadth of our expertise in wireless communications technology. This has allowed us to service the needs of the operations of these OEMs. In fiscal 2004, we acquired Himark Telecom Group Limited (“Himark”) and Paradigm Wireless Systems, Inc. (“Paradigm”), which have provided us with additional sales, marketing and integration design expertise.

Supply Niche Products Directly to Network Service Providers. We intend to continue expanding our marketing efforts to sell certain niche wireless products directly to network service providers. Although we do not intend to enter into direct competition with our OEM customers, there are several niche products that are not being marketed aggressively by OEMs, including base station antenna-line tower top products and booster amplifiers. We intend to continue expanding our product portfolio and our efforts to market these products to network service providers when we can do so without competing directly with our OEM customers or enter into partnership agreements with our OEM customers to integrate our products into their system solutions.

Enhance High Volume Manufacturing Capability. We intend to continue to implement process manufacturing automation and believe that our ability to develop a high level of automated product alignment and test capability will help us to further improve our cost effectiveness and time to market. We also intend to continue expanding our foreign manufacturing operations, both at our current locations such as Costa Rica and the Philippines and our newer manufacturing facility in China, when appropriate, in order to lower our costs or to access an available workforce. In addition, we intend to offer our manufacturing services to OEMs and subsystem and component developers or manufacturers who need high volume manufacturing of their own products either because of capacity constraints or lack of manufacturing expertise.

SIGNIFICANT BUSINESS DEVELOPMENT IN FISCAL YEAR 2004

In July we acquired Himark, a Chinese distribution company, located in Beijing, China in order to strengthen our presence in the China market. In November 2003, REMEC announced the completion of our acquisition of Paradigm. Paradigm is located in Irvine, California and designs and manufactures power amplifiers for the wireless infrastructure market. The Paradigm acquisition strengthens our position as a supplier of commercial wireless subsystem products in the Asia market.

SEGMENT INFORMATION

Financial information regarding our business segments may be found in Note 8 to the Consolidated Financial Statements, which is incorporated herein by reference, and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Form 10-K.

Commercial Segment

The Commercial segment addresses the mobile wireless infrastructure market, the broadband wireless market and the generic components market.

3

Table of Contents

The Mobile Wireless Market. The mobile wireless market includes the cellular infrastructure market that supports Code Division Multiple Access (“CDMA”), Time Division Multiple Access (“TDMA”), Global Standard for Mobile (“GSM”), Enhanced Data Rates for GSM Evolution (“EDGE”), Universal Mobile Telecommunications System (“UMTS”) and 3G networks. Wireless network service providers to date have focused primarily on satisfying the increasing demand for wireless telephony through the transmission of voice and low speed data signals over cellular systems and digital PCS. In addition, the capacity and quality of domestic and international mobile wireless communications networks have evolved with advances in technology. In response to capacity and increased level of service demands, service providers are expanding their current infrastructure and are implementing new wireless technologies.

The Broadband Wireless Market. The broadband wireless market includes higher frequency fixed wireless applications, such as point-to-multipoint fixed wireless access systems, point-to-point microwave radio systems, wireless fidelity (“WiFi”) and very small aperture terminals systems. Consumers around the world are using the Internet for an ever-increasing range of purposes, including email, high quality audio, streaming video and other multimedia services. This increased usage requires an expanded capacity for the quick and reliable transmission of voice, video and data, which can be accomplished through broadband access. Furthermore, new fixed wireless access broadband technology can provide quality of service comparable to the best land line network alternatives at speeds that are significantly faster than conventional copper wire-based networks. Fixed wireless access broadband technology is designed to be integrated with the existing network backbone to address the last mile bottleneck problem. In addition, certain types of fixed wireless access broadband technology provide an alternative for selective network backbone applications. Broadband wireless systems include point-to-point, point-to-multipoint and satellite-to-multipoint broadband technologies.

The Generic Components Market. The generic components segment includes the sale of single function components across all market segments, whereas the other segments focus on integrated solutions.

Defense & Space Segment

The Defense and Space segment addresses a broad spectrum of RF and microwave products for systems integrated by prime contractors in military and space applications. These products range from critical components and integrated modules to advanced integrated microwave assemblies for radar, missiles, electronic warfare and communication/navigation systems.

PRODUCTS

Commercial Segment Products

We provide our products to worldwide OEMs and service providers. These products include tower mounted amplifiers and boosters, power amplifiers, medium power and low noise amplifiers, integrated filtering and combining systems, filters, oscillators, mixers, transceivers and radio outdoor units.

Mobile Wireless. We provide a wide range of RF products and system solutions for use in cellular, TDMA, GSM, CDMA, PCS, PCN, EDGE and UMTS infrastructure networks. Our product lines include filter products, antenna line products and amplifier products and subsystems. Our products are designed to improve the capacity, coverage, efficiency, quality and reliability of today’s mobile infrastructure equipment networks.

4

Table of Contents

station manufacturers, but also include a line of “standard” SCPA and MCPA high-power booster amplifier subsystems that “boost” the transmit signal of standard base stations to higher power levels and are offered in the end user market. These products are used in coverage applications to extend the range of the base transceiver stations to cover a wide area or in capacity enhancement applications to boost the signal level of multiple carriers on a single antenna after they have been combined onto a single transmission line. Booster amplifier subsystems are offered as an integrated solution with our tower mounted amplifier products to provide a balanced link where the transmit power and receive sensitivity of the base transceiver stations are matched and optimized to a specific coverage area.

Broadband Wireless. We provide a full range of microwave products for point-to-point and point-to-multi-point microwave radio, fixed wireless access and very small aperture terminal wireless network systems.

Components. We provide a broad selection of single function components including power dividers, filters, amplifiers, mixers and oscillators to external customers in a number of niche markets that are complimentary to our core markets.

Defense & Space Products

We provide RF and microwave products for electronic warfare, radar and communications/navigation systems for the defense market. We design, build and integrate these products and their microwave functionality into integrated subsystems for defense programs that we believe have a high probability of follow-on production. Our products are integrated into various defense tactical aircraft, satellites, missile systems and smart weapons that comprise the majority of high priority platforms of our customers. These RF and microwave systems, subsystems and integrated components are comprised of specialized combinations of components that perform a variety of microwave functions that include filters, couplers, power divider switches, amplifiers, voltage controlled oscillators, mixers and multipliers. Defense industry programs for which we provide subsystems and integrated components include the following:

5

Table of Contents

We also provide reliable designs and hardware solutions for U.S. space applications. Our products are integrated into many global positioning, military and communications satellites.

In addition, our Monolithic Microwave Integrated Circuits (MMIC) supports U.S. government research labs and other customers with state-of-the-art design services for next generation system capabilities such as “system on a chip” solutions for high-volume T/R modules.

MANUFACTURING

Commercial

The Commercial segment has the ability to manufacture microwave products in high-volume, including test and critical hybrid circuits. Our manufacturing is organized into three main activities: volume manufacturing, new product introduction and manufacturing support. Volume manufacturing includes those sites that specialize in building our custom designs and those that have expertise in building to customer designs. Our volume manufacturing capabilities are located in several locations:

As part of our corporate strategy to globally manufacture in cost competitive locations that meet our customer’s needs, we commit significant resources to the development of and standardization to best-in-class processes and procedures. These manufacturing standards are developed in close coordination with our plants and our design groups. This allows our engineers to develop highly integrated products using a variety of packaging technologies and our manufacturing facilities to build those products using the most efficient and effective techniques. Additionally, we pursue the automation of key assembly and test processes in order to build on our competitive advantages.

All of our Commercial segment factories and major design centers have been certified to ISO-9001 or ISO-9002, as appropriate.

Defense & Space

The Defense & Space segment conducts its manufacturing activities at four major sites in North America. The primary manufacturing facility is located in San Diego, California. This facility includes design engineering, program management, manufacturing engineering, quality, supply chain management and other support functions for the U.S. based portion of this business.

The San Diego facility has been recently upgraded and includes a new plant layout to maximize design and manufacturing operational efficiency.

REMEC Mexico, SA de CV, located in Tijuana, Mexico, serves as a low-cost manufacturing facility that augments the high production activities of our San Diego site. The close proximity to our San Diego location enables a full range of timely technical support for our high-volume manufacturing activities. Both locations have ISO 9001:2000 certifications. The San Diego location also maintains a MIL-PRF-38534 certification status for manufacturing microwave hybrid assemblies. In addition, our environmental lab

6

Table of Contents

in San Diego was recently certified by the Defense Supply Center Columbus (DSCC) for the Commercial Lab Suitability on MIL-STD-833 test methods. On-site manufacturing capabilities include:

REMEC Nanowave Technologies, Inc., our majority-owned subsidiary, has the same manufacturing capabilities as our San Diego facility and is located in Toronto, Canada. This site is supported by research and engineering, manufacturing engineering, quality, supply chain management and other administrative support functions.

We maintain research and development facilities in Richardson, Texas and Forsyth, Missouri. The research and development team enables REMEC to provide vertically integrated solutions from custom circuit design through component development. Services include standard and custom MMIC and transistor design, “fabless” microwave and millimeterwave packaging solutions, and direct circuit/radio frequency (DC/RF) on wafer testing.

SUPPLY CHAIN

Our products are manufactured from both standard components and parts that are built to specifications by other manufacturers. Our most significant raw materials are aluminum, ceramics and liquid nitrogen. While there have been some shortages in components and other materials, we have generally been able to obtain materials and components from a variety of sources to meet our needs. We develop and maintain alternative sources for essential materials and components. For most of our purchased parts, we do not have a concentration of sources of supply materials, labor or services that, if suddenly eliminated, would severely impact our operations.

CUSTOMERS

REMEC derives a significant portion of our revenues from a limited group of customers. For the fiscal year ended January 31, 2004, our top ten customers comprised approximately 63% of revenues, compared to 63% in 2003 and 60% in 2002. For fiscal year 2004, only one customer accounted for more than 10% of total fiscal revenues. Nokia Telecommunications Company accounted for approximately 16% of total fiscal revenues. We anticipate that we will continue to derive a significant portion of our revenues from sales to a relatively small group of customers. Our revenues would be significantly reduced if any of these customers cancel, reduce or delay orders or product shipments on account of their manufacturing or supply difficulties, financial difficulties or reduction in demand for their systems and products or otherwise.

We sell our commercial wireless communications products primarily to OEMs, which in turn integrate our products into wireless infrastructure equipment solutions sold to network service providers. In addition, we also sell certain niche products directly to network service providers.

We sell RF and microwave equipment to major U.S. defense prime contractors for integration into larger systems, primarily radar electronic warfare, communications and navigation. Our customers for defense products include ATK, BAE Systems PLC, ITT Industries, Northrop Grumman Corporation, Raytheon Company, Lockheed Martin Corporation and The Boeing Company.

SALES AND MARKETING

REMEC uses a team-based sales approach to facilitate close management of relationships at multiple levels of a customer’s organization, including management, engineering and purchasing personnel. Our integrated sales approach involves a team consisting of a senior executive, a business development specialist, members of our engineering department and local sales representation. Our executive officers are also involved in our relationships with our major customers. To identify sales opportunities, we primarily utilize a direct sales force supplemented by a group of manufacturer sales representatives.

7

Table of Contents

We are expanding our international sales presence with direct sales offices in Europe and Asia. Sales to customers residing outside of the U.S. represented 37%, 34% and 24% of net sales in fiscal years ended January 31, 2004, 2003 and 2002, respectively. Our international sales figures do not include products sold to foreign end users by our domestic customers.

A summary of our domestic and international net revenue and net property, plant and equipment is set forth in Note 8 to the Consolidated Financial Statements appearing elsewhere in this Form 10-K, which is incorporated herein by reference.

BACKLOG

Our backlog, calculated as the aggregate of the sales price of orders received from customers less revenue recognized, was approximately $191.7 million on January 31, 2004 and $132.0 million on January 31, 2003. Approximately $44.9 million of the January 31, 2004 backlog and $38.6 million of the January 31, 2003 backlog, respectively, was for the Commercial segment.

Product orders in our backlog are frequently subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty. While we regularly review our backlog of orders to ensure that it adequately reflects product orders expected to be shipped within a one-year period, we cannot offer any assurance that such orders will actually be shipped or that such orders will not be cancelled in the future. We make regular adjustments to our backlog as customer delivery schedules change and in response to changes in our production schedule. Accordingly, backlog as of any particular date should not be considered a reliable indicator of sales for any future period and our revenues in any given period may depend substantially on orders booked in that period.

COMPETITION

The markets for our products are extremely competitive and are characterized by rapid technological change, new product development, product obsolescence and evolving industry standards. In addition, price competition is intense and the market prices and margins of our products decline as competitors begin making similar products. We face competition from component/subsystem manufacturers, but we believe that our primary competition is from the captive manufacturing operations of large wireless communications OEMs, including nearly all of the major telecommunications equipment providers, and defense prime contractors. We believe that our future success depends largely upon the extent to which these OEMs and defense prime contractors elect to purchase subsystems and integrated components from outside sources such as us. OEMs and defense prime contractors could develop greater internal capabilities and manufacture these products exclusively in-house, rather than outsourcing them, which would have a negative impact on our sales.

RESEARCH AND DEVELOPMENT

Our core competencies, including our emphasis on concurrent engineering, rely heavily on our research and development capabilities. These capabilities, including our breadth of engineering skills, have allowed us to develop products that operate across the range of frequencies used in commercial wireless communications. Research and development expenses for the fiscal years ended January 31, 2004, 2003 and 2002 were approximately $50.0 million, $34.6 million and $26.3 million, respectively. We expect that as our commercial business expands, research and development expenses may increase.

Our research and development efforts in the defense industry are conducted in direct response to the unique requirements of a customer’s order and, accordingly, are included in cost of sales and the related funding in net sales. We believe that to remain a technology leader in the future we will need to invest significant financial resources in research and development. The results of the research and development programs continue to enhance and add value to our already impressive integration capability.

INTELLECTUAL PROPERTY

REMEC currently has more than 72 patents and approximately 16 patents pending. These patents include technologies for improving performance and reducing the cost of power amplifiers, multimode intelligent components, filters and transceivers. We believe these patents provide a competitive advantage and are important to our success as a supplier of RF and microwave equipment supplier. Our intellectual property also includes a variety of trade secrets and technology licenses.

In order to protect our intellectual property rights, we rely on a documented intellectual property protection process that includes patents, trade secrets, copyrights and trademarks and employee and third party nondisclosure agreements. We also limit access to and distribution of proprietary information. The steps that we have taken to protect our intellectual property rights may not be adequate to prevent misappropriation of our technology or to preclude competitors from independently developing similar technology.

8

Table of Contents

Furthermore, in the future, third parties may assert infringement claims against us or with respect to our products. As to some of our products, we have agreed to indemnify our customers against possible claims by third parties that the products infringe their intellectual property rights. Asserting our rights or defending against third party claims could involve substantial costs and diversion of resources. If a third party was successful in a claim that one of our products infringed that third party’s proprietary rights, we may have to pay substantial royalties or damages or remove that product from the marketplace. We might also have to expend substantial financial and engineering resources in order to modify the product so that it would no longer infringe on those proprietary rights.

GOVERNMENT REGULATIONS

Our products are incorporated into commercial wireless communications systems that are subject to regulation domestically by the FCC and internationally by other government agencies. Although the equipment operators and not us are usually responsible for compliance with these regulations, regulatory changes, including changes in the allocation of available frequency spectrum, could negatively affect our business by restricting development efforts by our customers, making current products obsolete or increasing the opportunity for additional competition. In addition, the increasing demand for wireless telecommunications has exerted pressure on regulatory bodies worldwide to adopt new standards for these products, generally following extensive investigation of and deliberation over competing technologies. The delays inherent in this governmental approval process have in the past caused and may in the future cause the cancellation, postponement or rescheduling of the installation of communications systems by our customers.

We are also subject to a variety of local, state, federal and foreign governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our products. The failure to comply with current or future regulations could result in the imposition of substantial fines on us, suspension of production, alteration of our manufacturing processes or cessation of operations.

Because of our participation in the defense industry, we are subject to audit from time to time of our compliance with government regulations by various agencies, including the Defense Contract Audit Agency, the Defense Security Service, the Office of Federal Contract Compliance Programs and the Defense Supply Center Columbus. These and other governmental agencies may also, from time to time, conduct inquiries or investigations that may cover a broad range of our business activity. Responding to any governmental audits, inquiries or investigations may involve significant expense and divert management attention. Also, an adverse finding in any such audit, inquiry or investigation could involve penalties.

We believe that we operate our business in material compliance with applicable government regulations.

EMPLOYEES

As of January 31, 2004, we had a total of 5,071 employees, including 3,577 in manufacturing and operations, 618 in research, development and engineering, 229 in quality assurance, 132 in sales and marketing, and 515 in administration and material procurement. We believe our future performance will depend in large part on our ability to attract and retain highly skilled employees.

RISKS RELATING TO OUR BUSINESS

Current economic conditions are uncertain.

Current conditions in the domestic and global economies are extremely uncertain. As a result, it is difficult to estimate the level of growth, if any, for the economy as a whole, and even more difficult to estimate growth, if any, in the specific markets in which we participate. Because our budgeting and forecasting are dependent upon estimates regarding the markets we serve, the prevailing economic uncertainty renders estimates of future income and expenditures even more difficult than usual to make. The future direction of the overall domestic and global economies will have a significant impact on our overall performance.

The terrorist attacks in 2001, current conflicts in the Middle-East and the potential for future terrorist attacks and conflicts have created many economic and political uncertainties that have severely impacted the global economy. We experienced a further decline in demand for our products after the terrorist attacks in 2001. The long-term effects of these economic and political uncertainties on our business and the global economy remain unknown.

Operating in the commercial wireless communications industry carries certain risks.

Our success in the commercial wireless market depends in large part on investments by our customers in expensive wireless infrastructure equipment. Because the commercial wireless market has only recently begun to develop, it is difficult to predict the rate at which this market will grow, if at all. This market is currently experiencing a downturn, and as a result our customers may continue to reduce their capital expenditures in response to current or anticipated reductions in consumer demand for their products and services. If the current economic uncertainty continues, demand for our commercial wireless products may be sharply reduced or may fail to develop, which would adversely affect our revenues. In addition, the need to invest in the engineering, research and development and marketing required to penetrate markets and maintain service and support capabilities limits our ability to reduce expenses during downturns.

9

Table of Contents

The failure of our customers to sell wireless communications network solutions that include our subsystems and integrated components would harm our sales.

In general, our integrated components and subsystems must be custom designed for use in our customers’ products. As a result, we sell our products to a relatively small group of customers, and our products must be specifically engineered for each customer. While we select our customers based on our assessment of their ability to succeed in the marketplace, we can not be sure of their success. If our customers are not successful, the length of time required to re-engineer our product for another customer may delay our sales or prohibit us from getting our products to the marketplace in a timely manner or at all. In addition, many of our customers can internally design and/or manufacture their own RF and microwave subsystems and systems. If, for any reason, our customers decide to produce their RF and microwave subsystems and systems internally, increase the percentage of their internal production, require us to participate in joint venture manufacturing with them or compete directly against us, our revenues would decrease which would adversely impact our results of operations.

Our production schedules and manufacturing processes may cause fluctuations in quarterly results.

Our quarterly results have varied significantly in the past and are likely to continue to vary significantly. These fluctuations are due to a number of factors, including the following: timing, cancellation or rescheduling of customer estimates for product; customer orders and shipments; pricing and mix of products sold; introduction of new products; our ability to obtain components and subassemblies from contract manufacturers and suppliers; and variations in manufacturing efficiencies. Any one of these factors could substantially affect our results of operations for any particular fiscal quarter.

Our continued efforts to service the defense market may limit our growth in revenues.

We make a substantial portion of our sales to the U.S. defense market. As a result, lower defense spending by the U.S. government could materially reduce our revenues. Lower defense spending by the U.S. government on REMEC programs might occur because of defense budget cuts, general budget cuts or other causes.

We expect to continue to derive a substantial portion of our revenues from defense programs and to develop microwave products for defense applications. If a significant defense program or contract ends, and we fail to replace sales from that program or contract, our revenues will decline. In addition, a large portion of our expenses are fixed and difficult to reduce, thus magnifying the negative effect of any shortfall in revenue.

Our defense development contracts could cause our quarterly results to fluctuate.

We have entered into more defense industry development contracts as a source of defense revenues. Development contracts are contracts for the development of products, rather than the production of existing products and they tend to be fixed price contracts that generally result in lower gross profit margins than production contracts. As a result, our increased reliance on development contracts has led to increased quarterly fluctuations in sales and gross profit margins. Accordingly, our comparative performance from one fiscal quarter to the next is not necessarily an accurate indicator of our future performance.

Our exclusive arrangements with some customers may limit our pursuit of market opportunities and may result in a loss of revenues.

We have granted some of our customers exclusivity on specific products, which means that we are only permitted to sell those specially engineered products to them. We expect that in some cases our existing customers and new customers may require us to give them exclusivity on new products that we make for them. By entering into exclusive arrangements, we may forego opportunities to supply these products to other companies. In addition, if we enter into exclusive relationships with customers who prove to be unsuccessful, our revenues will be negatively affected. We may not be able to establish business relationships with, or negotiate acceptable arrangements with, significant customers in the future. Also, our current or future arrangements with significant customers may not continue or be successful.

Our dependence on a few sole suppliers may decrease our timeliness of product delivery to customers.

In some cases, we rely on sole suppliers or limited groups of suppliers to provide us with services and materials necessary for the manufacture of our products. If we are not able to obtain sufficient allocations of these components, our production and shipment of product will be delayed, we may lose customers and our profitability may be affected.

Other risks relating to our reliance on sole suppliers include reduced control over productions costs, delivery schedules, reliability and quality of materials. Any inability to obtain timely deliveries of acceptable quality materials, or any other circumstances that would require us to seek alternative suppliers, could adversely affect our ability to deliver products to our customers. While it is unlikely that costs from our major suppliers will increase as costs are strictly managed through long term contracts, if they did, we may suffer losses if we are unable to recover such cost increases under fixed price production commitments to our customers.

10

Table of Contents

Fixed-price contracts may increase risks of cost overruns and product non-performance.

Our customers establish demanding specifications for product performance, reliability and cost. Most of our customer contracts are firm fixed price contracts. Firm fixed price contracts provide for a predetermined fixed price for the products we make, regardless of the costs we incur. We have made pricing commitments to customers based upon our expectation that we will achieve more cost effective product designs and automate more of our manufacturing operations.

Manufacture of our products is an extremely complex process. We face risks of cost overruns or order cancellations if we fail to achieve forecasted product design and manufacturing efficiencies or if products cost more to produce than expected. The expense of producing products can rise due to increased cost of materials, components or labor, or other factors. We may have cost overruns or problems with the performance or reliability of our products in the future.

Our success in pursuing sales in international markets may be limited by risks related to international trade and marketing.

For the fiscal year ended January 31, 2004, approximately 37% of our revenue was derived from sales to customers residing outside the U.S. In addition, some of our U.S.-based customers who integrate our subsystems into their products may sell into these international markets. Adverse international economic conditions or developments, including economic instability in Asia, have in the past and could in the future negatively affect our direct sales and sales by our customers into these regions which would impact our revenues.

In addition to the uncertainty as to our ability to maintain and expand our international presence, there are certain risks inherent in foreign operations, including: delays resulting from export restrictions on certain products and technologies; fluctuations in foreign currencies and the U.S. dollar; loss of revenue, property and equipment from expropriation, nationalization, war, insurrection, terrorism and other political risks; transmission of contagious diseases; overlap of different tax structures; seasonal reductions in business activity; and risks of increases in taxes and other government fees. In addition, foreign laws treat the protection of proprietary rights differently from laws in the United States and may not protect our proprietary rights to the same extent as U.S. laws.