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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

Commission File Number: 0-30757

Sunrise Telecom Incorporated

(Exact name of Registrant as specified in its charter)

302 Enzo Drive, San Jose, California 95138

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (408) 363-8000

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

Common Stock, par value $0.001 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 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

    Yes x     No ¨

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12B-2).

    Yes ¨     No x

As of June 28, 2002, the aggregate market value of the Common Stock of the Registrant held by non-affiliates was $38,529,121.

As of February 28, 2003, there were 49,581,419 shares of the Registrant’s Common Stock outstanding, par value $0.001.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the 2003 Annual Meeting of Stockholders are incorporated by reference in Part III.

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SUNRISE TELECOM INCORPORATED

Index to Annual Report on Form 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

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Forward-Looking Statements

This report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding possible growth in the market for telecommunications test equipment and new product development. Except for historical information, the matters discussed in this report on Form 10-K are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected due to certain factors, including those discussed below in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results” and elsewhere in this report. You should not rely solely on forward-looking statements in this report to support an investment decision. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Report on Form 10-K.

Part I.

ITEM 1.    BUSINESS

OVERVIEW

We manufacture and market service verification equipment that enables service providers to pre-qualify facilities for services, verify newly installed services, and diagnose problems relating to telecommunications, cable TV, and internet networks. Our products offer broad functionality, leading edge technology, and compact size to test broadband services; these include wire line access services (including DSL), fiber optics, cable TV networks, and signaling networks. We design our products to maximize technicians’ effectiveness in the field and to provide realistic network simulations for equipment manufacturers to test their products. Our customers include incumbent local exchange carriers, cable companies, competitive local exchange carriers, and other service providers, network infrastructure suppliers, and installers throughout North America, Latin America, Europe, Africa, the Middle East, and the Asia/Pacific region.

In October 1991, we were incorporated in California as Sunrise Telecom, Inc. In July 2000, we reincorporated in Delaware and changed our name to Sunrise Telecom Incorporated (“Sunrise”). “Sunrise Telecom,” “SunSet,” and “SunLite” are trademarks of Sunrise Telecom Incorporated. This Report on Form 10-K also includes references to registered service marks and trademarks of other entities.

INDUSTRY BACKGROUND

High-Speed Data Access

Data traffic in the United States and Canada has surpassed the amount of voice traffic carried on the existing telephone network. Consumers are seeking higher-speed access to bandwidth intensive content and services, such as highly graphical Web sites, audio, video, and software downloads. As an increasing number of Internet users access more and different content, the ability to connect to and receive data from the Internet at high speeds has become and will continue to become more important.

One primary investment area is the redesign of the access network to support broadband access to end users. This portion of the network between the customer’s premise and the service provider’s central office is also known as the “last-mile.” The last mile typically consists of copper wires that operate at substantially lower transmission speeds than those offered in the long-haul segment of a network or by some available broadband alternatives. These copper wires were originally intended to carry only analog circuit-switched, low-speed voice signals and, as a result, have become a

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bottleneck that limits high-speed data transmission. Several access technologies are being deployed to support higher- speed Internet access in the networks, including digital subscriber lines, digital cable TV/MODEM, fiber optics, and broadband wireless. In addition, the signaling portion of the network is essential to the integration of new broadband services into the existing telecommunications network. We summarize some of these technologies below.

Wire line Access Technology.    Wire line access technology, including DSL technology, transmits data up to 50 times faster than a conventional dial-up modem using existing copper telephone wires. The early adoption of high speed transmission included technologies such as T-carrier, E-carrier, ISDN, and most recently DSL. Digital subscriber line technology, commonly known as DSL, today transmits data up to 50 times faster than a conventional dial-up modem using the existing copper telephone wires. Various implementations of DSL are being developed and deployed, including asymmetric DSL, known as ADSL, symmetric DSL, know as SDSL, high bit-rate DSL, known as HDSL, and integrated services digital network DSL, known as IDSL. Service providers deploying DSL technology include incumbent local exchange carriers, such as SBC Communications, Inc., Verizon Communications, Inc., and Sprint Corporation.

Cable TV Networks.    Cable TV operators use two-way cable, cable modems installed in the home, cable modem termination systems installed at major cable concentration points, and network headend equipment designed to interface their cable TV networks to video feeds and other networks. Several cable companies are currently offering broadband access services across two-way cable, including Comcast, Charter Communications, Cox, and TimeWarner Cable.

Fiber Optics.    Fiber optic cables use pulses of light to transmit digital information. Because fiber optic cables support thousands of high-speed, local digital connections onto a single higher-speed connection to the central office or the central side of the cable TV network where the video signals emanate, they offer virtually unlimited bandwidth capacity. Due to their high capacity, fiber optic cables are being used increasingly in the access network in both telecommunications and cable TV applications.

Signaling.    Telephone systems require a signaling mechanism to set up and end phone calls. These signals serve functions such as supervising or monitoring the status of a line on circuit to see if it is busy, idle, or requesting service; alerting or indicating the arrival of an incoming call; and addressing or transmitting routing and destination signals over the network. Signaling Systems 7, or SS7, is the standard signaling system used by telecom networks worldwide. Signaling networks must support new access technologies to ensure interoperability with the existing telephone network.

The Need for Service Verification Equipment

In order to successfully deploy and maintain broadband networks, service providers rely on sophisticated service verification equipment. This equipment allows service providers to pre-qualify facilities for services, verify proper operation of newly installed services, and diagnose problems. In addition, equipment manufacturers use service verification equipment to test simulated networks during equipment development and verify the successful production of equipment. Service verification equipment can be grouped into the following three types: field verification, remote testing, and alarm and surveillance.

Field Verification Equipment.    Field verification equipment is used by service providers to probe the actual wires, cables, or airwaves to verify that a service works. In the case of a service malfunction, a field technician can use the equipment to locate the exact fault so that repairs can be made. Research and development labs, manufacturing departments, and central office technicians also use field verification equipment in their day-to-day operations. Of the three types of service verification equipment, field verification equipment delivers the most detailed service information. Service providers have found field verification to be an effective method to ensure that the lines operate properly.

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Remote Test Equipment.    Remote test equipment can help verify services and identify certain types of service malfunctions from a centralized location. The equipment is typically controlled by a centralized test system that automates much of the remote testing process. It is commonly used to determine which section within a 3,000 mile circuit has malfunctioned and to diagnose quickly the nature of a customer’s complaint. Due to its centralized and automated nature, remote test equipment is an efficient way to complement field test equipment in the deployment and maintenance of broadband networks.

Alarm and Surveillance Equipment.    Alarm and surveillance equipment constantly monitors the telephone network, searching for facility or service degradations, including outages. When a problem is noticed, a report may be sent immediately to an automated trouble diagnostic system or to a human operator who interprets the message and decides what further action is required. Corrective action typically involves field verification or remote test equipment to identify and correct specific problems.

Because the competition for subscribers for high-speed bandwidth access is intense, the quality and reliability of network service has become critical to service providers because of the expense, loss of customers, and negative publicity resulting from poor service. Field technicians who use service verification equipment allow service providers to verify and repair service problems effectively and, thus, increase the quality and reliability of the network.

THE SUNRISE SOLUTION

We design and manufacture service verification equipment that enables service providers to pre-qualify facilities for services, verify newly installed services, and diagnose problems relating to wire line access services, including DSL services, fiber optic, cable TV, and signaling networks. Our products also enable equipment manufacturers to test simulated networks during equipment development and verify the successful production of equipment. Our field products offer the following features:

Because of the design and functionality of our products, we provide the following benefits to our customers:

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PRODUCTS

We currently offer two main categories of service verification products: broadband access service verification products and signaling testing products.

Broadband Access Service Verification Products

Our broadband access service verification products support a wide range of access technologies, including DSL, cable TV, and fiber optics, for both U.S. and international standards.

Our products enable technicians to verify if a broadband service has been properly installed and to identify and correct problems in case of an error. Our products are designed to be carried into the field by a technician and have a large graphical display, menu-driven functionality, an easy-to-use interface, and in most cases weigh less than three pounds. Many of our models support plug-in hardware modules that enable technicians to upgrade the test sets quickly and easily.

Within our broadband access testing products, we manufacture service verification equipment for three main technologies: wire line access, cable TV, and fiber optics. We describe our major products in each product category below.

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The percentage of our total revenue contributed by each class of products were as follows:

CUSTOMERS

Our customers include telecommunications service providers, cable network operators, network infrastructure suppliers and installers, technicians and engineers in North America, Latin America, Europe, Africa, the Middle East, and the Asia/Pacific region. The following is a selected list of our customers in 2002.

As of December 31, 2002, we had sold versions of our products to over 2,000 customers in over 60 countries. No individual customer accounted for 10% or more of our net sales in 2002 and 2001. Affiliates of SBC Communications accounted for approximately 6% of our net sales in 2002, 5% in 2001, and 16% in 2000. During 2000, 17% of our net sales were to Lucent Technologies, either directly or indirectly through the contract manufacturer Solectron. Besides SBC Communications and Lucent Technologies/Solectron, no individual customer accounted for 10% or more of our net sales in 2000. We expect, however, that we will continue to depend upon a relatively limited number of customers for substantially all of our revenues in future periods. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results—Customer Concentration.”

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SALES, MARKETING AND CUSTOMER SERVICE

Sales.    We sell our products to telecommunications service providers, cable network operators, network infrastructure suppliers and installers, technicians, and engineers through manufacturers’ representatives, independent distributor organizations, and our direct sales force.

In the United States, we sell our products through manufacturers’ representatives who are supported by our in-house direct sales force. Manufacturers’ representatives are paid on a commission basis and have exclusive rights in their respective regions. Our manufacturers’ representatives or direct salesmen solicit orders from the customer, and we ship our products directly to the customer. We pay commissions once we have received payment from the customer. Our direct sales force includes a team of regional sales managers who direct the efforts of our manufacturers’ representatives and regional account managers who focus on specific accounts within a region.

Outside the United States, we sell our products through independent distributor organizations, which are directed by our regional directors of marketing and sales. We sell our products to the distributor at a discount from the end user price, and the distributor then resells the products to the end user. International sales, including North American sales to Canada, were $16.1 million or 30% in 2002, $29.7 million or 38% in 2001, and $30.1 million or 27% in 2000. We expect that international sales will continue to account for a significant portion of our net sales in future periods. In addition to our network of international distributors, we have sales employees based in Anjou, Canada; Beijing, China; Tokyo, Japan; Seoul, Korea; Modena, Italy; and Geneva, Switzerland. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results—Risks of International Operations.”

We sell our products predominantly to large telecommunications and cable service providers. These types of customers generally commit significant resources to an evaluation of our and our competitors’ products and require each vendor to expend substantial time, effort, and money educating them about the value of the vendor’s solutions. Consequently, sales to this type of customer generally require an extensive sales effort throughout the prospective customer’s organization and final approval by an executive officer or other senior level employee. The result is lengthy sales and implementation cycles, which make sales forecasting difficult. In addition, even after a large service provider has approved our product for purchase, their future purchases are uncertain because we generally do not enter into long-term supply agreements or requirements contracts with those parties. Delays associated with a customer’s internal approval and contracting procedures, procurement practices, and testing and acceptance processes are common and may cause potential sales to be delayed or foregone. As a result of these and related factors, the sales cycle of new products for large customers typically ranges from six to twenty-four months. Over the past year, our major customers have decreased their volume of orders, implemented longer purchase cycles, and decreased capital expenditures for telecom and cable equipment.

We generally do not sell our products with rights of return, and on the few occasions when we have agreed to provide customers with rights of return, we have deferred recognition of sales revenue until the rights of return have lapsed. We generally do not provide extended payment terms to our customers.

Marketing.    We market and promote sales of our products by the following activities:

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Customer Service.    We believe that customer service following the sale of our products is a critical ingredient to our success. We provide customer service in numerous ways, including the following:

SEASONALITY

Our sales tend to be seasonal in nature and are typically tied to the buying patterns of our customers. Prior to 2000, the largest volume of quarterly sales had usually been during the last calendar quarter of the year, as customers spent the unused portions of their annual budgets. In 2001 and 2000, there was a change in this fourth quarter seasonality as our customers had fewer remaining unused budget dollars available to generate an increase in the fourth quarter seasonal sales. In 2002, however, we saw a return to the pre-2000 pattern, with increased sales in the fourth quarter. Market conditions in our industry are currently too uncertain for us to predict whether or not this pattern will persist. The first quarter of any given year has historically been a light period for orders because our large customers typically do not release their budgets for the year until mid-quarter. We expect that our quarterly operating results may fluctuate significantly and will be difficult to predict, given the nature of our business. Many factors could cause our operating results to fluctuate from quarter to quarter in the future, including the lengthy and unpredictable buying patterns of our customers, the degree to which our customers allocate and spend their yearly budgets, and the timing of our customers’ budget processes.

BACKLOG

Our backlog of customer orders at December 31, 2002 was approximately $4.4 million compared to approximately $1.5 million at December 31, 2001. Variations in the size and delivery schedules of purchase orders that we receive, as well as changes in customers’ delivery requirements may result in substantial fluctuations in the amount of backlog orders for our products from quarter to quarter.

RESEARCH AND DEVELOPMENT

We have assembled a team of highly skilled engineering professionals who are experienced at designing telecommunications and cable TV service verification test equipment. Our engineering personnel have expertise in a

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number of fields, including interfacing test equipment with digital loop carrier, voice and data switching technology, local loop equipment, and operations support systems. We spent approximately $17.4 million on research and development in 2002, $18.5 million in 2001, and $17.6 million in 2000. Research and development represents our largest direct employment expense. At December 31, 2002, we had a total of 138 employees engaged in research and development in San Jose, California; Norcross, Georgia; Anjou, Canada; Modena, Italy; Taipei, Taiwan; and Geneva, Switzerland.

We believe that our continued success depends on our ability to anticipate and respond to changes in the telecommunications industry and anticipate and satisfy our customers’ preferences and requirements. Accordingly, we continually review and evaluate technological and regulatory changes affecting the telecommunications industry and seek to offer products and capabilities that solve customers’ operational challenges and improve their efficiency. In general, we spend anywhere from two months to four years developing a new product.

REGULATIONS AND INDUSTRY STANDARDS

Our products are designed to comply with a significant number of industry standards and regulations, some of which are evolving as new technologies are deployed. In the United States, our products must comply with various regulations defined by the Federal Communications Commission and Underwriters Laboratories as well as industry standards established by Telcordia Technologies, Inc., formerly Bellcore, and the American National Standards Institute. Internationally, our products must comply with standards established by the European Committee for Electrotechnical Standardization, the European Committee for Standardization, the European Telecommunications Standards Institute, telecommunications authorities in various countries, and with recommendations of the International Telecommunications Union. The failure of our products to comply, or delays in compliance, with the various existing and evolving standards could negatively impact our ability to sell our products.

MANUFACTURING

Our production process consists of planning, procurement, fabrication, rework, system assembly, system final test, software option customization, and shipping. We purchase substantially all parts, including resistors, integrated circuit boards, LCDs, and printed circuit boards, from distributors and manufacturers worldwide. We package these parts into kits and send them to contract manufacturers to assemble them into printed circuit boards. We perform substantially all remaining manufacturing operations. We maintain sourcing and manufacturing operations in San Jose, California; Norcross, Georgia; Anjou, Canada; Taipei, Taiwan; and Modena, Italy. In 2001 and 2002, we performed the majority of sourcing, contract manufacturing, and final assembly in San Jose, California and Taipei, Taiwan. Our San Jose, California and Modena, Italy operations are ISO 9001 certified. In 2002, we increased our manufacturing capacity in Taiwan, while reducing capacity in San Jose to increase overall production cost effectiveness.

Our subsidiary in Taiwan, Taiwan Sunrise Telecom Company Limited, is a turn-key manufacturer and local procurement operation. We also own an equity interest of 10% in Top Union, a manufacturing company located in Taipei, Taiwan that has performed board level manufacturing as part of the Taiwan Sunrise Telecom Company Limited turn-key operation. We intend to continue increasing the use of our Taiwan subsidiary for complete turn-key manufacturing to help lower our manufacturing costs.

In our manufacturing process, we purchase many key products, such as microprocessors, bus interface chips, optical components, and oscillators, from a single source or from that source’s sole supplier. We rely exclusively on third-party subcontractors to manufacture certain sub-assemblies, and we have retained, from time to time, third party design services in the development of our products. We do not have long-term supply agreements with these vendors. In general, we make advance purchases of some products and components to ensure an adequate supply, particularly

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for products that require lead times of up to nine months to manufacture. For a discussion of the risks associated with our reliance on these third parties, see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results—Dependence on Sole and Single Source Suppliers.”

A total of $25.8 million of our net property and equipment is located in the United States and $2.3 million is located in other countries. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results—Risks of International Operations.”

COMPETITION

The market for field verification test equipment is fragmented and intensely competitive, both inside and outside the United States, and is subject to rapid technological change, evolving industry standards, regulatory developments, and varied and changing customer preferences and requirements. We compete with a number of United States and international suppliers that vary in size and in the scope and breadth of the products and services offered. The following table sets forth our principal competitors in each of our product categories:

We expect that, as our industry and market evolve, new competitors or alliances among competitors could emerge and acquire significant market share. We anticipate that competition in our markets will increase with the result that we will face greater threats to our market share, price pressure on our products, and the likelihood that, over time, our profitability may decrease. However, some of our competitors are experiencing unprecedented financial difficulties due to the generally difficult times in the telecommunications marketplace. As some of these competitors are impacted to a greater degree than we are, these difficulties may also present some opportunities for us to increase market share by better maintaining our business operations in comparison.

We believe that the principal competitive factors in our market include the following:

INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY

Our intellectual property, including our proprietary technology, processes and know-how, trade secrets, patents, trademarks, and copyrights, is important to our business and to our continued success. We have six patents relating to

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communications testers, and we have filed several applications for additional patents with the U.S. Patent and Trademark Office and with foreign patent offices. Our research and development and manufacturing process typically involves the use and development of a variety of forms of intellectual property and proprietary technology, although no one particular form of this intellectual property and proprietary technology is material to our business. In addition, we incorporate software, some of which we may license from several third party sources. These licenses generally renew automatically on an annual basis. We believe that alternative technologies for this licensed software are available both domestically and internationally.

We protect our proprietary technology by the following means:

In the future, we may receive notices from holders of patents that raise issues as to possible infringement by our products. As the number of telecommunications test, measurement, and network management products increases and the functionality of these products further overlap, we believe that we may become subject to allegations of infringement given the nature of the telecommunications industry and the high incidence of these kinds of claims. Questions of infringement and the validity of patents in the field of telecommunications technologies involve highly technical and subjective analyses. These kinds of proceedings are time consuming and expensive to defend or resolve, result in substantial diversion of management resources, cause product shipment delays, and could force us to enter into royalty or license agreements rather than dispute the merits of the proceeding initiated against us. For more information regarding the risks to our intellectual property, see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results—Intellectual Property Risks.”

EMPLOYEES

At December 31, 2002, we had a total of 404 full-time employees, consisting of 220 in the United States, 82 in Taiwan, 35 in Italy, 50 in Canada, five in Korea, five in Switzerland, four in China, and three in Japan. We also had 12 temporary employees at December 31, 2002. Of the total full-time employees, 138 were engaged in research and development, 104 were engaged in sales, marketing and customer support, 115 were engaged in operations, and 47 were engaged in administration and finance. None of our employees is subject to a collective bargaining agreement. The employees of our Pro.Tel subsidiary are protected by certain provisions of Italian law. We believe that our relations with our employees are good. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors Affecting Future Operating Results—Dependence on Key Employees.”

EXECUTIVE OFFICERS

The names and ages of our executive officers as of December 31, 2002 are as follows:

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Paul Ker-Chin Chang co-founded Sunrise in October 1991 and has served as Chairman, Chief Executive Officer, and President since that time. From 1984 to 1991, Mr. Chang was employed as Engineering Supervisor for the Wiltron division of Anritsu Corporation, a manufacturer of communications test equipment. Mr. Chang holds an M.S. in Electrical Engineering from the University of Kansas at Lawrence and a B.S. in Physics from Tunghai University in Taiwan.

Paul A. Marshall co-founded Sunrise in October 1991 and has served as Chief Operating Officer since December 1999, as Vice President of Marketing since March 1992, Acting Chief Financial Officer since October 2002, and as a director since October 1991. Mr. Marshall also served as Chief Financial Officer of Sunrise from March 1992 until December 1999. From 1980 to 1992, Mr. Marshall held various positions with the Wiltron division of Anritsu Corporation, most recently as Marketing Staff Engineer. Mr. Marshall holds an M.B.A. from the Harvard Business School and a B.S. in Mechanical Engineering from the University of California at Davis.

Raffaele Gerbasi joined Sunrise in January 2001 and has served as Vice President and General Manager Cable Broadband Division since September 1, 2001. Mr. Gerbasi has served as President of the Sunrise Telecom subsidiary Avantron since January 8, 2001 following the acquisition of Canada-based Avantron Technologies, Inc., a manufacturer of advanced test equipment for the cable broadband industry. Mr. Gerbasi formed Avantron Technologies in 1989 as a wholly-owned division of Dynastie Electronics and held the position of President prior to its acquisition by Sunrise. A graduate of the Radio Electronic Television School, Mr. Gerbasi started his career in the cable broadband industry in 1979. From 1979 to 1984, Mr. Gerbasi was employed as Technical Services Manager for Incospec Electronics, a Canadian cable broadband equipment company. In 1984, Mr. Gerbasi joined Dynastie, a cable broadband service and engineering company and became President and sole owner in 1987.

Scott E. Green joined Sunrise in February 2000 and has served as Corporate Controller since October 2002. Mr. Green also served as Assistant Controller from March 2001 to October 2002 and Accounting Manager from February 2000 to March 2001. Before joining Sunrise, Mr. Green was an Accounting Manager with ITT Industries from May 1997 to February 2000. Prior to 1997, Mr. Green held Senior Accountant positions with the public accounting firms Deloitte & Touche LLP and KPMG LLP. Mr. Green is a certified public accountant and a certified management accountant and is a member of the American Institute of Certified Public Accountants, and the Institute of Management Accountants. Mr. Green holds an M.B.A. from the University of California at Irvine and a B.A. in economics from the University of California at Berkeley.

Jeong E. Joo joined Sunrise in March 1994 and has served as Chief Technology Officer since July 2001. Mr. Joo served as Director of Engineering—New Technologies from December 2000 to July 2001. Since joining Sunrise in 1994, Mr. Joo has held lead engineering development and management positions in the Engineering Department, contributing most recently to our fiber optics products. Mr. Joo held Engineering Management positions with Taihan Electric Wire, Co. Ltd., a telecom electronics company in Korea, from 1988 to March 1994. Mr. Joo holds a BSEE from Chungang University, Seoul, Korea.

AVAILABLE INFORMATION

Our Web site is http://www.sunrisetelecom.com. We make available free of charge, on or through our Web site, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission (SEC). Information contained on our Web site is not part of this report.

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ITEM 2.    PROPERTIES

Our headquarters and manufacturing facility occupies 91,700 square feet in San Jose, California. As of December 31, 2002, we also leased 10,000 square feet of office and manufacturing space in Montreal, Canada; 16,500 square feet of office and manufacturing space in Norcross, Georgia; 10,000 square feet of office and manufacturing space in Modena, Italy; 26,290 square feet of office space in Taipei, Taiwan; 6,742 square feet of office space in Santa Rosa, California; and 2,000 square feet of office space in Geneva, Switzerland. We lease sales offices in Beijing, China; Seoul, Korea and Tokyo, Japan.

ITEM 3.    LEGAL PROCEEDINGS

From time to time, we may be involved in litigation relating to claims arising out of our day-to-day operations. As of December 31, 2002, we were not engaged in any legal proceedings that were expected, individually or in the aggregate, to have a material adverse effect on our business, financial condition, results of operations or cash flow.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the quarter ended December 31, 2002, there were no matters submitted to a vote of the security holders.

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Part II.

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

INFORMATION ABOUT OUR COMMON STOCK

Our common stock has been traded on the Nasdaq National Market under the symbol “SRTI” since our initial public offering on July 13, 2000. The following table sets forth, for the periods indicated, the highest and lowest closing sale prices for our common stock, as reported by the Nasdaq National Market.

As of December 31, 2002, we had approximately 96 stockholders of record of our common stock. Because many of our shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial stockholders represented by these record holders.

We did not declare or pay any cash dividend on our common stock in 2002 or 2001. We currently intend to retain any earnings for use in our business and do not anticipate paying any cash dividends in the foreseeable future. In the future, our board of directors may determine otherwise.

USE OF OUR INITIAL PUBLIC OFFERING PROCEEDS

During July 2000, we received net proceeds totaling approximately $51.6 million from our initial public offering. To date, we have used $38.2 million of these net proceeds to acquire complementary businesses, products or technology; construct our corporate headquarters; repay amounts drawn under our line of credit; and repay notes payable. Funds that have not been used have been invested in money market funds, auction rate securities and marketable debt securities. None of the costs and expenses related to the offering were paid directly or indirectly to any director, officer, general partner of Sunrise or its associates, persons owning 10 percent or more of any class of equity securities of Sunrise, or an affiliate of Sunrise.

We intend to use the remaining net proceeds of the offering for working capital and general corporate purposes and capital expenditures made in the ordinary course of our business. We may also acquire additional complementary businesses, products or technology with the remaining proceeds of the offering.

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ITEM 6.    SELECTED FINANCIAL DATA

The table below sets forth summary consolidated financial information for the periods indicated. It is important that you read this information together with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.

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ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In addition to the other information in this report, certain statements in the following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) are forward-looking statements. When used in this report, the word “expects,” “anticipates,” “estimates,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties are set forth below under “Risk Factors Affecting Future Operating Results.” The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this report.

OVERVIEW

We develop, manufacture, and market service verification equipment to pre-qualify, verify, and diagnose telecommunications, cable, and Internet networks. We design our products to increase technicians’ effectiveness in the field and to provide realistic network simulations for equipment manufacturers to test their products. Our customers include incumbent local exchange carriers, competitive local exchange carriers, other service providers, and network infrastructure suppliers and installers throughout North America, Latin America, Europe, Africa, the Middle East, and the Asia/Pacific region.

Sources of Net Sales

We sell our products predominantly to large telecommunications and cable TV service providers. These types of customers generally commit significant resources to an evaluation of our and our competitors’ products and require each vendor to expend substantial time, effort, and money educating them about the value of the proposed solutions. Delays associated with potential customers’ internal approval and contracting procedures, procurement practices, and testing and acceptance processes are common and may cause potential sales to be delayed or foregone. As a result of these and related factors, the sales cycle of new products for large customers typically ranges from six to twenty-four months. During the past two years, we have observed a significant decline in capital spending in the telecommunications industry, which may lengthen the sales cycle further. Substantially all of our sales are made on the basis of purchase orders rather than long-term agreements or requirements contracts. As a result, we commit resources to the development and production of products without having received advance or long-term purchase commitments from customers. We anticipate that our operating results for any given period will continue to be dependent to a significant extent on purchase orders, which can be delayed or cancelled by our customers without penalty.

Historically, a significant portion of our net sales has resulted from a small number of relatively large orders from a limited number of customers. However, no customers comprised more than 10% of our sales in 2002 and 2001. In 2000, there were two customers that comprised 16% and 17% of our net sales. In 2001, $6.3 million, or 8%, of our sales were from our Copper Loop Test Head sold to Lucent Technologies or to Solectron, a contract manufacturer for Lucent Technologies. Solectron integrated this product into the Stinger DSLAM product that it manufactures for Lucent Technologies. The initial order for the Cooper Loop Test Head was completed during the second quarter of 2001, and the prospects for significant future orders of the Copper Loop Test Head product remain uncertain. Overall, we anticipate that our operating results for a given period will be dependent on a small number of customers.

Our sales have been seasonal in nature and tied to the buying patterns of our customers. Prior to 2000, the largest volume of quarterly sales had usually been during the last calendar quarter of the year, as customers spent the unused portions of their annual budgets. In 2001 and 2000, there was a change in this fourth quarter seasonality as our customers had fewer remaining unused budget dollars available to generate an increase in the fourth quarter seasonal sales. In 2002, however, we saw a return to the pre-2000 pattern, with increased sales in the fourth quarter. Market conditions in our industry are currently too uncertain for us to predict whether or not this pattern will persist. The first

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quarter of any given year has historically been a light period for orders because our large customers typically do not release their budgets for the year until mid-quarter. We expect that our quarterly operating results may fluctuate significantly and will be difficult to predict, given the nature of our business. Many factors could cause our operating results to fluctuate from quarter to quarter in the future, including the lengthy and unpredictable buying patterns of our customers, the degree to which our customers allocate and spend their yearly budgets, and the timing of our customers’ budget processes.

Currently, competition in the telecommunications and cable equipment market is intense and is characterized by declining prices due to increased competition and new products and due to declining customer demand. Due to these market conditions and potential pricing pressures from large customers in the future, we expect that the average selling price for our products will decline over time. If we fail to reduce our production costs accordingly or fail to introduce higher margin new products, there will be a corresponding decline in our gross margin percentage. See “Risk Factors Affecting Future Operating Results—Competition” and “—Risks of the Telecommunications Industry.”

A substantial portion of our net sales comes from customers located outside of the United States, and we believe that future growth may require expansion of our sales into international markets. Currently, we maintain a manufacturing facility in Taipei, Taiwan; manufacturing, research, development, and sales facilities in Modena, Italy; manufacturing, research, development, and sales facilities in Anjou, Canada; and research and development facilities in Geneva, Switzerland and Hamburg, Germany. We also have a representative liaison office in Beijing, China, a foreign sales corporation in Barbados, and sales offices in Tokyo, Japan and Seoul, Korea.

We have a small amount of sales denominated in Euros and the Canadian dollar and have, in the past, used derivative financial instruments to hedge our foreign exchange risks. As of December 31, 2002, we had no derivative financial instruments. To date, foreign exchange exposure from sales has not been material to our operations. We have also been exposed to fluctuations in non-U.S. currency exchange rates related to our manufacturing activities in Taiwan. In the future, we expect that a growing portion of international sales may be denominated in currencies other than U.S. dollars, thereby exposing us to gains and losses on non-U.S. currency transactions. We may choose to limit this exposure by using hedging strategies. See “Risk Factors Affecting Future Operating Results—Risks of International Operations.”

Cost of Sales

Our cost of sales consist primarily of the following:

We recognize direct cost of sales, wages, taxes, benefits, and allocated overhead costs at the same time we recognize revenue for products sold. We expense scrapped materials as incurred.

Our industry is characterized by limited sources and long lead times for the materials and components that we use to manufacture our products. If we underestimate our requirements, we may have inadequate inventory, resulting in additional product costs for expediting delivery of long lead time components. An increase in the cost of components

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could result in lower margins. Additionally, these long lead times have in the past, and may in the future, cause us to purchase larger quantities of some parts, increasing our investment in inventory and the risk of the parts’ obsolescence. Any subsequent write-off of inventory could result in lower margins. See “Risk Factors Affecting Future Operating Results—Dependence on Sole and Single Source Suppliers.”

Operating Costs

We classify our operating expenses into three general operational categories: selling and marketing, research and development, and general and administrative. Our operating expenses include stock-based compensation expense, amortization of certain intangible assets, and, through December 31, 2001, amortization of goodwill. Effective January 1, 2002, and in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Accounting for Goodwill and Other Intangible Assets, goodwill is no longer amortized. We classify charges to the research and development, selling and marketing, and general and administrative expense categories based on the nature of these expenditures. Although each of these three categories includes expenses that are unique to the category type, each category also includes commonly recurring expenditures that typically relate to all of these categories, such as salaries, amortization of stock-based compensation, employee benefits, travel and entertainment costs, allocated communication costs, rent and facilities costs, and third party professional service fees. The selling and marketing category of operating expenses also includes expenditures specific to the selling and marketing group, such as commissions, public relations and advertising, trade shows, and marketing materials. The research and development category of operating expenses includes expenditures specific to the research and development group, such as design and prototyping costs. The general and administrative category of operating expenses includes expenditures specific to the general and administrative group, such as legal and professional fees and amortization of identifiable intangible assets.

We allocate the total cost of overhead and facilities to each of the functional areas that use overhead and facilities, based upon the square footage of facilities used, or the headcount in each of these areas. These allocated charges include facility rent, utilities, communications charges, and depreciation expenses for our building, equipment, and office furniture.

In 2002 and 2001, we recorded amortization of deferred stock-based compensation expense of $1.9 million and $2.1 million, respectively, related to the grant of pre-IPO options to purchase our common stock at exercise prices subsequently deemed to be below fair market value. Total compensation expense related to these options, which were granted in 1999 and the first quarter of 2000, is amortized on a straight-line basis, over the respective four-year vesting periods of the options, to the departments of the employees who received these below-market option grants. During 2002 and 2001, we allocated amortization of deferred stock-based compensation expense of $0.3 million to cost of sales, $0.7 million and $0.8 million, respectively, to research and development expense, $0.6 million to selling and marketing expense, and $0.3 million and $0.4 million, respectively, to general and administrative expense. At December 31, 2002, $2.1 million of deferred stock-based compensation expense remained to be amortized, of which $1.9 million is expected to be amortized during 2003.

Also, during 2002 and 2001, we charged $3.3 million and $5.1 million, respectively, to general and administrative expense for amortization of intangible assets obtained through various business acquisitions.

Acquisitions

On February 22, 2000, we acquired Pro.Tel. Srl and subsidiaries (“Pro.Tel.”), an Italian manufacturer of distributed network signaling analysis equipment, its U.S. affiliate, and the assets of an unrelated U.S. distributor, for $4.7 million in cash, acquisition costs, and short-term notes payable and 500,001 shares of our stock, valued at $5.0 million. We accounted for this acquisition using the purchase method of accounting and, accordingly, recorded goodwill and other

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intangible assets of $8.9 million, to be amortized on a straight-line basis over their original estimated useful lives of two to five years. At December 31, 2001, we had $2.8 million in unamortized goodwill remaining from the Pro.Tel. acquisition. In accordance with SFAS No. 142, we ceased amortizing this goodwill as of January 1, 2002. We will review goodwill for impairment on an annual basis as required by SFAS No. 142. In addition, we recorded deferred stock-based compensation for stock options granted to employees of Pro.Tel. in the first quarter of 2000 in the amount of $6.5 million, to be amortized on a straight-line basis over the four year vesting period of the options. Concurrent with the acquisition, we entered into non-compete agreements with certain employees of Pro.Tel. that will result in payments to these employees totaling $0.5 million over four years, provided that the employees perform as agreed to under the agreements. We are amortizing the corresponding non-compete assets on a straight-line basis over their four-year estimated useful lives.

On January 8, 2001, we acquired Avantron Technologies, Inc. (“Avantron”), a Canadian company that specializes in the design and manufacture of cable TV/modem spectrum analyzers and performance monitoring systems, for $11.9 million in cash, acquisition costs, and short-term notes payable. We accounted for this acquisition using the purchase method of accounting, and, accordingly, recorded goodwill and other intangible assets of $10.4 million, to be amortized on a straight-line basis over their original estimated useful lives of five years. At December 31, 2001, we had $5.2 million in unamortized goodwill remaining from the Avantron acquisition. In accordance with SFAS No. 142, we ceased amortizing this goodwill as of January 1, 2002. We will review goodwill for impairment on an annual basis as required by SFAS No. 142.

On February 28, 2002, we acquired the CaLan Cable TV test business from Agilent Technologies for approximately $7.2 million in cash and acquisition costs. We recorded acquired identifiable intangible assets of $3.5 million, to be amortized on a straight-line basis over their original estimated useful lives of two-and-a-half to five years, and goodwill of $2.6 million, which we will review for impairment on an annual basis as required by SFAS No. 142.

On June 19, 2002, we acquired the ADSL Tester business from Integrated Telecom Express, Inc. (“ITeX”) for approximately $100,000 in cash. We recorded goodwill of $68,000, which we will review for impairment on an annual basis as required by SFAS No. 142.

On September 4, 2002, we acquired Luciol Instruments SA (“Luciol”), a Swiss corporation specializing in fiber optic measurement and instrumentation, for approximately $1.2 million in cash and acquisition costs. We recorded acquired intangible assets of $0.1 million, to be amortized on a straight-line basis over their original estimated useful lives of five years, and goodwill of $1.3 million, which we will review for impairment on an annual basis as required by SFAS No. 142. Concurrent with this acquisition, we entered into a non-compete agreement with certain former owners of Luciol that will result in payments to the former owners totaling approximately $187,000 over four years, provided that they perform as agreed to under the agreements. We are amortizing the corresponding non-compete assets on a straight-line basis over their four-year estimated useful lives. We also entered into employment agreements with these same former owners that will result in bonus payments to the former owners totaling approximately $482,000 over four years, in addition to their regular salaries and subject to certain conditions, primarily related to their continued employment by Sunrise.

On February 28, 2003, we acquired substantially all of the assets of GIE GmbH (“GIE”), a German corporation located in Mannheim, specializing in wireless and RF measurement instrumentation for a total of approximately $520,000 in cash and acquisition costs. We also entered into non-compete agreements totaling $100,000 with the shareholders of GIE, which are payable over four years.

We believe that acquisitions and joint ventures may be an important part of our growth and competitive strategy. See “Risk Factors Affecting Future Operating Results—Acquisitions.”

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Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and we have prepared our discussion and analysis of our financial condition and results of operations based on these financial statements. The preparation of these financial statements requires us to apply accounting policies using estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. We base our estimates on historical experience and various other assumptions that we believe to be reasonable. Actual results may differ from these estimates, assumptions, and judgments.

We consider “critical” those accounting policies that meet both of the following criteria: They require our most difficult, subjective, or complex judgments, which often result from a need to make estimates about the effect of matters that are inherently uncertain, and they are among the most important of our accounting policies to the portrayal of our financial condition and results of operations. These critical accounting policies are determination of our allowance for doubtful accounts receivable, valuation of excess and obsolete inventory, accounting for warranty reserves, deferred income tax assets and liabilities, and revenue recognition.

We determine our allowance for doubtful accounts receivable by making our best estimate considering our historical accounts receivable collection experience and the information that we have about the status of our accounts receivable balances. If future conditions cause our collection experience to change or if we later obtain different information about the status of any or all of our accounts receivable, additional allowances for doubtful accounts receivable may be required.

We determine the valuation of excess and obsolete inventory by making our best estimate considering the current quantities of inventory on hand and our forecast of the need for this inventory to support future sales of our products. We often have only limited information on which to base our forecasts, and if future sales differ from these forecasts, the valuation of excess and obsolete inventory may change.

We offer a three-year warranty covering parts and labor on our wire line access products and fiber optic products sold in the United States, and generally offer a one-year warranty covering parts and labor for our products sold in all other countries, with the option to purchase a two-year extended warranty. Our cable TV and signaling products are covered by a one-year warranty. At the time we recognize revenue from a product’s sale, we determine the reserve for the future cost of meeting our obligations under the standard warranties by considering our historical experience with warranty costs. If the future costs of meeting these obligations differ from the historical experience, additional reserves for warranty obligations may be required.

We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and for the future tax consequences attributable to operating loss and tax credit carryforwards. In assessing the recoverability of deferred tax assets, we consider whether it is more likely than not that all or some portion of the deferred tax assets will be realized. The ultimate realization of certain deferred tax assets is dependent upon the generation of future taxable income during the periods in which the related temporary differences become deductible. If we obtain information that causes our forecast of future taxable income to change or if taxable income differs from our forecast, we may have to revise the carrying value of our deferred tax assets, which would affect our net income in the period in which the change occurs. The ultimate realization of certain deferred tax assets is dependent on our ability to carry forward or back operating losses and tax credits. If changes in the tax laws occur that inhibit our ability to carry forward or back operating losses or tax credits, we will recognize the effect on our deferred tax assets in the results of operations of the period that includes the enactment date of the change. Furthermore, we measure our deferred tax assets and liabilities using the enacted tax laws expected to apply to taxable income in the years in which temporary differences are expected to be recovered

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or settled. If tax laws change, we will recognize the effect on our deferred tax assets and liabilities in the results of operations of the period that includes the enactment date of the change.

We recognize revenue when earned. Therefore, we recognize revenue from product sales upon shipment, assuming collectibility of the resulting receivable is reasonably assured. When the arrangement with the customer includes future obligations or is contingent on obtaining customer acceptance, we recognize revenue when those obligations have been met or customer acceptance has been received. We defer revenue from sales of extended warranties and recognize it over the extended warranty term, which is generally two years. We recognize revenue for out-of-warranty repairs when we ship the repaired product.

RESULTS OF OPERATIONS

The following table sets forth certain operating data as a percentage of net sales for the periods indicated:

COMPARISON OF YEARS ENDED DECEMBER 31, 2002 AND 2001

Net Sales.    Net sales decreased 31%, to $54.3 million in 2002 from $79.1 million in 2001. Sales in 2002 of our wire line access products decreased by $25.7 million, sales of our fiber optics products decreased by $4.0 million, and sales of our signaling products decreased by $1.8 million. These sales decreases were generally due to reductions in capital spending by our customers in the telecommunications industry. These sales decreases were partially offset by a $6.7 million increase in sales of our cable TV products. Of our total increase in sales, $3.6 million was from the CaLan acquisition. The remaining $3.1 million increase was due to our existing product lines, primarily the CM1000, and the increasing acceptance of these products within the cable TV industry.

During 2002, our cable business continued to grow driven by the success of the CM1000 and by the continuing introduction of the 1776 Network Profiler acquired in development from Agilent in our acquisition of Calan. In addition, the CM500 made its first sales at the end of 2002, and represents an extension of the CM1000 family. Overall, we gained market share with our cable products during the year. On the telecom side, introduction of the STT, additional MTT modules, and the SDH STM-16 all provided a source of new revenues to help stabilize performance. Looking ahead, we expect net sales during the first quarter of 2003 to be lower than our reported net sales from the fourth

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quarter of 2002 of approximately $16.5 million, but higher than our reported net sales from the first quarter of 2002 of approximately $8.6 million. During the years ended December 31, 2002 and 2001, our quarterly net sales were as follows (in thousands):

During each quarter of 2002, there was in improving trend in the decrease in sales compared to the same quarter of 2001. Sales in 2002 decreased $13.6 million or 26% in North America, $5.0 million or 45% in Europe/Africa/Middle East, $3.7 million or 32% in Asia/Pacific, and $2.4 million or 65% in Latin America as compared to 2001.

Sales in 2002 decreased $13.6 million or 26% in North America, $5.0 million or 45% in Europe/Africa/Middle East, $3.7 million or 32% in Asia/Pacific, and $2.4 million or 65% in Latin America as compared to 2001.

The decrease in North American sales during 2002 was primarily due to a $18.4 million decrease in sales of our wire line access products, a $2.1 million decrease in the sales of our fiber optics products, and a $1.1 million decrease in the sales of our signaling products. These decreases were partially offset by an $8.0 million increase in the sales of our cable TV products. Of the growth in our cable TV product sales, 45% of the increase in 2002 over 2001 relates to products from the CaLan business acquired during the first quarter of 2002. The decreases in our North American sales were primarily the result of decreased capital spending by our telecommunications customers. In addition, over the past year, some DSL providers have encouraged customer self-installation and have reported that up to 90% of their customers perform self-installation successfully. The self-installation procedure reduces the need for technicians to test for DSL service, reducing the demand for our DSL wire line access products as our equipment is used primarily for troubleshooting rather than installation.

International sales, including North American sales in Canada, decreased to $16.1 million, or 30% of net sales, in 2002, from $29.7 million, or 38% of net sales in 2001. The decrease in international sales in absolute dollars is primarily due to decreased sales of our wire line access product lines and our fiber optics products.

Cost of Sales.    Cost of sales consists primarily of direct material, warranty, and personnel costs related to the manufacturing of our products and allocated overhead. Cost of sales decreased 30%, to $18.0 million in 2002 from $25.5 million in 2001. This decrease is primarily due to the decrease in net sales volumes. Cost of sales represented 33% and 32% of net sales in 2002 and 2001, respectively. We expect that cost of sales may increase as a percentage of sales in the future due to possible fluctuations in our overall product mix, if international sales grow as a percentage of total sales, or if pricing pressures increase.

Research and Development.    Research and development expenses consist primarily of the costs of payroll and benefits for engineers, equipment, and consulting services. Research and development expenses decreased 6%, to $17.4 million in 2002 from $18.5 million in 2001. This decrease is primarily due to decreased payroll dedicated to research and development activities. Research and development expenses represented 32% of net sales in 2002 and 23% of net sales in 2001. The increase as a percentage of net sales is primarily due to product sales decreasing more rapidly than research and development expenditures, as we continue to invest in product development and expansion of our product lines. Research and development expenses may increase in absolute dollars as we continue to invest in product development and expand our product lines.

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Selling and marketing.    Selling and marketing expenses consist primarily of the costs of payroll and benefits for selling and marketing personnel, manufacturers’ representative and direct sales commissions, travel and facilities expenses related to selling and marketing, and trade show and advertising expenses. Selling and marketing expenses decreased 18%, to $16.8 million in 2002 from $20.3 million in 2001. These decreases are primarily due to reductions in advertising and printing expenses, headcount reductions among selling and marketing personnel, and reduced commission expenses. Commission expenses decreased primarily due to the decrease in our sales, particularly North American sales, on which we make the preponderance of our commission payments. Selling and marketing expenses represented 31% of net sales in 2002 and 26% of net sales in 2001. The increase as a percentage of net sales in 2002 is primarily due to product sales decreasing more rapidly than selling and marketing expenditures and our efforts to continue to develop the market for and sell our products. Selling and marketing expenses may increase in absolute dollars as we continue to invest in our selling and marketing capabilities. In addition, commissions included in the selling and marketing expenses will continue to fluctuate with the fluctuation of revenues and sales mix each quarter.

General and Administrative.    General and administrative expenses consist primarily of payroll and benefits, facilities, other costs of our finance and administrative departments, legal and accounting expenses, and amortization expenses for goodwill and other intangible assets related to our business acquisitions. General and administrative expenses decreased 18%, to $11.3 million in 2002 from $13.8 million in 2001. These decreases are primarily due to a $1.8 million decrease in amortization of purchased intangible assets resulting from the cessation of amortization of goodwill related to acquisitions beginning on January 1, 2002. The remaining $0.7 million of the decrease is primarily due to cost reduction measures. General and administrative expenses represented 21% of net sales in 2002 and 17% of net sales in 2001. General and administrative expenses may increase in absolute dollars if we experience growth in our business, expand our infrastructure, or pursue additional acquisitions.

Other Income, Net.    Other income, net primarily represents interest earned on cash and investment balances. Other income, net decreased to $0.8 million in 2002 from $2.6 million in 2001. This decrease resulted primarily from a decrease in interest income as our cash, cash equivalents, and investments in marketable securities declined and interest rates declined.

Income Taxes Expense (Benefit).    Income tax expense (benefit) consists of federal, state, and international income taxes. We recorded an income tax benefit of $3.3 million in 2002 and income tax expense of $0.7 million in 2001. Our effective income tax rates were 40% in 2002 and 20% in 2001. Our income tax benefit and our change to a 40% effective income tax rate in 2002 were due to our loss before income taxes.

COMPARISON OF YEARS ENDED DECEMBER 31, 2001 AND 2000

Net Sales.    Net sales decreased $34.4 million, or 30%, to $79.1 million in 2001 from $113.5 million in 2000. Sales of our wire line access products, including DSL products, accounted for $41.7 million of the net sales decrease and sales of our signaling products accounted for $0.5 million of the net sales decrease. These decreases were offset by an increase of $6.9 million in sales of our cable TV products and an increase of $0.9 million in sales of our fiber optics products. Of the $6.9 million cable TV products sales increase, $5.7 million came from sales by our Avantron subsidiary, which we acquired in 2001, and $1.2 million came from increased sales of our existing product lines.

During the years ended December 31, 2001 and 2000, our quarterly net sales were as follows (in thousands):

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During the first three quarters of 2001, there was a worsening trend in sales from the same quarter in 2000. Sales in 2001 as compared to 2000 decreased $35.9 million, or 41%, in North America, increased $0.8 million, or 8%, in Europe/Africa/Middle East, increased $1.4 million, or 14%, in Asia Pacific,, and decreased $0.7 million, or 17%, in Latin America.

The decrease in North American sales from 2000 to 2001 is due to lower sales of our wire line access products, including DSL, and lower sales of our protocol and fiber optics products. Our wire line access product sales decreased $37.1 million in North America from 2000 to 2001. Of this decrease, $13.2 million was from reduced Copper Loop Test Head sales for Lucent Technologies’ stinger DSLAM product, which decreased from $19.6 million in 2000 to $6.3 million in 2001. North American sales of our protocol products decreased $2.0 million and our fiber optics products decreased $2.0 million from 2000 to 2001. The decreases in our North American sales were primarily the result of decreased capital spending by our telecommunications customers. Sales of our cable TV products increased by $5.3 million in North America from 2000 to 2001. Of this increase, $4.1 million was the result of the Avantron acquisition which occurred in the first quarter of 2001 and the remaining $1.2 million came from our existing product lines.

International sales, including North American sales to Canada, decreased to $29.7 million, or 38% of net sales, in 2001 from $30.1 million, or 27% of net sales, in 2000. The decrease in international sales is primarily due to decreased sales of our wire line access product lines, including DSL, which were partially offset by increased sales of our fiber optics products.

Cost of Sales.    Cost of sales decreased 23%, to $25.5 million in 2001 from $33.0 million in 2000. This decrease is primarily due to the decrease in net sales from 2000 to 2001. Cost of sales were 32% of net sales in 2001 versus 29% of net sales in 2000. The increase as a percentage of net sales resulted primarily from an increased presence in our sales mix of cable TV products, lower margin wire line access products, and international sales, which tend to carry lower margins than North American sales because they often go through distributor networks.

Research and Development.    Research and development expenses increased 5%, to $18.5 million in 2001 from $17.6 million in 2000. This increase is primarily due to costs associated with increased staffing dedicated to research and development activities. Research and development expenses were 23% of net sales in 2001 and 15% of net sales in 2000. The increase as a percentage of net sales in 2001 is primarily due to decreased product sales while research and development expenditures increased, as we continue to invest in product development and expansion of our product lines.

Selling and Marketing.    Selling and marketing expenses decreased 10%, to $20.3 million in 2001 from $22.7 million in 2000. This decrease is primarily due to a 49% decrease in commissions expense. Commission expense decreased primarily due to the decrease in our sales, particularly North American sales, for which we make the preponderance of our commission payments. Selling and marketing expenses were 26% of net sales in 2001 and 20% of net sales in 2000. The increase as a percentage of net sales in 2001 is primarily due to decreased OEM sales, which led to lower commission, occupancy, and salary and related expenses as a percentage of sales than in 2000.

General and Administrative.    General and administrative expenses increased 41%, to $13.8 million in 2001 from $9.8 million in 2000. General and administrative expenses were 17% of net sales in 2001 and 9% of net sales in 2000. The increase in both absolute dollars and as a percentage of net sales is primarily due to increased amortization of goodwill and other intangible assets related to recent business acquisitions, amortization of deferred stock-based compensation, and increased staffing and related costs associated with the growth of our business as a public company for the full year of 2001.

Other Income, Net.    Other income, net increased to $2.6 million in 2001 from $1.9 million in 2000. The increase in 2001 resulted primarily from increased interest earned on higher balances of cash and cash equivalents resulting

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from increased cash flow from operations, interest income earned for a full year in 2001 on the net proceeds received from our initial public offering in July 2000, and income earned from a grant from the Italian government.

Income Tax Expense.    We recorded income tax expense of $0.7 million in 2001 and $12.0 million in 2000. Our effective income tax rates were 20% in 2001 and 37% in 2000. Our income tax expense and effective income tax rate are lower in 2001 than in 2000 primarily due to lower levels of income.

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have financed our operations and satisfied our capital expenditure requirements primarily through cash flow from operations. Additionally, in July of 2000, we received net proceeds totaling $51.6 million from an initial public offering. To date, we have used $38.2 million of these net proceeds to acquire complementary businesses, products or technology, construct our corporate headquarters, repay amounts drawn under our line of credit, and repay notes payable. Funds that have not been used have been invested in money market funds, auction rate securities, and marketable debt securities.

As of December 31, 2002, 2001, and 2000, we had working capital of $52.8 million, $64.9 million, and $82.0 million, respectively, and cash and cash equivalents of $36.4 million, $48.7 million, and $56.3 million, respectively. As of December 31, 2002, 2001, and 2000, we also had $1.0 million, $3.5 million, and $6.3 million, respectively, in investments in marketable securities.

Cash provided by operating activities was $0.7 million in 2002, $19.8 million in 2001, and $13.4 million in 2000. Operating cash flows decreased during 2002 as compared to 2001 primarily because we went from having net income in 2001 to a net loss in 2002. Furthermore, although we continued to have net collections of accounts receivable and net reductions in inventory purchases during 2002, the amount of these net collections and net reductions was significantly less than during 2001. The factors decreasing operating cash flow during 2002 as compared to 2001 were partially offset by a reduction in payments on our accounts payable and accrued expenses. Operating cash flows increased during 2001 as compared to 2000 primarily as a result of net collections of accounts receivable and a net reduction in inventory purchases. Also, the amount of non-cash charges against net income increased significantly in 2001 from 2000. This was primarily the result of increased goodwill amortization from the acquisition of Avantron Technologies, Inc. in the first quarter of 2001 and increased depreciation resulting from the completion of our new corporate headquarters building in San Jose, CA, also in the first quarter of 2001. The factors increasing operating cash flow during 2001 as compared to 2000 were partially offset by decreases in accounts payable and accrued expenses and in income taxes payable.

Cash used in investing activities was $9.7 million in 2002, $27.8 million in 2001, and $16.9 million in 2000. The $18.1 million decrease in net cash used in investing activities during 2002 from 2001 is primarily due to decreased amounts paid for acquisitions and decreased capital expenditures. Capital expenditures during 2001 included $8.8 million for land and $5.6 million for construction of our facility in San Jose, California, which did not recur in 2002, and we also reduced our expenditures on equipment and other capital assets during 2002. Offsetting these reductions in cash flows used in investing activities was a loan made to our Chief Executive Officer in early 2002. The increase in net cash used in investing activities during 2001 from 2000 is primarily due to increased acquisitions and capital expenditures, partially offset by a reduction in net purchases of marketable securities.

Cash used in financing activities was $3.7 million in 2002 and cash provided by financing activities was $0.6 million in 2001, and $51.3 million in 2000. The increase in net cash used in financing activities during 2002 from 2001 is primarily due to increased repurchases of our common stock and a reduction in proceeds from common stock issued under our Employee Stock Purchase Plan. During 2002, we completed the repurchase of our stock under a plan approved by the Board of Directors in 2001. Under this plan, a total of 1.7 million shares have been repurchased since

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2001 for an aggregate total consideration of $5.1 million. The decrease in net cash provided by financing activities during 2001 from 2000 is primarily due to the effect of our initial public offering on year 2000 cash flows.

During 2002, we had a $3.0 million revolving line of credit with a financial institution. The line of credit expired on September 15, 2002, and was not renewed. At December 31, 2002, we did not have any balances outstanding under our remaining lines of credit.

Our outstanding debt at December 31, 2002 consisted primarily of a $0.9 million loan from the Italian government, payable over a period of eight years through semi-annual payments staring in 2004, and thirteen notes payable related to previous acquisitions totaling $0.7 million, that are being paid off in quarterly installments ending in 2006.

We believe that current cash balances and cash flows from operations will be sufficient to meet our anticipated cash needs for working capital, capital expenditures, and other activities for at least the next 12 months. However, a large acquisition of complementary businesses, products or technologies, or material joint ventures could require us to obtain additional equity or debt financing. We cannot assure you that such additional financing would be available on acceptable terms, if at all. Such an acquisition is not anticipated at this time.

OFF-BALANCE SHEET ARRANGEMENTS

As of December 31, 2002, we did not have any material off-balance sheet arrangements that have or are reasonably likely to have a material effect on our current or future financial condition, revenues or expenses, results of operations, liquidity, or capital resources.

CONTRACTUAL OBLIGATIONS

The following table summarizes, as of December 31, 2002, the timing of future cash payments due under certain contractual obligations (in thousands):

RISK FACTORS AFFECTING FUTURE OPERATING RESULTS

Quarterly Fluctuations—Because our quarterly operating results have fluctuated significantly in the past and are likely to fluctuate significantly in the future, our stock price may decline and may be volatile.

In the past, we have experienced significant fluctuations in our quarterly results due to a number of factors beyond our control. In the future, our quarterly operating results may fluctuate significantly and may be difficult to predict given the nature of our business. Many factors could cause our operating results to fluctuate from quarter to quarter in the future, including the following:

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The factors listed above may affect our business and stock price in several ways. Given our high fixed costs from overhead, research and development, and advertising and marketing, and other activities necessary to run our business, if our net sales are below our expectations in any quarter, we may not be able to adjust spending accordingly. For example, in 2002 our net sales declined 31% from 2001, but our operating expenses only declined 14% because of fixed costs. Our stock price may decline and may be volatile, particularly if public market analysts and investors perceive the factors listed above to exist, whether or not that perception is accurate. Furthermore, the above factors, taken together may make it more difficult for us to issue additional equity in the future or raise debt financing to fund future acquisitions and accelerate growth.

Declining Sales—We are experiencing decreased sales and increased difficulty in predicting future operating results.

As a result of current unfavorable economic and market conditions, our year-to-year sales have been declining, we are unable to predict future sales accurately, and we are currently unable to provide long-term guidance for future financial performance. The conditions contributing to this difficulty include the following:

Based on these and other factors, many of our major customers have reduced, modified, cancelled or rescheduled orders for our products and have expressed uncertainty as to their future requirements.

Economic Downturn—Our operating results and financial condition could continue to be harmed if the telecommunications industry remains over supplied.

The current economic downturn has resulted in reduced purchasing and capital spending in the telecommunications industry, which has been in a downward cycle characterized by diminished product demand, excess manufacturing capacity and the increasing erosion of average selling prices. The downturn has already adversely affected the businesses and cash flows of many of our customers and has even caused some of them to file for bankruptcy. We are uncertain how long the current downturn will last. Continuation of the downturn or any further decline in our customers’ markets or in general economic conditions would likely result in a further reduction in demand for our products and services and also would further limit our customers’ ability to pay for the products that they buy from us. All of these circumstances could harm our consolidated financial position, results of operations, cash flows and stock price, and could limit our ability to reach our goals for restoring long-term profitability.

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Long-term Impact of Cost Controls—The actions we have taken in response to the recent slowdown in demand for our products and services could have long-term adverse effects on our business.

Our business has been experiencing lower revenues due to decreased or cancelled customer orders. From the third quarter of 2000 through the first quarter of 2002, we experienced sequential declines in orders. In 2002, net sales were significantly below 2000 and 2001. To scale back our operations and to reduce our expenses in response to this decreased demand for our products and services and lower revenue, we have reduced our workforce, restricted hiring, reduced and frozen employee salaries, and reduced discretionary spending.

Since March 2001, we have reduced our workforce, including temporary employees and net of additions, by approximately 29 people, or 7%, and we may experience further workforce reductions in the future in the event current order levels do not improve. In addition, in May 2001 and February 2002, we instituted an average 7% pay reduction in 2001 and an average 10% pay reduction in 2002, applicable to many employees globally, wherever legally permissible. Some of the reductions in pay took effect via a reduction in hours for certain employees, in accordance with local law. We have also tightly restricted any subsequent increase in salaries. In addition to these measures, we are continuing our initiatives to streamline our operations.

There are several risks inherent in our efforts to transition to a reduced cost structure. These include the risk that we will not be able to reduce expenditures quickly enough and sustain them at a level necessary to restore profitability, and that we may have to undertake further restructuring initiatives that would entail additional charges. In addition, there is the risk that cost-cutting initiatives will impair our future ability to develop and market products effectively and remain competitive. Each of the above measures could have long-term effects on our business by reducing our pool of technical talent, decreasing or slowing improvements in our products, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our products increases, and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be.

Dependence on Wireline Access Products—A significant portion of our sales have been from our Wireline Access products. Demand for these products has declined significantly and may decline further.

Sales of our DSL and other wire line access products represented approximately 42% of our net sales in 2002 and 62% in 2001. Currently, our DSL products are primarily used by a limited number of incumbent local exchange carriers, including the regional Bell operating companies and competitive local exchange carriers who offer DSL services. A competitive local exchange carrier is a company that, following the Telecommunications Act of 1996, is authorized to compete in a local communications services market. These parties, and other Internet service providers and users, are continuously evaluating alternative high-speed data access technologies, including cable modems, fiber optics, wireless technology, and satellite technologies, and may at any time adopt these competing technologies. These competing technologies may ultimately prove to be superior to DSL services and reduce or eliminate the demand for our DSL products.

During 2001 and 2002, the business prospects of many competitive local exchange carriers and incumbent local exchange carriers declined significantly. Some competitive local exchange carriers filed for bankruptcy or went out of business, and many local exchange carriers have experienced significant revenue declines. Due to these and other factors, we have seen a significant decline in demand for our DSL products. If DSL deployment rates decrease or remain flat, demand for our DSL products may decline further. It is not possible to predict whether any decline would be temporary or sustained. Accordingly, our future success is partially dependent upon whether DSL technology continues to gain growing and widespread market acceptance by exchange carriers, end users of their services, and other Internet service providers and users.

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In the past, our customers have deployed DSL equipment, including our products, in substantially larger volumes than their subscriber count. Over the past two years, many of our customers have decreased the rate at which they deploy DSL equipment. This decrease has led to a decrease in demand for our products. In addition, the inability of our current or future customers to acquire or retain subscribers as planned, or to respond to increased competition or reduced demand for their services could cause them to reduce further or to eliminate entirely their DSL deployment plans.

Use of Field Technicians—If service providers reduce their use of field technicians and continue successful implementation of a self-service installation model, demand for our products could decrease.

To ensure quality service, our major service provider customers have historically sent a technician, who uses our products, into the field to verify service for installations. SBC Communications, Qwest Communications, Bell South Corporation, and Verizon Communications each encourage their customers to install DSL themselves. Over the past year, some DSL providers have reported that 90% or more of their customers perform self-installation successfully. Additionally, Comcast has begun a self-installation program for cable modem devices. By encouraging customers to install DSL and cable access themselves, these companies intend to reduce their expenses and expedite installation for their customers. To encourage self-installation, these companies offer financial incentives. If service providers continue successful implementation of these plans or choose to send technicians into the field only after a problem has been reported, or if alternative methods of verification become available, such as remote verification, the need for field technicians and the need for our products would decrease.

Manufacturing Capacity—If demand for our products does not match our manufacturing capacity, our earnings may suffer.

Because we cannot immediately adapt our production capacity and related cost structures to rapidly changing market conditions, when demand does not meet our expectations, our manufacturing capacity may exceed our production requirements, and profitability may decline. Conversely, if during a market upturn we cannot increase our manufacturing capacity to meet product demand, we will not be able to fulfill orders in a timely manner, which in turn may have a negative effect on our earnings and overall business.

Relocation of Manufacturing Facilities—We are in the process of relocating our production facilities overseas, and problems with the relocation could interfere with our operations.

To reduce our manufacturing costs, we are transitioning most of our manufacturing operations from our San Jose headquarters to our subsidiary in Taipei, Taiwan. We believe that relocating our production facilities will lower our manufacturing costs, in particular labor costs, provide us with more flexibility to scale our operations to meet changing demand, and allow us to focus our engineering resources on new product development and product enhancements. However, we may not be successful in transitioning our manufacturing operations overseas or maintaining the quality standards that our customers expect. Our failure to smoothly and successfully transition production could temporarily interrupt our operations and adversely impact our ability to run our business. In addition, any failure or significant downtime in our production capabilities could prevent us from fulfilling and shipping customer orders and could harm our business.

Risks of the Telecommunications Industry—We face several risks regarding the telecommunications industry, including the possible effects of its unpredictable growth or decline, the possible effects of consolidation among our principal customers, and the risk that deregulation will slow.

After the passage of the Telecommunications Act of 1996, the telecommunications industry experienced rapid growth. The growth led to great innovations in technology, intense competition, short product life cycles, and, to some extent, regulatory uncertainty inside and outside the United States. However, the course of the development of the

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telecommunications industry is difficult to predict. Companies operating in this industry have a difficult time forecasting future trends and developments and forecasting customer acceptance of competing technologies. One possible effect of this uncertainty is that there is, and may continue to be, a delay or a reduction in these companies’ investment in their business and purchase of related equipment, such as our products, and a reduction in their and our access to capital. In addition, deregulation may result in a delay or a reduction in the procurement cycle because of the general uncertainty involved with the transition period of businesses.

The growth that occurred after the passage of the Telecommunications Act of 1996 has slowed dramatically, and it is unknown whether or when it will resume. This slowdown has resulted in reduced investment in the telecommunications industry in general and delayed purchase orders for service verification equipment such as our products in particular. It is not possible to predict whether this slowdown will be temporary or sustained.

In addition, the telecommunications industry has been experiencing consolidation among its primary participants, such as incumbent local exchange carriers and competitive local exchange carriers, several of whom are our primary customers. For example, in recent years, GTE merged with Bell Atlantic to create Verizon Communications, Inc., both of which were customers of ours. Continued consolidation may cause delay or cancellation of orders for our products. The consolidation of our customers will likely provide them with greater negotiating leverage with us and may lead them to pressure us to lower the prices of our products.

If deregulation in international markets or in the United States were to slow or to take an unanticipated course, the telecommunications industry might suffer. The effects of which, among others, would be the following:

Cable Industry Health—The cable industry has debt and income problems for the major players.

The Cable industry has taken on significant debt as companies aggressively consolidated and built up impressive new digital networks to allow them to provide better picture quality, internet access, and even voice telephony. Profits have declined during the last year within the industry, however. As a result, most cable companies expect to reduce their capital expenditures and/or hiring, both of which could adversely impact our cable business more than we now expect.

Customer Concentration—A limited number of customers account for a high percentage of our net sales, and any adverse factor affecting these customers or our relationship with these customers could cause our net sales to decrease.

Our customer base is concentrated, and a relatively small number of companies have accounted for a large percentage of our net sales. Net sales from our top five customers in the United States represented approximately 31%

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of total net sales in 2002, 23% in 2001, and 42% in 2000. In general, our customers are not subject to long-term supply contracts with us, are not obligated to purchase a specific amount of products from us or to provide us with binding forecasts of purchases for any period.

The loss of a major customer or the reduction, delay, or cancellation of orders from one or more of our significant customers could cause our net sales and, therefore, profits to decline. In addition, many of our customers are able to exert substantial negotiating leverage over us. As a result, they may cause us to lower our prices for them and they may successfully negotiate other terms and provisions that may negatively affect our business and profits.

Goodwill Valuation—Our financial results could be materially and adversely affected if it is determined that the book value of goodwill is higher than fair value.

Our balance sheet at December 31, 2002 includes an amount designated as “goodwill” that represents approximately 11% of assets and 12% of stockholders’ equity. Goodwill arises when an acquirer pays more for a business than the fair value of the acquired tangible and separately measurable intangible net assets. Under accounting pronouncement SFAS No. 142, Goodwill and Other Intangible Assets, beginning in January 2002, the amortization of goodwill has been replaced with an “impairment test,” which requires that we compare the fair value of goodwill to its book value at least annually, and more frequently if circumstances indicate a possible impairment.

We completed our transitional impairment test of our goodwill as of January 1, 2002 and our annual impairment test during the fourth quarter and determined that goodwill was not impaired. The impairment testing is based on a market capitalization analysis. Accordingly, if our market capitalization were to diminish significantly, the book value of goodwill could be higher than the fair value, and we would need to record a non-cash impairment charge for the difference, which could materially and adversely affect our net income or loss.

Product Development—If we are unable to develop new products successfully and enhance our existing products, our future success may be threatened.

The market for our products is characterized by rapid technological advances, changes in customer requirements and preferences, evolving industry and customer-specific protocol standards, and frequent new product enhancements and introductions. For example, at December 31, 2002, we had approximately $0.6 million of orders for a cable product, which may be delayed or cancelled due to technical issues that must be overcome before the orders can be shipped. Our existing products and our products currently under development could be rendered obsolete by the introduction of products involving competing technologies, by the evolution of alternative technologies or new industry protocol standards, or by rival products by our competitors. These market conditions are more complex and challenging because of the high degree to which the telecommunications industry is fragmented.

We believe our future success will depend, in part, upon our ability, on a timely and cost-effective basis, to continue to do the following:

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We cannot ensure that we will accomplish these objectives, and our failure to do so could have a material adverse impact on our market share, business, and financial results.

Further, our percentage of net sales devoted to research and development is near a historic high for the company. If we do not continue to reduce this percentage, our income levels will not return to their desired levels. If we are successful in continuing to reduce this percentage, we may not continue to develop needed new products which could negatively impact our sources for new revenues.

Sales Implementation Cycles—The length and unpredictability of the sales and implementation cycles for our products makes it difficult to forecast revenues.

Sales of our products often entail an extended decision-making process on the part of prospective customers. We frequently experience delays following initial contact with a prospective customer and expend substantial funds and management effort pursuing these sales. Our ability to forecast the timing and amount of specific sales is therefore limited. As a result, the uneven buying patterns of our customers may cause fluctuations in our operating results, which could cause our stock price to decline.

Other sources of delays that lead to long sales cycles, or even a sales loss, include current and potential customers’ internal budgeting procedures, internal approval and contracting procedures, procurement practices, and testing and acceptance processes. Recently, our customers’ budgeting procedures have lengthened. The sales cycle for larger deployment now typically ranges from six to twenty-four months. The deferral or loss of one or more significant sales could significantly affect operating results in a particular quarter, especially if there are significant selling and marketing expenses associated with the deferred or lost sales.

Managing Growth and Slowdowns—We may have difficulty managing expansions and contractions in our operations, which could reduce our chances of maintaining or restoring our profitability.

We experienced rapid growth in revenues and in our business in 1999 and 2000 followed by a significant slowdown starting in 2001 that has placed, and may continue to place, a significant strain on our management and operations. For example, our revenues increased to $113.5 million in 2000 from $61.5 million in 1999. Yet revenues slowed to $79.1 million in 2001 and $54.3 million in 2002. Our number of employees, excluding temporary employees, increased to 404 at December 31, 2002 from 169 at December 31, 1999 and the 390 at December 31, 2001, but has decreased from 405 at March 31, 2001. As a result of our historical growth, potential future growth, or slowdowns, we face several risks, including the following:

We cannot ensure that we will be able to successfully manage growth or slowdowns profitably.

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Acquisitions—We have acquired multiple companies and lines of business, and we may pursue additional acquisitions in the future. These activities involve numerous risks, including the use of cash, acquired intangible assets, and the diversion of management attention.

We have acquired multiple companies and lines of business to date. As a result of these acquisitions, we face numerous risks, including the following:

The risks stated above are made more difficult by most of the companies we have acquired being located outside of the United States. In addition, if we make future acquisitions, these risks will be exacerbated by the need to integrate additional operations at a time when we may not have fully integrated all of our previous acquisitions.

If we pursue additional acquisitions, we will face similar risks as those outlined above and additional risks, including the following:

We cannot ensure that we will locate suitable acquisition candidates or that, if we do, we will be able to acquire them and then integrate them successfully and efficiently into our business.

Competition—Competition could reduce our market share and decrease our net sales.

The market for our products is fragmented and intensely competitive, both inside and outside the United States, and is subject to rapid technological change, evolving industry standards, regulatory developments, and varied and changing customer preferences and requirements. We compete with a number of United States and international suppliers that vary in size and in the scope and breadth of the products and services offered.

The following table sets forth our principal competitors in each of our product categories.

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Many of these competitors have longer operating histories, larger installed customer bases, longer relationships with customers, wider name recognition and product offerings, and greater financial, technical, marketing, customer service, and other resources than we have.

We expect that as our industry and markets evolve new competitors or alliances among competitors with existing and new technologies may emerge and acquire significant market share. We anticipate that competition in our markets will increase, and we will face greater threats to our market share and price pressure on our products. Also, over time, our profitability, if any, may decrease. In addition, it is difficult to assess accurately the market share of our products or of Sunrise overall because of the high degree of fragmentation in the market for service verification equipment. As a result, it may be difficult for us to forecast accurately trends in the market, which of our products will be the most competitive over the longer term, and therefore, what is the best use of our cash and human and other forms of capital.

Dependence on Key Employees—If one or more of our senior managers were to leave, we could experience difficulty in replacing them and our operating results could suffer.

Our success depends to a significant extent upon the continued service and performance of a relatively small number of key senior management, technical, sales, and marketing personnel. In particular, the loss of either of our two founders, Paul Ker-Chin Chang or Paul A. Marshall, would likely harm our business. Neither of these individuals is bound by an employment agreement with us, and we do not carry key man life insurance on them. If any of our senior managers were to leave Sunrise, we would need to devote substantial resources and management attention to replace them. As a result, management attention may be diverted from managing our business, and we may need to pay higher compensation to replace these employees.

Dependence on Sole and Single Source Suppliers—Because we depend on a limited number of suppliers and some sole and single source suppliers that are not bound by long-term contracts, our future supply of parts is uncertain.

We purchase many key parts, such as microprocessors, field programmable gate arrays, bus interface chips, optical components, and oscillators, from a single source or sole suppliers, and we license certain software from third parties. We rely exclusively on third-party subcontractors to manufacture some sub-assemblies, and we have retained, from time to time, third party design services in the development of our products. We do not have long-term supply agreements with these vendors. In general, we make advance purchases of some products and components to ensure an adequate supply, particularly for products that require lead times of up to nine months to manufacture. In the past, we have experienced supply problems as a result of financial or operating difficulties of our suppliers, shortages, and discontinuations resulting from component obsolescence or other shortages or allocations by suppliers. Our reliance on these third parties involves a number of risks, including the following:

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In addition, the purchase of these components on a sole source basis subjects us to risks of price increases and potential quality assurance problems. This dependence magnifies the risk that we may not be able to ship our products on a timely basis to satisfy customers’ orders. We cannot ensure that one or more of these factors will not cause delays or reductions in product shipments or increases in product costs, which in turn could have a material adverse effect on our business.

Risks of International Operations—Our plan to expand sales in international markets could lead to higher operating expenses and may subject us to unpredictable regulatory and political systems.

Sales to customers located outside of the United States represented 30% of our net sales in 2002, 38% in 2001, and 27% in 2000, and we expect international revenues to continue to account for a significant percentage of net sales for the foreseeable future. In addition, an important part of our strategy calls for further expansion into international markets. As a result, we will face various risks relating to our international operations, including the following:

We cannot ensure that one or more of these factors will not materially and adversely affect our ability to expand into international markets or our revenues and profits.

In addition, the Asia/Pacific and Latin America regions have experienced instability in many of their economies and significant devaluations in local currencies. 17% of our sales in 2002, 19% of our sales in 2001, and 13% of our sales in 2000 were from customers located in these regions. These instabilities may continue or worsen, which could have a materially adverse effect on our results of operations. If international revenues are not adequate to offset the additional expense of expanding international operations, our future growth and profitability could suffer.

Concentration of Control—Our executive officers and directors retain significant control over us, which allows them to decide the outcome of matters submitted to stockholders for approval. This influence may not be beneficial to all stockholders.

As of December 31, 2002, Paul Ker-Chin Chang, Paul A. Marshall, and Robert C. Pfeiffer beneficially owned approximately 27%, 24%, and 13%, respectively, of our outstanding shares of common stock. Consequently, these three individuals, acting together, control approximately 64% of our outstanding shares of common stock and are able to control the election of our directors and the approval of significant corporate transactions that must be submitted to a vote of stockholders. In addition, Mr. Chang, Mr. Marshall, and Mr. Pfeiffer constitute three of the six members of the board of directors and have significant influence in directing the actions taken by the board. The interests of these

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persons may conflict with the interests of other stockholders, and the actions they take or approve may be contrary to those desired by other stockholders. This concentration of ownership and control of the management and affairs of our company may also have the effect of delaying or preventing a change in control of our company that other stockholders may consider desirable.

Potential Product Liability—Our products are complex, and our failure to detect errors and defects may subject us to costly repairs and product returns under warranty and product liability litigation.

Our products are complex and may contain undetected defects or errors when first introduced or as enhancements are released. These errors may occur despite our testing and may not be discovered until after a product has been shipped and used by our customers. Many of the products that we ship contain known imperfections that we consider to be insignificant at the time of shipment. We may misjudge the seriousness of a product imperfection and allow it to be shipped to our customers. These risks are compounded by the fact that we offer many products, with multiple hardware and software modifications, which makes it more difficult to ensure high standards of quality control in our manufacturing process. The existence of these errors or defects could result in costly repairs and/or returns of products under warranty and, more generally, in delayed market acceptance of the product or damage to our reputation and business.

In addition, the terms of our customer agreements and purchase orders which provide us with protection against unwarranted claims of product defect and error may not protect us adequately from unwarranted claims against us, unfair verdicts if a claim were to go to trial, settlement of these kinds of claims, or future regulation or laws regarding our products. Our defense against such claims in the future, regardless of their merit, could result in substantial expense to us, diversion of management time and attention, and damage to our business reputation and our ability to retain existing customers or attract new customers.

Intellectual Property Risks—Policing any unauthorized use of our intellectual property by third parties and defending any intellectual property infringement claims against us could be expensive and disrupt our business.

Our intellectual property and proprietary technology is an important part of our business, and we depend on the development and use of various forms of intellectual property and proprietary technology. As a result, we are subject to several related risks, including the risks of unauthorized use of our intellectual property and the costs of protecting our intellectual property.

Much of our intellectual property and proprietary technology is not protected by patents. If unauthorized persons were to copy, obtain, or otherwise misappropriate our intellectual property or proprietary technology without our approval, the value of our investment in research and development would decline, our reputation and brand could be diminished, and we would likely suffer a decline in revenue. We believe these risks, which are present in any business in which intellectual property and proprietary technology play an important role, are exacerbated by the difficulty in finding unauthorized use of intellectual property in our business, the increasing incidence of patent infringement in our industry in general, and the difficulty of enforcing intellectual property rights in some foreign countries.

In addition, litigation has in the past been, and may in the future be, necessary to enforce our intellectual property rights. This kind of litigation is time-consuming and expensive to prosecute or resolve, and results in substantial diversion of management resources. We cannot ensure that we will be successful in that litigation, that our intellectual property rights will be held valid and enforceable in any litigation, or that we will otherwise be able to protect our intellectual property and proprietary technology.

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Nasdaq Continued Listing Requirements—If our share price falls and remains below $1.00, we could be delisted from the Nasdaq National Market.

Nasdaq Marketplace Rule 4450(a)(5) requires companies listed on the Nasdaq National Market to maintain a minimum bid price of $1.00. Recently, our common stock closed as low as $1.26 on September 24, 2002. If the price of our common stock were to trade below $1.00 for 30 consecutive trading days, our common stock could be delisted from the Nasdaq National Market. A delisting would impair our ability to raise additional working capital. Furthermore, because prices for delisted stocks are often not publicly available, a delisting would impair the liquidity of our common stock and make it difficult for you to sell your shares, and you may lose some or all of your investment.

Anti-takeover Provisions—Anti-takeover provisions in our charter documents could prevent or delay a change of control and, as a result, negatively impact our stockholders.

Some provisions of our certificate of incorporation and bylaws may have the effect of discouraging, delaying, or preventing a change in control of our company or unsolicited acquisition proposals that you, as a stockholder, may consider favorable. These provisions provide for the following:

Some provisions of Delaware law and our stock incentive plans may also have the effect of discouraging, delaying, or preventing a change in control of our company or unsolicited acquisition proposals. These provisions also could limit the price that some investors might be willing to pay in the future for shares of our common stock.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We sell our products in North America, Asia, Latin America, Africa, the Middle East, and Europe. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates. We have a small amount of sales denominated in Euros and the Canadian dollar and have at certain times used derivative financial instruments to hedge our foreign exchange risks. As of December 31, 2002, we had no derivative financial instruments. To date, foreign exchange risks from sales have not been material to our operations.

We are exposed to the impact of interest rate changes and changes in the market values of our investments. Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We have not held derivative financial instruments in our investment portfolio. We invest our excess cash in depository accounts with financial institutions, in debt instruments of the U.S. Government and its agencies, and in high-quality corporate issuers, and, by policy, we limit the amount of credit exposure to any one issuer. We protect and preserve our invested funds by limiting default, market, and reinvestment risk through portfolio diversification and review of the financial stability of the institutions with which we deposit funds and from whom we purchase debt instruments.

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Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. Because our investment policy restricts us to conservative, interest-bearing investments and because our business strategy does not rely on generating material returns from our investment portfolio, we do not expect our market risk exposure on our investment portfolio to be material.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements

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Independent Auditors’ Report

The Board of Directors and Stockholders

Sunrise Telecom Incorporated

We have audited the accompanying consolidated balance sheets of Sunrise Telecom Incorporated and subsidiaries (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sunrise Telecom Incorporated and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 5 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

Mountain View, California

January 24, 2003, except as to Note 17,

which is as of February 28, 2003

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SUNRISE TELECOM INCORPORATED AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except share data)