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 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 than needed to meet firm production requirements, 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 categories: research and development, selling and marketing, and general and administrative. Our operating expenses include stock-based compensation expense and amortization of certain intangible assets. We classify charges to the research and development, selling and marketing, and general and administrative expense categories based on the nature of the expenditures. Although each of these three categories includes expenses that are unique to the category type, each category also includes commonly occurring expenditures that typically relate to all of the categories, such as salaries, amortization of stock-based compensation, employee benefits, travel and entertainment costs, communications costs, rent and facilities costs, and third party professional service fees. The selling and marketing category of operating expenses includes expenditures specific to our sales and marketing groups, 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 of each of these areas. These allocated charges include facility rent, utilities, communications charges, and depreciation expenses for our building, equipment, and office furniture.

During the three months ended March 31, 2004 and 2003, we recorded amortization of deferred stock-based compensation expense of $0.3 million and $0.5 million, respectively, related to the grant of stock options at exercise prices subsequently deemed to be below fair market value. Compensation expense related to these options, which were granted in 1999 and the first quarter of 2000, has been amortized on a straight-line basis over the respective four-year vesting periods of the options and charged to the departments of the employees who received these option grants. During the first three months of 2004, we allocated amortization of deferred stock-based compensation expense of $0.1 million to research and development expense, $0.1 million to selling and marketing expense, and $0.1 million to general and administrative expense. During the first three months of 2003, we allocated amortization of deferred stock-based compensation expense of $0.1 million to cost of sales, $0.2 million to research and development expense, $0.1 million to selling and marketing expense, and $0.1 million to general and administrative expense. At March 31, 2004, no further deferred stock-based compensation expense remained to be amortized.

Also, during the three months ended March 31, 2004 and 2003, we charged approximately $0.8 million and $0.9 million, respectively, to general and administrative expense for amortization of intangible assets obtained through business acquisitions.

Litigation

On January 9, 2004, we, with our subsidiary Luciol and a former owner of Luciol, settled an intellectual property dispute over certain technology for testing fiber optic communication networks. In the settlement, we agreed to pay $500,000 to certain other parties in order to settle all their claims to the intellectual property. The former owners of Luciol will reimburse $300,000 of this amount in accordance with the terms of their employment agreements with us, and $200,000 is covered by a provision for litigation that we established at the time of the Luciol acquisition. As a result, this settlement had no effect on our financial condition or results of operations as of and for the three months ended March 31, 2004.

On March 31, 2004, Acterna, LLC ("Acterna") filed a lawsuit against us in the United States District Court for the District of Maryland alleging that our SunSet xDSL, SunSet MTT, and STT products infringe certain patents owned by Acterna. We believe that this lawsuit is without merit, and we intend to vigorously defend against the claims being made against us.  However, we cannot assure you as to the outcome of this lawsuit, nor can we presently estimate any potential losses or costs to us. On April 23, 2004, we filed a lawsuit against Acterna in the United States District Court for the Northern District of California asserting that two of Acterna's products infringe patents owned by us and also seeking judgments against the validity and enforceability of Acterna's patents involved in the March 31, 2004 lawsuit. See "Part II—Other Information: Item 1. Legal Proceedings." See also "Risk Factors Affecting Future Operating Results—Intellectual Property Risks" in this MD&A.

Dividend

On January 28, 2004, our Board of Directors declared a cash dividend in the aggregate amount of $2.5 million ($0.05 per share), which was paid on February 20, 2004 to stockholders of record as of February 10, 2004.

Net Sales.    Net sales increased 16%, to $13.8 million during the first quarter of 2004 from $11.9 million during the same quarter of 2003. Sales of our wire line access products increased by $1.1 million, sales of our cable broadband products increased by $0.3 million, and sales of our protocol products increased by $0.6 million. These increases were partially offset by a $0.1 million decrease in sales of our fiber optics products. The increase in wireline access product sales was generally driven by demand for our SunSet MTT and SunSet E20 products, and the increase in protocol product sales is due to sales of our NeTracker and 3G Master products. Cable broadband product sales, particularly sales of our AT2500R system, increased from a difficult first quarter in 2003. The small decrease in fiber optics product sales reflects normal fluctuations in customers' capital spending patterns. During the three months ended March 31, 2004, our revenues were not significantly affected by changes in prices.

Sales during the first quarter of 2004 increased $0.9 million, or 13%, in North America, $0.5 million, or 18%, in Asia, and $0.8 million, or 38%, in Europe/Africa/Middle East, compared with the same quarter in 2003. These increases were partially offset by a sales decrease of $0.3 million, or 63%, in Latin America. The increase in North American sales was primarily due to increased sales of our wireline access and protocol products, which were partially offset by decreased sales of our fiber optics and cable broadband products. Our growth in Asia reflects the results of our ongoing development of distribution channels in this region, leading to increased sales of wireline access, cable broadband, and protocol products, and our growth in Europe is the result of ongoing development of distribution channels in that region, as well, leading to growth in sales of wireline access, fiber optics, and protocol products.  Sales to Latin America remain a small part of our business; small changes in order volume from this region can represent large percentage fluctuations. International sales, including sales to Canada, increased to $6.9 million, or 50% of total net sales, in the first quarter of 2004, from $5.4 million, or 45% of net sales in the same quarter in 2003.

Cost of Sales.    Cost of sales decreased 6% to $4.2 million during the first quarter of 2004, from $4.5 million during the same quarter of 2003.   Cost of sales represented 31% and 38% of net sales during the first quarters of 2004 and 2003, respectively. Two main factors contributed to the decrease in cost of sales as a percentage of sales. First, a larger portion of our total sales came from the sales of plug-in modules. Many of our products are now designed as standardized chassis, for which customers may choose to purchase from a variety of plug-in modules that meet their varying testing needs. These modules generally carry higher margins than the chassis themselves and than our non-modular products. Second, we have seen a significant increase in the proportion of our products manufactured at our plant in Taiwan, which is our lowest cost production facility. We have been making significant investments in this facility, and during January 2004, it became ISO 9001 certified, further improving its capability to be a centralized manufacturer for many of our products.

Research and Development.    Research and development expenses decreased 7% to $3.9 million during the first quarter of 2004, from $4.2 million during the same quarter of 2003. This decrease is primarily due to a $0.3 million decrease in payroll costs, which resulted from reduced bonus expenses and decreased stock-based compensation expense. Research and development expenses were 28% and 35% of net sales during the first quarters of 2004 and 2003, respectively. Research and development expenses tend to fluctuate from period to period, depending on requirements at the various stages of our product development cycles. Through our research and development activities, we are attempting to balance two conflicting strategic priorities. The first is to tightly control costs in response to sales volume that has significantly decreased over the last three years. The second is to continue to develop products that address customer needs in a rapidly changing and very competitive market. In any given time period, research and development expenses may increase in absolute dollars and/or as a percentage of sales, as we continue to invest in product development and expand our product lines.

Selling and marketing.    Selling and marketing expenses decreased 9% to $4.0 million during the first quarter of 2004, from $4.4 million during the same quarter of 2003. This decrease is the combined effect of small reductions in payroll, commission, postage and freight, advertising placement, and service expenses. Selling and marketing expenses were 29% and 37% of net sales during the first quarters of 2004 and 2003, respectively.

General and Administrative.    General and administrative expenses decreased 20% to $1.8 million during the first quarter of 2004, from $2.3 million during the same quarter of 2003. The decrease in general and administrative expense resulted primarily from a net $0.2 million reversal in our allowance for doubtful accounts, a $0.2 million decrease in amortization of intangible assets, and a $0.1 million decrease in property taxes. The reduction in our allowance for doubtful accounts is the result of our ability to collect more of our accounts receivable than we had originally forecast based on our historical experience. The reduction in amortization of intangible assets is the result of completing the amortization of intangible assets acquired in 1999 and 2000, and the decrease in property taxes is primarily the result of a reduction in assessed value for property tax purposes on our corporate headquarters building, which we own. General and administrative expenses were 13% and 19% of net sales during the first quarters of 2004 and 2003, respectively. General and administrative expenses may increase in absolute dollars in future quarters, as we expect legal expenditures to increase as a result of recent litigation. See the discussion of our litigation in the "Overview" section of this MD&A.

Other Income, Net.    Other income, net primarily represents interest earned on cash and investment balances and gains and losses on assets, liabilities, and transactions denominated in foreign currencies. Other income (expense), net decreased 66%, to $0.1 million during the first quarter of 2004, from $0.2 million during the same quarter of 2003. This was primarily due to a reduction in foreign exchange gains.

Income Taxes Expense (Benefit).    Income tax expense (benefit) consists primarily of federal, state, and international income taxes. We recorded income tax expense of $7.4 million during the first quarter of 2004 and an income tax benefit of $1.3 million during the same quarter of 2003. Of the first quarter 2004 expense, $7.3 million was the result of recording a valuation allowance against all of our net deferred tax assets in most jurisdictions. The remaining $0.1 million of income tax expense pertained to certain foreign subsidiaries that had taxable income. Our income tax benefit during the first quarter of 2003 was the result of applying a 39% effective tax rate to our net loss before income taxes.

We determined the valuation allowance on deferred tax assets in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes, which require that we weigh both positive and negative evidence in order to ascertain whether it is more likely than not that deferred tax assets will be realized. 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 bases and for the future tax consequences attributable to operating losses and tax credit carryforwards. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which the related temporary differences become deductible. We evaluated all significant available positive and negative evidence, including the existence of  cumulative net losses in recent periods, benefits that could be realized from available tax strategies, and forecasts of future taxable income, in determining the need for a valuation allowance on our deferred tax assets. At December 31, 2003, we forecast having a small income before income taxes for both the three months ending March 31, 2004 and for the year ending December 31, 2004. Since our actual result for the three months ended March 31, 2004 was a small loss before income taxes, this lessened the weight that we assigned to future prospects for returning to consistent profitability. That, combined with cumulative net losses in recent periods, represented sufficient negative evidence that was difficult for positive evidence to overcome under the evaluation guidance of SFAS No. 109, and accordingly, a valuation allowance was recorded against all of our net deferred tax assets in most jurisdictions. We intends to maintain this valuation allowance until sufficient positive evidence, such as the resumption of a consistent earnings pattern, exists to support its reversal in accordance with SFAS No. 109. If some or all of the valuation allowance were reversed, our statement of operations for the period in which the reversal occurred would include an income tax benefit for the amount that was reversed, in addition to the effect of any changes in deferred tax assets and liabilities occurring during that period. Until such time, we will not record any significant tax benefits on future operating losses.

Cash Requirements and Capital Resources

As of March 31, 2004 and December 31, 2003, we had working capital of $48.3 million and $54.7 million, respectively, and cash and cash equivalents of $40.8 million and $39.9 million, respectively. We had $2.8 million and $2.1 million, respectively, in investments in marketable securities that consist entirely of the common stock of Top Union Electronics Corp., a Taiwan R.O.C. Company. These securities are considered to be available-for-sale, and accordingly we value them at their fair value. We do not consider this to be a liquid investment, and therefore classify it as a non-current asset.

We have generated positive cash flows from our operating activities every year since 1992. We believe that current cash balances and future cash flows from operations will be sufficient to meet our anticipated cash needs for our operations, complete needed business projects, achieve our plans and objectives, meet financial commitments, meet working capital requirements, make capital expenditures, and fund other activities well beyond the next 12 months. However, large acquisitions 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.

Sources and Uses of Cash

In general, we have financed our operations and capital expenditures primarily using cash flows generated by our operating activities, and we foresee continuing to rely on cash flows from our operating activities and existing cash resources to fund our business activities during at least the next 12 months.

Cash provided by operating activities was $3.8 million during the three months ended March 31, 2004, compared with $1.4 million during the same period of 2003. Our condensed consolidated statement of cash flows provides a reconciliation of the net losses that we incurred to cash provided by operating activities during the respective periods. The following discussion describes the changes in gross cash flows for operating activities between the three months ended March 31, 2004 and March 31, 2003. The $2.4 million increase in cash provided by operating activities was primarily due to a $3.4 million increase in cash collected from customers, and it was partially offset by a $1.1 million increase in cash paid to suppliers. The increase in cash collected from customers is attributable to our increased sales during the three-month periods ended March 31, 2004 and December 31, 2003 over the three-month periods ended March 31, 2003 and December 31, 2002. The increase in cash paid to suppliers was primarily in support of these increased sales.  The remaining $0.1 million of the increase in cash provided by operating activities was the net effect of a $0.4 million increase in net cash refunded for income taxes, less a $0.1 million increase in cash paid to employees and a $0.2 million decrease in interest and other cash flows received received. In general, our ability to continue to generate positive cash flows from operations will depend on our ability to generate and collect cash from future sales, while maintaining a cost structure lower than those sales amounts. Therefore, sales volume is by far the most significant uncertainty in our ability to generate cash flow from operations.

Cash used in investing activities was $0.4 million during the three months ended March 31, 2004, which is consistent with the same period of 2003. During the first three months of 2004, the only significant investing activity was $0.4 million of capital expenditures. During the first three months of 2003, capital expenditures were $0.8 million, and we spent $0.5 million for the acquisition of GIE GmbH.  Partially offsetting these expenditures was $1.0 million received from the sale of marketable securities. As of March 31, 2004, we had no plans for large capital expenditures outside the usual course of those needed for our ongoing production, research and development, and selling and marketing activities.

Cash used in financing activities was $2.7 million during the three months ended March 31, 2004, compared with  $0.1 million during the same period of 2003. During the first three months of 2004, the primary financing activities that used cash were cash dividends of $2.5 million, a $0.2 million increase in restricted cash, and the repayment of notes payable of $0.1 million.  The primary financing activity that provided cash was employees exercising stock options for $0.1 million. During the first three months of 2003, $0.1 million of borrowing under notes payable was repaid. In January 2004, our Board of Directors announced plans to institute an annual dividend payment, and the year 2004 dividend was paid during February.

Our outstanding debt at March 31, 2004 consisted primarily of a $0.9 million loan from the Italian government for research and development use that is payable in semi-annual payments starting in the second half of 2003 and ending in 2011, and nine notes payable, related to acquisitions, totaling $0.4 million that are being paid in quarterly installments ending in 2007. We have not used off-balance sheet financing arrangements, issued or purchased derivative instruments linked to our stock, or used our stock as a form of liquidity. We do not believe that there are any known or reasonably likely changes in credit ratings or ratings outlook, or an inability to achieve such changes, which would have any significant impact on our operations. We are not subject to any debt covenants that we believe might have a material impact on our business.

Debt Instruments, Guarantees, and Related Covenants

We have low levels of debt, and our operating, financing, and investing activities are not subject to any significant constraints related to outstanding debt, guarantees, or other contingent obligations. We are not, and during at least the next 12 months are not reasonably likely to be, in breach of debt covenants, and we are not subject to any significant debt covenants that may limit our ability to borrow additional funds or issue equity securities.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates, assumptions, and judgments that affect the amounts reported in our condensed consolidated financial statements and the accompanying notes. We base our estimates on historical experience and various other assumptions that we believe to be reasonable. Although these estimates are based on our present best knowledge of the future impact of current events and actions, actual results may differ from these estimates, assumptions, and judgments.

We consider "critical" those accounting policies that require our most subjective or complex judgments, which often result from a need to make estimates about the effect of matters that are inherently uncertain, and that 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 the determination of our allowance for doubtful accounts receivable, valuation of excess and obsolete inventory, valuation of goodwill and other intangible assets, accounting for the liability for product warranties, deferred income tax assets and liabilities, and revenue recognition.

Allowance for Doubtful Accounts Receivable

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 current 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 charge provisions for doubtful accounts receivable to general and administrative expenses on our statement of operations.

Valuation of Excess and Obsolete Inventory

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 charge provisions for excess and obsolete inventory to cost of sales on our statement of operations.

Valuation of Goodwill and Other Intangible Assets

We evaluate the valuation of goodwill in the manner prescribed by SFAS No. 142, Goodwill and Other Intangible Assets. As required by that standard, we test goodwill for impairment annually, during our fourth fiscal quarter. We would also test goodwill for impairment if certain events or changes in circumstances stipulated by SFAS No. 142 were to occur. SFAS No. 142 prescribes a two-step process for the impairment testing of goodwill. The first screens for impairment by comparing the fair value of our reporting unit, which we consider to be the market capitalization of our entire telecommunications testing equipment business, to its carrying value. If the carrying value were to exceed the fair value, the second step of the process would occur. In the second step, we would recognize an impairment for the excess of the carrying value, if any, of our goodwill over its implied fair value. The implied fair value of our goodwill would be the excess of our reporting unit's total fair value over the combined net fair values of its individual assets and liabilities. Based on the annual test for impairment performed during the fourth quarter of 2003, goodwill was determined not to be impaired, and no subsequent indicators of impairment have been noted.

We evaluate the valuation of intangible assets other than goodwill in the manner prescribed by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As required by that standard, we monitor events and changes in circumstances that could indicate that the carrying amounts of an intangible asset may not be recoverable. These events and circumstances include a significant change in how we use the asset, significant changes in legal factors or the business climate that could affect the asset's value, and current period operating or cash flow losses combined with a history of such losses or a forecast of continuing losses associated with the use of the asset. If such an event or change in circumstances were to occur, we would assess the recoverability of the intangible asset by determining whether its carrying value would be recovered through undiscounted expected future cash flows. If the carrying value of the asset were to exceed the undiscounted expected future cash flows, we would recognize an impairment for the excess of the carrying value over the asset's fair value.

Product Warranties

We offer a three-year warranty covering parts and labor on our wireline 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 broadband and protocol products are covered by a one-year warranty. We are also subject to laws and regulations in various countries in which we sell regarding vendor obligations to ensure product performance. 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 and product performance laws and regulations by considering our historical experience with the costs of meeting such obligations. If the future costs of meeting these obligations differ from the historical experience, additional reserves for warranty obligations may be required. We charge provisions for future warranty costs to cost of sales on our statement of operations.

Deferred Income Tax Assets and Liabilities

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 deferred tax assets is dependent on 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 other 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 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. As discussed in the "Results of Operations" section of this MD&A, during the three months ended March 31, 2004, we recorded a $7.3 million charge to establish a valuation allowance against all of our net deferred tax assets in most jurisdictions.

Revenue Recognition

We recognize revenue from a customer order when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. For product sales, we consider delivery to have occurred when title and risk of loss have been transferred to the customer, which is usually at the time that the product has been picked up by a common carrier. For services, we consider delivery to have occurred once the service has been provided. We use objective evidence of fair value to allocate revenue to elements in multiple element arrangements and recognize revenue when the criteria for revenue recognition have been met for each element. In the absence of objective evidence of fair value of a delivered element, we allocate revenue to the fair value of the undelivered elements and the residual revenue to the delivered elements. The price charged when an element is sold separately generally determines fair value.

When the arrangement with the customer includes future obligations or obtaining customer acceptance, we recognize revenue when those obligations have been met or customer acceptance has been received. We defer revenue from services and support provided under our warranty programs and recognize it on a straight-line basis over the warranty period. Deferred revenue represents amounts received from customers in advance of services and support to be provided and amounts received prior to customer acceptance. Provisions are recorded at the time of sale for estimated product returns, standard warranty obligations, and customer support.

As of March 31, 2004, we did not have any 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.

During the three months ended March 31, 2004, there were no material changes outside the ordinary course of our business in long-term debt obligations, capital lease obligations, operating lease obligations, purchase obligations, or any other long-term liabilities reflected on our condensed consolidated balance sheet.

In the past, we have experienced significant fluctuations in our quarterly results due to a number of factors. 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, including the following:

During the last two quarters, our sales have increased over the same quarters in the preceding years. However, because of unfavorable economic and market conditions over the last three years, our quarterly sales have generally declined or been flat since the beginning of 2001, and we are still unable to predict future sales accurately and 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.

The economic downturn in the telecommunications and cable broadband industries has characterized by diminished product demand, excess manufacturing capacity, and the increasing erosion of average selling prices. The downturn has 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 hinder our ability to reach our goals for restoring long-term profitability and growth.

Over the past three years, our business generally has experienced lower revenues due to decreased or cancelled customer orders. 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 portions of our workforce, restricted hiring, reduced most employee salaries, restricted pay increases, and reduced discretionary spending.

There are several risks inherent in our efforts to lower our cost structure. These include the risk that we will not be able to reduce expenditures quickly enough and maintain 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, to manage and control our business, and to remain competitive. Each of the above measures could have long-term effects on our business by reducing our pool of employee 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.

Sales of our DSL and other wireline access products represented approximately 52% of our net sales during the first three months of 2004 and 44% during the full year 2003. 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.

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 exceeds 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.

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 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, including our products. 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 and Bell Atlantic, both of which were customers of ours, merged to create Verizon Communications, Inc. 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.