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Exhibit 13.2

Managements Discussion and Analysis of Financial Condition and Results of
Operations

Forward-Looking Statements

This report contains forward-looking statements. In some cases, you can
identify these statements by terms such as may, intend, might, expect,
believe, seek, anticipate, estimate, predict, potential, target,
goals, projects, plan, should, could, would, or similar expressions
intended to identify forward-looking statements. These statements reflect our
current views with respect to future events and are based on assumptions and
subject to risks and uncertainties. We discuss many of these risks and
uncertainties in greater detail in Part I, Item 1 of our Annual Report on Form
10-K under the heading Risk Factors That Might Affect Future Operating Results
and Financial Condition as filed with the Securities and Exchange Commission
(SEC). These risks and uncertainties may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by the forward-looking statements. These
factors are not intended to be an all-encompassing list of risks and
uncertainties that may affect the operations, performance, development and
results of our business. You should not place undue reliance on these
forward-looking statements. Also, these forward-looking statements represent
our estimates and assumptions as of the date of this report. We are under no
duty to update any of the forward-looking statements after the date of this
report to conform such statements to actual results or to changes in our
expectations.

The following discussion should be read in conjunction with the financial
statements and notes included in this report. Copies of our Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and
any amendments to those reports filed or furnished to the SEC are accessible,
free of charge, at our Internet Website http://www.afc.com. Information on our
Website is not part of this report. Copies of these reports are also available
without charge by contacting the Investor Relations Department, c/o Advanced
Fibre Communications, Inc., P.O. Box 751239, Petaluma, California 94975-1239.

Overview

We sell access solutions to telecommunications companies in the U.S. and
international marketplaces. AFC is the largest U.S. wireline equipment
manufacturer dedicated solely to the access network. We market our product
family through our direct sales force and indirectly through distributors and
sales representatives. We sell our products primarily to service providers who
install our equipment as part of their access networks. Our customers in the
U.S. are generally incumbent local exchange carriers (ILECs), which include
independent operating companies (IOCs) and regional Bell operating companies
(RBOCs). In international markets, our customers are primarily incumbent local
service providers.

Our flagship product, AccessMAXTM, is an integrated multiservice access
platform that sits in both central offices and remote outside plant cabinets in
the access network. AccessMAX provides flexibility and scalability for
simultaneous delivery of the triple play of voice, video and high-speed Internet/data, as well as
any combination of narrowband, wideband and broadband service. AccessMAX
accommodates copper, fiber and wireless transport options, thereby offering
flexibility while maximizing the service providers existing infrastructure.

We have continued to expand our portfolio of innovative access solutions and
expand our presence within key customer accounts despite a challenging business
environment. Our long-term strategy includes continued development of access
solutions that enable carriers to deploy emerging broadband services in a more
efficient and cost-effective manner to their customers. We offer a
comprehensive portfolio of carrier-class, standards-based solutions to carriers
that satisfy the demand for such leading technologies and architectures as
packetized voice, Fiber-to-the-Premises (FTTP), video, and digital subscriber
line (DSL). Addressing these technologies, we have developed the following
solutions:



| |  |  | AdvancedVoiceSM, 
| | - |  | -----------------
|
| |  |  | FiberDirectSM,   
|
| |  |  | TelcoVideoSM, and
|
| |  |  | UniversalDSLSM.  

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Our AdvancedVoice solution enables convergence of the delivery of legacy and
emerging services in the network. Softswitch controlled voice interfaces can
be deployed directly from our AccessMAX platform, enabling packet network
convergence of voice and data services. This solution provides management,
transport and control of services, such as voice, video and high-speed
Internet/data over a single packetized network infrastructure. We believe
AdvancedVoice allows carriers to offer more services while significantly
reducing their operational costs.

We believe our FiberDirect solution enables carriers to quickly and
economically transition from legacy copper-based access networks to high-speed,
high-capacity all-fiber networks. With the addition of a passive optical
network plug-in card to our multiservice access platform, AccessMAX can be
upgraded to an AccessMAX FiberDirect system. Our FiberDirect solution enables
carriers to deliver voice, video and high-speed
Internet/data services and sets the foundation for the next generation network.

With our TelcoVideo solution, carriers worldwide can efficiently bundle voice,
video and high-speed Internet/data over a single infrastructure. Completing
this triple play makes it possible for carriers to compete more effectively,
and increase customer acquisition and retention. Our TelcoVideo solution is a
fully integrated offering including head-end equipment, transport, access and
routing, and customer premise equipment.

UniversalDSL utilizes our AccessMAX and Telliant platforms to fulfill the
stringent carrier-class requirements of central office and remote terminal
applications for copper-based broadband services delivery. AccessMAX can be
utilized as a low-density central office digital subscriber line access
multiplexer (DSLAM), as a remote terminal retrofit or DSLAM overlay, or in
remote cabinets for integrated delivery of DSL and plain old telephone service
(POTS). For central office applications, Telliant can be configured as a DSLAM,
an aggregator for DSLAMs, or a multiservice switch for inter-working frame
relay, asynchronous transfer mode and Ethernet services. It can be equipped
with an integrated broadband remote access server. Both platforms address a
carriers need to deliver high-speed data and Internet access today, and to
position its network for simplified migration to video and FTTP-based services
in the future.

AFC management views certain key sales information as indicators of our
position in the North American access market and the DSL market. Some of our
largest customers, including Sprint North Supply Company (Sprint) and Alltel
Communications Products, Inc. (Alltel), continued strong year-over-year
ordering patterns with us. Sales to another large customer, SBC Communications,
Inc., continued to increase during the latter half of 2003. We shipped
approximately 250,000 DSL lines during 2003 compared with 115,000 lines in
2002.

Factors Influencing Our Results of Operations.Our results of operations have
been and will continue to be influenced by a variety of factors, including:

Customer Demands. Our operating results reflect our ability to offer products
that meet the needs of our customers. In view of reduced overall industry
spending, our ability to grow revenue is significantly affected by the degree
to which carriers will devote their resources to the introduction of new
products and technologies in the access network. Our goal is to be the leading
supplier of advanced voice and broadband solutions in the access market. From
a regulatory standpoint, we believe the Federal Communications Commissions
(FCCs) Triennial Review has had some impact on the regional Bell operating
companies (RBOCs) investment decisions. We believe the final ruling
encourages long-term investment in broadband networks and migration to
FTTP-based services.

In November 2003, Verizon announced it selected us as one of four vendors to
provide the equipment for its planned deployment of high-speed,
high-capacity FTTP systems. In January 2004, we signed a multiyear agreement
with Verizon to be the primary FTTP project vendor in providing the central
office and premises electronics, also known as the active elements of FTTP
technology. We will incur costs and expenses associated with preparation for
the deployment of our FTTP systems; these deployment costs and expenses will
precede our generation of revenues from the FTTP systems. Our future revenues
and expenses will be affected by the degree to which Verizon invests in FTTP
systems and the timing of any such investment. We are currently in lab trials with Verizon and field trials are expected to
commence this summer. In addition, Verizon has already ordered FTTP systems
under this agreement.

In our work with large customers such as RBOCs, our agreements frequently
contain provisions for performance compensation payments (PCPs) that are tied
to key milestones related to the availability of product releases containing
certain product features. Completion of such milestones requires timely and
successful R&D efforts, and on converting the results of those R&D efforts into
usable, cost effective products. R&D efforts are, by their very nature, large
and complicated projects, which rely in part on the work of third parties over
which we have no control, and on which there can be no assurance of success.
For example, our agreement with Verizon to provide FTTP systems has several
provisions requiring PCPs for failure to meet key milestones or provide product
features by specified dates. We recently received notification from Verizon
that we failed to achieve a February 23, 2004 milestone for delivery of a
product release; the PCP for this milestone is $2 million. We subsequently
provided the required product release on March 8, 2004. Accordingly, we could
experience reduced net income in future quarters due to penalties imposed under
such agreements as a result of certain failures to comply with strict
contractual terms, regardless of the significance of any noncompliance in
relation to the overall project.

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Telecommunications Industry Conditions. Our results of operations have been
adversely affected by the downturn in the telecommunications industry and
worldwide economies over the last several years. Although the current economic
environment for our industry remains challenging, we believe we have positioned
our business for the long-term. On an ongoing basis, we attempt to balance our
operating expenses with lower overall revenue levels associated with the
industry downturn and reduced capital spending. We focus on cost controls while
we continue to invest in research and development activities that will keep us
in a strong position to take advantage of sales opportunities when industry
conditions improve and demand recovers.

Cost Containment Efforts. In an effort to balance our operating expenses with
forecasted revenues, we initiated a workforce reduction in April of 2003. The
workforce reduction was carried out during the second quarter of 2003 and
resulted in severance and employee related costs, along with consolidation of
excess leased facilities. See Liquidity and Capital Resources for further
discussion of this action.

During 2003, we also focused efforts on driving cost out of our manufacturing
operations. We completed the transition, initiated at the end of 2002, to a
new contract manufacturer and we achieved significant product cost savings
during 2003. We reviewed our warranty service activities and made several
changes in how we calculate the warranty reserve, which lowered cost of
revenues. We also achieved the objective of decreasing lead times with vendors
to reduce the amount of excess and obsolete inventories on hand.

Acquisition of NAA. Subsequent to our 2003 fiscal year end, we announced that
we had signed an agreement to purchase North American Access (NAA), a business
unit of Marconi Communications, Inc. (Marconi), a subsidiary of Marconi
Corporation plc. We completed the acquisition on February 20, 2004. The
acquisition supports our business strategy to expand our optical access
portfolio, and enhance our ability to serve the demands and requirements of
large telecommunications carriers. The acquisition will enable us to offer a
more robust portfolio of fiber-based access network solutions. It will also
position us to more effectively serve a broader base of customers from the
smallest IOC to the largest RBOC. We purchased certain assets of NAAs business
for approximately $240 million in cash, plus transaction related expenses. The results of
NAAs operations will be reflected in our consolidated results of operations as
of February 20, 2004. We are in the process of obtaining third party valuations
of certain assets. We expect to expense in-process research and development
during the first quarter of 2004. Our ability to successfully operate the NAA
business and integrate NAAs operations with our existing business will
materially affect our future results of operations.

Seasonality. Our customers normally install a portion of our systems in outdoor
locations, and shipments are subject to the effects of seasonality with fewer
installation projects scheduled for the winter months. Historically, we have
experienced weaker demand for our products during the beginning of the year as
compared with the shipment levels in the preceding fourth quarter. As a result,
we believe that over time, revenues for the quarter ended March 31 will be
lower than revenues in the preceding quarter ended December 31.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America, or GAAP. Applying GAAP requires our judgment in
determining the appropriateness of acceptable accounting principles and methods
of application in diverse and complex economic activities. The preparation of
these financial statements requires us to make estimates and judgments that
affect the reported amounts of revenues, expenses, assets and liabilities, and
related disclosure of contingent assets and liabilities. Many business
transactions are subject to uncertainty and the level of complexity and
subjectivity of estimates and judgments could decrease the precision of the
financial statements. We evaluate our estimates and judgments on an on-going
basis, including those related to our product warranty, product returns, excess
and obsolete inventory, and allowance for doubtful accounts. We base our
estimates on historical experience and other assumptions we believe are
reasonable under the circumstances. The results of these estimates form the
basis for making judgments about the carrying values of assets and liabilities,
which may not be readily apparent from other sources.

We believe the application of our accounting policies accurately reflects our
financial condition and results of operations in the consolidated financial
statements and provides comparability between periods. We believe

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our accounting policies are reasonable and appropriate for our business. The
following critical accounting policies require us to make significant estimates
and judgments in connection with the preparation of our consolidated financial
statements.

Revenue Recognition and Allowances. We recognize revenue when the earnings
process is complete, in compliance with the SEC Staff Accounting Bulletin (SAB)
No. 101, Revenue Recognition in Financial Statements,as updated by SAB No.
104, Revenue Recognition,and Statement of Financial Accounting Standards
(SFAS) No. 48, Revenue Recognition When Right of Return Exists. The earnings
process is considered complete when persuasive evidence of an arrangement
between a customer and AFC exists, when delivery and acceptance has occurred or
services have been rendered, when pricing is fixed or determinable, when any
right of return lapses or is reasonably estimable, and when collectibility is
reasonably assured. We follow these same revenue recognition standards for
sales made to our authorized distributors and sales representatives, including
consignment sale arrangements. In general, the ownership right, or title,
passes to the customer once the shipment leaves AFC property. We consider
differing market conditions when recognizing revenues, such as the recent
decline in capital spending in our industry and the relative financial
condition of our customers. Determining the amount of the return
reserve includes some
uncertainty due to the difficulty in determining if a customer will return
product in excess of what we have historically experienced.

We allocate revenues earned on software arrangements involving multiple
elements to each element based on the relative fair values of the elements in
accordance with Statements of Position (SOP) 97-2, Software Revenue
Recognition, and 98-9, Modification of SOP 97-2, Software Recognition, With
Respect to Certain Transactions. Revenues associated with maintenance are
recognized ratably over the maintenance term. Revenues from service activities
are generally recognized when services are performed.

We follow the Financial Accounting Standards Boards (FASB) consensus on
Emerging Issues Task Force (EITF) Issue No. 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. This issue addresses how to determine
whether an arrangement involving multiple revenue generating activities
contains more than one earnings process and, if so, how to divide the
arrangement into separate units of accounting consistent with the identified
earnings processes for revenue recognition purposes. This issue also addresses
how arrangement consideration should be measured and allocated to the separate
units of accounting in the arrangement.

A relatively small portion of our revenue is derived from arrangements with
multiple deliverables. Allocating revenue to each element or to multiple
revenue generating activities requires an understanding of the relative fair
value of each element or activity. We bear a risk in allocating revenues based
on the relative fair value of each element or activity because our fair value
assumptions may prove to be incorrect. This can affect the timing of recognized
revenues and results of operations.

Reserves for product returns, promotional rebates and other rebates and credits
are established based on contractual provisions and historical experience and
are recognized in the same period as the related revenue. We follow the
guidance of EITF Issue 01-09, Accounting for Consideration Given by a Vendor to
a Customer. We consider differing market conditions when recognizing revenues,
such as the recent decline in capital spending in our industry and the relative
financial condition of our customers. Our estimates of returns bear the risk of
change due to the uncertainty of determining the likelihood of customer product
retention. Our estimates of rebates and credits bear the risk of change due to
the uncertainty of determining the likelihood and timing of returns
and price
changes. During 2003, we evaluated how we recorded reserves for product
returns, promotional rebates and other rebates and credits. We formerly
recorded returns and other rebates and credits to accrued liabilities, and
promotional rebates to deferred revenue. We have changed to netting returns,
promotional rebates and other rebates and credits against accounts receivable.
As of December 31, 2003, these changes resulted in $2.0 million in product
returns, $1.4 million in promotional rebates and $2.0 million in other rebates
and credits netted against accounts receivable. The historical balance sheet
at December 31, 2002 was affected by these changes, resulting in the
reclassification of $0.7 million in product returns from accrued liabilities to
accounts receivable.

Allowance for Doubtful Accounts.We have an allowance for doubtful accounts for
estimated losses resulting from customers inability to pay amounts owed to us,
or for invoicing errors. The allowance is a combination of specific and general
reserves based on historical write-off of bad debt. We base our allowance on
periodic

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assessment of our customers liquidity and financial condition through credit
rating agencies, financial statement review, historical collection trends and
current economic conditions that may affect a customers ability to pay.
Write-offs against the allowances generally occur after we assess the
particular customers liquidity and financial condition and conclude that
collection in the future is highly unlikely. Our estimates of losses bear the
risk of change due to the uncertainty of determining the likelihood of customer
non-payment. The general reserve includes a reserve for customer credit memos
for pricing and shipping errors.

Warranty Costs.Our products are generally covered by warranty for a period of
two years, and for some customers, five years. Beginning in the fourth quarter
of 2003, we changed our warranty estimate methodology to accrue warranty costs
based on the number of units returned under warranty and applied that
percentage of returned inventory to the units sold in the period. We had
previously accrued warranty costs based on a percentage of revenues. We made
the change as a result of accumulating detailed information about actual field
data and product return rates. In connection with the change in warranty
estimate methodology, we reversed $2.0 million in warranty reserve. Material
cost is estimated based on historical trends in the volume of product returns
within the warranty period and the cost to repair or replace the products.
Technical support labor cost is estimated based on historical trends in the
rate of customer calls and the cost to support the calls during the warranty
period. Estimates for warranty costs bear a risk of change because the
estimates are based on historical trends and actual costs may differ.

In the second quarter of 2003, we performed an analysis of warranty service
activities and costs. We reversed $2.6 million of the reserve and reduced our
estimate for the warranty reserve accrual rate for future periods.
Additionally, some non-warranty personnel-related costs previously charged to
the warranty reserve are now charged to operating expenses as incurred.

If we experience an increase in warranty claims compared with our historical
experience, or if costs of servicing warranty claims are greater than the
expectations on which the accrual was based, our gross margin would be
adversely affected.

Research and Development and Software Development Costs.We expense all
research and development costs as incurred in accordance with SFAS No. 2,
Accounting For Research and Development Costs. We also follow SFAS No. 86,
Accounting For the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed. Significant costs incurred for the development of computer software
and enhancements to existing software products that will be sold, leased or
otherwise marketed are capitalized when technological feasibility has been
established. These capitalized costs are subject to an ongoing assessment of
recoverability based on anticipated future revenues and changes in
technologies. Costs that are capitalized include direct labor and related
overhead. Amortization of capitalized software development costs begins when
the product is available for general release. Amortization is based on the
greater of straight-line or the ratio of current gross revenues for a product
to the total of current and anticipated future gross revenue for that product.
Unamortized capitalized software development costs determined to be in excess
of net realizable value of the product are expensed immediately. We did not
incur significant computer software development costs during 2003 or 2002. The
amounts amortized during 2002 and 2001 were $1.9 million and $2.2 million,
respectively, resulting in full amortization of capitalized costs. Assessments
of recoverability bear the risk of change due to the difficulty in determining
future revenues and changes in technologies that would affect the amortization
period. If we changed the estimates used in the assessment of recoverability
for computer software-related capitalized costs, such as the anticipated future
revenues or changes in technologies, these changes could result in a lower net
realizable value. This in turn would increase our reported operating expenses
and lower net income.

Inventories and Reserve for Excess and Obsolete Inventories.Inventories
include material, labor and overhead and are valued at the lower of cost or
market, with cost computed on a first-in, first-out basis. A reserve for excess
and obsolete inventories is determined based primarily on future demand
forecasts. The reserve is assessed continuously and adjusted on a quarterly
basis. The reserve bears the risk of change due to the difficulty of accurately
forecasting future demand.

Equity-Based Compensation Plans.We account for equity-based compensation
plans with employees and non-employees on the board of directors using the
intrinsic value method called for in Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees. If compensation expense for
our

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stock-based compensation plans had been determined in accordance with the fair
value approach set forth in SFAS No. 123, Accounting for Stock-Based
Compensation, pro forma net income (loss) would have been lower than GAAP net
income in the years ended December 31, 2003, 2002 and 2001. See Note 1 of the
Notes to Consolidated Financial Statements for further discussion of our
equity-based compensation plans.

Reclassifications and Restatements

Certain amounts have been reclassified to conform with the current
year presentation:



| |  |  | Interest expense was formerly reflected in other income, whereas
the current presentation reflects interest expense netted against
interest income;                                                                                       
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Product returns reserve was formerly reflected in accrued liabilities,
whereas the current presentation reflects these returns netted against
accounts receivable;                                                                        
|
| |  |  | Promotional rebates reserve was formerly reflected in deferred revenues,
whereas the current presentation reflects these rebates netted against
accounts receivable;                                                                      
|
| |  |  | Other rebates and credits reserve was formerly reflected in accrued
liabilities, whereas the current presentation reflects these rebates and
credits netted against accounts receivable (for 2002 the balances
were not reclassified); and
|
| |  |  | Interest receivable on marketable securities was formerly recorded
in other current assets, whereas the current presentation reflects
interest receivable in other marketable securities.                                                 

Results of Operations

The table below sets forth, for the periods indicated, the percentage of
revenues represented by items reflected in our consolidated statements of
operations. The significant differences in results from 2001 and those in 2002
and 2003 are based on inventory-related charges in 2001 as well as the
recognition of unrealized gains on the Cisco securities from implementation of
SFAS No. 133 in 2001.

|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |    |    | 
|-------------------------- | --------------------------------------------------- | ------------------------ | --- | ------------------------ | -- | -------- | --- | -------- | -- |  | --- | -- | -- | 
|                           |                                                     |                          |     | Years Ended December 31,
|                           |                                                     |                          |     |                         
|                           |                                                     |                          |     | 2003                     |    | 2002 (1) |     | 2001 (1)
|                           |                                                     |                          |     |                          |    |          |     |         
|Revenues                   |                                                     |                          | 100 | %                        |    |          | 100 | %        |    |  | 100 | % 
|Cost of revenues           |                                                     |                          | 51  |                          |    |          | 52  |          |    |  | 66  |   
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|                           | Gross profit                                        |                          |     | 49                       |    |          |     | 48       |    |  |     | 34 |   
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|Operating expenses:        |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|                           | Research and development                            |                          |     | 20                       |    |          |     | 18       |    |  |     | 20 |   
|                           | Sales and marketing                                 |                          |     | 12                       |    |          |     | 14       |    |  |     | 15 |   
|                           | General and administrative                          |                          |     | 9                        |    |          |     | 8        |    |  |     | 11 |   
|                           | Amortization
and write-down of acquired intangibles |                          |     | 1                        |    |          |     | 1        |    |  |     |   |   
|                           | In-process research and development                 |                          |     |                         |    |          |     | 4        |    |  |     |   |   
|                           | Securities litigation settlement costs              |                          |     |                         |    |          |     | 1        |    |  |     |   |   
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|                           |                                                     | Total operating expenses |     |                          | 42 |          |     |          | 46 |  |     |    | 46 | 
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|Operating income (loss)    |                                                     |                          | 7   |                          |    |          | 2   |          |    |  | (12 | ) 
|Other income, net          |                                                     |                          | 4   |                          |    |          | 11  |          |    |  | 93  |   
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|Income before income taxes |                                                     |                          | 11  |                          |    |          | 13  |          |    |  | 82  |   
|Income taxes               |                                                     |                          | 3   |                          |    |          | 4   |          |    |  | 31  |   
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   
|Net income                 |                                                     |                          | 8   | %                        |    |          | 9   | %        |    |  | 51  | % 
|                           |                                                     |                          |     |                          |    |          |     |          |    |  |     |   



|(1) |  | Certain prior period amounts have been reclassified to conform to
the current presentation.
|--- |  | -------------------------------------------------------------------------------------------

2003 Compared with 2002

Although our revenues decreased slightly in 2003 as compared to 2002, our
operating income as a percentage of revenues increased. This increase resulted
primarily from the impact of material cost savings, changes in warranty reserve
and estimate methodology, workforce reduction and cost containment efforts in
2003. Operating income in 2002 was reduced by in-process research and
development and securities litigation settlement costs.

Revenues.Total revenues were $333.5 million in 2003, a 3% reduction from the
$344.1 million recorded in 2002.

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Sales to U.S. customers decreased 2% to $287.9 million in 2003, compared with
$295.0 million in 2002. Sales to U.S. customers decreased in 2003 primarily
due to decreased sales of network management products and an increase in the
return reserve. The decrease was partially offset by increased sales of
Telliant as compared with the prior year. Sales to U.S. customers accounted for
86% of total revenues in both 2003 and 2002. In 2003, we experienced a shift
in customer mix, with increased sales to larger customers and a decrease in
sales to some of our smaller IOC customers. The product mix we sold during 2003
also shifted to larger-line size cabinets, and more DSL ports.

Sales to international customers decreased 7% to $45.6 million in 2003, from
$49.0 million in 2002. The primary reason sales to international customers
decreased in 2003 was due to decreased sales of AccessMAX as compared with the
prior year. Sales to international customers accounted for 14% of total
revenues in both 2003 and 2002. We continue to experience softness in some of
our international markets, particularly Latin America. We believe the
telecommunications industry slowdown continues to affect capital spending in
international markets.

Sprint and Alltel accounted for 35.9% and 13.0% of total revenues in 2003,
respectively. Sprint, Verizon and Alltel accounted for 22.8%, 11.3% and 10.7%
of total revenues in 2002, respectively. No other customer accounted for 10% or
more of total revenues in either of these years. Although our largest customers
have varied over time, we anticipate that results of operations in any given
period will continue to depend to a great extent on sales to a small number of
large accounts. Sales to our top five customers accounted for 68% of total
revenues in 2003, an increase from 56% a year ago.

Sprint and Alltel are distribution subsidiaries of Sprint
Corporation and Alltel Corporation, respectively. These subsidiaries distribute
our products to their respective affiliates for deployment in their own
networks and also resell our products to third party IOC customers.
Historically, we believe that products representing approximately 25% to 40% of
our sales to Sprint and Alltel have been sold to IOC customers.

Gross Profit.Gross profit as a percentage of revenues increased to 49.2% in
2003, from 47.7% in 2002. Margin improved primarily due to cost reductions
across all product lines and changes in the warranty reserve and estimate
methodology. We realized significant material cost savings during 2003 as a
result of changing to a new contract manufacturer near the end of 2002 and
continued focus on cost reductions. These material cost reductions more than
offset competitive pricing pressures. We expect to continue to pursue cost
control measures in our supply chain management.

Two significant changes related to warranty resulted in improved overall
margins in 2003. First, a detailed analysis of costs related to warranty and
customer service resulted in a $2.6 million reversal of the warranty reserve
and reduction in the accrual rate beginning in the second quarter of 2003.
Second, a change in methodology to estimate the warranty reserve beginning in
the fourth quarter of 2003 led to a $2.0 million reversal of warranty reserve
and a lower accrual rate going forward.

In addition, 2002 margin reflected software development cost amortization,
which had the effect of lowering margin. There was no software development cost
amortization in 2003. During 2003, we reversed $2.5 million in purchase
commitment reserves as a result of changing the agreements with contract
manufacturers for the length of time we hold inventory at contract manufacturer
locations. Offsetting these favorable impacts to margin were higher costs
related to our professional services and inventory write-offs during the year.

Research and Development.Research and development expenses increased 7% to
$66.1 million in 2003, and represented 20% of revenues, compared with 18% of
revenues in 2002. Research and development expenses in 2003 were higher than
2002 primarily due to engineering materials and the use of outside consultants
for FiberDirect and other product development. Additionally, the April 2003
workforce reduction resulted in higher expenses due to fixed asset write-offs,
severance and related costs. Partially offsetting these increases between
years was a reduction in employee benefits as a result of cost containment
efforts.

We believe rapidly evolving technology and competition in our industry
necessitates the continued commitment of our resources to research and
development to remain competitive. We plan to continue to

7



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support the development of new products and features, while seeking to
carefully manage associated costs through expense controls.

Sales and Marketing.Sales and marketing expenses decreased 15% to $40.5
million in 2003, and represented 12% of revenues, compared with 14% of revenues
in 2002. Sales and marketing expenses in 2003 declined from 2002 primarily due
to the decrease in compensation, employee benefits and commissions as a result
of the April 2003 workforce reduction and cost containment efforts, and changes
in our sales commission structure. Additional reductions in expenses were
realized in international distributor commissions, lower depreciation expense,
trade show expense and hiring and relocation costs. Partially offsetting these
decreases between years were increased marketing costs related to our new
branding campaign in 2003.

We believe we have aligned sales and marketing expenses with current results of
operations. We plan to continue to monitor sales and marketing expenses in
view of our expected future operating results.

General and Administrative.General and administrative expenses increased 9% to
$28.8 million in 2003, and represented 9% of revenues, compared to 8% of
revenues in 2002. General and administrative expenses in 2003 increased
from 2002 primarily due to the April 2003 workforce reduction, which included
restructuring reserves for leased facility losses and severance and related
costs. Partially offsetting these increases between periods was a decrease in
employee benefits resulting from cost containment efforts.

We believe we have aligned general and administrative expenses with current
results of operations. We plan to continue to monitor general and
administrative expenses in view of our expected future operating results.

Amortization and Write-down of Acquired Intangibles.In 2003, we amortized
$2.0 million of deferred compensation, non-compete agreements and completed
technology arising from the acquisition of AccessLan Communications, Inc.
(AccessLan) in May 2002. During 2002, we amortized $3.3 million related to
these intangible assets. We expect to continue amortizing the remaining
intangible assets through approximately 2005. During 2003, we wrote down the
completed technology asset by $2.8 million after determining that revenues for
product based on the completed technology asset were not growing as originally
planned.

Other Income.Other income decreased to $11.8 million in 2003, from $38.5
million in 2002. The decrease was primarily the result of settling the Cisco
hedge contracts and the decreased gains on our Cisco investment. Historically,
the gains generated by the hedge contracts more than offset the Cisco share
losses, resulting in unrealized gains. As the hedge contracts approached
maturity, there were fewer fluctuations between the contracts and the Cisco
shares. The last hedge contract was settled in May of 2003. Other income in
2002 also included a distribution payment from Marconi. Other expense in 2003
included a $1.0 million impairment of a minority interest equity investment in
a privately-held company.

Income Taxes.The effective tax rate was 25% during 2003, as compared to 32%
during 2002. The proceeds from the Cisco hedge contract settlements in 2003
were invested primarily in tax-exempt marketable securities, which allowed us
to lower the tax rate in 2003.

2002 Compared with 2001

Although our revenues increased slightly in 2002 as compared to 2001, our
operating income as a percentage of revenues increased significantly between
the years. We had an operating loss in 2001 which resulted primarily from the
impact of inventory-related charges. Other income in 2001 was substantially
higher than 2002 due to the recognition of unrealized gains on the Cisco
securities from implementation of SFAS No. 133 in 2001.

Revenues. Total revenues were $344.1 million in 2002, a 5% increase from the
$327.6 million recorded in 2001.

Sales to U.S. customers increased 5% to $295.0 million in 2002, compared with
$282.0 million in 2001. Sales to U.S. customers increased in 2002 primarily
due to increased sales to Alltel, Sprint and Verizon, partially

8



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offset by a reduction in sales to IOCs and competitive local exchange carriers
(CLECs). Sales to U.S. customers accounted for 86% of total revenues in both
2002 and 2001.

Sales to international customers increased 8% to $49.0 million in 2002, from
$45.6 million in 2001. Sales to international customers increased in 2002
primarily due to an increase in AccessMAX sales to our larger customers. Sales
to international customers accounted for 14% of total revenues in both 2002 and
2001.

Sprint, Verizon and Alltel accounted for 22.8%, 11.3% and 10.7% of total
revenues in 2002, respectively. Sprint accounted for 17.2% of total revenues in
2001. No other customer accounted for 10% or more of total revenues in either
period. Although our largest customers have varied over time, we anticipate
that our results of operations in future periods will depend largely on sales
to a small number of large accounts. Sales to our five largest customers
accounted for 56% and 44% of total revenues in 2002 and 2001, respectively.

Gross Profit.Gross profit as a percentage of revenues increased to 47.7% in
2002, from 34.1% in 2001. The primary reason margins improved in 2002 was
significantly lower charges for inventory purchase commitments and excess and
obsolete inventory. Also contributing to the increase was our continued focus
on product cost reductions, which included among other things, identifying and
procuring material from certain financially distressed companies at
significantly reduced amounts. Gross profit increased, to a lesser degree, as a
result of higher margin product mix, which was partially offset by a lower
margin customer mix.

Research and Development.Research and development expenses decreased 4% to
$61.7 million in 2002, and represented 18% of revenues, compared with 20% of
revenues in 2001. Research and development expenses in 2002 were lower than
2001 primarily due to lower fixed asset write-offs, hiring and relocation
costs, development costs, use of outside services, and depreciation costs.
These decreases were partially offset by increased compensation, lease
impairment and software development costs. In 2001, we wrote off asset and
leasehold improvements associated with exiting our Largo, Florida facility.
This enabled us to minimize the amount of fixed asset disposals in 2002. The
resulting effect of reducing our fixed asset base also caused a decline in 2002 depreciation expense.

Sales and Marketing.Sales and marketing expenses decreased 4% to $47.6 million
in 2002, and represented 14% of revenues, compared with 15% of revenues in
2001. Sales and marketing expenses in 2002 declined from 2001 primarily due to
lower levels of demonstration and trade show material write-offs, depreciation
and continued cost containment efforts driving reductions in travel and
entertainment, employee recruitment and outside services usage. These decreases
were partially offset by increases in performance-based compensation and higher
trade show costs. In 2001, we wrote off obsolete trade show materials,
demonstration equipment and demonstration inventory. These write-offs, along
with an increasing number of assets becoming fully depreciated, caused a
decline in 2002 depreciation expense. We continued our cost containment
efforts in 2002 by reducing travel and entertainment, employee recruitment
and outside services costs. These decreases were partially offset by payment of
performance-based compensation awards in 2002. In contrast, we made no
performance-based compensation awards in 2001. Additional offsets included
higher total commissions due to higher revenue levels than the previous year
and higher commission rates for certain products. These decreases were also
offset by an increase in trade show costs.

General and Administrative.General and administrative expenses decreased 29%
to $26.4 million in 2002, and represented 8% of revenues, compared to 11% of
revenues in 2001. General and administrative expenses in 2002 decreased
from 2001 primarily due to a decline in provision for doubtful accounts,
depreciation and loss on fixed asset disposals. These were partially offset by
an increase in performance-based compensation awards. Unlike 2001, when we
recorded a significant provision for doubtful accounts related to one
financially troubled customer, doubtful accounts during 2002 were more in line
with historical trends. In 2001, we wrote off general and
administrative-related fixed assets. This enabled us to minimize the
need for a similar write-off in 2002, thus decreasing our 2002 loss on fixed
asset disposals and depreciation expense. These decreases were partially offset
by performance-based compensation awards in 2002. In contrast, we made no
performance-based compensation awards in 2001.

Amortization of Acquired Intangibles.In 2002, we amortized $3.3 million of
deferred compensation, non-compete agreements and completed technology arising
from the acquisition of AccessLan in 2002. We expect to continue amortizing
the remaining intangible assets through approximately 2005.

9



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In-Process Research and Development.Related to our acquisition of AccessLan
in 2002, we recognized a one-time $12.4 million write-off for technology that
had not reached technological feasibility, had no alternative future use and
for which successful development was uncertain.

Securities Litigation Costs. During 2002, we recorded charges of $4.4 million
to operating expenses in connection with the settlement of a consolidated class
action and two individual non-class action securities litigation cases arising
in 1998. The charges represent the portion of the settlement that was not
funded by insurance.

Other Income.Other income decreased to $38.5 million in 2002, from $306.2
million in 2001. The decrease was primarily the result of implementing SFAS No.
133 in 2001, resulting in the reclassification of our Cisco securities from
available-for-sale to trading securities. This resulted in the recognition of
$285.7 million in unrealized gains on our Cisco investment and related hedge
contracts in 2001. Other expense in 2001 included a $2.3 million impairment of
a minority interest equity investment in a privately-held company.

Income Taxes.The effective tax rate was 32% during 2002, as compared to 38%
during 2001. The higher rate in 2001 was due to the effect of recognizing an
investment gain related to our implementation of SFAS No. 133.

Pro Forma Fair Value Information

We account for equity-based compensation plans with employees and non-employee
members of the board of directors using the intrinsic value method under APB
Opinion No. 25, Accounting for Stock Issued to Employees. We follow the
disclosure requirements of SFAS No. 123, Accounting for Stock-Based
Compensationand SFAS No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure. We use the Black-Scholes option-pricing model to
calculate the disclosure requirements. The Black-Scholes option-pricing model
was developed for use in estimating the value of traded options that have no
vesting restrictions and are fully transferable. In addition, option-pricing
models require the input of highly subjective assumptions including the
expected stock price volatility. We use projected data for expected volatility
and the expected life of stock options based on historical and other
economic data trended into future years. Our employee stock options have
characteristics significantly different from those of traded options, and
changes in the subjective input assumptions can materially affect the estimate.
In managements opinion, the existing valuation models do not provide a
reliable measure of fair value of AFCs employee stock options. See Note 11 of
the Notes to Consolidated Financial Statements for further discussion of our
equity-based compensation plans.

10



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Summary of Significant Items

AFC management takes certain significant items into consideration when
evaluating internal performance and results of operations. We exclude certain
significant items from our GAAP results of operations for budgeting purposes,
reviewing business performance and making investment decisions. We exclude
these items because we believe the resulting amounts provide a more consistent
and useful basis for comparison between periods. Significant items excluded
from our GAAP results of operations include (in thousands):

|                                  |                                             |       |   |                          |       |      |   |         |         |   |   |          |          |  
|--------------------------------- | ------------------------------------------- | ----- | - | ------------------------ | ----- | ---- | - | ------- | ------- | - | - | -------- | -------- | -
|                                  |                                             |       |   | Years Ended December 31,
|                                  |                                             |       |   |                         
|                                  |                                             |       |   | 2003                     |       | 2002 |   | 2001   
|                                  |                                             |       |   |                          |       |      |   |        
|Operating income adjustments:     |                                             |       |   |                          |       |      |   |         |         |   |   |         
|                                  | Change in warranty estimate methodology     |       | $ | (1,411                   | )     |      | $ |        |         |   | $ |         |         
|                                  | Workforce reduction and restructuring       |       |   | 6,633                    |       |      |   | 931     |         |   |   | 4,935    |         
|                                  | Impairment of completed technology          |       |   | 2,800                    |       |      |   |        |         |   |   |         |         
|                                  | Amortization of acquired intangibles        |       |   | 2,040                    |       |      |   | 3,275   |         |   |   |         |         
|                                  | In-process research & development           |       |   |                         |       |      |   | 12,423  |         |   |   |         |         
|                                  | Securities
litigation settlement costs      |       |   |                         |       |      |   | 4,443   |         |   |   |         |         
|                                  | Cost of sales for revenues not recognized   |       |   |                         |       |      |   |        |         |   |   | 4,300    |         
|                                  | Excess and obsolete inventory               |       |   |                         |       |      |   |        |         |   |   | 18,850   |         
|                                  | Purchase commitments                        |       |   |                         |       |      |   |        |         |   |   | 13,412   |         
|                                  | Provision for doubtful accounts             |       |   |                         |       |      |   |        |         |   |   | 9,251    |         
|                                  | Loss on fixed asset disposals               |       |   |                         |       |      |   |        |         |   |   | 1,412    |         
|Non-operating income adjustments: |                                             |       |   |                          |       |      |   |         |         |   |   |         
|                                  | Unrealized gains on Cisco investment        |       |   | (1,386                   | )     |      |   | (18,352 | )       |   |   | (285,729 | )       
|                                  | Investment impairment                       |       |   | 1,000                    |       |      |   |        |         |   |   | 2,275    |         
|                                  | Litigation settlement distribution payments |       |   |                         |       |      |   | (13,600 | )       |   |   | (13,600  | )       
|                                  |                                             |       |   |                          |       |      |   |         |         |   |   |         
|                                  |                                             | Total |   | $                        | 9,676 |      |   | $       | (10,880 | ) |   | $        | (244,894 | )
|                                  |                                             |       |   |                          |       |      |   |         |         |   |   |         

2003



| |  | $1.4 million for change in warranty estimate methodology during 2003;                                                      
|- |  | ---------------------------------------------------------------------------------------------------------------------------
| 
| |  | $6.6 million in expenses from severance and facility lease write-offs arising from the April 2003 workforce reduction;     
| 
| |  | $2.8 million impairment and write-down of the completed technology asset arising from the acquisition of AccessLan in 2002;
| 
| |  | $2.0 million for amortization of acquired intangibles related to the acquisition of AccessLan in 2002;                     
| 
| |  | $1.4 million in unrealized gains on our Cisco securities holdings and related hedge contracts; and                         
| 
| |  | $1.0 million impairment in our minority interest equity investment in a privately-held company.                            

2002



| |  | $0.9 million resulting from
the 2002 workforce reduction;                                                    
|- |  | -------------------------------------------------------------------------------------------------------------
| 
| |  | $3.3 million for amortization of acquired intangibles related to the acquisition of AccessLan in 2002;       
| 
| |  | $12.4 million for in-process research and development costs related to the acquisition of AccessLan in 2002; 
| 
| |  | $4.4 million related to the securities litigation settlement;                                                
| 
| |  | $18.4 million in unrealized gains on our Cisco securities holdings and related hedge contracts; and          
| 
| |  | $13.6 million distribution payment from Marconi caused by its inability to meet specified distribution goals.

2001



| |  | $4.9 million for facility lease impairment, fixed assets write-down, severance costs and foreign sales office closures in
2001;
|- |  | -------------------------------------------------------------------------------------------------------------------------------
| 
| |  | $4.3 million charged to cost of revenues related to sales not recognized in 2001;                                              
| 
| |  | $18.9 million for excess and obsolete inventory, consisting of $18.8 million to cost of revenues and $0.1                      

11



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|  |  | million to sales and marketing expenses. These charges related to the abrupt decline in customers spending, customer bankruptcy,
changes in DSL rollout and the resulting impact these had on custom inventory and obsolete inventory levels;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | $13.4 million accrued for purchase commitments related to the abrupt decline in customers capital
spending and the impact this had on forecasted needs and long-term purchase agreements with vendors;                                       
| 
| |  | $9.3 million charged to provision for doubtful accounts related to the abrupt decline in a customers
financial condition;                                                                                                                    
| 
| |  | $1.4 million for loss on disposal of information technology fixed assets resulting from a fixed asset
inventory;                                                                                                                              
| 
| |  | $285.7 million in unrealized gains on our Cisco securities holdings and related hedge contracts;                                                                                                                                              
| 
| |  | $2.3 million impairment in
our minority interest equity investment in a privately-held company;
and                                                                                                                                           
| 
| |  | $13.6 million distribution payment from Marconi caused by its inability to meet specified distribution
goals.                                                                                                                                 

Liquidity and Capital Resources

Liquidity and capital resources refers to the ability to generate cash to meet
existing and known or reasonably likely future cash requirements in
the short-term and foreseeable future. Our forecasts take into account financial resource
needs, working capital and capital expenditure requirements, and operating
lease obligations. We believe our existing cash and marketable securities and
cash flows from operating and financing activities are adequate to support our
financial needs in both the short-term and the foreseeable future.

Cash, Cash Equivalents and Marketable Securities

The following table sets forth our cash, cash equivalents and marketable
securities (in thousands):

|                                                        |  |              |       |           |  |            |       |  |  |   |        |  
|------------------------------------------------------- |  | ------------ | ----- | --------- |  | ---------- | ----- |  |  | - | ------ | -
|                                                        |  | December 31, |       |           |  |           
|                                                        |  |              |       | Increase/
|                                                        |  | 2003         |       | 2002      |  | (Decrease)
|                                                        |  |              |       |           |  |           
|Cash and cash equivalents                               |  | $            | 246.6 |           |  | $          | 94.8  |  |  | $ | 151.8  |  
|Cisco marketable securities and
related hedge contracts |  |              | 250.8 |           |  |            | 688.8 |  |  |   | (438.0 | )
|Other marketable securities                             |  |              | 594.2 |           |  |            | 215.6 |  |  |   | 378.6  |  
|Restricted cash equivalents                             |  |              | 20.0  |           |  |            | 20.0  |  |  |   |       |  

Cash and cash equivalents. The $151.8 million increase was primarily as the
result of receiving the Cisco hedge contracts settlement proceeds during 2003
and investing a portion of the proceeds in cash equivalents.

Cisco marketable securities and related hedge contracts. The $438.0 million
decrease in Cisco marketable securities and related hedge contracts was the
result of settling the Cisco hedge contracts during 2003.

At December 31, 2003, we owned 10.6 million shares of Cisco common stock. We
acquired these shares as a result of our investment in privately-held Cerent
Corporation, which was merged with Cisco on November 1, 1999. In February and
May 2000, we entered into two three-year hedge contracts for 10.1 million and
0.5 million shares of Cisco stock, respectively. We pledged all of our Cisco
stock to secure the obligations under these contracts. The purpose of these
contracts was to minimize the potential adverse market risk on the value of the
Cisco shares. These contracts provided us with the right to receive
approximately $65 per share upon delivery of up to 10.1 million Cisco shares in
February 2003 and 0.5 million Cisco shares in May 2003. The accumulated
unrealized gains on the share value and hedge contract value through May 2003
were recognized in other income.

In February 2003, the primary hedge contract covering 10.1 million shares of
Cisco stock matured. In February 2003, we entered into a stock loan agreement
with a lender. We borrowed 10.1 million shares of Cisco stock to settle the
hedge contract and received $656.2 million in cash. We retained the Cisco
shares we already owned, which were pledged as security under the new Cisco
stock loan. The $656.2 million was invested in available-for-sale municipal and
corporate debt and equity securities in accordance with our investment policy.
The 10.1 million Cisco shares we own are reflected in current assets at fair
market value. We reclassified

12



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approximately $252 million in deferred taxes related to the recognized gain on
the 10.1 million Cisco shares and related hedge contract to current taxes
payable in the first quarter of 2003. The fair market value of the Cisco stock
loan obligation is reflected as a current liability.

In May 2003, the hedge contract covering 0.5 million shares of the Cisco stock
matured. We borrowed 0.5 million shares of Cisco stock in May 2003 to settle
the hedge contract and received $34.1 million in cash. We retained the Cisco
shares we already owned, which were pledged as security under the second Cisco
stock loan. The $34.1 million was invested in available-for-sale municipal and
corporate debt and equity securities in accordance with our investment policy.
The 0.5 million Cisco shares we own are reflected in current assets at fair
market value. We reclassified approximately $13 million in deferred taxes
related to the recognized gain on the 0.5 million Cisco shares and related
hedge contract to current taxes payable during the second quarter of 2003. The
fair market value of the Cisco stock loan obligation is reflected as a current
liability.

We believe that settling the hedge contracts using borrowed shares of Cisco
stock allows for a deferral of the tax on the hedge contract gains. If we had
used our existing Cisco shares to settle the hedge contracts, the total amount
of U.S. federal and state taxes would have been approximately $265 million in
2003. We paid estimated federal and state taxes net of applicable credits on
the full amount of the gains in order to avoid potentially significant interest
and penalties should we be unable to sustain our tax position. We expect to
seek a refund on the estimated $210 million portion we believe is subject to
deferral.

In connection with borrowing the Cisco shares under the stock loans, we pay
various borrowing fees on a quarterly basis. We pay borrowing fees and a fee
adjustment based on the average daily price of Cisco stock. The majority of the
borrowing fees are expensed based on the forecasted average share price of
Cisco stock during each quarter. A portion of the borrowing fees is expensed on
a straight-line basis over the lives of the loans. We expect to incur costs of
approximately $1 million annually, net of taxes, to pursue our tax position.
These costs include legal fees and borrowing fees, which are expensed as
incurred.

Provisions in the February and May 2003 Cisco stock loans contain make-whole
fee arrangements. The make-whole fees would provide the lender with the
discounted net present value of a portion of future borrowing fees. The
make-whole fees are triggered if we assign the loans to another lender, or
terminate and enter into a similar transaction with another lender, or we are
acquired by Cisco. The make-whole fees are calculated based on the net present
value, discounted at 10% per annum, of a portion of future borrowing fees due
up to and including the seventh year. Over the next six years, the maximum
gross potential amount payable would be $2.3 million.

Other marketable securities. The $378.6 million increase arose primarily as the
result of receiving the Cisco hedge contracts settlement proceeds during 2003
and investing a portion of the proceeds in other marketable securities.

Restricted cash equivalents. $20.0 million in restricted cash equivalents and
marketable securities are held as collateral to back a three-year bond posted
for a U.S. customer contract. The bond guarantees our performance under the
contract. We will continue to earn interest at an average rate of
approximately 0.9% on the restricted cash equivalents and marketable securities
during the bond period. The $20.0 million restricted cash is recorded in other
assets on the balance sheets.

Cash Flows

The following table sets forth our cash flows (in thousands):

|                                            |  |                          |  |  |  |      |        |      |  |      |       |   |  |   |       |  
|------------------------------------------- |  | ------------------------ |  |  |  | ---- | ------ | ---- |  | ---- | ----- | - |  | - | ----- | -
|                                            |  | Years Ended December 31,
|                                            |  |                         
|                                            |  |                          |  |  |  | 2003 |        | 2002 |  | 2001
|                                            |  |                          |  |  |  |      |        |      |  |     
|Cash flows provided by operating activities |  |                          |  |  |  | $    | 507.6  |      |  | $    | 79.3  |   |  | $ | 79.4  |  
|Cash flows used in investing activities     |  |                          |  |  |  |      | (387.3 | )    |  |      | (41.0 | ) |  |   | (62.5 | )
|Cash flows provided by financing activities |  |                          |  |  |  |      | 31.5   |      |  |      | 16.9  |   |  |   | 14.2  |  

Operating activities in 2003 generated cash primarily as a result of cash
proceeds from the settlement of the Cisco stock hedge contracts, net income and
the collection of a 2002 distribution payment receivable from

13



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Marconi. Partially offsetting these was an outflow of cash paid for taxes
related to the Cisco gains. Investing activities during 2003 used cash
primarily as a result of an increase in purchases, net of sales and maturities
of marketable securities. Purchases of marketable securities included using the proceeds from the settlement of the Cisco
hedge contracts.

By comparison, operating activities in 2002 generated cash primarily from net
income, collection of the 2002 Marconi distribution payment receivable and
collection of accounts receivables. Investing activities used cash primarily as
a result of $43.4 million in cash paid to acquire AccessLan and the
collaterization of a $20 million bond for a U.S. customer contract. These uses
were partially offset by a net increase in sales and maturities of marketable
securities.

Operating activities in 2001 generated cash primarily from net income and
adjustments for non-cash activities. These adjustments included unrealized
gains resulting from SFAS No. 133 implementation and related tax expense,
increases in accounts receivable collections, increases in inventory charges,
and higher depreciation and amortization expense. Investing activities used
cash primarily as a result of a net increase in purchases of marketable
securities.

Performance Metrics

The following table sets forth additional information with respect to our
performance metrics (in thousands, except days sales outstanding (DSO) and
inventory turns):

|                |  |                          |       |      |  |   |       | 
|--------------- |  | ------------------------ | ----- | ---- |  | - | ----- | 
|                |  | Years Ended December 31,
|                |  |                         
|                |  | 2003                     |       | 2002
|                |  |                          |       |     
|DSO             |  |                          | 58    |      |  |   | 43    | 
|Inventory turns |  |                          | 8.9   |      |  |   | 5.7   | 
|Working capital |  | $                        | 863.5 |      |  | $ | 784.8 | 

The increase in DSO during 2003 was the result of decreased shipping linearity
as compared with 2002. The shipment of customers orders was relatively
constant during the quarter ended December 31, 2002. Shipments during the
quarter ended December 31, 2003 were concentrated in the final month of the
quarter, which had the effect of increasing DSO.

Inventory turns increased in 2003 as a result of better supply chain
management, utilization of inventory stock, scrapping of excess inventories and
cost containment measures as compared with 2002.

The increase in 2003 working capital was primarily a result of settling the
Cisco hedge contracts. Cash, cash equivalents and marketable securities
increased as a result of the proceeds from the hedge settlements. Deferred
taxes payable decreased as a result of paying taxes related to the Cisco gains.
To a lesser extent, the additional liability for the Cisco stock loan
agreements increased current liabilities.

By comparison, the increase in 2002 working capital was primarily a result of
decreases in our overall spending and an increase in the value of the Cisco
hedge contracts. This was partially offset by cash paid in the AccessLan
acquisition, along with the collaterization of a bond for a U.S. customer
contract.

During 2003, we evaluated how we recorded reserves for product returns,
promotional rebates and other rebates and credits. We formerly recorded returns
and other rebates and credits to accrued liabilities, and promotional rebates
to deferred revenue. We have changed to netting returns, promotional rebates
and other rebates and credits against accounts receivable. This had the effect
of decreasing the following line items by $0.7 million in our balance sheets
as of December 31, 2002:



| |  |  | Accounts receivable,                       
| | - |  | -------------------------------------------
|
| |  |  | Total assets,                              
|
| |  |  | Accrued liabilities, and                   
|
| |  |  | Total liabilities and stockholders equity.

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Borrowings

We maintain an uncommitted bank facility for the issuance of commercial and
standby letters of credit. At December 31, 2003 we had $2.3 million in letters
of credit outstanding under this facility, including $0.5 million issued as a
five-year deposit on one of our leased facilities.

We maintain agreements with two banks under which we may enter into foreign
exchange contracts up to $40.0 million. There are no borrowing provisions or
financial covenants associated with these facilities. At December 31, 2003,
there were no foreign exchange contracts outstanding.

Workforce Reduction

In April 2003, we announced a reduction in our workforce to reduce expenses and
align our cost structure with our revised business outlook. The major
components of the reduction included severance and employee related expenses,
and consolidation of excess leased facilities. The following table displays
expenditures from April 2003 through December 31, 2003 related to the workforce
reduction (in thousands):

|                                                       |  |          |   |         |  |            |       |           |  |          |        |   |  |   |   |             |  |   |       | 
|------------------------------------------------------ |  | -------- | - | ------- |  | ---------- | ----- | --------- |  | -------- | ------ | - |  | - | - | ----------- |  | - | ----- | 
|                                                       |  | Reserve  |   |         |  |            |       |           |  |          |        |   |  |   |   | Reserve    
|                                                       |  | Balance  |   |         |  |            |       |           |  |          |        |   |  |   |   | Balance    
|                                                       |  | at March |   |         |  |            |       |           |  |          |        |   |  |   |   | at December
|                                                       |  | 31, 2003 |   | Charges |  | Reductions |       | Reversals |  | 31, 2003
|                                                       |  |          |   |         |  |            |       |           |  |         
|Severance and
employee-related
expenses                |  | $        |  |         |  | $          | 2,706 |           |  | $        | (2,630 | ) |  | $ |  |             |  | $ | 76    | 
|Excess leased
facilities due to
reduction in
workforce |  |          |  |         |  |            | 3,927 |           |  |          | (2,030 | ) |  |   |  |             |  |   | 1,897 | 
|                                                       |  |          |   |         |  |            |       |           |  |          |        |   |  |   |   |             |  |   |       | 
|Total                                                  |  | $        |  |         |  | $          | 6,633 |           |  | $        | (4,660 | ) |  | $ |  |             |  | $ | 1,973 | 

Cost savings from the workforce reduction were approximately $8.1 million
through December 31, 2003. We anticipate the remaining severance
and employee-related expenses will be paid through mid 2004. The remaining expenditures
relating to the consolidation of excess leased facilities will be paid through
2009.

Stock Repurchases

In 2001, our board of directors authorized a stock repurchase plan to
repurchase up to 8.2 million issued and outstanding shares of common stock.
Repurchases may be made from time to time at our discretion, through block
trades or otherwise. The plan became effective in October 2001 and may be
suspended at any time without prior notice. As of December 31, 2003, 62,676
shares had been repurchased or reacquired under this plan.

In connection with the stock repurchase plan announced in October 2001, we
established a written trading plan in accordance with SEC Rule 10b5-1 under
which we repurchased shares of common stock, subject to conditions set forth in
the trading plan. The trading plan ran from December 1, 2002 through December
2, 2003. We have not established a new 10b5-1 plan as of March 1, 2004.

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Contractual Obligations

The following table sets forth an overview of our known contractual obligations
as of December 31, 2003 that will affect our liquidity and cash flows in future
periods:

|                                               |  |                        |         |                  |  |           |        |           |  |                   |        |  |  |   |        |  |  |   |         | 
|---------------------------------------------- |  | ---------------------- | ------- | ---------------- |  | --------- | ------ | --------- |  | ----------------- | ------ |  |  | - | ------ |  |  | - | ------- | 
|                                               |  | Payments Due by Period
|                                               |  |                       
|Contractual Obligations                        |  | Total                  |         | Less
Than 1 Year |  | 1-3 Years |        | 3-5 Years |  | More
than 5 Years
|                                               |  |                        |         |                  |  |           |        |           |  |                  
|Operating lease obligations                    |  | $                      | 57,533  |                  |  | $         | 8,947  |           |  | $                 | 16,521 |  |  | $ | 13,694 |  |  | $ | 18,371  | 
|Cisco stock loans (1)                          |  |                        | 250,786 |                  |  |           |       |           |  |                   |       |  |  |   |       |  |  |   | 250,786 | 
|Cisco stock loan borrowing
fees (1)            |  |                        | 11,517  |                  |  |           | 1,463  |           |  |                   | 3,523  |  |  |   | 3,673  |  |  |   | 2,858   | 
|Purchase commitments to
contract manufacturers |  |                        | 18,789  |                  |  |           | 18,789 |           |  |                   |       |  |  |   |       |  |  |   |        | 
|Purchase commitments to
customers              |  |                        | 2,328   |                  |  |           | 2,328  |           |  |                   |       |  |  |   |       |  |  |   |        | 
|                                               |  |                        |         |                  |  |           |        |           |  |                   |        |  |  |   |        |  |  |   |         | 
|Total                                          |  | $                      | 340,953 |                  |  | $         | 31,527 |           |  | $                 | 20,044 |  |  | $ | 17,367 |  |  | $ | 272,015 | 



|(1) |  | Contractual obligations calculated using the $23.75 per share
closing price of Cisco stock at December 26, 2003, the last trading day
of our fiscal year 2003.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

We do not have contractual obligations related to:



| |  |  | Long-term debt obligations;             
| | - |  | ----------------------------------------
|
| |  |  | Capital lease obligations; or           
|
| |  |  | Significant other long-term liabilities.

See Subsequent Events below for additional cash commitments arising after
December 31, 2003.

We sublease three of our facilities. The total future minimum lease payments
above have not been reduced by $13.7 million of future sublease payments to be
received under non-cancelable subleases.

In 2001, we vacated an engineering facility in Largo, Florida and entered into
a sublease agreement for the entire space. Our lease term continues through
2007, while the sublease agreement extends through 2004. We accrued $1.5
million to short-term and long-term liabilities for this operating lease in 2001. The amount represents the present value of the loss we
expect to incur for the ongoing shortfall between our sublease income and
operating lease obligation. If the sublessee does not renew their lease
agreement with us, and we are unable to enter into another sublease agreement
through the March 31, 2007 term of the lease obligation, the amount of the
ultimate loss based on the lease could increase by up to $1 million before tax.

Total sublease payments received in 2003, 2002 and 2001 were $3.1 million, $2.2
million and $1.5 million, respectively. Total gross rent expense for all
operating leases was $9.4 million, $9.4 million and $8.6 million for the years
ended December 31, 2003, 2002 and 2001, respectively.

The Cisco stock loan obligations are repayable with 10.6 million shares of
Cisco stock. There is no contractual dollar obligation under the loan
agreements. We intend to settle the loans using the 10.6 million Cisco shares
we own. For purposes of the contractual obligations disclosure only, we used
Ciscos share price of $23.75 as of December 26, 2003 to determine the
hypothetical value of the loan obligations assuming the loans are
settled in 2010.

The Cisco stock loan borrowing fees are partially based on Ciscos average
share price at the end of each quarter. For purposes of the contractual
obligations disclosure, we used Ciscos share price of $23.75 as of December
26, 2003 to determine the hypothetical value of the borrowing fees
assuming the loans are settled in 2010.

We have purchase agreements with contract manufacturers. Under these
agreements, the maximum liability for

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purchase commitments as of December 31, 2003 was $18.8 million, of which $0.8
million was accrued on the balance sheet. As of December 31, 2002, the maximum
liability was $18.0 million, of which $6.3 million was accrued on the balance
sheet. During the year ended December 31, 2003, we reversed
$2.5 million in reserve for purchase commitments. We made the
reversal as a result of changing the contract arrangements for the
length of time we hold inventory at CM locations. Inventory older
than a certain period of time is brought back into AFCs
inventory and the reserve for inventory covers any excess or obsolete
inventory.

We have made commitments to purchase obsolete inventory from customers. We
consider the inventory to have little to no value upon return. The maximum
liability for this inventory at December 31, 2003 was $2.3 million, of which
$2.1 million was accrued on the balance sheet. As of December 31, 2002, we did
not have a liability for any such purchase commitments to customers.

Subsequent Events

Subsequent to our 2003 fiscal year end, we made two significant cash
expenditures:



| |  |  | We paid approximately $240 million in cash during the first quarter of 2004 to
acquire NAA, a business unit, from Marconi; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We invested $2.0 million during the first quarter of 2004 in a
privately-held company.                                        

See Note 15 of the Notes to Consolidated Financial Statements for further
discussion of both transactions.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have, or are reasonably
likely to have, a current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures, or capital resources that are material to investors.

Quantitative and Qualitative Disclosures About Market Risk

Our market risk lies primarily in changes in interest rates and fluctuations in
the value of our marketable securities.

We face interest rate risk exposure on our marketable securities. Our objective
is to preserve principal. We manage interest rate risk primarily by investing
in the highest rated U.S. government, municipal and corporate debt and equity
securities having various maturities of less than four years.

At December 31, 2003, the $594.2 million marketable securities portfolio
consisted of corporate equity, and domestic municipal and government debt
securities of various issuers, types and maturities. Approximately 34% of the
debt securities mature in one year or less. At December 31, 2003, the weighted
average yield on the debt securities was 1.98% and the weighted average yield
on cash equivalents was 1.09%.

If interest rates increase, the fair market value (FMV) of the debt securities
portfolio will decrease. To quantify interest rate risk on our debt securities
portfolio, we used a modeling technique that measures the change in FMV arising
from hypothetical shifts in the yield curve of plus 50 basis points over an
immediate time horizon. The resultant effect would be a loss of $5.3 million on
our portfolio valued at $594.2 million at December 31, 2003 as compared with a
loss of $1.4 million on our portfolio valued at $215.6 million at December 31,
2002.

We have a Cisco shares liability for 10.6 million shares of Cisco common stock
borrowed and outstanding at December 31, 2003. The following table shows the
changes in fair value of the Cisco shares liability arising from a hypothetical
20% increase or decrease in Ciscos stock price. Based on the $23.75 closing
price at December 26, 2003, the last trading day of our fiscal year, the
amounts were (in thousands):

|                       |  |                |         |           |  |                |         |  |  |   |         | 
|---------------------- |  | -------------- | ------- | --------- |  | -------------- | ------- |  |  | - | ------- | 
|                       |  | Valuation -20% |         | No change |  | Valuation +20%
|                       |  |                |         |           |  |               
|Cisco shares liability |  | $              | 200,629 |           |  | $              | 250,786 |  |  | $ | 300,943 | 

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##### 



We have a Cisco shares asset for 10.6 million shares of Cisco common stock as
of December 31, 2003. The following table shows the changes in fair value of
the Cisco shares arising from a hypothetical 20% increase or decrease in
Ciscos stock price. Based on the $23.75 closing price at December 26, 2003,
the amounts were (in thousands):

|                   |  |                |         |           |  |                |         |  |  |   |         | 
|------------------ |  | -------------- | ------- | --------- |  | -------------- | ------- |  |  | - | ------- | 
|                   |  | Valuation -20% |         | No change |  | Valuation +20%
|                   |  |                |         |           |  |               
|Cisco shares asset |  | $              | 200,629 |           |  | $              | 250,786 |  |  | $ | 300,943 | 

Because we have borrowed the same number of Cisco shares as we own, we do not
have any market risk exposure to changes in the per share price of Cisco stock.

We have foreign currency sales to two international customers. We hedge
foreign currency risk on certain accounts receivable and accounts payable with
forward contracts that generally expire within 60 days. These forward currency
contracts are not designated as hedges and changes in the fair value of the
forward contracts are recognized immediately in earnings. There were no hedge
contracts outstanding at December 31, 2003.

Minority Interest

At December 31, 2003, we held a $3.3 million minority interest equity
investment in a privately-held company. We recorded a $1.0 million impairment
as a result of the companys latest fundraising round and dilution in
ownership. The company designs and manufactures telecommunications equipment.
We began investing in the company in 1999. We maintain this investment on a
cost basis and do not have the ability to exercise significant influence over
the companys operations. Our investment carries risk because the products of
this company have been in general release for a limited time. This company is
also subject to risks resulting from uncertain standards for new products and
competition. If these products fail to generate customer interest, the value
of the company would likely decline and could result in impairment of our
investment. Additionally, macroeconomic conditions and an industry capital
spending slowdown are affecting the availability of venture capital funding,
and the valuations of development stage companies. We could lose our entire
investment in this company and be required to record a charge to operations for
any loss. Our ability to earn a return on this investment is largely dependent
on the occurrence of an initial public offering, merger, or sale of the
company.

Subsequent to our 2003 fiscal year end, we made a $2.0 million minority
interest equity investment in a privately-held company. The company is one of our
vendors for components used in providing our FTTP solution, FiberDirect. The
investment is accounted for as a minority interest investment under the cost
method. We do not have significant influence over the companys management or
operations. Our investment carries risk resulting from the price-competitive
nature of the telecommunications technology manufacturing industry. We could
lose our entire investment and be required to record a loss to operations if
the company fails to succeed in the market.

18