##### 



Exhibit 13.3

ADVANCED FIBRE COMMUNICATIONS, INC.

Consolidated Statements of Operations
(in thousands, except per share data)


|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |         |         | 
|--------------------------------------------- | --------------------------------------------------- | ------------------------ | ------- | ------------------------ | ------- | ---- | ------- | ------ | ------- | - | ------- | ------- | ------- | 
|                                              |                                                     |                          |         | Years Ended December 31,
|                                              |                                                     |                          |         |                         
|                                              |                                                     |                          |         | 2003                     |         | 2002 |         | 2001  
|                                              |                                                     |                          |         |                          |         |      |         |       
|Revenues                                      |                                                     | $                        | 333,457 |                          |         | $    | 344,063 |        |         | $ | 327,569 |        
|Cost of revenues                              |                                                     |                          | 169,368 |                          |         |      | 179,957 |        |         |   | 215,956 |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|                                              |                                                     | Gross profit             |         |                          | 164,089 |      |         |        | 164,106 |   |         |         | 111,613 | 
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Operating expenses:                           |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|                                              | Research and development                            |                          |         | 66,148                   |         |      |         | 61,658 |         |   |         | 64,169  |        
|                                              | Sales and marketing                                 |                          |         | 40,512                   |         |      |         | 47,625 |         |   |         | 49,385  |        
|                                              | General and administrative                          |                          |         | 28,756                   |         |      |         | 26,370 |         |   |         | 37,323  |        
|                                              | Amortization and write-down of acquired
intangibles |                          |         | 4,840                    |         |      |         | 3,275  |         |   |         |        |        
|                                              | Securities litigation settlement costs              |                          |         |                         |         |      |         | 4,443  |         |   |         |        |        
|                                              | In-process research and development                 |                          |         |                         |         |      |         | 12,423 |         |   |         |        |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|                                              |                                                     | Total operating expenses |         |                          | 140,256 |      |         |        | 155,794 |   |         |         | 150,877 | 
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Operating income (loss)                       |                                                     |                          | 23,833  |                          |         |      | 8,312   |        |         |   | (39,264 | )      
|Other income (expense):                       |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|                                              | Interest income, net                                |                          |         | 11,361                   |         |      |         | 7,649  |         |   |         | 9,829   |        
|                                              | Unrealized gains on Cisco investment                |                          |         | 1,386                    |         |      |         | 18,352 |         |   |         | 285,729 |        
|                                              | Equity in losses of investee                        |                          |         |                         |         |      |         | (1,079 | )       |   |         | (930    | )      
|                                              | Other                                               |                          |         | (973                     | )       |      |         | 13,581 |         |   |         | 11,610  |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|                                              |                                                     | Total other income, net  |         |                          | 11,774  |      |         |        | 38,503  |   |         |         | 306,238 | 
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Income before income taxes                    |                                                     |                          | 35,607  |                          |         |      | 46,815  |        |         |   | 266,974 |        
|Income taxes                                  |                                                     |                          | 8,902   |                          |         |      | 14,981  |        |         |   | 101,450 |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Net income                                    |                                                     | $                        | 26,705  |                          |         | $    | 31,834  |        |         | $ | 165,524 |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Basic net income per share                    |                                                     | $                        | 0.31    |                          |         | $    | 0.38    |        |         | $ | 2.03    |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Shares used in basic per share computations   |                                                     |                          | 85,849  |                          |         |      | 83,380  |        |         |   | 81,381  |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Diluted net income per share                  |                                                     | $                        | 0.31    |                          |         | $    | 0.37    |        |         | $ | 1.98    |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        
|Shares used in diluted per share computations |                                                     |                          | 87,470  |                          |         |      | 85,292  |        |         |   | 83,638  |        
|                                              |                                                     |                          |         |                          |         |      |         |        |         |   |         |        

See accompanying notes to consolidated financial statements.

1



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##### 



ADVANCED FIBRE COMMUNICATIONS, INC.

Consolidated Balance Sheets
(in thousands, except share data)


|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |        |         |           | 
|------------------------------------ | ------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------------ | --------- | ---- | ------ | ------- | --------- | 
|                                     |                                       |                                                                                                                                                                                                         |                                            |        | December 31,
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |             
|                                     |                                       |                                                                                                                                                                                                         |                                            |        | 2003         |           | 2002
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |     
|Assets                               |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |       
|                                     | Current assets:                       |                                                                                                                                                                                                         |                                            |        |              |           |      |        |        
|                                     |                                       | Cash and cash equivalents                                                                                                                                                                               |                                            | $      | 246,552      |           |      | $      | 94,754  |          
|                                     |                                       | Cisco marketable securities and related hedge contracts                                                                                                                                                 |                                            |        | 250,786      |           |      |        | 688,840 |          
|                                     |                                       | Other marketable securities                                                                                                                                                                             |                                            |        | 594,230      |           |      |        | 215,624 |          
|                                     |                                       | Accounts receivable, net                                                                                                                                                                                |                                            |        | 54,464       |           |      |        | 40,723  |          
|                                     |                                       | Inventories, net                                                                                                                                                                                        |                                            |        | 18,959       |           |      |        | 30,553  |          
|                                     |                                       | Other current assets                                                                                                                                                                                    |                                            |        | 27,026       |           |      |        | 24,073  |          
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |       
|                                     |                                       |                                                                                                                                                                                                         | Total current assets                       |        |              | 1,192,017 |      |        |         | 1,094,567 | 
|                                     | Property and equipment, net           |                                                                                                                                                                                                         |                                            | 43,762 |              |           |      | 51,076 |        
|                                     | Goodwill                              |                                                                                                                                                                                                         |                                            | 55,883 |              |           |      | 56,119 |        
|                                     | Other acquired intangible assets, net |                                                                                                                                                                                                         |                                            | 1,639  |              |           |      | 5,675  |        
|                                     | Other assets                          |                                                                                                                                                                                                         |                                            | 24,415 |              |           |      | 25,555 |        
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |       
|                                     |                                       |                                                                                                                                                                                                         | Total assets                               |        | $            | 1,317,716 |      |        | $       | 1,232,992 | 
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |        |         |          
|Liabilities and Stockholders Equity |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |       
|                                     | Current liabilities:                  |                                                                                                                                                                                                         |                                            |        |              |           |      |        |        
|                                     |                                       | Accounts payable                                                                                                                                                                                        |                                            | $      | 11,112       |           |      | $      | 7,503   |          
|                                     |                                       | Accrued liabilities                                                                                                                                                                                     |                                            |        | 39,605       |           |      |        | 46,726  |          
|                                     |                                       | Cisco securities loans payable                                                                                                                                                                          |                                            |        | 250,786      |           |      |        |        |          
|                                     |                                       | Current taxes payable                                                                                                                                                                                   |                                            |        | 26,989       |           |      |        | 33,875  |          
|                                     |                                       | Deferred tax liabilities                                                                                                                                                                                |                                            |        |             |           |      |        | 221,673 |          
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |        |         |          
|                                     |                                       |                                                                                                                                                                                                         | Total current liabilities                  |        |              | 328,492   |      |        |         | 309,777   | 
|                                     | Long-term liabilities                 |                                                                                                                                                                                                         |                                            | 4,068  |              |           |      | 4,426  |        
|                                     | Commitments and contingencies         |                                                                                                                                                                                                         |                                            |        |              |           |      |        |        
|                                     | Stockholders equity:                 |                                                                                                                                                                                                         |                                            |        |              |           |      |        |        
|                                     |                                       | Preferred stock, $0.01 par value; 5,000,000 shares authorized;
no shares issued and outstanding                                                                                                         |                                            |        |             |           |      |        |        |          
|                                     |                                       | Common stock, $0.01 par value; 200,000,000 shares authorized;
87,075,296 shares issued and 87,012,620 shares outstanding
in 2003 and 84,386,969 shares issued and 84,376,169 shares
outstanding in 2002 |                                            |        | 871          |           |      |        | 844     |          
|                                     |                                       | Additional paid-in capital                                                                                                                                                                              |                                            |        | 376,394      |           |      |        | 336,542 |          
|                                     |                                       | Deferred compensation                                                                                                                                                                                   |                                            |        | (29          | )         |      |        | (833    | )        
|                                     |                                       | Accumulated other comprehensive income                                                                                                                                                                  |                                            |        | 1,560        |           |      |        | 1,880   |          
|                                     |                                       | Retained earnings                                                                                                                                                                                       |                                            |        | 607,200      |           |      |        | 580,495 |          
|                                     |                                       | Treasury stock, 62,676 in 2003 and 10,800 shares in 2002                                                                                                                                                |                                            |        | (840         | )         |      |        | (139    | )        
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |       
|                                     |                                       |                                                                                                                                                                                                         | Total stockholders equity                 |        |              | 985,156   |      |        |         | 918,789   | 
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |       
|                                     |                                       |                                                                                                                                                                                                         | Total liabilities and stockholders equity |        | $            | 1,317,716 |      |        | $       | 1,232,992 | 
|                                     |                                       |                                                                                                                                                                                                         |                                            |        |              |           |      |        |         |          

See accompanying notes to consolidated financial statements.

2



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##### 



ADVANCED FIBRE COMMUNICATIONS, INC.

Consolidated Statements of Stockholders Equity and Comprehensive Income
Years Ended December 31, 2003, 2002 and 2001 (in thousands, except share data)




|                                               |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |   | 
|---------------------------------------------- | ------------------------------------------------------------- |  | ------------ | - | -------- | - | ---------- | - | -------- | - | ------ | - |  | - | ------- | - |  | - | ---- | - | 
|                                               |                                                               |  | Outstanding  |   | Deferred |   | Additional |   |          |   |       
|                                               |                                                               |  | Common Stock |   | Compen-  |   | Paid-in    |   | Treasury
|                                               |                                                               |  | Shares       |   | Amount   |   | sation     |   | Capital  |   | Stock 
|                                               |                                                               |  |              |   |          |   |            |   |          |   |       
|Balances as of
December 31, 2000               |                                                               |  | 80,729,972   |   |          | $ | 807        |   |          | $ |       |   |  | $ | 268,003 |   |  | $ |     |  
|Exercise of common stock
options               |                                                               |  | 1,125,894    |   |          |   | 11         |   |          |   |       |   |  |   | 9,931   |   |  |   |     |  
|Employee stock purchase plan
purchases         |                                                               |  | 265,582      |   |          |   | 3          |   |          |   |       |   |  |   | 4,249   |   |  |   |     |  
|Cancellation of common stock                   |                                                               |  | (7,618       | ) |          |   |           |   |          |   |       |   |  |   |        |   |  |   |     |  
|Tax benefit from
option exercises              |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   | 5,754   |   |  |   |     |  
|Net income                                     |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   |        |   |  |   |     |  
|Other comprehensive income:                    |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  
|                                               | Foreign exchange rate
translation                             |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               | Reclassification of net
unrealized gain on
trading securities |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               | Net unrealized gain on
available-for-sale
securities (1)      |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  
|Balances as of
December 31, 2001               |                                                               |  | 82,113,830   |   |          |   | 821        |   |          |   |       |   |  |   | 287,937 |   |  |   |     |  
|Exercise of common stock
options               |                                                               |  | 2,011,992    |   |          |   | 20         |   |          |   |       |   |  |   | 13,145  |   |  |   |     |  
|Employee stock purchase
plan purchases         |                                                               |  | 263,631      |   |          |   | 3          |   |          |   |       |   |  |   | 3,872   |   |  |   |     |  
|Tax benefit from
option exercises              |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   | 9,239   |   |  |   |     |  
|Treasury stock repurchase                      |                                                               |  | (10,800      | ) |          |   |           |   |          |   |       |   |  |   |        |   |  |   | (139 | )
|Acquisition of AccessLan                       |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   | 22,381  |   |  |   |     |  
|Settlement of note
receivable from stockholder |                                                               |  | (2,484       | ) |          |   |           |   |          |   |       |   |  |   | (32     | ) |  |   |     |  
|Deferred compensation                          |                                                               |  |             |   |          |   |           |   |          |   | (3,549 | ) |  |   |        |   |  |   |     |  
|Amortization of deferred
compensation          |                                                               |  |             |   |          |   |           |   |          |   | 2,716  |   |  |   |        |   |  |   |     |  
|Net income                                     |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   |        |   |  |   |     |  
|Other comprehensive income:                    |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  
|                                               | Foreign exchange rate
translation                             |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               | Net unrealized gain on
available-for-sale
securities (1)      |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  
|Balances as of
December 31, 2002               |                                                               |  | 84,376,169   |   |          |   | 844        |   |          |   | (833   | ) |  |   | 336,542 |   |  |   | (139 | )
|Exercise of common stock
options               |                                                               |  | 2,376,221    |   |          |   | 24         |   |          |   |       |   |  |   | 27,804  |   |  |   |     |  
|Employee stock purchase
plan purchases         |                                                               |  | 307,086      |   |          |   | 3          |   |          |   |       |   |  |   | 4,385   |   |  |   |     |  
|Tax benefit from
option exercises              |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   | 7,663   |   |  |   |     |  
|Restricted stock issuance                      |                                                               |  | 5,020        |   |          |   |           |   |          |   |       |   |  |   |        |   |  |   |     |  
|Treasury stock repurchases                     |                                                               |  | (51,876      | ) |          |   |           |   |          |   |       |   |  |   |        |   |  |   | (701 | )
|Amortization of deferred
compensation          |                                                               |  |             |   |          |   |           |   |          |   | 804    |   |  |   |        |   |  |   |     |  
|Net income                                     |                                                               |  |             |   |          |   |           |   |          |   |       |   |  |   |        |   |  |   |     |  
|Other comprehensive income:                    |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  
|                                               | Foreign exchange rate
translation                             |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               | Net unrealized loss on
available-for-sale
securities (1)      |  |              |  |          |   |            |  |          |   |        |  |  |   |         |  |  |   |      |  | 
|                                               |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  
|Balances as of
December 31, 2003               |                                                               |  | 87,012,620   |   |          | $ | 871        |   |          | $ | (29    | ) |  | $ | 376,394 |   |  | $ | (840 | )
|                                               |                                                               |  |              |   |          |   |            |   |          |   |        |   |  |   |         |   |  |   |      |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |          |  
|---------------------------------------------- | ------------------------------------------------------------- | - | ----------- | - | ------- | - | ----------- | -------- | -------- | - | ------- | - | ------- | - | ------- | -------- | - | - | ------- | -------- | -
|                                               |                                                               |   |             |   |         |   | Accumulated |          |          |   |         |   |         |   |         |          |   |   |        
|                                               |                                                               |   | Notes       |   | Other   |   |             |          |          |   | Total   |   |         |   |        
|                                               |                                                               |   | Receivable  |   | Compre- |   |             |          |          |   | Stock-  |   | Compre-
|                                               |                                                               |   | From Stock- |   | hensive |   | Retained    |          | holders |   | hensive
|                                               |                                                               |   | holders     |   | Income  |   | Earnings    |          | Equity   |   | Income 
|                                               |                                                               |   |             |   |         |   |             |          |          |   |        
|Balances as of
December 31, 2000               |                                                               | $ | (56         | ) |         | $ | 167,774     |          |          | $ | 383,137 |   |         | $ | 819,665 |          |   | $ | 144,374 |         
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|Exercise of common stock
options               |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 9,942   |          |   |   |         |         
|Employee stock purchase plan
purchases         |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 4,252   |          |   |   |         |         
|Cancellation of common stock                   |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   |        |          |   |   |         |         
|Tax benefit from
option exercises              |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 5,754   |          |   |   |         |         
|Net income                                     |                                                               |   |            |   |         |   |            |          |          |   | 165,524 |   |         |   | 165,524 |          |   | $ | 165,524 |         
|Other comprehensive income:                    |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|                                               | Foreign exchange rate
translation                             |   |             |  |         |   |             | 5        |          |   |         |  |         |   |         | 5        |   |   |         | 5        |  
|                                               | Reclassification of net
unrealized gain on
trading securities |   |             |  |         |   |             | (167,426 | )        |   |         |  |         |   |         | (167,426 | ) |   |         | (167,426 | )
|                                               | Net unrealized gain on
available-for-sale
securities (1)      |   |             |  |         |   |             | 889      |          |   |         |  |         |   |         | 889      |   |   |         | 889      |  
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|Balances as of
December 31, 2001               |                                                               |   | (56         | ) |         |   | 1,242       |          |          |   | 548,661 |   |         |   | 838,605 |          |   | $ | (1,008  | )       
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|Exercise of common stock
options               |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 13,165  |          |   |   |         |         
|Employee stock purchase
plan purchases         |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 3,875   |          |   |   |         |         
|Tax benefit from
option exercises              |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 9,239   |          |   |   |         |         
|Treasury stock repurchase                      |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | (139    | )        |   |   |         |         
|Acquisition of AccessLan                       |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 22,381  |          |   |   |         |         
|Settlement of note
receivable from stockholder |                                                               |   | 56          |   |         |   |            |          |          |   |        |   |         |   | 24      |          |   |   |         |         
|Deferred compensation                          |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | (3,549  | )        |   |   |         |         
|Amortization of deferred
compensation          |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 2,716   |          |   |   |         |         
|Net income                                     |                                                               |   |            |   |         |   |            |          |          |   | 31,834  |   |         |   | 31,834  |          |   | $ | 31,834  |         
|Other comprehensive income:                    |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|                                               | Foreign exchange rate
translation                             |   |             |  |         |   |             | (2       | )        |   |         |  |         |   |         | (2       | ) |   |         | (2       | )
|                                               | Net unrealized gain on
available-for-sale
securities(1)       |   |             |  |         |   |             | 640      |          |   |         |  |         |   |         | 640      |   |   |         | 640      |  
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|Balances as of
December 31, 2002               |                                                               |   |            |   |         |   | 1,880       |          |          |   | 580,495 |   |         |   | 918,789 |          |   | $ | 32,472  |         
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|Exercise of common stock
options               |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 27,828  |          |   |   |         |         
|Employee stock purchase
plan purchases         |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 4,388   |          |   |   |         |         
|Tax benefit from
option exercises              |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 7,663   |          |   |   |         |         
|Restricted stock issuance                      |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   |        |          |   |   |         |         
|Treasury stock repurchases                     |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | (701    | )        |   |   |         |         
|Amortization of deferred
compensation          |                                                               |   |            |   |         |   |            |          |          |   |        |   |         |   | 804     |          |   |   |         |         
|Net income                                     |                                                               |   |            |   |         |   |            |          |          |   | 26,705  |   |         |   | 26,705  |          |   | $ | 26,705  |         
|Other comprehensive income:                    |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|                                               | Foreign exchange rate
translation                             |   |             |  |         |   |             | 18       |          |   |         |  |         |   |         | 18       |   |   |         | 18       |  
|                                               | Net unrealized loss on
available-for-sale
securities(1)       |   |             |  |         |   |             | (338     | )        |   |         |  |         |   |         | (338     | ) |   |         | (338     | )
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         
|Balances as of
December 31, 2003               |                                                               | $ |            |   |         | $ | 1,560       |          |          | $ | 607,200 |   |         | $ | 985,156 |          |   | $ | 26,385  |         
|                                               |                                                               |   |             |   |         |   |             |          |          |   |         |   |         |   |         |          |   |   |         |         

|                                                                           |                                                                          |   |      |     |      |   |      |     |  |   |     |     |  
|-------------------------------------------------------------------------- | ------------------------------------------------------------------------ | - | ---- | --- | ---- | - | ---- | --- |  | - | --- | --- | -
|                                                                           |                                                                          |   | 2003 |     | 2002 |   | 2001
|                                                                           |                                                                          |   |      |     |      |   |     
|(1) Net unrealized gain (loss) on available-for-sale marketable securities |                                                                          | $ | (548 | )   |      | $ | 822  |     |  | $ | 835 |    
|                                                                           | Less: deferred income taxes (benefit) related to the net
unrealized gain |   |      | 210 |      |   |      | 182 |  |   |     | (54 | )
|                                                                           |                                                                          |   |      |     |      |   |      |     |  |   |     |    
|                                                                           |                                                                          | $ | (338 | )   |      | $ | 640  |     |  | $ | 889 |    
|                                                                           |                                                                          |   |      |     |      |   |      |     |  |   |     |    

See accompanying notes to consolidated financial statements.

3



---



##### 



ADVANCED FIBRE COMMUNICATIONS, INC.

Consolidated Statements of Cash Flows
(in thousands)


|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |         |   |          |         |  
|------------------------------------------------ | --------------------------------------------------------------------------------- | - | ---------------------------------------------------------------------------------- | ----------------------------------------- | - | ------------------------ | -------- | ------ | - | -------- | ------- | ------- | - | -------- | ------- | -
|                                                 |                                                                                   |   |                                                                                    |                                           |   | Years Ended December 31,
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                         
|                                                 |                                                                                   |   |                                                                                    |                                           |   | 2003                     |          | 2002   |   | 2001    
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |         
|Cash Flows from Operating Activities:            |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 | Net income                                                                        |   | $                                                                                  | 26,705                                    |   |                          | $        | 31,834 |   |          | $       | 165,524 |  
|                                                 | Adjustments to reconcile net income to net cash provided by
operating activities: |   |                                                                                    |                                           |   |                          |          |        |   |          |         |         |  
|                                                 |                                                                                   |   | Cash proceeds from settlement of Cisco hedge contracts                             |                                           |   | 690,226                  |          |        |   |         |         |         |   |         |        
|                                                 |                                                                                   |   | Deferred income taxes                                                              |                                           |   | (243,521                 | )        |        |   | 541      |         |         |   | (23,488  | )      
|                                                 |                                                                                   |   | Deferred income taxes related to SFAS No. 133 reclassification of Cisco investment |                                           |   |                         |          |        |   |         |         |         |   | 106,766  |        
|                                                 |                                                                                   |   | Depreciation and amortization                                                      |                                           |   | 18,376                   |          |        |   | 20,266   |         |         |   | 19,422   |        
|                                                 |                                                                                   |   | Tax benefit from option exercises                                                  |                                           |   | 7,663                    |          |        |   | 9,239    |         |         |   | 5,754    |        
|                                                 |                                                                                   |   | Current income taxes                                                               |                                           |   | (6,886                   | )        |        |   | 10,919   |         |         |   | 8,093    |        
|                                                 |                                                                                   |   | Reserve for returns, rebates and credits                                           |                                           |   | 4,787                    |          |        |   | 106      |         |         |   | (1,171   | )      
|                                                 |                                                                                   |   | Interest receivable                                                                |                                           |   | (4,177                   | )        |        |   | 376      |         |         |   | 324      |        
|                                                 |                                                                                   |   | Reserve for write-down of inventories                                              |                                           |   | 3,868                    |          |        |   | 2,502    |         |         |   | 25,449   |        
|                                                 |                                                                                   |   | Loss on disposal of fixed assets                                                   |                                           |   | 3,376                    |          |        |   | 972      |         |         |   | 4,901    |        
|                                                 |                                                                                   |   | Write-down of impaired intangible asset                                            |                                           |   | 2,800                    |          |        |   |         |         |         |   |         |        
|                                                 |                                                                                   |   | Reserve for purchase commitments                                                   |                                           |   | (2,450                   | )        |        |   | (911     | )       |         |   | 13,412   |        
|                                                 |                                                                                   |   | Unrealized gains on Cisco investment                                               |                                           |   | (1,386                   | )        |        |   | (18,351  | )       |         |   | (285,729 | )      
|                                                 |                                                                                   |   | Write-down of impaired investment                                                  |                                           |   | 1,000                    |          |        |   |         |         |         |   | 2,275    |        
|                                                 |                                                                                   |   | Allowance for doubtful accounts                                                    |                                           |   | 407                      |          |        |   | 850      |         |         |   | 10,261   |        
|                                                 |                                                                                   |   | Other non-cash adjustments to operating income                                     |                                           |   | 18                       |          |        |   | 16       |         |         |   | 5        |        
|                                                 |                                                                                   |   | In-process research and development                                                |                                           |   |                         |          |        |   | 12,423   |         |         |   |         |        
|                                                 |                                                                                   |   | Equity in losses of investee, net of tax                                           |                                           |   |                         |          |        |   | 734      |         |         |   | 577      |        
|                                                 |                                                                                   |   | Changes in operating assets and liabilities:                                       |                                           |   |                          |          |        |   |          |         |         |   |          |        
|                                                 |                                                                                   |   |                                                                                    | Accounts receivable                       |   |                          | (18,699  | )      |   |          | 16,761  |         |   |          | 30,953  |  
|                                                 |                                                                                   |   |                                                                                    | Inventories                               |   |                          | 7,726    |        |   |          | (2,980  | )       |   |          | 5,275   |  
|                                                 |                                                                                   |   |                                                                                    | Other current assets                      |   |                          | 18,895   |        |   |          | 90      |         |   |          | (5,690  | )
|                                                 |                                                                                   |   |                                                                                    | Other assets                              |   |                          | 303      |        |   |          | 1,666   |         |   |          | 1,368   |  
|                                                 |                                                                                   |   |                                                                                    | Accounts payable                          |   |                          | 3,609    |        |   |          | (3,027  | )       |   |          | (9,951  | )
|                                                 |                                                                                   |   |                                                                                    | Accrued and other liabilities             |   |                          | (5,029   | )      |   |          | (4,688  | )       |   |          | 5,096   |  
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   |                                                                                    | Net Cash Provided by Operating Activities |   |                          | 507,611  |        |   |          | 79,338  |         |   |          | 79,426  |  
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|Cash Flows from Investing Activities:            |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   | Purchases of other marketable securities                                           |                                           |   | (5,280,430               | )        |        |   | (566,187 | )       |         |   | (627,140 | )      
|                                                 |                                                                                   |   | Sales of other marketable securities                                               |                                           |   | 4,522,500                |          |        |   | 454,474  |         |         |   | 306,406  |        
|                                                 |                                                                                   |   | Maturities of other marketable securities                                          |                                           |   | 382,965                  |          |        |   | 145,048  |         |         |   | 283,668  |        
|                                                 |                                                                                   |   | Purchase of property and equipment, net of disposals                               |                                           |   | (12,362                  | )        |        |   | (11,218  | )       |         |   | (12,921  | )      
|                                                 |                                                                                   |   | Acquisition, net of cash acquired                                                  |                                           |   |                         |          |        |   | (42,978  | )       |         |   |         |        
|                                                 |                                                                                   |   | Restricted investment                                                              |                                           |   |                         |          |        |   | (20,120  | )       |         |   |         |        
|                                                 |                                                                                   |   | Other long-term investments                                                        |                                           |   |                         |          |        |   |         |         |         |   | (12,473  | )      
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   |                                                                                    | Net Cash Used in Investing Activities     |   |                          | (387,327 | )      |   |          | (40,981 | )       |   |          | (62,460 | )
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|Cash Flows from Financing Activities:            |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   | Proceeds from common stock issuances                                               |                                           |   | 32,215                   |          |        |   | 17,008   |         |         |   | 14,194   |        
|                                                 |                                                                                   |   | Purchase of treasury stock                                                         |                                           |   | (701                     | )        |        |   | (139     | )       |         |   |         |        
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   |                                                                                    | Net Cash Provided by Financing Activities |   |                          | 31,514   |        |   |          | 16,869  |         |   |          | 14,194  |  
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|Increase in Cash and Cash Equivalents            |                                                                                   |   | 151,798                                                                            |                                           |   |                          | 55,226   |        |   |          | 31,160  |        
|Cash and Cash Equivalents, Beginning of the Year |                                                                                   |   | 94,754                                                                             |                                           |   |                          | 39,528   |        |   |          | 8,368   |        
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|Cash and Cash Equivalents, End of Year           |                                                                                   | $ | 246,552                                                                            |                                           |   | $                        | 94,754   |        |   | $        | 39,528  |        
|                                                 |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|Supplementary Cash Flow Information:             |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   | Income (taxes) refund                                                              |                                           | $ | (245,232                 | )        |        | $ | 5,533    |         |         | $ | (4,784   | )      
|                                                 |                                                                                   |   | Interest income                                                                    |                                           |   | 9,795                    |          |        |   | 8,120    |         |         |   | 10,080   |        
|Non-Cash Investing and Financing Activity        |                                                                                   |   |                                                                                    |                                           |   |                          |          |        |   |          |         |        
|                                                 |                                                                                   |   | Cisco stock loans                                                                  |                                           | $ | 250,786                  |          |        | $ |         |         |         | $ |         |        
|                                                 |                                                                                   |   | Common stock options issued for acquisition                                        |                                           |   |                         |          |        |   | 22,381   |         |         |   |         |        

See accompanying notes to consolidated financial statements.

4



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##### 



ADVANCED FIBRE COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements

Note 1. Description of Business and Summary of Significant Accounting
Policies

We develop, manufacture and support a family of telecommunications access
solutions and services. We are an access market provider, delivering
multiservice broadband solutions to the global telecommunications industry. Our
comprehensive portfolio provides carriers with solutions, including
the delivery of the triple play: voice, video and high-speed Internet/data
delivered over a single network infrastructure. AFCs suite of access solutions
includes: AdvancedVoiceSM, which provides both legacy and packet-based voice
solutions; FiberDirectSM, an innovative Fiber-to-the-Premises (FTTP) offering
that enables carriers to deploy a high-capacity all-fiber network;
TelcoVideoSM, a solution that delivers advanced voice, high-speed Internet,
video and other entertainment services; and UniversalDSLSM, which delivers
digital subscriber line (DSL) technology in multiple deployment options and
configurations. Our suite of access solutions incorporates elements of our core
product portfolio, which includes:



| |  |  | AccessMAX,                                
| | - |  | -------------------------------------------
|
| |  |  | Telliant,                                 
|
| |  |  | TransMAX,                                 
|
| |  |  | PremMAX,                                  
|
| |  |  | AFCs network management
system, Panorama,
|
| |  |  | Professional Services, and                 
|
| |  |  | Plant cabinets and technologies.           

Fiscal Year

Our fiscal year is comprised of four 13-week fiscal quarters ending on the last
Saturday of each fiscal period. For presentation purposes only, the fiscal year
and quarters are shown as ending on the last day of the month of each fiscal
period.

Basis of Consolidation

The consolidated financial statements include the accounts of AFC and
subsidiaries. All significant intercompany balances and transactions have been
eliminated.

Critical Accounting Policies and Estimates

Some business transactions are subject to uncertainty and are recorded using
estimates and our best judgment at any given time, within the parameters of
GAAP. The following critical accounting policies require us to make significant
estimates and judgments in connection with the preparation of our consolidated
financial statements.

Estimates in Financial Statements. The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, to disclose contingent
assets and liabilities at the date of the financial statements and to report
amounts of revenues and expenses during the reporting period. Actual results
could differ from our estimates. Such estimates include allowance for customer
returns, allowance for doubtful accounts, reserve for warranty and reserve for
inventories.

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;

5



---



##### 





| |  |  | 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 current presentation reflects interest
receivable in other marketable securities.                                                     

We originally made an investment in AccessLan Communications, Inc. (AccessLan)
during 2001, accounted for using the cost method of accounting. Effective April
1, 2002, after exercising our option to purchase the remaining interests in
AccessLan, we changed the method of accounting from the cost method to the
equity method. We retroactively applied the equity method for our ownership
interest from the date of our initial investment as required under
Accounting Principles Board (APB) Opinion
No. 18, The Equity Method of Accounting for Investments in Common Stock. This
resulted in reductions to net income of $0.7 million for the four and a half
months through May 13, 2002, and $0.6 million for the year ended December 31,
2001.

Revenue Recognition and Allowances. We recognize revenue when the earnings
process is complete, in compliance with the Securities and Exchange Commission
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 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.

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. 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 customers 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 customers 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. A majority of the allowance is a combination of
specific and general reserves based on historical write-offs of bad debt. We
base our allowance

6



---



##### 



on periodic 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. Another portion of the
allowance includes a reserve for customer credit memos for pricing and shipping
errors.

Warranty Costs.Our products are generally covered by a warranty for periods of
two years, and for some customers, five years. 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. 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.

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

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.

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 primarily on future demand forecasts.
The reserve is assessed continuously and adjusted on a quarterly basis.

7



---



##### 



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 APB Opinion
No. 25, Accounting for Stock Issued to Employees. If compensation expense for
our 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, net income would have been reduced to the approximate pro
forma amounts as follows (in thousands, except per share data):

|                                                                                                                               |                       |   |                          |       |      |   |         |       |   |   |         |      | 
|------------------------------------------------------------------------------------------------------------------------------ | --------------------- | - | ------------------------ | ----- | ---- | - | ------- | ----- | - | - | ------- | ---- | 
|                                                                                                                               |                       |   | Years Ended December 31,
|                                                                                                                               |                       |   |                         
|                                                                                                                               |                       |   | 2003                     |       | 2002 |   | 2001   
|                                                                                                                               |                       |   |                          |       |      |   |        
|Net income, as reported                                                                                                        |                       | $ | 26,705                   |       |      | $ | 31,834  |       |   | $ | 165,524 |     
|Stock-based employee compensation expense
included in reported net income,
net of related tax effects                          |                       |   | 603                      |       |      |   | 1,847   |       |   |   |        |     
|Total stock-based employee compensation
expense determined under fair value methods
for all awards, net of related tax effects |                       |   | (36,191                  | )     |      |   | (40,140 | )     |   |   | (59,368 | )   
|                                                                                                                               |                       |   |                          |       |      |   |         |       |   |   |         |     
|Pro forma net income (loss)                                                                                                    |                       | $ | (8,883                   | )     |      | $ | (6,459  | )     |   | $ | 106,156 |     
|                                                                                                                               |                       |   |                          |       |      |   |         |       |   |   |         |     
|Earnings (loss) per share:                                                                                                     |                       |   |                          |       |      |   |         |       |   |   |         |     
|                                                                                                                               | Basic - as reported   |   | $                        | 0.31  |      |   | $       | 0.38  |   |   | $       | 2.03 | 
|                                                                                                                               | Basic - pro forma     |   |                          | (0.10 | )    |   |         | (0.08 | ) |   |         | 1.30 | 
|                                                                                                                               | Diluted - as reported |   |                          | 0.31  |      |   |         | 0.37  |   |   |         | 1.98 | 
|                                                                                                                               | Diluted - pro forma   |   |                          | (0.10 | )    |   |         | (0.08 | ) |   |         | 1.27 | 

See Note 11 for discussion of the assumptions used in the Pro Forma Fair Value
disclosure.

Other Significant Accounting Policies

Cash and Cash Equivalents. We consider all highly liquid investments in debt
instruments with original maturities of three months or less to be cash
equivalents. Cash and cash equivalents are generally invested in money market
securities.

Restricted Cash. Restricted cash equivalents and marketable securities of $20
million are included in other assets. The cash equivalents and marketable
securities are held as collateral to back a three-year bond posted for a U.S.
customer contract. Interest earned on the restricted cash equivalents and
marketable securities during the three year period ending in 2005 is not
restricted.

Marketable securities. Our marketable securities are reported at fair value and
are classified as trading or available-for-sale. Changes in the fair value of
trading securities are reported in other income. Changes in the fair value of
available-for-sale securities are reported in accumulated other comprehensive income.

Property and Equipment. Property and equipment are recorded at cost. We compute
depreciation using the straight-line method over the estimated useful lives.
Useful lives are generally three years for computers and internal use software,
and seven years for office, furniture and fixtures and engineering
equipment.

Long-Lived Assets. We evaluate long-lived assets in accordance with SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assetsfor
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be fully recoverable. Assets are assessed
based on factors specific to each type of asset. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of an asset to
the potential future income expected to be generated by the asset. If an asset
is considered to be impaired, it is written down to its market value. We used a
fair value model to determine the amount of impairment on our investment in a
privately-held company.

Goodwill and Other Acquired Intangibles. In addition to following the guidance
in SFAS No. 144, we also have adopted SFAS No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
the purchase method of accounting be used and establishes new standards for the
recognition of certain identifiable intangible assets, separate from goodwill,
for business combinations.

8



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SFAS No. 142 requires that goodwill and intangible assets with indefinite
useful lives be tested for impairment at least annually. Amortization of such
assets is no longer allowed. SFAS No. 142 also requires that intangible assets
with finite useful lives be amortized over their respective estimated useful
lives to their estimated residual values. During 2003, we performed an
impairment analysis on the completed technology intangible asset acquired in
the acquisition of AccessLan. We performed a discounted cash flow analysis of
the forecasted revenues and cost of revenues for products based on the
technology. We determined that the asset was impaired and recorded a $2.8
million charge, reducing other acquired intangible assets in the balance sheet
to their estimated fair value and increasing the expense recorded to
amortization and write-down of acquired intangibles in the statement of
operations.

Other Assets. Other assets principally include marketable securities held as
collateral for a U.S. customer contract bond and a minority interest equity
investment in a privately-held company accounted for under the cost method. We
own less than twenty percent in the company and do not have significant
influence over its operating or financial policies.

Income Taxes. We account for income taxes using the asset and liability method.
Under this method, deferred tax assets and liabilities are recognized based on
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.

Advertising Costs. We expense all advertising costs as incurred, which totaled
$1.9 million and $0.8 million in the years ended December 31, 2003 and 2002,
respectively.

Repurchases of Common Stock. We have 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 various prices in the open market, through block
trades or otherwise. The purpose of the repurchase plan is to help us achieve
our long-term goal of enhancing shareholder value.

Derivative Instruments and Hedging Activities

We have adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and SFAS No. 138, Accounting for Certain Derivative Instruments and
Certain Hedging Activities, which require the recognition of all derivatives as
either assets or liabilities in the balance sheet, measured at fair value. When
circumstances arise, we use foreign exchange contracts to offset gains and
losses on exchange rate fluctuations against gains and losses on hedged assets
or liabilities. There were no hedge contracts outstanding at December 31,
2003.

Net Income Per Share

Basic net income per share is computed using the weighted average number of
shares of common stock outstanding during the period. Diluted net income per
share is computed using the weighted average number of shares of common stock
outstanding, plus dilutive common stock equivalents during the period. Dilutive
common stock equivalents consist of stock options to purchase common stock and
contributions to the Employee Stock Purchase Plan using the treasury stock
method.

Foreign Currency Translation

Operations conducted in our foreign offices are transacted in their local
currencies. Assets and liabilities are translated into U.S. dollars using
exchange rates in effect at the balance sheet date, and income and expense
amounts are translated at weighted average exchange rates during the year.
Translation adjustments are recorded to accumulated other comprehensive income in the
equity section of the balance sheet.

Certain Risks and Concentrations

Our primary exposure to credit risk arises from trade
accounts receivable. To reduce credit risk, we perform ongoing credit
evaluations of our customers financial condition. In some cases, we may
require customer prepayment, bank guarantees or letters of credit and, if
necessary, we put customers on

9



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credit hold. We maintain adequate allowances for potential credit losses. Our
customers are concentrated in the public carrier telecommunications industry.
Our five largest customers accounted for 75% and 39% of our gross accounts
receivable at December 31, 2003 and 2002, respectively. Although our largest
customers have varied from period to period, we anticipate that receivables in
any given period will continue to be concentrated among a small number of
customers. Recent severe financial problems affecting the telecommunications
industry in general may continue to result in slower payments or defaults on
accounts receivable. To reduce the foreign receivables currency risk, we use
foreign exchange hedge contracts in certain situations where the risk is
material.

Our products are concentrated in the telecommunications equipment market, which
is highly competitive and subject to change. Significant technological changes
in the industry could adversely affect our operating results. Our inventories
include components that may be specialized in nature, and subject to rapid
technological obsolescence. We actively manage our inventory levels, and we
consider technological obsolescence and potential changes in product demand
when estimating allowances to reduce recorded inventory amounts to market
value. Such estimates could change in the future.

Our growth and ability to meet customer demands are also dependent on our
ability to obtain timely deliveries of components from our suppliers. We
currently purchase certain key components from sole or limited-source vendors.
Most of our component purchases are on a purchase order basis without
guaranteed supply arrangements. Some of our sole and limited-source vendors
allocate parts to multiple telecommunications equipment manufacturers based on
market demand for components and equipment. This may result in shortages of
certain key components sold to us. In the event of a disruption in
supply, we may not be able to identify an alternative source in a timely
manner, at favorable prices or of acceptable quality.

Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46
requires a company to consolidate a variable interest entity if the company is
subject to the majority of the risk of loss from the entitys activities, is
entitled to a majority of the entitys residual returns, or both. This
Interpretation became effective for AFC in the fourth quarter of 2003.
Adoption of the Interpretation has not had a material impact on our financial
position or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities under SFAS
No. 133. This Statement became effective for AFC in the third quarter of 2003.
Adoption of the Statement has not had a material impact on our financial
position or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity.SFAS No. 150
provides guidance on how a company classifies and measures certain financial
instruments with characteristics of both liabilities and equity. Under
previous guidance, a company could account for these financial instruments as
equity. The Statement requires that a company classify a financial instrument
that is within its scope as a liability, or as an asset in some circumstances.
This Statement became effective for AFC in the third quarter of 2003. Adoption
of the Statement has not had a material impact on our financial position or
results of operations.

10



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Note 2. Accounts Receivable

Accounts receivable are comprised of the following (in thousands):

|                                                                      |                         |   |              |        |      |   |        |        | 
|--------------------------------------------------------------------- | ----------------------- | - | ------------ | ------ | ---- | - | ------ | ------ | 
|                                                                      |                         |   | December 31,
|                                                                      |                         |   |             
|                                                                      |                         |   | 2003         |        | 2002
|                                                                      |                         |   |              |        |     
|Accounts receivable                                                   |                         | $ | 60,622       |        |      | $ | 42,199 |       
|Reserve for product returns                                           |                         |   | (2,047       | )      |      |   | (657   | )     
|Reserve for promotional rebates                                       |                         |   | (1,364       | )      |      |   |       |       
|Reserve for other rebates & credits                                   |                         |   | (2,028       | )      |      |   |       |       
|                                                                      |                         |   |              |        |      |   |        |       
|Accounts receivable, net of reserves for
returns, rebates and credits |                         |   | 55,183       |        |      |   | 41,542 |       
|Allowance for doubtful accounts                                       |                         |   | (719         | )      |      |   | (819   | )     
|                                                                      |                         |   |              |        |      |   |        |       
|                                                                      | Net accounts receivable |   | $            | 54,464 |      |   | $      | 40,723 | 
|                                                                      |                         |   |              |        |      |   |        |       

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 these against accounts
receivable, for 2002 most balances were also reclassified for
comparative purposes.

Note 3. Marketable Securities

Marketable securities are valued at fair market value, and are comprised of the
following (in thousands):

|                               |                                         |                             |   |              |         |      |   |         |         | 
|------------------------------ | --------------------------------------- | --------------------------- | - | ------------ | ------- | ---- | - | ------- | ------- | 
|                               |                                         |                             |   | December 31,
|                               |                                         |                             |   |             
|                               |                                         |                             |   | 2003         |         | 2002
|                               |                                         |                             |   |              |         |     
|Trading securities:            |                                         |                             |   |              |         |      |   |        
|                               | Corporate equity securities             |                             | $ | 250,786      |         |      | $ | 688,840 |        
|Available-for-sale securities: |                                         |                             |   |              |         |      |   |        
|                               | Municipal and corporate debt securities |                             |   | 594,230      |         |      |   | 215,624 |        
|                               |                                         |                             |   |              |         |      |   |        
|                               |                                         | Total marketable securities |   | $            | 845,016 |      |   | $       | 904,464 | 
|                               |                                         |                             |   |              |         |      |   |         |        

Trading Securities

Trading securities consist of the 10.6 million shares of Cisco Systems, Inc.
(Cisco) common stock we owned at December 31, 2003. We acquired these shares as
a result of an investment in privately-held Cerent Corporation, which was
merged with Cisco in 1999. In 2000, we entered into hedge contracts to minimize
the impact of potential adverse market risk on the Cisco stock we own.

We held the Cisco shares as
available-for-sale until 2001, when we implemented
SFAS No. 133. We reclassified the shares to trading and reclassified the gains
on the Cisco shares and the related hedge contracts from accumulated other
comprehensive income to non-operating income. As a result of SFAS No. 133, we
recognized $1.4 million, $18.4 million and $285.7 million in unrealized gains
during 2003, 2002 and 2001, respectively.

The hedge contracts matured in 2003 and we borrowed 10.6 million shares of
Cisco stock under two stock loans to settle the contracts. We retained the
Cisco shares we already owned, which were pledged as security under the new
Cisco stock loans.

11



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Available-For-Sale Securities

A summary of available-for-sale securities follows (in thousands):

|                                                                      |  |              |         |      |  |   |         | 
|--------------------------------------------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | 
|                                                                      |  | December 31,
|                                                                      |  |             
|                                                                      |  | 2003         |         | 2002
|                                                                      |  |              |         |     
|Amortized cost of securities                                          |  | $            | 592,548 |      |  | $ | 213,394 | 
|Unrealized gains recognized in accumulated
other comprehensive income |  |              | 1,682   |      |  |   | 2,230   | 
|                                                                      |  |              |         |      |  |   |         | 
|Fair value                                                            |  | $            | 594,230 |      |  | $ | 215,624 | 
|                                                                      |  |              |         |      |  |   |         | 

The fair value of securities maturing in one year or less and those maturing
between one year and five years was $202.2 million and $392.0 million,
respectively, as of December 31, 2003.

A summary of gains, losses and
interest income recognized in the Statements of Operations follows
(in thousands):

|                |  |              |        |      |  |   |       |  
|--------------- |  | ------------ | ------ | ---- |  | - | ----- | -
|                |  | December 31,
|                |  |             
|                |  | 2003         |        | 2002
|                |  |              |        |     
|Realized
gains  |  | $            | 869    |      |  | $ | 369   |  
|Realized
losses |  |              | (3     | )    |  |   | (63   | )
|Interest
income |  |              | 13,811 |      |  |   | 7,491 |  

Note 4. Cisco Stock Loan Fees

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. During 2003, we paid $0.8
million in borrowing fees.

Provisions in the 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.

Note 5. Bank Borrowings

We maintain an uncommitted bank facility for the issuance of commercial and
standby letters of credit. As of 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 for up to $40 million. There are no borrowing
provisions or financial covenants associated with these facilities. At December
31, 2003, there were no foreign exchange contracts outstanding.

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Note 6. Inventories

The major components of inventories are comprised of the following (in
thousands):

|                                          |                   |   |              |        |      |   |         |        | 
|----------------------------------------- | ----------------- | - | ------------ | ------ | ---- | - | ------- | ------ | 
|                                          |                   |   | December 31,
|                                          |                   |   |             
|                                          |                   |   | 2003         |        | 2002
|                                          |                   |   |              |        |     
|Raw materials                             |                   | $ | 13,558       |        |      | $ | 16,028  |       
|Reserve for raw materials                 |                   |   | (3,852       | )      |      |   | (6,109  | )     
|                                          |                   |   |              |        |      |   |         |       
|Net raw materials                         |                   |   | 9,706        |        |      |   | 9,919   |       
|Work-in-progress                          |                   |   | 1,314        |        |      |   | 1,152   |       
|Finished goods                            |                   |   | 17,146       |        |      |   | 24,474  |       
|Reserve for finished goods                |                   |   | (9,413       | )      |      |   | (10,966 | )     
|                                          |                   |   |              |        |      |   |         |       
|Net finished goods                        |                   |   | 7,733        |        |      |   | 13,508  |       
|Inventory consigned to others             |                   |   | 2,083        |        |      |   | 3,346   |       
|Reserve for inventory consigned to others |                   |   | (2,040       | )      |      |   | (2,487  | )     
|                                          |                   |   |              |        |      |   |         |       
|Net inventory consigned to others         |                   |   | 43           |        |      |   | 859     |       
|Other                                     |                   |   | 163          |        |      |   | 5,115   |       
|                                          |                   |   |              |        |      |   |         |       
|                                          | Total inventories |   | $            | 18,959 |      |   | $       | 30,553 | 
|                                          |                   |   |              |        |      |   |         |       

Note 7. Property and Equipment

A summary of property and equipment follows (in thousands):

|                                        |  |              |         |      |  |   |         |  
|--------------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                                        |  | December 31,
|                                        |  |             
|                                        |  | 2003         |         | 2002
|                                        |  |              |         |     
|Furniture and fixtures                  |  | $            | 14,469  |      |  | $ | 16,241  |  
|Computer, software and office equipment |  |              | 31,912  |      |  |   | 36,563  |  
|Engineering equipment                   |  |              | 56,251  |      |  |   | 57,046  |  
|                                        |  |              |         |      |  |   |         |  
|Gross property and equipment            |  |              | 102,632 |      |  |   | 109,850 |  
|Less: accumulated depreciation          |  |              | (58,870 | )    |  |   | (58,774 | )
|                                        |  |              |         |      |  |   |         |  
|Property and equipment, net             |  | $            | 43,762  |      |  | $ | 51,076  |  
|                                        |  |              |         |      |  |   |         |  

Depreciation expense for the years ended December 31, 2003 and 2002 were $16.3
million and $17.0 million, respectively. Gross property and equipment includes
$19.2 million in assets that are no longer being depreciated at December 31,
2003.

Note 8. Investment

We have a minority interest equity investment in a privately-held company.
During the companys most recent round of fund raising, we performed an
analysis of the equity offered. Using a fair value model, we determined that
the offering price per share was below the cost per share we had recorded for
our investment. We concluded that an other-than-temporary impairment in the
value of the investment had occurred and recorded a $1.0 million impairment and
write-down, reflected in other income, net. The resulting $3.3 million net
investment balance is included in other assets in the December 31, 2003 balance
sheet.

13



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Note 9. Accrued Liabilities

A summary of accrued liabilities follows (in thousands):

|                                               |  |              |        |      |  |   |        |  
|---------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                                               |  | December 31,
|                                               |  |             
|                                               |  | 2003         |        | 2002
|                                               |  |              |        |     
|Salaries and benefits                          |  | $            | 12,024 |      |  | $ | 12,926 |  
|Warranty                                       |  |              | 11,117 |      |  |   | 15,097 |  
|Facility losses                                |  |              | 2,325  |      |  |   | 1,576  |  
|Outside services                               |  |              | 2,155  |      |  |   | 598    |  
|Purchase commitments to customers              |  |              | 2,076  |      |  |   |       |  
|Purchase commitments to contract
manufacturers |  |              | 812    |      |  |   | 6,337  |  
|Deferred revenues                              |  |              | 990    |      |  |   | 2,314  |  
|Business and sales taxes                       |  |              | 432    |      |  |   | (266   | )
|Other accruals                                 |  |              | 7,674  |      |  |   | 6,644  |  
|Securities litigation settlement               |  |              |       |      |  |   | 1,500  |  
|                                               |  |              |        |      |  |   |        |  
|Total accrued liabilities                      |  | $            | 39,605 |      |  | $ | 46,726 |  
|                                               |  |              |        |      |  |   |        |  

We formerly recorded returns and other rebates and credits to accrued
liabilities. During 2003, we changed to netting returns and other rebates and
credits against accounts receivable.

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 reserve was booked to
accrued liabilities. The following table displays expenditures from April 2003
through December 31, 2003 and the ending reserve balance (in thousands):

|                                                       |  |          |   |         |  |            |       |           |  |          |        |   |  |   |   |            |  |   |       | 
|------------------------------------------------------ |  | -------- | - | ------- |  | ---------- | ----- | --------- |  | -------- | ------ | - |  | - | - | ---------- |  | - | ----- | 
|                                                       |  | Reserve  |   |         |  |            |       |           |  |          |        |   |  |   |   | Reserve   
|                                                       |  | Balance  |   |         |  |            |       |           |  |          |        |   |  |   |   | Balance at
|                                                       |  | at March |   |         |  |            |       |           |  |          |        |   |  |   |   | 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 | 

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.

14



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##### 



Note 10. Income Taxes

A summary of the components of income taxes (benefit) follows (in thousands):

|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 
|----------------------------- | ------- | - | ------- | ------- | ----------- | - | -------- | -------- | ----- | - | --------- | ----- |  | - | ------- | ------ | 
|                              |         |   |         |         |             |   |          |          |       |   | Charge in |       |  |   |        
|                              |         |   |         |         |             |   |          |          |       |   | Lieu of   |       |  |   |        
|                              |         |   |         |         |             |   |          |          |       |   | Income    |       |  |   |        
|                              |         |   | Current |         | Deferred(1) |   | Taxes(2) |          | Total
|                              |         |   |         |         |             |   |          |          |      
|Year ended December 31, 2003: |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |       
|                              | Federal |   | $       | 217,916 |             |   | $        | (217,213 | )     |   | $         | 6,952 |  |   | $       | 7,655  | 
|                              | State   |   |         | 26,844  |             |   |          | (26,308  | )     |   |           | 711   |  |   |         | 1,247  | 
|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 
|                              |         | $ | 244,760 |         |             | $ | (243,521 | )        |       | $ | 7,663     |       |  | $ | 8,902   |       
|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 
|Year ended December 31, 2002: |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |       
|                              | Federal |   | $       | (416    | )           |   | $        | 5,254    |       |   | $         | 8,271 |  |   | $       | 13,109 | 
|                              | State   |   |         | 5,617   |             |   |          | (4,713   | )     |   |           | 968   |  |   |         | 1,872  | 
|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 
|                              |         | $ | 5,201   |         |             | $ | 541      |          |       | $ | 9,239     |       |  | $ | 14,981  |       
|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 
|Year ended December 31, 2001: |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |       
|                              | Federal |   | $       | 7,215   |             |   | $        | 78,318   |       |   | $         | 5,204 |  |   | $       | 90,737 | 
|                              | State   |   |         | 5,203   |             |   |          | 4,960    |       |   |           | 550   |  |   |         | 10,713 | 
|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 
|                              |         | $ | 12,418  |         |             | $ | 83,278   |          |       | $ | 5,754     |       |  | $ | 101,450 |       
|                              |         |   |         |         |             |   |          |          |       |   |           |       |  |   |         |        | 



|(1) |  | Deferred tax expense excludes deferred taxes on the unrealized gains and
losses on available-for-sale marketable securities that are included in
equity in accumulated other comprehensive income. For 2001, the deferred
portion of the tax provision included $106.8 million that was reclassified
from accumulated other comprehensive income to tax expense upon our
implementation of SFAS No. 133 in January 2001.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | The charge in lieu of income taxes results from the tax benefit of stock
option exercises.                                                                                                                                                                                                                                                                                                                              

Income taxes differ from the amounts computed by applying the U.S. federal
statutory tax rate of 35% in each of the years ended December 31, 2003, 2002
and 2001 to income before income taxes as follows (in thousands):

|                                                                             |  |                          |        |      |  |      |        |   |  |   |         |  
|---------------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------- | -
|                                                                             |  | Years Ended December 31,
|                                                                             |  |                         
|                                                                             |  | 2003                     |        | 2002 |  | 2001
|                                                                             |  |                          |        |      |  |     
|Income taxes at statutory rate                                               |  | $                        | 12,462 |      |  | $    | 16,385 |   |  | $ | 93,441  |  
|State taxes, net of federal benefit                                          |  |                          | 810    |      |  |      | 1,217  |   |  |   | 6,963   |  
|Current losses and temporary differences
for which no benefit was recognized |  |                          |       |      |  |      | 639    |   |  |   | 1,390   |  
|Utilization of tax credits                                                   |  |                          | (1,016 | )    |  |      | (1,844 | ) |  |   | (1,632  | )
|Tax exempt interest                                                          |  |                          | (3,633 | )    |  |      | (2,007 | ) |  |   | (2,044  | )
|Other                                                                        |  |                          | 279    |      |  |      | 591    |   |  |   | 3,332   |  
|                                                                             |  |                          |        |      |  |      |        |   |  |   |         |  
|Income taxes                                                                 |  | $                        | 8,902  |      |  | $    | 14,981 |   |  | $ | 101,450 |  
|                                                                             |  |                          |        |      |  |      |        |   |  |   |         |  

15



---



##### 



The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities are as follows (in thousands):

|                          |                                          |  |              |        |      |  |        |          |  
|------------------------- | ---------------------------------------- |  | ------------ | ------ | ---- |  | ------ | -------- | -
|                          |                                          |  | December 31,
|                          |                                          |  |             
|                          |                                          |  | 2003         |        | 2002
|                          |                                          |  |              |        |     
|Deferred tax assets:      |                                          |  |              |        |      |  |        |         
|                          | Allowances and accruals                  |  | $            | 19,668 |      |  | $      | 20,363   |  
|                          | Research tax credit carry-forwards       |  |              |       |      |  |        | 16,816   |  
|                          | Amortization of acquired intangibles     |  |              | 5,107  |      |  |        | 4,745    |  
|                          | Net operating loss carry-forwards        |  |              | 2,397  |      |  |        | 7,014    |  
|                          | Unrealized loss on marketable securities |  |              | 3,120  |      |  |        | 1,270    |  
|                          |                                          |  |              |        |      |  |        |         
|Gross deferred tax assets |                                          |  | 30,292       |        |      |  | 50,208 |         
|                          |                                          |  |              |        |      |  |        |         
|                          | Deferred tax liabilities:                |  |              |        |      |  |        |          |  
|                          | Recognized gain on marketable securities |  |              |       |      |  |        | (263,062 | )
|                          | Unrealized gain on marketable securities |  |              | (3,262 | )    |  |        | (1,623   | )
|                          | Net book value over net tax basis        |  |              | (5,182 | )    |  |        | (7,196   | )
|                          |                                          |  |              |        |      |  |        |         
|                          | Gross deferred tax liabilities           |  |              | (8,444 | )    |  |        | (271,881 | )
|                          |                                          |  |              |        |      |  |        |         
|                          | Net deferred tax assets (liabilities)    |  | $            | 21,848 |      |  | $      | (221,673 | )
|                          |                                          |  |              |        |      |  |        |          |  

As of December 31, 2003, we had California net operating loss carry-forwards of
$41.7 million related to AccessLan. These net operating losses may be utilized
to offset future taxable income and will expire at various dates through 2013.

We regularly assess our ability to realize the deferred tax assets recorded.
Our methodology to determine the amount of deferred tax assets that are likely
to be realized is based on our recent earnings and our estimated future taxable
income. We believe that it is more likely than not that the total net deferred
tax assets recorded will be realized.

We had recorded a deferred tax liability of approximately $263 million at
December 31, 2002 related to the gain on our Cisco stock and two hedge
contracts. The hedge contracts matured and were settled during 2003. The
deferred tax liability of $263 million was reclassified to a current liability
during 2003 when the hedge contracts were settled.

In 2003, the total tax liability for the gain on the Cisco stock and hedge
contracts would have been approximately $265 million if we had settled the
hedge contracts with our existing Cisco shares. This is based on the increase
in the value of the hedge contracts during the year and application of the
appropriate statutory tax rates. We settled the hedge contracts during 2003
using borrowed shares of Cisco stock. We believe this allows for a deferral of
the tax on the hedge contract gain. The tax authorities may challenge our
position with respect to the deferral of the tax on this gain. Accordingly, we
paid estimated federal and state taxes net of applicable credits on the full
amount of the gain 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.

Note 11. Stockholders Equity

Shareholder Approved Plans

Our 1996 Stock Incentive Plan (the 1996 Plan) is the successor equity incentive
program to our 1993 Stock Option/Stock Issuance Plan (the Predecessor Plan).
The 1996 Plan share reserve automatically increases on the first trading day of
each calendar year by an amount equal to 3% of the number of shares of common
stock outstanding on the last trading day of the immediately preceding calendar
year. As of December 31, 2003, 31,173,563 shares of common stock were
authorized for issuance under the 1996 Plan. The difference in the number of
shares authorized under the plan and the amount available for grant at December
31, 2003

16



---



##### 



represents the amount that has been issued prior to December 31, 2003. There
are no remaining shares authorized for issuance under the Predecessor Plan as
of December 31, 2003.



| |  | Options issued prior to 1997 generally vest 20% on the first
anniversary of the grant date and ratably over the following 48
months.                                          
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Options issued after 1997 to new employees generally vest 25% on the
first anniversary of the grant date and ratably over the following 36
months.                            
| 
| |  | Options issued in 1997 through 1999 to employees with at least one
year of service generally vest ratably over 48 months from the date of
grant.                              
| 
| |  | Options issued after 1999 through November 2002 to employees with at
least one year of service generally vest ratably over 36 months from
the date of grant.                  
| 
| |  | Options issued after November 2002 to employees with at least one year
of service generally vest ratably over 48 months from the date of
grant.                               
| 
| |  | Options issued prior to 2000 to all non-employee directors of the
board vest 33% on the first anniversary of the grant and ratably over
the following 24 months.              
| 
| |  | Options issued after 2000 to newly-appointed non-employee directors of
the board vest 33% on the first anniversary of the grant date and
ratably over the following 24 months.
| 
| |  | Options issued after 2000 to existing non-employee directors of the
board vest 100% on the first anniversary of the grant date.                                               
| 
| |  | Options expire ten years from the date of grant and are normally
cancelled three months after termination of employment.                                                      

Non-Shareholder Approved Plan

Pursuant to the terms of the AccessLan acquisition, all AccessLan stock options
were assumed by us effective May 13, 2002 and become AFC common stock upon
exercise. Although assumed by us, the AccessLan stock options, excluding their
Employee Incentive Plan (EIP) stock options, remain exercisable upon the same
terms and conditions as under the AccessLan stock option plan pursuant to which
they were granted and the applicable option agreements. AccessLans EIP stock
options contained an acceleration clause which resulted in 65% of the granted
pool vesting on May 13, 2002. The remaining unvested portion of EIP stock
options vest at the rate of 2% for each month of continuous service.



| |  | AccessLan options generally vest 25% on the first anniversary of the
grant date and ratably over the following 36 months.
|- |  | -------------------------------------------------------------------------------------------------------------------------



| |  | Summary of activity for shareholder and non-shareholder approved stock
options plans:
| |  | -------------------------------------------------------------------------------------

|                             |                                            |  |                |            |                 |   |          |       |       |  |         |           |          |   |      |      | 
|---------------------------- | ------------------------------------------ |  | -------------- | ---------- | --------------- | - | -------- | ----- | ----- |  | ------- | --------- | -------- | - | ---- | ---- | 
|                             |                                            |  | Shareholder    |            | Non-Shareholder
|                             |                                            |  | Approved Plans |            | Approved Plans 
|                             |                                            |  |                |            |                
|                             |                                            |  |                |            |                 |   | Weighted |       |       |  |         |           | Weighted
|                             |                                            |  |                |            |                 |   | Average  |       |       |  |         |           | Average 
|                             |                                            |  |                |            |                 |   | Exercise |       |       |  |         |           | Exercise
|                             |                                            |  | Shares         |            | Price           |   | Shares   |       | Price
|                             |                                            |  |                |            |                 |   |          |       |      
|Balance at December 31, 2000 |                                            |  | 10,629,510     |            |                 | $ | 23.16    |       |       |  |        |           |          | $ |     |     
|                             | Granted                                    |  |                | 5,920,899  |                 |   |          | 17.91 |       |  |         |          |          |   |      |     | 
|                             | Exercised                                  |  |                | (1,125,894 | )               |   |          | 8.89  |       |  |         |          |          |   |      |     | 
|                             | Cancelled                                  |  |                | (1,162,936 | )               |   |          | 27.57 |       |  |         |          |          |   |      |     | 
|                             |                                            |  |                |            |                 |   |          |       |       |  |         |           |          |   |      |     
|Balance at December 31, 2001 |                                            |  | 14,261,579     |            |                 |   | 21.75    |       |       |  |        |           |          |   |     |     
|                             | Granted                                    |  |                | 4,339,567  |                 |   |          | 17.12 |       |  |         |          |          |   |      |     | 
|                             | Exercised                                  |  |                | (1,447,677 | )               |   |          | 9.07  |       |  |         | (564,315  | )        |   |      | 0.05 | 
|                             | Cancelled                                  |  |                | (1,801,743 | )               |   |          | 25.40 |       |  |         | (16,349   | )        |   |      | 0.05 | 
|                             | Options assumed from
AccessLan acquisition |  |                |           |                 |   |          |      |       |  |         | 1,231,078 |          |   |      | 0.05 | 
|                             |                                            |  |                |            |                 |   |          |       |       |  |         |           |          |   |      |     
|Balance at December 31, 2002 |                                            |  | 15,351,726     |            |                 |   | 21.21    |       |       |  | 650,414 |           |          |   | 0.05 |     
|                             | Granted                                    |  |                | 3,850,159  |                 |   |          | 19.17 |       |  |         |          |          |   |      |     | 
|                             | Exercised                                  |  |                | (1,970,872 | )               |   |          | 14.13 |       |  |         | (405,349  | )        |   |      | 0.05 | 
|                             | Cancelled                                  |  |                | (1,697,646 | )               |   |          | 24.08 |       |  |         | (21,532   | )        |   |      | 0.05 | 
|                             |                                            |  |                |            |                 |   |          |       |       |  |         |           |          |   |      |     
|Balance at December 31, 2003 |                                            |  | 15,533,367     |            |                 | $ | 21.29    |       |       |  | 223,533 |           |          | $ | 0.05 |     
|                             |                                            |  |                |            |                 |   |          |       |       |  |         |           |          |   |      |     

|                             |                                            |  |  |            |            |             |   |          |       |       |          |                |          |          |               |       |                |  |           
|---------------------------- | ------------------------------------------ |  |  | ---------- | ---------- | ----------- | - | -------- | ----- | ----- | -------- | -------------- | -------- | -------- | ------------- | ----- | -------------- |  | ----------
|                             |                                            |  |  |            |            |             |   |          |       |       |          | Exercisable at |          |          |               |       |                |  |           
|                             |                                            |  |  | All Plans  |            | End of Year |   |          |       |       | Weighted
|                             |                                            |  |  |            |            |             |   |          |       |       | Average 
|                             |                                            |  |  |            |            |             |   | Weighted |       |       |          |                |          | Weighted |               |       |                |  | Fair Value
|                             |                                            |  |  |            |            |             |   | Average  |       |       |          |                |          | Average  |               |       |                |  | Of Options
|                             |                                            |  |  |            |            |             |   | Exercise |       |       |          |                |          | Exercise | Available for |       | Granted During
|                             |                                            |  |  | Shares     |            | Price       |   | Shares   |       | Price | Grant    |                | The Year
|                             |                                            |  |  |            |            |             |   |          |       |       |          |                |         
|Balance at December 31, 2000 |                                            |  |  | 10,629,510 |            |             | $ | 23.16    |       |       |          | 3,219,604      |          |          | $             | 15.11 |                |  | 3,788,384 
|                             | Granted                                    |  |  |            | 5,920,899  |             |   |          | 17.91 |       |          |                |          |          |               |       |                |  |           
|                             | Exercised                                  |  |  |            | (1,125,894 | )           |   |          | 8.89  |       |          |                |          |          |               |       |                |  |           
|                             | Cancelled                                  |  |  |            | (1,162,936 | )           |   |          | 27.57 |       |          |                |          |          |               |       |                |  |           
|                             |                                            |  |  |            |            |             |   |          |       |       |          |                |          |          |               |       |                |  |           
|Balance at December 31, 2001 |                                            |  |  | 14,261,579 |            |             |   | 21.75    |       |       |          | 6,100,525      |          |          |               | 20.58 |                |  | 1,452,320 
|                             | Granted                                    |  |  |            | 4,339,567  |             |   |          | 17.12 |       |          |                |          |          |               |       |                |  |           
|                             | Exercised                                  |  |  |            | (2,011,992 | )           |   |          | 6.54  |       |          |                |          |          |               |       |                |  |           
|                             | Cancelled                                  |  |  |            | (1,818,092 | )           |   |          | 25.17 |       |          |                |          |          |               |       |                |  |           
|                             | Options assumed from
AccessLan acquisition |  |  |            | 1,231,078  |             |   |          | 0.05  |       |          |                |          |          |               |       |                |  |           
|                             |                                            |  |  |            |            |             |   |          |       |       |          |                |          |          |               |       |                |  |           
|Balance at December 31, 2002 |                                            |  |  | 16,002,140 |            |             |   | 20.35    |       |       |          | 8,182,134      |          |          |               | 21.42 |                |  | 1,394,264 
|                             | Granted                                    |  |  |            | 3,850,159  |             |   |          | 19.17 |       |          |                |          |          |               |       |                |  |           
|                             | Exercised                                  |  |  |            | (2,376,221 | )           |   |          | 11.73 |       |          |                |          |          |               |       |                |  |           
|                             | Cancelled                                  |  |  |            | (1,719,178 | )           |   |          | 23.78 |       |          |                |          |          |               |       |                |  |           
|                             |                                            |  |  |            |            |             |   |          |       |       |          |                |          |          |               |       |                |  |           
|Balance at December 31, 2003 |                                            |  |  | 15,756,900 |            |             | $ | 20.99    |       |       |          | 8,763,725      |          |          | $             | 22.45 |                |  | 1,789,559 
|                             |                                            |  |  |            |            |             |   |          |       |       |          |                |          |          |               |       |                |  |           

17



---



##### 





| |  | The following table summarizes information about stock options outstanding as
of December 31, 2003 for shareholder approved and non-shareholder approved
plans:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|                |                |  |  |        |  |                     |            |                     |  |           |     |          |  |   |       |          |  |          |           |  |  |   |       | 
|--------------- | -------------- |  |  | ------ |  | ------------------- | ---------- | ------------------- |  | --------- | --- | -------- |  | - | ----- | -------- |  | -------- | --------- |  |  | - | ----- | 
|                |                |  |  |        |  | Options Outstanding |            | Options Exercisable
|                |                |  |  |        |  |                     |            |                    
|                |                |  |  |        |  |                     |            |                     |  | Weighted  |     |          |  |   |       |          |  |          |           |  |  |  
|                |                |  |  |        |  |                     |            |                     |  | Average   |     | Weighted |  |   |       |          |  | Weighted
|                |                |  |  |        |  |                     |            |                     |  | Remaining |     | Average  |  |   |       |          |  | Average 
|Range Of Option |                |  |  |        |  |                     |            | Contractual         |  | Exercise  |     |          |  |   |       | Exercise
|Exercise Prices |                |  |  | Shares |  | Life (Years)        |            | Price               |  | Shares    |     | Price   
|                |                |  |  |        |  |                     |            |                     |  |           |     |         
|$               | 0.05 - $12.86  |  |  |        |  |                     | 1,506,023  |                     |  |           | 5.7 |          |  | $ | 7.08  |          |  |          | 1,342,666 |  |  | $ | 6.58  | 
|                | 12.92 -  16.31 |  |  |        |  |                     | 1,617,934  |                     |  |           | 7.8 |          |  |   | 15.55 |          |  |          | 807,401   |  |  |   | 15.83 | 
|                | 16.38 -  16.63 |  |  |        |  |                     | 1,867,882  |                     |  |           | 7.7 |          |  |   | 16.61 |          |  |          | 1,320,754 |  |  |   | 16.62 | 
|                | 16.68 -  16.81 |  |  |        |  |                     | 2,072,493  |                     |  |           | 8.9 |          |  |   | 16.78 |          |  |          | 533,567   |  |  |   | 16.77 | 
|                | 16.812 - 19.03 |  |  |        |  |                     | 1,359,298  |                     |  |           | 8.3 |          |  |   | 18.29 |          |  |          | 531,011   |  |  |   | 18.32 | 
|                | 19.06  - 19.67 |  |  |        |  |                     | 1,213,760  |                     |  |           | 8.0 |          |  |   | 19.63 |          |  |          | 770,651   |  |  |   | 19.64 | 
|                | 19.69  - 19.92 |  |  |        |  |                     | 1,779,765  |                     |  |           | 9.8 |          |  |   | 19.92 |          |  |          | 113,567   |  |  |   | 19.88 | 
|                | 19.99  - 24.06 |  |  |        |  |                     | 1,854,717  |                     |  |           | 7.4 |          |  |   | 22.77 |          |  |          | 1,440,262 |  |  |   | 23.23 | 
|                | 24.07  - 34.13 |  |  |        |  |                     | 816,727    |                     |  |           | 7.9 |          |  |   | 28.34 |          |  |          | 412,318   |  |  |   | 30.30 | 
|                | 34.88  - 81.31 |  |  |        |  |                     | 1,668,301  |                     |  |           | 6.3 |          |  |   | 47.66 |          |  |          | 1,491,528 |  |  |   | 47.71 | 
|                |                |  |  |        |  |                     |            |                     |  |           |     |          |  |   |       |          |  |          |           |  |  |   |       | 
|$               | 0.05 - $81.31  |  |  |        |  |                     | 15,756,900 |                     |  |           | 7.8 |          |  | $ | 20.99 |          |  |          | 8,763,725 |  |  | $ | 22.45 | 
|                |                |  |  |        |  |                     |            |                     |  |           |     |          |  |   |       |          |  |          |           |  |  |   |       | 

As of December 31, 2003, executive officers held 1.8 million of the 15.8
million total outstanding options held by employees and non-employee board of directors.

Restricted Shares

During 2003, we issued 5,020 restricted shares of common stock to one employee.
The issuance is based on past performance. The issuance has a two-year cliff
vesting ending on December 9, 2005. Quarterly compensation expense will be
recorded to our results of operations during the two-year period beginning with
the quarter ended March 31, 2004.

Employee Stock Purchase Plan

Under the 1996 Employee Stock Purchase Plan (the Purchase Plan) we are
authorized to issue up to three million shares of common stock to eligible
employees of AFC and participating subsidiaries. The Purchase Plan has been
implemented in a series of successive offering periods, each with a maximum
duration of 24 months. Eligible employees can enter on the start date of any
offering period or on any subsequent semi-annual entry date. The maximum
contribution rate allowed under the Purchase Plan is 15% of an employees
salary. The purchase price of the stock is the lower of 85% of: 1) the fair
market value of the common stock on the participants entry date (strike
price), or 2) the fair market value on the semi-annual purchase date. Purchase
dates are January 31 and July 31 of each year, or the closest business day
preceding those dates when the purchase date falls on a non-business day. If
the fair market value on any purchase date during the existing offering period
is less than the strike price established at the beginning of the offering
period, a new offering

18



---



##### 



period will commence. The current offering period commenced on February 1, 2003
and is scheduled to continue through January 31, 2005.

A total of 307,086 shares of common stock with a weighted average fair value of
$14.29 per share were purchased in fiscal 2003. 1,405,835 shares remained
available for issuance at December 31, 2003. A total of 176,611 shares with a
weighted average fair value of $14.20 were purchased on January 30, 2004 using
contributions withheld during the period from August 1, 2003 to January 31,
2004.

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. AFC uses projected data for expected
volatility and expected life of its stock options based on historical and other
economic data trended into future years. AFCs 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.

The fair value of option grants in 2003, 2002 and 2001 were estimated on the
date of grant using the Black-Scholes option pricing model, assuming no
dividend yield and with the following weighted average assumptions:

|     |  |            |     |               |  |                  |      |                  |  |  |   | 
|---- |  | ---------- | --- | ------------- |  | ---------------- | ---- | ---------------- |  |  | - | 
|     |  |            |     |               |  | Weighted Average |      | Weighted Average
|     |  |            |     |               |  | Risk-Free        |      | Expected Life   
|     |  | Volatility |     | Interest Rate |  | (Years)         
|     |  |            |     |               |  |                 
|2003 |  |            | 85  | %             |  |                  | 2.75 | %                |  |  | 4 | 
|2002 |  |            | 95  | %             |  |                  | 3.03 | %                |  |  | 4 | 
|2001 |  |            | 100 | %             |  |                  | 4.31 | %                |  |  | 3 | 

Pro forma compensation costs related to the Purchase Plan were recognized for
the fair value of the employees purchase rights, as of the date of purchase
using the Black-Scholes option-pricing model. The following weighted average
assumptions were used, assuming no dividend yield:

|               |  |            |     |               |  |                  |     |                  |  |  |    | 
|-------------- |  | ---------- | --- | ------------- |  | ---------------- | --- | ---------------- |  |  | -- | 
|               |  |            |     |               |  | Weighted Average |     | Weighted Average
|Semi-Annual    |  |            |     |               |  | Risk-Free        |     | Expected Life   
|Purchase Dates |  | Volatility |     | Interest Rate |  | (Months)        
|               |  |            |     |               |  |                 
|January 2004   |  |            | 91  | %             |  |                  | 1.1 | %                |  |  | 9  | 
|July 2003      |  |            | 94  | %             |  |                  | 1.2 | %                |  |  | 6  | 
|January 2003   |  |            | 96  | %             |  |                  | 1.0 | %                |  |  | 6  | 
|July 2002      |  |            | 97  | %             |  |                  | 1.7 | %                |  |  | 6  | 
|January 2002   |  |            | 100 | %             |  |                  | 4.8 | %                |  |  | 13 | 
|July 2001      |  |            | 100 | %             |  |                  | 4.8 | %                |  |  | 13 | 

Repurchase of Common Stock.In 2001, our board of directors authorized
a stock repurchase plan that provides for the repurchase of up to 8.2 million
shares of common stock. Repurchases may be made from time to time at various
prices in the open market, through block trades or otherwise. The plan became
effective in October 2001 and may be suspended at any time without prior
notice. During 2003, 51,876 shares were repurchased at a cost of $0.7 million
under this plan. The effect of the repurchase plan on the calculation of net
income per common share was insignificant.

Stockholders Rights Plan

In 1998, our board of directors adopted a Stockholders Rights Plan. This
plan is designed to deter any potential coercive or unfair takeover tactics in
the event of an unsolicited takeover attempt. In accordance with

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the plan, purchase rights were distributed as a dividend in 1998 at the
rate of one right for each share of common stock of AFC. Each right entitles
stockholders to buy a unit equal to one one-thousandth of a share of our Series
A Junior Participating Preferred Stock for $225.00 per unit, subject to
anti-dilution adjustments. The rights will be exercisable only if a person or a
group acquires, or announces a tender or exchange offer to acquire, 15% or more
of our common stock.

In the event the rights become exercisable, the rights plan allows for AFC
stockholders to acquire stock of the surviving corporation, whether or not AFC
is the surviving corporation, having a value twice that of the exercise price
of the rights. The rights will expire in May 2008 and are redeemable for $0.001
per right at the approval of our board of directors.

Net Income Per Share

The computation of shares and net income amounts used in the calculation of
basic and diluted net income per share are as follows (in thousands, except per
share data):

|                                                                                                        |  |                          |        |      |  |      |        |  |  |   |         | 
|------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------- | 
|                                                                                                        |  | Years Ended December 31,
|                                                                                                        |  |                         
|                                                                                                        |  | 2003                     |        | 2002 |  | 2001
|                                                                                                        |  |                          |        |      |  |     
|Net income                                                                                              |  | $                        | 26,705 |      |  | $    | 31,834 |  |  | $ | 165,524 | 
|                                                                                                        |  |                          |        |      |  |      |        |  |  |   |         | 
|Shares used in basic per share computations - weighted
average common shares outstanding for the period |  |                          | 85,849 |      |  |      | 83,380 |  |  |   | 81,381  | 
|Weighted average number of shares of dilutive options                                                   |  |                          | 1,621  |      |  |      | 1,912  |  |  |   | 2,257   | 
|                                                                                                        |  |                          |        |      |  |      |        |  |  |   |         | 
|Shares used in diluted per share computations                                                           |  |                          | 87,470 |      |  |      | 85,292 |  |  |   | 83,638  | 
|                                                                                                        |  |                          |        |      |  |      |        |  |  |   |         | 
|Basic net income per share                                                                              |  | $                        | 0.31   |      |  | $    | 0.38   |  |  | $ | 2.03    | 
|                                                                                                        |  |                          |        |      |  |      |        |  |  |   |         | 
|Diluted net income per share                                                                            |  | $                        | 0.31   |      |  | $    | 0.37   |  |  | $ | 1.98    | 
|                                                                                                        |  |                          |        |      |  |      |        |  |  |   |         | 

Options to purchase 6,358,467 shares, 11,572,757 shares and 5,504,953 shares of
common stock outstanding at December 31, 2003, 2002 and 2001, respectively,
were excluded from the computation of diluted net income per share because the
exercise prices for these options were greater than the respective average
market price of the common shares and their inclusion would be antidilutive.

Note 12. Commitments and Contingencies

Leases

Office space and certain equipment are leased under operating leases. Future
minimum payments under operating leases with an initial term of more than one
year as of December 31, 2003 are summarized as follows (in thousands):

|           |                              |   |        |        | 
|---------- | ---------------------------- | - | ------ | ------ | 
|2004       |                              | $ | 8,947  |       
|2005       |                              |   | 8,588  |       
|2006       |                              |   | 7,933  |       
|2007       |                              |   | 7,319  |       
|2008       |                              |   | 6,375  |       
|Thereafter |                              |   | 18,371 |       
|           |                              |   |        |       
|           | Total minimum lease payments |   | $      | 57,533 | 
|           |                              |   |        |       

We sublease three of our facilities. The total future minimum lease payments
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

20



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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 were $9.4 million, $9.4 million and $8.6 million for the
years ended December 31, 2003, 2002 and 2001, respectively.

Warranty Reserve

A summary of warranty reserve activity
follows (in thousands):

|                                              |  |              |        |      |  |      |        |   |  |   |        |  
|--------------------------------------------- |  | ------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                              |  | December 31,
|                                              |  |             
|                                              |  | 2003         |        | 2002 |  | 2001
|                                              |  |              |        |      |  |     
|Balance at beginning of period                |  | $            | 15,097 |      |  | $    | 12,639 |   |  | $ | 11,597 |  
|Accrual for warranty costs                    |  |              | 9,112  |      |  |      | 10,468 |   |  |   | 9,307  |  
|Change in warranty estimate methodology       |  |              | (1,960 | )    |  |      |       |   |  |   |       |  
|Reduction in reserve due to change in accrual |  |              | (2,600 | )    |  |      |       |   |  |   |       |  
|Settlements made in cash or in kind           |  | $            | (8,532 | )    |  |      | (8,010 | ) |  |   | (8,265 | )
|                                              |  |              |        |      |  |      |        |   |  |   |        |  
|Balance at end of period                      |  | $            | 11,117 |      |  | $    | 15,097 |   |  | $ | 12,639 |  
|                                              |  |              |        |      |  |      |        |   |  |   |        |  

We had previously accrued warranty costs based on a percentage of revenues. In
the second quarter of 2003, we performed an analysis of warranty service
activities and costs. We adjusted the reserve level down by $2.6 million and
reduced our estimate for the warranty reserve accrual rate for future periods.
Additionally, some personnel-related costs previously charged to the warranty
reserve are now charged to operating expenses as incurred. 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. As a
result of changing our warranty estimate methodology, we reversed $2.0 million
of the reserve. We evaluate the overall reasonableness and adequacy of the
warranty reserve provision at the end of each quarter.

Purchase Agreements

We have purchase agreements with certain contract manufacturers (CMs), which
allow us to negotiate volume discounts and provide us with a more steady supply
of components. The agreements require the CMs to purchase component parts to be
used in the manufacture of product and authorize the CMs to purchase such parts
in accordance with agreed upon lead times. While the agreements do not obligate
us to purchase any specified minimum volume, we provide CMs with forecasts of
our expected needs and we issue purchase orders covering a certain period of
time for specific quantities. In the event we terminate the manufacturing
agreement with a CM, cancel a purchase order previously issued to and accepted
by a CM, or no longer have need for components that a CM has purchased on our
behalf, we agree to compensate the respective CM as follows:



| |  | For any materials it has purchased and has in their possession for use in the manufacture of our products bought within
standard lead times, or otherwise, if we granted approval of the purchase;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | For any materials that the CM has on non-cancelable orders for use in the manufacture of our products bought within
standard lead times, or otherwise, if we granted approval of the purchase;    
| 
| |  | For work in process; and                                                                                                                                                                          
| 
| |  | For all finished products manufactured for us that are in the CMs possession.                                                                                                                    

Under these agreements, the maximum liability for 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
for purchase commitments was $18.0 million, of which $6.3 million was accrued on the balance sheet. During the
fourth quarter of 2003, we changed our methodology to reserve only for
specific, known obsolescence and scrap issues for which we have purchase
commitments. As a result of this change, during the year ended December 31, 2003, we reversed $2.5 million
in reserve for purchase commitments. The change in methodology
resulted from 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.

Employee Benefit Plan

We have a 401(k) plan (the Plan) under which employees may contribute a portion
of their compensation on a tax-deferred basis to the Plan. We contributed to
the Plan on a matching basis up to a maximum of $3,000 per employee during
2003. Participants in the Plan are not required, nor solicited by us, to elect
a stock fund that contains AFC common stock. We act as the Plan administrator.
During 2003, 2002 and 2001, we contributed $1.3 million, $2.5 million and $2.6
million, respectively, to the Plan.

21



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Note 13. Acquisition

AccessLan Acquisition. On May 13, 2002, we completed the acquisition of
AccessLan, a privately-held development stage company. We acquired the San
Jose, California-based company for its technology designed to consolidate
multiple network elements into a single, cost effective platform for next
generation networks. The acquisition was accounted for as a purchase business
combination, and the results of AccessLans operations after May 13, 2002 have
been included in our consolidated statements of operations.

We originally invested $12.5 million in AccessLan during 2001, accounted for
using the cost method of accounting. Effective April 1, 2002, after exercising
our option to purchase the remaining interests in AccessLan, we changed our
method of accounting from the cost method to the equity method. We
retroactively applied the equity method for our ownership interest in AccessLan
from the date of our initial investment. This resulted in reductions to net
income of $0.7 million for the four and a half months through May 13, 2002, and
$0.6 million for the year ended December 31, 2001.

The value of the purchase was $82.1 million, which consisted of the following:



| |  | $10.8 million, our initial investment in AccessLan, net of acquisition-related costs;                        
|- |  | -------------------------------------------------------------------------------------------------------------
| 
| |  | $43.4 million in cash paid to acquire all of the outstanding shares of AccessLan that we did not already own;
| 
| |  | $5.5 million for liabilities assumed; and                                                                    
| 
| |  | $22.4 million representing the fair value of 1.2 million stock options issued to AccessLan employees.        

Pursuant to the terms of acquisition, all AccessLan stock options were assumed
by AFC effective May 13, 2002 and were converted into 1,231,078 AFC common
stock options.

As part of finalizing the allocation of the purchase price, we engaged third
party appraisers to value the acquired tangible and intangible assets. The
final allocation was as follows:



| |  |  | Goodwill of $55.9 million, to be reviewed annually for impairment;                                 
| | - |  | ---------------------------------------------------------------------------------------------------
|
| |  |  | Other identifiable intangibles with finite lives, of $6.3 million, to be expensed over three years;
|
| |  |  | Deferred compensation of $3.5 million, to be expensed over three and a half years;                 
|
| |  |  | Other assets, including property and equipment, totaling $4.0 million; and                         
|
| |  |  | In-process research and development of $12.4 million.                                              

At the time of acquisition, we
recognized a $12.4 million charge for acquired
technology that had not reached technological feasibility, had no alternative
future use and for which successful development was uncertain.

Pro forma results of operations have not been presented because the results of
AccessLans operations were not significant relative to the results of AFCs
operations.

22



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##### 



Note 14. Segment Information

We operate in the access market and derive substantially all of our revenues
from sales of AFC product solutions. The chief operating decision maker
evaluates performance, makes operating decisions and allocates resources based
on consolidated financial data. Accordingly, we consider AFC to be a single
operating segment. As such, we are required to disclose certain information
about geographic concentrations and major customers. The following table
summarizes certain geographic information (in thousands):

|                                         |                         |   |                          |         |      |   |           |         |   |   |           |         |  
|---------------------------------------- | ----------------------- | - | ------------------------ | ------- | ---- | - | --------- | ------- | - | - | --------- | ------- | -
|                                         |                         |   | Years Ended December 31,
|                                         |                         |   |                         
|                                         |                         |   | 2003                     |         | 2002 |   | 2001     
|                                         |                         |   |                          |         |      |   |          
|Revenues:                                |                         |   |                          |         |      |   |           |         |   |   |           |        
|Domestic                                 |                         | $ | 287,876                  |         |      | $ | 295,017   |         |   | $ | 282,004   |        
|International                            |                         |   | 45,581                   |         |      |   | 49,046    |         |   |   | 45,565    |        
|                                         |                         |   |                          |         |      |   |           |         |   |   |           |        
|                                         | Total revenues          |   | $                        | 333,457 |      |   | $         | 344,063 |   |   | $         | 327,569 |  
|                                         |                         |   |                          |         |      |   |           |         |   |   |           |        
|Long-lived assets:                       |                         |   |                          |         |      |   |           |         |   |   |           |        
|Domestic                                 |                         | $ | 43,755                   |         |      | $ | 51,033    |         |   | $ | 55,311    |        
|International                            |                         |   | 7                        |         |      |   | 43        |         |   |   | 95        |        
|                                         |                         |   |                          |         |      |   |           |         |   |   |           |        
|                                         | Total long-lived assets |   | $                        | 43,762  |      |   | $         | 51,076  |   |   | $         | 55,406  |  
|                                         |                         |   |                          |         |      |   |           |         |   |   |           |        
|Total assets                             |                         | $ | 1,317,716                |         |      | $ | 1,232,992 |         |   | $ | 1,146,859 |        
|                                         |                         |   |                          |         |      |   |           |         |   |   |           |        
|Major customers, percentage of revenues: |                         |   |                          |         |      |   |           |         |   |   |           |        
|                                         | Customer A              |   |                          | 36      | %    |   |           | 23      | % |   |           | 17      | %
|                                         | Customer B              |   |                          |        |      |   |           | 11      | % |   |           |        |  
|                                         | Customer C              |   |                          | 13      | %    |   |           | 11      | % |   |           |        |  

Note 15. Subsequent Events

NAA Acquisition.On February 20, 2004, we completed the acquisition of North
American Access (NAA), a business unit of Marconi Communications, Inc., a
subsidiary of Marconi Corporation plc. This acquisition enables us to offer a
more robust portfolio of fiber-based access network solutions. We view the
product line from NAA to be complementary to our own, particularly NAAs
fiber-to-the-curb platform and our FTTP solution. We anticipate that synergies
among our product lines will enable us to serve a broader base of customers,
from the smallest IOCs to the largest RBOCs.

The acquisition is being accounted for as a purchase in accordance with the
guidance in SFAS No. 141, Business Combinations.The purchase consideration for
NAA consisted of approximately $240 million in cash, and transaction related expenses. We are
in the process of obtaining third party valuations of certain assets.
Accordingly, allocation of the NAA purchase price is subject to refinement.

Our methodology for allocating the purchase price to in-process research and
development (in-process R&D) will be determined through established valuation
techniques in the high-technology communications equipment industry and based
on valuations performed by an independent third party. In-process R&D is
expensed upon acquisition because technological feasibility has not been
established and no future alternative uses exist.

Investment. We made a
$2.0 million minority interest equity investment during the
first quarter of 2004 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 under the cost method. We do not have significant
influence over the companys management or operations.

23



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##### 



INDEPENDENT AUDITORS REPORT The Board of Directors and Stockholders
Advanced Fibre Communications, Inc.: We have audited the accompanying consolidated balance sheets of Advanced Fibre
Communications, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operations, stockholders equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 2003. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Advanced Fibre
Communications, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, in 2001 the
Company changed its method of accounting for derivative financial instruments
upon implementation of Statement of Financial Accounting Standards (SFAS) No.
133, Accounting for Derivative Instruments and Hedging Activities, as amended
by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities. In 2001, the Company also adopted SFAS No. 141, Business
Combinations, and certain provisions of SFAS No. 142, Goodwill and Other
Intangible Assets, as required, for the goodwill and intangible assets
resulting from business combinations consummated after June 30, 2001. In 2002,
the Company fully adopted the provisions of SFAS No. 142, as required, for
goodwill and intangible assets resulting from business combinations consummated
after June 30, 2001. KPMG LLP San Francisco, California
February 23, 2004




---



##### 



ADVANCED FIBRE COMMUNICATIONS, INC.
Quarterly Results of Operations
Selected quarterly financial data is summarized below (unaudited, in thousands)

|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |        |        | 
|--------------------------------------------- | --------------------------------------------------- | ------------------------ | ------ | -------------- | ------ | --------- | ------ | -------- | ------ | -------- | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                              |                                                     |                          |        | Quarters Ended
|                                              |                                                     |                          |        |               
|                                              |                                                     |                          |        | Dec. 31,       |        | Sept. 30, |        | June 30, |        | Mar. 31,
|                                              |                                                     |                          |        | 2003 (1)       |        | 2003      |        | 2003 (2) |        | 2003 (3)
|                                              |                                                     |                          |        |                |        |           |        |          |        |         
|Revenues                                      |                                                     | $                        | 84,753 |                |        | $         | 85,214 |          |        | $        | 83,038 |        |        | $ | 80,452 |       
|Cost of revenues                              |                                                     |                          | 42,001 |                |        |           | 44,600 |          |        |          | 41,914 |        |        |   | 40,853 |       
|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|Gross profit                                  |                                                     |                          | 42,752 |                |        |           | 40,614 |          |        |          | 41,124 |        |        |   | 39,599 |       
|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|Operating expenses:                           |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|                                              | Research and development                            |                          |        | 15,981         |        |           |        | 14,831   |        |          |        | 19,392 |        |   |        | 15,944 |       
|                                              | Sales and marketing                                 |                          |        | 10,316         |        |           |        | 9,355    |        |          |        | 11,065 |        |   |        | 9,776  |       
|                                              | General and administrative                          |                          |        | 7,443          |        |           |        | 6,498    |        |          |        | 8,875  |        |   |        | 5,940  |       
|                                              | Amortization and write-down of acquired intangibles |                          |        | 3,047          |        |           |        | 349      |        |          |        | 651    |        |   |        | 793    |       
|                                              |                                                     | Total operating expenses |        |                | 36,787 |           |        |          | 31,033 |          |        |        | 39,983 |   |        |        | 32,453 | 
|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|Operating income                              |                                                     |                          | 5,965  |                |        |           | 9,581  |          |        |          | 1,141  |        |        |   | 7,146  |       
|Other income, net                             |                                                     |                          | 1,672  |                |        |           | 2,850  |          |        |          | 3,305  |        |        |   | 3,947  |       
|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|Income before taxes                           |                                                     |                          | 7,637  |                |        |           | 12,431 |          |        |          | 4,446  |        |        |   | 11,093 |       
|Income taxes                                  |                                                     |                          | 1,909  |                |        |           | 3,108  |          |        |          | 1,112  |        |        |   | 2,773  |       
|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|Net income                                    |                                                     | $                        | 5,728  |                |        | $         | 9,323  |          |        | $        | 3,334  |        |        | $ | 8,320  |       
|                                              |                                                     |                          |        |                |        |           |        |          |        |          |        |        |        |   |        |       
|Basic net income per share                    |                                                     | $                        | 0.07   |                |        | $         | 0.11   |          |        | $        | 0.04   |        |        | $ | 0.10   |       
|Shares used in basic per share computations   |                                                     |                          | 86,963 |                |        |           | 86,246 |          |        |          | 85,287 |        |        |   | 84,901 |       
|Diluted net income per share                  |                                                     | $                        | 0.06   |                |        | $         | 0.11   |          |        | $        | 0.04   |        |        | $ | 0.10   |       
|Shares used in diluted per share computations |                                                     |                          | 89,373 |                |        |           | 87,906 |          |        |          | 86,388 |        |        |   | 86,174 |       

|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |        |        | 
|--------------------------------------------- | -------------------------------------- | ------------------------ | ------ | -------- | ------ | --------- | ------ | -------- | ------ | -------- | ------- | ------ | ------ | - | ------ | ------ | ------ | 
|                                              |                                        |                          |        | Dec. 31, |        | Sept. 30, |        | June 30, |        | Mar. 31,
|                                              |                                        |                          |        | 2002 (4) |        | 2002 (5)  |        | 2002 (6) |        | 2002 (7)
|                                              |                                        |                          |        |          |        |           |        |          |        |         
|Revenues                                      |                                        | $                        | 85,746 |          |        | $         | 91,767 |          |        | $        | 86,286  |        |        | $ | 80,264 |       
|Cost of revenues                              |                                        |                          | 43,356 |          |        |           | 46,603 |          |        |          | 47,336  |        |        |   | 42,662 |       
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|Gross profit                                  |                                        |                          | 42,390 |          |        |           | 45,164 |          |        |          | 38,950  |        |        |   | 37,602 |       
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|Operating expenses:                           |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|                                              | Research and development               |                          |        | 15,534   |        |           |        | 17,058   |        |          |         | 15,824 |        |   |        | 13,242 |       
|                                              | Sales and marketing                    |                          |        | 10,997   |        |           |        | 12,264   |        |          |         | 12,952 |        |   |        | 11,412 |       
|                                              | General and administrative             |                          |        | 6,303    |        |           |        | 6,701    |        |          |         | 6,878  |        |   |        | 6,488  |       
|                                              | Securities litigation settlement costs |                          |        | 1,500    |        |           |        |         |        |          |         | 2,943  |        |   |        |       |       
|                                              | Amortization of acquired intangibles   |                          |        | 912      |        |           |        | 1,280    |        |          |         | 1,083  |        |   |        |       |       
|                                              | In-process research and development    |                          |        | 27       |        |           |        |         |        |          |         | 12,396 |        |   |        |       |       
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|                                              |                                        | Total operating expenses |        |          | 35,273 |           |        |          | 37,303 |          |         |        | 52,076 |   |        |        | 31,142 | 
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|Operating income (loss)                       |                                        |                          | 7,117  |          |        |           | 7,861  |          |        |          | (13,126 | )      |        |   | 6,460  |       
|Other income, net                             |                                        |                          | 18,708 |          |        |           | 6,255  |          |        |          | 9,750   |        |        |   | 3,790  |       
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|Income (loss) before taxes                    |                                        |                          | 25,825 |          |        |           | 14,116 |          |        |          | (3,376  | )      |        |   | 10,250 |       
|Income taxes (benefit)                        |                                        |                          | 8,264  |          |        |           | 4,517  |          |        |          | (1,080  | )      |        |   | 3,280  |       
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|Net income (loss)                             |                                        | $                        | 17,561 |          |        | $         | 9,599  |          |        | $        | (2,296  | )      |        | $ | 6,970  |       
|                                              |                                        |                          |        |          |        |           |        |          |        |          |         |        |        |   |        |       
|Basic net income (loss) per share             |                                        | $                        | 0.21   |          |        | $         | 0.11   |          |        | $        | (0.03   | )      |        | $ | 0.08   |       
|Shares used in basic per share computations   |                                        |                          | 84,211 |          |        |           | 83,836 |          |        |          | 83,121  |        |        |   | 82,354 |       
|Diluted net income (loss) per share           |                                        | $                        | 0.21   |          |        | $         | 0.11   |          |        | $        | (0.03   | )      |        | $ | 0.08   |       
|Shares used in diluted per share computations |                                        |                          | 85,577 |          |        |           | 85,754 |          |        |          | 83,121  |        |        |   | 83,932 |       



| | (1) |  | The quarter ended
December 31, 2003 included an increase to the reserve for
product returns which reduced revenue by $3.1 million and
reduced gross profit by $1.1 million, a benefit of
$0.3 million for reversal of purchase commitment reserve, a
benefit of $2.0 million from change in warranty estimate methodology and reversal of
reserve, a charge of $2.8 million for impairment of an intangible
asset, a charge of $1.1 million for severance and related costs
resulting from the 2003 workforce reduction, and a charge of $1
million for impairment of an investment.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (2) |  | The quarter ended June 30, 2003 included a benefit of $2.6 million
from change in warranty estimate and accruals and a charge of $5.5
million resulting from the 2003 workforce reduction.                                                                                                                                                                                                                                                                                                                                                                                          
|
| | (3) |  | The quarter ended March 31, 2003 included a benefit of $2.0 million
from reversal of purchase commitment reserve and $1.4 million in
unrealized gains on the Cisco investment.                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | (4) |  | The quarter ended December 31, 2002 included a $0.5 million charge
resulting from the 2002 workforce reduction, $3.3 million in unrealized
gains on the Cisco investment and $13.6 million in distribution payment
due from Marconi.                                                                                                                                                                                                                                                                                                                                                
|
| | (5) |  | The quarter ended September 30, 2002 included a $0.4 million charge
resulting from the 2002 workforce reduction and $4.4 million in unrealized
gains on the Cisco investment.                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | (6) |  | The quarter ended June 30, 2002 included $8.2 million in unrealized
gains on the Cisco investment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | (7) |  | The quarter ended March 31, 2002 included $2.5 million in
unrealized gains on the Cisco investment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

See accompanying notes to consolidated financial statements.

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