From time to time, we make written or oral "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, including statements contained in our filings with the Securities and Exchange Commission (including this Report on Form 10-K), our annual report to stockholders and in other communications. These statements do not convey historical information, but relate to predicted or potential future events, such as statements of our plans, strategies and intentions, or our future performance or goals, and can often be identified by the use of forward-looking terminology such as "believes," "expects," "intends," "may," "will," "should" or "anticipates" or similar terminology. Investors and prospective investors are cautioned that such statements are only projections. These statements involve risks and uncertainties and are based upon various assumptions. We discuss many of these risks and uncertainties under the heading "Risks That Could Affect Future Results" in "Man agement's Discussion and Analysis of Financial Condition and Results of Operations," below, and elsewhere in this Report. These risks, among others, could cause our actual future results to differ materially from those described in our forward-looking statements or from our historic results. We are not obligated to update these forward-looking statements, even though our situation may change in the future.

INTRODUCTION

We are a leading independent designer, manufacturer and marketer of manipulator and docking hardware products, temperature management systems and tester interface products that are used by semiconductor manufacturers in conjunction with automatic test equipment, or ATE, in the testing of integrated circuits, or ICs. Our high performance products are designed to enable semiconductor manufacturers to improve the efficiency of their IC test processes and, consequently, their profitability. We supply our products worldwide to major semiconductor manufacturers directly and through leading ATE manufacturers. Our largest customers include Agilent Technologies, Texas Instruments, Cascade Microtech, Teradyne, National Semiconductor, Intersil, ST Microelectronics, LTX, Agere Systems and Analog Devices.

We were incorporated in New Jersey in 1981 and reincorporated in Delaware in April 1997. We established inTEST Limited in the U.K. in 1985, inTEST Kabushiki Kaisha (inTEST K.K.) in Japan in 1987, inTEST PTE, Limited in Singapore in 1990 and inTEST GmbH in Germany in 2000. inTEST Limited designs, manufactures, markets and provides technical support for our products principally in Europe. inTEST K.K. acts as a liaison office with Japanese ATE manufacturers, and markets and provides technical support for our products in Japan. inTEST PTE, Limited designs, manufactures, markets and provides technical support to customers in Southeast Asia. inTEST GmbH provides sales and service in continental Europe for temperature management systems as well as sales and service for manipulator, docking hardware and tester interface products for selected accounts. In 1997, we completed our initial public offering. In 1998, we acquired all of the stock of TestDesign Corporation, which expanded our capabilities in the design, manu facture and marketing of tester interface products. In 2000, we acquired all of the stock of Temptronic Corporation, a designer, manufacturer and marketer of high-performance temperature management systems used in the testing of ICs, printed circuit boards and other subassemblies. In 2002, we acquired all of the stock of INTESTLOGIC GmbH (formerly known as Intelogic Technologies GmbH), located in Rosenheim, Germany, a designer, manufacturer and marketer of manipulator and docking hardware products.

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports that are filed with the Securities and Exchange Commission (the "SEC") pursuant to Section 13(a) or 15(d) of the Exchange Act, are available through our website (www.intest.com) as soon as reasonably practicable after we electronically file them.

INDUSTRY

Overview

The semiconductor market has been characterized by rapid technological change, wide fluctuations in demand and shortening product life cycles. Designers and manufacturers of a variety of electronic and industrial products, such as cell phones, telecom and datacom systems, Internet access devices, computers and consumer electronics, require increasingly complex ICs to provide improved end-product performance demanded by their customers.

Semiconductor manufacturers generally compete based on product performance and price. We believe that testing costs represent a significant portion of the total cost of manufacturing ICs. As product life cycles shorten, semiconductor manufacturers are under more pressure to maximize production yields and reduce testing costs. At the same time, the growing

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complexity of ICs has increased the difficulty of maximizing test yields. In order to address these market trends, semiconductor manufacturers strive for more effective utilization of ATE, smaller test areas and increased wafer level testing.

The demand for new ATE and related equipment depends upon several factors, including the demand for products that incorporate ICs, the increasing complexity of ICs and the emergence of new IC design, production and packaging technologies. Some of the newer IC technologies include the use of 300 mm wafers in production, system-on-a-chip, or SOC, where digital, analog and memory functions are combined on a single IC, and chip scale packaging. As a result of these and other advances, semiconductor manufacturers may require additional ATE not only to handle increases in production but also to handle more sophisticated testing requirements of ICs.

IC Test Process

Semiconductor manufacturers typically produce ICs in multiples of several hundred on a silicon wafer which is later separated or "diced" into individual ICs. Extended leads are then attached to the individual ICs, for later connection to other electrical components, before the ICs are put in a plastic, ceramic or other protective housing. This process step is called "packaging." Wafers are tested before being diced and packaged, to ensure that only properly functioning ICs are packaged. This testing step has several names including "front-end test," "wafer test" or "wafer probe." In front-end test, an electronic handling device known as a wafer prober automatically positions the wafer under a "test head," which connects electrically to a test system. Once the good ICs have been identified, they are packaged. The packaged IC also requires testing, called "back-end test," to determine if it meets design and performance specifications. Packaged ICs are placed into another type of electronic handling device call ed a "package handler" or "handler", which then plugs the packaged ICs into a test head, which includes a test socket, which may be environmentally controlled, for testing. "Wafer probers" and "handlers" are sometimes referred to in this Report collectively as "electronic device handlers."

Testers range in price from approximately $100,000 to over $5.0 million each, depending primarily on the complexity of the IC to be tested and the number of test heads, typically one or two, with which each tester is configured. Probers and handlers range in price from approximately $50,000 to $500,000. A typical test floor of a large semiconductor manufacturer may have 100 test heads and 100 probers or 250 handlers supplied by various vendors for use at any one time.

Test head manipulators, also referred to as positioners, facilitate the movement of the test head to the electronic device handler. Docking hardware connects the test head to the wafer prober or handler. Tester interface products provide the electrical connection between the test head and the wafer or packaged IC. Traditionally, temperature management products are used in back-end test to allow a manufacturer to test packaged ICs under the extreme temperature conditions in which the IC may be required to operate. However, we believe that temperature-controlled testing will be an increasingly important part of front-end wafer testing as more parameters traditionally tested for in back end-test are moved to front-end test.

Trends in IC Testing

Although the demand for ICs and ATE experienced a severe cyclical downturn over the last several years, we believe that as the cycle reverses, and demand for ICs increases, the ATE industry will again be required to assist IC manufacturers not only to identify unacceptable products, but also to perform the IC test in the most efficient and cost-effective manner possible. To provide testing equipment that can help manufacturers meet this goal, the ATE industry must address the following issues:

Change in Technology. Currently, most semiconductor manufacturers use 150 mm and 200 mm wafer technology. In order to increase throughput and lower IC cost, semiconductor manufacturers will need to add 300 mm wafer production capability as existing 150 mm and 200 mm production capacity becomes more fully utilized. In addition, end-user applications are demanding ICs with increasingly higher performance, greater speeds, and smaller sizes. ICs that meet these higher standards are more complex and dense. SOC designs are likely to be more in demand in the future. These technology trends have significant implications for the IC testing process, including:

Need for Plug-Compatibility and Integration. Semiconductor manufacturers need test methodologies that will perform increasingly complex tests while lowering the overall cost of testing. This can require combining ATE manufactured by various companies into optimally performing systems. Semiconductor manufacturers have to work closely with various test hardware, software, interface and component vendors to resolve design and compatibility issues in order to make these vendors' products plug-compatible with test equipment manufactured by other vendors.

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Testing Under Extreme Conditions. ICs will have to perform across a wider spectrum of temperature and environmental conditions than ever before because of the growing complexity of products in which they are deployed. Temperature testing will likely find an increasing role in front-end, wafer level testing. Creating a uniform thermal profile over much larger wafer areas represents a significant engineering and design challenge for ATE manufacturers.

Demand for Higher Levels of Technical Support. As IC testing becomes more complex, semiconductor manufacturers are demanding higher levels of technical support on a routine basis. ATE manufacturers must commit greater resources to technical support in order to develop close working relationships with their customers. This level of support also requires close proximity of service and support centers to customers' facilities.

Cost Reduction Through Increased Front-End Testing. As the cost of testing ICs increases, semiconductor manufacturers will continue to look for ways to streamline the testing process to make it more cost-effective. We believe that this factor will lead to more front-end, wafer-level testing.

OUR SOLUTIONS

We focus our development efforts on designing and producing high quality products that provide superior performance and cost-effectiveness. We seek to address each manufacturer's individual needs through innovative and customized designs, use of the best materials available, quality manufacturing practices and personalized service. We design solutions to overcome the evolving challenges facing the ATE industry by providing the following advantages:

Scalable, Universal, High Performance Interface Technology. Our universal test head manipulators provide at least six degrees of motion freedom to enable a high degree of flexibility with the minimum amount of effort. As a result, our products can be used in virtually any test setting. Our manipulators have kept pace with the increasing size of test heads, which can weigh up to 3,000 pounds and which may become larger and heavier as the required level of testing sophistication increases. Our docking hardware offers precise control over the connection to test sockets, probing assemblies and interface boards, reducing downtime and minimizing costly damage to fragile components. Our tester interface products optimize the integrity of the transmitted signal between the test head and the device under test by being virtually transparent to the test signal, resulting in increased accuracy of the test data. We believe that these characteristics will gain even more significance as testing becomes more complica ted.

Compatibility and Integration. A hallmark of our products has been, and continues to be, compatibility with a wide variety of ATE. Our universal manipulators can handle test heads produced by different manufacturers. We also design and manufacture docking hardware that can be used with otherwise incompatible ATE. We believe this integrated approach to ATE facilitates smooth changeover from one tester to another, longer lives for interface components, better test results, increased ATE utilization and lower overall test costs.

Wafer Level Testing. Semiconductor manufacturers use our ThermoChuck(R) products for front-end temperature stress screening at the wafer level. This can provide significant cost savings from early identification of defective ICs that will not perform at specified temperatures thereby eliminating the costs of packaging and testing these defective ICs. ThermoChuck(R) products are capable of handling any size wafer, including a 300 mm wafer, for uniform, accurate and stable thermal testing without contributing to the wafer distortion that can occur as temperature changes are introduced.

Worldwide Customer Service and Support. We have long recognized the need to maintain a physical presence near our customers' facilities. We have manufacturing facilities in New Jersey, Massachusetts, California, the U.K., Germany and Singapore, and we provide service to our customers from 11 sales and service offices in the U.S., the U.K., Japan, Singapore and Germany. Our engineers are easily accessible to, and can work directly with, most of our customers from the time we begin developing our initial proposal, through the delivery, installation and use of the product by our customer. In this way, we are able to develop and maintain close relationships with our customers.

OUR STRATEGY

Although demand for ICs and ATE experienced a severe cyclical downturn over the last several years, and much of our effort had been focused on reducing costs and conserving cash until the cycle reversed, we remain committed to our goals of being recognized in our industry as the designer and manufacturer of the highest quality products in our markets and becoming the supplier of all of our customers' ATE needs, other than probers, handlers and testers. Our strategies to achieve these goals include the following:

Providing Technologically Advanced Solutions. We are committed to designing and producing only the highest quality products which incorporate innovative designs to achieve optimal cost-effectiveness and functionality for each customer's particular situation. Our engineering and design staff is continually engaged in developing new and improved products and manufacturing processes.

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Leveraging our Strong Customer Relationships. Our technical personnel work closely with ATE manufacturers to design tester interface and docking hardware that are compatible with their ATE. As a result, we are often privy to proprietary technical data and information about these manufacturers' products. We believe that because we do not compete with ATE manufacturers in the prober, handler and tester markets, we have been able to establish strong collaborative relationships with these manufacturers that enable us to develop ancillary ATE products on an accelerated basis.

Continuing our International Expansion. Our existing and potential customers are concentrated in certain regions throughout the world. We believe that we must maintain a presence in the markets in which our customers operate. We currently have offices in the U.S., the U.K., Japan, Singapore and Germany.

Pursuing Synergistic Acquisitions. A key element of our growth strategy is to acquire businesses, technologies or products that are complementary to our current product offerings. Our TestDesign, Temptronic and INTESTLOGIC acquisitions have expanded our line of product offerings and have given us the opportunity to market a broader range of products to our customer base. We expect to make acquisitions that will further expand our product lines, enabling us to become a single source supplier to the test floor for a complete selection of equipment compatible with testers, probers and handlers of all manufacturers.

Pursuing Revenue Growth Opportunities Outside the Semiconductor ATE Market. Another element of our growth strategy is pursuing revenue growth opportunities in markets we have not traditionally served, such as the aerospace, automotive, communications, consumer electronics, defense and medical industries. We believe that we will reduce some of the cyclicality that we have historically experienced by diversifying our revenue streams outside the semiconductor ATE market.

OUR PRODUCTS

We design and manufacture manipulators, docking hardware, temperature management systems and tester interface products, all of which are designed to improve the utilization and performance of ATE used by semiconductor manufacturers in the testing of ICs. Semiconductor manufacturers mainly use our primary lines of manipulators and docking hardware during back-end testing of specialized packaged ICs. They use our temperature management systems and tester interface products in both front-end and back-end testing of ICs. These ICs include microprocessors, digital signal processing chips, application specific ICs and specialized memory ICs, and are used primarily in the automotive, computer, consumer products and telecommunications industries. We custom design most of our products for each customer's particular combination of ATE. We have designed over 5,000 models, each of which is mechanically different. These models are designed to facilitate the use of one or more of over 175 different test heads with one or more of over 30 probers or 300 handlers.

Manipulator Products

We offer three lines of manipulator products. The inTEST line of manipulator products consists of the in2(R), the in2 Pro and the M Series test head positioners, which are free-standing universal manipulators. Universal manipulators can hold a variety of test heads and enable an operator to reposition a test head for alternate use with any one of several probers or handlers on a test floor.

The in2(R) and in2 Pro differ from universal manipulators manufactured by our competitors due to our innovative floating-head design. This design permits a test head weighing up to 3,000 pounds to be held in an effectively weightless state, so it can be moved manually or, in the case of the in2 Pro, with optional powered assistance, up or down, right or left, forward or backward and rotated around each axis (known as six degrees of motion freedom) by an operator using a modest amount of force. The same design features enable the operator to dock the test interface board without causing inadvertent damage to the fragile electrical contacts. As a result, after testing a particular production lot of ICs, the operator can quickly and easily disconnect a test head held in an in2(R) or in2 Pro manipulator and equipped with our docking hardware and dock it to another electronic device handler for testing either a subsequent lot of the same packaged IC or to test a different IC. in2(R) and in2 Pro manipulators range in price from approximately $12,000 to $159,000.

The M Series line of manipulator products consists of the M400 and M500 manipulators. These compact universal manipulators are designed to handle test heads weighing less than 550 pounds. The up and down movement is supported by an air-pressure-based floating state technology. M Series manipulators range in price from approximately $12,000 to $45,000.

Docking Hardware Products

Our docking hardware products ensure proper repeatable and precise alignment of the delicate interface between the test head's interface board and the prober's probing assembly or the handler's test socket as they are brought together, or "docked." A simple cam action docks and locks the test head to the prober or handler, thus eliminating motion of the test head relative to the prober or handler. This minimizes deterioration of the interface boards, test sockets and probing assemblies which is caused by the constant vibration during testing. Our docking hardware products are used primarily with floating-head universal

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manipulators when maximum mobility and inter-changeability of handlers between test heads is required. By using our docking hardware products, semiconductor manufacturers can achieve cost savings through improved ATE utilization, improved accuracy and integrity of test results, and reduced repairs and replacements of expensive ATE interface products.

Our docking hardware products differ from those offered by competing ATE manufacturers by our ability to make various competing brands of test heads compatible with various brands of probers and handlers used by a semiconductor manufacturer by only changing interface boards. This is called "plug-compatibility." Plug-compatibility enables increased flexibility and utilization of test heads, probers and handlers purchased from various manufacturers. We believe that because we do not compete with ATE manufacturers in the sale of probers, handlers or testers, ATE manufacturers are willing to provide us with the information that is integral to the design of plug-compatible products. Our docking hardware products range in price from approximately $2,000 to $25,000.

Temperature Management Systems

Our temperature management systems are sold into a wide variety of industries including the aerospace, automotive, communications, consumer electronics, defense, medical and semiconductor industries. Our temperature management systems enable a manufacturer to test a semiconductor wafer, IC or electronic sub-assembly over the extreme and variable temperature conditions that can occur in the actual use of the electronic device containing the ICs.

ThermoChuck(R) Products: Our ThermoChuck(R) precision vacuum platform assemblies quickly change and stabilize the temperature of semiconductor wafers accurately and uniformly during testing without removing the wafer from its testing environment. Such temperatures can range from as low as -65 degrees Celsius to as high as +400 degrees Celsius. ThermoChucks(R) are incorporated into wafer prober equipment for laboratory analysis and for in-line production testing of semiconductor wafers. ThermoChuck(R) products range in price from approximately $14,000 to $105,000.

ThermoStream(R) Products: Our ThermoStream(R) stand-alone temperature management systems use a temperature-controlled air stream to rapidly change and stabilize the temperature of packaged ICs, electronic sub-assemblies and printed circuit boards. ThermoStream(R) products provide a source of heated and cooled air which can be directed over the component or device under test. These systems are capable of controlling temperatures to within +/- 0.1 degree Celsius over a range of -80 degrees Celsius to as high as +225 degrees Celsius within 1.0 degree Celsius of accuracy. Traditionally, our customers used ThermoStream(R) products primarily in engineering, quality assurance and small-run manufacturing environments. However, increasingly, our customers use ThermoStream(R) products in longer-run production applications. ThermoStream(R) products range in price from approximately $4,500 to $40,000.

Other Temperature Management Products: We also manufacture ancillary temperature management products including temperature-controlled contact probes, temperature-controlled enclosures, and precision temperature platforms. For example, recent developments in wireless communications have resulted in the mounting of wireless transmitters outdoors to reduce transmission line problems. As a result, these transmitters are exposed to extreme temperature variations and require testing over the full range of temperature exposure that will be encountered. Historically, the standard approach to this type of testing has been to use conventional thermal chambers, which can require removing equipment during testing, which could potentially cause damage to the sensitive microwave cables or create erroneous measurements. Our other temperature management products can be used to provide a closed, temperature-controlled environment for temperature testing of high frequency transmitters and receivers without the need for removal during testing, eliminating the risk of damage due to interruption of the test. Other temperature management products range in price from $4,500 to $25,000.

Tester Interface Products

Tester interface products provide the electrical connections between the tester and the wafer prober or IC handler to carry the electrical signals between the tester and the probe card on the prober or the test socket on the handler. Our designs optimize the integrity of the transmitted signal which increases the accuracy of the test data. Therefore, our tester interface products can be used with high speed, high frequency, digital or mixed signal interfaces used in testing more complex ICs. Because our tester interface products enable the tester to provide more reliable yield data, our interfaces may also reduce IC production costs. For example, our new Centaur(TM) modular interface, introduced in July 2003, is designed to provide flexibility and scalability through the use of removable signal modules which can be easily changed on the test floor as our customers' testing requirements change. In addition to the Centaur(TM) modular interface, we also offer over 200 different types of tester interface models that we custom designed for our customers' specific applications. These products range in price from approximately $6,000 to $64,000.

Financial Information About Product Segments and Geographic Areas

Please refer to Note 4 of our consolidated financial statements included in this Report for additional data regarding each of our product segments and revenues attributable to foreign countries.

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MARKETING, SALES AND CUSTOMER SUPPORT

We market and sell our products in all markets where the manufacture of semiconductors occurs. North American and European semiconductor manufacturers have located most of their back-end factories in Southeast Asia. The front-end wafer fabrication plants of U.S. semiconductor manufacturers are primarily in the U.S. Likewise, European, Taiwanese, South Korean and Japanese semiconductor manufacturers generally have located their wafer fabrication plants in their respective countries.

Manipulator, Docking Hardware and Tester Interface Products: In North America, we sell to semiconductor manufacturers principally through independent, commissioned sales representatives. North American sales representatives also coordinate product installation and support with our technical staff and participate in trade shows.

Our regional and account managers handle sales to ATE manufacturers and are responsible for a portfolio of customer accounts and for managing certain independent sales representatives. In addition, our account managers are responsible for pricing, quotations, proposals and transaction negotiations, and they assist with applications engineering and custom product design. Technical support is provided to North American customers and independent sales representatives by employees based in New Jersey, California, Texas and Arizona.

In Europe and Japan, we sell to semiconductor and ATE manufacturers through our account managers. In China, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand, we sell through independent sales representatives and distributors. International sales representatives and distributors are responsible for sales, installation, support and trade show participation in their geographic market areas.

Temperature Management Systems: Sales to ATE manufacturers are handled directly by our own sales force. Sales to semiconductor manufacturers and customers in other industries in the U.S. are handled through independent sales representative organizations. In Singapore, Malaysia and Indonesia, our sales and service are handled through our own sales and service personnel. In the rest of Asia, our sales are handled through distributors. In Europe, sales managers at our offices in Germany and the U.K., as well as regional distributors, sell directly to semiconductor manufacturers and customers in other industries. Our distributors represent us in 30 countries. We visit our distributors regularly and have trained them to sell and service all of our temperature management products.

CUSTOMERS

We market all of our products to semiconductor manufacturers and ATE manufacturers. In the case of temperature management products, we also market our products to independent testers of semiconductors, manufacturers of electronic, automotive and aeronautical products, and semiconductor research facilities. Our customers use our products principally in production testing, although our ThermoStream(R) products traditionally have been used largely in engineering development and quality assurance. We believe that we sell to most of the major semiconductor manufacturers in the world.

Our largest customers include:

BACKLOG

At December 31, 2003, our backlog of unfilled orders for all products was approximately $13.6 million compared with approximately $9.8 million at December 31, 2002. Our backlog includes customer purchase orders which we have accepted, substantially all of which we expect to deliver in 2004. While backlog is calculated on the basis of firm purchase orders, a customer may cancel an order or accelerate or postpone currently scheduled delivery dates. As a result, our backlog at a particular date is not necessarily indicative of sales for any future period.

EMPLOYEES

At December 31, 2003, we had 260 full time employees, including 116 in manufacturing operations, 107 in customer support/operations and 37 in administration. Substantially all of our key employees are highly skilled and trained technical personnel. None of our employees is represented by a labor union, and we have never experienced a work stoppage. We believe that our relationship with our employees is very good.

At December 31, 2003, we leased 11 facilities worldwide. The following chart provides information regarding each of our principal facilities which we occupied at December 31, 2003.

From time to time we may be a party to legal proceedings occurring in the ordinary course of business. We are not currently involved in any material legal proceedings.

No matters were submitted to our stockholders for a vote during the fourth quarter of 2003.

Our common stock is traded on the Nasdaq National Market under the symbol "INTT." The following table sets forth the high and low sale prices of our common stock, as reported on the Nasdaq National Market, for the periods indicated. Sale prices have been rounded to the nearest full cent.

On March 15, 2004, the closing price for our common stock as reported on the Nasdaq National Market was $5.61. As of March 15, 2004, we had 8,362,857 shares outstanding that were held of record by approximately 1,000 shareholders.

We have not paid dividends on our common stock since our initial public offering, and we do not plan to pay cash dividends in the foreseeable future. Our current policy is to retain any future earnings for reinvestment in the operation and expansion of our business, including possible acquisitions of other businesses, technologies or products. Payment of any future dividends will be at the discretion of our board of directors. In addition, our current credit agreement prohibits us from paying cash dividends without the lender's prior consent.

The following table shows the number of securities that may be issued pursuant to our equity compensation plans (including individual compensation arrangements) as of December 31, 2003:

The following table contains certain selected consolidated financial data of inTEST and is qualified by the more detailed Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the other financial information included in this Annual Report on Form 10-K.

Overview

Our business and results of operations are substantially dependent upon the demand for ATE by semiconductor manufacturers and companies that specialize in the testing of ICs. Demand for ATE is driven by semiconductor manufacturers that are opening new, or expanding existing, semiconductor fabrication facilities or upgrading existing equipment, which in turn is dependent upon the current and anticipated market demand for semiconductors and products incorporating semiconductors. The semiconductor industry has been highly cyclical with recurring periods of oversupply, which often have a severe impact on the semiconductor industry's demand for ATE, including the products we manufacture. This cyclicality has been clearly demonstrated during the past eight years, with downward cycles in 1996, 1998 and 2001-2002 and up cycles in 1997, 1999-2000 and 2003.

Net Revenues and Bookings

The most recent downturn, which began during the fourth quarter of 2000 and reversed in 2003, was the most severe and prolonged downturn the ATE industry has ever experienced. Our consolidated quarterly net revenues declined from a peak of $24.5 million for the quarter ended September 30, 2000 to $7.0 million for the quarter ended March 31, 2002, a decline of approximately 72%. The decrease we experienced in net revenues during this period was comparable to the peak to trough differences experienced by most of the companies in our industry.

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During this downturn, the trend in both our bookings and net revenues was erratic. Our bookings and revenues began declining during the fourth quarter of 2000 and continued declining until the first quarter of 2002, when our bookings increased sequentially for three quarters (in the case of net revenues, this increase began in the second quarter of 2002 and lasted two quarters), followed by a decline again in bookings and net revenues in the fourth quarter of 2002 that continued until the second quarter of 2003, when both bookings and net revenues began to increase sequentially again.

The current industry consensus is that the next up cycle began in 2003 and should continue for 18 to 24 months. This view is supported by the increase in our quarterly bookings during 2003, which increased from $7.7 million in the first quarter to $16.1 million in the fourth quarter. This improvement is also shown in our quarterly net revenues, which increased from $9.2 million in the first quarter of 2003 to $14.8 million in the fourth quarter. While we cannot be sure what the rate of increase of this up cycle will be or how long it will last, we currently expect the trend of growth in both bookings and net revenues to continue throughout 2004, although the rate of quarter-over-quarter increases may decline. We currently anticipate that our sales for the first quarter of 2004 will increase from the level of the fourth quarter of 2003 and be in the range of $15.0 to $16.0 million; however,

Cost Containment Initiatives

During 2001 and 2002, in response to the downturn, we implemented significant cost containment initiatives to reduce operating losses and preserve cash. These cost containment initiatives included an approximate 40% reduction in worldwide personnel, as well as temporary reductions in compensation for all employees and the elimination of matching contributions to retirement plans for all domestic employees. In addition, we made significant reductions in spending on corporate travel, advertising, professional services and supplies. As a result of these cost containment efforts, we reduced operating expenses from a peak of $7.3 million for the quarter ended December 31, 2000 to $3.8 million for the quarter ended March 31, 2002. During 2002, we temporarily reinstated some of the benefits which had been reduced or eliminated after our bookings and net revenues began to increase. However, when we began experiencing declines in our bookings, as well as customer order delays, during the second half of 2002, both of which resulted in reduced net revenues during the fourth quarter of 2002, we again temporarily eliminated certain employee benefits and instituted additional expense controls in certain facilities.

The goal of our cost containment initiatives was to reduce fixed operating costs to a level which, based on our then current revenue projections, would allow us to maintain our level of cash while still continuing our research and development programs and positioning ourselves such that, as the market improved, we would be able to be a prime supplier for both new and existing technologies developed by our customers.

As of December 31, 2003, all personnel worldwide remained on a salary freeze and matching contributions to retirement plans for all domestic employees were still temporarily eliminated. Given the improvements in our bookings and net revenues in the second half of 2003, and in light of the industry consensus that the up cycle has begun and should continue through 2004 and into 2005, we are monitoring our costs and evaluating when we will be able to return employee benefits as well as provide salary increases to personnel worldwide. However, should the current upward trend reverse itself, or if our bookings and net revenues do not increase as currently projected, we are prepared to take appropriate actions necessary to preserve cash.

Inventory Obsolescence Charges

We review our inventories and record inventory obsolescence charges based upon our established obsolescence criteria, that identifies material that has not been used in a work order during the prior 12 months and the excess quantity of material on hand that is greater than the average annual usage of that material over the prior three years (or in the case of our temperature management systems, three years of average annual usage due to our after-sale obligations for servicing these products). In addition, in certain cases, additional inventory obsolescence charges are recorded based upon facts which would not give rise to an obsolescence charge under the normal obsolescence criteria or, if in management's opinion, additional amounts are felt to be necessary based upon the current industry conditions. See also "Critical Accounting Policies".

The most recent downturn significantly reduced demand for a number of products we design and manufacture. As a result, inventory obsolescence charges have historically increased during downturns and through the beginning of the subsequent upturn. We incurred inventory obsolescence charges of $886,000, $1.0 million and $3,4 million in the years ended December 31, 2003, 2002 and 2001, respectively. While the trend of these inventory obsolescence charges has been reducing over the last three years, we cannot determine if this downward trend will continue or if these charges will increase in 2004 due to potential technological obsolescence of our current inventories.

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Product Warranty Charges

We accrue product warranty charges on a quarterly basis based upon our historical product warranty expense. In addition, we accrue additional amounts based upon known product warranty issues, such as product retrofits. Our product warranty charges were $1.9 million, $1.1 million and $1.0 million for the years ended December 31, 2003, 2002 and 2001, respectively, and our product warranty charges as a percentage of net revenues were 4.0%, 2.3% and 2.0% for the same periods, respectively. The increase in both the absolute dollar amount of product warranty charges and the level of the product warranty charges as a percentage of net revenues was due to a number of factors including the volatility of net revenues in the ATE industry, the prototype nature of much of our business, the introduction of products offering power assisted features in our positioner/docking hardware segment and providing warranty repairs or replacements to customers after the warranty has expired in certain situations, in order to promote strong customer relations.

During 2003, we accrued significant product warranty charges for future product retrofits for two products we sell to ATE manufacturers. In our positioner/docking hardware segment, we accrued approximately $700,000 for retrofits to a positioner product developed and first sold during 2001. This power-assisted positioner, whose prototype design was significantly different from the positioner products we have historically sold, had approximately 200 units in the field that required several different modifications and enhancements. In our temperature management segment, we accrued approximately $220,000 related to a temperature chuck product that was first introduced in 2001. This temperature chuck product was designed to allow for rapid temperature changes between -65 and +400 degrees Celsius. Under certain environmental and usage conditions this product did not perform consistently, so we are replacing it in those cases with another of our products that is better suited for the conditions. We believe we have accrued adequate warranty charges at December 31, 2003 for the product retrofits planned for both of these products. We cannot determine at this time if we will have any further material warranty costs related to additional product modifications or enhancements for these or any of our other current products. See also "Critical Accounting Policies."

Customer Mix

We sell our products to both semiconductor manufacturers (end user sales) and to ATE manufacturers (OEM sales) who ultimately resell our equipment with theirs to semiconductor manufacturers. The mix of customers during any given period will affect our gross margin due to differing sales discounts and commissions. Prior to 2000, the majority of our positioner, docking hardware and tester interface product sales were made directly to semiconductor manufacturers, with sales to these end users typically in the range of 65% to 75% of our net revenues. However, since the beginning of 2000, many semiconductor manufacturers have shown a preference for purchasing from a single source the various components of the ATE (excluding temperature management systems) that they need. Typically, this source is the tester manufacturer, who manufactures the largest and most expensive components of the ATE system.

Our OEM sales as a percentage of net revenues for the years ended December 31, 2003, 2002 and 2001 were 34%, 43% and 54%, respectively, for our positioner/docking hardware segment. The decline in the percentage of sales to OEMs in the positioner/docking hardware segment in 2002 and 2003 reflects the return of demand by certain semiconductor customers who prefer to acquire their equipment directly from us. We anticipate that OEM sales as a percentage of net revenues for our positioner/docking hardware segment will range from 35% to 55% in future periods. In our tester interface segment, our OEM sales as a percentage of net revenues for the years ended December 31, 2003, 2002 and 2001 were 79%, 62% and 70%, respectively. The increase in the percentage of sales to OEMs in the tester interface segment in 2003 reflects significantly increased demand by one OEM customer in 2003. We anticipate that OEM sales as a percentage of net revenues for our tester interface segment will range from 60% to 80% in future period s. In our temperature management segment, OEM sales as a percentage of net revenues were 32%, 36% and 32% for the years ended December 31, 2003, 2002 and 2001, respectively. We anticipate that OEM sales as a percentage of net revenues for our temperature management segment will range from 30% to 40% in future periods.

The impact of an increase in OEM sales as a percentage of net revenues is a reduction in our gross margin, as OEM sales historically have had a more significant discount than end user sales. Our current net operating margins on most OEM sales for these product segments, however, are only slightly less than margins on end user sales because of the payment of third party sales commissions on most end user sales. We also expect to continue to experience demands from our OEM customers' supply line management groups to reduce our sales prices to them. This continued price pressure may have the ultimate effect of reducing our gross and operating margins if we cannot further reduce our manufacturing and operating costs.

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We believe that purchases of most of our products are typically made from semiconductor manufacturers' capital expenditure budgets. Certain portions of our business, however, are generally less dependent upon the capital expenditure budgets of the end users. For example, purchases of certain related ATE interface products, such as sockets and interface boards, which must be replaced periodically, are typically made from the end users' operating budgets. In addition, purchases of certain of our products, such as docking hardware, for the purpose of upgrading or to improve the utilization, performance and efficiency of existing ATE, tend to be counter cyclical to sales of new ATE. Moreover, we believe a portion of our sales of temperature management systems results from the increasing need for temperature testing of circuit boards and specialized components that do not have the design or quantity to be tested in an electronic device handler. We believe that this business usually is less cyclical than new ATE s ales. However, during the recent downward cycle, we saw our customers' orders for these types of products decline as much as, or in some cases more than, the other products we offer as compared with prior periods of reduced capital spending for ATE. We attribute this in part to reductions in our customers' operating budgets combined with significant excess capacity that existed throughout the industry, which significantly reduced our customers' equipment utilization rates. We believe that much of this excess capacity was the result of capital equipment purchases made during the 1999-2000 up-cycle, and that this newer equipment did not need to be upgraded or improved. We also believe that many of our customers' equipment utilization rates have been steadily increasing throughout 2003 due to increased IC unit production and are approaching, or have already exceeded, the levels where additional ATE equipment purchases will be necessary to meet increased IC production demands.

Please refer to the section entitled "Risks That Could Affect Future Results" below for a discussion of other important factors that could cause our results to differ materially from our prior results or those expressed or implied by our forward-looking statements.

Results of Operations

All of our products are used by semiconductor manufacturers in conjunction with ATE in the testing of ICs. Consequently, the results of operations for each product segment are generally affected by the same factors. Separate discussions and analyses for each product segment would be repetitive and obscure any unique factors that affected the results of operations of our different product segments. The discussion and analysis that follows, therefore, is presented on a consolidated basis for the Company as a whole and includes discussion of factors unique to each product segment where significant to an understanding of each such business.

The following table sets forth for the periods indicated the principal items included in the Consolidated Statements of Operations as a percentage of total net revenues.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Net Revenues. Net revenues were $48.0 million for 2003 compared to $47.1 million for 2002, an increase of $901,000 or 2%. In 2003, net revenues for our positioner/docking hardware and tester interface segments increased $3.6 million, or 18%, and $799,000, or 8%, respectively. These increases were offset by a decrease in net revenues in our temperature management segment of $926,000, or 5%. We believe the increases in our positioner/docking hardware and tester interface segments are due to the aforementioned increase in demand we experienced for our products throughout 2003. We believe that the decrease in net revenues for our temperature management segment reflects the severe cyclical downturn in demand for ATE in the industry generally.

Gross Margin. Gross margin remained relatively unchanged in 2003 from 2002. The gross margin in 2003 was slightly over 39% compared to slightly less than 39% in 2002. The slight increase in gross margin in 2003 is primarily the result of a decrease in component material costs as a percentage of net revenues that reflects lower levels of fabrication costs due to process improvements as well as the mix of products sold and, to a lesser extent, a decrease in OEM sales as a percentage of total sales in 2003 compared to 2002, as previously discussed. Also, as previously discussed, we incurred significant charges for inventory obsolescence during both 2003 and 2002 as a result of the continued downturn in the industry.

Selling Expense. Selling expense was $10.2 million for 2003 compared to $8.5 million in 2002, an increase of $1.7 million or 20%. We attribute the increase primarily to the aforementioned increase in product warranty costs in our positioner/docking hardware and temperature management segments. Other significant year-over-year increases included commission expense as well as salary and benefits expense. The increase in commission expense of $303,000 was due to an increase in end-user commissionable sales. The increase in salary and benefit expense of $304,000 was due to the hiring of new sales staff in the positioner/docking hardware and tester interface segments as well as the return of certain benefits that had previously been reduced or eliminated. To a lesser extent, there were increases in travel expenses, freight costs and demonstration equipment, all of which were driven by the increased level of business activity as demand improved throughout 2003.

Engineering and Product Development Expense. Engineering and product development expense was $6.4 million for 2003 compared to $5.7 million in 2002, an increase of $734,000 or 13%. We attribute the increase primarily to an increase of $759,000 in salary and benefits expense in our positioner/docking hardware and tester interface segments, where we increased our engineering and product development staff as well as returned certain benefits that had previously been reduced or eliminated. Also contributing to the increase were higher levels of spending on third-party product development consultants and travel in our positioner/docking hardware and temperature management segments. The increases in staffing, third-party consultant costs and travel were due to increased product development efforts throughout 2003. These increases were partially offset by reductions in spending on product development materials in our temperature management segment in 2003 compared to 2002.

General and Administrative Expense. General and administrative expense was $6.1 million for 2003 compared to $5.9 million for 2002, an increase of $192,000 or 3%. We attribute the increase primarily to increased data processing costs in our positioner/docking hardware segment as well as increased salary and benefits expense in our positioner/docking hardware and tester interface segments. The $149,000 increase in data processing costs are related to a company-wide ERP system conversion that began in the fourth quarter of 2003 at our primary location in the positioner/docking hardware segment and will continue into 2004 at our tester interface segment and into 2005 at the remaining locations in our positioner/docking hardware segment. The $222,000 increase in salary and benefits expense was the result of the return of certain benefits that had been reduced or eliminated. These increases were partially offset by a decrease in legal fees as well as reductions in spending on fees for tax services and comm unications. The decrease in legal fees in 2003 compared to 2002 is primarily due to the settlement of patent litigation during the first quarter of 2003.

Other Income. Other income was $224,000 for 2003 compared to $143,000 in 2002, an increase of $81,000 or 57%. The increase in other income was primarily due to a decrease in foreign exchange transaction losses of $96,000 in 2003 compared to 2002. To a lesser extent, the increase was attributable to reduced interest expense in 2003 compared to 2002. Partially offsetting the benefit of these two items was a reduction in interest income in 2003 compared to 2002 due to lower average cash balances.

Income Tax Expense (Benefit). Income tax expense was $1.8 million for 2003 compared to an income tax benefit of $1.4 million for 2002. Our effective tax rate for 2003 was 51% compared to (83)% for 2002. During 2003, we recorded a $1.4 million valuation allowance against our beginning of the year net deferred tax assets due to our 2003 operating losses which

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resulted in the realizability of the net deferred tax assets to no longer be considered more likely than not. In addition, we recorded approximately $400,000 of income tax expense in 2003, due to the earnings of certain of our foreign operations as well as a reduction in the anticipated amount of tax refunds resulting from research and development credits filed for in 2002. During 2002, we recorded a one-time tax benefit of $750,000, which resulted from our filing amended prior year tax returns to claim additional research and experimentation credits for prior years.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Net Revenues. Net revenues were $47.1 million for 2002 compared to $51.6 million for 2001, a decrease of $4.5 million or 9%. Net revenues for our temperature management segment decreased $8.5 million or 33%. This decline was offset by increases in net revenues in both our positioner/docking hardware and tester interface segments of $726,000 or 4% and $3.2 million or 55%, respectively. We believe that the significant decrease in net revenues for our temperature management segment reflected the severe cyclical downturn in demand for ATE in the industry generally and, more specifically, the demand for products used in research and product development by semiconductor manufacturers declined in 2002 compared to 2001. We believe the increase in net revenues for our positioner/docking hardware segment reflected the aforementioned increased demand we experienced for our products in the second and third quarters of 2002, due to significant under spending in 2001. We believe the significant increase in the net revenues of our tester interface segment was primarily the result of the increased demand for our products in the second and third quarters of 2002.

Gross Margin. Gross margin increased to 39% in 2002 from 25% in 2001. The increase in gross margin in 2002 is primarily the result of a decrease in component material costs as a percentage of net revenues which reflects lower levels of fabrication costs due to process improvements as well as the mix of products sold and, to a lesser extent, a decrease in OEM sales as a percentage of total sales in 2002 compared to 2001, as previously discussed. Significant charges for inventory obsolescence were recorded during both 2002 and 2001 as a result of the continued downturn in the industry which had caused items in our inventory to become obsolete.

Selling Expense. Selling expense was $8.5 million for 2002 compared to $8.8 million for 2001, a decrease of $276,000 or 3%. We attribute the decrease primarily to decreased commission expense, which declined $409,000 due to the lower sales levels at our temperature management segment. However, this trend was partially offset by a $333,000 increase in commission expense in our positioner/docking hardware and tester interface product segments, where end user sales increased in 2002 compared to 2001. In addition, salary and benefit expenditures decreased $276,000 in 2002 as compared to 2001, primarily as a result of our cost containment program.

Engineering and Product Development Expense. Engineering and product development expense was $5.7 million for 2002 compared to $6.1 million for 2001, a decrease of $464,000 or 8%. We attribute the decrease primarily to a $402,000 decline in salary and benefit expense resulting from our cost containment program and, to a lesser extent, reduced expenditures for travel. These declines were partially offset by increased spending on product development initiatives in 2002 compared to 2001.

General and Administrative Expense. General and administrative expense was $5.9 million for 2002 compared to $7.9 million for 2001, a decrease of $2.0 million or 25%. We attribute the decrease primarily to the elimination of goodwill amortization of $381,000 in 2002, reductions in salary and benefit expense of $1.1 million and reductions of $298,000 in travel. In addition, there were reductions in spending on professional services, outside directors' fees and data processing. The reduction in salary and benefits expense reflects the results of our cost containment program, combined with the fact that 2001 included an accrual for separation payments to a former executive of one of our subsidiaries. The reductions in all other areas, with the exception of goodwill amortization, reflect the results of our cost containment program.

Impairment of Goodwill. During the third quarter of 2001, due to the significant decline in our operations that had occurred over the preceding four quarters, we determined that an assessment of our goodwill for impairment under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, was warranted. As a result of this assessment, we concluded that no impairment was indicated for the goodwill associated with our foreign subsidiaries; however, a $4.6 million impairment charge was recorded for the goodwill associated with TestDesign, which was the net book value of this goodwill as of that date.

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In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142, Goodwill and Other Intangible Assets, which superceded the provisions of SFAS No. 121 related to the assessment of goodwill for impairment. SFAS No. 142 was effective for us as of January 1, 2002. Under SFAS No. 142, we are required to assess our goodwill for impairment at least annually, or more often if circumstances warrant. In accordance with the provisions of SFAS No. 142, we completed the first step of the transitional goodwill impairment test as well as the annual goodwill impairment test and concluded that there was no further impairment of goodwill. See Note 2 to the consolidated financial statements.

Other Income. Other income was $143,000 for 2002 compared to $551,000 for 2001, a decrease of $408,000 or 74%. The decline is primarily the result of reduced levels of interest income due to lower interest rates, an increase of $92,000 in foreign exchange translation losses and reductions in the level of third party royalty income from the licensing of our intellectual property caused by the continued industry downturn.

Income Tax Benefit. Income tax benefit was $1.4 million for 2002 compared to $2.8 million for 2001. Our effective tax rate for 2002 was 83% compared to 20% for 2001. During 2002 we recorded a one-time tax benefit of approximately $750,000. This benefit resulted from our filing amended prior year returns to claim additional research and experimentation credits. During 2001 we recorded a non-tax deductible charge for the impairment of goodwill of $4.6 million.

Liquidity and Capital Resources

Net cash used in operations for the year ended December 31, 2003 was $1.4 million compared to net cash provided by operations of $2.5 million in 2002. The swing from cash provided by operations in 2002 to cash used in operations in 2003 was primarily the result of our operating losses in 2003. Also contributing to this swing was the growth in accounts receivable and inventories. Accounts receivable increased $2.4 million from December 31, 2002 to December 31, 2003 due to higher net revenue levels in the fourth quarter of 2003 compared to the same period in 2002, while inventories increased $229,000, primarily due to the purchasing of materials to fulfill current and future orders. Refundable domestic income taxes decreased $948,000, primarily as the result of state and federal income tax refunds received during 2003. Deferred tax assets decreased $1.4 million, primarily as a result of recording a full valuation allowance against our net deferred tax assets. Accounts payable increased $1.1 million due to incr eased purchases to support higher production levels during the fourth quarter of 2003 compared to the same period in 2002. Accrued expenses increased $933,000 primarily as a result of increased accruals for product warranty expense as previously discussed. In addition, there were increases in accruals for wages and sales commissions.

Purchases of property and equipment were $1.7 million for the year ended December 31, 2003, which consisted of $714,000 primarily for demonstration equipment for our Temptronic facility, $458,000 primarily for computer hardware and software related to the implementation of a new ERP system for our Cherry Hill facility and $369,000 primarily for demonstration equipment and equipment for our machine shop at our Sunnyvale facility. The balance of purchases were for equipment for our foreign subsidiaries.

Net cash provided by financing activities for the year ended December 31, 2003 was $53,000, which consisted of $139,000 in proceeds received from the exercise of employee stock options offset by $86,000 in payments made under capital lease obligations.

Our total committed contracts that will affect cash over the next five years and beyond are as follows:

We have a secured credit facility that provides for maximum borrowings of $200,000. We have not utilized this facility to borrow any funds. Our only usage consists of the issuance of a letter of credit in the face amount of $200,000. We pay a quarterly commitment fee of 0.425% per annum on the unused portion of the facility; however, based upon current projected usage, we do not expect to pay a fee in 2004. The terms of the loan agreement require that we maintain a minimum level of $200,000 of domestic cash. This credit facility expires on September 30, 2004. We currently plan to renew this facility at its current size to support the issuance of the letter of credit. We do not currently foresee any reason that we will not be able to renew or replace this credit facility upon its expiration.

We believe that our existing cash balances plus the anticipated cash provided from operations will be sufficient to satisfy our cash requirements for the foreseeable future. As previously discussed, the current industry consensus is that an upturn has begun, and that the industry will sustain moderate quarter-over-quarter growth in bookings and net revenues throughout 2004 and into 2005. However, if the upturn were to be more rapid than we expect, or if the upturn should falter and the industry should enter another downturn, we may require additional debt or equity financing to meet working capital or capital expenditure needs. We cannot be certain that, if needed, we would be able to raise such additional financing or upon what terms such financing would be available.

New Accounting Pronouncements

In December 2003, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition, effective December 17, 2003. SAB No. 104 updates portions of the interpretive guidance included in Topic 13 of the codification of SABs to make this interpretive guidance consistent with current authoritative accounting guidance and SEC rules and regulations related to revenue recognition. We believe our revenue recognition policies are in compliance with SAB No. 104.

On January 1, 2003, we adopted SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses the accounting and reporting of expenses related to restructurings initiated after 2002, and applies to costs associated with an exit activity (including a restructuring) or with a disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities or personnel. SFAS No. 146 changes some of the criteria for recognizing a liability for these activities. The adoption of SFAS No. 146 did not have an effect on our results of operations, financial condition or long-term liquidity.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. Effective January 1, 2003, we adopted the disclosure requirements of SFAS No. 148. We have determined that we will not make the voluntarily change to the fair value based method of accounting for stock-based employee compensation at this time.

In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"). FIN 45 requires that the guarantor recognize, at the inception of certain guarantees, a liability for the fair value of the obligation undertaken in issuing such guarantees. FIN 45 also requires additional disclosure about the guarantor's obligations under certain guarantees that it has issued. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, and the disclosure requirements are effective after December 15, 2002. The adoption of this interpretation did not have a material impact on our results of operations, financial condition or long-term liability.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, identifiable intangibles, long-lived assets and related goodwill, deferred income tax valuation allowances and warranty reserves. We base our estimates on historical experience and on appropriate and customary

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assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Some of these accounting estimates and assumptions are particularly sensitive because of their significance to our consolidated financial statements and because of the possibility that future events affecting them may differ markedly from what had been assumed when the financial statements were prepared.

Inventories are stated at the lower of cost (first-in, first-out basis) or net realizable value. We use consistent methodologies to evaluate all inventories for net realizable value. We record a provision for excess and obsolete inventory based upon our review process. The criteria to determine if inventory is excess or obsolete are if (1) the inventory was not utilized in a work order during the prior 12 months or (2) if the excess quantity of inventory on hand is greater than the average annual usage of that inventory (or in the case of our temperature management systems, three years of average annual usage due to the after-sale service requirements of these products). In addition, operations and accounting staff review inventory that would not meet these criteria for excess or obsolescence to determine if additional obsolescence charges are necessary based upon assumptions about future demand, product mix and possible alternative uses. Finally, in certain cases, a subjective amount is recorded based upon either additional facts which would not give rise to an obsolescence charge under the initial obsolescence criteria or, if in management's opinion, additional amounts are felt to be necessary based upon the current industry conditions. In 2003, we recorded an inventory obsolescence charge for excess and obsolete inventory of $886,000.

We assess the impairment of identifiable intangibles and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could indicate impairment include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of our use of the asset or the strategy for our overall business and significant negative industry or economic trends. When we determine that the carrying value of intangibles and/or long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we prepare projections of operations for our product segments where these intangibles and/or long-lived assets are associated. If the carrying value of the intangible assets and/or long-lived assets exceeds the undiscounted cash flows per the projections, then we would record an impairment charge. We measure the impairment based upon the projected discounted cash flows using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

When we determine that an impairment review is necessary for goodwill, we compare the fair value of our reporting units to their carrying values. If the result from this analysis indicates that an impairment charge is required, the fair value of the reporting unit is allocated to its identifiable tangible and intangible assets, resulting in an implied valuation of goodwill associated with the reporting unit. We would measure the impairment based on the difference between the implied valuation of the goodwill and its actual carrying value. During 2003, we did not record any impairment charges for identifiable intangibles, long-lived assets or goodwill. Intangibles, long-lived assets and related goodwill were $6.1 million at December 31, 2003.

Deferred tax assets are analyzed to determine if there will be sufficient taxable income in the future in order to realize such assets. We assess all of the positive and negative evidence concerning the realizability of the deferred tax assets, including our historical results of operations for the recent past and our projections of future results of operations, in which we make subjective determinations of future events. If, after assessing all of the evidence, both positive and negative, a determination is made that the realizability of the deferred tax assets is not more likely than not, we establish a deferred tax valuation allowance for all or a portion of the deferred tax assets depending upon the specific facts. If any of the significant assumptions were changed, materially different results could occur, which could significantly change the amount of the deferred tax valuation allowance established. During 2003, we recorded a $1.4 million valuation allowance against our beginning of year net deferred tax assets due to the cumulative losses we have generated during recent years.

Finally, in connection with the accrual of warranty costs associated with our products, we make assumptions about the level of product failures that will occur in the future. These assumptions are primarily based upon historical claims experience. Should the rate of future product failures significantly differ from historical levels, our accrued warranty reserves would need to be adjusted, and the amount of the adjustment could be material. In 2003, we recorded product warranty charges of $1.9 million.

Risks That Could Affect Future Results

The factors discussed below are cautionary statements that identify important factors that could cause our actual results to differ materially from those expressed or implied by our forward-looking statements. These factors may also cause our future results to differ materially from our prior results.

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Our forward-looking statements can often be identified by the use of forward-looking terminology such as "believes," "expects," "intends," "may," "will," "should" or "anticipates" or similar terminology, and include, but are not limited to, statements made in this Report regarding: