inTEST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except for share and per share data)

We are a leading independent designer, manufacturer and marketer of positioner and docking hardware products, temperature management systems and tester interface products that are used by semiconductor manufacturers in conjunction with automatic test equipment ("ATE") in the testing of integrated circuits ("ICs" or "semiconductors").

The consolidated entity is comprised of inTEST Corporation (parent) and our wholly-owned subsidiaries. We manufacture our products in the U.S., the U.K., Germany and Singapore. Marketing and support activities are conducted worldwide from our facilities in the U.S., the U.K., Germany, Japan and Singapore.

Basis of Presentation

The accompanying unaudited consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain of our accounts, including goodwill, inventory, deferred income tax valuation allowances and warranty reserves, are particularly impacted by estimates.

In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position, results of operations, and changes in cash flows for the interim periods presented. Certain footnote information has been condensed or omitted from these consolidated financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2003.

Concentration of Other Risks

The semiconductor industry in which we operate is characterized by rapid technological change, competitive pricing pressures and cyclical market patterns. This industry is subject to significant economic downturns at various times. Our financial results are affected by a wide variety of factors, including, without limitation: the highly cyclical nature of the semiconductor industry; dependence upon capital expenditures of semiconductor manufacturers; developments and trends in the semiconductor and ATE industries; changes in general economic, business and financial market conditions; future acquisitions and our ability to successfully integrate the businesses, technologies or products that we may acquire; costs and capital requirements associated with future acquisitions and integration of operations; the impairment of goodwill related to prior or future acquisitions; increased competition and potential loss of market share due to the expiration of patent rights; the loss of, or reduction in orders from, one or more major customers; cancellation or delays in shipment of orders in our backlog; competition from other manufacturers of docking hardware, positioners, tester interfaces and temperature management products; progress of product development programs; technological obsolescence of our inventory and obsolescence due to changes in demand for our products; product warranty expense related to product retrofits and other product replacements driven by the prototype nature of much of our business; unanticipated exchange rate fluctuations; the availability of qualified personnel; the ability to retain key personnel whose salaries have been reduced; the ability to effectively reduce and control operating costs and successfully restructure our operations to reduce our break-even point; competitive pricing pressures; the mix of products sold; the mix of customers and geographic regions where products are sold; the development of new products and technologies by our competitors; our ability to obtain patent protecti on and to enforce patent rights for existing and developing proprietary technologies; the utilization of management time and the expenses of various professionals retained to assist us with compliance with new securities regulations; and the sufficiency of cash balances, lines of credit and net cash from operations. As a result of these or other factors, we may experience significant period-to-period fluctuations in future operating results.

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inTEST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

Reclassification

Certain prior year amounts have been reclassified to be comparable with the current year's presentation.

Goodwill and Intangibles

Goodwill at both September 30, 2004 and 2003 relates to the positioner/docking hardware segment. Changes in the amount of the carrying value of goodwill for the nine months ended September 30, 2004 and 2003 are as follows:

Net Earnings (Loss) Per Common Share

Net earnings (loss) per common share is computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share. Basic earnings (loss) per common share is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during each period. Diluted earnings (loss) per common share is computed by dividing net earnings (loss) by the weighted average number of common shares and common share equivalents outstanding during each period. Common share equivalents represent stock options and are calculated using the treasury stock method. Common share equivalents are excluded from the calculation if their effect is anti-dilutive. The table below sets forth for the periods indicated the average number of employee stock options and their respective weighted average exercise prices that were excluded from the calculation of diluted earnings per share because their effect was anti-dilutive.

We have three reportable segments: positioner/docking hardware products, temperature management systems and tester interface products. The positioner/docking hardware segment includes the operations of our Cherry Hill, New Jersey manufacturing facility as well as the operations of four of our foreign subsidiaries: inTEST Limited (U.K.), inTEST Kabushiki Kaisha (Japan), inTEST PTE, Limited (Singapore) and Intestlogic GmbH (Germany). Sales of this segment consist primarily of positioner and docking hardware products which we design, manufacture and market, as well as certain other related products which we design and market, but which are manufactured by third parties. The temperature management segment includes the operations of Temptronic Corporation in Sharon, Massachusetts as well as inTEST GmbH (Germany). Sales of this segment consist primarily of temperature management systems which we design, manufacture and market under our Temptronic product line. In addition, this segment provides after sale s ervice and support, which is paid for by its customers. The tester interface segment includes the operations of inTEST Sunnyvale Corp. in Sunnyvale, California. Sales of this segment consist primarily of tester interface products which we design, manufacture and market under our TestDesign product line.

We operate our business worldwide, and all three segments sell their products both domestically and internationally. All three segments sell to semiconductor manufacturers and ATE manufacturers.

Intercompany pricing between segments is either a multiple of cost for component parts or a percentage discount from list price for finished goods.

In mid November, we announced organizational changes and cost structure adjustments that are part of our continuing efforts to effectively meet the needs and expectations of the fluid ATE market. These changes will give our divisional general managers increased responsibility for marketing, sales and service, thus allowing for the reduction of corresponding central corporate staff. We believe this reorganization and resultant decentralization will make us a more competitive company positioned to rapidly adapt to new market challenges and opportunities through continued research and development as well as strategic merger and acquisition activities.

Specific actions resulting from the reorganization include the elimination of four executive-level positions, an approximate 18% reduction in domestic head count, and certain salary and benefit adjustments. During the fourth quarter of 2004, we expect we will incur severance costs of approximately $500 related to these actions. We expect these actions will reduce our annual operating expense structure by approximately $4.5 million. Additional organizational changes are still being developed that may result in additional implementation costs in future quarters prior to realizing future savings.
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Overview

As discussed more fully in our Annual Report on Form 10-K for the year ended December 31, 2003 (our "2003 Form 10-K"), 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. In the past, 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 can cause wide fluctuations in both our bookings and net revenues and can significantly impact our results of operations, depending on our ability to react quickly to these shifts in demand. The se industry cycles have lasted typically 18 to 24 months; however, recently the cycles have become less predictable. Because the industry cycles are generally characterized by sequential quarterly growth or declines in bookings and net revenues throughout the cycle, year over year comparisons of operating results may not always be as meaningful as comparisons of periods at similar points in either up or down cycles.

During both downward and upward cycles in our industry, while the general trend over several quarters tends to be one of either growth or decline, in any given quarter the trend in both our bookings and net revenues can be erratic. This can occur, for example, when orders are pulled in or pushed out by a significant customer or when customer forecasts and general business conditions fluctuate during a quarter causing one particular month and/or quarter to have either stronger or weaker than anticipated growth or decline.

Net Revenues and Bookings

The following table sets forth for the periods indicated a breakdown of the net revenues from unaffiliated customers both by product segment and geographic area (based on the location of the selling entity).

We cannot determine at this time if the ATE industry has entered the next down cycle, or if the downward trend in our bookings and net revenues in the third quarter of 2004 represents only a temporary softening of demand in the markets we serve. At present, we cannot predict how long the current weaker market conditions will remain, nor how significant the declines in both our quarterly net revenues and bookings will be through this period of contraction.

Cost Containment and Organizational Changes

In mid November, we announced organizational changes and cost structure adjustments that are part of our continuing efforts to effectively meet the needs and expectations of the fluid ATE market. These changes will give our divisional general managers increased responsibility for marketing, sales and service, thus allowing for the reduction of corresponding central corporate staff. We believe this reorganization and resultant decentralization will make us a more competitive company positioned to rapidly adapt to new market challenges and opportunities through continued research and development as well as strategic merger and acquisition activities.

Specific actions resulting from the reorganization include the elimination of four executive-level positions, an approximate 18% reduction in domestic head count, and certain salary and benefit adjustments. During the fourth quarter of 2004, we expect we will incur severance costs of approximately $500 related to these actions. We expect these actions will reduce our annual operating expense structure by approximately $4.5 million. Additional organizational changes are still being developed that may result in additional implementation costs in future quarters prior to realizing future savings.

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. 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 historical 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", below.

For the nine months ended September 30, 2004 and 2003, our inventory obsolescence charges were $1.1 million and $275,000, respectively. The level of inventory obsolescence charges can fluctuate significantly from period to period and are based upon a variety of factors including changes in demand for our products and new product designs. The increase in inventory obsolescence charges during 2004 was primarily the result of order cancellations where we had already purchased inventory to fulfill the orders and where that inventory can not be used in other products we manufacture due to its highly customized nature. In addition we had increases in our reserves for excess quantities related to materials with long lead times that were purchased based upon forecasted orders which did not materialize. After the close of the third quarter of 2004, management made the determination to cease the practice of purchasing significant amounts of inventory against forecasted orders due to the increased level of uncertainty in our current business outlook. However, at some point in the future, we may determine that it is appropriate to increase the level of such purchases based on a variety of factors, including, but not limited to, general market conditions and the specific delivery requirements of our customers.

Product Warranty Charges

We accrue product warranty charges on a quarterly basis based upon our historical claims experience. In addition, we accrue additional amounts based upon known product warranty issues, such as product retrofits. During the nine months ended September 30, 2004 and 2003 our product warranty charges were $1.5 million and $1.3 million, or 2.6% and 4.0% of net revenues, respectively. The level of our product warranty charges both in absolute dollars and as a percentage of net revenues is affected by a number of factors including the cyclicality of demand in the ATE industry, the prototype nature of much of our business, the complex nature of many of our products and, at our discretion, providing warranty repairs or replacements to customers after the warranty has expired in order to promote strong customer relations.

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Product/Customer Mix

Our three product segments each have multiple products that we design, manufacture and sell to our customers. The gross margin on each product we offer is impacted by a number of factors, including the amount of intellectual property (such as patents) utilized in the product, the number of units ordered by the customer at one time, or the amount of inTEST designed and fabricated material included in our product compared with the amount of third-party designed and fabricated material included in our product. The weight of each of these factors, as well as the current market conditions, determines the ultimate sales price we can obtain for our products and the resulting gross margin.

The mix of products we sell in any period is ultimately determined by our customers' needs. Therefore, the mix of products sold in any given period can change significantly from the prior period. As a result, our consolidated gross margin can be significantly impacted in any given period by a change in the mix of products sold in that period.

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. For the nine months ended September 30, 2004 and 2003, our OEM sales as a percentage of net revenues were 42% and 40%, respectively.

The impact of an increase in OEM sales as a percentage of net revenues is generally 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.

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.

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 inTEST 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.

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Selling Expense. Selling expense was $3.2 million for the quarter ended September 30, 2004 compared to $3.0 million for the same period in 2003, an increase of $250,000 or 8%. We attribute the increase primarily to increased commission expense as well as higher levels of salary and benefits expense in the third quarter of 2004 as compared to the same period in 2003. The increase in commission expense of $301,000 was primarily due to the significantly higher net revenue levels. The increase in salary and benefits expense primarily reflects the reinstatement of certain employee benefits as previously discussed. These increases were partially offset by decreases in warranty, travel and advertising expenses during this same time period. Warranty expense decreased $166,000 primarily due to the fact that our total warranty expense of $808,000 in the third quarter of 2003 included an accrual of $500,000 related to a product retrofit and improvement for one customer. During the third quarter of 2004, our t otal warranty expense was $642,000 and did not include any product retrofits or improvements for a single customer of this magnitude.

Engineering and Product Development Expense. Engineering and product development expense was $1.9 million for the quarter ended September 30, 2004 compared to $1.7 million for the same period in 2003, an increase of $143,000 or 8%. We attribute the increase primarily to a $216,000 increase in salary and benefits expense due largely to hiring additional staff and the reinstatement of certain employee benefits as previously discussed. This increase was partially offset by a reduction in fees paid to third party product development consultants.

General and Administrative Expense. General and administrative expense was $1.9 million for the quarter ended September 30, 2004 compared to $1.5 million for the same period in 2003, an increase of $404,000 or 27%. We attribute the increase primarily to a $264,000 increase in salary and benefits expense, which is largely a result of the reinstatement of employee benefits, as previously mentioned. To a lesser extent, we attribute the increase to higher levels of accruals for profit-based bonuses and an increase in fees paid to members of our Board of Directors.

Other Income. Other income was $36,000 for the quarter ended September 30, 2004 compared to $29,000 for the same period in 2003, an increase of $7,000 or 24%. There were no significant changes in the components of other income during this time period.

Income Tax Expense (Benefit). Income tax benefit was $384,000 for the quarter ended September 30, 2004 compared to income tax expense of $2.1 million for the same period in 2003. During the third quarter of 2003, we recorded a 100% valuation allowance against our net deferred tax assets due to the uncertainty surrounding whether we would be able to generate sufficient taxable income to fully utilize these deferred tax assets before they expire. A significant portion of these deferred tax assets relate to net operating loss carryforwards for certain domestic and foreign subsidiaries. During the first nine months of 2004, these subsidiaries have generated taxable income and recorded tax expense.

At June 30, 2004 we estimated our consolidated effective income tax rate for 2004 to be approximately 19% based upon our estimates of earnings in the second half of 2004. As a result of a significant reduction in the level of our profitability in the third quarter of 2004, relative to what we forecasted at the end of the second quarter, as well as our current forecast of operating losses for the fourth quarter of 2004, we recorded a net consolidated income tax benefit of $384 during the quarter ended September 30, 2004. In addition, based upon current projections of our taxable income for the year ended December 31, 2004, we now do not expect to have sufficient taxable income to be able to fully utilize our remaining domestic Federal net operating loss carryforwards during 2004. Our current estimate is that our consolidated effective income tax rate for 2004 will be approximately 8%.

During the quarter ended ended September 30, 2004, approximately $300 of income tax benefits were generated as the result of stock option exercises. Upon the future realization of these income tax benefits, the amount attributable to stock option exercises will be recorded as additional paid-in capital in stockholders' equity.

Nine Months Ended September 30, 2004 Compared to Nine Months Ended September 30, 2003

Net Revenues. Net revenues were $59.2 million for the nine months ended September 30, 2004 compared to $33.2 million for the same period in 2003, an increase of $26.0 million or 79%. We believe the increase in our net revenues for the nine months ended September 30, 2004 as compared to the same period in 2003 reflects the upturn in demand in our industry which began in the first half of 2003. However, as discussed above in the Overview, our order activity in the positioner/docking hardware and tester interface product segments declined significantly late in the third quarter of 2004. As a result of these weakened market conditions, we expect our consolidated net revenues for the fourth quarter to decline from the level of the third quarter of 2004.

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Net revenues in our positioner/docking hardware segment, temperature management segment and tester interface segment increased 105%, 43% and 58%, respectively, for the nine months ended September 30, 2004 compared to the comparable prior period. The larger increases in the net revenues of both our positioner/docking hardware and tester interface segments reflects the significantly increased demand for these products caused by the increased production requirements of our customers. During the nine months ended September 30, 2004, our net revenues from customers in the U.S., Europe and Asia-Pacific increased 85%, 75% and 47%, respectively, over the comparable prior period. The higher growth rates in net revenues in the U.S. and Europe reflect the greater demand from customers in those regions during the nine months ended September 30, 2004.

Gross Margin. Gross margin was 43% for the nine months ended September 30, 2004 as compared to 39% for the same period in 2003. The increase in gross margin in 2004 is primarily the result of our fixed operating costs being more fully absorbed over the significantly higher net revenue levels in 2004. While the absolute dollar amount of our fixed operating costs increased $1.7 million for the first nine months of 2004 as compared to the same period in 2003, the percentage of net revenues which these costs represent decreased from 21% in 2003 to 15% in 2004. This improvement in gross margin was partially offset by an increase in component material costs and inventory obsolescence charges as a percentage of net revenues during the first nine months of 2004 as compared to the same period in 2003.

We attribute the increase in the absolute dollar amount of our fixed operating costs primarily to higher salary and benefits expense, which increased $1.2 million over the comparable prior period. The increase in salary and benefits expense reflects the reinstatement of certain employee benefits as previously discussed. Also contributing to the increase in fixed operating costs, but to a lesser extent, were increases in third party consultants, insurance, facilities costs and depreciation, which were all driven by the increased level of business activity in 2004 as compared to 2003.

We attribute the increase in component material costs primarily to the mix of products sold. As previously discussed, the increase in inventory obsolescence charges was primarily the result of order cancellations where we had already purchased inventory to fulfill the orders and where that inventory can not be used in other products we manufacture due to its highly customized nature. In addition, we had increases in our reserves for excess quantities related to materials with long lead times that were purchased based upon forecasted orders which did not materialize.

Selling Expense. Selling expense was $9.3 million for the nine months ended September 30, 2004 compared to $7.2 million for the same period in 2003, an increase of $2.1 million or 28%. We attribute the increase primarily to increased commission expense, and, to a lesser extent, increases in salary and benefits, freight, warranty and travel expenses. Commission expense increased $942,000 primarily due to the significantly higher net revenue levels. Salary and benefits expense increased $450,000 primarily reflecting the reinstatement of employee benefits, as previously mentioned. Increases in freight, warranty and travel were all driven by the increased level of business activity in the first nine months of 2004 as compared to the same period in 2003.

Engineering and Product Development Expense. Engineering and product development expense was $5.3 million for the nine months ended September 30, 2004 compared to $4.7 million for the same period in 2003, an increase of $689,000 or 15%. We attribute the increase primarily to a $625,000 increase in salary and benefits expense due largely to hiring additional staff and reinstatement of employee benefits, as previously mentioned. Also contributing to the increase, but to a lesser extent, were higher levels of spending on travel, primarily in our positioner/docking hardware segments, in the first nine months of 2004 as compared to the same period in 2003. These increases were partially offset by a decrease in fees paid to third party product development consultants.

General and Administrative Expense. General and administrative expense was $5.7 million for the nine months ended September 30, 2004 compared to $4.3 million for the same period in 2003, an increase of $1.4 million or 32%. We attribute the increase primarily to higher salary and benefits expense and, to a lesser extent, increases in accruals for profit-related bonuses, legal fees and travel costs. Salary and benefits expense increased $425,000 primarily as a result of the fact that, as previously mentioned, we reinstated certain employee benefits. Profit-related bonus accruals increased $269,000 as a result of our higher earnings for the first nine months of 2004 as compared to the same period in 2003. Legal fees increased $242,000 primarily as a result of having received a settlement of patent infringement litigation during the first quarter of 2003 that was recorded as a reduction of legal expense in that quarter, and, to a lesser extent, due to a higher level of patent filings in 2004 as compared t o 2003. The increase in travel reflects additional travel by administrative personnel related to general business matters including implementation of our new company-wide ERP system and compliance with new securities regulations.

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Other Income. Other income was $90,000 for the nine months ended September 30, 2004 compared to $126,000 for the same period in 2003, a decrease of $36,000 or 29%. The decrease in other income was primarily due to a higher level of foreign exchange transaction losses in the first nine months of 2004 as compared to the same period in 2003.

Income Tax Expense. Income tax expense was $421,000 for the nine months ended September 30, 2004 compared to $1.4 million for the same period in 2003. Our effective tax rate for the first nine months of 2004 was 8% compared to (44)% for the same period in 2003. During 2003, we recorded a 100% valuation allowance against our net deferred tax assets due to the uncertainty surrounding whether we would be able to generate sufficient taxable income to fully utilize these deferred tax assets before they expire. A significant portion of these deferred tax assets relate to net operating loss carryforwards for certain domestic and foreign subsidiaries. In 2004, these subsidiaries have generated taxable income and recorded tax expense.

At June 30, 2004 we estimated our consolidated effective income tax rate for 2004 to be approximately 19% based upon our estimates of earnings in the second half of 2004. As a result of a significant reduction in the level of our profitability in the third quarter of 2004, relative to what we forecasted at the end of the second quarter, as well as our current forecast of operating losses for the fourth quarter of 2004, we recorded a net consolidated income tax benefit of $384 during the quarter ended September 30, 2004. In addition, based upon current projections of our taxable income for the year ended December 31, 2004, we now do not expect to have sufficient taxable income to be able to fully utilize our remaining domestic Federal net operating loss carryforwards during 2004. Our current estimate is that our consolidated effective income tax rate for 2004 will be approximately 8%.

During the nine months ended ended September 30, 2004, approximately $300 of income tax benefits were generated as the result of stock option exercises. Upon the future realization of these income tax benefits, the amount attributable to stock option exercises will be recorded as additional paid-in capital in stockholders' equity.

Liquidity and Capital Resources

Net cash provided by operations for the nine months ended September 30, 2004 was $2.7 million compared to $1.4 million used in operations for the same period in 2003. The shift from cash used in operations to cash provided by operations was primarily the result of our generating operating income for the first nine months of 2004 compared with an operating loss for the same period in 2003. Increases in accounts receivable and inventories during the first nine months of 2004 were partially offset by increases in accounts payable and accrued expenses during this same period. Accounts receivable increased $2.9 million from December 31, 2003 to September 30, 2004 due to higher net revenue levels, and inventories increased $3.2 million during this same period, primarily due to the purchasing of materials to fulfill current and future orders. Accounts payable increased $1.3 million from December 31, 2003 to September 30, 2004 due to increased purchases to support higher production levels during the first nine month s of 2004. Accrued wages and benefits increased $830,000 during this same period primarily as a result of the timing of payroll dates and the aforementioned reinstatement of salary increases for staff in 2004, as well as the accrual of profit-related bonuses.

Purchases of property and equipment were $1.6 million for the nine months ended September 30, 2004, which consisted of $603,000 primarily for computer hardware and software for our Cherry Hill facility, $275,000 primarily for additional machine shop equipment for our UK subsidiary, $264,000 primarily for demonstration equipment and computer hardware and software for our Temptronic facility, and $213,000 primarily for a combination of quality assurance and inspection equipment and engineering software and testing equipment for our Sunnyvale facility. The balance of purchases was for equipment for our other foreign subsidiaries. We currently estimate that we will spend up to $750,000 during the balance of 2004 to purchase additional property and equipment, including approximately $225,000 for improvements to our existing facility in New Jersey, approximately $300,000 for tenant improvements to our new facility in California that we expect to occupy in early 2005, and approximately $100,000 for equipment for on e of our German operations.

Net cash provided by financing activities for the nine months ended September 30, 2004 was $624,000, which consisted of proceeds from the exercise of stock options of $696,000 offset by $72,000 in payments made under capital lease obligations.

We have a secured credit facility that provides for maximum borrowings of $250,000. 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 $250,000. 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, 2005.

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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, late in the third quarter of 2004, we saw a significant decline in our orders and sales activity that may signal the beginning of the next cyclical downturn in our industry. As with prior cycles, we cannot predict how long the current weaker market conditions will remain, nor how significant the declines in both our quarterly net revenues and bookings will be throughout this period of contraction. As previously discussed, we are currently in the process of restructuring our operations to reduce operating expenses and lower our break-even point. However, if we are unable to sufficiently reduce our operating expenses 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.

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 and 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 assumptions that are believed 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 bec ause of the possibility that future events affecting them may differ markedly from what had been assumed when the financial statements were prepared. As of September 30, 2004, there have been no significant changes to the accounting policies that we have deemed critical. Our critical accounting policies are more fully described in our 2003 Form 10-K.

International Operations

Net revenues generated by our foreign subsidiaries were 22% and 24% of consolidated net revenues for the nine months ended September 30, 2004 and 2003, respectively. We anticipate that net revenues generated by our foreign subsidiaries will continue to account for a significant portion of consolidated net revenues in the foreseeable future. The net revenues generated by our foreign subsidiaries will continue to be subject to certain risks, including political and economic instability of foreign countries, the imposition of financial and operational controls or regulatory restrictions by foreign governments, the need to comply with a variety of U.S. and foreign export and import laws, trade restrictions, changes in tariffs and taxes, longer payment cycles, fluctuations in foreign currency exchange rates, and the greater difficulty of administering business abroad. We cannot predict whether quotas, duties, taxes or other charges or restrictions will be implemented by the U.S. or any other country upon the importation or exportation of our products in the future. Any of these factors or the adoption of restrictive policies could have a material adverse effect on our business, financial condition or results of operations.

Net revenues denominated in foreign currencies were 9% and 10% of consolidated net revenues for the nine months ended September 30, 2004 and 2003, respectively. Although we seek to operate our business such that a significant portion of our product costs are denominated in the same currency as the associated sales, we may be adversely affected in the future due to our exposure to foreign operations. Moreover, net revenues denominated in currencies other than U.S. dollars expose us to currency fluctuations, which can adversely affect our results of operations.

Net revenues derived from sales to the Asia-Pacific region were 12% and 15% of consolidated net revenues for the nine months ended September 30, 2004 and 2003, respectively. Countries in the Asia-Pacific region, including Japan, have experienced economic instability resulting in weaknesses in their currency, banking and equity markets. Continued economic instability could have a material adverse effect on demand for our products and our consolidated results of operations.

Risks That Could Affect Future Results

A number of the matters and subject areas discussed in this Item 2 "Management's Discussion and Analysis of Financial Condition and Resul