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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission File Number 0-28582

CHANNELL COMMERCIAL CORPORATION
(Exact name of registrant as specified in its charter)

        Securities registered pursuant to Section 12(b) of the Act:

None

        Securities registered pursuant to Section 12(g) of the Act:

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

        On March 2, 2004, the Registrant had 9,127,661 shares of Common Stock outstanding with a par value of $.01 per share. The aggregate market value of the 4,207,531 shares held by non-affiliates of the Registrant was $23,141,421 computed by reference to the price at which the shares were last sold, as of the last business day of the Registrant's most recently completed second fiscal quarter. Shares of Common Stock held by each officer and director and by each person who may be deemed to be an affiliate have been excluded.

        Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o    No ý

DOCUMENTS INCORPORATED BY REFERENCE

        Part III of this Form 10-K incorporates by reference certain information from the Registrant's definitive proxy statement (the "Proxy Statement") for its annual meeting of stockholders to be held on April 27, 2004.

TABLE OF CONTENTS

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PART I

Item 1.    Business

Background

        Channell Commercial Corporation (the "Company") was incorporated in Delaware on April 23, 1996, as the successor to Channell Commercial Corporation, a California corporation. The Company's executive offices are located at 26040 Ynez Road, Temecula, California 92591, and its telephone number at that address is (909) 719-2600.

General

        The Company is a designer and manufacturer of telecommunications equipment supplied to broadband and telephone network providers worldwide. Major product lines include a complete line of thermoplastic and metal fabricated enclosures, advanced copper termination and connectorization products, fiber optic cable management systems, and heat shrink products. The Company believes it was the first to design, manufacture and market thermoplastic enclosure products for use in the telecommunications industry on a wide scale, and the Company believes it currently supplies a substantial portion of the enclosure product requirements of a number of major broadband service providers. The Company's enclosure products house, protect and provide access to advanced telecommunications hardware, including both radio frequency ("RF") electronics and photonics, and transmission media, including coaxial cable, copper wire and optical fibers, used in the delivery of voice, video and data services. The enclosure products are deployed within the access portion of the local signal delivery network, commonly known as the "outside plant", "local loop" or "last mile", that connects the network provider's signal origination point or local office with its residential and business customers. The Company's connectivity products provide critical connection points between cable or network electronics.

Industry

        Broadband and local telephone operators are building, rebuilding or upgrading signal delivery networks around the world. These networks are designed to deliver video, voice and/or data transmissions to individual residences and businesses. Operators deploy a variety of network technologies and architectures, such as HFC, FTTC, DLC and ADSL (see "Glossary of Terms") to carry broadband and narrowband signals. These architectures are constructed of electronic hardware connected via coaxial cables, copper wires and/or optical fibers, including various access devices, amplifiers, nodes, hubs and other signal transmission and powering electronics. Many of these devices in the outside plant require housing in secure, protective enclosures and cable management connectivity systems, such as those manufactured by the Company.

        As critical components of the outside plant, enclosure products provide (i) protection against weather and vandalism, (ii) ready access for technicians who maintain and manage the outside plant and, (iii) in some cases, provide dissipation of heat generated by the active electronic hardware. Broadband and local telephone network operators place great reliance on manufacturers of protective enclosures because any material damage to the signal delivery networks is likely to disrupt communications services. Connectivity products provide critical data-rated connection points which support cost effective service deployment and ensure signal integrity is maintained throughout the network.

        The primary drivers of demand for enclosures in the communications industry are the construction, rebuilding, upgrading and maintenance of signal delivery networks by broadband operators and local telephone companies. For example, broadband networks are being upgraded and prepared for advanced two-way services such as high-speed Internet access via cable modems, telephony and PCS transport. Local telephone service providers are employing advanced technologies, such as a variety of digital subscriber line ("DSL") technologies, which utilize installed copper wires for broadband services. These "local loop" copper wire systems often require significant upgrading and maintenance to provide the

optimal throughput necessary to carry high-speed broadband signals, increasing the need for fully sealed outside plant facilities in order to sustain network reliability and longevity.

Business Strategy

        The Company's strategy is to capitalize on opportunities in the global communications industry by providing enclosures, connectivity products and other complementary components to meet the evolving needs of its customers' communications networks. The Company's wide range of products, manufacturing expertise, application-based sales and marketing approach and reputation for high quality products address key requirements of its customers. Principal elements of the Company's strategy include the following:

        Focus on Core Telecommunications Business.    The Company will continue to seek to capitalize on its position as a leading designer, manufacturer and marketer of enclosures and copper wire connectors for the broadband and local telephone industries in the United States and Canada through new product development for both domestic and international market applications. The Company believes it currently supplies a substantial portion of the enclosure product requirements of a number of major broadband operators.

        The Company has invested in the development of a broad range of products designed specifically for telephone applications. The Company has successfully marketed its traditional broadband products to local telephone companies that have been designing and deploying broadband networks to deliver competitive video and data services. The Company will continue to target this market for growth, both with telephone network operators and with major system OEMs.

        Expand International Presence.    Management believes international markets offer significant opportunities for increased sales to both broadband and telephone companies. The Company's principal international markets currently include Canada, Mexico, Asia, the Pacific Rim, the Middle East and Europe. Trends expected to result in international growth opportunities include the on-going deregulation and privatization of telecommunications in many nations around the world, the focus of numerous countries on building, expanding and enhancing their communications systems to deliver broadband services in order to participate fully in the information-based global economy, and multinational expansion by many U.S.-based network carriers. The Company will concentrate on expansion in international markets that are characterized by deregulation or privatization of telecommunications and by the availability of capital for the construction of signal delivery networks.

        Develop New Products and Enter New Markets.    The Company continues to leverage its core capabilities in developing innovative products that meet the evolving needs of its customers. Innovative products offered by the Company include its DSLink™ modular terminal block, its MAH Series™ free-breathing telephony enclosures, the Mini-Rocker™ insulation displacement copper connectivity products, and a range of Rhino™ metal fabricated enclosures. The Company continually invests in ongoing improvement and enhancement projects for the existing products developed by the Company, several of which have received U.S. patent protection. The Company's products are designed to improve the performance of its customers' outside plant systems. The Company has a proven record in designing, developing and manufacturing "next generation" products that provide solutions for its customers and offer advantages over those offered by other suppliers to the industry. The Company also believes its core capabilities are applicable to markets outside the telecommunications industry.

Products

        The Company currently markets over 50 product families, with several thousand optional product configurations. The primary functions of the Company's products designed for the telecommunications industry are cable routing and management, equipment access, heat dissipation and security. The

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Company believes that it offers one of the most complete lines of outside plant infrastructure products in the telecommunications industry.

        Enclosures.    The Company manufactures precision-molded, highly engineered and application-specific thermoplastic and metal fabricated enclosures that are considered state-of-the-industry for many applications, having been field tested and received approvals and standardization certifications from major broadband and telephone company operators. Most of the Company's products are designed for buried and underground network applications. The Company's enclosure products provide technicians access to network equipment for maintenance, upgrades and installation of new services. Buried and underground networks and enclosures are generally preferred by broadband operators for increased network reliability, lower maintenance, improved security, reduced utility right-of-way conflicts, and aesthetic appeal. The enclosure products, particularly the thermoplastic versions, must provide advanced heat dissipation characteristics increasingly required for the protection of active electronics in many network installations. The Company is also a designer and manufacturer of metal fabricated enclosures that house advanced electronics, fiber optic cable and power systems for broadband telecommunications networks (branded as "Rhino Enclosures™"). The Company designs and manufactures a series of termination blocks, brackets and cable management devices for mounting inside its enclosure products. To position itself as a full-line product supplier, the Company also offers a variety of complementary products, including thermoplastic and concrete grade level boxes. These products are typically purchased by customers as part of a system package and are marketed by the Company through its direct sales force to its customer base. The Company is recognized in the industry for its differentiated product designs and the functionality, field performance and service life of its products.

        Copper Connectivity.    The Company is a designer and manufacturer of innovative telephone connectivity devices. The Company's Insulation Displacement Connector ("IDC") technology provides advanced "tool-less" termination systems for copper wires, the predominant medium used in the "Last Mile" for telephone services worldwide. These proprietary IDC products environmentally seal network termination points with a high level of reliability. The Company's DSLink™ modular terminal block offers telephone service providers a CAT 5 solution to the rising costs of DSL deployment in the local loop. The Company's Mini-Rocker™ line of copper connectivity modules, blocks and accessories offer environmentally sealed and Category 5 data rated IDC tool-less circuit installation and have been accepted as a universal connectivity platform for network applications worldwide.

        Fiber Optic Products.    The Company offers a range of fiber optic cable management products designed for use in telephone and broadband networks. These products are particularly well suited for fiber to the premises (FTTP) network architectures. The Company's fiber optic splice cases are used for organizing, managing and protecting the connection points between separate lengths of fiber optic cable in the outside plant network. Fiber optic cable assemblies and interconnect hardware are used to connect fiber optic electronics and fiber optic cables primarily for in-building applications. Fiber optic electronic enclosures house optical electronics, power supplies and cables. All of these products are designed and manufactured by the Company and marketed worldwide.

        OEM Programs.    The Company has OEM marketing programs through which other manufacturers incorporate the Company's products as components of their telecommunications systems. These OEM programs generally include exchanges of technical information that the Company can use in developing new products and improvements and enhancements to existing designs. The Company has established additional relationships with systems integrators and innovative end users that provide valuable product improvement information.

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Marketing and Sales

        The Company markets its products primarily through a direct sales force of technically trained salespeople. The Company employs an application-specific, systems approach to marketing its products, offering the customer a complete, cost-effective system solution to meet its outside plant requirements. All sales personnel have technical expertise in the products they market and are supported by the Company's engineering and technical marketing staff.

        An internal sales/customer service department administers and schedules incoming orders, handles requests for product enhancements and service inquiries and supports the Company's direct sales force. This department maintains direct communications with customers and the Company's field sales and operations personnel.

        By engaging in public relations activities, product literature development, market research and advertising, the marketing department also promotes and positions the Company within both domestic and international markets. The Company regularly attends, participates and exhibits its products at industry trade shows and conferences within domestic and international telecommunications markets throughout the year.

Manufacturing Operations

        The Company's vertically integrated manufacturing operations enable the Company to control each step in the manufacturing process, including product design and engineering; design and production of many of its own dies, tools, molds and fixtures.

        The Company's manufacturing expertise enables it to modify its product lines to meet changing market demands, rapidly and efficiently produce large volumes of products, control expenses and ensure product quality. Management considers the Company's manufacturing expertise a distinct and significant competitive advantage, providing it with the ability to satisfy the requirements of major customers with relatively short lead-times by promptly booking and shipping orders.

        The Company owns a majority of its manufacturing equipment. Manufacturing processes are performed by trained Company personnel. These manufacturing processes include injection molding, structural foam molding, rotational molding, metal fabrication, automated discrete connector fabrication, rubber injection, transfer and compression molding, and termination block fabrication. The Company has implemented several comprehensive process and quality assurance programs, including continuous monitoring of key processes, regular product inspections and comprehensive testing.

        The Company's manufacturing and distribution facilities as of December 31, 2003, include approximately 367,000 square feet in Temecula, California; 7,000 square feet in Mississauga, Ontario, Canada; 43,000 square feet in Orpington, United Kingdom; and 40,000 square feet in Sydney, Australia. A plan was developed to close all manufacturing operations in the United Kingdom by mid-year 2004.

Product Development and Engineering

        The Company's product development and engineering staff has designed and tested the Company's products and has developed core competencies in telecommunications outside plant product development and engineering. As a direct result, the Company has been able to develop a broad series of superior products designed to meet the specific needs of telecommunications companies. Distinguishing characteristics of the Company's products include:

•

Advanced mechanical innovations providing unique application specific performance and feature sets;



•

Effective heat dissipation qualities;

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•

Advanced copper IDC connectivity products;



•

A superior environmental sealing and protection system that, unlike many competitors' products, does not require gels, compounds or other methods to maintain the required seal;



•

Sub-surface network access systems;



•

Product designs allowing technicians easy access through circular covers that can be removed to fully expose the enclosed electronics;



•

Compatibility with a variety of signal delivery network architectures;



•

Modular metal fabricated enclosure product line covering multiple network applications;



•

Versatility of design to accommodate network growth through custom hardware and universal mounting systems that adapt to a variety of new electronic hardware;



•

Excellent protection and management of optical fibers and cables; and



•

Thermoplastic Laminated Coating (TLC®) that bonds directly to metal hardware and protects against rust and deterioration.

        The Company's product development approach is applications-based and customer driven. A team comprised of engineering, marketing, manufacturing and direct sales personnel work together to define, develop and deliver comprehensive systems solutions to customers, focusing on the complete design cycle from product concept through tooling and high-volume manufacturing. The Company is equipped to conduct many of its own product testing requirements for performance qualification purposes, enabling it to accelerate the product development process. The Company spent $2.3 million in 2001, $1.6 million in 2002, and $1.9 million in 2003 on research and development.

Customers

        The Company sells its products directly to broadband operators and telephone companies throughout the world, principally within developed nations. The Company also sells its products to OEMs on a global basis. During 2003, the Company's five largest customers accounted for 57.7% of total net sales. In 2003, the Company's five largest customers by sales in the United States were Comcast, Verizon, Time Warner, Cox and Adelphia. Comcast and Verizon accounted for 27.1% and 10.5%, respectively, of the Company's net sales in 2003. In international markets, the Company's five largest customers in 2003 by sales were Telstra (Australia), Rogers (Canada), Eircom (Ireland), British Telecom, and Unitelco (Malaysia).

        The Company has historically operated with a relatively small backlog. Sales and operating results in any quarter are primarily dependent upon orders booked and products shipped in the quarter. The Company's customers generally do not enter into long-term supply contracts providing for future purchase commitments of the Company's products. Rather, the Company believes that many of its customers periodically review their supply relationships and adjust buying patterns based upon their current assessment of the products and pricing available in the marketplace. From fiscal period to fiscal period, significant changes in the level of purchases of the Company's products by specific customers can and do result from this periodic assessment.

Intellectual Property

        The Company owns substantially all of the patents and other technology employed by it in the manufacture and design of its products. The Company's patents, which expire through the year 2010, cover various aspects of the Company's products. In addition, the Company has certain trade secrets, know-how and trademarks related to its technology and products.

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        Management does not believe any single patent or other intellectual property right is material to the Company's success as a whole. The Company maintains an intellectual property protection program designed to preserve its intellectual property assets.

Competition

        The telecommunications industry is highly competitive. The Company's competitors include companies that are much larger than the Company, such as Tyco, 3M, Marconi, Arris and Corning. The Company believes its competitive advantages include its ability to service national and multi-national customers, its direct sales force, its specialized engineering resources and its vertically integrated manufacturing operations.

        Management believes the principal competitive factors in the telecommunications equipment market are customer service, new product capabilities, price, product availability, and product performance.

        Competitive price pressures are common in the industry. In the past, the Company has responded effectively to competition with cost controls through vertical integration utilizing advanced manufacturing techniques, cost-effective product designs and material selection, and an aggressive procurement approach.

        In the past, certain of the Company's telecommunications customers have required relatively lengthy field testing of new products prior to purchasing such products in quantity. While field testing can delay the introduction of new products, it can also act as a competitive advantage for those products tested and approved because to a certain extent it creates a barrier to new product introduction and sales by competitors.

Raw Materials; Availability of Complementary Products

        The principal raw materials used by the Company are thermoplastic resins, neoprene rubbers, hot and cold rolled steel, stainless steel, copper and brass. The Company also uses certain other raw materials, such as fasteners, packaging materials and communications cable. Management believes the Company has adequate sources of supply for the raw materials used in its manufacturing processes and it attempts to develop and maintain multiple sources of supply in order to extend the availability and encourage competitive pricing of these materials.

        Most plastic resins are purchased under annual or multi-year purchase agreements to stabilize costs and improve supplier delivery performance. Neoprene rubbers are manufactured using the Company's proprietary formulas. Metal products are supplied in standard stock shapes, coils and custom rollforms.

        The Company also relies on certain other manufacturers to supply products that complement the Company's own product line, such as grade level boxes. The Company believes there are multiple sources of supply for these products.

Employees

        As of December 31, 2003, the Company employed 411 people, of whom 52 were in sales, 317 were in manufacturing operations, 8 were in research and development and 34 were in administration. The Company considers its employee relations to be good and recognizes its ability to attract and retain qualified employees is an important factor in its growth and development. None of the Company's employees is subject to a collective bargaining agreement, and the Company has not experienced any business interruption as a result of labor disputes within the past five years.

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Regulation

        The telecommunications industry is subject to regulations in the United States and other countries. Federal and state regulatory agencies regulate most of the Company's domestic customers. On February 1, 1996, the United States Congress passed the Telecommunications Act of 1996 that the President signed into law on February 8, 1996. The Telecommunications Act lifted certain restrictions on the ability of companies, including RBOCs and other customers of the Company, to compete with one another and generally reduced the regulation of the communications industry.

        The Company is also subject to a wide variety of federal, state and local environmental laws and regulations. The Company utilizes, principally in connection with its thermoplastic manufacturing processes, a limited number of chemicals or similar substances that are classified as hazardous. It is difficult to predict what impact these environmental laws and regulations may have on the Company in the future. Restrictions on chemical uses or certain manufacturing processes could restrict the ability of the Company to operate in the manner that it currently operates or is permitted to operate. Management believes that the Company's operations are in compliance in all material respects with current environmental laws and regulations. Nevertheless, it is possible that the Company may experience releases of certain chemicals to environmental media which could constitute violations of environmental law (and have an impact on its operations) or which could cause the Company to incur material cleanup costs or other damages. For these reasons, the Company might become involved in legal proceedings involving exposure to chemicals or the remediation of environmental contamination from past or present operations. Because certain environmental laws impose strict joint and several retrospective liability upon current owners or operators of facilities from which there have been releases of hazardous substances, the Company could be held liable for remedial measures or other damages (such as liability in personal injury actions) at properties it owns or utilizes in its operations, even if the contamination were not caused by the Company's operations.

Available Information

        The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports are available as soon as reasonably practicable after they are filed or furnished to the Securities and Exchange Commission ("SEC"), through our Internet website, www.channellcomm.com. Company filings are also available through a database maintained by the SEC at www.sec.gov.

Item 2.    Properties

        The Company's facilities approximate 541,000 square feet, of which approximately 52%, 32% and 16% were used for manufacturing, warehouse and office space, respectively. In Temecula, California, 261,000 square feet of the total 367,000 square feet are leased from William H. Channell, Sr., the Company's Chairman of the Board. (See "Certain Relationships and Related Transactions", Item 13.) The Company also leases an aggregate of approximately 180,000 square feet of manufacturing, warehouse and office space in Canada, Australia and the United Kingdom. In November, 2001, the Company announced a restructuring plan (see Financial Statement Footnote H, Restructuring Charge) that, among other things, reduced its facilities utilization in the Americas and International operations to improve operating efficiencies and reduce facilities expense. In December, 2002, the Company announced additional steps to rationalize international manufacturing operations to further consolidate manufacturing operations. The Company has completed the majority of its facilities reduction program. Included in the Company's facilities of 541,000 square feet is 84,000 square feet that has been vacated as part of restructuring activities. The Company is attempting to sublease the vacated space. In 2002, the Company completed a sale and leaseback of approximately 103,000 square feet of manufacturing, warehouse and office space in Temecula, California. The Company sold approximately 43,000 square feet of manufacturing, warehouse and office space in the United Kingdom in January, 2003. In the

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fourth quarter of 2003, the Company further evaluated International operations to improve profitability. A plan was developed to close a manufacturing facility in the United Kingdom by mid-year 2004. The Company considers its current facilities, and its facilities following the completion of the foregoing restructuring activities, to be adequate for its operations.

Item 3.    Legal Proceedings

        The Company is from time to time involved in ordinary routine litigation incidental to the conduct of its business. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate for such litigation matters. Management believes that no presently pending litigation matters will have a material adverse effect on its business or on its results of operations.

Item 4.    Submission of Matters to a Vote of Security Holders

        No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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PART II

Item 5.    Market for Registrant's Common Equity and Related Shareholder Matters

        The following table sets forth, for the periods indicated, the high and low sale prices for the Company's Common Stock, as reported on the NASDAQ National Market.

        The Company has not declared any dividends subsequent to its initial public offering in July 1996.

        The Company currently anticipates it will retain all available funds to finance its business. The Company does not intend to pay cash dividends in the foreseeable future. Under the terms of the Company's Loan and Security Agreement, the Company has agreed not to pay any dividends.

        As of March 2, 2004, the Company had 9,127,661 shares of its Common Stock outstanding, held by approximately 1,052 shareholders of record.

Item 6.    Selected Financial Data

        The selected consolidated financial data presented below for each of the five years in the period ended December 31, 2003, have been derived from audited consolidated financial statements, which for the most recent three years appear elsewhere herein. The data should be read in conjunction with the

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financial statements, related notes and other financial information included therein (amounts in thousands, except per share data).

Selected Financial Data
(amounts in thousands, except per share data)

(1)

Gross margin is gross profit as a percentage of net sales.

(2)

Operating margin is income (loss) from operations as a percentage of net sales.

(3)

EBITDA represents income (loss) from operations before interest and income taxes, plus depreciation and amortization expense. EBITDA is not intended to represent cash flow, operating income or any other measure of performance in accordance with generally accepted accounting principles, but is included here because

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management believes that certain investors find it to be a useful tool for measuring a company's ability to service its debt.

(4)

Includes all interest bearing debt and capital lease obligations.

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

General

        The Company is a designer and manufacturer of telecommunications equipment supplied to telephone and broadband network providers worldwide. In addition to Company manufactured products, the Company markets complementary products manufactured by third parties. The Company sells products directly to broadband operators and telephone companies throughout the United States, Canada, Australia, United Kingdom and certain other international markets, principally within developed nations. The Company believes that many of its customers periodically review their supply relationships and consequently the Company can experience significant changes in buying patterns from specific customers between fiscal periods. The Company has historically operated with a relatively small backlog with sales and operating results in any quarter principally dependent upon orders booked and products shipped in that quarter. The Company's customers generally do not enter into long-term supply contracts providing for future purchase commitments for the Company's products. These factors, when combined with the Company's operating leverage and the need to incur certain capital expenditures and expenses in part based upon the expectation of future sales, causes the Company's operating results to be at risk to changing customer buying patterns. If sales levels in a particular period do not meet the Company's expectations, operating results for that period may be materially and adversely affected.

        The Company uses numerous raw materials in its manufacturing processes. Although management believes that the Company has adequate sources of supply for such raw materials, increases in the market prices of the Company's raw materials could significantly increase the Company's cost of goods sold and materially adversely affect the Company's profitability. The Company's profitability may also be materially and adversely affected by decreases in its sales volume because many of the costs associated with the Company's facilities, product development, engineering, tooling and other manufacturing processes are essentially fixed in nature and must be spread over its sales base in order to maintain historical levels of profitability.

Critical Accounting Policies

        The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management bases its estimates on historical experience and on assumptions that are believed to be reasonable under the circumstances and revises its estimates, as appropriate, when changes in events or circumstances indicate that revisions may be necessary. Although these estimates are based on management's knowledge of and experience with past and current events and on management's assumptions about future events, it is possible that they may ultimately differ materially from actual results.

        The critical accounting policies requiring estimates and assumptions that management believes have the most significant impact on the Company's consolidated financial statements are:

•

Accounts receivables reserves



•

Allowances for excess and obsolete inventory



•

Valuation of goodwill and long-lived assets

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•

Restructuring costs



•

Accounting for income taxes



•

Foreign currency translation

        Accounts Receivable Reserves.    Allowances for doubtful accounts are maintained for estimated losses expected to result from the inability of our customers to make required payments. Provisions for estimated sales returns, sales allowances and uncollectible accounts are made at the time of sale based on (i) the Company's estimate of the rate on which customers take discounts allowed and (ii) the Company's specific assessment of the collectability of all past due accounts. An adverse change in financial condition of a significant customer or group of customers could materially affect management's estimates related to doubtful accounts.

        Allowances for excess and obsolete inventory.    The estimates of excess and obsolete inventory are based on management's assumptions about and analysis of relevant factors including historical sales and usage of items in inventory, current levels of orders and backlog, forecasted demand, product life cycle and market conditions. Management does not believe the Company's products are subject to a significant risk of obsolescence in the short term and management believes it has the ability to adjust production levels in response to declining demand. However, if actual market conditions become less favorable than anticipated by management, additional allowances for excess and obsolete inventory could be required. In the event management adjusts estimates such as forecasted sales or expected product lifecycles, the value of the Company's inventory may become understated or overstated and recognition of such understatement or overstatement will affect cost of sales in a future period, which could materially affect the Company's operating results and financial position.

        Valuation of goodwill and long-lived assets.    Management reviews goodwill and long-lived assets for impairment when events or changes in circumstances indicate the carrying values may not be fully recoverable. Management assesses potential impairment of the carrying values of these assets based on market prices, if available, and/or assumptions about and estimates of future cash flows expected to be generated from these assets. Future cash flows may be adversely impacted by operating performance, market conditions and other factors. An impairment charge would be based on the amount by which the carrying value exceeds fair value. Fair value is estimated by management based on market prices, if available, and/or forecasted discounted cash flows, using a discount rate commensurate with the risks involved. Assumptions related to future cash flows and discount rates involve management judgment and are subject to significant uncertainty. If future cash flows, discount rates and other assumptions used in the assessment and measurement of impairment differ from management's estimates and forecasts, additional impairment charges could be required.

        Restructuring Costs.    Restructuring costs are recorded in accordance with FASB Statement 146, Accounting for Costs Associated With Exit or Disposal Activities. One-time severance benefits for employees terminated are recorded at the time management commits to the plan to reduce the work force, knows the amount of the termination benefit, is unlikely to change the plan and has communicated to employees the intended work force reduction. Liabilities for costs that will continue to be incurred under a contract for its remaining term without an economic benefit, such as for facility lease payments for premises vacated, are recorded when the Company ceases to use the right conveyed by the contract. In the case of vacated leased facilities, the liability is based on the future lease payments required under the contract less the estimated future rental income the Company may earn by subletting the facilities or estimates of costs incurred to terminate a lease with a landlord. These estimates of future sublet income are based on current economic conditions, current condition of the local leasing market, past experience and judgments supplied by professionals in the local real estate market. These estimates are subject to significant uncertainty and may change. Additional charges could be required as a result in the changes in estimates.

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        Accounting for income taxes.    Income taxes are recorded for each of the jurisdictions in which the Company operates. Management records the actual current income tax payable and assesses the temporary differences resulting from differing treatment of items, such as reserves and accruals, for tax and accounting purposes. These differences result in deferred tax assets and liabilities which are included within the consolidated balance sheet. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. In addition, the realization of deferred tax assets is also dependent upon audits by tax authorities of tax filings which may result in a revision to previous amounts claimed. Significant management judgment is involved in assessing the Company's ability to realize any future benefit from deferred tax assets. In the event that actual results differ from management estimates and management adjusts these estimates in future periods, the Company's operating results and financial position could be materially affected.

        Foreign Currency Translation.    The Company has foreign subsidiaries that together accounted for 18.9% of the Company's net revenues and 27.4% of the Company's assets as of and for the year ended December 31, 2003. In preparing the Company's consolidated financial statements, the Company is required to translate the financial statements of its foreign subsidiaries from the currencies in which they keep their accounting records into United States dollars. This process results in exchange gains and losses which, under relevant accounting guidance, are either included within the Company's statement of operations or as a separate part of the Company's net equity under the caption "cumulative translation adjustment."

        Under relevant accounting guidance, the treatment of these translation gains or losses depends upon management's determination of the functional currency of each subsidiary. This determination involves consideration of relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures, would be considered the functional currency. However, management must also consider any dependency of the subsidiary upon the parent and the nature of the subsidiary's operations.

        If management deems any subsidiary's functional currency to be its local currency, then any gain or loss associated with the translation of that subsidiary's financial statements is included in a cumulative translation adjustment. However, if management deems the functional currency to be United States dollars, then any gain or loss associated with the translation of these financial statements would be included within the Company's statement of operations.

        If the Company disposes of any of its subsidiaries, any cumulative translation gains or losses would be realized into the Company's statement of operations. If management determines that there has been a change in the functional currency of a subsidiary to United States dollars, then any translation gains or losses arising after the date of the change would be included within the Company's statement of operations.

        Based on management's assessment of the factors discussed above, the Company considers the functional currency of each of its international subsidiaries to be each subsidiary's local currency. Accordingly, the Company had cumulative translation losses of $11 that were included as part of accumulated other comprehensive loss within the Company's balance sheet at December 31, 2003. During the year ended December 31, 2003, the Company included translation adjustments of a gain of approximately $1,982 under accumulated other comprehensive income and loss.

        If the Company had determined that the functional currency of its subsidiaries was United States dollars, these gains or losses would have decreased or increased the Company's loss for the year ended December 31, 2003. The magnitude of these gains or losses depends upon movements in the exchange

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rates of the foreign currencies in which the Company transacted business as compared to the value of the United States dollar. These currencies include the British pound, the Canadian dollar and the Australian dollar. Any future translation gains or losses could be significantly higher than those the Company recorded for the year ended December 31, 2003.

New Accounting Pronouncements

        In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is effective for the Company beginning July 1, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company's results of operations or financial position.

        In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities—an interpretation of ARB No. 51" ("FIN 46"). FIN 46 requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. FIN 46 requires that its provisions are effective immediately for all arrangements entered into after January 31, 2003. For those arrangements entered into prior to January 31, 2003, the FIN 46 provisions are required to be adopted at the end of the first interim or annual period ending after December 15, 2003. The adoption of FIN 46 did not have a material impact on the Company's results of operations or financial position.

        In July 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under previous guidance, a liability for an exit cost was recognized at the date of the commitment to an exit plan. The provisions of this statement will be applied prospectively, as applicable, and are effective for exit or disposal activities that are initiated after December 31, 2002. The Company applied the provisions of SFAS No. 146, on the 2003 restructuring charge discussed in Financial Statement Footnote H.

        In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under specified guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements in this interpretation were effective for financial statements of interim or annual periods ending after December 15, 2002. Additionally, the recognition of a guarantor's obligation should be applied on a prospective basis to guarantees issued after December 31, 2002. The adoption of FIN 45 did not have a material effect on the Company's financial position or results of operation.

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Results of Operations

        The following table sets forth the Company's operating results for the periods indicated expressed as a percentage of net sales.

Comparison of Year Ended December 31, 2003 with Year Ended December 31, 2002

        The Company implemented actions in 2002 and 2003 to restructure the Company due to decreased demand in the telecommunications industry. These actions resulted in a lower cos