Shares of set-top cable box and cable modem maker Scientific-Atlanta (NYSE:SFA) extended their difficult second half of 2004 on Friday, with the company's market value falling more than 7% following the release of mixed fiscal Q1 (ended Oct. 1) financial results.

If you stop at the "obvious" numbers, it's difficult to see how investors could have been unhappy with Thursday night's announcement. Sales rose 14% to approximately $453 million, while net income improved 31% year over year to nearly $56 million.

But the company's business isn't particularly seasonal, and so investors watch sequential quarter numbers carefully -- and both revenue and net profit were down from the company's Q4 figures. (It's worth pointing out, however, that Q4's net income figure included a credit for an income tax settlement without which Q1's number would have been higher.)

Also troubling, meanwhile, was news that gross margins fell both year over year and sequentially as selling prices fell -- not surprising, as prices for consumer electronics can be expected to fall over time. Still, the 60-basis-point drop was mitigated in part by insurance proceeds related to a fire that happened in the last fiscal year, improving the numbers somewhat.

The macro environment for companies in this business -- also including Motorola (NYSE:MOT) and digital video recorder (DVR) maker TiVo (NASDAQ:TIVO) -- is good, but challenges exist nonetheless. DVRs are making up more and more of Scientific-Atlanta's sales, as the Q1 numbers indicate. But as the market continues to grow, competition and profit pressure will increase.

Improved cost management at Scientific-Atlantic is encouraging, but investors are right to watch sequential growth and gross margins closely -- and they're doing just that, as Friday's move indicates.

Fool contributor Dave Marino-Nachison doesn't own any of the companies in this story.