e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

COMMISSION FILE NUMBER: 000-24597

CARRIER ACCESS CORPORATION

(Exact name of registrant as specified in its charter)


DELAWARE		84-1208770

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5395 Pearl Parkway, Boulder, CO 80301

(Address of principal executive offices) (Zip Code)

(303) 442-5455

(Registrant’s telephone number, including area code)

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 o No þ

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No þ

The number of shares outstanding of the issuer’s common stock, par value $0.001 per share, as of June 30, 2005 was 34,671,295 shares.

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARRIER ACCESS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except per share amounts)


	June 30,			December 31,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	45,088		$	46,753
Marketable securities available for sale		56,549			61,930
Accounts receivable, net of allowance for doubtful accounts of $768 and $359 in 2005 and 2004, respectively		14,710			11,949
Income tax receivable		67			161
Deferred income taxes		289			363
Inventory, net		31,693			32,009
Prepaid expenses and other		2,993			4,513

Total current assets		151,389			157,678

Property and equipment, net of accumulated depreciation and amortization of $20,010 and $18,585 in 2005 and 2004, respectively		11,933			12,239
Goodwill		7,588			7,588
Intangible assets, net of accumulated amortization of $2,200 and $1,580 in 2005 and 2004, respectively		5,795			6,412
Other assets		245			218

Total assets	$	176,950		$	184,135


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	8,682		$	11,246
Accrued compensation payable		3,646			2,917
Accrued expenses and other liabilities		1,239			1,116
Deferred revenue		1,020			352

Total current liabilities		14,587			15,631
Deferred income taxes		289			363

Total liabilities		14,876			15,994

Stockholders’ equity:
Common stock, $0.001 par value, 60,000 shares authorized, 34,671 shares issued and outstanding at June 30, 2005, and 34,479 shares issued and outstanding at December 31, 2004		35			34
Additional paid-in capital		188,677			188,147
Accumulated deficit		(26,368	)		(19,910	)
Accumulated other comprehensive loss		(270	)		(130	)

Total stockholders’ equity		162,074			168,141


Total liabilities and stockholders’ equity	$	176,950		$	184,135

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CARRIER ACCESS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share amounts)


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
				(As restated)						(As restated)
Revenue, net of allowances for sales returns	$	18,925		$	29,549		$	33,621		$	58,087
Cost of sales		11,281			16,274			20,871			31,723


Gross profit		7,644			13,275			12,750			26,364


Operating expenses:
Research and development		4,257			4,692			9,058			8,662
Sales and marketing		3,208			4,047			6,532			8,625
General and administrative		2,035			1,800			3,715			3,524
Bad debt expense (recoveries)		58			(98	)		386			(281	)
Restructuring charges		—			92			369			92
Intangible asset amortization		307			307			614			654


Total operating expenses		9,865			10,840			20,674			21,276


Income (loss) from operations		(2,221	)		2,435			(7,924	)		5,088
Other income, net		772			491			1,466			711


Income (loss) before income taxes		(1,449	)		2,926			(6,458	)		5,799

Income taxes		—			52			—			67


Net income (loss)	$	(1,449	)	$	2,874		$	(6,458	)	$	5,732


Income (loss) per share:
Basic		(0.04	)		0.09			(0.19	)		0.18
Diluted		(0.04	)		0.08			(0.19	)		0.17

Weighted average common shares outstanding:
Basic		34,663			33,744			34,592			32,010
Diluted		34,663			35,790			34,592			34,243

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CARRIER ACCESS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)


	Six Months Ended June 30,
	2005			2004
				(As restated)
Cash flows from operating activities:
Net income (loss)		(6,458	)		5,732
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Depreciation and amortization expense		2,045			2,287

Provision for (recoveries of) doubtful accounts, net		386			(281	)
Gain on sale of property		—			(143	)
Stock-based compensation		47			5
Changes in operating assets and liabilities:
Accounts receivable		(3,147	)		4,889
Income tax receivable		94			—
Inventory		315			(4,716	)
Prepaid expenses and other		1,490			1,675
Deferred revenue		668			649
Accounts payable and accrued expenses		(1,711	)		(3,449	)

Net cash provided (used) by operating activities		(6,271	)		6,648


Cash flows from investing activities:
Purchases of property and equipment		(1,119	)		(1,137	)
Proceeds from sales of property		—			368
Net cash paid in the purchase of Paragon		—			(350	)
Purchases of marketable securities		(29,488	)		(55,946	)
Sales and maturities of marketable securities available for sale		34,729			27,658

Net cash provided (used) by investing activities		4,122			(29,407	)


Cash flows from financing activities:
Proceeds from stock offering		—			83,607
Stock issuance costs		—			(5,227	)
Proceeds from exercise of stock options		484			1,623

Net cash provided by financing activities		484			80,003

Net increase (decrease) in cash and cash equivalents		(1,665	)		57,244
Cash and cash equivalents at beginning of period		46,753			10,107

Cash and cash equivalents at end of period		45,088			67,351

The accompanying notes are an integral part of these condensed consolidated financial statements.

Page 6

CARRIER ACCESS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Restatement of Consolidated Financial Statements

The fiscal 2003 and fiscal 2004 consolidated financial statements and related interim financial information of Carrier Access Corporation (the “Company”) were restated and filed in the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004 (the “Form 10-K/A”), filed with the Securities Exchange Commission (“SEC”) on August 2, 2005 to correct for certain accounting errors. The restated financial statements include a number of adjustments that impacted previously reported revenue, costs of sales, accounts receivable and inventory reserves. The restated financial statements also included related adjustments to deferred revenue, sales and marketing expense and income taxes and a reallocation of the valuation allowance on deferred income tax assets between the current and non current portions. Other than filing the 2004 Form 10-K/A, the Company has not amended, and does not anticipate amending, its previously filed annual reports on Form 10-K or its quarterly reports on From 10-Q for any periods. However, this Form 10-Q includes restated information for the three and six-month periods ended June 30, 2004. All 2004 amounts included herein reflect the restatements; June 30, 2004 amounts have been restated; December 31, 2004 amounts have been previously reported as restated. A summary of the restatement adjustments follows.

Passage of Title

Sales transactions were identified for which revenue should have been recognized upon delivery rather than upon shipment. For certain of these transactions, shipments occurred at a quarter or year-end and the deliveries did not occur until the beginning of the next accounting period. Adjustments were made to record the revenue and related cost of sales for these transactions in the appropriate periods.

Probability of Collection

Revenue was recognized upon shipment for sales to certain distributors that were not obligated to or could not pay the Company unless the Company’s products were sold through to an end user. If realization of revenue is contingent upon sell-through it is not appropriate to recognize revenue until sell-through occurs or upon receipt of cash. The Company made adjustments to recognize revenue for sales to these distributors upon receipt of cash rather than upon shipment of product.

Undelivered Elements

It was determined that certain customer arrangements contained obligations to provide training, support and other deliverables that had not previously been accounted for as separate elements of the arrangement. Generally accepted accounting principles in the U.S. require accounting for each separate element and that a portion of the arrangement fee be allocated to each of those separable elements using an appropriate methodology. The Company made adjustments to account for the separate elements that, for some arrangements, resulted in the deferral of a portion of the revenue from the arrangements.

Inventory Valuation

It was discovered that the Company had reduced inventory reserves in situations in which it was determined that the products were saleable. Generally accepted accounting principles in the U.S. provide that once inventory has been written down below cost as the close of a fiscal accounting period, it should not be written back up. As a result, the Company made adjustments to reduce inventory balances to the appropriate amounts at December 31, 2003 and 2004.

Summary

The following tables reconcile certain previously reported financial information to amounts as restated for the periods indicated, in thousands, except per share amounts:

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	Three Months				Six Months
	Ended		Three Months		Ended		Six Months
	June 30,		Ended		June 30,		Ended
	2004		June 30,		2004		June 30,
	As previously		2004		As previously		2004
Statements of Operations	reported		As restated		reported		As restated
Revenue	$	30,845	$	29,549	$	59,391	$	58,087
Cost of sales		16,894		16,274		32,506		31,723
Gross profit		13,951		13,275		26,885		26,364
Sales and marketing		4,041		4,047		8,617		8,625
Total operating expenses		10,834		10,840		21,269		21,276
Income from operations		3,117		2,435		5,616		5,088
Income before taxes		3,608		2,926		6,327		5,799
Net income		3,556		2,874		6,260		5,732
Per-share amounts:
Basic earnings per share	$	0.11	$	0.09	$	0.20	$	0.18
Diluted earnings per share	$	0.10	$	0.08	$	0.18	$	0.17


	Quarter ended
	Six months
	June 30, 2004			Six months
	As previously			June 30, 2004
	reported			As restated
Statements of Cash Flows
Net income	$	6,260		$	5,732
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
Changes in operating assets and liabilities:
Accounts receivable		3,697			4,889
Inventory		(3,709	)		(4,716	)
Accounts payable and accrued expenses		(3,269	)		(3,449	)

Note 2. Summary of Significant Accounting Policies

a. Business and Basis of Presentation. The Company designs, manufactures and sells broadband access equipment to wireline and wireless carriers. The products are used to upgrade capacity and provide enhanced services to wireline and wireless communications networks. The products also enable our customers to offer enhanced voice and data services, delivered over multiple technologies, which historically have been offered onto separate networks, on a single converged network. The Company designs products to enable our customers to deploy new revenue-generating voice and data services, while lowering their capital expenditures and ongoing operating costs. The Company operates in one business segment and substantially all of its sales and operations are domestic.

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the SEC. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC regulations. The unaudited

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condensed consolidated financial statements reflect all adjustments and disclosures that are, in the opinion of management, necessary for a fair presentation. All such adjustments are of a normal recurring nature. Certain amounts in the 2004 consolidated financial statements have been reclassified to conform to the 2005 presentation. Management does not believe the effects of such reclassifications are material. The results of operation for the interim period ended June 30, 2005 are not necessarily indicative of the results that may be expected for the full year or any fiscal quarter. For further information, refer to the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2004.

The preparation of consolidated financial statements in conformity with accounting standards generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates include accounts receivable and inventory reserve calculations, the estimated useful lives of depreciable and amortizable assets, as well as methods used to estimate contingencies and assumptions regarding fair value. Actual results could differ from those estimates.

b. Earnings Per Share. Basic earnings per share (“EPS”) is computed by dividing net income or loss by the weighted average number of common shares outstanding during the period. Diluted EPS reflects basic EPS adjusted for the potential dilution, computed using the treasury stock method that could occur if securities or other contracts to issue common stock were exercised or converted and resulted in the issuance of common stock.

A reconciliation of the weighted average shares used in computing basic and diluted earnings (loss) per share amounts is presented below. There were no adjustments to net income (loss) in order to determine diluted earnings (loss) per share.


	Three Months Ended				Six Months Ended
	June 30,				June 30
(in thousands)	2005		2004		2005		2004

Weighted-average shares
Average shares outstanding-basic		34,663		33,744		34,592		32,010
Shares assumed issued through exercises of stock options		—		2,046		—		2,233


Average shares outstanding-diluted		34,663		35,790		34,592		34,243


Number of shares excluded from computation because their effect is anti-dilutive		2,725		731		2,728		624

Due to the company’s net loss for the three months ended June 30, 2005, all potentially dilutive securities are considered anti-dilutive and therefore the number of shares used to compute dilutive earnings per share is equal to the basic weighted average shares outstanding for the period.

c. Stock-Based Compensation. The following table summarizes relevant information regarding reported results under the intrinsic value method of accounting for stock awards, with supplemental information provided as if the fair value recognition provisions of SFAS No. 123, Accounting for Stock Based Compensation, had been applied for the three months and six months ended June 30, 2005 and 2004 (in thousands, except per share amounts):

Page 10


	Three Months Ended						Six months Ended
	June 30,						June 30,
	2005			2004			2005			2004
				As restated						As restated
Net income (loss)	$	(1,449	)	$	2,874		$	(6,458	)	$	5,732
Add back: Stock-based compensation expense, as reported		47			—			47			5
Deduct: Stock-based compensation expense, determined under fair-value-based method for all awards		(347	)		(1,500	)		(1,276	)		(2,781	)


Net income (loss), as adjusted	$	(1,749	)	$	1,374		$	(7,687	)	$	2,956


Earnings (loss) per share — basic, as reported	$	(0.04	)	$	0.09		$	(0.19	)	$	0.18
Earnings (loss) per share — diluted, as reported	$	(0.04	)	$	0.08		$	(0.19	)	$	0.17
Earnings (loss) per share — basic, as adjusted	$	(0.05	)	$	0.04		$	(0.22	)	$	0.09
Earnings (loss) per share — diluted, as adjusted	$	(0.05	)	$	0.04		$	(0.22	)	$	0.09
Per share weighted average fair value of options granted during period	$	3.79		$	9.13		$	4.58		$	8.84

The weighted average fair values of options granted during the three and six months ended June 30, 2005 and 2004 were estimated using the Black-Scholes option-pricing model with the following assumptions:


	Three Months						Six Months
	Ended						Ended
	June 30,						June 30,
	2005			2004			2005			2004
Volatility		106	%		108	%		107	%		110	%
Expected life	5 years			5 years			5 years			5 years
Risk-free interest rate		3.7	%		3.8	%		3.9	%		3	%
Expected dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

d. Product Warranty and Service. The Company provides warranties against defects in materials and workmanship for its products generally ranging from 90 days to up to 60 months. At the time the product is shipped, the Company establishes a provision for estimated expenses of providing service under these warranties based on historical warranty experience. A summary of activity for accrued product warranty and service is as follows (in thousands):


	Three months ended						Six months ended
	June 30,						June 30,
	2005			2004			2005			2004
Beginning balance, accrued product warranties and service	$	601		$	526		$	634		$	410
Additions to the accrual for product warranties		202			469			385			805
Reductions for incurred warranty charges		(187	)		(361	)		(403	)		(581	)

Ending balance, accrued product warranties and service	$	616		$	634		$	616		$	634

e. Reclassifications. Certain investments in auction rate securities of $24 million were reclassified as of December 31, 2004 from cash and cash equivalents into marketable securities available for sale in the consolidated balance sheet. Auction rate securities are

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used as part of the Company’s cash management strategy. These investments are highly liquid, variable-rate debt securities. While the underlying security typically has a stated maturity of 20 to 30 years, the interest rate is reset through Dutch auctions that are held every 7, 28 or 35 days, creating a highly liquid, short-term instrument. The securities trade at par and are callable at par on any interest payment date at the option of the issuer. Interest is paid at the end of each auction period. We have also reclassified the purchase and sales of these auction rate securities in our consolidated statement of cash flows, increasing previously reported cash used by investing activities by $19.0 million for the six months ended June 30, 2004. The reclassification had no impact on previously reported total current assets, total assets, working capital position or results of operations and does not affect previously reported cash flows from operating or financing activities.

f. Exit and Disposal Activities. In December 2002, the Company completed a restructuring plan designed to reduce its expenses in accordance with anticipated reductions in revenue. Included in this plan were reductions in salary-related expenses, facility closures or downsizing, and disposal of excess or unused assets. As a result of these expense reductions, the Company took a charge in the fourth quarter of 2002 of $2.0 million. In the first six months of 2005, the Company recorded an additional provision of $369,000 as the Company made corrections to and revised its estimates of the losses on abandoned leases. The Company paid approximately $400,000 of this charge in the fourth quarter of 2002, approximately $1 million in 2003, approximately $500,000 in 2004 and approximately $359,000 in the first six months of 2005. Although most of the remaining cash disbursements related to the restructuring plan will be paid by December 31, 2005, the Company does not anticipate that the total amount will be paid until December 31, 2007.

Restructuring reserve activity resulting from the 2002 fourth quarter restructuring plan for 2005 is detailed below (in thousands):


	Beginning Reserve		Restructuring					Ending Reserve
	Balance		Charges		Payments			Balance
2003	$	1,586		—	$	(1,050	)	$	536
2004	$	536		218	$	(494	)	$	260
2005	$	260		369	$	(359	)	$	270

g. Development Activities. The Company entered into an agreement to perform development activities for a certain customer. Under the terms of the agreement, the customer paid the Company $125,000 in exchange for the completion of certain development activities. The Company has accounted for the arrangement as a contract to perform research and development in accordance with SFAS 68, Research and Development Arrangements. The Company has incurred costs of $25,000 in the first six months of 2005.

h. Significant Customers. The Company’s sales to one significant customer resulted in a significant concentration of revenue for the three and six months ended June 30, 2005 (as a percentage of sales):


Three months ended						Six months ended
June 30,						June 30,
2005			2004			2005			2004
	48	%		4	%		36	%		4	%

Note 3. Inventory

The components of inventory are as follows (in thousands):


				December
	June 30,			31,
	2005			2004
Raw materials	$	30,865		$	31,276
Work-in-process		34			16
Finished goods		8,017			7,269

		38,916			38,561
Reserve for obsolescence		(7,223	)		(6,552	)


Total inventory, net	$	31,693		$	32,009

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Note 4. Commitments and Contingencies

The Company leases office space under various noncancellable-operating leases that expire through 2007. The Company records rent expense under noncancellable operating leases using the straight-line method after consideration of increases in rental payments over the lease term, and records the difference between actual payments and rent expense as deferred rent concessions.

The Company has placed noncancellable purchase orders for $11.7 million of inventory from certain of its vendors for delivery in 2005. These orders are generally placed up to 4 months in advance based on the lead-time of the inventory.

In November of 2003, the Company acquired Paragon Networks International, Inc (Paragon). In connection with the acquisition, the Company assumed liabilities for value-added taxes and employee payroll taxes that may be payable to certain foreign taxing authorities. The estimated fair value of value-added taxes, employee payroll taxes and associated interest and penalties assumed is estimated to be approximately $840,000. Estimated employee payroll taxes, value-added taxes, and interest and penalties on un-remitted balances incurred after the acquisition dates have been accrued and expensed. Interest and penalties accrued and expensed in 2004 related to pre-acquisition value-added taxes and employee payroll taxes was approximately $80,000. In addition, the Company continued to incur value-added taxes and employee payroll taxes, and related penalties and interest during 2004 that were accrued and expensed which totaled approximately $263,000. The total amount of the contingent liability as of December 31, 2004 was approximately $1.2 million. During the first six months ended June 30, 2005, approximately $41,000 was accrued for payroll taxes and value added taxes. It is reasonably possible that the Company’s estimates will differ from the amounts ultimately paid to settle this liability. Adjustments to the Company’s estimates or to what is ultimately paid to taxing authorities in future periods will be included in earnings of the period in which the adjustment is determined.

Beginning on June 3, 2005, three purported shareholder class action lawsuits were filed in the United States District Court for the District of Colorado against Carrier Access Corporation and certain of our officers and directors. The cases, captioned Croker v. Carrier Access Corporation, et al., Case No. 05-cv-1011-LTB; Chisman v. Carrier Access Corporation, et al., Case No. 05-cv-1078-REB, and Sved v. Carrier Access Corporation, et al, Case No. 05-cv-1280-EWN, have been consolidated and are purportedly brought on the behalf of those who purchased our publicly traded securities between October 21, 2003 and May 20, 2005. Plaintiffs allege that defendants made false and misleading statements, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. The complaints are based upon allegations of wrongdoing in connection with our announcement of our intention to restate previously issued financial statements for the year ended December 31, 2004 and certain interim periods in each of the years ended December 31, 2004 and 2003.

Beginning on June 13, 2005, three purported shareholder derivative lawsuits were filed in the United States District Court for the District of Colorado, against various of our officers and directors and naming Carrier Access as a nominal defendant. The cases are captioned Kenney v. Koenig, et al., Case No. 05-cv-1074-PSF, Chaitman v. Koenig, et al., Case No. 05-cv-1095-LTB and West Coast Management and Capital, LLC v. Koenig [sic], et al. Case No. 05-cv-1134-RPM. These actions were consolidated on August 11, 2005. The complaints include claims for breach of fiduciary duty, abuse of control, waste of corporate assets, mismanagement and unjust enrichment; seek compensatory damages, disgorgement, and other relief; and are based on essentially the same allegations as the class actions described in the preceding paragraph.

Management believes that the claims in the class action are without merit. Because these lawsuits are at a very preliminary stage, management cannot at this time determine the probability or reasonably estimate a range of loss, if any. Were an unfavorable outcome to occur, it could have a material adverse impact on the Company’s financial position and results of operations for the period in which such outcome occurred.

In addition, Carrier Access is involved in legal proceedings from time to time arising from the normal course of business activities including claims of alleged infringement of intellectual property rights, commercial, employment and other matters. In the Company’s opinion, resolution of pending matters is not expected to have a material adverse impact on its consolidated results of operations, cash flows or its financial position, However, it is possible that an unfavorable resolution of one or more such proceedings could in the future materially affect the Company’s future results of operations, cash flows or financial position in a particular period.

Page 13

The Company provides indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of the Company’s products. The Company evaluates estimated losses for such indemnifications under SFAS 5, Accounting for Contingencies, as interpreted by FASB Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). The Company considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. To date, the Company has not encountered material costs as a result of such obligations, and has not accrued any liabilities related to such indemnifications in its financial statements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NOTICE CONCERNING FORWARD-LOOKING STATEMENTS

This Management’s Discussion and Analysis contains “forward-looking statements” within the meaning of the federal securities laws, including forward-looking statements regarding general economic conditions and industry consolidation, future sales of our products to our customers, inventory levels, our expectations regarding research and development and selling, general and administrative expenses, customer revenue mix, sources of revenue, gross margins, our tax liability and operating costs and expenses. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “intends,” “plans,” “anticipates,” “estimates,” “potential,” or “continue, “ or the negative thereof or other comparable terminology. These statements are based on current expectations and projections about our industry and assumptions made by the management and are not guarantees of future performance. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, these expectations or any of the forward-looking statements could prove to be incorrect, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition, as well as any forward-looking statements, is subject to risks and uncertainties, including but not limited to the factors set forth under the heading “Risk Factors” in Item 2 of this report. All forward looking statements and reasons why results may differ included in this report are made as of the date hereof, and, unless required by law, we undertake no obligation to update any forward-looking statements or reasons why actual results may differ in this report.

Restatement of Consolidated Financial Statements

As described in our Annual Report on Form 10-K/A for the year ended December 31, 2004, we restated, among other periods, our financial statements and certain other information for each of the quarters of 2004, with respect to our accounting for reported revenue, cost of sales, accounts receivable and inventory reserves. The restated financial statements also include related adjustments to deferred revenue, sales and marketing expense and income taxes and a reallocation of the valuation allowance on deferred income tax assets between the current and non current portions. Please refer to Note 1 of Notes to Consolidated Financial Statements for more detailed discussions of the restatement.

Following is a summary of the effects of the restatements on our results of operations for the three and six months ended June 30, 2004 (in thousands, except per share amounts):


	Three months ended,									Six months ended,
	June 30, 2004									June 30, 2004
							Diluted									Diluted
							earnings per									earnings per
	Net sales			Net income			share			Net sales			Net income			share
As previously reported	$	30,845		$	3,556		$	0.10		$	59,391		$	6,260		$	0.18
Effect of restatements		(1,296	)		(682	)		(0.02	)		(1,304	)		(528	)		(0.01	)

As restated	$	29,549		$	2,874		$	0.08		$	58,087		$	5,732		$	0.17

Page 14

For a more complete analysis of the effects of the restatements on our results of operations and statements of cash flow for the year ended December 31, 2004 and on our balance sheet as of December 31, 2004, please refer to our amended annual report on Form 10-K/A as filed with the Securities and Exchange Commission on August 2, 2005.

Overview

We design, manufacture and sell next-generation broadband access communications equipment to wireline and wireless communications carriers. We were incorporated in September 1992 as a successor company to Koenig Communications, Inc., equipment systems integration and consulting company that had been in operation since 1986. In the summer of 1995, we ceased our systems integration and consulting business and commenced our main product sales with the commercial deployment of our first network access products, which was followed by the introduction of our Wide Bank products in November 1997, Access Navigator products in January 1999, Adit products in December 1999, the Broadmore products in October 2000, which we acquired from Litton Network Access Systems, Inc., or LNAS, and the Axxius products in June 2002. In November 2003 we acquired the MASTER Series and BROADway product lines through our acquisition of Paragon.

During the late 1990s, a substantial number of carriers, including CLECs, invested heavily in network infrastructure and service delivery projects, which accelerated growth in the telecommunications equipment market. By 2000, when our annual net revenues reached $148.1 million, we relied on a limited number of CLECs for a significant portion of our net revenue. However, starting in late 2000, many of these CLECs encountered sharp declines in the amount of capital they had available to fund network infrastructure and service delivery projects. As a result, there was a significant decline in the demand for telecommunications equipment, including demand for our products.

We have since broadened our product portfolio into new markets, including wireless carriers and incumbent wireline carriers. For example, in 2000, 62% of our net revenue was derived from CLECs, 13% from ILECs, and 5% from wireless carriers compared to 7%, 13% and 65%, respectively, in the second quarter of 2005. Currently, the wireless and ILEC markets are dominated by a small number of large companies, and we continue to rely upon a small number of customers in these markets for a significant portion of our revenue. For the three months ended June 30, 2005, direct sales to one wireless customer accounted for approximately 48% of our revenue.

When the downturn in the telecommunications industry adversely affected our net revenue and operating results in late 2000, we reduced our operating expenses in an effort to better position our business for the long term. In December 2002, we completed a restructuring plan designed to reduce our expenses and align our workforce and operations to be more in line with anticipated net revenues. As a result of the restructuring plan, we recorded a $2.0 million restructuring charge in the fourth quarter of 2002. This charge was comprised of $1.4 million for future rent payments related to facility closures and downsizing and $600,000 for salary-related expenses due to reductions in our workforce. Our objective has been to focus on cost controls while continuing to invest in the development of new and enhanced products, which we believe will position us to take advantage of sales opportunities as economic conditions improve and demand recovers, a trend that we have started to see over the past year. However, we believe current economic conditions and industry consolidations may continue to cause our customers and potential customers to defer and reduce capital spending.

Historically, most of the sales of our products have been through a limited number of distributors and OEM’s. Sales to Walker & Associates accounted for 11% in 2003, 7% in 2004 and 3% for the three months ended June 30, 2005. Sales to distributors and OEM’s for the year ended 2004 accounted for 47% of our annual revenue. Recently, however, an increasing proportion of our product sales have been made directly to wireless telecommunications carriers. For the three months ended June 30, 2005, one wireless customer accounted for approximately 48% of our net revenue. We expect that the sale of our products will continue to be made to a small number of distributors, OEMs, and direct customers. As a result, the loss of, or reduction of sales to, any of these customers would have a material adverse effect on our business.

Page 15

Our net revenue continues to be affected by the timing and number of orders for our products, which continue to vary from quarter to quarter due to factors such as demand for our products, economic conditions, and the financial stability and ordering patterns of our direct customers, distributors, and OEMs. In addition, a significant portion of our net revenue has been derived from a limited number of large orders, and we believe that this trend will continue in the future, especially if the percentage of OEM and direct sales to customers continues to increase since such customers typically place larger orders than our distributors. The timing of such orders and our ability to fulfill them has caused material fluctuations in our operating results, and we anticipate that such fluctuations will continue in the future.

Results of Operations

Net Revenue and Cost of Goods Sold (in thousands):


	Three months ended June 30,				Six months ended June 30,
	2005		2004		2005		2004
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
			As restated				As restated
Net revenue	$	18,925	$	29,549	$	33,621	$	58,087
Cost of goods sold	$	11,281	$	16,274	$	20,871	$	31,723

Net revenue for the three months ended June 30, 2005 decreased to $18.9 million from $29.5 million for the three months ended June 30, 2004. Net revenue for the six months ended June 30, 2005 decreased to $33.6 million from $58.1 million for the six months ended June 30, 2004. The decrease in net revenue was due primarily to a significant decrease in sales from our OEM customers supplying product into the wireless market as well as reduced sales into two of our major wireless customers. We believe that this decrease in sales was primarily due to the consolidation in the wireless industry as wireless customers were rationalizing their networks due to the consolidation and sale of assets and therefore did not release their 2005 capital expenditure budgets. In addition, sales to direct customers for integrated T-1 business offerings declined and were not offset by sales of Voice Over IP offering as carriers were determining their roll out strategies for Voice over IP business service offerings. These events resulted in relative decreases in the number of units sold into the wireless business markets in the three and six months ended June 30, 2005 as compared to the prior year period. The decreased unit sales related primarily to Axxius, Adit and MasterSeries products.

A significant portion of our net revenue has been derived from a limited number of large orders, and we believe that this trend will continue in the future, especially if the percentage of direct sales to end-users increases. In each of fiscal 2003, fiscal 2004 and for the six months ended June 30, 2005, 23% of our net revenue was derived from 16, 24 and 8 orders, respectively. We have experienced a substantial decrease in the number of orders from some of these customers as a result of decreases in their capital spending budgets and the impact of adverse economic conditions both in general and in the telecommunications equipment industry in particular, which has resulted in decreased demand for telecommunications equipment during this period. In order to maintain or grow our net revenue, as well as offset the loss of anticipated net revenue from some of our prior customers, we will need to sell more products to both our remaining customers and new customers, and we can provide no assurance that we will be able to make such sales. Our net revenue was and continues to be affected by the timing and quantities of orders for our products which may vary from quarter to quarter in the future, as they have in the past, due to factors such as demand for our products, economic conditions, bankruptcies of our customers and distributors, and ordering patterns of distributors, OEMs and other direct customers. We believe that this trend could continue in the future, especially if the percentage of direct sales to end-users increases. The timing of customer orders and our ability to fulfill them can cause material fluctuations in our operating results, and we anticipate that such fluctuations will occur in the future.

During the first six months of 2005, approximately 31% of our revenue was derived from the sales of our products through our distributors and OEMs. Our success depends in part on the continued sales and customer support efforts of our network of distributors and OEMs as well as increased sales to our direct customers. We expect that the sale of our products will continue to be made to a small number of distributors. Accordingly, the loss of, or a reduction in sales to, any of our key distributors or OEMs could have a material adverse effect on our business. In addition to being dependent on a small number of distributors and OEMs, our products are sold directly to a limited number of service provider customers. For the three months ended June 30, 2005, approximately 48% of our net revenue related to one wireless customer. A decrease in sales to this or other significant customers could have a material adverse effect on our business.

Cost of goods sold for the three months ended June 30, 2005 was $11.3 million compared to $16.3 million in the three months ended June 30, 2004. For the six months ended June 30, 2005, cost of goods sold was $20.9 million compared to $31.7 million for the six months ended June 30, 2004.

Page 16

Gross Margins (in thousands):


	Three months ended June 30,						Six months ended June 30,
	2005			2004			2005			2004
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
				As restated						As restated
Gross Profit	$	7,644		$	13,275		$	12,750		$	26,364

Gross Margin		40	%		45	%		38	%		45	%

Gross margin decreased to 40% for the quarter ended June 30, 2005 from 45% for the quarter ended June 30, 2004, and 38% for the six months ended June 30, 2005 as compared to 45% for six months ended June 30, 2004. Gross margins for the quarter ended June 30, 2005 were negatively impacted from continued decreases in selling prices of some of our mature product lines. In addition, gross margins were negatively impacted due to overall lower sales volumes combined with fixed overhead amounts. Gross margins for the six months ended June 30, 2005 were additionally impacted by shifts in product mix to lower margin products including the MasterSeries product shipped with lower margin service cards in the first quarter of 2005. We believe that the average selling prices and the related gross margins will decline for mature products as volume price discounts in distributor contracts and direct sales relationships take effect due to competition. We have seen the average selling price for the Wide Bank products, Adit products, and MasterSeries products decrease during 2004. In addition, new product introductions could decrease gross margins until production volume increases.

Research and Development Expenses (in thousands):


	Three months ended June 30,						Six months ended June 30,
	2005			2004			2005			2004
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Research and development expenses	$	4,257		$	4,692		$	9,058		$	8,662

As a percentage of net revenue		22	%		16	%		27	%		15	%

Research and development expenses for the three months ended June 30, 2005 decreased to $4.3 million from $4.7 million for the three months ended June 30, 2004. Research and development expenses for the six months ended June 30, 2005 increased to $9.1 million from $8.7 million for the six months ended June 30, 2004. The decrease for the three months ended June 30, 2005 was primarily related to decreases in hardware expenses of approximately $300,000 and pilot expenses of $131,000 primarily for our wireless and Voice over IP product introductions. The increase for the six month period ended June 30, 2005 was related to increases in personnel expenses of $400,000. We believe that the trend in our research and development expenses could continue in the second half of 2005 as we accelerate our development of new product platforms and service cards for our existing development for wireless and Voice over IP solutions.

Page 17

Selling, General and Administrative Expenses (in thousands):


	Three months ended June 30,						Six months ended June 30,
	2005			2004			2005			2004
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
				As restated						As restated
Sales and marketing expenses	$	3,208		$	4,047		$	6,532		$	8,625
General and administrative expenses		2,035			1,800			3,715			3,524
Bad debt expense (recoveries)		58			(98	)		386			(281	)
Restructuring charges		—			92			369			92
Intangible asset amortization		307			307			614			654

Total selling, general and administrative expenses	$	5,608		$	6,148		$	11,616		$	12,614
Total selling, general and administrative expenses as a percentage of net revenue		30	%		21	%		35	%		22	%

Selling, general and administrative expenses for the three months ended June 30, 2005 decreased to $5.6 million from $6.1 million for the three months ended June 30, 2004. Selling, general and administrative expenses for the six months ended June 30, 2005 decreased to $11.6 million from $12.6 million for the six months ended June 30, 2004. Sales and marketing expenses for the three months ended June 30, 2005 decreased to $3.2 million from $4.0 million for the three months ended June 30, 2004. Sales and marketing expenses for the six months ended June 30, 2005 decreased to $6.5 million from $8.6 million for the six months ended June 30, 2004. Sales and marketing expenses decreased primarily as a result of a $1.8 million decrease in personnel expense and sales commissions during the six months ended June 30, 2005. General and administrative expenses for the three months ended June 30, 2005 increased to $2.0 million from $1.8 million for the three months ended June 30, 2004. General and administrative expenses for the six months ended June 30, 2005 increased to $3.7 million from $3.5 million for the six months ended June 30, 2004. The increase was primarily attributable to professional service costs, including legal and accounting expenses associated with the restatement of the fiscal 2003 and fiscal 2004 financial statements.

Other Income, Net

Interest and other income, net for the three months ended June 30, 2005 increased to $772,000 from $491,000 for the three months ended June 30, 2004. For the six months ended June 30, 2005 interest and other income, net increased to $1,466,000 from $711,000. The increase was attributable to interest earned on larger cash balances due to the proceeds from our public stock offering in February 2004 and higher overall interest earned.

Income Taxes

We did not record an income tax provision in the second quarter of 2005. While we have identified net operating loss carryforwards that may be used to offset up to $49.0 million of future taxable income for federal tax purposes and up to $35.2 million for state tax purposes, we cannot conclude that realization of the resulting deferred tax assets is more likely than not. As these net operating loss carryforwards are utilized, we will reduce the related valuation allowance. Reductions in the valuation allowance, if any, will generally be recognized in our statements of operations as an income tax benefit, and may offset any current income tax expense. In addition, should we demonstrate a history of sustained profitability, we may reverse all or a significant portion of the remaining valuation allowance. A portion of the valuation allowance relates to deferred tax assets obtained in connection with our acquisition of Paragon in 2003. Should we reverse the valuation allowance related to these acquired deferred tax assets, such reversal will result in an increase to the amount of acquired goodwill and will have no impact on our income tax provision.

Page 18

Liquidity and Capital Resources (in thousands):


	June 30,		December 31,
	2005		2004
	(unaudited)		(unaudited)
Working capital	$	136,802	$	142,047
Cash, cash equivalents and marketable securities	$	101,637	$	108,683
Total assets	$	176,950	$	184,135


	Six Months Ended
	June 30,			June 30,
	2005			2004
	(unaudited)			(unaudited)
(In thousands)				As restated
Net cash provided (used) by:
Operating activities	$	(6,271	)	$	6,648
Investing activities	$	4,122		$	(29,407	)
Financing activities	$	484		$	80,003

At June 30, 2005, our principal sources of liquidity included cash, cash equivalents and marketable securities available for sale totaling approximately $101.6 million. At June 30, 2005, our working capital was approximately $136.8 million. We have no significant capital spending commitments although we do have inventory purchase commitments and facilities leases.

Cash used by operations was $6.3 million for the six months ended June 30, 2005 contrasted to $6.6 million provided by operations in the six months ended June 30, 2004. Cash used by operations for the six months ended June 30, 2005 was primarily due to our net loss of $6.5 million adjusted for depreciation and amortization expense of $2.0 million and increases in prepaid expenses of approximately $1.5 million, offset by increases in accounts receivable of $3.1 million and decreases in accounts payable of $1.7 million. For the six months ended June 30, 2004, our cash provided by operations resulted from net income of $5.7 million adjusted for depreciation and amortization expense of $2.3 million, decreases in accounts receivable of $4.9 million, offset by increases in inventory of $4.7 million.

Cash provided by investing activities for the six months ended June 30, 2005 was $4.1 million compared to cash used in the six months ended June 30, 2004 of $29.4 million. For the six months ended June 30, 2005, we had net sales of $5.2 million of marketable securities compared to net purchases of $28.3 million for the six months ended June 30, 2004. Our capital expenditures for the six months ended June 30, 2005 were $1.1 million for equipment to support research, development, and manufacturing activities compared to $1.1 million for the six months ended June 30, 2004. We believe our current facilities are sufficient to meet our current operating requirements.

Financing activities provided $484,000 for the six months ended June 30, 2005, which was the result of the exercise of stock options. Financing activities provided $80.0 million for the six months ended June 30, 2004, which was primarily the result of $78.4 million of cash received upon the completion of our public offering. In addition, we received $1.6 million from the exercise of stock options during the six months ended June 30, 2004.

Our net inventory levels decreased approximately $315,000 to a net $31.7 million at June 30, 2005 from $32.0 million at December 31, 2004. The decrease was primarily the result of the increase in our inventory obsolescence reserve due to changes in product demand.

We believe that our existing cash and investment balances are adequate to fund our projected working capital and capital expenditure requirements for a period greater than 12 months. Although operating activities may provide cash in certain periods, to the extent we experience growth in the future, we anticipate that our operating and investing activities may use cash. We may consider using our capital to make strategic investments, acquisitions of companies, or to acquire or license technology or products. However, we cannot assure you that additional funds or capital will be available to us in adequate amounts and with reasonably acceptable terms.

Page 19

Off Balance Sheet Arrangements. Other than operating leases and inventory purchase commitments discussed in Commitments and Contingencies, we have no off balance sheet arrangements.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements 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 ongoing basis, we evaluate our estimates, including those related to revenue and product returns, inventory valuations, allowance for doubtful accounts, intangible assets, deferred income taxes and warranty reserves. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We consider the following accounting areas to have the most significant impact on the reported financial results and financial position of our company.

Revenue Recognition. We recognize revenue from product sales using guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements,” as amended by Staff Accounting Bulletin No. 104. Our revenue from sales of products is recognized upon shipment or delivery based upon shipping terms, provided there is evidence of an arrangement, the fee is fixed and determinable and collectibility is reasonably assured. Certain customers have the right to return products for a limited time after shipment as part of a stock rotation program. Revenue is reduced by estimated stock rotation returns based upon historical return rates. If future returns exceed estimates, revenue would be further reduced.

When collectibility is not reasonably assured, revenue is not recorded until such time as collection becomes reasonably assured, which is generally upon the receipt of cash. We assess reasonable assurance of collectibility based on a number of factors, including past transaction history and the creditworthiness of the customer. We generally recognize revenue upon shipment to resellers and distributors unless they are thinly capitalized and their ability to pay is, in substance, contingent upon their resale of the Company’s product. If reliable reporting from the reseller or distributor exists, revenue is recognized when the reseller or distributor sells the product to an end-user (“sell through”). For multiple element arrangements, the fair value of the individual elements is determined primarily based on sales prices when the products and services are sold separately. Revenue from installation and training services are deferred and recognized when the services are performed. Revenue from maintenance services is deferred and recognized over the term of the maintenance agreement.

For all sales, a binding contract, purchase order or another form of documented agreement is used as evidence of an arrangement with the customer. Sales to distributors may be evidenced by a master agreement governing the relationship, together with binding purchase orders on a transaction-by-transaction basis. Delivery is considered to occur upon shipment the product, so long as title and risk of loss have passed to the customer. At the time of the transaction the company assesses whether the sale amount is fixed or determinable based upon the terms of the documented agreement. If it is determined the fee is not fixed or determinable, revenue is recognized when the fee becomes fixed and determinable.

For arrangements with customers that include acceptance provisions, revenue is recognized upon the customer’s acceptance of the product, which occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

Inventory Reserves. We value our inventory at the lower of the actual cost to purchase and/or manufacture or the current estimated net realizable value of inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than our estimates, then additional inventory write-downs may be required.

Allowance for Doubtful Accounts. We perform ongoing credit evaluations of our customers and adjust open account status based upon payment history and the customer’s current creditworthiness, as determined by our review of current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon the age of outstanding invoices and any specific customer collection issues that we have identified. While such credit losses have usually been within our expectations and the provisions established, we did recover a significant portion of aged receivables in 2003

Page 20

and 2004 that we had previously provided for. This recovery amounted to approximately $3.1 million. We cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Because our sales are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material impact on our ability to collect our accounts receivable and, accordingly, on our future operating results.

Valuation of Intangible Assets. We regularly evaluate the potential impairment of goodwill and other intangible assets. In assessing whether the value of our goodwill and other intangibles has been impaired, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of these assets. If these estimates or their related assumptions change in the future, we may be required to record additional impairment charges. At the time of an acquisition we estimate the fair value of identifiable intangible assets acquired and amortize the cost over the estimated useful life.

Deferred Income Taxes. Current income tax expense (benefit) represents actual or estimated amounts payable or receivable on tax return filings each year. Deferred tax assets and liabilities are recorded for the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying balance sheets, and for operating loss and tax credit carryforwards. The change in deferred tax assets and liabilities for the period determines the deferred tax provision or benefit for the period. Effects of changes in enacted tax laws on deferred tax assets and liabilities are reflected as adjustments to the tax provision or benefit in the period of enactment. A valuation allowance is required to reduce the carrying amount of deferred tax assets if management cannot conclude that realization of such assets is more likely than not at the balance sheet date. Based upon our recent history of losses and an analysis of projected net taxable income for future operating periods, we determined that realization of our tax net operating loss carryforwards, tax credit carryforwards and other deferred tax assets is not sufficiently assured. Based upon this analysis, a valuation allowance has been recorded as of June 30, 2005, to reduce the carrying amount of our $29.0 million of net deferred tax assets to zero.

Warranty Reserves. We offer warranties of various lengths to our customers depending on the specific product and the terms of our customer purchase agreements. Our standard warranties require us to repair or replace defective product returned to us during the warranty period at no cost to the customer. We record an estimate for warranty related costs based on our actual historical return rates and repair costs at the time of sale. On an on-going basis, management reviews these estimates against actual expenses and makes adjustments when necessary. While our warranty costs have historically been within our expectations and the provisions established, we could not guarantee that we will continue to experience the same warranty return rates or repair costs that we have in the past. A significant increase in products return rates or the costs to repair our products could have a material adverse impact on our operating results.

Loss Contingencies. We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of a loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.

Employee Stock Options. As further explained in Note 2(c) in Notes to Consolidated Financial Statements, stock options are granted to employees, consultants and directors. Upon vesting, an option becomes exercisable; that is, the option holder can purchase a share of our common stock at a price that is equal to the share price on the day of grant. SFAS No. 123, “Accounting for Stock-Based Compensation,” permits companies either to continue accounting for stock options under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” or to adopt a fair-value-based method to measure compensation cost. We currently account for our stock-based compensation plans under the “intrinsic value” recognition and measurement principles of APB No. 25 and provide supplemental information in Notes to Consolidated Financial Statements as if we used the fair value recognition provisions of SFAS No. 123. Under SFAS No. 123, an option is valued on grant day, and then expensed evenly over its vesting period. We use the Black-Scholes option valuation model to estimate the option’s fair value. The option valuation model requires a number of assumptions, including future stock price volatility and expected option life (the amount of time until the options are exercised or expire). Expected option life is based on actual exercise activity from previous option grants. Volatility is calculated based upon stock price movements over the most recent period equal to the expected option life. Additionally our share price on grant day influences the option value. The higher the share price, the more the option is worth. Changes in the option value after grant day are not reflected in expense.

Page 21

Recently Issued Accounting Pronouncements

In November 2004, SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4” was issued to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). The provisions of this Statement must be adopted for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after the date this Statement is issued. The Company plans on adopting the Statement effective January 1, 2006. The guidance in SFAS No. 151 is not expected to have a material effect on our results of operations or financial position.

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share Based Payment. SFAS No. 123(R) is a revision of FASB Statement No. 123, “Accounting for Stock Based Compensation”, and supercedes APB Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows”. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. The amount of compensation cost will be measured based on the grant date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. Pro forma disclosure is no longer an alternative. The provisions of this statement will become effective for the Company beginning January 1, 2006.

SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:

1. A “modified prospective” method in which the compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.

2. A “modified retrospective” method which includes the requirements of the modified prospective method, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures for either: (a) all prior periods presented or (b) prior interim periods of the year of adoption.

The Company has not determined the method it will use upon adoption of SFAS No. 123(R).

As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using the APB No. 25 intrinsic value method and generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R) will have a significant impact on the Company’s results of operations, although it will have no impact on the financial position or cash flows. The impact of the adoption of SFAS No. 123(R) cannot be predicted with certainty at this time because it will depend on the share-based payments granted in the future. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the adoption. The Company has not assessed the impact of this provision on net operating loss carryforwards.

In December 2004, SFAS Statement No. 153, “Exchanges of Nonmonetary Assets an amendment of APB Opinion No. 29” was issued. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. As the Company has not entered into nonmonetary exchanges, the Statement will not have an impact on the Company’s results of operations or financial position.

In May of 2005, SFAS Statement No. 154 “Accounting Changes and Error Corrections a replacement of APB Opinion No. 20 and FASB Statement No. 3” was issued. This Statement provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This Statement also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The correction of an error in previously issued financial statements is not an accounting change. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retrospectively. Therefore, the reporting of a correction of an error by restating previously issued financial statements is also addressed Statement. The Statement is not expected to have a material impact on the Company’s results of operations or financial position.

Page 22

RISK FACTORS

Any investment in our common stock involves a high degree of risk. You should consider carefully the following information about these risks, together with the other information contained and incorporated in this Quarterly Report on Form 10-Q, before you decide to invest in our common stock. If any of the following risks actually occur, our business, financial condition and results of operations would likely suffer. In these circumstances, the market price of our common stock could decline and you may lose all or part of your investment.

Our common stock may be delisted from the NASDAQ National Market and transferred to the Over-the-Counter (“OTC”) Bulletin Board, which may, among other things, reduce the price of our common stock and the levels of liquidity available to our stockholders.

If we fail to keep current in our SEC filings, our common stock may be delisted from the NASDAQ National Market and subsequently would trade on the OTC Bulletin Board. The OTC Bulletin Board is generally considered less efficient than the NASDAQ National Market. If our common stock is traded on the OTC Bulletin Board, our stockholders could find it more difficult to dispose of our common stock or to obtain accurate quotations as to the price of our common stock. The trading of our common stock on the OTC Bulletin Board could also increase the level of volatility in our stock price, could result in a decrease in the price of our common stock and could reduce the level of liquidity available to our stockholders. In addition, the trading of our common stock on the OTC Bulletin Board will materially adversely affect our access to the capital markets, and the limited liquidity and reduced price of our common stock could materially adversely affect our ability to raise capital through alternative financing sources on terms acceptable to us or at all. A company trading on the OTC Bulletin Board cannot avail itself of federal preemption of state securities or “blue sky” laws, which adds substantial compliance costs to securities issuances, including pursuant to employee option plans, stock purchase plans and private or public offerings of securities. Our delisting from the NASDAQ National Market and transfer to the OTC Bulletin Board may also result in other negative implications, including the potential loss of confidence by suppliers, customers and employees, the loss of institutional investor interest and fewer business development opportunities.

We have been unable to predict accurately the costs associated with evaluating our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and may continue to be unable to do so in the future.

We have been unable to accurately predict the costs, including the costs of both internal assessments and external auditor assessments, associated with complying with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and in evaluating our internal control over financial reporting. Costs of compliance were significantly larger than originally anticipated in 2004, and costs of compliance in future periods may continue to be unpredictable, which could have an adverse effect on our financial results.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, our business could be harmed and current and potential stockholders could lose confidence in our financial reporting, which could negatively impact the trading price of our stock.

Maintaining an effective system of internal control over financial reporting is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. We have in the past discovered, and may in the future discover, areas of our internal control over financial reporting that need improvement including control deficiencies that may constitute material weaknesses. As more fully described in Item 9A of our Annual Report on Form 10-K/A filed on August 2, 2005, as of December 31, 2004, and in Item 4 of our Form 10Q disclosed herein, our management concluded that we did not maintain effective controls over certain aspects of our review of our statements of cash flow and certain revenue recognition policies. These control deficiencies resulted in a restatement of our previously issued financial statements for the fiscal years ended December 31, 2003 and 2004, and for each of the quarters therein.

A failure to implement and maintain effective internal control over financial reporting, including a failure to implement corrective actions to address the control deficiencies identified above, could result in a material misstatement of our financial statements or otherwise cause us to fail to meet our financial reporting obligations. This, in turn, could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.

We experienced large net losses and decreases in net revenue in 2001 and 2002, which caused a significant decline in the market price of our common stock, and we could experience similar declines in net revenue in the future, which could negatively impact the market price of our common stock.

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Our quarterly and annual operating results have fluctuated significantly in the past and may continue to vary significantly in the future. For example, although we were profitable on an annual basis from 1997 to 2000, we experienced net losses of $14.9 million and $52.7 million in 2001 and 2002, respectively. In addition, our net revenue decreased from $148.1 million in 2000 to $100.7 million and $50.2 million in 2001 and 2002, respectively.

Although our revenues increased from $62.5 million in 2003 to $95.5 million in 2004, our quarterly revenues decreased in the third and fourth quarters of 2004, resulting in a decrease in net revenue from $58.1 million in the first six months to $37.4 million in the last six months of 2004. In addition, we have reported a loss of $6.5 million for the first six months of 2005. We cannot be certain that our annual and quarterly revenue will not fluctuate in the future.

We face a number of risks that could cause our future net revenue and operating results to experience similar fluctuations, including the following:

	•		The loss of, or significant reduction in purchases by, any of our large distributor, direct and OEM customers, two of whom were each responsible for more than 10% of our net revenue in the year ended December 31, 2004 and one of whom was responsible for 48% of our net revenue in the three months ended June 30, 2005;

	•		Overall movement toward industry consolidation among both our competitors and our customers, both wireless and wireline;

	•		Reductions in capital spending for equipment by the telecommunications industry and reductions in capital spending for wireless equipment due to mergers and consolidation in the wireless market, a factor that resulted in a large decline in our product sales starting in year 2000, 2001 and 2003 and in the second half of 2004 and the first quarter of 2005;

	•		Costs related to acquisitions of technologies or businesses;

	•		Fluctuations in demand for our products and services, especially with respect to Internet businesses and communications carriers, in part due to the changing global economic and regulatory environment;

	•		Changes in sales and implementation cycles for our products and reduced visibility into our customers’ spending plans and associated revenue;

	•		Price and product competition in the communications and networking industries, which can change rapidly due to technological innovation;

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	•		The timing, size, and mix of orders from customers;

	•		The introduction and market acceptance of new technologies and products and our success in new markets;

	•		Variations in sales channels, product costs, or mix of products sold;

	•		The ability of our customers, channel partners, and suppliers to obtain financing or to fund capital expenditures;

	•		Our ability to achieve targeted cost reductions and to execute on our strategy and operating plans; and

	•		Potential difficulties in completing projects associated with in-process research and development.

The unpredictability of our quarterly results may adversely affect the trading price of our common stock.

Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control and any of which may cause our stock price to fluctuate. Generally, purchases by service providers of telecommunications equipment from manufacturers have been unpredictable and clustered, rather than steady, as the providers build out their networks. The primary factors that may affect our revenues and results include the following:

	•		Fluctuation in demand for our voice infrastructure products and the timing and size of customer orders;

	•		The cancellation or deferral of existing customer orders or the renegotiation of existing contractual commitments;

	•		The failure of certain of our customers to successfully and timely reorganize their operations, including emerging from bankruptcy;

	•		The length and variability of the sales cycle for our products;

	•		The timing of revenue recognition and amount of deferred revenues;

Deterioration of the wireless infrastructure industry could lead to reductions in capital spending budgets by wireless operators and original equipment manufacturers, which could adversely affect our revenues, gross margins and income.

Our revenues and gross margins will depend significantly on the overall demand for wireless infrastructure subsystems products. A reduction in capital spending budgets by wireless operators and OEMs caused by an economic downturn, consolidation within the industry such as the mergers of Cingular and AT&T Wireless, and the recently announced mergers of Sprint and Nextel, or otherwise could lead to a softening in demand or delay procurement of our products and services. Such factors resulted in a decrease in revenues and earnings in the third and fourth quarter of 2004, as well as in the first six months of 2005 and could result in decreases in revenues and earnings in future periods.

We rely on a limited number of distributors and OEMs, the loss of any of which could cause a decline in our net revenue and have an adverse effect on our results of operations and the price of our common stock.

A significant portion of the sales of our products are through distributors and OEMs, which generally are responsible for warehousing products, fulfilling product orders, servicing end-users and, in some cases, customizing and integrating our products at end-users’ sites. We rely on a limited number of distributors and OEMs to sell our products. For example, one distributor, Walker & Associates, Inc., accounted for 11% and 7% of our net revenue in 2003 and 2004, respectively. In addition, for the year ended 2004, an OEM customer, Ericsson, accounted for approximately 10% of our revenue. We expect that, in the future, a significant portion of our products will continue to be sold to a small number of distributors and OEMs. Accordingly, if we lose any of our significant distributors and OEMs or experience reduced sales to such distributors and OEMs, our net revenue would decline, which would have an adverse effect on our operating results and could cause a decline in the price of our common stock.

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If our distributors are not successful both in terms of operating their own businesses and in selling our products to their customers, we could experience a decline in net revenue, an increase in inventory and bad debt, and deterioration in our operating results.

In the past, some of our distributors have experienced problems with their financial and other resources that have impaired their ability to pay us. For example, in 2002 we incurred bad debt of approximately $1.1 million from one of our distributors when it declared bankruptcy. Although we continually monitor and adjust our reserves for bad debts, we cannot assure you that any future bad debts that we incur will not exceed our reserves. Furthermore, we cannot assure you that the financial instability of one or more of our distributors will not result in decreased net revenue for us and deterioration in our operating results. Distributors have, in the past, reduced planned purchases of our products due to overstocking and such reductions may occur again in the future. Moreover, distributors who have overstocked our products have, in the past, reduced their inventories of our products by selling such products at significantly reduced prices. This may occur again in the future. Any reduction in planned purchases or sales at reduced prices by distributors in the future could harm our business by, among other things, reducing the demand for our products and creating conflicts with other distributors and our direct sales efforts.

Some of our distributors and OEMs have stock rotation, limited return, on time delivery and price protection rights which could cause a material decrease in the average selling prices and gross margins of our products, either of which would have an adverse effect on our operating results and financial condition.

We generally provide our distributors and OEMs with limited stock rotation, on time delivery, return rights and price protection rights. Three times a year, some of these customers can return up to 15% of our unsold products to us in return for an equal dollar amount of new products. The returned products must have been held in stock by such distributor or OEM and have been purchased within the four-month period prior to the return date. We cannot be certain that we will not experience significant returns of our products, or ensure that our shipment in the future will be on time, or that we will make adequate allowances to offset these returns and late deliveries.

We also provide certain distributors and OEMs with price protection rights in which we provide some of these customers with 60-days notice of price increases. Orders we receive from distributors or OEMs within the 60-day period are filled at the lower product price. In the event of a price decrease, we may be required to credit distributors and OEMs the difference in price for any stock they have in their inventory. In addition, we grant certain of our distributors and OEMs “most favored customer” terms, pursuant to which we have agreed not to knowingly grant another distributor or OEM the right to resell the same products on terms more favorable than those granted to the existing distributor or OEM, without offering the more favorable terms to the existing distributor or OEM. It is possible that these price protection and “most favored customer” clauses could cause a material decrease in the average selling prices and gross margins of our products, which could in turn have a material adverse effect on distributor or OEM inventories, our business, financial condition, or results of operations.

We do not have exclusive agreements with our distributors, who sell other broadband communications equipment that competes with our products. As a result, our distributors may not recommend or continue to use and offer our products or devote sufficient resources to market and support our products, which could result in a reduction in sales of our products.

Our agreements with our distributors generally do not grant exclusivity, prevent the distributor from carrying competing products or require the distributor to purchase any minimum dollar amount of our products. Additionally, our distribution agreements do not attempt to allocate certain territories for our products among our distributors. To the extent that different distributors target the same end-users of our products, distributors may come into conflict with one another, which could damage our relationship with, and sales to, such distributors.

Most of our existing distributors also distribute the products of our competitors. Our distributors may not recommend or continue to use and offer our products, or our distributors may recommend competitive products in place of our products and not devote sufficient resources to market and provide the necessary customer support for our products. In addition, it is possible that our distributors will give a higher priority to the marketing and customer support of competitive products or alternative solutions.

Our distributors do not have any obligation to purchase additional products, and accordingly, they may terminate their purchasing arrangements with us, or significantly reduce or delay the amount of our products that they order, without penalty. Any such termination, change, reduction, or delay in orders would harm our business.

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We continue to rely on a limited number of direct customers, the loss of any of which could result in a decline in net revenue and the price of our common stock.

A significant portion of our net revenue has been derived from a limited number of large direct customers, and we believe that this trend will continue in the future. For example, for fiscal year 2004, we sold directly to a wireless customer who accounted for approximately 10% of our net revenue, and for the three months ended June 30, 2005, we sold directly to another wireless customer who accounted for approximately 48% of our net revenue. The majority of our direct customers do not have any obligation to purchase additional products, and, accordingly, they may terminate their purchasing arrangements with us or significantly reduce or delay the amount of our products that they order or forecast without penalty. We have experienced cancellations and delays of orders in the past and significant reductions in product forecasts, and we expect to continue to experience order cancellations and delays from time to time in the future. Any such termination, change, reduction or delay in orders would harm our business. The timing of customer orders and accuracy of customer forecasts and our ability to fulfill these forecasts and orders can cause material fluctuations in our operating results, and we anticipate that such fluctuations will continue in the future.

If our direct customers do not successfully operate their own businesses, their capital expenditures could be limited, which could result in a delay in payment for, or a decline in the purchase of, our products, which could result in a decrease in our net revenue and a deterioration of our operating results.

In the past, some of our direct customers have experienced problems with their financial and other resources that have impaired their ability to pay us. For example, in 2002, one of our direct customers filed for bankruptcy protection, and, as a result, we incurred approximately $1.1 million in bad debt. Another direct customer, which accounted for 13.5% of our net revenues in 2002, has experienced financial difficulty and restructured its operations, and it may not be in a position in the future to continue its historic purchase levels. We cannot be certain that any bad debts that we incur in connection with direct sales will not exceed our reserves or that the financial instability of one or more of our direct customers will not continue to adversely affect future sales of our products or our ability to collect on accounts receivable for current sales of our products.

In addition, we sell a moderate volume of products to competitive carriers. The competitive carrier market is experiencing consolidation. Many of our competitive carrier customers do not have a strong financial position and have limited ability to access the public financial markets for additional funding for growth and operations. Currently, one of our large customers must rely on funding from its parent to fund operating losses and meet its working capital, capital expenditure, debt service and other obligations.

Neither equity nor debt financing may be available to these companies on favorable terms, if at all. To the extent that these companies are unable to obtain the financing they need, our ability to make future sales to these customers and realize revenue from any such sales could be harmed. In addition, if one or more of these competitive carriers fail, we could face a loss in revenue and an increased bad debt expense, due to their inability to pay outstanding invoices, as well as a corresponding decrease in customer base and future revenue. Furthermore, a significant portion of our sales to competitive carriers is made through independent distributors. The failure of one or more competitive carriers could cause a distributor to experience business failure and/or default on payments to us.

We grant certain of our direct customers “most favored customer” terms, which could cause a material decrease in the average selling prices and gross margins of our products, which would have an adverse effect on our operating results and financial condition.

In agreements with direct customers that contain “most favored customer” terms, we have agreed to not knowingly provide another direct customer with similar terms and conditions or a better price than those provided to the existing direct customer without offering the more favorable terms, conditions or prices to the existing direct customer. It is possible that these “most favored customer” clauses could cause a material decrease in the average selling prices and gross margins of our products, which could, in turn, have an adverse effect on our operating results and financial condition.

A longer than expected sales cycle could cause our revenues and operating results to vary significantly from quarter to quarter.

Our sales cycle averages approximately four to 24 months but can take longer in the case of incumbent local exchange carriers, or ILECs, and other end-users. This process is often subject to delays because of factors over which we have little or no control, including:

	•		a distributor’s, OEM’s or carrier’s budgetary constraints including the timing of expenditures;

	•		consolidation and merger discussions between wireless and wireline carriers;

	•		outsourcing of inventory management by a distributor or OEM customer;

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	•		a distributor’s, OEM’s or carrier’s internal acceptance reviews;

	•		a distributor’s, OEM’s or carriers staffing levels and availability of lab time for product testing;

	•		the success and continued internal support and development of a carrier’s product offerings;

	•		the possibility of cancellation or delay of projects by distributors, OEMs or carriers; and

	•		the possibility of a regulatory investigation of our distributors, OEMs or carriers.

In addition, as carriers have matured and grown larger both through internal growth and acquisitions, their purchase processes have typically become more institutionalized, requiring more of our time and effort to gain the initial acceptance and final adoption of our products by these customers. Although we attempt to develop our products with the goal of facilitating the time to market of our customer’s products, the timing of the commercialization of a new distributor or carrier applications or services based on our products is primarily dependent on the success and timing of a customer’s own internal deployment program. Delays in purchases of our products can also be caused by late deliveries by other vendors, changes in implementation priorities and slower than anticipated growth in demand for our products. A delay in, or a cancellation of, the sale of our products could cause our results of operations to vary significantly from quarter to quarter.

In the industry in which we compete, a supplier must first obtain product approval from an ILEC or other carrier to sell its products to them. This process can last from four to 18 months or longer depending on the technology, the service provider, and the demand for the product from the service provider’s subscribers. Consequently, we are involved in a constant process of submitting for approval succeeding generations of products, as well as products that deploy new technology or respond to new technology demand from certain carriers or other end-users. We have been successful in the past in obtaining such approvals. However, we cannot be certain that we will obtain such approvals in the future or that sales of such products will continue to occur. Furthermore, the delay in sales until the completion of the approval process, the length of which is difficult to predict, could result in fluctuations of revenue and uneven operating results from quarter to quarter or year to year.

Communications carriers face capital constraints which have restricted and may continue to restrict their ability to buy our products, thereby resulting in longer sales cycles, deferral or delay of purchase commitments for our products, and increased price competition.

Our customers consist primarily of communications carriers, including wireless carriers, local exchange carriers, multi-service cable operators, and competitive local and international communications providers. These carriers require substantial capital for the development, construction, and expansion of their networks and the introduction of their services. Although the economy has slightly improved, there is still oversupply of communications bandwidth that has resulted in a constraint on the availability of capital for these carriers and has had a material adverse effect on many of our customers with numerous customers substantially reducing their capital spending. If our current or potential customers cannot successfully raise necessary funds or if they experience any other adverse effects with respect to their operating results or profitability, their capital spending programs could continue to be adversely impacted. These conditions adversely impacted the sale of our products and our operating results most severely in the fourth quarter of 2000, and they continued to have an adverse impact throughout 2001, 2002, 2003, 2004 and the first six months of 2005. These conditions may continue to result in longer sales cycles, deferral or delay of purchase commitments for our products, and increased price competition. In addition, to the extent we choose to provide financing to these prospective customers, we will be subject to additional financial risk that could increase our expenses.

If we are unable to develop new or enhanced products that achieve market acceptance, we could experience a reduction in our future product sales, which would cause the market price of our common stock to decline.

The communications industry is characterized by rapidly changing technology, evolving industry standards, changes in end-user requirements, and frequent new product introductions and enhancements, each of which may render our existing products obsolete or unmarketable. Our success depends on our ability to enhance our existing products and to timely and cost-effectively develop new products with features that meet changing end-user requirements and emerging industry standards. The development of new, technologically advanced products is an expensive, complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. We may not be successful in identifying, developing, manufacturing, and marketing product enhancements or new products that will respond to technological change or evolving industry standards. In the recent past, we have experienced delays in the development and shipment of new products and enhancements, which has resulted in distributor and end-user frustration and delay or loss of net revenue. It is possible that we will experience similar or other difficulties in the future that could delay or prevent the successful development, production, or shipment of such new products or enhancements, or that our new products and enhancements will not adequately meet the requirements of the marketplace and achieve market

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acceptance. Announcements of currently planned or other new product offerings by our competitors or us have in the past caused, and may in the future cause, distributors or end-users to defer or cancel the purchase of our existing products. Our inability to develop new products or enhancements to existing products on a timely basis, or the failure of such new products or enhancements to achieve market acceptance, could result in a decline in our future product sales and the price of our common stock.

The introduction of new or enhanced products could cause disruptions in our distribution channels and the management of our operations, which could cause us to record lower net revenue or adversely affect our gross margins.

Our introduction of new or enhanced products will require us to manage the transition from older products in order to minimize disruption in customer ordering patterns, avoid excessive levels of older product inventories, and ensure that adequate supplies of new products can be delivered to meet customer demand. We have historically reworked certain of our products in order to add new features that were included in subsequent releases of the products, which generally resulted in reduced gross margins for those products until such time as production volumes of these new products increase. We can give no assurance that these historical practices will not occur in the future and cause us to record lower net revenue or negatively affect our gross margins.

We rely on the introduction of new or enhanced products to offset the declining sales prices and gross margins of our older products, and the failure of our new or enhanced products to achieve market acceptance could result in a decline in our net revenue and operating results.

We believe that average selling prices and gross margins for our products will decline as such products mature and as competition intensifies. For example, the average selling price for our Wide Bank products and Adit products has decreased substantially in the past. These decreases were due to general economic conditions and the introduction of competitive products with lowers prices. To offset declining selling prices, we believe that, in addition to reducing the costs of production of our existing products, we must introduce and sell new and enhanced products on a timely basis at a low cost or incorporate features in these products that enable them to be sold at higher average selling prices. To the extent that we are unable to reduce costs sufficiently to offset any declining average selling prices or that we are unable to introduce enhanced products with higher selling prices, our gross margins would decline and such decline could adversely affect our operating results and the price of our common stock.

To develop new products or enhancements to our existing products, we will need to continue to invest in research and development, which could adversely affect our financial condition and operating results, especially if we need to increase the amount of our investment to successfully respond to developing industry standards.

As standards and technologies evolve, we will be required to modify our products or develop and support new versions of our products. Our research and development expenses increased 65% to $18.2 million in 2004 from $11.0 million in 2003. As a result, we may experience periods of limited profitability due to the resources needed to develop new and enhanced products to remain competitive. The failure of our products to comply, or delays in achieving compliance, with the various existing and evolving technological changes and industry standards could harm sales of our current products or delay introduction of our future products.

Our industry is highly competitive; if we fail to compete successfully against our competitors, our market share and product sales could be adversely affected, resulting in a decline in our net revenue and deterioration of our operating results.

The market for our products is intensely competitive, with a large number of equipment suppliers providing a variety of products to diverse market segments within the telecommunications industry. Our existing and potential competitors include many large domestic and international companies, including companies that have longer operating histories, greater name recognition, larger customer bases and substantially greater financial, manufacturing, technological, sales and marketing, distribution, and other resources. Our principal competitors include Adtran, Inc., Audiocodes, Cisco Systems, Inc., Eastern Research, Inc., Lucent Technologies, Inc., Natural Microsystems, Telco Systems, Inc., Tellabs, Inc., Verilink Corporation, Zhone Technologies, Inc. and other small independent systems integrators and private and public companies. Most of these companies offer products competitive with one or more of our product lines. We expect that our competitors that currently offer products competitive with only one of our products will eventually offer products competitive with all of our products. Due to the rapidly evolving markets in which we compete, additional competitors with significant market presence and financial resources, including large telecommunications equipment manufacturers and computer hardware and software companies, may enter these markets through acquisition, thereby further intensifying competition.

Many of our current and potential competitors are substantially larger than we are and have significantly greater financial, sales and marketing, technical, manufacturing, and other resources and more established channels of distribution. As a result, such competitors may be able to respond more rapidly to new or emerging technologies and changes in customer requirements, or to devote greater resources than we can devote to the development, promotion, and sale of their products. In addition, such competitors may enter our existing or future markets with solutions, either developed internally or through acquisition, that may be less costly, provide higher performance or additional features, or be introduced earlier than our solutions. Successful new product introductions or

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enhancements by our competitors could cause a significant decline in sales or loss of market acceptance of our products. Competitive products may also cause continued intense price competition or render our products or technologies obsolete or noncompetitive.

To be competitive, we must continue to invest significant resources in research and development and sales and marketing. We may not have sufficient resources to make such investments or be able to make the technological advances necessary to be competitive. In addition, our current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced gross margins, and loss of market share, any of which could cause a decline in the price of our common stock.

Our customers are subject to heavy government regulation in the telecommunications industry, and regulatory changes could adversely affect our customers’ capital expenditure budgets and result in reduced sales of our products and significant fluctuations in the price of our common stock.

Competitive local exchange carriers, or CLECs, are allowed to compete with ILECs in the provisioning of local exchange services primarily as a result of the adoption of regulations under the Telecommunications Act of 1996, or the 1996 Act, that imposed new duties on ILECs to open their local telephone markets to competition. Although the FCC and federal district courts in various rulings in 2004 rejected efforts of several state regulators to subject certain VoIP services to intrastate telecommunications regulation, there are still uncertainties regarding other regulatory, economic, and political factors. Any changes to the 1996 Act or the regulations adopted thereunder, the adoption or repeal of new regulations by federal or state regulatory authorities apart from or under the 1996 Act, including the E911 FCC mandate or any legal challenges to the 1996 Act could have a material adverse impact upon the market for our products.

We are aware of certain litigation challenging the validity of the 1996 Act and local telephone competition rules adopted by the FCC for the purpose of implementing the 1996 Act. Furthermore, Congress has indicated that it may hold hearings to gauge the competitive impact of the 1996 Act, and it is possible that Congress will propose changes to the 1996 Act. This litigation and potential regulatory change may delay further implementation of the 1996 Act, which could negatively impact demand for our products. Our distributors or carrier customers may require that we modify our products to address actual or anticipated changes in the regulatory environment, or we may voluntarily decide to make such modifications. In addition, the increasing demand for wireless communications has exerted pressure on regulatory bodies worldwide to adopt new standards for such products, generally following extensive investigation and deliberation over competing technologies. In the past, the delays inherent in this governmental approval process have caused, and may in the future cause, the cancellation or postponement of the deployment of new technologies. These delays could have a material adverse effect on our revenues, gross margins and income.

Our inability to modify our products in a timely manner or address such regulatory changes could cause a reduction in demand for our products, a loss of existing customers or the failure to attract new customers, which would result in lower than expected net revenue and a decline in the price of our common stock.

Telecommunication industry carriers are currently experiencing a period of consolidation that may impact the timing of future capital expenditures, which could adversely affect the demand for our products.

We are experiencing rapid consolidation in our customer base. During the past 18 months a number of large mergers in the telecommunications industry have been announced, including the following: Cingular Wireless and AT&T Wireless, Sprint and Nextel, SBC and AT&T, Alltel and Western Wireless, and Verizon. The integration of the operations of the entities involved in these acquisitions may take a long time, and this could cause delays in new capital expenditures until the merged entities budget for additions for their asset base. The effects of a consolidation involving any of our customers could result in postponed orders, decreased orders, or canceled orders. For instance, in the third and fourth quarters of 2004, market consolidation in the wireless industry relating to the merger of Cingular and AT&T Wireless and T-Mobile’s purchase of spectrum from Cingular resulted in reduced sales to our wireless customers and OEMs. In addition, industry consolidation may result in sole-source vendors by our customers, which in turn could have a material adverse effect on our business, operating results, and financial condition. In particular, consolidation in the telecommunication industry carriers will lead to fewer customers in that market and the loss of a major customer could have a material impact on results not anticipated in a customer marketplace composed of a larger number of participants.

We have limited supply sources for some key parts and components of our products, and our operations could be harmed by supply interruptions, component defects or unavailability of these parts and components.

Many key parts and components are purchased from sole source suppliers for which alternative sources are not currently available. We currently purchase 1,183 key components from suppliers for which there are currently no substitutes. Lead times for materials and components vary significantly and depend on many factors, some of which are beyond our control, such as specific supplier performance, contract terms and general market demand for components. If product orders vary significantly from forecasts, we may

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not have enough inventories of certain materials and components to fill orders. In addition, many companies utilize the same materials and supplies as we do in the production of their products. Companies with more resources than our own may have a competitive advantage in obtaining materials and supplies due to greater buying power. These factors can result in reduced supply, higher prices of certain materials, and delays in the receipt of certain of our key components, which in turn may generate increased costs, lower margins, and delays in product delivery. We attempt to manage these risks through developing alternative sources, through engineering efforts designed to obviate the necessity of certain components, and by building long-term relationships and maintaining close personal contact with each of our suppliers. However, we have experienced delays in or failures of deliveries of key components in the past, either to us or to our contract manufacturers, and consequent delays in product deliveries, may occur in the future.

We currently do not have long-term supply contracts for many of our key components. Our suppliers may enter into exclusive arrangements with our competitors, be acquired by our competitors, stop selling their products or components to us at commercially reasonable prices, refuse to sell their products or components to us at any price, or be unable to obtain or have difficulty obtaining components for their products from their suppliers.

Our distributors, OEMs and direct customers frequently require rapid delivery after placing an order. Our inability to obtain sufficient quantities of the components needed to fulfill such orders has in the past resulted in, and may in the future result in, delays or reductions in product shipments, which could have an adverse effect on sales and customer relationships, our business, financial condition, or results of operations. In the event of a reduction or interruption of supply, it could take up to nine months or more for us to begin receiving adequate supplies from alternative suppliers. Furthermore, we may not be able to engage an alternative supplier who could be in a position to satisfy our production requirements on a timely basis, if at all. Delays in shipments by one of our suppliers have led to lost or delayed sales and sales opportunities in the past and may do so again in the future. For example, in the third quarter of 2004, we were not able to fulfill all of our open purchase orders of our Adit and BROADway products due to unforecasted demand and a lack of availability of parts.

In addition, the manufacturing process for certain single or sole source components is extremely complex. Our reliance on suppliers for these components, especially for newly designed components, exposes us to potential production difficulties and quality variations that the suppliers experience. In the past, this reliance on outside suppliers for these components has negatively impacted cost and the timely delivery of our products to our customers.

Our dependence on third-party manufacturers could result in product delivery delays, which would adversely affect our ability to successfully sell and market our products and could result in a decline in our net revenue and operating results.

We currently use several third-party manufacturers to provide certain components, printed circuit boards, chassis, and subassemblies. Our reliance on third-party manufacturers involves a number of risks, including the potential for inadequate capacity, the unavailability of, or interruptions in, access to certain process technologies, transportation interruptions, and reduced control over procurement of critical components, product quality delivery schedules, manufacturing yields, and costs. Some of our manufacturers are undercapitalized and may be unable in the future to continue to provide manufacturing services to us. If these manufacturers are unable to manufacture our components in required volumes, we will have to identify and qualify acceptable additional or alternative manufacturers, which could take in excess of twelve months. We cannot assure you that any such source would become available to us or that any such source would be in a position to satisfy our production requirements on a timely basis. Any significant interruption in our supply of these components would result in delays, the payment of damages for such delays, or reallocation of products to customers, all of which could have a material adverse effect on our ability to successfully sell and market our products and could result in a decline in our net revenue and operating results. Moreover, since a significant portion of our final assembly and test operations are performed in one location, any fire or other disaster at our assembly facility could also have an adverse effect on our net revenue and operating results.

Our executive officers and certain key personnel are critical to our business, and any failure to retain these employees could adversely affect our ability to manage our operations and develop new products or enhancements to current products.

Our success depends to a significant degree upon the continued contributions of our Chief Executive Officer and key management, sales, engineering, finance, customer support, and product development personnel, many of whom would be difficult to replace. In particular, the loss of Roger L. Koenig, President and Chief Executive Officer and our co-founder, could adversely affect our ability to manage our operations. We believe that our future success will depend in large part upon our ability to attract and retain highly skilled managerial, sales, customer support and product development personnel. We do not have employment contracts with any of our key personnel. The loss of the services of any such persons, the inability to attract or retain qualified personnel in the future, or delays in hiring required personnel, particularly engineering personnel and qualified sales personnel, could adversely affect our ability to manage our operations and develop new products or enhancements to current products.

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Our customers are subject to numerous and changing regulations, interoperability requirements and industry standards. If the products they purchase from us do not meet these regulations or are not compatible with these standards or interoperate with the equipment solution selected by our customers, our ability to continue to sell our products could be seriously harmed.

Our products must comply with a significant number of voice and data regulations and standards, which vary between U.S. and international markets, and may also vary within specific foreign markets. We also need to ensure that our products are easily integrated with various telecommunications systems. Standards for new services continue to evolve, requiring us to continuously modify our products or develop new versions to meet new standards. Testing to ensure compliance and interoperability requires significant investments of time and money. Our VoIP products currently interoperate with approximately 11 different product solutions and we are required to continually update our products based on our partners’ new releases of software for these products. If our systems fail to timely comply with evolving standards in U.S. and international markets, if we fail to obtain compliance on new features or if we fail to maintain interoperability with equipment from other companies, our ability to sell our products would be significantly impaired. We could thereby experience, among other things, customer contract penalties, delayed or lost customer orders and decreased revenues.

We have maintained compliance with ISO 9001:2000 since we were first certified in May 2000, with Telcordia OSMINE when we were first certified in the fourth quarter of 2001 and with Network Equipment Building Standards Level 3 since we were first certified in April 1998. ISO 9001:2000 is a set of comprehensive standards that provide quality assurance requirements and quality management guidance. These standards act as a model for quality assurance for companies involved with the design, testing, manufacture, delivery and service of products. Telcordia, formerly known as Bellcore, developed the Osmine program, which is a process designed to ensure that all of the network equipment used by Regional Bell Operating Companies, or RBOCs, can be managed by the same software programs. NEBS, or Network Equipment Building Standards, are a set of performance, quality and safety requirements — which were developed internally at Bell Labs and later at Telcordia — for network switches. RBOCs and local exchange carriers rely on NEBS-compliant hardware for their central office telephone switching. We cannot assure that we will maintain these certifications. The failure to maintain any of these certifications may adversely impair the competitiveness of our products.

Our products may suffer from defects or errors that may subject us to product returns and product liability claims, which could adversely affect our reputation and seriously harm our results of operations.

Our products have contained in the past, and may contain in the future, undetected or unresolved errors when first introduced or when new versions are released. Despite our extensive testing, errors, defects, or failures are possible in our current or future products or enhancements. If such defects occur, we may be subject to:

	•		delays in or losses of market acceptance and sales;

	•		penalties for network outages in our installed network base;

	•		product returns;

	•		diversion of development resources resulting in new product development delay;

	•		injury to our reputation; or

	•		increased service and warranty costs.

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Delays in meeting deadlines for announced product introductions, or enhancements or performance problems with such products, could undermine customer confidence in our products, which would harm our customer relationships.

Our agreements with our distributors, OEMs and direct customers typically contain provisions designed to limit our exposure to potential product liability claims. However, it is possible that the limitation of liability provisions contained in our agreements may not be effective or adequate under the laws of certain jurisdictions. It is also possible that our errors and omissions insurance may be inadequate to cover any potential product liability claim. Although we have not experienced any product liability claims to date, the sale and support of our products entails the risk of such claims, and it is possible that we will be subject to such claims in the future. Product liability claims brought against us could harm our business.

Difficulties in integrating past or future acquisitions could adversely affect our operating results and result in a decline in the price of our common stock.

We have spent and may continue to spend significant resources identifying businesses to be acquired by us. The efficient and effective integration of any businesses we acquire into our organization is critical to our growth. Acquisitions involve numerous risks including difficulties in integrating the operations, technologies and products of the acquired companies, the diversion of our management’s attention from other business concerns and the potential loss of key employees of the acquired companies. Failure to achieve the anticipated benefits of these and any future acquisitions or to successfully integrate the operations of the companies we acquire could also harm our business, results of operations and cash flows. Additionally, we cannot assure you that we will not incur material charges in future quarters to reflect additional costs associated with our future acquisitions.

If we have insufficient proprietary rights or if we fail to protect those rights we have, third parties could develop and market products that are equivalent to our own, which would harm our sales efforts and could result in a decrease in our net revenue and the price of our common stock.

We rely primarily on a combination of patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. As June 30, 2005, we held a total of 22 issued U.S. patents and had approximately 6 pending U.S. patent applications. We have one U.S. trademark application pending and have 15 registered trademarks. We cannot assure you that our pending patent or trademark applications will be granted or, if granted, will be sufficient to protect our rights. We have entered into confidentiality agreements with our employees and consultants, and non-disclosure agreements with our suppliers, customers, and distributors in order to limit access to and disclosure of our proprietary information. However, such measures may not be adequate to deter and prevent misappropriation of our technologies or independent third-party development of similar technologies. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy our products or obtain and use trade secrets or other information that we regard as proprietary. Furthermore, we may be subject to additional risks as we enter into transactions in foreign countries where intellectual property laws do not protect our proprietary rights as fully as the laws of the U.S. Based on the effort and cost associated with enforcing foreign intellectual property protections as compared with the comparative value of such protections, we suspended our activities related to obtaining international trademark and patent registrations in the first quarter of 2003. We cannot assure that our competitors will not independently develop similar or superior technologies or duplicate any technology that we have. Any such events could harm our ability to sell and market our products, which could result in a decrease in net revenue and the price of our common stock.

We may face intellectual property infringement claims that could result in significant expense to us, divert the efforts of our technical and management personnel, or cause product shipment delays.

The telecommunications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As the number of entrants in our markets increases and the functionality of our products is enhanced and overlaps with the products of other companies, we may become subject to claims of infringement or misappropriation of the intellectual property rights of others. From time to time, third parties may assert patent, copyright, trademark, and other intellectual property rights to technologies that are important to us. Any future third-party claims, whether or not such claims are determined adversely to us, could result in significant expense, divert the efforts of our technical and management personnel, or cause product shipment delays. In the event of an adverse ruling in any litigation, we might be required to discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology, or obtain licenses from third parties. In addition, any public announcements related to litigation or interference proceedings initiated or threatened against us, even if such claims are without merit, could cause our stock price to decline.

In our customer agreements, we agree to indemnify our customers for any expenses or liabilities resulting from claimed infringements of our product patents, trademarks, or copyrights of third parties. In certain limited instances, the amount of such indemnities may be greater than the net revenue we may have received from our customer.

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Increased sales volume in international markets could result in increased costs or loss of revenue due to factors inherent in these markets.

We are in the process of expanding into international markets, and we anticipate increased sales from these markets. A number of factors inherent to these markets expose us to significantly more risk than domestic business, including:

	•		local economic and market conditions;

	•		exposure to unknown customs and practices;

	•		legal regulations and requirements in foreign countries;

	•		potential political unrest;

	•		foreign exchange exposure;

	•		unexpected changes in or impositions of legislative or regulatory requirements;

	•		less regulation of patents or other safeguards of intellectual property; and

	•		difficulties in collecting receivables and inability to rely on local government aid to enforce standard business practices.

Any of these factors, or others, of which we are not currently aware, could result in increased operating costs or loss of net revenue.

A small number of shareholders can exert significant influence on the outcome of matters requiring the approval of a majority of the outstanding shares of our common stock.

As of June 30, 2005, our directors and executive officers, together with members of their families and entities that may be deemed affiliates of, or related to, such persons or entities, beneficially owned approximately 39% of our outstanding shares of common stock. In particular, Mr. Koenig, a director and our President and Chief Executive Officer, and Ms. Pierce, a director and our Secretary, former CFO and Corporate Development Officer, are married. As of June 30, 2005, Mr. Koenig and Ms. Pierce together beneficially owned approximately 38% of our outstanding shares of common stock. Accordingly, these two stockholders can exert significant influence over the election of members of our Board of Directors and the outcome of all corporate actions requiring stockholder approval of a majority of the voting power held by our stockholders, such as mergers and acquisitions. This level of ownership by such persons and entities may delay, defer, or prevent a change in control and may harm the voting and other rights of other holders of our common stock.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss that may impact the financial position, results of operations, or cash flows of the Company due to adverse changes in financial and commodity market prices and rates. Historically, and as of June 30, 2005, we have had little or no exposure to market risk in the area of changes in foreign currency exchange rates as measured against the United States dollar.

As part of our cash management strategy, at June 30, 2005, we had cash, cash equivalents and investments in marketable securities of approximately $101.6 million mainly in the form of bank demand deposits, money markets and government securities. We have completed a market risk sensitivity analysis of these cash and cash equivalents based on an assumed 100 basis point change in interest rates. A hypothetical increase or decrease in market rates of 100 basis points would increase or decrease interest income on an annualized basis by approximately $1.0 million.

ITEM 4. CONTROLS AND PROCEDURES

a) Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this Quarterly Report on Form 10-Q because we have not yet completed the remediation of the material weaknesses discussed in our Annual Report on Form 10-K/A for the year ended December 31, 2004 (“2004 Form 10-K/A”).

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(b) Changes in internal control over financial reporting. We made a number of changes in our internal control over financial reporting during and subsequent to the three months ended June 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, as discussed in Item 4(c) below.

(c) Remediation of weaknesses in internal control over financial reporting. As discussed in more detail in our 2004 Form 10-K/A, as of December 31, 2004, we did not maintain effective controls over (i) review of our consolidated statement of cash flows, (ii) evaluation of customer arrangements for the appropriate application of revenue recognition criteria, (iii) accounting for our inventory reserves and (iv) identification and accounting for complex transactions. During and subsequent to the three months ended June 30, 2005, we have implemented, or plan to implement, the specific measures described below to remediate the material weaknesses described above.

Statement of Cash Flows

We have required the Chief Financial Officer to monitor compliance with our established policy, which provides for a review of the statement of cash flows by a technically competent individual.

Revenue Recognition

We are in the process of establishing controls to remediate the material weakness in internal controls relating to accounting for revenue recognition. A review by a technically qualified person will be performed on all customer arrangements for the purpose of evaluating the appropriate application of the revenue recognition criteria as contemplated by generally accepted accounting principles in the U.S.

Inventory Reserves

We have designed an additional policy, which requires a review of reserve activity by a qualified individual.

Lack of Depth of Personnel with adequate Technical Knowledge

We are in the process of addressing the material weakness related to the lack of depth of personnel with sufficient technical accounting expertise. In this regard, in June 2005, the Company hired a new Chief Financial Officer and has established a formal process for the periodic technical training of the financial and sales personnel.

The aforementioned material weaknesses will not be considered remediated until new processes are fully implemented, operate for a period of time and are tested and we conclude that they are operating effectively. We are fully committed to remediating our material weaknesses in internal control over financial reporting, and we believe we are taking the appropriate steps to properly address these issues during 2005. However, the remediation of the design of the deficient controls and the associated testing efforts are not complete, and may require further remediation.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Beginning on June 3, 2005, three purported shareholder class action lawsuits were filed in the United States District Court for the District of Colorado against Carrier Access Corporation and certain of our officers and directors. The cases, captioned Croker v. Carrier Access Corporation, et al., Case No. 05-cv-1011-LTB; Chisman v. Carrier Access Corporation, et al., Case No. 05-cv-1078-REB, and Sved v. Carrier Access Corporation, et al, Case No. 05-cv-1280-EWN, have been consolidated and are purportedly brought on behalf of those who purchased our publicly traded securities between October 21, 2003 and May 20, 2005. Plaintiffs allege that defendants made false and misleading statements, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. The complaints are based upon allegations of wrongdoing in connection with our announcement of our intention to restate previously issued financial statements for the year ended December 31, 2004 and certain interim periods in each of the years ended December 31, 2004 and 2003.

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Management and Capital, LLC v. Koening [sic], et al. Case No. 05-cv-1134-RPM. These actions were consolidated on August 11, 2005. The complaints include claims for breach of fiduciary duty, abuse of control, waste of corporate assets, mismanagement and unjust enrichment; seek compensatory damages, disgorgement, and other relief; and are based on essentially the same allegations as the class actions described in the preceding paragraph.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the second quarter of 2005.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

	10.1		Offer Letter between the Company and Gary Gatchell dated June 8, 2005.

	31.1		Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).

	31.2		Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).

	32.1		Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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	Page No.
PART I FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)		3
Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004
Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004 (Restated)
Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the Six Months Ended June 30, 2005
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004 (Restated)
Notes to Condensed Consolidated Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14

Item 3. Quantitative and Qualitative Disclosures About Market Risk		34

Item 4. Controls and Procedures		34

PART II OTHER INFORMATION

Item 1. Legal Proceedings		35

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		36

Item 3. Defaults Upon Senior Securities		36

Item 4. Submission of Matters to a Vote of Security Holders		36

Item 5. Other Information		36

Item 6. Exhibits		36

SIGNATURES		37

Certification of the Chief Executive Officer
Certification of the Chief Financial Officer
Certifications of the CEO and CFO


	Three months			Six months
	ended			ended
	June 30,			June 30,
	2004			2004
Net income, as previously reported	$	3,556			6,260

Restatement adjustments:

Passage of title		(676	)		(687	)

Undelivered elements		(37	)		(60	)

Inventory valuation		31			219



Total restatement adjustments		(682	)		(528	)


Net income, as restated	$	2,874			5,732


	CARRIER ACCESS CORPORATION
	(Registrant)

	By:	/s/ Gary Gatchell

September 14, 2005		Gary Gatchell
		Executive Vice President and Chief Financial Officer
		(Principal Accounting Officer and Authorized Signatory)

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										Accumulated
					Additional					Other			Total
	Common Stock				Paid-in		Accumulated			Comprehensive			Stockholders’
	Shares		Amount		Capital		Deficit			Loss			Equity
BALANCES AT DECEMBER 31, 2004		34,479	$	34	$	188,147	$	(19,910	)	$	(130	)	$	168,141
Exercise of stock options		192		1		483		—			—			484
Stock-based compensation						47		—			—			47
Comprehensive loss:
Net change in unrealized loss on investments		—		—		—		—			(140	)		(140	)
Net loss		—		—		—		(6,458	)		—			(6,458	)


Total comprehensive loss														(6,598	)


BALANCES AT JUNE 30, 2005		34,671	$	35	$	188,677	$	(26,368	)	$	(270	)	$	162,074


Exhibit
Number		Description of Document
10.1		Offer Letter between the Company and Gary Gatchell dated June 8, 2005.

31.1*		Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).

31.2*		Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(c) and 15d-14(a).

32.1*		Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Filed herewith.