Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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** **

**FORM 10-Q**

 

**(Mark One)**

** **
| **x** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended September 30, 2008**

 

**Or**

** **
| **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: 001-33069**

** **

**OCCAM NETWORKS, INC.**

(Exact name of registrant as specified in itscharter)

** **

| **Delaware**                             | ** ** | **77-0442752**         |
|------------------------------------------|------------|------------------------|
| (State or other jurisdiction of          |       | (I.R.S. Employer       |
| incorporation or organization)           |       | Identification Number) |
| ** **                               | ** ** | ** **             |
| **6868 Cortona Drive**                   | ** ** | ** **             |
| **Santa Barbara, California**            | ** ** | **93117**              |
| (Address of principal executive offices) |       | (Zip Code))            |

 

Registrant’s telephone number, including area code: **(805) 692-2900**

** **

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes  x  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (check one).

 

|                                           | Large accelerated filer o |   | Accelerated filer x         |
|------------------------------------------------|---------------------------|--------|-----------------------------|
|                                           |                      |   |                        |
|                                           | Non-accelerated filer o   |   | Smaller reporting company o |
|                                           |                      |   |
| (Do not check if a smaller  reporting company) |                      |   |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o No x

 

Asof October 31, 2008, the number of shares outstanding of the registrant’scommon stock was 19,988,574 shares.

 

 

 

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**INDEX**

 
| ** **                             | ** **                                                                                  | **Page** |
|----------------------------------------|---------------------------------------------------------------------------------------------|----------|
|                                   |                                                                                        |     |
| PART I—FINANCIAL INFORMATION | 1                                                                                           |
|                                   |                                                                                        |     |
| Item 1.                                | Financial Statements                                                                        | 1        |
|                                   |                                                                                        |     |
| Item 2.                                | Management’s  Discussion And Analysis Of Financial Condition And Results Of Operations | 14       |
|                                   |                                                                                        |     |
| Item 3.                                | Quantitative  And Qualitative Disclosures About Market Risk                                 | 26       |
|                                   |                                                                                        |     |
| Item 4.                                | Controls And  Procedures                                                                    | 26       |
|                                   |                                                                                        |     |
| PART II—OTHER  INFORMATION   | 30                                                                                          |
|                                   |                                                                                        |     |
| Item 1.                                | Legal Proceedings                                                                           | 30       |
|                                   |                                                                                        |     |
| Item 1a.                               | Risk Factors                                                                                | 32       |
|                                   |                                                                                        |     |
| Item 2.                                | Unregistered  Sales Of Equity Securities And Use Of Proceeds                                | 50       |
|                                   |                                                                                        |     |
| Item 3.                                | Defaults Upon  Senior Securities                                                            | 50       |
|                                   |                                                                                        |     |
| Item 4.                                | Submission Of  Matters To A Vote Of Security Holders                                        | 50       |
|                                   |                                                                                        |     |
| Item 5.                                | Other Information                                                                           | 50       |
|                                   |                                                                                        |     |
| Item 6.                                | Exhibits                                                                                    | 50       |

 

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**PART I—FINANCIAL INFORMATION**

 

**ITEM 1.****        FINANCIALSTATEMENTS**

 

**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In thousands, except share data)**

 
| ** **                                                                                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2008**               | ** ** | **2007 (*)**     | ** ** |
| ** **                                                                                                                                                                                   | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                   |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                              |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                      | 21,882     |                  | $          | 37,637 |   |
| Restricted cash                                                                                                                                                                              |       | 16,909                 |       | 13,103                |       |
| Accounts receivable, net                                                                                                                                                                     |       | 17,104                 |       | 14,819                |       |
| Inventories                                                                                                                                                                                  |       | 18,965                 |       | 13,371                |       |
| Prepaid and other current assets                                                                                                                                                             |       | 3,215                  |       | 2,108                 |       |
| Total current assets                                                                                                                                                                         |       | 78,075                 |       | 81,038                |       |
| Property and equipment, net                                                                                                                                                                  |       | 11,035                 |       | 8,874                 |       |
| Intangibles, net                                                                                                                                                                             |       | 161                    |       | 890                   |       |
| Other assets                                                                                                                                                                                 |       | 89                     |       | 83                    |       |
| Total assets                                                                                                                                                                                 |       | $                      | 89,360     |                  | $          | 90,885 |   |
|                                                                                                                                                                                         |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                         |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                             |       | $                      | 9,879      |                  | $          | 10,135 |   |
| Accrued liabilities                                                                                                                                                                          |       | 7,128                  |       | 6,464                 |       |
| Deferred revenue                                                                                                                                                                             |       | 14,575                 |       | 12,420                |       |
| Deferred rent                                                                                                                                                                                |       | 403                    |       | 237                   |       |
| Capital lease obligations                                                                                                                                                                    |       | 23                     |       | 17                    |       |
| Total current liabilities                                                                                                                                                                    |       | 32,008                 |       | 29,273                |       |
| Deferred rent, net of current portion                                                                                                                                                        |       | 1,958                  |       | 1,299                 |       |
| Capital lease obligations, net of current  portion                                                                                                                                           |       | 50                     |       | 47                    |       |
| Total liabilities                                                                                                                                                                            |       | 34,016                 |       | 30,619                |       |
| Commitments and contingencies (note 6)                                                                                                                                                       |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                   |       |                   |       |                  |       |
| Common stock, $0.001 par value, 250,000,000  shares authorized; 19,988,574 and 19,773,730 shares issued and outstanding at  September 30, 2008 and December 31, 2007, respectively |       | 289                    |       | 289                   |       |
| Additional paid-in capital                                                                                                                                                                   |       | 182,391                |       | 179,455               |       |
| Warrants                                                                                                                                                                                     |       | 331                    |       | 331                   |       |
| Accumulated deficit                                                                                                                                                                          |       | (127,667               | )          | (119,809              | )          |
| Total stockholders’ equity                                                                                                                                                              |       | 55,344                 |       | 60,266                |       |
| Total liabilities and stockholders’ equity                                                                                                                                              |       | $                      | 89,360     |                  | $          | 90,885 |   |

 

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***    **Derived from audited consolidated financialstatements included in its Annual Report on Form 10-K.

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except per share data)**

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Revenue                                                       |       | $                                | 25,131     |                            | $          | 15,660 |   | $ | 67,610 |   | $ | 53,884 |   |
| Cost of revenue                                               |       | 14,380                           |       | 9,959                           |       | 38,331 |   | 34,054 |   |
| Gross margin                                                  |       | 10,751                           |       | 5,701                           |       | 29,279 |   | 19,830 |   |
| Operating expenses:                                           |       |                             |       |                            |       |   |   |   |   |
| Research and development                                      |       | 5,004                            |       | 3,245                           |       | 14,337 |   | 8,985 |   |
| Sales and marketing                                           |       | 4,677                            |       | 3,728                           |       | 14,760 |   | 10,779 |   |
| General and administrative                                    |       | 2,050                            |       | 4,218                           |       | 8,253 |   | 8,030 |   |
| Total operating expenses                                      |       | 11,731                           |       | 11,191                          |       | 37,350 |   | 27,794 |   |
| Loss from operations                                          |       | (980                             | )          | (5,490                          | )          | (8,071 | ) | (7,964 | ) |
| Other income (expense), net                                   |       | —                           |       | (200                            | )          | (702 | ) | (91 | ) |
| Interest income (expense), net                                |       | 250                              |       | 784                             |       | 885 |   | 2,232 |   |
| Loss before provision for (benefit from)  income taxes        |       | (730                             | )          | (4,906                          | )          | (7,888 | ) | (5,823 | ) |
| Provision for (benefit from) income taxes                     |       | (71                              | )          | —                          |       | (30 | ) | — |   |
| Net loss                                                      |       | $                                | (659       | )                               | $          | (4,906 | ) | $ | (7,858 | ) | $ | (5,823 | ) |
| Net loss per share attributable to common  stockholders:      |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                             |       | $                                | (0.03      | )                               | $          | (0.25 | ) | $ | (0.40 | ) | $ | (0.29 | ) |
| Weighted average shares attributable to  common stockholders: |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                             |       | 19,894                           |       | 19,765                          |       | 19,826 |   | 19,756 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,  2008**    | ** ** | **September 30,  2007** | ** ** |
| **Operating activities**                                                     |       |                            |       |   |   |
| Net loss                                                                     |       | $                               | (7,858     | ) | $ | (5,823 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                            |       |   |   |
| Stock-based compensation                                                     |       | 2,348                           |       | 1,565 |   |
| Depreciation and amortization                                                |       | 2,354                           |       | 1,186 |   |
| Impairment of intangibles                                                    |       | 981                             |       | — |   |
| Accounts receivable reserves                                                 |       | (110                            | )          | — |   |
| Inventory reserves                                                           |       | (3                              | )          | 645 |   |
| Loss from disposal of property and  equipment                                |       | 26                              |       | — |   |
| Changes in operating assets and  liabilities:                                |       |                            |       |   |   |
| Accounts receivable                                                          |       | (2,176                          | )          | (3,155 | ) |
| Inventories                                                                  |       | (5,785                          | )          | (1,080 | ) |
| Prepaid and other current assets                                             |       | (1,113                          | )          | (3,434 | ) |
| Accounts payable and accrued liabilities                                     |       | 1,233                           |       | 6,709 |   |
| Deferred revenue                                                             |       | 2,155                           |       | 1,259 |   |
| Net cash used in operating activities                                        |       | (7,948                          | )          | (2,128 | ) |
| **Investing activities**                                                     |       |                            |       |   |   |
| Increase in restricted cash                                                  |       | (3,806                          | )          | (4,630 | ) |
| Net purchases of property and equipment                                      |       | (4,438                          | )          | (7,988 | ) |
| Purchase of intangibles                                                      |       | (160                            | )          | — |   |
| Purchase of investments                                                      |       | —                          |       | (1,575 | ) |
| Net cash used in investing activities                                        |       | (8,404                          | )          | (14,193 | ) |
| **Financing activities**                                                     |       |                            |       |   |   |
| Exercise of stock options                                                    |       | 69                              |       | 194 |   |
| Payments of payroll taxes for vested  restricted stock units                 |       | (68                             | )          | — |   |
| Capital lease obligations                                                    |       | 9                               |       | — |   |
| Proceeds from employee stock purchase plan                                   |       | 587                             |       | 245 |   |
| Common stock issuance cost                                                   |       | —                          |       | (75 | ) |
| Net cash provided by financing activities                                    |       | 597                             |       | 364 |   |
| Net decrease in cash and cash equivalents                                    |       | (15,755                         | )          | (15,957 | ) |
| Cash and cash equivalents, beginning of  period                              |       | 37,637                          |       | 59,219 |   |
| Cash and cash equivalents, end of period                                     |       | $                               | 21,882     |   | $ | 43,262 |   |
| **Supplemental disclosure of cash flow  information:**                       |       |                            |       |   |   |
| Interest paid                                                                |       | $                               | 35         |   | $ | 3 |   |
| Income taxes paid                                                            |       | $                               | 40         |   | $ | 190 |   |
|                                                                              |            |                                 |            |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.****   ****Business and Basis ofPresentation**

** **

Occam Networks, Inc. (“Occam,”the “Company,” “we” or “us”) develops markets and supports innovative broadbandaccess products designed to enable telecom service providers to offer bundledvoice, video and high speed internet, or Triple Play, services over both copperand Gigabit Point-to-point fiber optic networks.  The Company’s Broadband Loop Carrier (BLC) isan integrated hardware and software platform that uses Internet Protocol (IP)and Ethernet technologies to increase the capacity of local access networks,enabling the delivery of advanced Triple Play services.

 

*Basis ofPresentation*

* *

The accompanying condensedconsolidated financial statements are unaudited.  The condensed consolidated balance sheet at December 31,2007 is derived from Occam’s audited consolidated financial statements includedin its Annual Report on Form 10-K for the year ended December 31,2007.  These unaudited condensedconsolidated financial statements reflect all material adjustments, consistingonly of normal recurring adjustments, which, in the opinion of management, arenecessary to fairly state our financial position, results of operations andcash flows for the interim periods.  Theresults of operations for the current interim periods are not necessarilyindicative of results to be expected for the entire year.

 

The unaudited condensedconsolidated financial statements include management’s estimates and assumptionsthat affect the reported amounts of assets and liabilities as of the date ofthe consolidated financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from those estimates, and material effectson consolidated operating results and consolidated financial position mayresult.

 

The unaudited interimcondensed financial statements have been prepared in accordance with accountingprinciples generally accepted in the United States (“GAAP”) for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly,they do not include all of the information and notes required by GAAP forannual financial statements.  In theopinion of management, all adjustments consisting of normal and recurringentries considered necessary for a fair statement of the results for theinterim periods have been included in the Company’s financial position as of September 30,2008, the results of its operations for the three months and nine months ended September 30,2008 and 2007, and its cash flow for the nine months ended September 30,2008 and 2007.  The December 2007condensed consolidated balance sheet data was derived from audited consolidatedfinancial statements included in the Company’s 2007 Annual Report on Form 10-Kbut does not include all disclosures required by GAAP.

 

Effective January 1,2007, Occam adopted a fiscal reporting schedule based on calendar quarter andyear end.

 

Certain reclassificationshave been made to our prior year balances in order to conform to the currentperiod presentation.

 

*Use ofEstimates*

* *

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the

 

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amounts reported in theconsolidated financial statements and the accompanying notes.  Actual results could differ from thoseestimates and such differences may be material to the consolidated financialstatements.

 

*RevenueRecognition*

* *

Occam recognizes revenuewhen persuasive evidence of sales arrangements exist, delivery has occurred orservices have been rendered, the buyer’s price is fixed or determinable andcollection is reasonably assured.  Weallow credit for products returned within our policy terms.

 

In addition to theaforementioned general policy, we enter into transactions that representmultiple-element arrangements, which may include training and post-salestechnical support and maintenance to our customers as needed to assist them ininstallation or use of our products, and make provisions for these costs in theperiods of sale.  Multiple-elementarrangements are assessed to determine whether they can be separated into morethan one unit of accounting.  A multiple-elementarrangement is separated into more than one unit of accounting if all of thefollowing criteria are met:

 

·**     **the delivered item(s) has value to the customer on a stand-alonebasis;

 

·**     **there is objective and reliable evidence of the fair value of theundelivered item(s); and

 

·**     **the arrangement includes a general right of return relative to thedelivered item(s) and delivery or performance of the undelivered item(s) isconsidered probable and substantially in our control.

 

If these criteria are notmet, then revenue is deferred until such criteria are met or until the period(s) overwhich the last undelivered element is delivered.  If there is objective and reliable evidenceof fair value for all units of accounting in an arrangement, the arrangementconsideration is allocated to the separate units of accounting based on eachunit’s relative fair value.

 

In certain circumstances,the Company enters into arrangements with customers who receive financingsupport in the form of long-term low interest rate loans from the United StatesDepartment of Agriculture’s Rural Utilities Service, or RUS.  The terms of certain RUS contracts providethat transfer of title of the Company’s products does not occur until customeracceptance. The Company classifies the deferred revenue associated with thesecontracts as an offset to accounts receivable until payment is received. Thenthe Company reclassifies the amount to the liability account for deferredrevenue. As of September 30, 2008 and December 31, 2007, the Companyhad $6.5 million and $5.6 million, respectively, offset against accounts receivable.****The Company does not recognize revenueuntil all of the contract payments have been received, assuming the remainingrevenue recognition criteria are met.

 

In certain circumstances,the Company enters into transactions with value-added resellers where theresellers may not have the ability to pay for these sales independent ofpayment to them by the end-user.  Inthese cases, the Company does not recognize revenue until payment has beenreceived, provided the remaining revenue recognition criteria are met.

 

We warrant our products forperiods up to five years and record an estimated warranty accrual when shipped.

 

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**2.****   ****Fair Value Measurements**

** **

Effective January 1,2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS157”), except as it applies to the nonfinancial assets and nonfinancialliabilities subject to Financial Staff Position SFAS 157-2.  SFAS 157 clarifies that fair value is an exitprice, representing the amount that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participants.  As such, fair value is a market-based measurementthat should be determined based on assumptions that market participants woulduse in pricing an asset or a liability. As a basis for considering such assumptions, SFAS 157 establishes athree-tier value hierarchy, which prioritizes the inputs used in the valuationmethodologies in measuring fair value:

 

Level 1 - Observable inputsthat reflect quoted prices (unadjusted) for identical assets or liabilities inactive markets.

 

Level 2 - Include otherinputs that are directly or indirectly observable in the marketplace.

 

Level 3 - Unobservableinputs which are supported by little or no market activity.

 

The fair value hierarchyalso requires an entity to maximize the use of observable inputs and minimizethe use of unobservable inputs when measuring fair value.

 

In accordance with SFAS 157,we measure our cash equivalents at fair value. Our cash equivalents are classified within Level 1.  Cash equivalents are valued primarily usingquoted market prices utilizing market observable inputs.  At September 30, 2008, cash equivalentsconsisted of money market funds measured at fair value on a recurringbasis.  Fair value of our money marketfunds was $20.6 million at September 30, 2008.

 

**3.****   ****Inventories**

** **

Inventories consist of thefollowing (in thousands):

 
| ** **         | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials      |       | $                            | 186        |                        | $          | 1,078 |   |
| Work-in-process    |       | 6                            |       | 14                          |       |
| Finished goods (1) |       | 18,773                       |       | 12,279                      |       |
|               |       | $                            | 18,965     |                        | $          | 13,371 |   |

 

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(1)**  **$10.1 million and $8.8 million of finished goods inventory were shippedto customers as of September 30, 2008 and December 31, 2007,respectively.  The majority were sent toRUS contract customers and value-added resellers.  Revenue and related Cost of revenue were notrecognized at the time of shipments as defined by the Company’s revenue recognitionpolicy and therefore were included in inventories.  For more information regarding our revenuerecognition policy, see Revenue Recognition under Note 1 to theseunaudited condensed consolidated financial statements.

 

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**4.****   ****Intangibles, net**

 

In October 2007, wepurchased certain assets from Terawave Communications, Inc., including abroadband passive optical network (BPON) asset purchase that addressedMetro-Ethernet/Telemetry applications. We intended to sell this line of business and recorded an intangibleasset of approximately $0.8 million as of the asset acquisition date.  During the period ended March 31, 2008,we were unable to secure a feasible offer and therefore decided to terminatethe sales efforts and instead focus on bringing new Gigabyte Passive OpticalNetwork (“GPON”) technology to market. As a result of this decision, we wrote-off both the intangible asset andthe related inventory.

 

In June 2008, wedetermined the intangible for customer relationships to be fully impaired andwrote-off the remaining unamortized balance of approximately $37,000.  Valuation for the intangible was based onestimated Broadband Passive Optical Network (“BPON”) revenues through 2009 fromcertain customers of Terawave Communications, Inc.  With final shipments of our last-time-buypromotion of BPON products to former Terawave customers during the period endedJune 30, 2008, these customer relationships ceased to have future valuefor the Company.

 

**5.****   ****Net Loss Per Share**

** **

The following table setsforth the computation of basic net loss per share (in thousands, except pershare data):

 
| ** **                                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                  | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
| Net loss attributable to common  stockholders                                               |       | $                                | (659       | )                               | $          | (4,906 | ) | $ | (7,858 | ) | $ | (5,823 | ) |
| **Shares used in computation:**                                                             | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average common shares outstanding  used in computation of basic net loss per share |       | 19,894                           |       | 19,765                          |       | 19,826 |   | 19,756 |   |
| Dilutive effect of stock options                                                            |       | —                           |       | —                          |       | — |   | — |   |
| Dilutive effect of common stock warrants                                                    |       | —                           |       | —                          |       | — |   | — |   |
| Shares used in computation of diluted net  loss per share                                   |       | 19,894                           |       | 19,765                          |       | 19,826 |   | 19,756 |   |
| Basic and diluted net loss per share                                                        |       | $                                | (0.03      | )                               | $          | (0.25 | ) | $ | (0.40 | ) | $ | (0.29 | ) |

 

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**6.****   ****Commitments and Contingencies**

** **

The Company leases itsoffice facilities and certain equipment under non-cancelable operating leaseagreements, which expire at various dates through 2015.  Operating leases contain escalation clauseswith annual base rent adjustments or a cost of living adjustment.  Total rent expense was $0.3 million and $0.1million for the three months ended September 30, 2008 and 2007 respectively,and $1.0 million and $0.8 million, for the nine months ended September 30, 2008and 2007 respectively.  Minimum annuallease commitments under non-cancelable operating leases are as follows (inthousands):

 
| **September 30,**       | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|
| 2008 (remaining)             |       | $          | 349        |   |
| 2009                         |       | 1,398      |       |
| 2010                         |       | 1,433      |       |
| 2011                         |       | 1,469      |       |
| 2012                         |       | 1,505      |       |
| Thereafter                   |       | 2,510      |       |
| Total Minimum Lease Payments |       | $          | 8,664      |   |

 

Royalties

 

From time to time, theCompany may license certain technology for incorporation into itsproducts.  Under the terms of thesemulti-year agreements, royalty payments will be made based on per-unit sales ofcertain of the Company’s products.  TheCompany incurred royalty expense of $95,000 and $27,000 for the three monthsended September 30, 2008 and 2007 respectively and $241,000 and $98,000 for thenine months ended September 30, 2008 and 2007, respectively.

 

Legal Proceedings

 

2007 Class ActionLitigation

 

On April 26, 2007 and May 16,2007, two putative class action complaints were filed in the United StatesDistrict Court for the Central District of California against Occam and certainof its officers.  The complaints allegethat the defendants violated sections 10(b) and 20(a) of theSecurities Exchange Act of 1934, or the Exchange Act, and SEC Rule 10b-5promulgated thereunder by making false and misleading statements and omissionsrelating to our financial statements and internal controls with respect torevenue recognition.  The complaintsseek, on behalf of persons who purchased our common stock during the periodfrom May 2, 2006 and April 17, 2007, damages of an unspecifiedamount.

 

On July 30, 2007, JudgeChristina A. Snyder consolidated these actions into a single action, appointedNECA-IBEW Pension Fund (The Decatur Plan) as lead plaintiff, and approved itsselection of lead counsel.  On November 16,2007, the lead plaintiff filed a consolidated complaint.  This consolidated complaint added asdefendants certain of Occam’s current and former directors and officers, itscurrent and former outside auditors, the lead underwriter of its secondarypublic offering in November 2006, and two venture capital firms who were earlyinvestors in Occam.  The consolidatedcomplaint alleged that defendants violated sections 10(b), 20(a) and 20Aof the Exchange Act and SEC Rule 10b-5 promulgated thereunder, as well assections 11 and 15 of the Securities Act of 1933, or Securities Act, by makingfalse and misleading statements and omissions relating to our financialstatements and internal controls with respect to revenue recognition thatrequired restatement.  The consolidatedcomplaint seeks, on behalf of persons who purchased

 

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Occam’s common stock duringthe period from April 29, 2004 to October 15, 2007, damages of anunspecified amount.

 

On January 25, 2008,defendants filed motions to dismiss the consolidated complaint.  On July 1, 2008, Judge Snyder issued anorder granting in part and denying in part defendants’ motions.  This order dismissed all claims againstcertain of our current and former directors, the 20A claim in its entirety, thesection 10(b) claim against the auditors and venture capital firms, andthe section 11 claims against the venture capital firms.  On July 16, 2008, lead plaintiff filedan amended complaint to conform to the Court’s July 1, 2008 order.  Defendants answered this amended complaint onAugust 29, 2008. A scheduling conference has been set by the Court for November 17,2008.

 

Occam believes that it hasmeritorious defenses in this action, and intends to defend itselfvigorously.  Failure by Occam to obtain afavorable resolution of the claims set forth in the consolidated complaintcould have a material adverse effect on its business, results of operations andfinancial condition.  Currently, theamount of such material adverse effect cannot be reasonably estimated.

 

*IPOAllocation Litigation*

* *

In June 2001, threeputative stockholder class action lawsuits were filed against AcceleratedNetworks, certain of its then officers and directors and several investment banksthat were underwriters of Accelerated Networks’ initial public offering.  The cases, which have since beenconsolidated, were filed in the United States District Court for the SouthernDistrict of New York.  The Court appointeda lead plaintiff on April 16, 2002, and plaintiffs filed a ConsolidatedAmended Class Action Complaint (the “Complaint”) on April 19,2002.  The Complaint was filed on behalfof investors who purchased Accelerated Networks’ stock between June 22,2000 and December 6, 2000 and alleged violations of Sections 11 and 15 ofthe 1933 Act and Sections 10(b) and 20(a) and Rule 10b-5 of the1934 Act against one or both of Accelerated Networks and the individualdefendants.  The claims were based onallegations that the underwriter defendants agreed to allocate stock inAccelerated Networks’ initial public offering to certain investors in exchangefor excessive and undisclosed commissions and agreements by those investors tomake additional purchases in the aftermarket at pre-determined prices.  Plaintiffs alleged that the prospectus forAccelerated Networks’ initial public offering was false and misleading inviolation of the securities laws because it did not disclose thesearrangements.  These lawsuits are part ofthe massive “IPO allocation” litigation involving the conduct of underwritersin allocating shares of successful initial public offerings.  We believe that over three hundred othercompanies have been named in more than one thousand similar lawsuits that havebeen filed by some of the same plaintiffs’ law firms.  In October 2002, the plaintiffsvoluntarily dismissed the individual defendants without prejudice.  On February 1, 2003 a motion to dismissfiled by the issuer defendants was heard and the court dismissed the 10(b), 20(a) andrule 10b-5 claims against Occam. On October 13, 2004, the Courtcertified a class in six of the approximately 300 other nearly identicalactions (the “focus” cases) and noted that the decision was intended to provideguidance to all parties regarding class certification in the remaining cases.The Underwriter Defendants appealed the decision and the Second Circuit Courtof Appeals vacated the district court’s decision granting class certificationin those six cases on December 5, 2006. Plaintiffs filed a motion for rehearing. On April 6, 2007, the Second Circuit denied the petition, but notedthat Plaintiffs could ask the District Court to certify a more narrow classthan the one that was rejected. On October 3, 2007 Plaintiff has filed amotion to certify a new class and a second amended complaint based on theSecond Circuit Appeals Court decision. An opposition brief was filed by bothUnderwriter Defendants and the Issuer Defendants on December 21, 2007 anda reply brief was filed on January 28, 2008. On March 28, 2008, theplaintiffs filed an amended reply brief in support of their motion to certifythe class of plaintiffs. The Underwriter Defendants and the issuer Defendantshad until August 31, 2008 to file an answer to the amended complaint. The Courthas not ruled on the motion. The insurers, the underwriters and the Plaintiff’ssubsequently agreed to global mediation in the interest of trying to resolvethis case without

 

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the further need forlitigation. The mediation commenced in late June and is ongoing andsettlement talks are in process.

 

Prior to the Second Circuit’sDecember 5, 2006 ruling, we agreed, together with over three hundred othercompanies similarly situated, to settle with the Plaintiffs. A settlementagreement and related agreements were submitted to the Court for approval.  The settlement would have provided, amongother things, a release of the Company and of the individual defendants for theconduct alleged to be wrongful in the Complaint in exchange for a guaranteefrom the Company’s insurers regarding recovery from the underwriter defendantsand other consideration from the Company regarding its underwriters.  In light of the Second Circuit opinion,liaison counsel for the issuers informed the District Court that the settlementcannot be approved because the defined settlement class, like the litigationclass, cannot be certified.  We cannotpredict whether we will be able to renegotiate a settlement that complies withthe Second Circuit’s mandate.

 

Due to the inherentuncertainties of litigation, we cannot accurately predict the ultimate outcomeof the matter. We have not recorded any accrual related to this proposedsettlement because Occam expects any settlement amounts to be covered by itsinsurance policies.

 

*ThreatenedLitigation*

* *

In late 2007, Occam receiveda letter from Vanessa Simmonds, a putative shareholder of the Company, demandingthat Occam investigate and prosecute a claim for alleged short-swing trading inviolation of Section 16(b) of the Securities Exchange Act of 1934, 15U.S.C. § 78p(b), by the underwriter of its initial public offering (“IPO”) andcertain unidentified directors, officers and shareholders of Occam (then knownas Accelerated Networks).  Occamevaluated the demand and declined to prosecute the claim.  On October 12, 2007, the putativeshareholder commenced a civil lawsuit in the U.S. District Court for theWestern District of Washington against Credit Suisse Group, the leadunderwriter of Occam’s IPO, alleging violations of Section 16(b).  The complaint alleges that the combinednumber of shares of Occam’s common stock beneficially owned by the lead underwriterand certain unnamed officers, directors, and principal shareholders exceededten percent of its outstanding common stock from the date of Occam’s IPO on June 23,2000, through at least June 22, 2001. It further alleges that those entities and individuals were thus subjectto the reporting requirements of Section 16(a) and the short-swingtrading prohibition of Section 16(b), and failed to comply with thoseprovisions.  The complaint seeks torecover from the lead underwriter any “short-swing profits” obtained by it inviolation of Section 16(b).  Occamwas named as a nominal defendant in the action, but has no liability for theasserted claims.  No directors orofficers of Occam are named as defendants in this action.

 

On October 29, 2007,the case was reassigned to Judge James L. Robart along with fifty-four other Section 16(b) casesseeking recovery of short-swing profits from underwriters in connection withvarious IPOs. The Underwriters and Issuers have filed a motion to dismiss thecase and reply briefs have been filed. Oral argument has been requested and hasbeen set for January 19, 2009. It is anticipated that it will be three tofour months before the Court will rule on the motion after completion oforal argument.

 

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Due to the inherentuncertainties of threatened litigation, we cannot accurately predict theultimate outcome of the matter, but we believe that the outcome of thislitigation will not have a material adverse impact on our consolidatedfinancial position and results of operations. We have not recorded any accruals related to the demand letters or Section 16(b) litigationbecause we expect any resulting resolution to be covered by our insurancepolicies.

 

*OtherMatters*

* *

From time to time, theCompany is subject to threats of litigation or actual litigation in theordinary course of business, some of which may be material.  The Company believes that there are nocurrently pending matters that, if determined adversely to the Company, wouldhave a material effect on its business or that would not be covered by itsexisting liability insurance.

* *

*Indemnificationsand Guarantees*

* *

The Company enters intoindemnification provisions under its agreements with other companies in theordinary course of business, typically with its contractors, customers,value-added resellers, and landlords.  Inconnection with its 2006 offering, the Company also agreed to indemnify theunderwriters in the offering and certain stockholders who sold shares as partof the offering with respect to certain liabilities arising from theoffering.  Under these provisions, theCompany generally indemnifies and hold harmless the indemnified party forlosses suffered or incurred by the indemnified party as a result of itsactivities or, in some cases, as a result of the indemnified party’s activitiesunder the agreement.  Theseindemnification provisions generally survive termination of the underlyingagreement.  The maximum potential amountof future payments the Company could be required to make under theseindemnification provisions is generally unlimited.  As of September 30, 2008, the Companyhad not incurred material costs to defend lawsuits or settle claims related tothese indemnification agreements **.**Duringthe quarter indemnification requests were received by the Company.

 

*PurchaseOrders*

* *

Under the terms of Occam’scontract manufacturer agreements, Occam is required to place orders with itscontract manufacturers to provide inventory to meet its estimated salesdemand.  Certain contract manufactureragreements include production forecast change, lead-time and cancellationprovisions.  At September 30, 2008,open purchase orders with contract manufacturers were $13.0 million.

 

*Warranties*

* *

Occam provides standardwarranties with the sale of products for up to five years from date ofshipment.  The estimated cost ofproviding the product warranty is recorded at the time of shipment.  Occam maintains product quality programs andprocesses including actively monitoring and evaluating the quality of itssuppliers.  Occam quantifies and recordsan estimate for warranty related costs based on Occam’s actual

 

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history, projected returnand failure rates and current repair and replacement costs.  The following table summarizes changes inOccam’s accrued warranty liability that is included in accrued liabilities (inthousands):

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
| Balance at beginning of period |       | $                                | 3,710      |                            | $          | 2,772 |   | $ | 3,470 |   | $ | 1,862 |   |
| Warranty accruals              |       | 625                              |       | 837                             |       | 1,576 |   | 2,658 |   |
| Warranty settlements           |       | (459                             | )          | (612                            | )          | (1,170 | ) | (1,523 | ) |
| Balance at end of period       |       | $                                | 3,876      |                            | $          | 2,997 |   | $ | 3,876 |   | $ | 2,997 |   |

** **

**7.****   ****Accrued Liabilities**

 

The major components ofaccrued liabilities are (in thousands):

 
| ** **                                  | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Warranty accruals                           |       | $                            | 3,876      |                        | $          | 3,470 |   |
| Payroll, paid time off and related accruals |       | 1,940                        |       | 1,032                       |       |
| Commissions                                 |       | 173                          |       | 250                         |       |
| Royalty accruals                            |       | 471                          |       | 368                         |       |
| Other accruals                              |       | 668                          |       | 1,344                       |       |
| Total                                       |       | $                            | 7,128      |                        | $          | 6,464 |   |

 

**8.****   ****Stock Options, Stock Awards, Employee Stock Purchase Plan,and Share-Based Compensation**

** **

Stock option activity, underthe Company’s stock option plan for the nine months ended September 30,2008 is summarized as below (in thousands):

 
| ** **                             | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2008    |       | 3,014      |       | $                                           | 7.17       |                                                 | 7.99       |                            | $          | 184 |   |
| Granted                                |       | 274        |       | $                                           | 4.25       |                                                 |       |                            |       |   |
| Exercised                              |       | (20        | )          | $                                           | 3.54       |                                                 |       |                            |       |   |
| Forfeited or expired                   |       | (262       | )          | $                                           | 9.23       |                                                 |       |                            |       |   |
| Outstanding at September 30, 2008 |       | 3,006      |       | $                                           | 6.75       |                                                 | 7.39       |                            | $          | 727 |   |
| Exercisable at September 30, 2008 |       | 1,494      |       | $                                           | 7.73       |                                                 | 5.79       |                            | $          | 173 |   |
|                                        |            |            |            |                                             |            |                                                      |            |                                 |            |  |  |  |

 

Weighted-average fair valuefor options granted during the nine months ended September 30, 2008 was$2.24 per share.

 

During the nine months endedSeptember 30, 2008, the Company reserved an additional 593,212 shares ofthe Company’s common stock for issuance pursuant to the 2006 Equity IncentivePlan.  The 2006 Equity Incentive Planprovides for annual increases in the number of shares available for issuancethereunder on the first day of each fiscal year, beginning with fiscal 2007,equal to the lesser of :

 

·**                 **3.0% of the outstanding shares of the Company’scommon stock on the first day of the fiscal year;

 

·**                 **750,000 shares; or

 

·**                 **such other amount as the Company’s board ofdirectors or a committee thereof may determine.

 

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***Stock Awards***

*** ***

A summary of the Company’srestricted stock unit activities is as follows (in thousands):

 
| ** **                             | ** ** | **Shares** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2008    |       | 390        |       | 1.95                                                 |       | $                               | 1,390      |   |
| Awarded                                |       | 35         |       |                                                 |       |                            |       |
| Released                               |       | (41        | )          |                                                 |       |                            |       |
| Forfeited or expired                   |       | (21        | )          |                                                 |       |                            |       |
| Outstanding at September 30, 2008 |       | 363        |       | 1.39                                                 |       | $                               | 972        |   |
|                                        |            |            |            |                                                      |            |                                 |            |  |  |

*** ***

***Employee Stock Purchase Plan***

*** ***

In March 2008, theBoard of Directors approved an amendment to the 2006 Employee Stock PurchasePlan (the “ESPP”).  The amendmentincreased the maximum number of shares of the Company’s common stock that aneligible employee may purchase during each offering period from 1,000 shares to5,000 shares.  Employee participation inthe plan resumed in November 2007 and the next issuance of shares underthe plan is scheduled for February 2009. In connection with the ESPP, on August 15, 2008, 58,685 and 111,426shares were issued at a purchase price per share of $2.86 and $3.77,respectively.

 

***Stock-Based Compensation***

*** ***

The following tablesummarizes the impact of SFAS 123(R) for all share-based awards toemployees and directors, including employee stock options, restricted stockunits and employee stock purchase right based on the estimated fair value onour Consolidated Statements of Operations for the three and nine months ended September 30,2008 and 2007 (in thousands):

 
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
| **Employee stock-based compensation in:**                              |       |                             |       |                            |       |   |   |   |   |
| Cost of revenue                                                        |       | $                                | 72         |                            | $          | 71 |   | $ | 290 |   | $ | 194 |   |
| Research and product development expense                               |       | 243                              |       | 164                             |       | 868 |   | 542 |   |
| Sales and marketing expense                                            |       | 149                              |       | 144                             |       | 557 |   | 422 |   |
| General and administrative expense                                     |       | 164                              |       | 110                             |       | 633 |   | 407 |   |
| Total SFAS 123(R) stock-based  compensation in operating expenses |       | 556                              |       | 418                             |       | 2,058 |   | 1,371 |   |
| Total SFAS 123(R) stock-based  compensation                       |       | $                                | 628        |                            | $          | 489 |   | $ | 2,348 |   | $ | 1,565 |   |

 

As of September 30,2008, total unamortized stock-based compensation cost related to non-vestedstock options after accounting for estimated forfeitures was $4.4 million,which the Company expects to recognize over the remaining vesting period ofeach grant, up to the next 48 months.

 

Upon adoption of SFAS123(R), we selected the Black-Scholes option pricing model as the mostappropriate model for determining the estimated fair value for stock-basedawards.  The use of the Black-Scholes

 

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model requires the use ofextensive actual employee exercise behavior data and the use of a number ofcomplex assumptions including expected volatility, risk-free interest rate,forfeitures, and expected dividends.  Theassumptions used to value options granted are as follows:

 
| ** **              | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **September 30,  2008**    | ** ** | **September 30,  2007** | ** ** |
| Risk-free interest rate |       | 3.2                             | %          | 4.0 | % |
| Expected term (years)   |       | 4.9                             |       | 4.9 |   |
| Dividend yield          |       | 0                               | %          | 0 | % |
| Expected volatility     |       | 59                              | %          | 51 | % |

 

The risk-free interest rateis based on the U.S. Treasury yield curve in effect at the time of grant.  We do not anticipate declaring dividends inthe foreseeable future.  Expectedvolatility is based on the annualized weekly historical volatility of our stockprice and we believe it is indicative of future volatility.  We estimate the expected life of optionsgranted based on historical exercise and post-vesting cancellation patternswith consideration of our industry peers of similar size with similar optionvesting periods.  Our analysis of stockprice volatility and option lives involves management’s best estimates at thetime of determination.  SFAS 123(R) alsorequires that we recognize compensation expense for only the portion of optionsor stock units that are expected to vest. Therefore, we apply an estimated forfeiture rate that is derived fromhistorical employee termination behavior. If the actual number of forfeitures differs from those estimated bymanagement, additional adjustments to compensation expense may be required infuture periods.

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

** **

You should read thefollowing discussion and analysis in conjunction with our condensedconsolidated financial statements and the related notes thereto included inthis Report on Form 10-Q and with Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contained in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2007.  The discussion in this Report contains bothhistorical information and forward-looking statements.  A number of factors affect our operatingresults and could cause our actual future results to differ materially from anyforward-looking results discussed below. In some cases, you can identify forward-looking statements byterminology such as “anticipates,” “appears,” “believes,” “continue,” “could,” “estimates,”“expects,” “feels,” “goal,” “hope,” “intends,” “may,” “our future successdepends,” “plans,” “potential,” “predicts,” “projects,” “reasonably,” “seek tocontinue,” “should,” “thinks,” “will” or the negative of these terms or othercomparable terminology.  These statementsare only predictions.  Actual events orresults may differ materially.  Inaddition, historical information should not be considered an indicator offuture performance.  Factors that couldcause or contribute to these differences include, but are not limited to, therisks discussed in this Report in Part II, Item 1A under the caption “RiskFactors.”  These factors may cause ouractual results to differ materially from any forward-looking statements.

 

Although we believe that theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements.  Moreover, we are under noduty to update any of the forward-looking statements after the date of thisReport on Form 10-Q to conform these statements to actual results.  These forward-looking statements are made inreliance upon the safe harbor provision of The Private Securities LitigationReform Act of 1995.

 

**Overview**

** **

We develop, market andsupport innovative broadband access products designed to enable telecom serviceproviders to offer bundled voice, video and high speed internet, or TriplePlay, services over both

 

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copper and GigabitPoint-to-point fiber optic networks.  OurBroadband Loop Carrier, or BLC, is an integrated hardware and software platformthat uses Internet Protocol, or IP, and Ethernet technologies to increase thecapacity of local access networks, enabling our customers to deliver advancedservices, including voice-over-IP, or VoIP, IP-based television, or IPTV,video-on-demand, or VoD, and high-definition television, or HDTV.  Our platform simultaneously supports traditionalvoice and data services, enabling our customers to leverage their existingnetworks and migrate to IP without disruption. In addition to providing our customers with increased bandwidth, ourproducts provide incremental value by offering software-based features toimprove the quality, resiliency and security of network service offerings.  We market our products through a combinationof direct and indirect channels.  Our directsales efforts are focused on the incumbent local exchange providers, or ILECs,segment of the telecom service provider market. As of September 30, 2008, we had shipped our BLC platform to over300 service provider customers.

 

From our inception through September 30,2008, we have incurred cumulative net losses of approximately $127.7million.  We realized income fromoperations and were profitable on a net income basis during the quarters ended September 24,2006 and December 31, 2006 and for the year ended December 31,2006.  Previously, we had not beenprofitable on a quarterly or annual basis, excluding the quarter ended December 25,2005, in which we realized modest operating income of $3,000.  We experienced operating and net losses inthe second, third and fourth quarters of fiscal 2007 and for fiscal 2007 as awhole.

 

**CriticalAccounting Policies and Estimates**

** **

Management’s Discussion andAnalysis of Financial Condition and Results of Operations discusses ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America.  The preparation of these consolidatedfinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the consolidated financial statements andthe reported amounts of revenue and expenses during the reporting period.  On an ongoing basis, we evaluate ourestimates and judgments, including those related to revenue recognition,accounts receivable, inventories, litigation, warranty reserve, stock-basedcompensation, and valuation of deferred income tax assets.  We base our estimates and judgments onhistorical experience and on various other factors that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources.

 

We included in our AnnualReport on Form 10-K for the year ended December 31, 2007 a discussionof our most critical accounting policies, which are those that are mostimportant to the portrayal of our financial condition and results of operationsand require management’s most difficult, subjective and complex judgments,often as a result of the need to make estimates about the effect of mattersthat are inherently uncertain.  We didnot make changes to such critical accounting policies during the nine monthsended September 30, 2008.

 

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**Results ofOperations**

** **

*Three-monthsended September 30, 2008 and 2007*

* *

*Revenue*

 
| ** ** | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Revenue    |       | $                                | 25,131     |                                                      | $          | 15,660 |   | $ | 9,471 |   | 60 | % |
|            |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Our revenue is principallycomprised of our BLC 6000 series system product line, cabinets and relatedaccessories.  Revenue increased by $9.5million or 60% to $25.1 million for the three months ended September 30,2008 as compared to revenue of $15.7 million for the three months ended September 30,2007.  The increase in our revenue forthe three months ended September 30, 2008 was due to higher sales offiber products. We believe our revenues in the quarter ended September 30,2007 were also adversely affected by our then-pending audit committeeinvestigation and financial restatement. We currently expect modest growth in revenue for the remainder of 2008relative to 2007.

 

*Cost ofrevenue and gross margin*

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|-------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Cost of revenue         |       | $                                | 14,380     |                                                      | $          | 9,959 |   | $ | 4,421 |   | 44 | % |
| Gross margin            |       | $                                | 10,751     |                                                      | $          | 5,701 |   | $ | 5,050 |   | 89 | % |
| Gross margin percentage |       | 43                               | %          | 36                                                        | %          |   |   |   |   |

 

Cost of revenue includes thecost of products shipped for which revenue was recognized, warranty costs,costs of any manufacturing yield problems, field replacements, re-work costs,manufacturing overhead, provisions for obsolete inventory and the cost ofpost-sales support.  Cost of revenueincreased by $4.4 million or 44% to $14.4 million for the three months ended September 30,2008 as compared to $10.0 million for the three months ended September 30,2007.  The increase in cost of revenueduring the three months ended September 30, 2008 was attributableprimarily to increased revenue shipments and sales of our products.

 

Gross margin increased to43% of revenue for three months ended September 30, 2008 compared to grossmargin of 36% of revenue for the three months ended September 30,2007.  The increase in gross margin forthe three months ended September 30, 2008 was primarily the result ofincremental revenue and lower product costs. For the three months ended September 30, 2007, gross margin wasadversely affected by a specific warranty accrual related to design issuesassociated with a transistor that resulted in potential equipmentdisruption.  The design issues required are-engineering effort and resulting specific warranty accrual.

 

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We expect that our grossmargins will fluctuate from quarter-to-quarter due in part to variations inproduct mix, production start-up of new products, and changes in costs relatedto our supply chain logistics.  To theextent that cabinets and other lower-margin products represent an increasedpercentage of our total revenue in any period, it will tend to reduce our grossmargin.

 

*Researchand development expenses*

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Research and development                             |       | $                                | 5,004      |                                                      | $          | 3,245 |   | $ | 1,759 |   | 54 | % |
| Research and development as a percentage of  revenue |       | 20                               | %          | 21                                                        | %          |   |   |   |   |
|                                                      |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Research and developmentexpenses consist primarily of salaries and other personnel-related costs,prototype component and assembly costs, third-party design services andconsulting costs, and other costs related to the design, development, andtesting of our products.  Research anddevelopment costs are expensed as incurred, except for capital expenditures,which are capitalized and depreciated over their estimated useful lives,generally two to five years.  Researchand development expenses increased by $1.8 million or 54% to $5.0 million forthe three months ended September 30, 2008 as compared to $3.2 million forthe three months ended September 30, 2007. The increase in research and development expenses was attributable tothe development of our Gigabit Passive Optical Networks (“GPON”) products,which brought with it an increase in head-count, salary and personnel-relatedcosts, and third-party design and test costs. We currently expect research and development expenses to continue toincrease in future periods as we continue to make investments in our productsand technologies.

 

*Sales andmarketing expenses*

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                      | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Sales and marketing                             |       | $                                | 4,677      |                                                      | $          | 3,728 |   | $ | 949 |   | 25 | % |
| Sales and marketing as a percentage of  revenue |       | 19                               | %          | 24                                                        | %          |   |   |   |   |
|                                                 |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Sales and marketing expensesconsist primarily of salaries, sales commissions, and other personnel-relatedcosts, development and distribution of promotional materials, and other costsrelated to generating sales and conducting corporate marketing activities.  Sales and marketing expenses increased by$1.0 million or 25% to $4.7 million for the three months ended September 30,2008 as compared to $3.7 million for the three months ended September 30,2007.  This increase was primarily due toincreased headcount, higher commissions and increases in marketing eventexpenses.  Also contributing to theincrease was a change to our Sales Incentive Compensation Plan effective January 2008,which changed from 50% of commission earned when orders booked and 50% ofcommissions earned when orders shipped to 100% commission earned when ordersare booked.  We currently expect salesand marketing expenses through the end of 2008 to remain consistent withcurrent expense levels.

 

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*Generaland administrative expenses*

* *
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| General and administrative                             |       | $                                | 2,050      |                                                      | $          | 4,218 |   | $ | (2,168 | ) | (51 | )% |
| General and administrative as a percentage  of revenue |       | 8                                | %          | 27                                                        | %          |   |   |   |   |
|                                                        |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist primarily of salaries and other personnel-related costs forexecutive, finance, human resources, and administrative personnel.  Additionally, general and administrativeexpenses include professional fees, liability insurance and other generalcorporate costs.  General andadministrative expenses decreased by $2.2 million or 51% to $2.1 million forthe three months ended September 30, 2008 as compared to $4.2 million forthe three months ended September 30, 2007. General and administrative expenses decreased primarily due to decreasedprofessional fees and expenses related to the audit committee investigation offsetpartially by legal fees related to outstanding stockholder litigation,increased salaries and other costs related to certain remedial measures toaddress internal control weaknesses identified in 2007.  We currently expect legal fees related tooutstanding stockholder litigation to be reimbursed by our insurance carriers,subject to applicable retentions. However, legal fees associated with indemnification obligations tounderwriters and certain selling stockholders are not covered byinsurance.  The timing of the claimreceipts and reimbursements will affect the amount of expense being reported inany given period.  We currently expectgeneral and administrative expenses for the remainder of 2008 to remain atcurrent levels.

 

*Stock-basedcompensation*

 
| ** **                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| ** **                     | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007** | ** ** |
| Cost of revenue                |       | $                                | 72         |   | $ | 71 |   |
| Research and development       |       | 243                              |       | 164 |   |
| Sales and marketing            |       | 149                              |       | 144 |   |
| General and administrative     |       | 164                              |       | 110 |   |
| Total stock-based compensation |       | $                                | 628        |   | $ | 489 |   |

 

Stock-based compensationexpense increased by approximately $139,000 or 28% to $0.6 million for thethree months ended September 30, 2008 as compared to approximately $0.5million for the three months ended September 30, 2007.  This increase is primarily attributable to achange in the estimated forfeiture rate used in our stock-based compensationexpense calculations and grants of additional options.  We anticipate that the stock-basedcompensation expense calculated under SFAS No. 123(R) will continueto have a material effect on our consolidated statement of operations.

 

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*Interestincome (expense), net*

* *
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                           | ** ** | **September 30,  2008**     | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Interest income                      |       | $                                | 254        |                                                      | $          | 584 |   | $ | (330 | ) | (57 | )% |
| Interest expense                     |       | (4                               | )     | —                                                    |       | (4 | )  | N/A |   |
| Total interest income (expense), net |       | $                                | 250        |                                                      | $          | 584 |   | $ | (334 | ) | (57 | )% |

 

Interest income and expense,net decreased by $0.3 million or 57% to $0.3 million for the three months endedSeptember 30, 2008, as compared to $0.6 million for the three months endedSeptember 30, 2007.  The decrease ininterest income was primarily attributable to lower average cash balances andlower interest rates.

 

*Income taxexpense*

 

For income tax purposes, weconsider our projected annual income and the utilization of our net operatingloss carryforwards among other factors. For the three months ended September 30, 2008 and 2007, we recordeda tax benefit of $71,000 and none respectively, for federal and state incometaxes. The benefit is primarily related to the federal refundable research anddevelopment credit due to the new legislation that was passed during thisquarter.

 

*Ninemonths ended September 30, 2008 and 2007*

 

*Revenue*

 
| ** ** | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **September 30,  2008**    | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Revenue    |       | $                               | 67,610     |                                                      | $          | 53,884 |   | $ | 13,726 |   | 25 | % |
|            |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Revenue increased by $13.7million or 25% to $67.6 million for the nine months ended September 30,2008 as compared to revenue of $53.9 million for the nine months ended September 30,2007. This increase was primarily attributable to an expanded customer base,repeat orders from existing customers and increased sales of BLC 6000 products,increase in fiber product revenue, accessories and cabinets, and an increase inthe recognition of previously deferred revenue. We believe 2007 revenue was adversely affected in part due to customeruncertainty concerning our then-pending audit committee investigation andfinancial restatement.  We currentlyexpect modest growth in 2008 revenue relative to 2007.

 

*Cost ofrevenue and gross margin*

 
| ** **              | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|-------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **September 30,  2008**    | ** ** | **September 30,**

**2007**                          | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Cost of revenue         |       | $                               | 38,331     |                                                      | $          | 34,054 |   | $ | 4,277 |   | 13 | % |
| Gross margin            |       | $                               | 29,279     |                                                      | $          | 19,830 |   | $ | 9,449 |   | 48 | % |
| Gross margin percentage |       | 43                              | %          | 37                                                        | %          |   |   |   |   |

 

Cost of revenue increased by$4.2 million or 13% to $38.3 million for the nine months ended September 30,2008 as compared to $34.1 million for the nine months ended September 30,2007.  The 

 

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increase in cost of revenue during the nine months ended September 30,2008 was attributable primarily to increased shipments and sales of ourproducts.

 

Gross margin increased to43% of revenue in the nine months ended September 30, 2008 compared togross margin of 37% of revenue for the nine months ended September 30,2007.  The increase in gross margin forthe nine months ended September 30, 2008 was primarily the result ofincremental revenue, lower product costs and a one-time reduction in a warrantyprovision.  For the nine months ended September 30,2007, gross margin was adversely affected by additional warranty costs relatedto design issues associated with a transistor that resulted in potentialequipment disruption.  The design issuesrequired a re-engineering effort and resulting specific warranty accrual.  These accruals were based upon experiencewith failures of certain parts and based on estimated repair costs.

 

We expect that our grossmargins will fluctuate due in part to variations in product mix, productionstart-up of new products, and changes in costs related to our supply chainlogistics.  To the extent that cabinetsand other lower-margin products represent an increased percentage of our totalrevenue, it will tend to reduce our gross margin.

 

*Researchand development expenses*

 
| ** **                                           | ** ** | **Nine Months Ended**  | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **September 30,**

**2008** | ** ** | **September 30,**

**2007**                          | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Research and development                             |       | $                                | 14,337     |                                                      | $          | 8,985 |   | $ | 5,352 |   | 60 | % |
| Research and development as a percentage of  revenue |       | 21                               | %          | 17                                                        | %          |   |   |   |   |
|                                                      |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Research and developmentexpenses increased by $5.4 million or 60% to $14.3 million for the nine monthsended September 30, 2008 as compared to $9.0 million for the nine monthsended September 30, 2007.  Theincrease in research and development expenses was attributable to increasedpersonnel-related costs and third-party design costs to support the developmentof our GPON equipment.  We currentlyexpect research and development expenses to continue to increase in futureperiods as we continue to make investments in our products and technologies.

 

*Sales andmarketing expenses*

 
| ** **                                      | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                      | ** ** | **September 30,  2008**    | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Sales and marketing                             |       | $                               | 14,760     |                                                      | $          | 10,779 |   | $ | 3,981 |   | 37 | % |
| Sales and marketing as a percentage of  revenue |       | 22                              | %          | 20                                                        | %          |   |   |   |   |
|                                                 |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Sales and marketing expensesincreased by $4.0 million or 37% to $14.8 million for the nine months ended September 30,2008 as compared to $10.8 million for the nine months ended September 30,2007.  This increase was primarily due toincreased headcount, commissions and marketing events.  We currently expect sales and marketingexpenses to remain generally consistent with recent quarters through the end of2008.

 

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*Generaland administrative expenses*

 
| ** **                                             | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30,  2008**    | ** ** | **September 30,**

**2007**                          | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| General and administrative                             |       | $                               | 8,253      |                                                      | $          | 8,030 |   | $ | 223 |   | 3 | % |
| General and administrative as a percentage  of revenue |       | 12                              | %          | 15                                                        | %          |   |   |   |   |
|                                                        |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

General and administrativeexpenses increased by $0.2 million or 3% to $8.3 million for the nine monthsended September 30, 2008 as compared to $8.0 million for the nine monthsended September 30, 2007.  Generaland administrative expenses increased primarily due to increased legal feesrelated to outstanding stockholder litigation, stock-based compensationcharges, salaries, and labor-related costs to address internal controlweaknesses identified in the audit.  Wecurrently expect general and administrative expenses for the remainder of 2008to remain generally consistent with recent quarters.

 

*Stock-basedcompensation*

 
| ** **                     | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **September 30,  2008**    | ** ** | **September 30,  2007** | ** ** |
| Cost of revenue                |       | $                               | 290        |   | $ | 194 |   |
| Research and development       |       | 868                             |       | 542 |   |
| Sales and marketing            |       | 557                             |       | 422 |   |
| General and administrative     |       | 633                             |       | 407 |   |
| Total stock-based compensation |       | $                               | 2,348      |   | $ | 1,565 |   |

 

Stock-based compensationexpenses increased by approximately $0.8 million or 50% to $2.3 million for thenine months ended September 30, 2008 as compared to approximately $1.6million for the nine months ended September 30, 2007.  This increase is primarily attributable to achange in the forfeiture rate used in our stock-based compensation expensecalculations and grants of additional options. We anticipate that the stock-based compensation expense calculated underSFAS No. 123(R) will continue to have a material effect on ourconsolidated statement of operations.

 

*Otherincome (expense), net*

 

Other expense, net was $0.7million for the nine months ended September 30, 2008 as compared to $91,000for the nine months ended September 30, 2007.  During the three months ended March 31,2008, we wrote-off an intangible for technology developed forMetro-Ethernet/Telemetry technology of $0.8 million and its related inventoryof approximately $0.2 million.  As partof the purchase of certain assets of Terawave Communications, Inc. on October 25,2007, we acquired the intangible and the related inventory.  Subsequent to the date of the asset purchasewe had sought potential buyers for the Metro-Ethernet/Telemetry technology torecover cash paid for the assets. However, by March 31, 2008, we decided to terminate efforts to sellthe Metro-Ethernet/Telemetry technology and to focus instead on bringing tomarket GPON technology.  Other income of$0.3 million represents payments received that pertained to accounts receivablethat were acquired as part of the purchase of certain assets of TerawaveCommunications, Inc. in October 2007. At the date of purchase, the accounts were deemed to be uncollectibleand no value was recorded on our books.

 

The decision to write-offthe intangible and its related inventory is based on the primary intent behindour asset purchase which was to obtain intellectual property rights related toTerawave’s in-development GPON technology. As of the date of the asset purchase, both Occam and Terawave wereindependently developing 

 

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GPON products.  We believeTerawave’s product incorporated superior, proprietary hardware technology whileOccam’s product development was being built around a superior software packetengine.  Our purchase of the assets ofTerawave was intended to allow Occam to match its packet engine with Terawave’shardware technology in order to create a combined product incorporating thebest elements of each individual products.

 

In June 2008, werecorded an impairment charge of $37,000 related to customer relationshipsacquired from Terawave Communications, Inc.

 

*Totalother interest income (expense), net*

 
| ** **                                 | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2008 vs. 2007** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                 | ** ** | **September 30,  2008**    | ** ** | **September 30,  2007**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| Interest income                            |       | $                               | 946        |                                                      | $          | 2,141 |   | $ | (1,195 | ) | (56 | )% |
| Other Income                               |       |                            | 290        |                                                      | —     |   |   | 290 |   | N/A |   |
| Other expense                              |       |                            | (992       | )                                                         | —     |   |   | (992 | ) | N/A |   |
| Interest Expense                           |       | (61                             | )     | —                                                    |       |   | (61 | )  | N/A |   |
| Total other interest income (expense), net |       | $                               | 183        |                                                      | $          | 2,141 |   | $ | (1,958 | ) | (91 | )% |

 

Total other interest incomeand expense, net decreased by $2.0 million or 91% to $0.2 million for the ninemonths ended September 30, 2008, as compared to $2.1 million for the ninemonths ended September 30, 2007. The decrease in interest income was primarily attributable to loweraverage cash balances and lower interest rates.

 

*Income taxexpense*

 

For income tax purposes, weconsider our projected annual income and the utilization of our net operatingloss carryforwards among other factors. For the nine months ended September 30, 2008 and 2007, we recordeda tax benefit of $30,000 and zero respectively, for federal and state incometaxes. . The benefit is primarily related to the federal refundable researchand development credit due to the new legislation that was passed during thisquarter.

 

**Liquidityand Capital Resources**

 

As of September 30,2008, we had cash and cash equivalents of $21.9 million, restricted cash of$16.9 million, stockholders’ equity of $55.3 million, and working capital of$46.1 million, compared with cash and cash equivalents of $37.6 million,restricted cash of $13.1 million, stockholders’ equity of $60.3 million, andworking capital of $51.8 million as of December 31, 2007.  The majority of the increase in restrictedcash at September 30, 2008, was related to performance bonds required forour Rural Utilities Service, or RUS 397 contracts.

 

Net cash used in operatingactivities for the nine months ended September 30, 2008, was $8.0 millioncompared to $2.1 million during the same period ended 2007.  The sum of our net loss and certain non-cashexpenses, such as stock-based compensation, depreciation and amortization,impairment of intangibles related to developed technology and customerrelationships, accounts receivable reserves and inventory reserves resulted inan outflow of $2.3 million in the 2008 period, compared to an outflow of $2.4million in the 2007 period.  The overallimpact of change in certain operating assets and liabilities on total operatingcash flows resulted in a cash outflow of $5.7 million in the 2008 periodcompared to a cash inflow of $0.3 million in the 2007 period.

 

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Net cash used in investingactivities for the nine months ended September 30, 2008, was $8.4 millioncompared to $14.2 million during the same period ended 2007.  Cash used in investing activities for thenine months ended September 30, 2008, was primarily due to an increase of$3.8 million in restricted cash related to performance bonds required inconnection with our RUS contracts and $4.4 million for purchases of propertyand equipment of which $3.1 million was for our new facility in Fremont,California, compared to $8.0 million for purchases of property and equipmentwhich was primarily leasehold improvements for our corporate headquarters inSanta Barbara, California during the same period in 2007.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2008 was $0.6million compared to $0.4 million provided by financing activities for the sameperiod in 2007.  Cash provided byfinancing activities for the nine months ended September 30, 2008, wasmainly due to proceeds from the issuance of common stock under the ESPP of $0.6million and exercise of stock options of $69,000 offset by payments of payrolltaxes for vested restricted stock units of $68,000 as compared to proceeds of$0.4 million for exercise of options and the issuance of common stock under theESPP for the same period in 2007.

 

**Working Capital**

 

Working capital decreased to$46.1 million as of September 30, 2008, compared to $51.8 million as of December 31,2007.

 

Our future liquidity andcapital requirements will depend on numerous factors, including the:

 

·                  collectability of accounts receivable;

 

·                  amount and timing of revenue;

 

·                  extent to which our existing and new productsgain market acceptance;

 

·                  extent to which funds are restricted due toperformance bonds required in connection with our RUS contracts;

 

·                  cost and timing of product developmentefforts and the success of these development efforts;

 

·                  cost and timing of marketing and sellingactivities; and

 

·                  availability of borrowing arrangements andthe availability of other means of financing.

 

We believe that our cash andcash equivalents will be sufficient to finance our operations over the next 12months.  Although we believe these fundswill be sufficient to maintain and expand our operations in accordance with ourbusiness strategy, we may need additional funds in the future.  If we are unable to raise additionalfinancing when and if needed, we may be required to reduce certaindiscretionary spending, which could have a material adverse effect on our abilityto achieve our intended business objectives.

 

**ContractualObligations**

 

We lease our facilities andcertain assets under non-cancelable operating leases expiring through 2015,excluding various renewal options.

 

We lease certain officeequipment under capital leases.

 

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The following tablesummarizes our minimum purchase commitments to our contract manufacturers, ourminimum commitments under non-cancelable operating leases,our commitment undercapital leases, our commitment under fixed assets and licensing agreements asof September 30, 2008 (in thousands):

 
| ** **                  | ** ** | **Payments Due By Period** | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| **Contractual Obligations** |       |                                      |       |   |   |   |   |   |   |   |   |
| Purchase commitments (1)    |       | $                                         | 12,917     |   | $ | 12,917 |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases            |       | $                                         | 8,664      |   | $ | 349 |   | $ | 2,831 |   | $ | 2,974 |   | $ | 2,510 |   |
| Capital leases              |       | $                                         | 63         |   | $ | 21 |   | $ | 41 |   | $ | 1 |   | $ | — |   |
| Fixed asset commitments     |       | $                                         | 125        |   | $ | 125 |   | $ | — |   | $ | — |   | $ | — |   |
| Licensing agreements        |       | $                                         | 290        |   | $ | 15 |   | $ | 265 |   | $ | 10 |   | $ | — |   |

 

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(1)          Under the terms of our agreement with ourcontract manufacturers, we issue purchase orders for the production of ourproducts.  We are required to placeorders in advance with our contract manufacturer to meet estimated salesdemands.  The agreement includes certainlead-time and cancellation provisions. Future amounts payable to the contract manufacturer will vary based onthe level of purchase requirements.

 

*Off-BalanceSheet Arrangements*

 

As of September 30,2008, we had no material off-balance sheet arrangements, other than operatingleases and certain purchase commitments described in the contractualobligations table referenced above.

 

*IndemnificationObligations*

 

We enter intoindemnification provisions under our agreements with other companies in ourordinary course of business, typically with our contractors, customers, andlandlords.  In connection with our 2006public offering, we also agreed to indemnify the underwriters in the offeringand certain stockholders who sold shares as part of the offering with respectto certain liabilities arising from the offering.  Under these provisions, we generallyindemnify and hold harmless the indemnified party for losses suffered orincurred by the indemnified party as a result of our activities or, in somecases, as a result of the indemnified party’s activities under theagreement.  These indemnificationprovisions generally survive termination of the underlying agreement.  The maximum potential amount of futurepayments we could be required to make under these indemnification provisions isgenerally unlimited.  As of September 30,2008, we had not incurred material costs to defend lawsuits or settle claimsrelated to these indemnifications agreements. During the quarterindemnification requests were received by the Company.

 

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Recent AccountingPronouncements

 

In December 2007, theFASB issued Statement of Financial Accounting Standards No. 160, “NoncontrollingInterests in Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS 160”).  SFAS 160 will change theaccounting and reporting for minority interests which will be recharacterizedas noncontrolling interests and classified as a component of equity.  SFAS 160 is effective for fiscal yearsbeginning on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation anddisclosure requirements for existing minority interests.  We are currently assessing the impact thatSFAS 160 may have on our financial position, results of operations, and cashflows.

 

In December 2007, theFASB issued Statement of Financial Accounting Standards No. 141 (revised2007), “Business Combinations” (“SFAS 141R”). SFAS 141R changes accounting for acquisitions that close beginning in2009.  More transactions and events willqualify as business combinations and will be accounted for at fair value underthe new standard.  SFAS 141R promotesgreater use of fair values in financial reporting.  Some of the changes will introduce morevolatility into earnings.  SFAS 141R iseffective for fiscal years beginning on or after December 15, 2008.  The adoption of SFAS 141R will have an impacton accounting for business combinations once adopted, but the effect on us willdepend upon our level of acquisition activity.

 

In December 2007, theSecurities and Exchange Commission issued Staff Accounting Bulletin No. 110(“SAB No. 110”), “Certain Assumptions Used in Valuation Methods.”  SAB No. 110 expresses the views of thestaff regarding the use of a “simplified” method in developing an estimate ofexpected term of “plain vanilla” share options in accordance with the Statementof Financial Accounting No. 123R, “Shared-Based Payment.”  Companies electing to use this method shouldapply it consistently to all “plain vanilla” employee share options, anddisclose the use of the method in the notes to the financial statements.  We are currently evaluating the impact ofapplying SAB No. 110 on our business and financial condition.

 

In May 2007, the FASBissued FSP No. FIN 48-1 “Definition of Settlement in FASB Interpretation No. 48,”(FSP FIN 48-1 amends FIN 48 to provide guidance on how an entity shoulddetermine whether a tax provision is effectively settled for the purpose ofrecognizing previously unrecognized tax benefits.  The term “effectively settled” replaces theterm “ultimately settled” when used to describe recognition, and the terms “settlement”or “settled” replace the terms “ultimate settlement” or “ultimately settled”when used to describe measurement of a tax position under FIN 48.  FSP FIN 48-1 clarifies that a tax positioncan be effectively settled upon the completion of an examination by a taxingauthority without being legally extinguished. For tax positions considered effectively settled, an entity wouldrecognize the full amount of tax benefit, even if the tax position is notconsidered more likely than not to be sustained based solely on the basis ofits technical merits and the statue of limitations remains open.  We do not anticipate that the adoption of FSPFIN 48-1 will have a material effect on our results of operations or financialposition, although we are continuing to evaluate the full impact of theadoption of FSP FIN 48-1.

 

In February 2007, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities—Including an Amendment of FASB Statement No. 115”(SFAS 159).  SFAS 159 expands the use offair value accounting but does not affect existing standards which requireassets or liabilities to be carried at fair value.  Under SFAS 159, a company may elect to usefair value to measure accounts and loans receivable, available-for-sale andheld-to-maturity securities, equity method investments, accounts payable,guarantees and issued debt.  Othereligible items include firm commitments for financial instruments that 

 

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otherwise would not be recognized at inception and non-cash warrantyobligations where a warrantor is permitted to pay a third party to providewarranty goods or services.  If the useof fair value is elected, any upfront cost and fees related to the item must berecognized in earnings and cannot be deferred. The fair value election is irrevocable and generally made on aninstrument-by-instrument basis even if a company has similar instruments thatit elects not to measure at fair value. At the adoption date, unrealized gains and losses on existing items forwhich the fair value option has been elected are reported as a cumulativeadjustment to beginning retained earnings. Subsequent to the adoption of SFAS 159, changes to fair value arerecognized in earnings.  SFAS 159 iseffective for fiscal years beginning after November 15, 2007 and isrequired to be adopted by Occam in the first quarter of 2008.  The adoption of SFAS No. 159 did nothave a material impact on our results of operations and financial position. 

 

In March 2008the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments andHedging Activities, an Amendment to FASB Statement No. 133” (“SFAS 161”). Thisstatement is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced qualitative andquantitative disclosures regarding derivative instruments, gains and losses onsuch instruments and their effects on an entity’s financial position, financialperformance and cash flows. SFAS No. 161 is effective for financial statementsissued for fiscal years beginning after November 15, 2008, and interim periodswithin those fiscal years.  We do notanticipate that SFAS 160 will have a material impact on our financial position,results of operations, and cash flows.

 

In April 2008,the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination ofthe Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends the factorsthat should be considered in developing renewal or extension assumptions usedto determine the useful life of a recognized intangible asset under SFAS No.142, “Goodwill and Other Intangible Assets” and also requires expandeddisclosure related to the determination of intangible asset useful lives. FSP142-3 is effective for fiscal years beginning after December 15, 2008. Earlyadoption is prohibited. The Company is currently evaluating the impact theadoption of FSP 142-3 will have on its consolidated financial statements.

 

**ITEM 3.     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

** **

Because our portfolio ofcash equivalents is of a short-term nature, we are not subject to significantmarket price risk related to investments. However, our interest income is sensitive to changes in the generallevel of taxable and short-term U.S. interest rates.  Our exposure to market risk due to changes inthe general level of United States interest rates relates primarily to our cashequivalents.  We generally invest oursurplus cash balances in money-market funds with original or remainingcontractual maturities of less than 90 days. The primary objective of our investment activities is the preservationof principal while minimizing risk.  Wedo not hold financial instruments for trading or speculative purposes.  We do not use any derivatives or similarinstruments to manage our interest rate risk.

 

**ITEM 4.     CONTROLSAND PROCEDURES**

** **

***(a)   Evaluation of DisclosureControls and Procedures***

*** ***

Under the supervision andwith the participation of our management, including our chief executive officerand chief financial officer, we conducted an evaluation of the effectiveness ofthe design and operation of our disclosure controls and procedures, as definedin Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of September 30,2008, which we refer to as the Evaluation Date or the end of the period coveredby this Quarterly Report on Form 10-Q.

 

The purpose of thisevaluation was to determine whether as of the Evaluation Date our disclosurecontrols and procedures were effective to provide reasonable assurance that theinformation we are required to 

 

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disclose in our filings with the Securities and Exchange Commission, (i) isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms and (ii) accumulated and communicated toour management, including our chief executive officer and chief financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

Based on their evaluation,our chief executive officer and chief financial officer have concluded, asdiscussed below, that a material weakness existed in our disclosure controlsand procedures as of the Evaluation Date, and as a result, our disclosurecontrols and procedures were not effective as of the Evaluation Date.

 

An internal control deficiencyexists when the design or operation of a control does not allow management oremployees, in the normal course of performing their assigned functions, toprevent or detect misstatements on a timely basis.  A “material weakness” is a controldeficiency, or combination of control deficiencies, that results in a more thana remote likelihood that a material misstatement of the annual or interimconsolidated financial statements will not be prevented or detected.  A “significant deficiency” is a control deficiency,or combination of control deficiencies, that adversely affects a company’sability to initiate, authorize, record, process or report external financialdata reliably in accordance with accounting principles generally accepted inthe United States.  In the case of asignificant deficiency, a more-than-remote likelihood exists of a misstatementof the company’s annual or interim consolidated financial statements that ismore than inconsequential.

 

Our audit committeeinitiated an internal review of our revenue recognition practices.  On September 12, 2007, we announced thatour audit committee had identified errors in revenue recognition and that ourboard of directors, based on the recommendation of our audit committee, hadconcluded that we should restate our financial statements for fiscal years 2004and 2005, the corresponding interim quarterly periods of fiscal 2004 and fiscal2005, and the first, second, and third quarters of fiscal 2006.  Our board of directors also concluded thatour previously filed financial statements for those periods should not berelied on.  On October 16, 2007, weannounced that our audit committee had concluded its investigation, and weannounced the final restated financial information.

 

Our audit committeeconcluded that the restatement was required because of errors in our accountingfor (i) commitments to certain customers in connection with sales forfeatures or deliverables that were not available at the time revenue wasoriginally recognized, including commitments to prospectively provide freeproduct, software, training, and installation services, for which weprematurely recognized approximately $9.3 million in revenue from fiscal 2004to fiscal 2006; (ii) sales to value-added resellers where the resellersdid not have the ability to pay us for these sales independent of payment tothem by the end-user, for which we prematurely recognized approximately $20.2million in revenue from fiscal 2004 to fiscal 2006; and (iii) for certainquarters ending on weekends, our use of a shipping vendor who picked up productfor subsequent delivery to another shipping company where the terms andconditions of the shipments did not appropriately transfer title or risk ofloss at the time of shipment, for which we prematurely recognized approximately$2.3 million in revenue from fiscal 2004 to fiscal 2006.  In addition, we prematurely recognizedapproximately $1.1 million of revenue from fiscal 2004 through fiscal 2006relating principally to errors in accounting for software and softwaremaintenance, customer credits, and undelivered free product.

 

Our audit committeedetermined that the foregoing errors resulted from deficiencies in our internalcontrols, in particular resulting from internal communication failures betweenour finance and sales departments, a lack of clear understanding by, andcommunication to, sales personnel of technical accounting rules, understaffedfinance functions, and on occasion, failure of finance personnel to applytechnical revenue recognition rules correctly.  As part of its internal control deficienciesletter dated October 15, 2007, our current independent registered publicaccounting firm also identified a material weakness relating to revenuerecognition.  Our independent registeredpublic accounting firm noted that we did not have policies and 

 

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procedures in place to ensure that modifications to, or side agreementsassociated with, our standard terms of contract were properly documented andapproved.  Our independent registeredpublic accounting firm also cited a lack of understanding of the accountingconsequences of modifications to standard terms by certain sales employees anda lack of communication among our sales, engineering, and finance departmentsto ensure that all sales transactions are properly tracked, documented,approved, and recorded.

 

In their October 2007letter, our independent registered public accounting firm identified additionalcontrol deficiencies that it determined to be significant deficiencies but thatit did not deem to be material weaknesses. In particular, it identified a significant deficiency relating tosegregation of duties, noting among other things that in certain instancesjournal entries and account reconciliations were approved by the preparer ofthe entry or reconciliation.  Ourindependent registered public accounting firm also noted a significantdeficiency relating to post-closing adjusting journal entries and recommendedthat we reassess the timeline of our financial statement process to ensure thatwe have reasonable time to conclude a thorough financial statement closingprocess.  Finally, our independentregistered public accounting firm identified significant deficiencies relatingto recording certain purchase transactions, where parts were ordered andaccepted by our engineering department, without approval or involvement of ourfinance department, and where fixed assets were not properly classified fordepreciation purposes.

 

In connection with the auditof our consolidated financial statements for the year ended December 31,2007 and the effectiveness of our internal control over financial reporting asof December 31, 2007, our independent registered public accounting firmidentified a material weakness and some significant deficiencies in ourinternal control over financial reporting in a letter dated March 10,2008.  Specifically, our independentregistered public accounting firm noted a continuing material weakness relatingto revenue recognition and our policies and procedures to ensure thatmodifications to, or side agreements associated with, our standard terms ofcontract were properly approved, documented, tracked and recorded.

 

***(b)   Changes in Internal ControlOver Financial Reporting***

*** ***

On September 28, 2007,our audit committee presented the findings and recommendations of its internalinvestigation to our board of directors, including a proposed remediation planregarding internal control over financial reporting.  Our board of directors adopted the auditcommittee’s remediation plan, and we are in the process of implementingit.  Remedying the material weakness andother control deficiencies described above will require substantial managementtime and attention and will result in our incurring substantial incrementalexpenses, including increasing the size of our finance organization andretaining outside consultants to assist in the implementation of new internalcontrols.  Any failure on our part toremedy our identified control deficiencies or any additional errors or delaysin our financial reporting would have a material adverse effect on our businessand results of operations and could have a substantial adverse impact on thetrading price of our common stock and our relationships with customers.

 

Subject to oversight by ourboard of directors, our chief executive officer and chief financial officer areresponsible for implementing the internal control remediation plan recommendedby our audit committee and approved by our board of directors.  We have also engaged an outside consultant inconnection with implementing the remediation plan.

 

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Our audit committee’sremediation plan consists of the following modifications and improvements inour internal controls relating to the revenue- recognition transactioncycle.  Modifications and improvements toour internal controls completed and in remediation as of September 30,2008 are also set forth below:

 

Implementedas of September 30, 2008

 

·                  adjust our reporting structure so thatfinance has direct oversight of sales administration and the sales proposalgeneration management group;

 

·                  reorganize our variable compensation plan toensure that sales personnel are not incentivized to attempt to influence thetiming of revenue recognition;

 

·                  retain a senior revenue recognitionspecialist who will report directly to our chief financial officer and willpossess the appropriate level of experience, authority, and seniority toindependently serve as the liaison between all levels of corporate functionsand finance.  This individual should havesome degree of managerial oversight of other “liaison” areas (e.g., order entrypersonnel, sales administration, and sales proposals generation) and be responsiblefor the review and reconciliation of terms given to a customer in the bid/quoteprocess as well as in the final contract;

 

·                  the revenue recognition specialist, oremployees acting under his or her supervision, should review all documentationrelating to a transaction, including purchase orders, special pricing approvalforms, customer quotes, letters of intent, emails, etc. to determine whetherany of the terms will result in the deferral of revenue;

 

·                  a revenue recognition checklist shouldaccompany the financial package for each transaction;

 

·                  engage an outsourced internal audit group toreview all significant revenue transactions each quarter to ensure thattransactions have been recorded appropriately, to monitor the status of theremediation of control structure, and report to the audit committee theprogress achieved;

 

·                  implement formal training, which wouldinclude a signed acknowledgement of all attendees certifying that they haveattended and understood the topics covered, from all finance, executive, sales,and sales administration personnel, to ensure they understand that certainterms impact revenue recognition, as well as understand how to document andreceive approval for such terms, as well as report them to finance;

 

·                  institute a formal communication processamong marketing, engineering, and finance to ensure that all functionsunderstand that any changes have potential accounting implications and toensure that finance is appropriately advised as to the impact on existing andfuture transactions;

 

·                  implement policies and procedures thatdelineate clear roles, responsibilities, and authorization levels for allpositions defined as “key” to the revenue recognition transaction cycle;

 

·                  compliance with the stated order addendumprocess, to ensure that all terms agreed upon with a customer following theissuance of the customer quote or purchase order have been captured andprovided to finance;

 

·                  implement controls required to ensure that noitems are shipped or provided to the customer without being entered as separateline items in our systems;

 

·                  implement controls required to ensure thatall requests for price responses, contract closeout, acceptance documentation,and other delivery information is provided to and reviewed by the financedepartment and is received prior to recording of revenue;

 

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·                  implement controls to ensure that singletransactions with a customer are not split into various contracts, purchaseorders, or shipments, unless these requests are approved by the financedepartment; and

 

·                  implement procedures to ensure that creditchecks are performed and the decision-making process as to the credit limit isdocumented and maintained.

 

·                  implement a policies and procedure documentthat will be provided to all sales and sales administration personnel,including an annual sign off that they have received, read, understood, andcomplied with the materials, that will ensure that all terms related to anytransaction are evidenced in the sales quotes and purchase orders, and that alltransaction documentation has been provided to the finance department prior tothe recording of revenue;

 

InRemediation as of September 30, 2008

 

·                  standardize language on each customer’s quoteand invoice, as well as on the standard terms and conditions, stating that onlythose terms listed by the customer on its purchase order will be deemed part ofthe final agreement; and

 

·                  establish a central, virtual repository forall documentation relating to a transaction, including quotes, emails, lettersof intent, volume pricing agreements, special pricing approval forms, and allother transaction documents, which are uploaded by sales and sales administrationpersonnel.

 

In May 2008, weannounced that we had hired a new chief financial officer, and since May, wehave also hired a new corporate controller and other finance personnel.  Our current chief financial officer,corporate controller, and other personnel are currently evaluating our internalcontrols and procedures, including changes implemented as part of theremediation plan described above.  Withrespect to those changes identified above as having been implemented, we expectour finance department will continue to test and evaluate the effectiveness oftheses changes over the next few quarters. In addition, they may identify and implement additional remedial changesbased on any issues they may identify.

 

**PART II—OTHER INFORMATION**

** **

**ITEM 1.LEGAL PROCEEDINGS**

** **

2007 ClassAction Litigation

 

On April 26, 2007 and May 16,2007, two putative class action complaints were filed in the United StatesDistrict Court for the Central District of California against Occam and certainof its officers.  The complaints allegethat the defendants violated sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934, or the Exchange Act, and SEC Rule 10b-5 promulgatedthereunder by making false and misleading statements and omissions relating toour financial statements and internal controls with respect to revenuerecognition.  The complaints seek, onbehalf of persons who purchased our common stock during the period fromMay 2, 2006 and April 17, 2007, damages of an unspecified amount.

 

OnJuly 30, 2007, Judge Christina A. Snyder consolidated these actions into asingle action, appointed NECA-IBEW Pension Fund (The Decatur Plan) as lead plaintiff, andapproved its selection of lead counsel. On November 16, 2007, the lead plaintiff filed a consolidatedcomplaint.  This consolidated complaintadded as defendants certain of Occam’s current and former directors andofficers, its current and former outside auditors, the lead underwriter of itssecondary public offering in November 2006, and two venture capital firmswho were early investors in Occam.  Theconsolidated complaint alleged that defendants violated sections 10(b), 20(a)and 20A of the Exchange Act and SEC Rule 10b-5 promulgated thereunder, aswell as sections 11 and 15 of the Securities Act of 1933, or Securities Act, bymaking false and misleading statements and omissions relating to our financialstatements and internal controls with respect to revenue recognition thatrequired restatement.  The consolidatedcomplaint seeks, on behalf of persons who purchased Occam’s common stock duringthe period from April 29, 2004 to October 15, 2007, damages of anunspecified amount.

 

On January 25, 2008, defendantsfiled motions to dismiss the consolidated complaint.  On July 1, 2008, Judge Snyder issued anorder granting in part and denying in part defendants’ motions.  This order dismissed all claims againstcertain of our current and former directors, the 20A claim in its entirety, thesection 10(b) claim against the auditors and venture capital firms, and thesection 11 claims against the venture capital firms.  On July 16, 2008, lead plaintiff filedan amended complaint to conform to the Court’s July 1, 2008 order.  Defendants answered this amended complaint onAugust 29, 2008. A scheduling conference has been set by the Court forNovember 17, 2008.

 

Occam believes that it has meritoriousdefenses in this action, and intends to defend itself vigorously.  Failure by Occam to obtain a favorableresolution of the claims set forth in the consolidated complaint could have amaterial adverse effect on its business, results of operations and financialcondition.  Currently, the amount of suchmaterial adverse effect cannot be reasonably estimated.

** **

*IPOAllocation Litigation*

* *

In June 2001, threeputative stockholder class action lawsuits were filed against AcceleratedNetworks, certain of its then officers and directors and several investmentbanks that were underwriters of Accelerated Networks’ initial publicoffering.  The cases, which have sincebeen consolidated, were filed in the United States District Court for theSouthern District of New York.  The Courtappointed a lead plaintiff on April 16, 2002, and plaintiffs filed aConsolidated Amended Class Action Complaint (the “Complaint”) on April 19,2002.  The Complaint was filed on behalfof investors who purchased Accelerated Networks’ stock between June 22,2000 and December 6, 2000 and alleged violations of Sections 11 and 15 ofthe 1933 Act and Sections 10(b) and 20(a) and Rule 10b-5 of the1934 Act against one or both of Accelerated Networks and the individualdefendants.  The claims were based onallegations that the underwriter defendants agreed to allocate stock inAccelerated Networks’ initial public offering to certain investors in exchangefor excessive and undisclosed commissions and agreements by those investors tomake additional purchases in the aftermarket at pre-determined prices.  Plaintiffs alleged that the prospectus forAccelerated Networks’ initial 

 

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public offering was false and misleading in violation of the securitieslaws because it did not disclose these arrangements.  These lawsuits are part of the massive “IPOallocation” litigation involving the conduct of underwriters in allocatingshares of successful initial public offerings. We believe that over three hundred other companies have been named inmore than one thousand similar lawsuits that have been filed by some of thesame plaintiffs’ law firms.  In October 2002,the plaintiffs voluntarily dismissed the individual defendants withoutprejudice.  On February 1, 2003 amotion to dismiss filed by the issuer defendants was heard and the courtdismissed the 10(b), 20(a) and rule 10b-5 claims against Occam. On October 13,2004, the Court certified a class in six of the approximately 300 other nearlyidentical actions (the “focus” cases) and noted that the decision was intendedto provide guidance to all parties regarding class certification in theremaining cases. The Underwriter Defendants appealed the decision and theSecond Circuit Court of Appeals vacated the district court’s decision grantingclass certification in those six cases on December 5, 2006.  Plaintiffs filed a motion for rehearing.  On April 6, 2007, the Second Circuitdenied the petition, but noted that Plaintiffs could ask the District Court tocertify a more narrow class than the one that was rejected. On October 3,2007 Plaintiff has filed a motion to certify a new class and a second amendedcomplaint based on the Second Circuit Appeals Court decision. An oppositionbrief was filed by both Underwriter Defendants and the Issuer Defendants on December 21,2007 and a reply brief was filed on January 28, 2008. On March 28,2008, the plaintiffs filed an amended reply brief in support of their motion tocertify the class of plaintiffs. The Underwriter Defendants and the issuerDefendants had until August 31, 2008 to file an answer to the amendedcomplaint. The Court has not ruled on the motion. The insurers, theunderwriters and the Plaintiff’s subsequently agreed to global mediation in theinterest of trying to resolve this case without the further need forlitigation. The mediation commenced in late June and is ongoing andsettlement talks are in process.

 

Prior to the Second Circuit’sDecember 5, 2006 ruling, we agreed, together with over three hundred othercompanies similarly situated, to settle with the Plaintiffs. A settlementagreement and related agreements were submitted to the Court for approval.  The settlement would have provided, amongother things, a release of the Company and of the individual defendants for theconduct alleged to be wrongful in the Complaint in exchange for a guarantee fromthe Company’s insurers regarding recovery from the underwriter defendants andother consideration from the Company regarding its underwriters.  In light of the Second Circuit opinion,liaison counsel for the issuers informed the District Court that the settlementcannot be approved because the defined settlement class, like the litigationclass, cannot be certified.  We cannotpredict whether we will be able to renegotiate a settlement that complies withthe Second Circuit’s mandate.

 

Due to the inherentuncertainties of litigation, we cannot accurately predict the ultimate outcomeof the matter. We have not recorded any accrual related to this proposedsettlement because Occam expects any settlement amounts to be covered by itsinsurance policies.

 

*ThreatenedLitigation*

* *

In late 2007, Occam receiveda letter from Vanessa Simmonds, a putative shareholder of the Company,demanding that Occam investigate and prosecute a claim for alleged short-swingtrading in violation of Section 16(b) of the Securities Exchange Actof 1934, 15 U.S.C. § 78p (b), by the underwriter of its initial public offering(“IPO”) and certain unidentified directors, officers and shareholders of Occam(then known as Accelerated Networks). Occam evaluated the demand and declined to prosecute the claim.  On October 12, 2007, the putativeshareholder commenced a civil lawsuit in the U.S. District Court for theWestern District of Washington against Credit Suisse Group, the leadunderwriter of Occam’s IPO, alleging violations of Section 16(b).  The complaint alleges that the combinednumber of shares of Occam’s common stock beneficially owned by the leadunderwriter and certain unnamed officers, directors, and principal shareholdersexceeded ten percent of its outstanding common stock from the date of Occam’sIPO on June 23, 2000, through at least June 22, 2001.  It further alleges that those entities andindividuals were thus subject to the reporting requirements of Section 16(a) andthe short-swing trading prohibition of Section 16(b), and 

 

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failed to comply with those provisions. The complaint seeks to recover from the lead underwriter any “short-swingprofits” obtained by it in violation of Section 16(b).  Occam was named as a nominal defendant in theaction, but has no liability for the asserted claims.  No directors or officers of Occam are namedas defendants in this action.

 

On October 29, 2007,the case was reassigned to Judge James L. Robart along with fifty-four other Section 16(b) casesseeking recovery of short-swing profits from underwriters in connection withvarious IPOs. The Underwriters and Issuers have filed a motion to dismiss the caseand reply briefs have been filed. Oral argument has been requested and has beenset for January 19, 2009. It is anticipated that it will be three to fourmonths before the Court will rule on the motion after completion of oralargument.

 

Due to the inherentuncertainties of threatened litigation, we cannot accurately predict theultimate outcome of the matter, but we believe that the outcome of thislitigation will not have a material adverse impact on our consolidatedfinancial position and results of operations. We have not recorded any accruals related to the demand letters or Section 16(b) litigationbecause we expect any resulting resolution to be covered by our insurancepolicies.

 

Other Matters

 

From time to time, we aresubject to threats of litigation or actual litigation in the ordinary course ofbusiness, some of which may be material. We believe that, except as described above, there are no currentlypending matters that, if determined adversely to us, would have a materialeffect on our business or that would not be covered by our existing liabilityinsurance maintained by us.

 

**ITEM 1A.  RISKFACTORS**

** **

This Quarterly Report on Form 10-Q,or Form 10-Q, including any information incorporated by reference herein,contains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, referred to as the Securities Act, and Section 21Eof the Securities Exchange Act of 1934, as amended, referred to as the ExchangeAct.  In some cases, you can identifyforward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,”“intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,”“continue” or the negative of these terms or other comparable terminology.  The forward-looking statements contained inthis Form 10-Q involve known and unknown risks, uncertainties andsituations that may cause our or our industry’s actual results, level ofactivity, performance or achievements to be materially different from anyfuture results, levels of activity, performance or achievements expressed orimplied by these statements.  Thesefactors include those listed below in this Item 1A and those discussedelsewhere in this Form 10-Q.  Weencourage investors to review these factors carefully.  We may from time to time make additionalwritten and oral forward-looking statements, including statements contained inour filings with the SEC.  However, we donot undertake to update any forward-looking statement that may be made fromtime to time by or on behalf of us.

 

Before you invest in oursecurities, you should be aware that our business faces numerous financial andmarket risks, including those described below, as well as general economic andbusiness risks.  The following discussionprovides information concerning the material risks and uncertainties that wehave identified and believe may adversely affect our business, our financialcondition and our results of operations. Before you decide whether to invest in our securities, you should carefullyconsider these risks and 

 

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uncertainties, together with all of the other information included inthis Quarterly Report on Form 10-Q our Annual Report on Form 10-K forthe year ended December 31, 2007 and in our other public filings.

 

**RisksRelated to Our Restatement, Internal Control Deficiencies, and StockholderLitigation**

** **

***Matters relating to or arising from our recent restatement, errors inour historic revenue recognition practices, and weaknesses in our internalcontrols, including the outcome of pending stockholder litigation as well asany future litigation, could have a material adverse effect on our business,revenues, operating results, or financial condition.***

*** ***

In March 2007, ouraudit committee initiated a review of our historic revenue recognitionpractices that resulted in the restatement of our previously filed financialstatements for the fiscal years ended December 26, 2004 and December 25,2005, each of the interim quarterly periods of such fiscal years, and thefirst, second, and third quarters of the fiscal year ended December 31,2006.  On October 16, 2007, weannounced the completion of the investigation and filed our Annual Report on Form 10-Kfor the year ended December 31, 2006, which included our consolidatedfinancial statements for the year ended December 31, 2006 and our restatedfinancial statements for the years ended December 26, 2004 and December 25,2005.

 

Among other adverse effects,the investigation and resulting restatement resulted in the initiation ofsecurities class action litigation, which is described in greater detail below,and could result in other civil litigation or formal or informal regulatoryinquiries or litigation, any of which could have a material adverse effect onour business, revenues, operating results, or financial condition.  Under Delaware law, our bylaws, and certainindemnification agreements, we may have an obligation to indemnify certaincurrent and former officers and directors, as well as certain underwriters andstockholders, in relation to these matters. Such indemnification may have a material adverse effect on our business,results of operations, and financial condition to the extent insurance does notcover our costs.  The insurance carriersthat provide our directors’ and officers’ liability policies may seek torescind or deny coverage with respect to those pending investigations oractions in whole or in part, or we may not have sufficient coverage under suchpolicies, in which case our business, results of operations, and financialcondition may be materially and adversely affected.

 

In particular, we, certainof our directors and executive officers and others are defendants in aconsolidated federal securities class action. The consolidated complaint alleges that defendants violated sections10(b), 20(a) and 20A of the Exchange Act and SEC Rule 10b-5promulgated thereunder, as well as sections 11 and 15 of the Securities Act bymaking false and misleading statements and omissions relating to our financialstatements and internal controls with respect to revenue recognition thatrequired restatement.  We cannot provideany assurances that the final outcome of this consolidated securities classaction will not have a material adverse effect on our business, results ofoperations, or financial condition.  Wemay become subject to additional litigation, regulatory inquiries, includingpotential SEC inquiries, or other proceedings or actions arising out of theaudit committee review and the related restatement of our historic financialstatements.  Litigation and any potentialregulatory actions or proceedings can be time-consuming and expensive and coulddivert management time and attention from our business, which could have amaterial adverse effect on our revenues and results of operations.  The adverse resolution of any specificlawsuit or potential regulatory action or proceeding could have a materialadverse effect on our business, results of operations, and financial condition.

 

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***If we fail to establish and maintain proper and effective internalcontrols, our ability to produce accurate financial statements on a timelybasis could be impaired, which would adversely affect our consolidatedoperating results, our ability to operate our business and our stock price.***

*** ***

Ensuring that we haveadequate internal financial and accounting controls and procedures in place toproduce accurate financial statements on a timely basis is a costly andtime-consuming effort that needs to be re-evaluated frequently.  Failure on our part to have effectiveinternal financial and accounting controls would cause our financial reportingto be unreliable, could have a material adverse effect on our business,operating results, and financial condition and could cause the trading price ofour common stock to fall dramatically. We and our current and former independent registered public accountingfirms have identified control deficiencies in the past, and in connection withits investigation and determination to restate our financial statements, ouraudit committee, management, and current independent registered publicaccounting firm have recently identified deficiencies in our internal controlsthat contributed to the need to restate our historic financial statements.  As a result of these identified controldeficiencies, our chief executive officer and chief financial officer havedetermined that, as of September 30, 2008, our internal controls overfinancial reporting were not effective to provide reasonable assuranceregarding the reliability of our financial reporting and the preparation offinancial statements for external reporting in accordance with accountingprinciples generally accepted in the United States of America.

 

Our audit committee’sinvestigation of revenue recognition issues identified weaknesses and othercontrol deficiencies relating principally to revenue recognition and theprocesses and procedures associated with customer transactions and interactionwith and review by our finance department. As part of its internal control deficiencies letter dated October 15,2007, our current independent registered public accounting firm identified amaterial weakness relating to revenue recognition.  Our independent registered public accountingfirm noted that we did not have policies and procedures in place to ensure thatmodifications to, or side agreements associated with, our standard terms ofcontract are properly documented and approved. Our independent registered public accounting firm also cited a lack ofunderstanding of the accounting consequences of modifications to standard termsby certain sales employees and a lack of communication among our sales,engineering, and finance departments to ensure that all sales transactions areproperly tracked, documented, approved, and recorded.

 

In their October 2007letter, our independent registered public accounting firm identified additionalcontrol deficiencies that it determined to be significant deficiencies but thatit did not deem to be material weaknesses. In particular, it identified a significant deficiency relating tosegregation of duties, noting among other things that in certain instancesjournal entries and account reconciliations were approved by the preparer ofthe entry or reconciliation.  Ourindependent registered public accounting firm also noted a significantdeficiency relating to post-closing adjusting journal entries and recommendedthat we reassess the timeline of our financial statement process to ensure thatwe have reasonable time to conclude a thorough financial statement closingprocess.  Finally, our independentregistered public accounting firm identified significant deficiencies relatingto recording certain purchase transactions, where parts were ordered andaccepted by our engineering department, without approval or involvement of ourfinance department, and where fixed assets were not properly classified fordepreciation purposes.

 

In connection with the auditof our consolidated financial statements for the year ended December 31,2007 and the effectiveness of our internal control over financial reporting asof December 31, 2007, our independent registered public accounting firmidentified a material weakness and some significant deficiencies in ourinternal control over financial reporting in a letter dated March 10,2008. Specifically, our independent registered public accounting firm noted acontinuing material weakness relating to revenue recognition and our policiesand procedures to ensure that modifications to, or side agreements associatedwith, our standard terms of contract were properly approved, documented,tracked and recorded.

 

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Remedying our materialweakness and other control deficiencies require substantial management time andattention and could result in our incurring substantial incremental expenses,including with respect to increasing the size of our finance organization andretaining outside consultants to assist in the implementation of new internalcontrols.  Any failure to remedy ouridentified control deficiencies or any additional errors or delays in ourfinancial reporting, whether or not resulting from a failure to remedy thedeficiencies that resulted in the current restatement, would have a materialadverse effect on our business and results of operations and could have asubstantial adverse impact on the trading price of our common stock and ourrelationships with customers.

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting to provide reasonable assurance regarding the reliabilityof our financial reporting and the preparation of financial statements for externalpurposes in accordance with accounting principles generally accepted in theUnited States of America.  Our managementdoes not expect that our internal control over financial reporting will preventor detect all errors and all fraud.  Acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the control system’s objectives willbe met.  Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that misstatements due to error or fraud will not occur orthat all control issues and instances of fraud, if any, within the company willhave been detected.  As discussed in thisQuarterly Report on Form 10-Q, our audit committee and management,together with our current and former independent registered public accountingfirms, have identified numerous control deficiencies in the past and mayidentify additional deficiencies in the future.

 

We are required to complywith Section 404 of the Sarbanes-Oxley Act of 2002 in connection with ourAnnual Report on Form 10-K for our year ending December 31,2008.  We have expended significantresources in developing the necessary documentation and testing proceduresrequired by Section 404 of the Sarbanes-Oxley Act.  We cannot be certain that the actions we havetaken and are taking to improve our internal controls over financial reportingwill be sufficient or that we will be able to implement our planned processes andprocedures in a timely manner.  In addition,we may be unable to produce accurate financial statements on a timelybasis.  Any of the foregoing could causeinvestors to lose confidence in the reliability of our consolidated financialstatements, which could cause the market price of our common stock to declineand make it more difficult for us to finance our operations and growth.

 

**RisksRelated to Our Business and Industry**

** **

***Our focus on independent telephone operating companies limits our salesvolume with individual customers and makes our future operating resultsdifficult to predict.***

*** ***

We currently focus our salesefforts on the independent telephone operating companies, or IOCs, in NorthAmerica.  These customers generallyoperate relatively small networks with limited capital expenditure budgets.  Accordingly, we believe the total potentialsales volume for our products at any individual IOC is limited, and we mustidentify and sell products to new IOC customers each quarter to continue toincrease our sales.  In addition, thespending patterns of many IOCs are characterized by small and sporadicpurchases.  Moreover, because our salesto IOCs are predominantly based on purchase orders rather than long-termcontracts, our customers may stop purchasing equipment from us with littleadvance notice.  As a result, we havelimited backlog, our future operating results are difficult to predict and wewill likely continue to have limited visibility into future operating results.

 

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***We have had limited experience selling to larger telecommunicationcompanies, and our ability to recognize revenue, if any, from contracts withthese companies may be difficult to predict***

 

In early 2008, we announcedthat we had been selected as the lead access equipment provider for asubstantial broadband upgrade by Fairpoint Communications, Inc. in itsnetwork in Vermont, New Hampshire, and Maine. Fairpoint recently acquired these networks through its acquisitions ofcertain assets of Verizon Communications, Inc.  Fairpoint represented our first customerconsidered Tier 1 based on the number of telephone lines serviced.  Occam has limited experience selling orservicing Tier 1 customers, and our ability to recognize substantial revenuefrom the Fairpoint relationship or any other relationships we may establishwith Tier 1 customers will depend on several factors, including, among others,the timing of orders and the terms and conditions of the orders, which canaffect our ability to satisfy revenue recognition criteria.  We cannot currently predict with any accuracythe timing of orders from Fairpoint, and any delays or termination of Fairpoint’santicipated upgrade of its northern New England network could have a materialadverse effect on our future revenues and operating results.

 

***Fluctuations in our quarterly and annual operating results mayadversely affect our business and prospects.***

*** ***

A number of factors, many ofwhich are outside our control, may cause or contribute to significantfluctuations in our quarterly and annual operating results.  These fluctuations may make financialplanning and forecasting more difficult. In addition, these fluctuations may result in unanticipated decreases inour available cash, which could limit our growth and delay implementation ofour expansion plans.  Factors that maycause or contribute to fluctuations in our operating results include:

 

·                  fluctuations in demand for our products,including the timing of decisions by our target customers to upgrade theirnetworks and deploy our products;

 

·                  delays in customer orders as IOCs evaluateand consider their capital expenditures and investments in light of theindustry transition from copper wire to fiber;

 

·                  increases in warranty accruals and othercosts associated with remedying any performance problems relating to ourproducts;

 

·                  seasonal reductions in field work during thewinter months and the impact of annual budgeting cycles;

 

·                  the size and timing of orders we receive andproducts we ship during a given period;

 

·                  delays in recognizing revenue underapplicable revenue recognition rules, particularly from government-fundedcontracts, as a result of additional commitments we may be required to make tosecure purchase orders, or with respect to sales to value-added resellers wherewe cannot establish based on our credit analysis that collectability isreasonably assured;

 

·                  introductions or enhancements of products,services and technologies by us or our competitors, and market acceptance ofthese new or enhanced products, services and technologies;

 

·                  the amount and timing of our operating costs,including sales, engineering and product costs and capital expenditures; and

 

·                  quarter-to-quarter variations in ouroperating margins resulting from changes in our product mix.

 

·                  deterioration of  credit market and economic conditions.

 

As a consequence, operatingresults for a particular future period are difficult to predict and priorresults are not necessarily indicative of results to be expected in thefuture.  Any of the foregoing factors mayhave a material adverse effect on our consolidated results of operations.

 

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***We have a history of losses and negative cash flow, and we may not beable to generate positive operating income and cash flows in the future tosupport the expansion of our operations.***

 

We have incurred significantlosses since our inception.  As of September 30,2008, we had an accumulated deficit of $127.7 million.  We incurred substantial losses in 2007.  We expect to continue to incur losses in2008.  We cannot assure you that we willnot continue to incur losses or experience negative cash flow in thefuture.  We have only generated operatingincome in the quarters ended December 25, 2005, September 24, 2006,and December 31, 2006.  Ourcontinued inability to generate positive operating income and cash flow wouldmaterially and adversely affect our liquidity, consolidated results ofoperations and consolidated financial condition.

 

A significant portion of ourexpenses is fixed, and we expect to continue to incur significant expenses forresearch and development, sales and marketing, customer support, and generaland administrative functions.  Given therate of growth in our customer base, our limited operating history and theintense competitive pressures we face, we may be unable to adequately controlour operating costs.  In order to achieveand maintain profitability, we must increase our revenue while maintainingcontrol over our expense levels.

 

***Because our markets are highly competitive and dominated by large,well-financed participants, we may be unable to compete effectively.***

 

Competition in our market isintense, and we expect competition to increase. The market for broadband access equipment is dominated primarily bylarge, established suppliers such as ADTRAN, Inc., Alcatel-Lucent, andTellabs, Inc.  While these suppliersfocus primarily on large service providers, they have competed, and mayincreasingly compete, in the IOC market segment.  In addition, a number of emerging companies,including Calix Networks, Inc., have developed, or are developing,products that compete with ours, including within our core IOC segment.

 

Our ability to competesuccessfully depends on a number of factors, including:

 

·                  the successfulidentification and development of new products for our core market;

 

·                  our ability totimely anticipate customer and market requirements and changes in technologyand industry standards;

 

·                  our ability togain access to and use technologies in a cost-effective manner;

 

·                  our ability totimely introduce cost-effective new products;

 

·                  our ability todifferentiate our products from our competitors’ offerings;

 

·                  our ability togain customer acceptance of our products;

 

·                  the performanceof our products relative to our competitors’ products;

 

·                  our ability tomarket and sell our products through effective sales channels;

 

·                  our ability toestablish and maintain effective internal financial and accounting controls andprocedures and restore confidence in our financial reporting;

 

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·                  the protectionof our intellectual property, including our processes, trade secrets andknow-how; and

 

·                  our ability toattract and retain qualified technical, executive and sales personnel.

 

Many of our existing andpotential competitors are larger than we are and have greater financialresources and better-established brands and customer relationships.  Unlike many of our competitors, we do notprovide financing to potential customers. In addition, many of our competitors have broader product lines than wedo, so they can offer bundled products, which may appeal to certain customers.

 

As the market for ourproducts is new and evolving, winning customers early in the growth of thismarket is critical to our ability to expand our business and increaserevenue.  Because the products that weand our competitors sell require a substantial investment of time and funds toinstall, customers are typically reluctant to switch equipment suppliers once aparticular supplier’s product has been installed.  As a result, competition among equipmentsuppliers to secure contracts with potential customers is particularly intenseand will continue to place pressure on product pricing.  Some of our competitors have in the past andmay in the future resort to offering substantial discounts to win new customersand generate cash flows.  If we areforced to reduce prices in order to secure customers, we may be unable tosustain gross margins at desired levels or achieve profitability.

 

***We have relied, and expect to continue to rely, on our BLC 6000 productline for the substantial majority of our sales, and a decline in sales of ourBLC 6000 line would cause our overall sales to decline proportionally.***

 

We have derived asubstantial majority of our sales in recent years from our BLC 6000 productline.  We expect that sales of thisproduct line will continue to account for a substantial majority of our salesfor the foreseeable future.  Any factorsadversely affecting the pricing of, or demand for, our BLC 6000 line, includingcompetition or technological change, could cause our sales to declinematerially and our business to suffer.

 

***If we fail to enhance our existing products and develop new productsand features that meet changing customer requirements and support newtechnological advances, our sales would be materially and adversely affected.***

 

Our market is characterizedby rapid technological advances, frequent new product introductions, evolvingindustry standards and recurring changes in end-user requirements.  Our future success will depend significantlyon our ability to anticipate and adapt to such changes and to offer, on atimely and cost-effective basis, products and features that meet changingcustomer demands and industry standards. The timely development of new or enhanced products is a complex anduncertain process, and we may not be able to accurately anticipate markettrends or have sufficient resources to successfully manage long developmentcycles.  We may also experience design,manufacturing, marketing and other difficulties that could delay or prevent thedevelopment, introduction or marketing of new products and enhancements.  The introduction of new or enhanced productsalso requires that we manage the transition from older products to these new orenhanced products in order to minimize disruption in customer ordering patternsand ensure that adequate supplies of new products are available for delivery tomeet anticipated customer demand.  If weare unable to develop new products or enhancements to our existing products ona timely and cost-effective basis, or if our new products or enhancements failto achieve market acceptance, our business, consolidated financial conditionand consolidated results of operations would be materially and adverselyaffected.

 

We recently enhanced our BLC6000 platform to support active Gigabit Ethernet fiber-to-the-premises, orFTTP, services.  Although we haveinvested significant time and resources to develop this 

 

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enhancement, theseFTTP-enabled products are relatively new, with limited sales to date, andmarket acceptance of these products may fall below our expectations.  In addition, in 2007 we acquired new GPONtechnology and we may experience unanticipated delays in improving or deployingit.  The introduction of new products isalso expected to place pressure on our gross margins as most new productsrequire time and increased sales volumes to achieve cost-saving efficiencies inproduction.  To the extent our newproducts and enhancements do not achieve broad market acceptance, we may notrealize expected returns on our investments, and we may lose current andpotential customers.

 

***Our efforts to increase our sales and marketing efforts to largertelecom operators such as Fairpoint Communications, which may require us tobroaden our reseller relationships, may be unsuccessful.***

 

To date, our sales andmarketing efforts have been focused on small and mid-sized IOCs.  A key element of our long-term strategy is toincrease sales to large IOCs, competitive local exchange carriers, regionalBell operating companies and international telecom service providers.  We may be required to devote substantialtechnical, marketing and sales resources to the pursuit of these customers, whohave lengthy equipment qualification and sales cycles.  In particular, sales to these customers mayrequire us to upgrade our products to meet more stringent performance criteria,develop new customer-specific features or adapt our product to meetinternational standards.  We may incursubstantial technical, sales and marketing expenses and expend significantmanagement effort without any assurance of generating sales.  Because we have limited resources and largetelecom operators may be reluctant to purchase products from a relatively smallsupplier like us, we plan to target these customers in cooperation withstrategic resellers.  These resellerrelationships may not be available to us, and if formed, may include terms,such as exclusivity and non-competition provisions, that restrict ouractivities or impose onerous requirements on us.  Moreover, in connection with theserelationships, we may forego direct sales opportunities in favor of formingrelationships with strategic resellers. If we are unable to successfully increase our sales to larger telecomoperators or expand our reseller relationships, we may be unable to implementour long-term growth strategy.

 

***If we were to experience payment problems with either resellers orcustomers for whom we are unable to assess creditworthiness, it could have anadverse impact on our business, operating results, or financial condition.***

 

Value added resellers, orVARs, account for a substantial portion of our revenue in a quarter.  Some of these VARs are not well capitalized,making collection of receivables from them uncertain.  In addition, in certain instances, we arelimited in our ability to evaluate the creditworthiness of direct customers whodecline to provide us with financial information.  In 2007, in connection with our restatement,we adopted a revenue recognition policy that we would not recognize revenuefrom those resellers who lacked an independent ability to pay us until wereceived cash payment.  Sales to VARs forwhom we are not able to recognize revenue until we receive cash payment arereflected as deferred revenue.  Anycollection problems we may experience with these resellers or direct customerscould have an adverse impact on our business, operating results, or financialcondition.  In particular, when we selland ship to resellers and other customers, legal title to the equipment passesto the reseller or customer on shipment, even though we have not recognizedrevenue and, under GAAP accounting requirements, the equipment continues to bereflected as inventory on our balance sheet. Any material collection issues with resellers or other customers couldresult in increases in bad debt expense or collection costs, inventoryimpairments, or adjustments to our reported revenues or deferred revenues, anyof which could result in a decline in our stock price.

 

***We may be unable to successfully expand our internationaloperations.  In addition, ourinternational expansion plans, if implemented, will subject us to a variety ofrisks that may adversely affect our business.***

 

We currently generate almostall of our sales from customers in North America and have very limitedexperience marketing, selling and supporting our products and services outsideNorth America or managing 

 

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the administrative aspectsof a worldwide operation.  While weintend to expand our international operations, we may not be able to create ormaintain international market demand for our products.  In addition, regulations or standards adoptedby other countries may require us to redesign our existing products or developnew products suitable for sale in those countries.  If we invest substantial time and resourcesto expand our international operations and are unable to do so successfully andin a timely manner, our business, financial condition and results of operationswill suffer.

 

In the course of expandingour international operations and operating overseas, we will be subject to avariety of risks, including:

 

·                  differingregulatory requirements, including tax laws, trade laws, labor regulations,tariffs, export quotas, custom duties or other trade restrictions and changesthereto;

 

·                  greaterdifficulty supporting and localizing our products;

 

·                  different orunique competitive pressures as a result of, among other things, the presenceof local equipment suppliers;

 

·                  challengesinherent in efficiently managing an increased number of employees over largegeographic distances, including the need to implement appropriate systems,policies, benefits and compliance programs;

 

·                  limited orunfavorable intellectual property protection;

 

·                  changes in aspecific country’s or region’s political or economic conditions; and

 

·                  restrictions onthe repatriation of earnings.

 

***If we lose any of our key personnel, or are unable to attract, trainand retain qualified personnel, our ability to manage our business and continueour growth would be negatively impacted.***

 

Our success depends, inlarge part, on the continued contributions of our key management, engineering,sales and marketing personnel, many of whom are highly-skilled and would bedifficult to replace.  None of our seniormanagement or key technical or sales personnel is bound by a written employmentcontract to remain with us for a specified period.  In addition, we do not currently maintainkey-man life insurance covering our key personnel.  If we lose the services of any key personnel,our business, financial condition and results of operations may suffer.

 

Competition for skilledpersonnel, particularly those specializing in engineering and sales isintense.  We cannot be certain that wewill be successful in attracting and retaining qualified personnel, or thatnewly-hired personnel will function effectively, either individually or as agroup.  In particular, we must continueto expand our direct sales force, including hiring additional sales managers,to grow our customer base and increase sales. Even if we are successful in hiring additional sales personnel, newsales representatives require up to a year to become effective, and the recentloss of a senior sales executive could have an adverse impact on our ability torecruit and train additional sales personnel. In addition, our industry is characterized by frequent claims relatingto unfair hiring practices.  We maybecome subject to such claims and may incur substantial costs in defendingourselves against these claims, regardless of their merits.  If we are unable to effectively hire,integrate and utilize new personnel, the execution of our business strategy andour ability to react to changing market conditions may be impeded, and ourbusiness, financial condition and results of operations could suffer.

 

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***We may have difficulty managing our growth, which could limit ourability to increase sales and cash flow.***

 

We have experiencedsignificant growth in our sales and operations in recent years.  We expect to expand our research anddevelopment, sales, marketing and support activities, including our activitiesoutside the U.S. Our historical growth has placed, and planned future growth isexpected to continue to place, significant demands on our management, as wellas our financial and operational resources, as required to:

 

·                  implement andmaintain effective financial disclosure controls and procedures, including theremediation of internal control deficiencies identified in our audit committeeinvestigation;

 

·                  implementappropriate operational and financial systems;

 

·                  manage a largerorganization;

 

·                  expand ourmanufacturing and distribution capacity;

 

·                  increase oursales and marketing efforts; and

 

·                  broaden ourcustomer support capabilities.

 

In addition, as discussed inthis Form 10-Q under Part I, Item 3, our internal controls overfinancial reporting are currently ineffective, and we will need to expand ourfinance organization and retain outside advisors to implement adequate andeffective financial controls.  If wecannot grow or manage our business growth effectively, we may not be able toexecute our business strategies and our business, consolidated financialcondition and consolidated results of operations would suffer.

 

***Because we depend upon a small number of outside contractors tomanufacture our products, our operations could be disrupted if we encounterproblems with any of these contractors.***

 

We do not have internalmanufacturing capabilities and rely upon a small number of contractmanufacturers to build our products.  Inparticular, we rely on Flash Electronics, Inc. for the manufacture of ourBLC 6000 blade products.  Our reliance ona small number of contract manufacturers makes us vulnerable to possible capacityconstraints and reduced control over component availability, deliveryschedules, manufacturing yields and costs. We do not have long-term supply contracts with our primary contractmanufacturers.  Consequently, thesemanufacturers are not obligated to supply products to us for any specificperiod, in any specific quantity or at any certain price, except as may beprovided by a particular purchase order. If any of our manufacturers were unable or unwilling to continuemanufacturing our products in required volumes and at high quality levels, wewould have to identify, qualify and select acceptable alternativemanufacturers.  It is possible that analternate source may not be available to us when needed or may not be in aposition to satisfy our production requirements at commercially reasonableprices and quality.  Any significantinterruption in manufacturing would require us to reduce our supply of productsto our customers, which in turn could have a material adverse effect on ourcustomer relations, business, consolidated financial condition and consolidatedresults of operations.

 

We recently moved a portionof our manufacturing to the overseas facilities of our primary contractmanufacturer.  This transition presents anumber of risks, including the potential for a supply interruption or areduction in manufacturing quality or controls, any of which would negativelyimpact our business, customer relationships and results of operations.

 

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***We depend on sole source and limited source suppliers for keycomponents and license technology from third parties.  If we are unable to source these componentsand technologies on a timely basis, we will not be able to deliver our productsto our customers.***

 

We depend on sole source andlimited source suppliers for key components of our products.  Any of the sole source and limited sourcesuppliers upon which we rely could stop producing our components, ceaseoperations entirely, or be acquired by, or enter into exclusive arrangementswith, our competitors.  We do not havelong-term supply agreements with our suppliers, and our purchase volumes arecurrently too low for us to be considered a priority customer by most of oursuppliers.  As a result, these supplierscould stop selling components to us at commercially reasonable prices, or atall.  Any such interruption or delay mayforce us to seek similar components from alternate sources, if available atall.  Switching suppliers may requirethat we redesign our products to accommodate the new component and maypotentially require us to re-qualify our products with our customers, which wouldbe costly and time-consuming.  Any interruptionin the supply of sole source or limited source components would adverselyaffect our ability to meet scheduled product deliveries to our customers andwould materially and adversely affect our business, consolidated financialcondition and consolidated results of operations.

 

Periodically, we may berequired to license technology from third parties to develop new products orproduct enhancements.  These third-partylicenses may be unavailable to us on commercially reasonable terms, if at all.  Our inability to obtain necessary third-partylicenses may force us to obtain substitute technology of lower quality orperformance standards or at greater cost, any of which could seriously harm thecompetitiveness of our products and which would result in a material andadverse effect on our business, consolidated financial condition andconsolidated results of operations.

 

***If we fail to accurately predict our manufacturing requirements andmanage our inventory, we could incur additional costs, experience manufacturingdelays, or lose revenue.***

 

Lead times for the materialsand components that we order through our contract manufacturers may varysignificantly and depend on numerous factors, including the specific supplier,contract terms and market demand for a component at a given time.  If we overestimate our productionrequirements, our contract manufacturers may purchase excess components andbuild excess inventory.  If our contractmanufacturers purchase excess components that are unique to our products orbuild excess products, we could be required to pay for these excess parts orproducts and recognize related inventory write-down costs.  If we underestimate our product requirements,our contract manufacturers may have inadequate component inventory, which couldinterrupt manufacturing of our products and result in delays or cancellation ofsales.  In prior periods we haveexperienced excess and obsolete inventory write-downs which impact the Company’scost of goods sold.  This may continue inthe future, which would have an adverse effect on our gross margins,consolidated financial condition and consolidated results of operations.  If we underestimate demand, we will haveinadequate inventory, which could slow down or interrupt the manufacturing ofour products and result in delays in shipment and our ability to recognizerevenue.

 

***If our products contain undetected defects, including errors andinteroperability issues, we could incur significant unexpected expenses toremedy the defects, which could have a material adverse effect on our sales,results of operations or financial condition.***

 

Although our products aretested prior to shipment, they may contain software or hardware errors, defectsor interoperability issues (collectively described as “defects”) that can onlybe detected when deployed in live networks that generate high amounts ofcommunications traffic.  We also continueto introduce new products that may have undetected software or hardwaredefects.  Our customers may discoverdefects in our products after broad deployment and as their networks areexpanded and modified.  Any defects inour products discovered in the future, or failures of our customers’ networks,whether caused by our 

 

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products or those of anothervendor, could result in lost sales and market share and negative publicityregarding our products.  For example,during fiscal 2004, we experienced unusually high repair costs related to theeffect of lightning strikes on selected BLC 6000 installations.  As a result, we experienced higher thananticipated costs of sales, which management believes were necessary tomaintain customer satisfaction.  In 2007,we experienced higher than average failures of certain assemblies that werefabricated between October 2005 and January 2006 and identifieddesign issues associated with a transistor that resulted in equipmentdisruption and that required a re-engineering effort.  As a result, we increased our warrantyaccruals in 2007.  Any similaroccurrences in the future could have a material adverse effect on our business,consolidated financial condition and consolidated results of operations.

 

Our business is dependent onthe capital spending patterns of telecom operators, and any decrease or delayin capital spending by our customers, such as recently appears to have occurredamong IOCs evaluating their capital expenditures and investment decisions inlight of the industry transition from copper wire to fiber, would adverselyaffect our consolidated operating results and consolidated financial condition.

 

***Demand for our products depends on the magnitude and timing of capitalspending by telecom service providers as they construct, expand and upgradetheir networks.  The capital spendingpatterns of telecom service providers are dependent on a variety of factors,including:***

 

·                  competitivepressures, including pricing pressures;

 

·                  consumer demandfor new services;

 

·                  an emphasis ongenerating sales from services delivered over existing networks instead of newnetwork construction or upgrades;

 

·                  the timing ofannual budget approvals;

 

·                  evolvingindustry standards and network architectures;

 

·                  free cash flowand access to external sources of capital; and

 

·                  completion ofmajor network upgrades.

 

Beginning in late 2000 andcontinuing into 2004, the telecom industry experienced a severe downturn, andmany telecom service providers filed for bankruptcy.  Those companies that survived the downturnsubstantially reduced their investments in new equipment.  In addition, uncertain and volatile capitalmarkets depressed the market values of telecom service providers and restrictedtheir access to capital, resulting in delays or cancellations of certainprojects.  More recently, we believecapital expenditures among IOCs have been adversely affected as our customersconsider their investment and capital expenditure decisions in light of theindustry transition from copper wire to fiber. Because many of our customers are IOCs, their revenues are particularlydependent upon intercarrier payments (primarily interstate and intrastateaccess charges) and federal and state universal service subsidies.  The FCC and some states are consideringchanges to both intercarrier payments and universal service subsidies, and suchchanges could reduce IOC revenues. Furthermore, many IOCs use government-supported loan programs or grantsto finance capital spending.  Changes tothose programs, such as the United States Department of Agriculture’s RuralUtility Service, could reduce the ability of IOCs to access capital.  Any decision by telecom service providers toreduce capital expenditures, whether caused by economic cycles, changes ingovernment regulations and subsidies, or other reasons, would have a materialadverse effect on our business, consolidated financial condition and results ofoperations.

 

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Demand for our products isdependent on the willingness of our customers to deploy new services, thesuccess of our customers in selling new services to their subscribers, and thewillingness of our customers to utilize IP and Ethernet technologies in localaccess networks.

 

Demand for our products isdependent on the success of our customers in deploying and selling services totheir subscribers.  Our BLC 6000 platformsimultaneously supports IP-based services, such as broadband Internet, VoIP,IPTV and FTTP, and traditional voice services. If end-user demand for IP-based services does not grow as expected ordeclines and our customers are unable or unwilling to deploy and market thesenewer services, demand for our products may decrease or fail to grow at rateswe anticipate.

 

Our strategy includesdeveloping products for the local access network that incorporate IP andEthernet technologies.  If thesetechnologies are not widely adopted by telecom service providers for use inlocal access networks, demand for our products may decrease or not grow.  As a result, we may be unable to sell ourproducts to recoup our expenses related to the development of these productsand our consolidated results of operations would be harmed.

 

***Changes in existing accounting or taxation rules or practices mayadversely affect our consolidated results of operations.***

 

Changes in existingaccounting or taxation rules or practices, or varying interpretations ofcurrent rules or practices, could have a significant adverse effect on ourfinancial results or the manner in which we conduct our business.  For example, prior to fiscal 2006, weaccounted for options granted to employees using the intrinsic value method,which, given that we generally granted employee options with exercise pricesequal to the fair market value of the underlying stock at the time of grant,resulted in no compensation expense. Beginning in fiscal 2006, we began recording expenses for our stock-basedcompensation plans, including option grants to employees, using the fair valuemethod, under which we expect our ongoing accounting charges related to equityawards to employees to be significantly greater than those we would haverecorded under the intrinsic value method. We expect to continue to use stock-based compensation as a significantcomponent of our compensation package for existing and future employees.  Accordingly, changes in accounting forstock-based compensation expense under the newer accounting method are expectedto have a material adverse affect on our reported results.  Any similar changes in accounting or taxationrules or practices could have a material impact on our consolidatedfinancial results.

 

***We may pursue acquisitions, which may involve a number of risks.  If we are unable to address and resolve theserisks successfully, such acquisitions could have a material adverse impact toour business, consolidated results of operations and consolidated financialcondition.***

 

We may make acquisitions ofbusinesses, products or technologies to expand our product offerings andcapabilities, customer base and business. In October 2007, we acquired certain assets and assumed certainliabilities of Terawave Communications and we have evaluated, and expect tocontinue to evaluate, a wide array of potential strategic transactions.  We have limited experience making suchacquisitions.  Any of these transactionscould be material to our consolidated financial condition and results ofoperations.  The anticipated benefit ofacquisitions may never materialize.  Inaddition, the process of integrating an acquired business, products ortechnologies may create unforeseen operating difficulties andexpenditures.  Some of the areas where wemay face acquisition-related risks include:

 

·                  diversion ofmanagement time and potential business disruptions;

 

·                  expenses,distractions and potential claims resulting from acquisitions, whether or notthey are completed;

 

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·                  retaining andintegrating employees from any businesses we may acquire;

 

·                  issuance ofdilutive equity securities or incurrence of debt;

 

·                  integratingvarious accounting, management, information, human resource and other systemsto permit effective management;

 

·                  incurringpossible write-offs, impairment charges, contingent liabilities, amortizationexpense or write-offs of goodwill;

 

·                  difficultiesintegrating and supporting acquired products or technologies;

 

·                  unexpectedcapital equipment outlays and related costs;

 

·                  insufficientrevenues to offset increased expenses associated with the acquisition;

 

·                  under-performanceproblems associated with acquisitions;

 

·                  opportunitycosts associated with committing capital to such acquisitions;, and

 

·                  becominginvolved in acquisition-related litigation.

 

Foreign acquisitions involveunique risks in addition to those mentioned above, including those related tointegration of operations across different cultures and languages, currencyrisks and the particular economic, political and regulatory risks associatedwith specific countries.  We cannotassure that we will be able to address these risks successfully, or at all,without incurring significant costs, delay or other operating problems.  Our inability to resolve any of such riskscould have a material adverse impact on our business, consolidated financialcondition and consolidated results of operations.

 

***Business combinations and other financial restructurings by telecomservice providers or our competitors could adversely affect our business.***

 

In recent years, the telecomservice provider market has undergone substantial consolidation, illustrated bythe merger of SBC Communications Inc. with AT&T Inc., the merger of SBCCommunications (now renamed AT&T) with BellSouth Corporation (now alsorenamed AT&T), and the merger of Verizon Communications Inc. with MCI, Inc.  Transactions such as these generally havenegative implications for equipment suppliers like us, including a reduction inthe number of potential customers for telecom equipment products, a decrease inaggregate capital spending and greater pricing power by service providers overequipment suppliers.  Continuedconsolidation of the telecom service provider industry, including among IOCcustomers which we focus on, could make it more difficult for us to grow ourcustomer base, increase sales of our products and maintain adequate grossmargins.

 

The telecommunicationsequipment industry is also characterized by frequent mergers and acquisitions,as illustrated by the merger of Alcatel with Lucent Technologies and theacquisition of Advanced Fibre Communications, Inc. by Tellabs.  An acquisition of one of our competitors, ormerger between our competitors, could harm our competitive position or causeour target customers to delay purchases of our products while they assess theimpact of the combination.  If a largercompany with more resources were to acquire a competitor of ours, they mayinvest additional resources in developing, marketing and supporting competitiveproducts, which would negatively impact our business, consolidated financialcondition and consolidated results of operations.

 

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***Our customers are subject to government regulation, and changes incurrent or future laws or regulations that negatively impact our customerscould harm our business.***

 

The jurisdiction of theFederal Communications Commission, or FCC, extends to the entiretelecommunications industry, including our customers.  Future FCC regulations affecting thebroadband access industry, our customers, or the service offerings of ourcustomers, may harm our business.  Forexample, FCC regulatory policies affecting the availability of data andInternet services may impede the penetration of our customers into certainmarkets or affect the prices they may charge in such markets.  Furthermore, many of our customers aresubject to FCC rate regulation of interstate telecommunications services, andare recipients of federal universal service subsidies implemented andadministered by the FCC.  In addition,many of our customers are subject to state regulation of intrastatetelecommunications services, including rates for such services, and may alsoreceive state universal service subsidies. Changes in FCC or state rate regulations or federal or state universalservice subsidies or the imposition of taxes on Internet access service, couldadversely affect our customers’ revenues and capital spending plans.  In addition, international regulatory bodiesare beginning to adopt standards and regulations for the telecom industry.  These domestic and foreign standards, lawsand regulations address various aspects of VoIP and broadband use, includingissues relating to liability for information retrieved from, or transmittedover, the Internet.  Changes instandards, laws and regulations, or judgments in favor of plaintiffs inlawsuits against service providers could adversely affect the development ofInternet and other IP-based services. This, in turn, could directly or indirectly materially adversely impactthe telecom industry in which our customers operate.  To the extent our customers are adverselyaffected by laws or regulations regarding their business, products or serviceofferings, our business, financial condition and results of operations wouldsuffer.

 

***If we fail to comply with regulations and evolving industry standards,sales of our existing and future products could be adversely affected.***

 

The markets for our productsare characterized by a significant number of laws, regulations and standards,both domestic and international, some of which are evolving as new technologiesare deployed.  Our products are requiredto comply with these laws, regulations and standards, including thosepromulgated by the FCC.  For example, theFCC recently required that all facilities-based providers of broadband Internetaccess and interconnect VoIP services meet the capability requirements of theCommunications Assistance for Law Enforcement Act by May 14, 2007.  Subject to certain statutory parameters, weare required to make available to our customers, on a reasonably timely basisand at a reasonable charge, such features or modifications as are necessary topermit our customers to meet those capability requirements.  In some cases, we are required to obtain certificationsor authorizations before our products can be introduced, marketed or sold.  There can be no assurance that we will beable to continue to design our products to comply with all necessaryrequirements in the future.  Accordingly,any of these laws, regulations and standards may directly affect our ability tomarket or sell our products.

 

Some of our operations areregulated under various federal, state and local environmental laws.  Our planned international expansion willlikely subject us to additional environmental and other laws.  For example, the European Union Directive2002/96/EC on waste electrical and electronic equipment, known as the WEEEDirective, requires producers of certain electrical and electronic equipment,including telecom equipment, to be financially responsible for the specifiedcollection, recycling, treatment and disposal of past and present coveredproducts placed on the market in the European Union.  The European Union Directive 2002/95/EC onthe restriction of the use of hazardous substances in electrical and electronicequipment, known as the RoHS Directive, restricts the use of certain hazardoussubstances, including lead, in covered products.  Failure to comply with these and otherenvironmental laws could result in fines and penalties and decreased sales,which could adversely affect our planned international expansion and ourconsolidated operating results.

 

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***We may not be able to protect our intellectual property, which couldadversely affect our ability to compete effectively.***

 

We depend on our proprietarytechnology for our success and ability to compete.  We currently hold 24 issued patents and haveseveral patent applications pending.  Werely on a combination of patent, copyright, trademark and trade secret laws, aswell as confidentiality agreements and licensing arrangements, to establish andprotect our proprietary rights.  Existingpatent, copyright, trademark and trade secret laws will afford us only limitedprotection.  In addition, the laws ofsome foreign countries do not protect proprietary rights to the same extent, asdo the laws of the U.S.  We cannot assureyou that any pending patent applications will result in issued patents, andissued patents could prove unenforceable. Any infringement of our proprietary rights could result in significantlitigation costs.  Further, any failureby us to adequately protect our proprietary rights could result in ourcompetitors offering similar products, resulting in the loss of our competitiveadvantage and decreased sales.

 

Despite our efforts toprotect our proprietary rights, attempts may be made to copy or reverseengineer aspects of our products, or to obtain and use information that weregard as proprietary.  Accordingly, wemay be unable to protect our proprietary rights against unauthorizedthird-party copying or use.  Furthermore,policing the unauthorized use of our intellectual property would be difficultfor us.  Litigation may be necessary inthe future to enforce our intellectual property rights, to protect our tradesecrets or to determine the validity and scope of the proprietary rights ofothers.  Litigation could result insubstantial costs and diversion of resources and could have a material adverseeffect on our business, consolidated financial condition and consolidatedresults of operations.

 

***We could become subject to litigation regarding intellectual propertyrights that could materially harm our business.***

 

We may be subject tointellectual property infringement claims that are costly to defend and couldlimit our ability to use some technologies in the future.  Our industry is characterized by frequentintellectual property litigation based on allegations of infringement ofintellectual property rights.  From timeto time, third parties have asserted against us and may assert against us inthe future patent, copyright, trademark or other intellectual property rightsto technologies or rights that are important to our business.  In addition, we have agreed, and may in thefuture agree, to indemnify our customers for any expenses or liabilitiesresulting from claimed infringements of patents, trademarks or copyrights ofthird parties.  Any claims asserting thatour products infringe, or may infringe on, the proprietary rights of thirdparties, with or without merit, could be time-consuming, resulting in costlylitigation and diverting the efforts of our management.  These claims could also result in productshipment delays or require us to modify our products or enter into royalty orlicensing agreements.  Such royalty orlicensing agreements, if required, may not be available to us on acceptableterms, if at all.

 

***Our business could be shut down or severely impacted if a naturaldisaster or other unforeseen catastrophe occurs, particularly in California.***

 

Our business and operationsdepend on the extent to which our facilities and products are protected againstdamage from fire, earthquakes, power loss and similar events.  Some of our key business activities currentlytake place in regions considered as high risk for certain types of naturaldisasters.  Despite precautions we havetaken, a natural disaster or other unanticipated problem could, among otherthings, hinder our research and development efforts, delay the shipment of ourproducts and affect our ability to receive and fulfill orders.  While we believe that our insurance coverageis comparable to those of similar companies in our industry, it does not coverall natural disasters, in particular, earthquakes and floods.

 

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**RisksRelated to Our Common Stock**

 

***Our executive officers, directors and their affiliates hold a largepercentage of our stock and their interests may differ from other stockholders.***

 

As of December 31,2007, our executive officers, directors and their affiliates beneficiallyowned, in the aggregate, approximately 31.3% of our outstanding commonstock.  Investment funds affiliated withU.S. Venture Partners and Norwest Venture Partners, collectively controlapproximately 27.7% of our outstanding common stock.  Representatives of U.S. Venture Partners andNorwest Venture Partners are directors of Occam.  These stockholders have significant influenceover most matters requiring approval by stockholders, including the election ofdirectors, any amendments to our certificate of incorporation and significantcorporate transactions.

 

***Our stock price may be volatile, and you may not be able to resellshares of our common stock at or above the price you paid.***

 

Our shares of common stockbegan trading on The NASDAQ Global Market in November 2006.  An active public market for our shares on TheNASDAQ Global Market may not be sustained. In particular, limited trading volumes and liquidity may limit theability of stockholders to purchase or sell our common stock in the amounts andat the times they wish.  Trading volumein our common stock tends to be modest relative to our total outstandingshares, and the price of our common stock may fluctuate substantially(particularly in percentage terms) without regard to news about us or generaltrends in the stock market.

 

In addition, the tradingprice of our common stock could become highly volatile and could be subject towide fluctuations in response to various factors, some of which are beyond ourcontrol.  These factors include thosediscussed in this “Risk Factors” section of this Quarterly Report on Form 10-Qand others such as:

 

·                  quarterlyvariations in our consolidated results of operations or those of ourcompetitors;

 

·                  changes inearnings estimates or recommendations by securities analysts;

 

·                  announcementsby us or our competitors of new products, significant contracts, commercialrelationships, acquisitions or capital commitments;

 

·                  developmentswith respect to intellectual property rights;

 

·                  our ability todevelop and market new and enhanced products on a timely basis;

 

·                  commencementof, or involvement in, litigation;

 

·                  changes ingovernmental regulations or in the status of our regulatory approvals; and

 

·                  a slowdown inthe telecom industry or general economy.

 

·                  deterioration of credit market andeconomic conditions.

 

In recent years, the stockmarket in general, and the market for technology companies in particular, hasexperienced extreme price and volume fluctuations that have often beenunrelated or disproportionate to the operating performance of thosecompanies.  Broad market and industryfactors may seriously affect the market price of our common stock, regardlessof our actual operating performance.  Inaddition, in the past, following periods of volatility in the overall marketand the market price of a particular company’s securities, securities classaction litigation has often been instituted against these companies.  We are currently a 

 

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defendant in securitiesclass action litigation arising from our restatement.  This litigation or any additional litigationthat may be instituted against us could result in substantial costs and adiversion of our management’s attention and resources.

 

***Provisions in our charter documents and under Delaware law coulddiscourage a takeover that stockholders may consider favorable.***

 

Provisions in ourcertificate of incorporation and bylaws, as amended and restated upon theclosing of this offering, may have the effect of delaying or preventing achange of control or changes in our management. These provisions include the following:

 

·                  our board ofdirectors has the right to elect directors to fill a vacancy created by theexpansion of the board of directors or the resignation, death or removal of adirector, which prevents stockholders from being able to fill vacancies on ourboard of directors;

 

·                  ourstockholders may not act by written consent or call special stockholders’meetings; as a result, a holder, or holders, controlling a majority of ourcapital stock would not be able to take certain actions other than at annualstockholders’ meetings or special stockholders’ meetings called by the board ofdirectors, the chairman of the board, the chief executive officer or thepresident;

 

·                  our certificateof incorporation prohibits cumulative voting in the election of directors,which limits the ability of minority stockholders to elect director candidates;

 

·                  stockholdersmust provide advance notice to nominate individuals for election to the boardof directors or to propose matters that can be acted upon at a stockholders’meeting, which may discourage or deter a potential acquiror from conducting asolicitation of proxies to elect the acquiror’s own slate of directors orotherwise attempting to obtain control of our company; and

 

·                  our board ofdirectors may issue, without stockholder approval, shares of undesignatedpreferred stock; the ability to authorize undesignated preferred stock makes itpossible for our board of directors to issue preferred stock with voting orother rights or preferences that could impede the success of any attempt toacquire us.

 

As a Delaware corporation,we are also subject to certain Delaware anti-takeover provisions.  Under Delaware law, a corporation may notengage in a business combination with any holder of 15% or more of its capitalstock unless the holder has held the stock for three years or, among otherthings, the board of directors has approved the transaction.  Our board of directors could rely on Delawarelaw to prevent or delay an acquisition of us.

 

***We may be unable to raise additional capital to fund our futureoperations, and any future financings or acquisitions could result insubstantial dilution to existing stockholders.***

 

While we anticipate our cashbalances and any cash from operations will be sufficient to fund our operationsfor at least the next 12 months, we may need to raise additional capital tofund operations in the future.  There isno guarantee that we will be able to raise additional equity or debt fundingwhen or if it is required.  The terms ofany financing, if available, could be unfavorable to us and our stockholdersand could result in substantial dilution to the equity and voting interests ofour stockholders.  Any failure to obtainfinancing when and as required would have an adverse and material effect on ourbusiness, consolidated financial condition and consolidated results ofoperations.

 

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***If securities or industry analysts do not publish research or publishmisleading or unfavorable research about our business, our stock price andtrading volume could decline.***

 

The trading market for ourcommon stock depends in part on the research and reports that securities orindustry analysts publish about us or our business.  If no or few securities or industry analystscover our company, the trading price for our stock would be negativelyimpacted.  If one or more of the analystswho covers us downgrades our stock or publishes misleading or unfavorableresearch about our business, our stock price would likely decline.  If one or more of these analysts ceasescoverage of our company or fails to publish reports on us regularly, demand forour stock could decrease, which could cause our stock price or trading volumeto decline.

 

**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

 

None.

 

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

None

 

**ITEM 5.  OTHER INFORMATION**

 

None

 

**ITEM 6.  EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Exhibit Title**                                                                                                                                                                     |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.01               |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  |
| 31.02               |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  |
| 32.01               |       | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|   | OCCAM NETWORKS, INC. |
|--------|----------------------|
|   | (Registrant)         |
|   |                 |
|   |                 |
|   | By:                  | /s/ JEANNE SEELEY |
|   |                 | Jeanne Seeley |
|   |                 | Chief Financial Officer |
|   |                 | (Principal Financial and  Accounting Officer) |

 

Dated: November 10,2008

 

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**EXHIBIT INDEX**
| **Exhibit  Number** | ** ** | **Exhibit Title**                                                                                                                                                                     |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.01               |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  |
| 31.02               |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  |
| 32.01               |       | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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