Table ofContents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2010**

 

**Or**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from                    to                     **

 

**Commission file number: 001-33069**

 

**OCCAMNETWORKS, 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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o 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 18, 2010, the number of shares outstanding of the registrant’scommon stock was 21,161,838 shares.

 

 

 

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Table of Contents

 

**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 | 13       |
|                                    |                                                                                        |     |
| Item 3.                                 | Quantitative  And Qualitative Disclosures About Market Risk                                 | 24       |
|                                    |                                                                                        |     |
| Item 4.                                 | Controls And Procedures                                                                     | 24       |
|                                    |                                                                                        |     |
| PART II—OTHER  INFORMATION    | 25                                                                                          |
|                                    |                                                                                        |     |
| Item 1.                                 | Legal Proceedings                                                                           | 25       |
|                                    |                                                                                        |     |
| Item 1a.                                | Risk Factors                                                                                | 27       |
|                                    |                                                                                        |     |
| Item 2.                                 | Unregistered  Sales Of Equity Securities And Use Of Proceeds                                | 45       |
|                                    |                                                                                        |     |
| Item 3.                                 | Defaults Upon  Senior Securities                                                            | 45       |
|                                    |                                                                                        |     |
| Item 4.                                 | Removed and Reserved                                                                        | 45       |
|                                    |                                                                                        |     |
| Item 5.                                 | Other Information                                                                           | 45       |
|                                    |                                                                                        |     |
| Item 6.                                 | Exhibits                                                                                    | 45       |

 

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Table of Contents

 

**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,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                  | ** ** | **2010**               | ** ** | **2009 (*)**     | ** ** |
| ** **                                                                                                                                                                                                                  | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                                             |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                   |       | $                      | 44,174     |                  | $          | 39,268 |   |
| Restricted cash                                                                                                                                                                                                             |       | 1,804                  |       | 5,721                 |       |
| Accounts receivable, net                                                                                                                                                                                                    |       | 21,189                 |       | 14,874                |       |
| Inventories                                                                                                                                                                                                                 |       | 13,481                 |       | 12,927                |       |
| Prepaid and other current assets                                                                                                                                                                                            |       | 1,247                  |       | 1,426                 |       |
| Total current assets                                                                                                                                                                                                        |       | 81,895                 |       | 74,216                |       |
| Property and equipment, net                                                                                                                                                                                                 |       | 8,254                  |       | 8,699                 |       |
| Intangibles, net                                                                                                                                                                                                            |       | 85                     |       | 156                   |       |
| Other assets                                                                                                                                                                                                                |       | 71                     |       | 91                    |       |
| Total assets                                                                                                                                                                                                                |       | $                      | 90,305     |                  | $          | 83,162 |   |
|                                                                                                                                                                                                                        |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                              |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                        |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                                            |       | $                      | 17,231     |                  | $          | 8,274 |   |
| Accrued liabilities                                                                                                                                                                                                         |       | 9,816                  |       | 6,999                 |       |
| Deferred revenue                                                                                                                                                                                                            |       | 8,131                  |       | 13,035                |       |
| Deferred rent                                                                                                                                                                                                               |       | 361                    |       | 361                   |       |
| Capital lease obligations                                                                                                                                                                                                   |       | —                 |       | 26                    |       |
| Total current liabilities                                                                                                                                                                                                   |       | 35,539                 |       | 28,695                |       |
| Deferred rent, net of current portion                                                                                                                                                                                       |       | 1,336                  |       | 1,597                 |       |
| Capital lease obligations, net of current portion                                                                                                                                                                           |       | —                 |       | 20                    |       |
| Total liabilities                                                                                                                                                                                                           |       | 36,875                 |       | 30,312                |       |
| Commitments and contingencies (See Note 5)                                                                                                                                                                                  |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                                                  |       |                   |       |                  |       |
| Common stock, $0.001 par value, 250,000,000 shares  authorized; and 21,161,838 shares issued and outstanding at  September 30, 2010 and 20,669,089 shares issued and outstanding at  December 31, 2009. |       | 289                    |       | 289                   |       |
| Additional paid-in capital                                                                                                                                                                                                  |       | 191,374                |       | 188,013               |       |
| Accumulated deficit                                                                                                                                                                                                         |       | (138,233               | )          | (135,452              | )          |
| Total stockholders’ equity                                                                                                                                                                                             |       | 53,430                 |       | 52,850                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                             |       | $                      | 90,305     |                  | $          | 83,162 |   |

 

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*Derivedfrom audited consolidated financial statements included in the registrant’sAnnual Report on Form 10-K for the year ended December 31, 2009.

 

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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,  2010**     | ** ** | **September 30,  2009**    | ** ** | **September 30,  2010** | ** ** | **September 30,  2009** | ** ** |
| ** **                                                    | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                       |       | $                                | 29,810     |                            | $          | 21,673 |   | $ | 75,930 |   | $ | 62,120 |   |
| Cost of revenue                                               |       | 17,878                           |       | 12,725                          |       | 44,396 |   | 36,970 |   |
| Gross margin                                                  |       | 11,932                           |       | 8,948                           |       | 31,534 |   | 25,150 |   |
| Operating expenses:                                           |       |                             |       |                            |       |   |   |   |   |
| Research and product-development                              |       | 3,949                            |       | 3,762                           |       | 11,549 |   | 12,186 |   |
| Sales and marketing                                           |       | 5,082                            |       | 4,459                           |       | 14,200 |   | 13,404 |   |
| General and administrative                                    |       | 1,898                            |       | 1,760                           |       | 5,702 |   | 6,179 |   |
| Restructuring charges                                         |       | —                           |       | —                          |       | — |   | 213 |   |
| Loss on litigation settlement                                 |       | —                           |       | 1,700                           |       | — |   | 1,700 |   |
| Merger related expenses                                       |       | 2,840                            |       | —                          |       | 2,840 |   | — |   |
| Total operating expenses                                      |       | 13,769                           |       | 11,681                          |       | 34,291 |   | 33,682 |   |
| Loss from operations                                          |       | (1,837                           | )          | (2,733                          | )          | (2,757 | ) | (8,532 | ) |
| Other income (expense), net                                   |       | —                           |       | 43                              |       | — |   | 147 |   |
| Interest income (expense), net                                |       | 2                                |       | 38                              |       | 8 |   | 274 |   |
| Loss before benefit from income taxes                         |       | (1,835                           | )          | (2,652                          | )          | (2,749 | ) | (8,111 | ) |
| Provision for (benefit from) income taxes                     |       | 16                               |       | (21                             | )          | 32 |   | (35 | ) |
| Net loss                                                      |       | $                                | (1,851     | )                               | $          | (2,631 | ) | $ | (2,781 | ) | $ | (8,076 | ) |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Net loss per share attributable to common  stockholders:      |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                             |       | $                                | (0.09      | )                               | $          | (0.13 | ) | $ | (0.13 | ) | $ | (0.40 | ) |
| Weighted average shares attributable to common  stockholders: |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                             |       | 20,973                           |       | 20,273                          |       | 20,820 |   | 20,214 |   |

 

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,  2010**    | ** ** | **September 30,  2009** | ** ** |
| ** **                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Operating activities**                                                     |       |                            |       |   |   |
| Net loss                                                                     |       | $                               | (2,781     | ) | $ | (8,076 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                            |       |   |   |
| Stock-based compensation                                                     |       | 2,032                           |       | 2,685 |   |
| Depreciation and amortization                                                |       | 2,212                           |       | 2,501 |   |
| Accounts receivable reserves                                                 |       | (11                             | )          | 176 |   |
| Inventory reserves                                                           |       | 8                               |       | 160 |   |
| Changes in operating assets and liabilities:                                 |       |                            |       |   |   |
| Accounts receivable                                                          |       | (6,304                          | )          | 1,073 |   |
| Inventories                                                                  |       | (562                            | )          | 6,428 |   |
| Prepaid expenses and other current assets                                    |       | 199                             |       | 1,710 |   |
| Accounts payable                                                             |       | 8,957                           |       | 230 |   |
| Accrued expenses                                                             |       | 2,817                           |       | (173 | ) |
| Deferred revenue                                                             |       | (4,904                          | )          | (5,415 | ) |
| Deferred rent                                                                |       | (261                            | )          | (244 | ) |
| Net cash provided by operating activities                                    |       | 1,402                           |       | 1,055 |   |
| **Investing activities**                                                     |       |                            |       |   |   |
| Decrease (increase) in restricted cash                                       |       | 3,917                           |       | 7,512 |   |
| Net purchases of property and equipment                                      |       | (1,696                          | )          | (707 | ) |
| Net cash provided by investing activities                                    |       | 2,221                           |       | 6,805 |   |
| **Financing activities**                                                     |       |                            |       |   |   |
| Exercise of stock options                                                    |       | 1,052                           |       | 61 |   |
| Payments of payroll taxes for vested restricted  stock units                 |       | (259                            | )          | — |   |
| Capital lease obligations                                                    |       | (46                             | )          | (17 | ) |
| Proceeds from employee stock purchase plan                                   |       | 536                             |       | 571 |   |
| Net cash provided by financing activities                                    |       | 1,283                           |       | 615 |   |
| Net increase in cash and cash equivalents                                    |       | 4,906                           |       | 8,475 |   |
| Cash and cash equivalents, beginning of period                               |       | 39,268                          |       | 30,368 |   |
| Cash and cash equivalents, end of period                                     |       | $                               | 44,174     |   | $ | 38,843 |   |
| **Supplemental disclosure of cash  flow information:**                       |       |                            |       |   |   |
| Income taxes paid                                                            |       | $                               | 211        |   | $ | 202 |   |
| Interest paid                                                                |       | $                               | 3          |   | $ | 4 |   |

 

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.****   ****Businessand Basis of Presentation**

 

Occam Networks, Inc. (“Occam,” the “Company,” “we”or “us”) develops markets and supports innovative broadband access productsdesigned to enable telecom service providers to offer bundled voice, video andhigh speed internet, or Triple Play, services over both copper and fiber opticnetworks.  The Company’s coreproduct line is the Broadband Loop Carrier (BLC), an integrated hardwareand software platform that uses Internet Protocol (IP) and Ethernettechnologies to increase the capacity of local access networks, enabling the deliveryof advanced Triple Play services.    The Company also offers afamily of Optical Network Terminals (ONTs) for fiber optic networks, remoteterminal cabinets, and professional services.

 

*Basis ofPresentation*

 

The accompanying condensedconsolidated financial statements are unaudited.  The condensed consolidated balance sheet atDecember 31, 2009 is derived from Occam’s audited consolidated financialstatements included in its Annual Report on Form 10-K for the year endedDecember 31, 2009.  These unauditedcondensed consolidated financial statements reflect all material entries,consisting only of normal recurring entries, which, in the opinion ofmanagement, are necessary to fairly state our financial position, results ofoperations and cash flows for the interim periods.  The results of operations for the currentinterim periods are not necessarily indicative of results to be expected forthe 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 andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and notesrequired by GAAP for annual financial statements.  Because all of the disclosures required byGAAP are not included, as permitted by the rules of the Securities andExchange Commission, or the SEC, these interim condensed consolidated financialstatements should be read in conjunction with the audited consolidated financialstatements and accompanying notes included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2009. In the opinion ofmanagement, all adjustments consisting of normal and recurring entriesconsidered necessary for a fair statement of the results for the interimperiods have been included in the Company’s financial position as of September 30,2010, the results of its operations for the three and nine months ended September 30,2010 and 2009, and its cash flow for the nine months ended September 30,2010 and 2009.

 

Certain amounts in the priorperiods presented have been reclassified to conform to the current periodfinancial statement presentation. These reclassifications had no effect onpreviously reported net income (loss).

 

The Company warrants itsproducts for periods up to five years and records an estimated warranty accrualwhen shipped.

 

*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 amounts reported in the consolidated financial statements andthe accompanying notes.  Actual resultscould differ from those estimates and such differences may be material to the consolidatedfinancial statements.

 

*RevenueRecognition*

 

Occam generally recognizes revenue under Staff Accounting BulletinCodification Topic 13, Revenue Recognition, in the period when all of therequirements of Staff Accounting Bulletin Codification Topic 13: RevenueRecognition have been met:

 

·                  persuasive evidence of salesarrangements,

 

·                  delivery has occurred orservices have been rendered,

 

·                  the buyer’s price is fixedor determinable and

 

·                  collection is reasonablyassured.

 

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The Company enters into transactions with value-added resellers wherethe resellers may not have the ability to pay for these sales independent ofpayment to them by the end-user. In these cases, the Company does not recognizerevenue until payment has been received, provided the remaining revenuerecognition criteria are met.

 

The Company sells hardware products that contain embedded operatingsystem software. These tangible products contain software components andnon-software components that function together to deliver the product’sessential functionality. Revenue is recognized for these products under StaffAccounting Bulletin Codification Topic 13: Revenue Recognition. The Company hasone minor software network management product which is a stand- alone productnot essential to the functionality of other products that the Company sells.Revenue is recognized for this product in accordance with FASB AccountingStandard Codification Topic 985, Software. The amount of sales of this productand the related revenue recognized to date by the Company has been immaterial.

 

In addition to the aforementioned general policy, the Company entersinto transactions that represent multiple-element arrangements, which mayinclude training and post-sales technical support and maintenance to ourcustomers as needed to assist them in installation or use of our products, andmakes provisions for these costs in the periods of sale. Multiple-elementarrangements are assessed to determine whether they can be separated into morethan one unit of accounting. A multiple-element arrangement is separated intomore than one unit of accounting if all of the following criteria are met:

 

·                  the delivered item(s) hasvalue to the customer on a stand-alone basis;

 

·                  there is objective andreliable evidence of the fair value of the undelivered item(s); and

 

·                  the arrangement includes ageneral right of return relative to the delivered item(s) and delivery orperformance of the undelivered item(s) is considered probable andsubstantially in our control.

 

If these criteria are not met, then revenue is deferred until suchcriteria are met or until the period(s) over which the last undeliveredelement is delivered. If there is objective and reliable evidence of fair valuefor all units of accounting in an arrangement, the arrangement consideration isallocated to the separate units of accounting based on each unit’s relativefair value. When the Company is unable to establish selling price using vendorspecific objective evidence or third party evidence, the Company uses “estimatedselling price” (“ESP”) in its allocation of arrangement consideration. Theobjective of ESP is to determine the price at which the Company would transacta sale if the product or service were sold on a stand-alone basis. ESP isgenerally used for new products, and it applies to a small proportion of theCompany’s arrangements with multiple deliverables. The Company determines ESPfor a product or service by considering multiple factors including, but notlimited to, geographies, market conditions, competitive landscape, internalcosts, gross margin objectives, and pricing practices.

 

Incertain circumstances, the Company enters into arrangements with customers whoreceive financing support in the form of long-term low interest rate loans fromthe United States Department of Agriculture’s Rural Utilities Service, or RUS.The terms of the RUS contracts provide that in certain instances transfer oftitle of the Company’s products does not occur until customer acceptance, TheCompany recognizes revenue on these RUS contracts upon customer acceptance,given the remaining revenue recognition criteria, such as collectability, underStaff Accounting Bulletin Codification Topic 13: Revenue Recognition have beenmet.

 

**2.     Pending Merger**

 

OnSeptember 16, 2010, the Company announced that it had entered into anAgreement and Plan of Merger, which is referred to in this report as the MergerAgreement with Calix, Inc. The Merger agreement provides that, upon theterms and subject to the conditions set forth therein, Calix will acquire Occamand as a result, Occam will become a wholly-owned subsidiary of Calix.

 

Thetransaction is valued at approximately $171 million, or approximately $7.75 pershare of Occam common stock (based on the closing trading price of Calix’sstock as of September 14, 2010). Subject to the terms and conditions of the Merger Agreement, at theeffective time of the first merger, each share of Occam’s common stock issuedand outstanding will be converted into the right to receive $3.8337 in cash,without interest plus $0.2925 of a validly issued, fully paid andnon-assessable share of Calix common stock. At the closing of the merger, former Occam stockholders will own between14.1% and 15.9% of the outstanding shares of Calix’s common stock (based on thenumber of Calix shares outstanding as of September 14, 2010).

 

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Thecompletion of the transaction is subject to various closing conditions,including obtaining the approval of our stockholders, registering the shares ofCalix common stock to be issued in connection with the merger and receipt ofregulatory clearance under the Hart-Scott-Rodino Antitrust Improvements Act of1976, as amended.  The Company currentlyexpects the transaction to close in the fourth quarter of 2010 or the firstquarter of 2011.  Both companies willcontinue to operate their businesses independently until the close of themerger.

 

TheCompany has incurred $2.8 million, in merger related expenses for the quarterended September 30, 2010. The Company expects to incur continuing expensesassociated with the merger.

 

Theforegoing description of the Merger Agreement and other references to the MergerAgreement in the Form 10-Q do not purport to be complete and are qualifiedin their entirety by reference to the full text of the Merger Agreement, a copyof which has been filed with the SEC and the terms of which are incorporatedherein by reference to the full text of the Merger Agreement.

 

**3.****   ****Fair ValueMeasurements**

 

Effective January 1,2008, the Company adopted the authoritative guidance on fair valuemeasurements. Fair value is defined as an exit price, representing the amountthat would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants.  As such, fair value is a market-basedmeasurement that should be determined based on assumptions that marketparticipants would use in pricing an asset or a liability.  As a basis for considering such assumptions,the guidance establishes a three-tier value hierarchy, which prioritizes theinputs used in the valuation methodologies 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 thisguidance, we measure our cash equivalents at fair value.  Our cash equivalents are classified withinLevel 1.  Cash equivalents are valuedprimarily using quoted market prices utilizing market observable inputs.  At September 30, 2010, cash equivalentsconsisted of money market funds measured at fair value on a recurringbasis.  Fair value of our money marketfunds was $35.5 million at September 30, 2010.

 

Effective January 1,2009, the Company adopted the FASB staff position that delayed the guidance onfair value measurements for non financial assets and non financial liabilities.The adoption of this guidance did not have a material impact on the Company’sconsolidated financial statements.

 

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

 
| ** **        | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials     |       | $                            | 962        |                        | $          | 274 |   |
| Work-in-process   |       | 286                          |       | 56                          |       |
| Finished goods(1) |       | 12,233                       |       | 12,597                      |       |
| Total inventories |       | $                            | 13,481     |                        | $          | 12,927 |   |

 

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(1)                                 $4.7 millionand $6.2 million of finished goods inventory were shipped to customers asof September 30, 2010 and December 31, 2009, respectively. Themajority were sent to RUS contract customers and value-added resellers. Revenueand related cost of revenue were not recognized at the time of shipments asdefined by the Company’s revenue recognition policy and therefore were includedin inventories. For more information regarding our revenue recognition policy,see Revenue Recognition under Note 1 to these unaudited condensedconsolidated financial statements.

 

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**4.    Net Loss Per Share Attributable to CommonStockholders**

 

The following table sets forth the computation of basic and dilutedloss per share (in thousands, except per share data):

 
| ** **                                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                  | ** ** | **September 30,  2010**     | ** ** | **September 30,  2009**    | ** ** | **September 30,  2010** | ** ** | **September 30,  2009** | ** ** |
| ** **                                                                                  | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss attributable to common stockholders                                                |       | $                                | (1,851     | )                               | $          | (2,631 | ) | $ | (2,781 | ) | $ | (8,076 | ) |
| **Shares used in computation:**                                                             |       |                             |       |                            |       |   |   |   |   |
| Weighted average common shares outstanding used in  computation of basic net loss per share |       | 20,973                           |       | 20,273                          |       | 20,820 |   | 20,214 |   |
| Dilutive effect of stock options                                                            |       |                             |       | —                          |       |   |   | — |   |
| Dilutive effect of common stock warrants                                                    |       |                             |       | —                          |       |   |   | — |   |
| Shares used in computation of diluted net income  (loss) per share                          |       | 20,973                           |       | 20,273                          |       | 20,820 |   | 20,214 |   |
| Basic  and diluted net loss per share                                                       |       | $                                | (0.09      | )                               | $          | (0.  13 | ) | $ | (0.13 | ) | $ | (0.40 | ) |

 

Basic and diluted net loss per share, are identical because we hadlosses from continuing operations and the impact of common equivalent shareswas anti-dilutive and therefore excluded. The anti-dilutive weighted averageshares that were excluded from the shares used in computing diluted net lossper share for three months ended September 30, 2010 and September 30,2009, amounted to approximately 0.7 million and 3.5 million shares,respectively and for the nine months ended September 30, 2010 andSeptember 30, 2009, amounted to approximately 0.6 million and 3.3 millionshares, respectively.

 

**5.    Commitments and Contingencies**

 

The Company leases itsoffice facilities and certain equipment under non-cancelable operating leaseagreements, which expire at various dates through 2016. Operating leasescontain escalation clauses with annual base rent adjustments or a cost ofliving adjustment. Total rent expense was $0.3 million for both the threemonths ended September 30, 2010 and September 30, 2009, and $0.9million, for both the nine months ended September 30, 2010 and September 30,2009 respectively.

 

Minimum annual leasecommitments under non-cancelable operating leases are as follows (inthousands):

 
| **Remainder of fiscal year,**        | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2010                                 |       | $          | 389        |   |
| Fiscal year ending December 31, |       |       |       |
| 2011                                 |       | 1,504      |       |
| 2012                                 |       | 1,540      |       |
| 2013                                 |       | 1,577      |       |
| 2014                                 |       | 674        |       |
| 2015                                 |       | 328        |       |
| Total Minimum Lease Payments         |       | $          | 6,012      |   |

 

Royalties

 

From time to time, theCompany may license certain technology for incorporation into its products.Under the terms of these multi-year agreements, royalty payments will be madebased on per-unit sales of certain of the Company’s products. The Companyincurred royalty expense of $85,000 and $63,000 for the three months endedSeptember 30, 2010 and September 30, 2009, respectively. The Companyincurred $215,000 and $171,000 in royalty expenses for the nine months endedSeptember 30 2010 and September 30, 2009, respectively.

 

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*LegalProceedings*

 

*MergerTransaction Class Action Lawsuits*

 

OnSeptember 17, 20, and 21, 2010, three purported class action complaintswere filed in the California Superior Court for Santa Barbara County:  (1) Kardosh v. Occam Networks, Inc.,et al., Case No. 1371748 (“Kardosh Complaint”); (2) Kennedy v. OccamNetworks, Inc., et al., Case No. 1371762 (“Kennedy Complaint”); and (3) Moghaddamv. Occam Networks, Inc., et al., Case No. 1371802 (“MoghaddamComplaint”) (together, the “California Complaints”).  Each of the California Complaints namesOccam, the members of the Occam board, and Calix as defendants.  The Kennedy Complaint also names Calix’smerger subsidiaries (Ocean Sub I, Inc. and Ocean Sub II, LLC) asdefendants.  The California Complaintsgenerally allege that the members of the Occam board breached their fiduciaryduties in connection with the proposed acquisition of Occam by Calix, by, amongother things, engaging in an allegedly unfair process and agreeing to anallegedly unfair price for the proposed merger transaction.  The California Complaints further allege thatOccam and the other entity defendants aided and abetted these alleged breachesof fiduciary duty.  The plaintiffs seekvarious forms of relief, including an order certifying a class of Occamshareholders and a preliminary and permanent injunction of the proposed merger.

 

OnOctober 6, 2010, another purported class action complaint was filed in theCourt of Chancery of the State of Delaware: Steinhart, et al. v. Howard-Anderson, et al., Case No. 5878-VCL(the “Delaware Complaint”).  Like theCalifornia Complaints, the Delaware Complaint names the members of Occam’sboard as defendants and generally alleges that the members of the Occam boardbreached their fiduciary duties in connection with the proposed acquisition ofOccam by Calix, by, among other things, engaging in an allegedly unfair processand agreeing to an allegedly unfair price for the proposed mergertransaction.  Also, like the plaintiffswho filed the California Complaint, the plaintiffs who filed the DelawareComplaint seek various forms of relief, including an order certifying a classof Occam shareholders and a preliminary and permanent injunction of theproposed merger.

 

Occamis reviewing the complaints and has not yet formally responded to them, but believesthe plaintiffs’ allegations are without merit and intends to defend againstthem vigorously.  However, litigation isinherently uncertain and there can be no assurance regarding the likelihoodthat Occam’s defense of these actions will be successful.  Additional complaints containingsubstantially similar allegations may be filed in the future.

 

*AtwaterPartners of Texas LLC v. AT&T, Inc. et al.*

 

On May 27, 2010, Atwater Partners of Texas LLC filed a complaintin the U.S. District Court for the Eastern District of Texas alleginginfringement of certain U.S. Patent Nos. 6,490,296; 7,158,523; 7,161,953;7,310,310; and 7,349,401 by 25 companies, including Occam.  The complaint seeks an injunction,unspecified damages, and other relief. The disclosure of each of the patents in suit relates to the field ofdigital networks. The Company has answered the complaint and has assertedthirteen affirmative defenses, including invalidity, non-infringement, andpatent exhaustion.  This case iscurrently pending.

 

Due to the inherent uncertainties of litigation, the Company cannotaccurately predict the ultimate outcome of the matter.

 

*IPO ShortSwing Profits Litigation*

 

In late 2007, the Company received a letter from Vanessa Simmonds, aputative shareholder, demanding that the Company investigate and prosecute aclaim for alleged short-swing trading in violation ofSection 16(b) of the Securities Exchange Act of 1934, 15 U.S.C.§ 78p(b), by the underwriter of the Company’s initial public offering (“IPO”)and certain unidentified directors, officers and shareholders of the Company(then known as Accelerated Networks). The Company evaluated the demand anddeclined 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 the Company IPO, alleging violations of Section 16(b). Thecomplaint alleges that the combined number of shares of the Company commonstock beneficially owned by the lead underwriter and certain unnamed officers,directors, and principal shareholders exceeded ten percent of its outstandingcommon stock from the date of Occam’s IPO on June 23, 2000, through atleast June 22, 2001. It further alleges that those entities andindividuals were thus subject to the reporting requirements ofSection 16(a) and the short-swing trading prohibition ofSection 16(b), and failed to comply with those provisions. The complaintseeks to recover from the lead underwriter any “short-swing profits” obtainedby it in violation of Section 16(b). The Company was named as a nominaldefendant in the action, but has no liability for the asserted claims. None ofthe directors or officers of the Company are named as defendants in thisaction.

 

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On October 29, 2007, the case was reassigned to Judge James L.Robart along with fifty-four other Section 16(b) cases seekingrecovery of short-swing profits from underwriters in connection with variousIPOs. The Underwriters and Issuers have filed a motion to dismiss the case andreply briefs have been filed. The Court heard oral argument on January 19,2009 from all parties. On March 12, 2009, the Court dismissed the 16(b) complaint against the issuer defendants including Occam on bothjurisdictional and statute of limitation grounds. On March 31, 2009, thePlaintiffs filed a Notice of Appeal and their opening brief on August 26,2009. The Issuers including Occam and the underwriters filed their responses onOctober 2, 2009. Each party’s reply briefs have been filed as ofNovember 17, 2009. The Appellate Court for the Ninth Circuit heard oralargument on October 5, 2010. It is likely that it will be at least until April 2011before the Court renders a decision on this matter.

 

Due to the inherent uncertainties of threatened litigation, the Companycannot accurately predict the ultimate outcome of the matter. The Company hasnot recorded any accruals related to the demand letters orSection 16(b) litigation because the Company expects any resultingresolution to be covered by its insurance policies.

 

*IPOAllocation Litigation*

 

In June 2001, three putative stockholder class action lawsuitswere filed against Accelerated Networks, certain of its then officers anddirectors and several investment banks that were underwriters of AcceleratedNetworks’ initial public offering. The cases, which were later consolidated,were filed in the United States District Court for the Southern District of NewYork, and the operative Complaint was filed on April 19, 2002. TheComplaint was filed on behalf of investors who purchased Accelerated Networks’stock between June 22, 2000 and December 6, 2000 and allegedviolations of Sections 11 and 15 of the 1933 Act andSections 10(b) and 20(a) and Rule 10b-5 of the 1934 Actagainst one or both of Accelerated Networks and the individual defendants. Theclaims were based on allegations that the underwriter defendants agreed toallocate stock in Accelerated Networks’ initial public offering to certaininvestors in exchange for excessive and undisclosed commissions and agreementsby those investors to make additional purchases in the aftermarket atpre-determined prices. Plaintiffs alleged that the prospectus for AcceleratedNetworks’ initial public offering was false and misleading in violation of thesecurities laws because it did not disclose these arrangements.

 

The Company believes that over three hundred other companies have beennamed in over three hundred similar lawsuits that have been coordinated withthe Company’s case. In October 2002, the plaintiffs voluntarily dismissedthe individual defendants without prejudice. On February 1, 2003 a motionto dismiss filed by the issuer defendants was heard and the court dismissed the10(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 Second Circuit Court of Appeals vacated the district court’sdecision granting class certification in those six cases on December 5,2006. Plaintiffs filed a motion for rehearing. On April 6, 2007, theSecond Circuit denied the petition, but noted that Plaintiffs could ask theDistrict Court to certify a more narrow class than the one that was rejected.

 

The parties in the approximately 300 coordinated cases, including theCompany’s, reached a settlement. On October 5, 2009, the Court approvedthe settlement and certified a settlement class. Six notices of appeal of the SecondCircuit of the Court’s approval of the settlement have been filed. As of October 6,2010, the deadline for filing appellate briefs opposing the settlement, onlyone brief was filed. On October 8, 2010 the remaining objectors along withPlaintiff filed a stipulation withdrawing their appeals with prejudice. Theremainder of the briefing schedule has not been set. Appellees, including theCompany, are required to request a date not later than one hundred twenty daysfrom the date of the appellate brief filing to file their brief. The caseremains open pending the briefing schedule and the outcome of the court rulingon the appeal.

 

Due to the inherent uncertainties of litigation, the Company cannotaccurately predict the ultimate outcome of the matter. The Company has notrecorded any accrual related to the settlement because the Company expects anysettlement amounts to be covered by its insurance policies.

 

*OtherMatters*

 

From time to time, the Company is subject to threats of litigation oractual litigation in the ordinary course of business, some of which may bematerial. The Company believes that, except as described above, there are nocurrently pending matters that, if determined adversely to us, would have amaterial effect on the Company’s business or that would not be covered by ourexisting liability insurance maintained by the Company.

 

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*Indemnificationsand Guarantees*

 

TheCompany enters into indemnification provisions under its agreements with othercompanies in the ordinary course of business, typically with its contractors,customers, value-added resellers, and landlords. As of September 30, 2010,the Company did not have any material accrued liability related to theseindemnification agreements.

 

Occamis also a party to indemnification agreements with its officers and directors. Consequently,it has obligations to hold harmless and indemnify each of the directors who arenamed defendants in the California Complaints and the Delaware Complaint (asdescribed above) against associated judgments, fines, settlements and expensesrelated to such claims and otherwise to the fullest extent permitted underDelaware law and Occam’s bylaws and certificate of incorporation.

 

*PurchaseOrders*

 

Under the terms of Occam’scontract manufacturer agreements and original design manufacturer agreements,Occam is required to place orders with its contract manufacturers and originaldesign manufacturers to provide inventory to meet its estimated sales demand.Certain contract manufacturer agreements include production forecast change,lead-time and cancellation provisions. At September 30, 2010, openpurchase orders with contract manufacturers were $29.0 million.

 

*Warranties*

 

Occam provides standardwarranties with the sale of products for up to five years from date ofshipment. The estimated cost of providing the product warranty is recorded atthe time of shipment. Occam maintains product quality programs and processesincluding actively monitoring and evaluating the quality of its suppliers.Occam quantifies and records an estimate for warranty related costs based onOccam’s actual history, projected return and failure rates and current repairand replacement costs. The following table summarizes changes in Occam’saccrued warranty liability that is included in accrued liabilities (inthousands):

 
| ** **                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                  | ** ** | ** **             | ** ** | ** **            | ** ** |
| Warranty liability at beginning of the year |       | $                      | 4,818      |                  | $          | 4,326 |   |
| Accruals for warranty during the period     |       | 2,129                  |       | 2,830                 |       |
| Warranty utilization                        |       | (2,979                 | )          | (2,338                | )          |
| Warranty liability at end of the period     |       | $                      | 3,968      |                  | $          | 4,818 |   |

 

Theincreased warranty utilization for the nine months ended September 30,2010, was primarily due to field rework and replacement for specific customerdeployments related to capacitor power function failures.

 

**6.    Accrued Liabilities**

 

The major components ofaccrued liabilities are (in thousands):

 
| ** **                                         | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Warranty accruals                                  |       | $                            | 3,968      |                        | $          | 4,818 |   |
| Payroll, paid time off, bonus and related accruals |       | 2,804                        |       | 1,620                       |       |
| Accrued Legal Expenses                             |       | 2,112                        |       | 65                          |       |
| Commissions                                        |       | 400                          |       | 234                         |       |
| Other accruals                                     |       | 532                          |       | 262                         |       |
| Total                                              |       | $                            | 9,816      |                        | $          | 6,999 |   |

 

As of September 30,2010, accrued legal expenses primarily consisted of accruals related to theproposed merger transaction.

 

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**7.    Stock Options, Stock Awards, Employee StockPurchase Plan, and Stock-Based Compensation**

 

Stock option activity, underthe Company’s stock option plan for the nine months ended September 30,2010, is summarized as below (shares and intrinsic value in thousands):

 
| ** **                             | ** ** | **Options** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|-------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2010    |       | 3,923       |       | $                                           | 5.65       |                                                 | 7.18       |                            | $          | 6,379 |   |
| Granted                                |       | 81          |       |                                        |       |                                                 |       |                            |       |
| Exercised                              |       | (290        | )          |                                        |       |                                                 |       |                            |       |
| Forfeited or expired                   |       | (47         | )          |                                        |       |                                                 |       |                            |       |
| Outstanding at September 30, 2010 |       | 3,667       |       | $                                           | 5.68       |                                                 | 6.51       |                            | $          | 13,254 |   |
| Exercisable at September 30, 2010 |       | 2,628       |       | $                                           | 6.63       |                                                 | 5.79       |                            | $          | 8,497 |   |

 

The weighted-average fairvalue of options granted to employees on the date of the grant for the threemonths ended September 30, 2010 was $2.32 per share and for the ninemonths ended September 30, 2010 was $3.02 per share.

 

The 2006 Equity IncentivePlan, or 2006 Plan, provides for automatic annual increases in the number ofshares available for issuance under the 2006 Plan effective as of the first dayof each fiscal year equal to the lesser of (a) 3% of the outstandingshares of the common stock on the first day of the applicable fiscal year;(b) 750,000 shares; or (c) such other amount as the Board ofDirectors or a committee of the board may determine. On February 23, 2010,the Board of Directors approved an increase of 620,073 shares reserved forissuance under the 2006 Plan for fiscal 2010. This represented 3% of theoutstanding common shares as of January 1, 2010.

 

***Stock Awards***

 

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

 
| ** **                             | ** ** | **Restricted Stock  Units** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2010    |       | 315                              |       | 1.09                                                 |       | $                               | 1,703      |   |
| Awarded                                |       | 3                                |       |                                                 |       |                            |       |
| Released                               |       | (67                              | )          |                                                 |       |                            |       |
| Forfeited or expired or cancelled      |       | (47                              | )          |                                                 |       |                            |       |
| Outstanding at September 30, 2010 |       | 204                              |       | 0.81                                                 |       | $                               | 1,599      |   |

 

***Employee Stock Purchase Plan***

 

In March 2008, theBoard of Directors approved an amendment to our 2006 Employee Stock PurchasePlan or the ESPP. The amendment increased the maximum number of shares of theCompany’s common stock that an eligible employee may purchase during eachoffering period from 1,000 shares to 5,000 shares. Under the ESPP, 78,320 and65,518 shares were issued on February 16, 2010 and August 15, 2010,at a purchase price per share of $2.97 and $4.63, respectively.

 

The ESPP provides for anautomatic annual increase in the number of shares available for issuance underthe ESPP effective as of the first day of each fiscal year equal to the lesserof (a) 300,000 shares of common stock; (b) 1.5% of the outstandingshares of common stock on the first day of the applicable fiscal year; or(c) an amount determined by the Board of Directors. On February 23,2010, the Board of Directors approved an increase of 300,000 shares in thenumber of shares reserved for issuance under the ESPP.

 

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***Stock-Based Compensation***

 

The following tablesummarizes the stock-based compensation expense, for all stock-basedawards to employees and directors, including employee stock options, restrictedstock and restricted stock units and shares purchased pursuant to the ESPPbased on the estimated fair value on our Consolidated Statements of Operations(in thousands):

 
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                  | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** |
| ** **                                                                  | ** ** | ** **                       | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Employee stock-based  compensation in:**                                  |       |                             |       |                             |       |   |   |   |   |
| Cost of revenue                                                             |       | $                                | 63         |                             | $          | 133 |   | $ | 234 |   | $ | 326 |   |
| Research and product development expense                                    |       | 146                              |       | 297                              |       | 594 |   | 778 |   |
| Sales and marketing expense                                                 |       | 156                              |       | 248                              |       | 560 |   | 692 |   |
| General and administrative expense                                          |       | 177                              |       | 373                              |       | 644 |   | 889 |   |
| Total SFAS 123(R) stock-based compensation in  operating expenses |       | 479                              |       | 918                              |       | 1,798 |   | 2,359 |   |
| Total SFAS 123(R) stock-based compensation                             |       | $                                | 542        |                             | $          | 1,051 |   | $ | 2,032 |   | $ | 2,685 |   |

 

As of September 30,2010, total unamortized stock-based compensation cost related to non-vestedstock options after accounting for estimated forfeitures was $1.6 million,which the Company expects to recognize over the remaining vesting period ofeach grant, up to the next 48 months.

 

Upon adoption of the FASBAccounting Standard Codification Topic 718, stock-based compensation, weselected the Black-Scholes option pricing model as the most appropriate modelfor determining the estimated fair value for stock-based awards. The use of theBlack-Scholes model requires the use of extensive actual employee exercisebehavior data and the use of a number of complex assumptions including expectedvolatility, risk-free interest rate, forfeitures, and expected dividends. Theassumptions used to value options granted are as follows:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **September 30,  2010**     | ** ** | **September 30,  2009**    | ** ** | **September 30,  2010** | ** ** | **September 30,  2009** | ** ** |
| Risk-free interest rate |       | 1.38                             | %          | 2.41                            | %          | 2.1 | % | 2.87 | % |
| Expected term (years)   |       | 5.0                              |       | 4.9                             |       | 4.9 |   | 4.9 |   |
| Dividend yield          |       | 0                                | %          | 0                               | %          | 0 | % | 0 | % |
| Expected volatility     |       | 55                               | %          | 54%-57                          | %          | 54 | % | 54%-57 | % |

 

The risk-free interest rateis based on the U.S. Treasury yield curve in effect at the time of grant. We donot anticipate declaring dividends in the 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 theexpected life of options granted based on historical exercise and post-vestingcancellation patterns with consideration of our industry peers of similar sizewith similar option vesting periods. Our analysis of stock price volatility andoption lives involves management’s best estimates at the time of determination.FASB Accounting Standard Codification Topic 718, stock-based compensation, alsorequires that we recognize compensation expense for only the portion of optionsor stock units that are expected to vest. Therefore, we apply an estimatedforfeiture rate that is derived from historical employee termination behavior.If the actual number of forfeitures differs from that estimated by management,additional adjustments to compensation expense may be required in future periods.

 

**8.****             ****IncomeTaxes —Final Outcome of Section 382 Analysis**

 

Asof December 31, 2009, the Company had net operating loss carry forwards ofapproximately $109.1 million and $72.1 million to offset federal andstate future taxable income, respectively.   These amounts have beenreduced due to an ownership change which occurred, as defined by Sections 382of the Internal Revenue Code, resulting in the forfeiture of a portion of theCompany’s net operating loss carryforwards.  Gross deferred tax assets andrelated valuation allowance have been reduced by $2.8 million to $54.0 millionin the first quarter of 2010 to reflect the conclusions of this analysis.

 

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**9.****             ****FairPointCommunications, Inc. Bankruptcy**

 

OnJune 1, 2010, the US Bankruptcy Court ordered the payment of $1.7 millionby FairPoint Communications in full satisfaction of Occam’s pre-petition claim.On June 18, 2010, Occam received the amount of $1.7 million. As a resultwe have recognized $1.7 million as revenue in the quarter ended June 30,2010, previously deferred, since all the criteria of Staff Accounting BulletinCodification Topic 13: Revenue Recognition have been met. The expensepreviously recorded for inventory impairment, $138,000, was reversed in thequarter ended June 30, 2010 since the related revenue has been recognized.There are no remaining pre-petition claims outstanding.

 

**ITEM 2.****                        ****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*You should read the followingdiscussion and analysis in conjunction with our condensed consolidatedfinancial statements and the related notes thereto included in this Quarterly Reporton Form 10-Q and with Management’s Discussion and Analysis of FinancialCondition and Results of Operations contained in the Company’s Annual Report onForm 10-K for the year ended December 31, 2009. The followingdiscussion contains both historical information and forward-looking statementswithin the meaning of Section 21E of the Exchange Act. A number of factorsaffect our operating results and could cause our actual future results todiffer materially from any forward-looking results discussed below. In somecases, you can identify forward-looking statements by terminology such as “anticipates,”“appears,” “believes,” “continue,” “could,” “estimates,” “expects,” “feels,” “goal,”“hope,” “intends,” “may,” “our future success depends,” “plans,” “potential,” “predicts,”“projects,” “reasonably,” “seek to continue,” “should,” “thinks,” “will” or thenegative of these terms or other comparable terminology. These statements areonly predictions. Actual events or results may differ materially. In addition,historical information should not be considered an indicator of futureperformance. Factors that could cause or contribute to these differencesinclude, but are not limited to, the risks discussed in this Report inPart II, Item 1A under the caption “Risk Factors.”*

 

*In addition, the potential merger with Calix presents additional risksand uncertainties that could cause the actual results to differ from thoseexpressed or implied by forward looking statements including the risk that thepending merger with Calix may not be consummated due to a failure to obtainstockholder or regulatory approval or for any other reason; the risk that theclosing of the merger will be delayed; uncertainties concerning the effect ofthe transaction on relationships with customers, employees and suppliers ofeither or both of the companies; the risk that the two companies will not beintegrated successfully and in a timely manner even if the closing occurs asanticipated; and the risk that the transaction may involve unexpected costs orunexpected liabilities.*

 

*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 no duty to update any of theforward-looking statements after the date of this Quarterly Report onForm 10-Q to conform these statements to actual results. Theseforward-looking statements are made in reliance upon the safe harbor provisionof The Private Securities Litigation Reform Act of 1995.*

 

**Overview**

 

Wedevelop, market and support innovative broadband access products designed toenable telecom service providers to offer bundled voice, video and high speedinternet, or Triple Play, services over both copper and fiber opticnetworks.  Our Broadband Loop Carrier, orBLC, is an integrated hardware and software platform that uses InternetProtocol, or IP, and Ethernet technologies to increase the capacity of localaccess networks, enabling our customers to deliver advanced services, includingvoice-over-IP, or VoIP, IP-based television, or IPTV, video-on-demand, orVoD, and high-definition television, or HDTV. Our platform simultaneously supports traditional voice and dataservices, enabling our customers to leverage their existing networks andmigrate to IP without disruption.  Inaddition to providing our customers with increased bandwidth, our productsprovide incremental value by offering software-based features to improve thequality, resiliency and security of network service offerings.  We market our products through a combinationof direct and indirect channels.  Ourdirect sales efforts are focused on the North American independent operatingcompany, or IOC, segment of the telecom service provider market. As of September 30,2010, we had shipped our BLC platform to over 380 telecommunications customers.

 

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Fromour inception through September 30, 2010, we have incurred cumulative netlosses of approximately $138.2 million. We realized income from operations and were profitable on a net incomebasis during the quarters ended December 31, 2008, December 31, 2006and September 24, 2006, and for the year ended December 31,2006.  Previously, we had not beenprofitable on a quarterly or annual basis, excluding the quarter endedDecember 25, 2005, in which we realized modest operating income of$3,000.  We experienced operating and netlosses in all four quarters of fiscal 2009. During the current quarter, weexperienced an increase in customer bookings activity due to certain ordersrelated to the broadband funding initiatives. In the short term, we expect thatbooking activity may vary depending on our customers’ ability to make capitalinvestments, using their own funds, and their access to credit facilities orother loan program funds.

 

**RecentDevelopment**

 

OnSeptember 16, 2010, the Company announced that it had entered into anAgreement and Plan of Merger and Reorganization, or Merger Agreement, withCalix and two wholly owned subsidiaries of Calix. The Merger Agreement providesthat, upon the terms and subject to the conditions set forth therein, Calixwill acquire Occam by means of a series of mergers involving two wholly ownedsubsidiaries of Calix.  As a result ofthe merger, Occam will become a wholly-owned subsidiary of Calix.

 

Thetransaction is valued at approximately $171 million, or approximately $7.75 pershare of Occam common stock (based on the closing trading price of Calix’sstock as of September 14, 2010). Subject to the terms and conditions of the Merger Agreement, at theeffective time of the first merger, each share of Occam’s common stock issuedand outstanding, will be converted into the right to receive $3.8337 in cash,without interest plus $0.2925 of a validly issued, fully paid andnon-assessable share of Calix common stock. At the closing of the merger, former Occam stockholders will own between14.1% and 15.9% of the outstanding shares of Calix’s common stock (based on thenumber of Calix shares outstanding as of September 14, 2010).

 

Thecompletion of the transaction is subject to various closing conditions,including obtaining the approval of our stockholders, registering the shares ofCalix common stock to be issued in connection with the merger and receipt ofregulatory clearance under the Hart-Scott-Rodino Antitrust Improvements Act of1976, as amended.  The Company currentlyexpects the transaction to close in the fourth quarter of 2010 or the firstquarter of 2011.  Both companies willcontinue to operate their businesses independently until the close of themerger.

 

**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. Thepreparation of these consolidated financial statements requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the consolidated financial statements and the reported amounts of revenueand expenses during the reporting period. On an ongoing basis, we evaluate ourestimates and judgments, including those related to revenue recognition,inventories, accounts receivable reserves, sales return reserves, litigation,warranty reserve, stock-based compensation, and valuation of deferred incometax assets. We base our estimates and judgments on historical experience and onvarious other factors that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources.

 

Weincluded in our Annual Report on Form 10-K for the year endedDecember 31, 2009, a discussion of our most critical accounting policies,which are those that are most important to the portrayal of our financialcondition and results of operations and require management’s most difficult,subjective and complex judgments, often as a result of the need to makeestimates about the effect of matters that are inherently uncertain.

 

We warrant our products forperiods up to five years and the estimated cost of providing the productwarranty is recorded at the time of shipment. We maintain product qualityprograms and processes, including actively monitoring and evaluating thequality of our suppliers. We quantify and record an estimate forwarranty-related costs based on a variety of factors including but not limitedto our actual history, projected return and failure rates and current repaircosts. Our estimates are primarily based on an estimate of products that may bereturned for warranty repair, estimated costs of repair, including parts andlabor, depending on the type of service required. These estimates require us toexamine past and current warranty issues and consider their continuing impactin the future. Our accrual is based on consideration of all these factors whichare known as of the preparation of our consolidated financial statements. Ourestimates of future warranty liability are based on prediction of futureevents, conditions and other complicated factors that are difficult topredict.   The actual costs we incur maydiffer materially from our estimates.

 

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**Results ofOperations**

 

*Three-monthsended September 30, 2010 and 2009*

 

*Revenue (in thousands, except percentages)*

 
| ** ** | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **September 30,  2010**     | ** ** | **September 30,  2009**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** ** | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue    |       | $                                | 29,810     |                                                      | $          | 21,673 |   | $ | 8,137 |   | 38 | % |
|            |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Ourrevenue is principally comprised of our BLC 6000 series system product line,Optical Network Terminals, cabinets and related accessories.  Revenue increased by $8.1 million or 38% to$29.8 million for the three months ended, September 30, 2010 as comparedto revenue of $21.7 million for the three months ended September 30, 2009.The increase in revenue was primarily due to the recognition of revenueassociated with customer orders related to government broadband fundinginitiatives, which included increased volumes of our ONT products.

 

Althoughwe expect that IOCs will continue to carefully evaluate their capitalinvestment decisions in light of continued economic uncertainty, governmentbroadband funding initiatives should have a favorable impact on capitalspending trends among telecommunications carriers for the balance of 2010 andinto 2011.  In the short term, we expectthat booking activity may vary depending on our customers’ ability to makecapital investments, using their own funds and their access to creditfacilities or other loan program funds. However, our announcement of an agreement to be acquired by Calix couldhave an adverse effect on our revenues and revenue growth, if any, in thefourth quarter of 2010 and the first quarter of 2011.  In particular, while the transaction remainspending, customers could defer purchase decisions pending the outcome of thetransaction (including obtaining required stockholder and regulatory approval),or customers could elect to purchase from other suppliers.

 

Wehave experienced and believe we may continue to experience supply constraintsas demand increases or as we introduce our newest products.

 

*Cost of revenue and gross margin (in thousands, exceptpercentages)*

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|-------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **September 30,  2010**     | ** ** | **September 30,  2009**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **              | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenue         |       | $                                | 17,878     |                                                      | $          | 12,725 |   | $ | 5,153 |   | 40 | % |
| Gross margin            |       | $                                | 11,932     |                                                      | $          | 8,948 |   | $ | 2,984 |   | 33 | % |
| Gross margin percentage |       | 40                               | %          | 41                                                        | %          |   |   |   |   |

 

Costof revenue includes the cost of products shipped for which revenue wasrecognized, warranty costs, costs of any manufacturing yield problems, re-workcosts, manufacturing overhead, provisions for obsolete inventory and the costof post-sales support.  The increase incost of revenue during the three months ended September 30, 2010 from thesimilar period during the prior year was primarily attributable to increasedrevenue shipments.

 

Grossmargin was 40% of revenue for the three months ended September 30, 2010and 41% of revenue for the three months ended September 30, 2009.  The decrease in gross margin percent wasprimarily attributable to product mix related to increased revenue of our lowermargin ONT products.

 

Weexpect that our gross margin will vary from quarter-to-quarter due in part toproduct mix, average selling price changes and manufacturing cost changes.  To the extent that lower margin productsrepresent an increased percentage of our total revenue in any period, it willtend to reduce our gross margin. Additionally, as we introduce new products into the market, weanticipate our gross margin may fluctuate.

 

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*Researchand product-development expenses (in thousands, except percentages)*

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                   | ** ** | **September 30,  2010**     | ** ** | **September 30,  2009**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                                   | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and product-development                             |       | $                                | 3,949      |                                                      | $          | 3,762 |   | $ | 187 |   | 5 | % |
| Research and product-development as a percentage  of revenue |       | 13                               | %          | 17                                                        | %          |   |   |   |   |
|                                                              |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Research andproduct-development expenses consist primarily of salaries and otherpersonnel-related costs, prototype component and assembly costs, third-partydesign services and consulting costs, and other costs related to the design,development, and testing of our products. Research and product-development costs are expensed as incurred, exceptfor capital expenditures, which are capitalized and depreciated over theirestimated useful lives, generally two to three years.  Research and development expenses increasedby $0.2 million or 5% to $4.0 million for the three months endedSeptember 30, 2010 as compared to $3.8 million for the three months endedSeptember 30, 2009. This net increase in research and product-developmentexpenses was primarily attributable to personnel related costs partially offsetby lower stock-based compensation expense.

 

We currently expect researchand product-development expenses in future periods to be largely consistentwith current expense levels but may vary with the introduction of new products.

 

*Sales andmarketing expenses (in thousands, except percentages)*

 
| ** **                                     | ** ** | **Three Months Ended**   | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                     | ** ** | **September 30,   2010** | ** ** | **September 30,   2009**                        | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                     | ** ** | ** **                         | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales and marketing                            |       | $                                  | 5,082      |                                                      | $          | 4,459 |   | $ | 623 |   | 14 | % |
| Sales and marketing as a percentage of revenue |       | 17                                 | %          | 21                                                        | %          |   |   |   |   |
|                                                |            |                                    |            |                                                           |            |  |  |  |  |  |  |  |

 

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$0.6 million or 14% to $5.1 million for the three months endedSeptember 30, 2010 from $4.5 million for the same period in 2009. This netincrease was primarily due to higher sales commissions due to an increase inbookings activity and higher personnel related costs.

 

We currently expect salesand marketing expenses in future periods to be consistent with current expenselevels but may vary with the level of customer bookings and the level ofspending on new or expanded marketing programs.

 

*Generaland administrative expenses (in thousands, except percentages)*

 
| ** **                                             | ** ** | **Three Months Ended**   | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30,   2010** | ** ** | **September 30,   2009**                        | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                             | ** ** | ** **                         | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative                             |       | $                                  | 1,898      |                                                      | 1,760      |   | $ | 138 |   | 8 | % |
| General and administrative as a percentage of  revenue |       | 6                                  | %          | 8                                                         | %          |   |   |   |   |
|                                                        |            |                                    |            |                                                           |            |  |  |  |  |  |  |

 

General and administrativeexpenses consist primarily of salaries and other personnel-related costs forexecutive, finance, human resources, and administrative personnel.Additionally, general and administrative expenses include professional fees,liability insurance and other general corporate costs such as rent, legal,utilities and accounting expenses. General and administrative expensesincreased by $0.1 million or 8% to $1.9 million for the three months endedSeptember 30, 2010 as compared to $1.8 million for the three months endedSeptember 30, 2009. General and administrative expenses increased primarilydue to personnel related costs, partially offset by lower stock basedcompensation expense.

 

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We currently expect general and administrative expenses infuture periods to be largely consistent with current expense levels.

 

*Loss onlitigation settlement*

 

On September 10, 2009 we entered into a memorandum ofunderstanding regarding the settlement of the April 26th, 2007 stockholderclass action lawsuit. On November 2, 2009 the parties signed and submitteda formal binding stipulation of settlement to the court. The court issued itspreliminary approval of the settlement on November 13, 2009. On February 22,2010, the court held a hearing dismissing the litigation with prejudice andentered a final judgment. The total settlement amount of $13.9 million wasagreed to by all of the parties, of which we contributed $1.7 million. Werecorded a charge of $1.7 million as a loss on settlement for the quarterended September 30, 2009, associated with this settlement. There was nosuch loss recorded for the quarter ended September 30, 2010.

 

*Mergerrelated expenses*

 

On September 16, 2010, we announced that we had entered into theMerger Agreement with Calix and two wholly owned subsidiaries of Calix.  The Merger Agreement provides that, upon theterms and subject to the conditions set forth therein, Calix will acquire Occamby means of a series of mergers involving two wholly owned subsidiaries ofCalix. As a result of the merger, Occam will become a wholly-owned subsidiaryof Calix.  We have incurred $2.8 million,in merger related expenses for the quarter ended September 30, 2010. Wecurrently expect to incur continuing merger related expenses during the fourthquarter of 2010.

 

The completion of the transaction is subject to various closingconditions, including obtaining the approval of our stockholders, registeringthe shares of Calix Common Stock to be issued in connection with the merger andreceipt of regulatory clearance under the Hart-Scott-Rodino AntitrustImprovements Act of 1976, as amended.  Wecurrently expect the transaction to close in the fourth quarter of 2010 or thefirst quarter of 2011.

 

*Stock-basedcompensation (in thousands)*

 
| ** **                     | ** ** | **Three Months Ended**   | ** ** |
|--------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **September 30,   2010** | ** ** | **September 30,   2009** | ** ** |
| ** **                     | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Cost of sales                  |       | $                                  | 63         |   | $ | 133 |   |
| Research and development       |       | 146                                |       | 297 |   |
| Sales and marketing            |       | 156                                |       | 248 |   |
| General and administrative     |       | 177                                |       | 373 |   |
| Total stock-based compensation |       | $                                  | 542        |   | $ | 1,051 |   |

 

Stock-based compensationexpense decreased by approximately $0.5 million or 48% to $0.6 million for thethree months ended September 30, 2010 as compared to approximately $1.1million for the three months ended September 30, 2009. This net decreasewas primarily attributable to the completion of four years of vesting ofcertain higher value grants during the initial months of the last quarter andcurrent quarter and no performance related stock based compensation expensewhen compared to the stock based compensation expense for  quarter ended September 30, 2009.

 

We anticipate that thestock-based compensation expense calculated under FASB Accounting StandardsCodification Topic 718 will continue to have a material effect on ourconsolidated statement of operations.

 

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*Interestincome (expense), net (in thousands)*

* *
| ** **                           | ** ** | **Three Months Ended**   | ** ** | **Increase (Decrease) 2010 vs.  2009** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **September 30,   2010** | ** ** | **September 30,   2009**                    | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                           | ** ** | ** **                         | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                      |       | $                                  | 2          |                                                  | $          | 38 |   | $ | (36 | ) | (95 | )% |
| Interest expense                     |       | 0                                  |       | 0                                                     |       | 0 |   | 0 | % |
| Total interest income (expense), net |       | $                                  | 2          |                                                  | $          | 38 |   | $ | (36 | ) | (95 | )% |

 

Interest income, net decreasedby $36,000 or 95% to $2,000 for the three months ended September 30, 2010,as compared to $38,000 for the three months ended September 30, 2009. Thedecrease is primarily attributable to lower average restricted cash balancesearning interest and lower interest rates.

 

*Provisionfor (benefit from) income taxes*

 

For income tax purposes, weconsider our projected annual income and the utilization of our net operatingloss carry forwards among other factors. For the three months endedSeptember 30, 2010, we provided for $16,000 for income taxes and for thethree months ended September 30, 2009, we recorded a tax benefit of$21,000, for federal and state income taxes.

 

*Nine months endedSeptember 30, 2010 and September 30, 2009*

 

*Revenue**(in thousands, except percentages)*

 
| ** ** | ** ** | **Nine Months Ended**    | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|------------|------------|------------------------------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **September 30,   2010** | ** ** | **September 30,   2009**                        | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** ** | ** ** | ** **                         | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue    |       | $                                  | 75,930     |                                                      | $          | 62,120 |   | $ | 13,810 |   | 22 | % |
|            |            |                                    |            |                                                           |            |  |  |  |  |  |  |  |

 

Revenueincreased by $13.8 million or 22% to $75.9 million for the nine months endedSeptember 30, 2010 as compared to revenue of $62.1 million for the ninemonths ended September 30, 2009. The increase in revenue is primarily due to the recognition of revenue associatedwith customer orders related to government broadband funding initiatives, whichincluded increased volumes of our ONT and BLC 6000 products and the recognitionof $1.7 million of FairPoint revenue that was deferred in the third quarter of2009.

 

Inthe first nine months of 2010, we experienced an increase in customer bookingsactivity, due to certain orders related to government broadband fundinginitiatives.  Although we expect thatIOCs will continue to carefully evaluate their capital investment decisions inlight of continued economic uncertainty, government broadband fundinginitiatives should have a favorable impact on capital spending trends amongtelecommunications carriers for the balance of 2010 and into 2011. In the shortterm, we expect that booking activity may vary depending on our customers’ability to make capital investments, using their own funds, and their access tocredit facilities or other loan program funds. However, our announcement of an agreement to be acquired by Calix couldhave an adverse effect on our revenues and revenue growth, if any, in thefourth quarter of 2010 and the first quarter of 2011.  In particular, while the transaction remainspending, customers could defer purchase decisions pending the outcome of thetransaction (including obtaining required stockholder and regulatory approval),or customers could elect to purchase from other suppliers.

 

Wehave experienced and believe we may continue to experience supply constraintsas demand increases or as we introduce our newest products.

 

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*Cost of revenue and gross margin**(inthousands, except percentages)*

 
| ** **              | ** ** | **Nine Months Ended**    | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|-------------------------|------------|------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **September 30,   2010** | ** ** | **September 30,   2009**                        | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **              | ** ** | ** **                         | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenue         |       | $                                  | 44,396     |                                                      | $          | 36,970 |   | $ | 7,426 |   | 20 | % |
| Gross margin            |       | $                                  | 31,534     |                                                      | $          | 25,150 |   | $ | 6,384 |   | 25 | % |
| Gross margin percentage |       | 42                                 | %          | 40                                                        | %          |   |   |   |   |

 

Cost of revenue increased by$7.4 million or 20% to $44.4 million for the nine months endedSeptember 30, 2010 as compared to $37.0 million for the nine months endedSeptember 30, 2009. The increase in cost of revenue during the nine monthsended September 30, 2010 was primarily attributable to increased revenueshipments.

 

Gross margin increased to42% of revenue in the nine months ended September 30, 2010 compared togross margin of 40% of revenue for the nine months ended September 30,2009. The increase in gross margin percent was primarily attributable toproduct mix and decreased unit cost of our blades and ONT products.

 

Weexpect that our gross margin will vary from quarter-to-quarter due in part toproduct mix, average selling price changes and manufacturing cost changes.  To the extent that lower margin productsrepresent an increased percentage of our total revenue in any period, it willtend to reduce our gross margin. Additionally, as we introduce new products into the market, weanticipate our gross margin may fluctuate.

 

*Research and product-development expenses**(inthousands, except percentages)*

 
| ** **                                                     | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                     | ** ** | **September 30,  2010**    | ** ** | **September 30,  2009**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                                     | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and product-development                               |       | $                               | 11,549     |                                                      | $          | 12,186 |   | $ | (637 | ) | (5 | )% |
| Research and product*-*development  as a percentage of revenue |       | 15                              | %          | 20                                                        | %          |   |   |   |   |
|                                                                |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Research andproduct-development expenses decreased by $0.6 million or 5% to $11.6 millionfor the nine months ended September 30, 2010 as compared to$12.2 million for the nine months ended September 30, 2009. Thedecrease in research and product-development expenses was primarilyattributable to the decrease in personnel related costs, decreasedproduct-development expenses and lower stock-based compensation expense.

 

We currently expect researchand product-development expenses in future periods to be largely consistentwith current expense levels but may vary with the introduction of new products.

 

*Sales and marketing expenses**(inthousands, except percentages)*

 
| ** **                                     | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                     | ** ** | **September 30,  2010**    | ** ** | **September 30,  2009**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                     | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales and marketing                            |       | $                               | 14,200     |                                                      | $          | 13,404 |   | $ | 796 |   | 6 | % |
| Sales and marketing as a percentage of revenue |       | 19                              | %          | 22                                                        | %          |   |   |   |   |
|                                                |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Salesand marketing expenses increased by $0.8 million or 6% to $14.2 million for thenine months ended September 30, 2010 as compared to $13.4 million for thenine months ended September 30, 2009. This increase was primarily due tohigher sales commissions due to the increase in bookings activity, partiallyoffset by lower personnel related costs.

 

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Wecurrently expect sales and marketing expenses in future periods to beconsistent with current expense levels but may vary with the level of customerbookings and the level of spending on new or expanded marketing programs.

 

*General and administrative expenses**(inthousands, except percentages)*

 
| ** **                                             | ** ** | **Nine Months Ended**    | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30,   2010** | ** ** | **September 30,   2009**                        | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                             | ** ** | ** **                         | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative                             |       | $                                  | 5,702      |                                                      | $          | 6,179 |   | $ | (477 | ) | (8 | )% |
| General and administrative as a percentage of  revenue |       | 8                                  | %          | 10                                                        | %          |   |   |   |   |
|                                                        |            |                                    |            |                                                           |            |  |  |  |  |  |  |  |

 

General and administrativeexpenses decreased by $0.5 million or 8% to $5.7 million for the nine monthsended September 30, 2010 as compared to $6.2 million for the nine monthsended September 30, 2009. General and administrative expenses decreasedprimarily due to lower professional fees and lower stock-based compensationexpense, partially offset by an increase in personnel related costs.

 

We currently expect general and administrative expenses infuture periods to be largely consistent with current expense levels.

 

*Restructuringcharges*

 

On May 7, 2009, weimplemented a reduction-in-force that resulted in the termination ofapproximately 10% of our work force. We substantially completed thereduction-in-force by the end of the second quarter of 2009. The purpose of theworkforce reduction was to reduce costs, streamline operations, and improve thecost structure in light of the economic and operating environment. During thequarter ended June 30, 2009, we recorded approximately $213,000 ofrestructuring charges related to termination benefits in connection with thereduction- in- force. There were no such restructuring charges incurred duringthe quarter ended September 30, 2010.

 

*Loss onlitigation settlement*

 

On September 10, 2009 we entered into a memorandum ofunderstanding regarding the settlement of the April 26th, 2007 stockholderclass action lawsuit. On November 2, 2009 the parties signed and submitteda formal binding stipulation of settlement to the court. The court issued itspreliminary approval of the settlement on November 13, 2009. On February 22,2010, the court held a hearing dismissing the litigation with prejudice andentered a final judgment. The total settlement amount of $13.9 million had beenagreed by all parties, of which we contributed $1.7 million. We recorded acharge of $1.7 million as a loss on settlement for the quarter endedSeptember 30, 2009, associated with this settlement. There was no suchloss recorded for the quarter ended September 30, 2010.

 

*MergerRelated Expenses*

 

On September 16, 2010, we announced that we had entered into theMerger Agreement with Calix and two wholly owned subsidiaries of Calix.  The Merger Agreement provides that, upon theterms and subject to the conditions set forth therein, Calix will acquire Occamby means of a series of mergers involving two wholly owned subsidiaries ofCalix. As a result of the merger, Occam will become a wholly-owned subsidiaryof Calix. We have incurred $2.8 million, in merger related expenses for thequarter ended September 30, 2010. We currently expect to incur continuingmerger related expenses during the fourth quarter of 2010.

 

The completion of the transaction is subject to various closingconditions, including obtaining the approval of our stockholders, registeringthe shares of Calix Common Stock to be issued in connection with the merger andreceipt of regulatory clearance under the Hart-Scott-Rodino AntitrustImprovements Act of 1976, as amended.  Weexpect the transaction to close in the fourth quarter of 2010 or the firstquarter of 2011.

 

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*Stock-based compensation**(inthousands)*

 
| ** **                     | ** ** | **Nine Months Ended**    | ** ** |
|--------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **September 30,   2010** | ** ** | **September 30,   2009** | ** ** |
| ** **                     | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Cost of revenue                |       | $                                  | 234        |   | $ | 326 |   |
| Research and development       |       | 594                                |       | 778 |   |
| Sales and marketing            |       | 560                                |       | 692 |   |
| General and administrative     |       | 644                                |       | 889 |   |
| Total stock-based compensation |       | $                                  | 2,032      |   | $ | 2,685 |   |

 

Stock-based compensationexpenses decreased by approximately $0.7 million or 24% to $2.0 million for thenine months ended September 30, 2010 as compared to approximately $2.7million for the nine months ended September 30, 2009. This net decreasewas primarily attributable to the completion of four years of vesting ofcertain higher value grants during the initial months of the prior quarter andthe current quarter and no performance related stock based compensation expensewhen compared to the stock based compensation expense for  the nine months ended September 30,2009.

 

Weanticipate that the stock-based compensation expense calculated under FASBAccounting Standards Codification Topic 718 will continue to have amaterial effect on our consolidated statement of operations.

 

*Interest income (expense), net**(inthousands, except percentages)*

 
| ** **                           | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2010 vs. 2009** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                           | ** ** | **September 30,  2010**    | ** ** | **September 30,  2009**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                           | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                      |       | $                               | 11         |                                                      | 278        |   | (267 | ) | (96 | )% |
| Interest expense                     |       | (3                              | )          | (4                                                        | )          | 1 |   | 25 | % |
| Total interest income (expense), net |       | $                               | 8          |                                                      | $          | 274 |   | $ | (266 | ) | (97 | )% |
|                                      |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Interest income and expense,net decreased by $266,000 or 97% to $8,000 for the nine months endedSeptember 30, 2010, as compared to $274,000 for the nine months ended September 30,2009. The decrease was primarily attributable to lower average restricted cashbalances earning interest and lower interest rates.

 

*Provisionfor (benefit from) income taxes*

 

For income tax purposes, weconsider our projected annual income and the utilization of our net operatingloss carry forwards among other factors. For the nine months endedSeptember 30, 2010 and 2009, we recorded an income tax expense of $32,000and an income tax benefit of $35,000 respectively, for federal and state incometaxes.

 

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**Liquidityand Capital Resources**

 

As of September 30,2010, we had cash and cash equivalents of $44.2 million, restricted cash of$1.8 million, stockholders’ equity of $53.4 million, and working capital of$46.4 million, compared with cash and cash equivalents of $39.3 million,restricted cash of $5.7 million, stockholders’ equity of $52.9 million, andworking capital of $45.5 million as of December 31, 2009.

 

Netcash provided by operating activities for the nine months endedSeptember 30, 2010, was $1.4 million compared to $1.1 million during thesame period ended September 30, 2009. The sum of our net loss and certainnon-cash expenses, such as stock-based compensation, depreciation andamortization, accounts receivable reserves and inventory reserves resulted inan inflow of $1.5 million in the 2010 period, compared to an outflow of $2.5million in the nine months ended September 30, 2009. The overall impact ofchange in certain operating assets and liabilities on total operating cashflows resulted in a cash outflow of $0.1 million in the nine months endedSeptember 30, 2010 compared to a cash inflow of $3.6 million in the ninemonths ended September 30, 2009.

 

Net cash provided byinvesting activities for the nine months ended September 30, 2010, was$2.2 million compared to $6.8 million, during the same period endedSeptember 30, 2009. Cash provided by investing activities for the ninemonths ended September 30, 2010, was primarily due to a decrease of $3.9million in restricted cash required for performance bonds in connection withour Rural Utility Service, or RUS, contracts offset by $1.7 million for purchasesof property and equipment, as compared to a decrease of $7.5 million inrestricted cash, offset by $0.7 million for purchases of property and equipmentin the nine months ended September 30, 2009.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2010, was$1.3 million compared to $615,000 for the same period ended September 30,2009.  Cash provided by financingactivities for the nine months ended September 30, 2010, was mainly due toproceeds from the exercise of stock options of $1.1 million and sale of commonstock under the ESPP of $0.5 million partially offset by payment of payrolltaxes for vested restricted stock units of $0.3 million and payment of capitallease obligations of approximately $46,000, as compared to proceeds ofapproximately $61,000 related to the exercise of stock options and sale ofcommon stock under the ESPP of $0.6 million which was offset by the payment ofapproximately $17,000 for capital lease obligations for the nine months ended September 30,2009.

 

**WorkingCapital**

 

Working capital increased to$46.4 million as of September 30, 2010, as compared to $45.5 million as ofDecember 31, 2009.  The increase inthe working capital is primarily attributable to an increase in accountsreceivable and inventory balance and a decrease in deferred revenue partiallyoffset by an increase in accounts payable and accrued expenses balance.

 

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

 

·                  amount andtiming of revenue;

 

·                  collectabilityof accounts receivable;

 

·                  extent to whichour existing and new products gain market acceptance;

 

·                   cost and timingof product development efforts and the success of these development efforts;

 

·                  cost and timingof marketing and selling activities;

 

·                  extent to which funds arerestricted due to performance bonds required in connection with our RUScontracts; and

 

·                  availability ofborrowing arrangements and the 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 ourability to achieve our intended business objectives.

 

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**ContractualObligations**

 

We lease our facilities andcertain assets under non-cancelable operating leases expiring through 2016, excludingvarious renewal options. We lease certain office equipment under capitalleases.

 

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, 2010 (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)    |       | 28,991                                    |       | 28,991 |   | — |   | — |   | — |   |
| Operating leases            |       | 6,012                                     |       | 389 |   | 4,621 |   | 1,002 |   | — |   |
| Licensing agreements        |       | 41                                        |       | 31 |   | 10 |   | — |   | — |   |

 

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| (1) |   | Under the terms of  agreements with our contract manufacturers and original design manufacturers,  we issue purchase orders for the production of our products. We are required  to place orders in advance with our contract manufacturers and original  design manufacturers to meet estimated sales demands. The agreements include  certain lead-time and cancellation provisions. Future amounts payable to our  contract manufacturer will vary based on the level of purchase requirements. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Of the unrecognized tax benefit liability of approximately$9.3 million, unrecognized tax benefits of only $0.1 million would requirea cash settlement and is not included in the table above due to our significanttax net loss and research tax credit carry forward position. If some or all ofthe unrecognized tax benefit liability became a recognized tax liability, itwould generally result in reduction of these net operating losses and taxcredits and would not result in the use of cash to satisfy the tax liability.

 

*Off-BalanceSheet Arrangements*

 

As of September 30,2010, we did not have any material off-balance sheet arrangements, other thanoperating leases and certain purchase commitments described in the contractualobligations table above.

 

*IndemnificationObligations*

 

We enter into indemnification provisions under our agreements withother companies in our ordinary course of business, typically with ourcontractors, customers, and landlords. As of September 30, 2010, we did not have any material accruedliability related to these indemnification agreements.

 

We are also a party to indemnification agreements with our officers anddirectors, consequently, we have obligations, to hold harmless and indemnifyeach of our directors as defendants in the California Complaints and theDelaware Complaint (as described above) against judgments, fines, settlementsand expenses and otherwise to the fullest extent permitted under Delaware lawand our bylaws and certificate of incorporation.

 

Recent AccountingPronouncements

 

There were no new accountingupdates for the three months ended September 30, 2010, that would have amaterial impact on our financial position, results of operations and cashflows.

 

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**ITEM 3.****                       ****QUANTITATIVE AND 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 issensitive to changes in the general level of taxable and short-term U.S.interest rates.  Our exposure to marketrisk due to changes in the general level of U.S. interest rates relatesprimarily to our cash equivalents.  Wegenerally invest our surplus cash balances in money-market funds with originalor remaining contractual maturities of less than 90 days.  The primary objective of our investmentactivities is the preservation of principal while minimizing risk.  We do not hold financial instruments fortrading or speculative purposes.  We donot use any derivatives or similar instruments to manage our interest raterisk.

 

**ITEM 4.****                       ****CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, as of September 30, 2010, which werefer to as the Evaluation Date or the end of the period covered by thisQuarterly Report on Form 10-Q.

 

The purpose of this evaluation was to determine whether as of theEvaluation Date our disclosure controls and procedures were effective toprovide reasonable assurance that the information we are required to disclosein reports that we file or submit under the Exchange Act, (i) is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms and (ii) is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

 

Based on this evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that as of the Evaluation Date, our disclosurecontrols and procedures were effective.

 

***Changes in Internal Control Over FinancialReporting***

 

Therehave been no changes in our internal control over financial reporting duringthe three months ended September 30, 2010 that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

***Limitations of Internal Control Procedures***

 

Our management does notexpect that our internal control over financial reporting will prevent ordetect all errors and all fraud. A control system, no matter how well designedand operated, can provide only reasonable, not absolute, assurance that thecontrol system’s objectives will be met. Because of the inherent limitations inall control systems, no evaluation of controls can provide absolute assurancethat misstatements due to error or fraud will not occur or that all controlissues and instances of fraud, if any, within our company will have beendetected.

 

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**PART II—OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

*MergerTransaction Class Action Lawsuits*

 

OnSeptember 17, 20, and 21, 2010, three purported class action complaintswere filed in the California Superior Court for Santa Barbara County:  (1) Kardosh v. Occam Networks, Inc.,et al., Case No. 1371748 (“Kardosh Complaint”); (2) Kennedy v. OccamNetworks, Inc., et al., Case No. 1371762 (“Kennedy Complaint”); and (3) Moghaddamv. Occam Networks, Inc., et al., Case No. 1371802 (“MoghaddamComplaint”) (together, the “California Complaints”).  Each of the California Complaints namesOccam, the members of the Occam board, and Calix as defendants.  The Kennedy Complaint also names Calix’smerger subsidiaries (Ocean Sub I, Inc. and Ocean Sub II, LLC) as defendants.  The California Complaints generally allegethat the members of the Occam board breached their fiduciary duties inconnection with the proposed acquisition of Occam by Calix, by, among otherthings, engaging in an allegedly unfair process and agreeing to an allegedlyunfair price for the proposed merger transaction.  The California Complaints further allege thatOccam and the other entity defendants aided and abetted these alleged breachesof fiduciary duty.  The plaintiffs seekvarious forms of relief, including an order certifying a class of Occamshareholders and a preliminary and permanent injunction of the proposed merger.

 

OnOctober 6, 2010, another purported class action complaint was filed in theCourt of Chancery of the State of Delaware: Steinhart, et al. v. Howard-Anderson, et al., Case No. 5878-VCL(the “Delaware Complaint”).  Like theCalifornia Complaints, the Delaware Complaint names the members of Occam’sboard as defendants and generally alleges that the members of the Occam boardbreached their fiduciary duties in connection with the proposed acquisition ofOccam by Calix, by, among other things, engaging in an allegedly unfair processand agreeing to an allegedly unfair price for the proposed merger transaction.  Also, like the plaintiffs who filed theCalifornia Complaint, the plaintiffs who filed the Delaware Complaint seekvarious forms of relief, including an order certifying a class of Occamshareholders and a preliminary and permanent injunction of the proposed merger.

 

Occamis reviewing the complaints and has not yet formally responded to them, butbelieves the plaintiffs’ allegations are without merit and intends to defendagainst them vigorously.  However,litigation is inherently uncertain and there can be no assurance regarding thelikelihood that Occam’s defense of these actions will be successful.  Additional complaints containingsubstantially similar allegations may be filed in the future.

 

*AtwaterPartners of Texas LLC v. AT&T, Inc. et al.*

 

On May 27, 2010, Atwater Partners of Texas LLC filed a complaintin the U.S. District Court for the Eastern District of Texas alleginginfringement of certain U.S. Patent Nos. 6,490,296; 7,158,523; 7,161,953;7,310,310; and 7,349,401 by 25 companies, including Occam.  The complaint seeks an injunction,unspecified damages, and other relief. The disclosure of each of the patents in suit relates to the field ofdigital networks. We have answered the complaint and have asserted thirteen affirmativedefenses, including invalidity, non-infringement, and patent exhaustion.  This case is currently pending.

 

Due to the inherent uncertainties of litigation, we cannot accuratelypredict the ultimate outcome of the matter.

 

*IPO ShortSwing Profits Litigation*

 

In late 2007, we received a letter from Vanessa Simmonds, a putativeshareholder, demanding that we investigate and prosecute a claim for allegedshort-swing trading in violation of Section 16(b) of the SecuritiesExchange Act of 1934, 15 U.S.C. § 78p(b), by the underwriter of ourinitial public offering (“IPO”) and certain unidentified directors, officersand shareholders of us (then known as Accelerated Networks). We evaluated thedemand and declined to prosecute the claim. On October 12, 2007, theputative shareholder commenced a civil lawsuit in the U.S. District Court forthe Western District of Washington against Credit Suisse Group, the leadunderwriter of our IPO, alleging violations of Section 16(b). Thecomplaint alleges that the combined number of shares of our common stockbeneficially owned by the lead underwriter and certain unnamed officers,directors, and principal shareholders exceeded ten percent of its outstandingcommon stock from the date of 

 

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ourIPO on June 23, 2000, through at least June 22, 2001. It furtheralleges that those entities and individuals were thus subject to the reportingrequirements of Section 16(a) and the short-swing trading prohibitionof Section 16(b), and failed to comply with those provisions. Thecomplaint seeks to recover from the lead underwriter any “short-swing profits”obtained by it in violation of Section 16(b). We were named as a nominaldefendant in the action, but have no liability for the asserted claims. None ofour directors or officers 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) cases seekingrecovery of short-swing profits from underwriters in connection with variousIPOs. The Underwriters and Issuers have filed a motion to dismiss the case andreply briefs have been filed. The Court heard oral argument on January 19,2009 from all parties. On March 12, 2009, the Court dismissed the 16(b) complaint against the issuer defendants including Occam on bothjurisdictional and statute of limitation grounds. On March 31, 2009, thePlaintiffs filed a Notice of Appeal and their opening brief on August 26,2009. The Issuers including Occam and the underwriters filed their responses onOctober 2, 2009. Each party’s reply briefs have been filed as ofNovember 17, 2009. The Appellate Court for the Ninth Circuit heard oralargument on October 5, 2010. It is likely that it will be at least until April 2011before the Court renders a decision on this matter.

 

Due to the inherent uncertainties of threatened litigation, we cannotaccurately predict the ultimate outcome of the matter. We have not recorded anyaccruals related to the demand letters or Section 16(b) litigationbecause we expect any resulting resolution to be covered by our insurancepolicies.

 

*IPOAllocation Litigation*

 

In June 2001, three putative stockholder class action lawsuitswere filed against Accelerated Networks, certain of its then officers anddirectors and several investment banks that were underwriters of AcceleratedNetworks’ initial public offering. The cases, which were later consolidated,were filed in the United States District Court for the Southern District of NewYork, and the operative Complaint was filed on April 19, 2002. TheComplaint was filed on behalf of investors who purchased Accelerated Networks’stock between June 22, 2000 and December 6, 2000 and allegedviolations of Sections 11 and 15 of the 1933 Act andSections 10(b) and 20(a) and Rule 10b-5 of the 1934 Actagainst one or both of Accelerated Networks and the individual defendants. Theclaims were based on allegations that the underwriter defendants agreed toallocate stock in Accelerated Networks’ initial public offering to certaininvestors in exchange for excessive and undisclosed commissions and agreementsby those investors to make additional purchases in the aftermarket atpre-determined prices. Plaintiffs alleged that the prospectus for AcceleratedNetworks’ initial public offering was false and misleading in violation of thesecurities laws because it did not disclose these arrangements.

 

We believe that over three hundred other companies have been named inover three hundred similar lawsuits that have been coordinated with our case.In October 2002, the plaintiffs voluntarily dismissed the individualdefendants 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) 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 Second Circuit Court of Appeals vacated the district court’sdecision granting class certification in those six cases on December 5,2006. Plaintiffs filed a motion for rehearing. On April 6, 2007, theSecond Circuit denied the petition, but noted that Plaintiffs could ask theDistrict Court to certify a more narrow class than the one that was rejected.

 

The parties in the approximately 300 coordinated cases, including ours,reached a settlement. On October 5, 2009, the Court approved thesettlement and certified a settlement class. Six notices of appeal of theSecond Circuit of the Court’s approval of the settlement have been filed. As ofOctober 6, 2010, the deadline for filing appellate briefs opposing thesettlement, only one brief was filed. On October 8, 2010 the remainingobjectors along with Plaintiff filed a stipulation withdrawing their appealswith prejudice. The remainder of the briefing schedule has not been set.Appellees, including us, are required to request a date not later than onehundred twenty days from the date of the appellate brief filing to file theirbrief. The case remains open pending the briefing schedule and the outcome ofthe court ruling on the appeal.

 

Due to the inherent uncertainties of litigation, we cannot accuratelypredict the ultimate outcome of the matter. We have not recorded any accrualrelated to the settlement because we expect any settlement amounts to becovered by our insurance policies.

 

*OtherMatters*

 

From time to time, we are subject to threats of litigation or actuallitigation in the ordinary course of business, some of which may be material. Webelieve that, except as described above, there are no currently pending mattersthat, if determined adversely to us, would have a material effect on ourbusiness or that would not be covered by our existing liability insurance maintainedby us.

 

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**ITEM1A.  RISK FACTORS**

 

*This Quarterly Report onForm 10-Q, or Form 10-Q, including any information incorporated byreference herein, contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, referred to as theSecurities Act, and Section 21E of the Securities Exchange Act of 1934, asamended, referred to as the Exchange Act. In some cases, you can identify forward-looking statements by terms suchas “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,”“believe,” “estimate,” “predict,” “potential,” “continue” or the negative ofthese terms or other comparable terminology. These statements are onlypredictions. Actual events or results may differ materially. Theforward-looking statements contained in this Form 10-Q involve known andunknown risks, uncertainties and situations that may cause our or our industry’sactual results, level of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by these statements.  These factors include those listed below inthis Item 1A and those discussed elsewhere in this Form 10-Q.  We encourage investors to review thesefactors carefully.*

 

*In addition, the potential mergerwith Calix presents additional risks and uncertainties that could cause ouractual results to differ from those expressed or implied by forward lookingstatements, including the risk that the pending merger with Calix may not beconsummated due to a failure to obtain stockholder or regulatory approval orfor any other reason; the risk that the closing of the merger will be delayed;uncertainties concerning the effect of the transaction on relationships withcustomers, employees and suppliers of either or both of the companies; the riskthat the two companies will not be integrated successfully and in a timelymanner even if the closing occurs as anticipated; and the risk that thetransaction may involve unexpected costs or unexpected liabilities.*

 

*We may from time to time makeadditional written and oral forward-looking statements, including statementscontained in our filings with the SEC. However, we do not undertake to update any forward-looking statementthat may be made from time to time by or on behalf of us. Before you invest inour securities, you should be aware that our business faces numerous financialand market risks, including those described below, as well as general economicand business risks.  The followingdiscussion provides information concerning the material risks and uncertaintiesthat we have identified and believe may adversely affect our business, ourfinancial condition and our results of operations.  Before you decide whether to invest in oursecurities, you should carefully consider these risks and uncertainties,together with all of the other information included in this Quarterly Report onForm 10-Q, our Annual Report on Form 10-K for the year endedDecember 31, 2009 and in our other public filings.*

 

**RisksRelated to the Pending Merger with Calix**

 

***Because the market price of Calix commonshares will fluctuate, Occam stockholders cannot be sure of the market value ofCalix common shares that they will receive in the merger transaction.***

 

Atthe effective time, each share of Occam common stock, other than dissentingshares, if any, and shares owned by Calix, Occam or any of their respectivesubsidiaries (which will be cancelled), will be converted into the right toreceive $3.8337 in cash, without interest and 0.2925 shares of Calix commonstock. There will be a time lapse between the date on which Occam stockholdersvote on the adoption of the merger agreement and the date on which Occamstockholders will actually receive such shares. The market value of Calixcommon shares will fluctuate during this period. These fluctuations may becaused by changes in the businesses, operations, results and prospects of bothCalix and Occam, market expectations of the likelihood that the mergertransaction will be completed and the timing of its completion, the effect ofany of the conditions or restrictions imposed on or proposed with respect tothe merging parties by regulatory agencies, general market and economicconditions or other factors, including those risks discussed elsewhere in thisproxy statement/prospectus. The actual market value of Calix common shares,when received by Occam stockholders, will depend on the market value of thoseshares on that date. This market value may be less than the value used todetermine the number of shares to be received, as that determination was madeas of September 15, 2010.

 

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***The failure to successfully combine thebusinesses of Calix and Occam in the expected time frame may adversely affectCalix’s future results, which may adversely affect the value of the Calixcommon shares that Occam stockholders may receive in the merger transaction.***

 

Thesuccess of the merger transaction will depend, in part, on the ability of apost-merger Calix to realize the anticipated benefits from combining thebusinesses of Calix and Occam, including integrating Occam into Calix’sbusiness. To realize these anticipated benefits, Calix’s business and Occam’sbusiness must be successfully combined. If the combined company is not able toachieve these objectives, the anticipated benefits of the merger transactionmay not be realized fully or at all or may take longer to realize thanexpected. In addition, the actual integration may result in additional andunforeseen expenses, which could reduce the anticipated benefits of the mergertransaction.

 

Calixand Occam, including their respective subsidiaries, have operated and, untilthe completion of the merger transaction, will continue to operateindependently. It is possible that the integration process could result in theloss of key employees, as well as the disruption of each company’s ongoingbusinesses or inconsistencies in standards, controls, procedures and policies.Any or all of those occurrences could adversely affect Calix’s ability tomaintain relationships with customers and employees after the mergertransaction or to achieve the anticipated benefits of the merger transaction.Integration efforts between the two companies will also divert managementattention and resources. These integration matters could have an adverse effecton the combined company.

 

***Whether or not the merger is completed, theannouncement and pendency of the merger transaction could cause disruptions andmaterially adversely affect the future business and operations of Calix andOccam or result in a loss of Occam employees.***

 

Inconnection with the pending announcement or pendency of the merger, it ispossible that some customers, suppliers and other persons with whom Calix orOccam have a business relationship may delay or defer certain businessdecisions, or determine to purchase a competitor’s products.   In particular, customers could be reluctantto purchase the products of Calix and/or Occam due to uncertainty about thedirection of their respective technology and products, and uncertaintyregarding the willingness of the combined company to support and serviceexisting products after the transaction.  If Calix’s or Occam’s customers, suppliers or other persons, delay ordefer business decisions, or purchase a competitor’s products, it couldnegatively impact revenues, earnings and cash flows of Calix or Occam, as wellas the market prices of Calix common shares or Occam common stock, regardlessof whether the merger transaction is completed.

 

Similarly,current and prospective employees of Occam may experience uncertainty abouttheir future roles with Occam and Calix following completion of the mergertransaction.  These potentialdistractions of the merger may adversely affect the ability of Occam to attract, motivate and retain key employees andexecutives and keep them focused on the strategies and goals of the combinedcompany. Any failure by Occam to retain and motivate executives and keyemployees during the period prior to the completion of the merger couldseriously harm its business, as well as the business of the combined company.

 

***The merger transaction is subject to thereceipt of consents and approvals from governmental entities, which may imposeconditions on, jeopardize or delay completion of the merger transaction, resultin additional expenditures of money and resources or reduce the anticipatedbenefits of the merger transaction; alternatively, antitrust regulators maypreclude the completion of the merger transaction altogether.***

 

Completionof the merger transaction is conditioned upon the making of filings with, andthe receipt of required consents, orders, approvals or clearances from, certaingovernmental entities, including under the Hart-Scott-Rodino Act, or the HSRAct. The Federal Trade Commission, or the FTC, and the Antitrust Divisionfrequently scrutinize the legality under the antitrust laws of transactionslike the merger. At any time before or after the completion of the merger, theFTC or the Antitrust Division could take any action under the antitrust laws asit deems necessary or desirable in the public interest, including seeking toenjoin the completion of the merger or seeking the divestiture of substantialassets of Calix or Occam. In addition, certain private parties, as well asstate attorneys general and other antitrust authorities, may challenge thetransaction under antitrust laws under certain circumstances. In addition,conditions may be imposed upon the approval of the merger. Such conditions mayjeopardize or delay completion of the merger or may reduce the anticipatedbenefits of the merger. Subject to compliance with the terms of the mergeragreement, Calix may not be willing to accept such conditions, and the mergerthus may not be consummated. There can be no assurance that these requiredconsents, orders, approvals and clearances will be obtained. If they areobtained, governmental entities may attempt to impose conditions on, or requiredivestitures relating to, the divisions, operations or assets of Calix orOccam.  These conditions or divestituresmay jeopardize or delay completion of the merger transaction or reduce theanticipated benefits of the merger transaction or result in additionalexpenditures of money and resources.

 

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***Directors and executive officers of Occamhave interests in the merger transaction that are different from, or inaddition to, the interests of Occam stockholders generally, and Occamstockholders should consider these interests in connection with their votes onthe merger agreement.***

 

Someof the directors and executive officers of Occam have interests in the mergertransaction that are different from, or in addition to, the interests of Occamstockholders generally.

 

Theseinterests include:

 

·                 the vesting and settlement or conversion ofOccam equity awards into awards for Calix common shares held by Occam directorsand executive officers;

 

·                 executive officers’ receipt of specifiedbenefits under their change in control agreements, if certain terminations ofemployment occur in connection with the merger transaction; and

 

·                 Calix’s agreement to indemnify directors andofficers against certain claims and liabilities and to continue suchindemnification for a period of six years from the effective time of the mergertransaction.

 

·                 Occam stockholders should consider theseinterests in connection with their votes on the merger agreement.

 

***Failure to complete the merger transactioncould negatively impact the stock prices and future businesses and financialresults of Calix and Occam.***

 

Ifthe merger transaction is not completed, neither Calix nor Occam would realizeany anticipated benefits from being a part of the combined company.  In addition, Calix and/or Occam mayexperience negative reactions from the financial markets, which could cause adecrease in the market price of their stock, particularly if the market pricereflects a market assumption that the merger will be completed.  Calix and Occam may also experience negativereactions from their respective customers, employees and dealers.  Such reactions may have an adverse effect onCalix’s and/or Occam’s business.  Calixand/or Occam also could be subject to litigation related to any failure tocomplete the merger transaction or to enforcement proceedings commenced againstCalix and/or Occam to perform their respective obligations under the mergeragreement.

 

Inaddition, if the merger transaction is not completed, the ongoing businesses ofCalix and Occam may be adversely affected and Calix and Occam will be subjectto several risks and consequences, including the following:

 

·                 Occam may be required, under certaincircumstances, to pay Calix a termination fee of $5.2 million under the mergeragreement;

 

·                 Calix may be required, under certaincircumstances, to pay Occam a termination fee of $5.0 million or $10.0 millionunder the merger agreement;

 

·                 Occam and Calix will be required to paycertain costs relating to the merger transaction, whether or not the mergertransaction is completed, such as legal, accounting, financial advisor andprinting fees;

 

·                 Occam may not be able to find another buyerwilling to pay an equivalent or higher price in an alternative transaction thanthe price that would be paid pursuant to the Merger;

 

·                 under the merger agreement, Occam is subjectto certain restrictions on the conduct of its business prior to completing themerger transaction which may adversely affect its ability to execute certain ofits business strategies; and

 

·                 Occam and Calix will be required to paycertain costs relating to the merger transaction, whether or not the mergertransaction is completed, such as legal, accounting, financial advisor andprinting fees; under the merger agreement, Occam is subject to certainrestrictions on the conduct of its business prior to completing the mergertransaction which may adversely affect its ability to execute certain of itsbusiness strategies; and matters relating to the merger transaction may requiresubstantial commitments of time and resources by Calix and Occam management,which could otherwise have been devoted to other opportunities that may havebeen beneficial to Calix and Occam as independent companies, as the case maybe.

 

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***Occam’s obligation to pay a termination feeunder certain circumstances and the restrictions on its ability to solicitother acquisition proposals may discourage other companies from trying toacquire Occam.***

 

Untilthe merger is completed or the merger agreement is terminated, with limitedexceptions, the merger agreement prohibits Occam from entering into orsoliciting any acquisition proposal or offer for a merger or other businesscombination with a party other than Calix. Occam has agreed to pay Calix atermination fee of $5.2 million under specified circumstances. These provisionscould discourage other companies from trying to acquire Occam for a higherprice.

 

***Occam stockholders will own a smallerpercentage of Calix than they currently own in Occam.***

 

Aftercompletion of the merger transaction, Occam stockholders will own a smallerpercentage of Calix than they currently own in Occam. Occam stockholders, inthe aggregate, will own between approximately 14.1% and 15.9% of Calix’soutstanding shares of common stock immediately after completion of the mergertransaction (such ownership percentages are based on the number of Calix sharesof common stock outstanding as of September 14, 2010 and will vary basedupon the actual number of Calix and Occam shares outstanding as of theeffective time).

 

***Four purported class action lawsuits havebeen filed against Occam and its directors challenging the merger, and anunfavorable judgment or ruling in these lawsuits could prevent or delay theconsummation of the merger, result in substantial costs or both.***

 

On September 17, 20,and 21, 2010, three purported class action complaints were filed in theCalifornia Superior Court for Santa Barbara County:(1) Kardoshv. Occam Networks, Inc., et al., Case No. 1371748 (“Kardosh Complaint”);(2) Kennedy v. Occam Networks, Inc., et al., Case No. 1371762 (“KennedyComplaint”); and (3) Moghaddam v. Occam Networks, Inc., et al., Case No. 1371802(“Moghaddam Complaint”) (together, the “California Complaints”).  Each of the CaliforniaComplaints names Occam, themembers of the Occam board, and Calix asdefendants.  The Kennedy Complaint alsonames Calix’s merger subsidiaries (Ocean Sub I, Inc. and Ocean Sub II,LLC) as defendants.  The CaliforniaComplaints generally allege that the members of the Occam board breached theirfiduciary duties in connection with the proposed acquisition of Occam by Calix,by, among other things, engaging in an allegedly unfair process and agreeing toan allegedly unfair price for the proposed merger transaction.  The California Complaints further allege thatOccam and the other entity defendants aided and abetted these alleged breachesof fiduciary duty.  The plaintiffs seekvarious forms of relief, including an order certifying a class of Occamshareholders and a preliminary and permanent injunction of the proposed merger.

 

OnOctober 6, 2010, another purported class action complaint was filed in theCourt of Chancery of the State of Delaware: Steinhart, et al. v. Howard-Anderson, et al Case No. 5878-VCL (the “DelawareComplaint”).  Like the CaliforniaComplaint, the Delaware Complaint names the members of Occam’s board asdefendants and generally alleges that the members of the Occam board breachedtheir fiduciary duties in connection with the proposed acquisition of Occam byCalix, by, among other things, engaging in an allegedly unfair process and agreeingto an allegedly unfair price for the proposed merger transaction.  Also, like the plaintiffs who filed theCalifornia Complaint, the plaintiffs who filed the Delaware Complaint seekvarious forms of relief, including an order certifying a class of Occamshareholders and a preliminary and permanent injunction of the proposed merger.

 

Occamhas obligations to hold harmless and indemnify each of the defendant directorsagainst judgments, fines, settlements and expenses related to claims againstsuch directors and otherwise to the fullest extent permitted under Delaware lawand Occam’s bylaws and certificate of incorporation.

 

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**Risks Related to Current Economic Environment and OurFuture Revenues**

 

***Our business is substantiallydependent on the capital spending patterns of telecom operators and hasrecently been adversely affected by reductions and delays in capital spendingby our customers, primarily due to the economic recession. Any reductions inspending or delays in customer orders in response to macroeconomic conditions,availability of funding under government economic stimulus programs, orotherwise, would adversely affect our business, operating results, andfinancial condition. We cannot predict the financial impact, if any, of government economic stimulus programs oncapital spending by telecom operators.***

 

Demand for our products depends on the magnitude and timing of capitalspending by telecom service providers as they construct, expand and upgradetheir networks. In the fourth quarter of 2008, we identified a weakening in neworder activity that continued throughout 2009 and into 2010. We believe thisweakening relates to reductions in capital expenditures and capital equipmentinvestment budgets resulting from the worldwide financial crisis and economicdownturn. In addition, we believe that many of our customers, particularlythose that participate in government funding initiatives such as the UnitedStates Department of Agriculture’s RUS loan program, were delaying investmentand purchase activity pending their analysis of the availability of fundingunder recently announced government economic stimulus programs. Although weexpect that our customers will continue to carefully evaluate their capitalinvestment decisions in light of continued economic uncertainties, governmentalbroadband funding initiatives should have a favorable impact on capitalspending trends among telecommunication carriers for the balance of 2010 andinto 2011. However, we cannot accurately predict the timing or the extent offinancial impact, if any, that such government economic stimulus programs mayhave on our business. In addition, these programs may not result in a netincrease in capital spending activity if telecom operators substitute spendingunder government stimulus programs for capital spending they would otherwisehave made or if private capital spending decreases by more than the incrementalincrease attributable to government programs. Reductions, delays, orcancellations in order activity by our customers would be expected to adverselyaffect our future revenues by reducing the revenue we recognize in any quarterfrom orders booked and shipped in that quarter and by reducing the amount ofdeferred revenues that may become recognizable in future periods uponsatisfaction of revenue recognition criteria.

 

In addition to the impact of macroeconomic factors, we believe capitalexpenditures among IOCs have also been adversely affected as our customers considertheir investment and capital expenditure decisions in light of the industrytransition from copper wire to fiber.

 

Other factors affecting the capital spending patterns of telecomservice providers include the following:

 

·                 competitive pressures, includingpricing pressures;

 

·                 consumer demand for newservices;

 

·                 an emphasis on generatingsales from services delivered over existing networks instead of new networkconstruction or upgrades;

 

·                 the timing of annual budgetapprovals;

 

·                 evolving industry standardsand network architectures;

 

·                 free cash flow and access toexternal sources of capital; and

 

·                 completion of major networkupgrades.

 

Changes in government funding programs can also affect capitalexpenditures by IOCs. Because many of our customers are IOCs, their revenuesare particularly dependent upon intercarrier payments (primarily interstate andintrastate access charges) and federal and state universal service subsidies.The Federal Communications Commission, or FCC, and some states are consideringchanges to both intercarrier payments and universal service subsidies, and suchchanges could reduce IOC revenues, which would be expected to have an adverseimpact on capital spending budgets. Furthermore, many IOCs use governmentsupported loan programs or grants to finance capital spending. Changes to thoseprograms, such as the Department of Agriculture’s RUS loan program, couldreduce the ability of IOCs to access capital. Any decision by telecom serviceproviders to reduce capital expenditures, whether caused by the economicdownturn, changes in government regulations and subsidies, or other reasons,would have a material adverse effect on our business, consolidated financialcondition and results of operations.

 

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***Our focus on independent telephoneoperating companies limits our sales volume with individual customers and makesour future operating results difficult to predict.***

 

We currently focus our sales efforts on IOCs in North America. Thesecustomers generally operate relatively small networks with limited capitalexpenditure budgets. Accordingly, we believe the total potential sales volumefor our products at any individual IOC is limited, and we must identify andsell products to new IOC customers each quarter to continue to increase oursales. In addition, the spending patterns of many IOCs are characterized bysmall and sporadic purchases. Moreover, because our sales to IOCs arepredominantly based on purchase orders rather than long-term contracts, ourcustomers may stop purchasing equipment from us with little advance notice. Asa result, we have limited backlog, our future operating results are difficultto predict and we will likely continue to have limited visibility into futureoperating results.

 

***We have had limited experienceselling to larger telecommunication companies, and our ability to recognizerevenue, if any, from contracts with these companies may be difficult topredict. In addition, FairPoint Communications, our only Tier-2 customer,recently filed for bankruptcy protection.***

 

In early 2008, we announced that we had been selected as the leadaccess equipment provider for a substantial broadband upgrade by FairPointCommunications, Inc. in its network in Vermont, New Hampshire, and Maine.FairPoint acquired these networks through its acquisition of certain assets ofVerizon Communications, Inc. FairPoint represented our first customer whois considered Tier 2 based on the number of telephone lines serviced. Wehave limited experience selling or servicing Tier 2 customers, and ourability to recognize substantial revenue from the FairPoint relationship or anyother relationships we may establish with Tier 2 customers will depend onseveral factors, including, among others, the timing of orders and the termsand conditions of the orders, which can affect our ability to satisfy revenuerecognition criteria. We cannot currently predict with any accuracy the timingof 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.

 

On October 26, 2009, FairPoint announced that it had filed abankruptcy petition under chapter 11 of the United States Bankruptcy Code.And on February 7, 2010, FairPoint filed its bankruptcy reorganizationplan. Since filing for reorganization on October 26, 2009, FairPoint hasoperated under the supervision of the bankruptcy court.  As of September 30, 2010, we had anoutstanding receivable balance from FairPoint of approximately $1.8 million. Asof March 31, 2010, we had an outstanding receivable balance from FairPointof $2.1 million. Of this amount, $1.7 million related to transactions thatoccurred before FairPoint filed its bankruptcy petition. FairPoint has remittedthe entire balance of the $1.7 million pre-bankruptcy petition claims and wehave recognized revenue and related cost of revenue in the quarter ended,June 30, 2010.

 

***Fluctuations in our quarterly andannual operating results may adversely affect our business and prospects.***

 

A number of factors, many of which are outside our control, may causeor contribute to significant fluctuations in our quarterly and annual operatingresults. These fluctuations may make financial planning and forecasting moredifficult. In addition, these fluctuations may result in unanticipateddecreases in our available cash, which could limit our growth and delayimplementation of our expansion plans. Factors that may cause or contribute tofluctuations 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;

 

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

 

·                 our ability to achieve targeted costreductions;

 

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

 

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

 

As a consequence, operating results for a particular future period aredifficult to predict and prior results are not necessarily indicative ofresults to be expected in the future. Any of the foregoing factors may have amaterial adverse effect on our consolidated results of operations.

 

***We have a history of losses andnegative cash flow, and we may not be able to generate positive operatingincome and cash flows in the future to support the expansion of our operations.***

 

We have incurred significant losses since our inception. As of September 30,2010, we had an accumulated deficit of $138.2 million. We incurred substantiallosses in 2009. We expect to continue to incur losses in 2010. We cannot assureyou that we will not continue to incur losses or experience negative cash flowin the future. We have only generated operating income in the quarters endedDecember 25, 2005, September 24, 2006, December 31, 2006 andDecember 31, 2008. Our inability to generate positive operating income andcash flow would materially and adversely affect our liquidity, consolidatedresults of operations and consolidated financial condition.

 

A significant portion of our expenses is fixed, and we expect tocontinue to incur significant expenses for research and development, sales andmarketing, customer support, and general and administrative functions. Giventhe rate 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 achieve and maintain profitability, we mustincrease our sales while maintaining control over our expense levels.

 

**Risks Related to Internal Controls**

 

***If we fail to maintain proper andeffective internal controls, our ability to produce accurate financialstatements on a timely basis could be impaired, which would adversely affectour consolidated operating results, our ability to operate our business and ourstock price.***

 

In connection with the 2007 audit committee review of our revenuerecognition practices and our resulting financial restatement, we determinedthat we did not have adequate internal financial and accounting controls toproduce accurate and timely financial statements. Among weaknesses anddeficiencies identified in our review, we determined that we had a material weaknesswith respect to revenue recognition. The material weakness continued to existat December 31, 2008. Since the restatement was completed in October 2007, wehave implemented new processes and procedures to improve our internal controlsand have expanded our finance and accounting staff. We believe that theseactions have remediated the identified weaknesses and deficiencies, includingthe material weakness. As of December 31, 2009, our chief executive officer andchief financial officer determined that our internal controls over financialreporting were effective to provide reasonable assurance regarding thereliability of our financial reporting and the preparation of financialstatements for external reporting in accordance with generally accepted accountingprinciples in the United States.

 

Ensuring that we have adequate internal financial and accountingcontrols and procedures in place to produce accurate financial statements on atimely basis is a costly and time-consuming effort that needs to be re-evaluatedfrequently. Our management is responsible for establishing and maintainingadequate internal control over financial reporting to provide reasonableassurance regarding the reliability of our financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles in the United States. Our managementdoes not expect that our internal control over financial reporting will preventor detect all errors and all fraud. A control system, no matter how welldesigned and operated, can provide only reasonable, not absolute, assurancethat the control system’s objectives will be 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 our company willhave been detected. As discussed in our Annual Report on Form 10-K for our2009 fiscal year and our Quarterly Reports on Form 10-Q for our 2009fiscal quarters, our audit committee and management, together with our currentand former independent registered public accounting firms, have identifiednumerous control deficiencies in the past and may identify additionaldeficiencies in the future. Failure on our part to have effective internalfinancial and accounting controls could cause our financial reporting to beunreliable, could have a material adverse effect on our business, operatingresults, and financial condition, and could adversely affect the trading priceof our common stock.

 

We were initially required to comply with Section 404 of theSarbanes Oxley Act of 2002 in connection with our Annual Report onForm 10-K for our year ended December 31, 2007. We have expendedsignificant resources in developing the necessary documentation and testingprocedures required by Section 404 of the Sarbanes Oxley Act. We cannot becertain that the actions we 

 

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havetaken and are taking to improve our internal controls over financial reportingwill be sufficient to maintain effective internal controls over financialreporting in subsequent reporting periods or that we will be able to implementour planned processes and procedures in a timely manner. In addition, we may beunable to produce accurate financial statements on a timely basis. Any of theforegoing could cause investors to lose confidence in the reliability of ourconsolidated financial statements, which could cause the market price of ourcommon stock to decline and make it more difficult for us to finance ouroperations and growth.

 

**Risks Related to Our Business and Industry**

 

***Because our markets are highlycompetitive and dominated by large, well-financed participants, we may beunable to compete effectively.***

 

Competition in our market is intense, and we expect competition toincrease. The market for broadband access equipment is dominated primarily bylarge, established suppliers such as Alcatel Lucent SA, Motorola, Tellabsand ADTRAN Inc. While these suppliers focus primarily on large serviceproviders, they have competed, and may increasingly compete, in the IOC marketsegment. In addition, a number of companies, including Calix, Inc., havedeveloped, or are developing, products that compete with ours, including withinour core IOC segment.

 

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

 

·                 the successful identification and developmentof new products for our core market;

 

·                 our ability to timely anticipate customer andmarket requirements and changes in technology and industry standards;

 

·                 our ability to gain access to and usetechnologies in a cost-effective manner;

 

·                 our ability to timely introducecost-effective new products;

 

·                 our ability to differentiate our productsfrom our competitors’ offerings;

 

·                 our ability to gain customer acceptance ofour products;

 

·                 the performance of our products relative toour competitors’ products;

 

·                 our ability to market and sell our productsthrough effective sales channels;

 

·                 our ability to establish and maintaineffective internal financial and accounting controls and procedures and restoreconfidence in our financial reporting;

 

·                 the protection of our intellectual property,including our processes, trade secrets and know-how; and

 

·                 our ability to attract and retain qualifiedtechnical, executive and sales personnel.

 

Many of our existing and potential competitors are larger than we arewith longer operating histories, and have substantially greater financial,technical, marketing or other resources; significantly greater namerecognition; and a larger installed base of customers than we do. Unlike manyof our competitors, we do not provide equipment financing to potentialcustomers. In addition, many of our competitors have broader product lines thanwe do, so they can offer bundled products, which may appeal to certaincustomers.

 

Because the products that we and our competitors sell require asubstantial investment of time and funds to install, customers are typicallyreluctant to switch equipment suppliers once a particular supplier’s producthas been installed. As a result, competition among equipment suppliers tosecure contracts with potential customers is particularly intense and willcontinue to place pressure on product pricing. Some of our competitors have inthe past and may in the future resort to offering substantial discounts to win newcustomers and generate cash flows. If we are forced to reduce prices in orderto secure customers, we may be unable to sustain gross margins at desiredlevels or achieve profitability.

 

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***We have relied, and expect tocontinue to rely, on our BLC 6000 product line for the substantial majority ofour sales, and a decline in sales of our BLC 6000 line would cause our overallsales to decline proportionally.***

 

We have derived a substantial majority of our sales in recent yearsfrom our BLC 6000 product line. We expect that sales of this product line willcontinue to account for a substantial majority of our sales for the foreseeablefuture. Any factors adversely affecting the pricing of, or demand for, our BLC6000 line, including competition or technological change, could cause our salesto decline materially and our business to suffer.

 

***If we fail to enhance our existingproducts and develop new products and features that meet changing customerrequirements and support new technological advances, our sales would bematerially and adversely affected.***

 

Our market is characterized by rapid technological advances, frequentnew product introductions, evolving industry standards and recurring changes inend-user requirements. Our future success will depend significantly on ourability to anticipate and adapt to such changes and to offer, on a timely andcost-effective basis, products and features that meet changing customer demandsand industry standards. The timely development of new or enhanced products is acomplex and uncertain process, and we may not be able to accurately anticipatemarket trends or have sufficient resources to successfully manage longdevelopment cycles. We may also experience design, manufacturing, marketing andother difficulties that could delay or prevent the development, introduction ormarketing of new products and enhancements. The introduction of new or enhancedproducts also requires that we manage the transition from older products tothese new or enhanced products in order to minimize disruption in customerordering patterns and ensure that adequate supplies of new products areavailable for delivery to meet anticipated customer demand. If we are unable todevelop new products or enhancements to our existing products on a timely andcost-effective basis, or if our new products or enhancements fail to achievemarket acceptance, our business, consolidated financial condition andconsolidated results of operations would be materially and adversely affected.

 

We have enhanced our BLC 6000 platform to support active GigabitEthernet fiber-to-the-premises, or FTTP, services. Although we have invested significanttime and resources to develop this enhancement, these FTTP-enabled products arerelatively new, with limited sales to date, and market acceptance of theseproducts may fall below our expectations. 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 new products and enhancements do not achievebroad market acceptance, we may not realize expected returns on ourinvestments, and we may lose current and potential customers.

 

***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.***

 

Althoughour products are tested prior to shipment, they may contain software orhardware errors, defects or interoperability issues (collectively described as “defects”)that may only be detected when deployed in live networks that generate highamounts of communications traffic.  Inaddition, defects or other malfunctions or quality control issues may notappear until the equipment has been deployed for an extended period oftime.  We also continue to introduce newproducts that may have undetected software or hardware defects.  Our customers may discover defects in ourproducts at any time after deployment or as their networks are expanded andmodified.  Any defects in our productsdiscovered in the future, or failures of our customers’ networks, whethercaused by our products or those of another vendor, could result in lost salesand market share and negative publicity regarding our products. In 2007, we experiencedhigher than average failures of certain assemblies that were fabricated betweenOctober 2005 and January 2006 and identified design issues associatedwith a transistor that resulted in equipment disruption and that required arework effort. Recently, we have identified malfunctions or defects in specificcustomer deployments related to capacitor power function failures in equipmentthat had been in service for extended periods of time that we were required torepair under applicable warranties or elected to repair for customer relationspurposes.

 

Defects,malfunctions, or other performance issues relating to our products couldincrease our warranty accruals and operating expenses, could have an adverseeffect on market perceptions of our products, and could have a material adverseeffect on our business, consolidated results of operations, and consolidatedfinancial condition.  We quantify andrecord an estimate for warranty-related costs based on a variety of factorsincluding but not limited to our actual history, projected return and failurerates and current repair costs.  Ourestimates are primarily based on an estimate of products that may be returnedfor warranty repair, estimated costs of repair, including parts and labor,depending on the type of service required. These estimates require us to examine past and current warranty issuesand consider their continuing impact in the future.  Our estimates of future warranty liabilityare based on prediction of future events, conditions and other complicatedfactors that are difficult to predict. The actual costs we incur may differ materially from our estimates.

 

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***Our efforts to increase our salesand marketing efforts to larger telecom operators, which may require us tobroaden our reseller relationships, may be unsuccessful.***

 

To date, our sales and marketing efforts have been focused on small andmid-sized IOCs. A key element of our long-term strategy is to increase sales tolarge IOCs, competitive local exchange carriers, regional Bell operatingcompanies and international telecom service providers. We may be required todevote substantial technical, marketing and sales resources to the pursuit ofthese customers, who have lengthy equipment qualification and sales cycles. Inparticular, sales to these customers may require us to upgrade our products tomeet more stringent performance criteria, develop new customer specificfeatures or adapt our product to meet international standards. We may incursubstantial technical, sales and marketing expenses and expend significantmanagement effort without any assurance of generating sales. Because we havelimited resources and large telecom operators may be reluctant to purchaseproducts from a relatively small supplier like us, we plan to target thesecustomers in cooperation with strategic resellers. These reseller relationshipsmay not be available to us, and if formed, may include terms, such asexclusivity and non-competition provisions, that restrict our activities orimpose 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 successfullyincrease our sales to larger telecom operators or expand our resellerrelationships, we may be unable to implement our long-term growth strategy.

 

***If we were to experience payment problemswith either resellers or customers for whom we are unable to assesscreditworthiness, it could have an adverse impact on our business, operatingresults, or financial condition.***

 

Value added resellers, or VARs, account for a substantial portion of ourrevenue in a quarter. Some of these VARs are not well capitalized, makingcollection of receivables from them uncertain. In addition, in certaininstances, we are limited in our ability to evaluate the creditworthiness ofdirect customers who decline to provide us with financial information. In 2007,in connection with the restatement of our consolidated financial statements, weadopted a revenue recognition policy that we would not recognize revenue fromthose resellers who lacked an independent ability to pay us until we receivedcash payment. Sales to VARs for whom we are not able to recognize revenue untilwe receive cash payment are reflected as deferred revenue. Any materialcollection issues we may experience with these resellers or direct customerscould have an adverse impact on our business, operating results, or financialcondition and could result in increases in bad debt expense or collectioncosts, inventory impairments, or adjustments to our reported revenues ordeferred revenues. Any of these could result in a decline in our stock price.

 

***We rely on resellers to promote,sell, install and support our products to small customers in North America, andinternationally. Their failure to do so or our inability to recruit or retainresellers may substantially reduce our sales and thus seriously harm ourbusiness.***

 

We rely on value added resellers who can provide high quality sales andsupport services. We compete with other telecommunications systems providersfor our resellers’ business as our resellers generally market competingproducts. If a reseller promotes a competitor’s products to the detriment ofour products or otherwise fails to market our products and serviceseffectively, we could lose market share. In addition, the loss of a key reselleror the failure of resellers to provide adequate customer service could have anegative effect on customer satisfaction and could cause harm to our business.If we do not properly train our resellers to sell, install and service ourproducts, our business, financial condition and results of operations willsuffer.

 

***We may be unable to successfullyexpand our international operations. In addition, our international expansionplans, if implemented, will subject us to a variety of risks that may adverselyaffect our business.***

 

We currently generate almost all of our sales from customers in NorthAmerica and have very limited experience marketing, selling and supporting ourproducts and services outside North America or managing the administrativeaspects of a worldwide operation. While we intend to expand our internationaloperations, we may not be able to create or maintain international marketdemand for our products. In addition, regulations or standards adopted by othercountries may require us to redesign our existing products or develop newproducts suitable for sale in those countries. If we invest substantial timeand resources to expand our international operations and are unable to do sosuccessfully and in a timely manner, our business, financial condition andresults of operations will suffer. In the course of expanding our internationaloperations and operating overseas, we will be subject to a variety of risks,including:

 

·                 differing regulatory requirements, includingtax laws, trade laws, labor regulations, tariffs, export quotas, custom dutiesor other trade restrictions and changes thereto;

 

·                 greater difficulty supporting and localizingour products;

 

·                 different or unique competitive pressures asa result of, among other things, the presence of local equipment suppliers;

 

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·                 challenges inherent in efficiently managingan increased number of employees over large geographic distances, including theneed to implement appropriate systems, policies, benefits and complianceprograms;

 

·                 limited or unfavorable intellectual propertyprotection;

 

·                 changes in a specific country’s or region’spolitical or economic conditions; and

 

·                 restrictions on the repatriation of earnings.

 

***We may pursue acquisitions tobroaden our product line or address new or larger markets. Acquisitions involvea number of risks. If we are unable to address and resolve these riskssuccessfully, such acquisitions could have a material adverse impact to ourbusiness, consolidated results of operations and consolidated financialcondition.***

 

We may make acquisitions of businesses, products or technologies toexpand our product offerings and capabilities, customer base and business. InOctober 2007, we acquired certain assets and assumed certain liabilitiesof Terawave Communications and we have evaluated, and expect to continue toevaluate, a wide array of potential strategic transactions. We have limitedexperience making such acquisitions. Any of these transactions could bematerial to our consolidated financial condition and results of operations. Theanticipated benefit of acquisitions may never materialize. In addition, theprocess of integrating an acquired business, products or technologies maycreate unforeseen operating difficulties and expenditures. Some of the areaswhere we may face acquisition related risks include:

 

·                 diversion of management time and potentialbusiness disruptions;

 

·                 expenses, distractions and potential claimsresulting from acquisitions, whether or not they are completed;

 

·                 retaining and integrating employees from anybusinesses we may acquire;

 

·                 issuance of dilutive equity securities orincurrence of debt;

 

·                 integrating various accounting, management,information, human resource and other systems to permit effective management;

 

·                 incurring possible write-offs, impairmentcharges, contingent liabilities, amortization expense or write-offs ofgoodwill;

 

·                 difficulties integrating and supportingacquired products or technologies;

 

·                 unexpected capital equipment outlays andrelated costs;

 

·                 insufficient revenues to offset increasedexpenses associated with the acquisition;

 

·                 under performance problems associated withacquisitions;

 

·                 opportunity costs associated with committingcapital to such acquisitions; and

 

·                 becoming involved in acquisition relatedlitigation.

 

Foreign acquisitions involve unique risks in addition to thosementioned above, including those related to integration of operations acrossdifferent cultures and languages, currency risks and the particular economic,political and regulatory risks associated with 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. Ourinability to resolve any of such risks could have a material adverse impact onour business, consolidated financial condition and consolidated results ofoperations.

 

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

 

Our success depends, in large part, on the continued contributions ofour key management, engineering, sales and marketing personnel, many of whomare highly skilled and would be difficult 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 notcurrently maintain key-man life insurance covering our key personnel. If welose the services of any key personnel, our business, financial condition andresults of operations may suffer.

 

Competition for skilled personnel, particularly those specializing inengineering and sales is intense. We cannot be certain that we will besuccessful in attracting and retaining qualified personnel, or that newly hiredpersonnel will function effectively, either individually or as a group. Inparticular, we must continue to expand our direct sales force, including hiringadditional sales managers, to grow our customer base and increase sales. Evenif we are successful in hiring additional sales personnel, new salesrepresentatives require up to a year to become effective, and the recent lossof a senior sales executive could have an adverse impact on our ability torecruit and train additional sales personnel. In addition, our industry ischaracterized by frequent claims relating to 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 toeffectively hire, integrate and utilize new personnel, the execution of ourbusiness strategy and our ability to react to changing market conditions may beimpeded, and our business, financial condition and results of operations couldsuffer.

 

***We may have difficulty managinggrowth in our business, if any, which could limit our ability to increase salesand cash flow.***

 

We expect to expand our research and development, sales, marketing andsupport activities, including our activities outside the U.S. depending onfuture business and economic conditions. Our historical growth has placed, andis expected to continue to place, significant demands on our management, aswell as our financial and operational resources, as required to:

 

·                 implement and maintain effective financialdisclosure controls and procedures, including the remediation of internalcontrol deficiencies identified in our audit committee investigation;

 

·                 implement appropriate operational andfinancial systems;

 

·                 manage a larger organization;

 

·                 expand our manufacturing and distributioncapacity;

 

·                 increase our sales and marketing efforts; and

 

·                 broaden our customer support capabilities.

 

In addition, if we cannot grow or manage our business growtheffectively, we may not be able to execute our business strategies and ourbusiness, consolidated financial condition and consolidated results ofoperations would suffer.

 

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***Because we depend upon a smallnumber of outside contractors to manufacture our products, our operations couldbe disrupted if we encounter problems with any of these contractors.***

 

We do not have internal manufacturing capabilities and rely upon asmall number of contract manufacturers to build our products. In particular, werely on AsteelFlash Group (formerly Flash Electronics), Inc. for themanufacture of our BLC 6000 blade products. Our reliance on a small number ofcontract manufacturers makes us vulnerable to possible capacity constraints andreduced control over component availability, delivery schedules, manufacturingyields and costs. We do not have long-term supply contracts with our primarycontract manufacturers. Consequently, these manufacturers are not obligated tosupply products to us for any specific period, in any specific quantity or atany certain price, except as may be provided by a particular purchase order. Ifany of our manufacturers were unable or unwilling to continue manufacturing ourproducts in required volumes and at high quality levels, we would have toidentify, qualify and select acceptable alternative manufacturers. It ispossible that an alternate source may not be available to us when needed or maynot be in a position to satisfy our production requirements at commerciallyreasonable prices and quality. Any significant interruption in manufacturingwould require us to reduce our supply of products to our customers, which inturn could have a material adverse effect on our customer relations, business,consolidated financial condition and consolidated results of operations.

 

A portion of our manufacturing was moved to the overseas facilities ofour primary contract manufacturer. This transition presents a number of risks,including the potential for a supply interruption or a reduction inmanufacturing quality or controls, any of which would negatively impact ourbusiness, customer relationships and results of operations.

 

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

 

We depend on sole source and limited source suppliers for keycomponents of our products. We may from time to time enter into originalequipment manufacturer (OEM) and/or original design manufacturer (ODM) agreementsto manufacture and/or design certain products. Any of the sole source andlimited source suppliers, OEM and ODM suppliers upon which we rely could stopproducing our components, cease operations entirely, or be acquired by, orenter into exclusive arrangements with, 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. We have recently experienced supply constraints with respect tocertain components as demand has increased and expect that we may continue toexperience supply constraints in near-term periods. As a result, thesesuppliers could stop selling components to us at commercially reasonableprices, or at all. Any such interruption or delay may force us to seek similarcomponents from alternate sources, if available at all. Switching suppliers mayrequire that we redesign our products to accommodate the new component and maypotentially require us to re-qualify our products with our customers, whichwould be costly and time-consuming. Any interruption in the supply of solesource or limited source components would adversely affect our ability to meetscheduled product deliveries to our customers and would materially andadversely affect our business, consolidated financial condition andconsolidated results of operations.

 

Periodically, we may be required to license technology from thirdparties to develop new products or product enhancements. These third partylicenses may be unavailable to us on commercially reasonable terms, if at all.Our inability to obtain necessary third party licenses may force us to obtainsubstitute technology of lower quality or performance standards or at greatercost, any of which could seriously harm the competitiveness of our products andwhich would result in a material and adverse effect on our business,consolidated financial condition and consolidated results of operations.

 

***If we fail to accurately predict ourmanufacturing requirements and manage our inventory, we could incur additionalcosts, experience manufacturing delays, or lose revenue.***

 

Lead times for the materials and components that we order through ourcontract manufacturers may vary significantly and depend on numerous factors,including the specific supplier, contract terms and market demand for acomponent at a given time. If we overestimate our production requirements, ourcontract manufacturers may purchase excess components and build excessinventory. If our contract manufacturers purchase excess components that areunique to our products or build excess products, we could be required to payfor these excess parts or products and recognize related inventory write-downcosts. If we underestimate our product requirements, our contract manufacturersmay have inadequate component inventory, which could interrupt manufacturing ofour products and result in delays or cancellation of sales. In prior periods wehave experienced excess and obsolete inventory write downs which impact ourcost of revenue. This may continue in the future, which would have an adverseeffect on our gross margins, consolidated financial condition and consolidatedresults of operations.

 

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***Demand for our products is dependenton the willingness of our customers to deploy new services, the success of ourcustomers in selling new services to their subscribers, and the willingness ofour customers to utilize IP and Ethernet technologies in local access networks.***

 

Demand for our products is dependent on the success of our customers indeploying and selling services to their subscribers. Our BLC 6000 platformsimultaneously supports IP-based services, such as broadband Internet,VoIP, IPTV and FTTP, and traditional voice services. If end-user demandfor IP-based services does not grow as expected or declines and our customersare unable or unwilling to deploy and market these newer services, demand forour products may decrease or fail to grow at rates we anticipate.

 

Our strategy includes developing products for the local access networkthat incorporate IP and Ethernet technologies. If these technologies are notwidely adopted by telecom service providers for use in local access networks,demand for our products may decline or not grow. As a result, we may be unableto sell our products to recoup our expenses related to the development of theseproducts and our consolidated results of operations would be harmed.

 

***Changes in existing accounting ortaxation rules or practices may adversely affect our consolidated resultsof operations. In addition, as we expand our business, we could become subjectto taxation in new states or jurisdictions, which will require us to incuradditional compliance costs and potential taxes and fees associated withcomplying with such tax laws.***

 

We are subject to numerous tax and accounting requirements, and changesin existing accounting or taxation rules or practices, or varyinginterpretations of current rules or practices, could have a significantadverse effect on our financial results or the manner in which we conduct ourbusiness. For example, prior to fiscal 2006, we accounted for options grantedto employees using the intrinsic value method, which, given that we generallygranted employee options with exercise prices equal to the fair market value ofthe 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 stockbased compensation as a significant component of our compensation package forexisting and future employees.

 

Accordingly, changes in accounting for stock based compensation expenseare expected to have a material adverse affect on our reported results. Anysimilar changes in accounting or taxation rules or practices could have amaterial impact on our consolidated financial results or the way we conduct ourbusiness.

 

In recent years, the geographic scope of our business has expanded, andsuch expansion requires us to comply with the tax laws and regulations ofmultiple jurisdictions. Requirements as to taxation vary substantially amongstates and other jurisdictions. We have recently expanded our internationalsales activity and may become subject to foreign tax laws as well, particularlyrelated to value added taxes. Complying with the tax laws of thesejurisdictions can be time consuming and expensive and could subject us topenalties and fees if we inadvertently fail to comply. In the United States,tax authorities in states where we believed we were not subject to sales taxcould assert jurisdiction and seek to collect sales taxes, which could resultin increased compliance expense as well as penalties and could adversely affectour customer relationships if it is determined we need to collect sales taxesfor prior transactions. In the event we fail inadvertently to comply with applicabletax laws, it could have a material adverse effect on our business, results ofoperations, and financial condition.

 

***The amount of our net operating loss(NOL) and credit carryforwards is uncertain. Prior transactions to which we orour stockholders or their affiliates have been a party, and future transactionsto which we or our stockholders or their affiliates may become a party,including stock issuances and certain shareholder stock transactions couldjeopardize our ability to use some or all of our NOLs and tax credits, and theamounts of NOLs or tax credits we would be precluded from using could bematerial. In addition, California and certain states have recently suspended orare considering suspending, the ability to use net operating loss carryforwardsin future years and this could adversely affect future operating results.***

 

Based on current tax law, we believe we have certain NOLs and taxcredits for U.S. federal and state income tax purposes to offset future taxableincome and related taxes.  As ofDecember 31, 2009, we had incurred significant losses and credits in theUnited States.  Our ability to utilizethese tax attributes may be subject to significant limitations underSections 382 and 383 of the Internal Revenue Code if we have undergone, orundergo in the future, an ownership change. An ownership change occurs for purposes of Section 382 of theInternal Revenue Code if, among other things, stockholders who own or haveowned, directly or indirectly, 5% or more of our common stock (with certaingroups of less-than-5% stockholders treated as a single stockholder for thispurpose) increase their aggregate percentage ownership of our common stock bymore than fifty percentage points above the lowest percentage of the stockowned by these stockholders at any time during the relevant three-year testingperiod.  In the event of an ownershipchange, 

 

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Sections 382and 383 impose an annual limitation, based upon our company valuation at thetime of the ownership change, on the amount of taxable income a corporation mayoffset with NOLs and credits.  Any unusedannual limitation may be carried over to later years until the applicableexpiration date for the respective NOLs and credits.  In general, the higher our company valuationat the time of such an ownership change, the higher the annual limitation wouldbe, and we could offset a greater amount of taxable income with the NOLs andcredits.  However, if an ownership changehas occurred in a period when our company valuation was low, the annuallimitation would be lower, and we could only offset a lesser amount of taxableincome with the NOLs and credits.

 

To the extent that these tax attributes become significantly limited,we expect to be taxed on our income, if any, at the U.S. federal and statestatutory rates.  As a result, anyinability to utilize these tax attributes would adversely affect future operatingresults by the amount of the federal or state taxes that would not haveotherwise been payable, having an adverse impact on our operating results andfinancial condition.  In addition,inability to use NOLs and credits would adversely affect our financialcondition relative to our financial condition had these tax attributes beenavailable.  In addition, California andcertain states have suspended use of NOLs, and other states are consideringsimilar measures.  As a result, we mayincur higher state income tax expense in the future.  Depending on our future tax position,continued suspension of our ability to use state NOLs could have an adverseimpact on our operating results and financial condition.

 

***Our customers are subject togovernment regulation, and changes in current or future laws or regulationsthat negatively impact our customers could harm our business.***

 

The jurisdiction of the Federal Communications Commission, or FCC,extends to the entire telecommunications industry, including our customers.Future FCC regulations affecting the broadband access industry, our customers,or the service offerings of our customers, may harm our business. For example,FCC regulatory policies affecting the availability of data and Internetservices may impede the penetration of our customers into certain markets oraffect the prices they may charge in such markets. Furthermore, many of ourcustomers are subject to FCC rate regulation of interstate telecommunicationsservices, and are recipients of federal universal service subsidies implementedand administered by the FCC. In addition, many of our customers are subject tostate regulation of intrastate telecommunications services, including rates forsuch services, and may also receive state universal service subsidies. Changesin FCC or state rate regulations or federal or state universal servicesubsidies or the imposition of taxes on Internet access service, couldadversely affect our customers’ revenues and capital spending plans. Inaddition, international regulatory bodies are beginning to adopt standards andregulations for the telecom industry. These domestic and foreign standards,laws and regulations address various aspects of VoIP and broadband use,including issues relating to liability for information retrieved from, ortransmitted over, the Internet. Changes in standards, laws and regulations, orjudgments in favor of plaintiffs in lawsuits against service providers couldadversely affect the development of Internet and other IP-based services. This,in turn, could directly or indirectly materially adversely impact the telecomindustry in which our customers operate. To the extent our customers areadversely affected by laws or regulations regarding their business, products orservice offerings, our business, financial condition and results of operationswould suffer.

 

***If we fail to comply withregulations and evolving industry standards, sales of our existing and futureproducts could be adversely affected.***

 

The markets for our products are characterized by a significant numberof laws, regulations and standards, both domestic and international, some ofwhich are evolving as new technologies are deployed. Our products are requiredto comply with these laws, regulations and standards, including thosepromulgated by the FCC. For example, the FCC required that all facilities basedproviders of broadband Internet access and interconnect VoIP services meet thecapability requirements of the Communications Assistance for Law EnforcementAct by May 14, 2007. Subject to certain statutory parameters, we wererequired to make available to our customers, on a reasonably timely basis andat a reasonable charge, such features or modifications as are necessary topermit our customers to meet those capability requirements. In some cases, weare required to obtain certifications or authorizations before our products canbe introduced, marketed or sold. There can be no assurance that we will be ableto continue to design our products to comply with all necessary requirements inthe future. Accordingly, any of these laws, regulations and standards maydirectly affect our ability to market or sell our products.

 

Some of our operations are regulated under various federal, state andlocal environmental laws. Our planned international expansion will likelysubject us to additional environmental and other laws. For example, theEuropean Union Directive 2002/96/EC on waste electrical and electronicequipment, known as the WEEE Directive, requires producers of certain electricaland electronic equipment, including telecom equipment, to be financiallyresponsible for the specified collection, recycling, treatment and disposal ofpast and present covered products placed on the market in the European Union.The European Union Directive 2002/95/EC on the restriction of the use ofhazardous substances in electrical and electronic equipment, known as the RoHSDirective, restricts the use of certain hazardous substances, including lead,in covered products. Failure to comply with these and other environmental lawscould result in fines and penalties and decreased sales, which could adverselyaffect our planned international expansion and our consolidated operatingresults.

 

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***Compliance with changing regulationof corporate governance and public disclosure may result in additionalexpenses.***

 

Changing laws, regulations and standards relating to corporategovernance and public disclosure may create uncertainty regarding compliancematters. New or changed laws, regulations and standards are subject to varyinginterpretations in many cases. As a result, their application in practice mayevolve over time. We are committed to maintaining high standards of corporategovernance and public disclosure. Complying with evolving interpretations ofnew or changed legal requirements may cause us to incur higher costs as werevise current practices, policies and procedures, and may divert managementtime and attention from revenue generating to compliance activities. If ourefforts to comply with new or changed laws, regulations and standards differfrom the activities intended by regulatory or governing bodies due toambiguities related to practice, our reputation might also be harmed. Further,our board members, chief executive officer and chief financial officer couldface an increased risk of personal liability in connection with the performanceof their duties. As a result, we may have difficulty attracting and retainingqualified board members and executive officers, which could harm our business.

 

***We may not be able to protect ourintellectual property, which could adversely affect our ability to competeeffectively.***

 

We depend on our proprietary technology for our success and ability tocompete. We currently hold 27 issued patents and have several patentapplications pending. We rely on a combination of patent, copyright, trademarkand trade secret laws, as well as confidentiality agreements and licensingarrangements, to establish and protect our proprietary rights. Existing patent,copyright, trademark and trade secret laws will afford us only limitedprotection. In addition, the laws of some foreign countries do not protectproprietary rights to the same extent, as do the laws of the U.S. We cannotassure you that any pending patent applications will result in issued patents,and issued patents could prove unenforceable. Any infringement of ourproprietary rights could result in significant litigation costs. Further, anyfailure by 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 to protect our proprietary rights, attempts may bemade to copy or reverse engineer aspects of our products, or to obtain and useinformation that we regard as proprietary. Accordingly, we may be unable toprotect our proprietary rights against unauthorized third party copying or use.Furthermore, policing the unauthorized use of our intellectual property wouldbe difficult for us. Litigation may be necessary in the future to enforce ourintellectual property rights, to protect our trade secrets or to determine thevalidity and scope of the proprietary rights of others. Litigation could resultin substantial costs and diversion of resources and could have a materialadverse effect on our business, consolidated financial condition and consolidatedresults of operations.

 

***We could become subject tolitigation regarding intellectual property rights that could materially harmour business.***

 

We may be subject to intellectual property infringement claims that arecostly to defend and could limit our ability to use some technologies in thefuture. Our industry is characterized by frequent intellectual propertylitigation based on allegations of infringement of intellectual propertyrights. From time to time, third parties have asserted against us and mayassert against us in the future patent, copyright, trademark or otherintellectual property rights to technologies or rights that are important toour business. In addition, we have agreed, and may in the future agree, toindemnify our customers for any expenses or liabilities resulting from claimedinfringements of patents, trademarks or copyrights of third parties. Any claimsasserting that our products infringe, or may infringe on, the proprietaryrights of third parties, with or without merit, could be time-consuming,resulting in costly litigation and diverting the efforts of our management.These claims could also result in product shipment delays or require us tomodify our products or enter into royalty or licensing agreements. Such royaltyor licensing agreements, if required, may not be available to us on acceptableterms, if at all.

 

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

 

Our business and operations depend on the extent to which ourfacilities and products are protected against damage 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 have taken, a natural disaster or otherunanticipated problem could, among other things, hinder our research anddevelopment efforts, delay the shipment of our products and affect our abilityto receive and fulfill orders. While we believe that our insurance coverage iscomparable to those of similar companies in our industry, it does not cover allnatural disasters, in particular, earthquakes and floods.

 

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**Risks Related to Our Common Stock**

 

***Our executive officers, directorsand their affiliates hold a large percentage of our stock and their interestsmay differ from other stockholders.***

 

As of September 30, 2010, our executive officers, directors andtheir affiliates beneficially owned, in the aggregate, approximately 27% of ouroutstanding common stock, of this 25% is collectively owned by investment fundsaffiliated with U.S. Venture Partners and Norwest Venture Partners.Representatives of U.S. Venture Partners and Norwest Venture Partners aredirectors of Occam. These stockholders have significant influence over mostmatters requiring approval by stockholders, including the election ofdirectors, any amendments to our certificate of incorporation and significantcorporate transactions.

 

***Our stock price may be volatile, andyou may not be able to resell shares of our common stock at or above the priceyou paid.***

 

Our shares of common stock began trading on The NASDAQ Global Market inNovember 2006. An active public market for our shares on The NASDAQ GlobalMarket may not be sustained. In particular, limited trading volumes andliquidity may limit the ability of stockholders to purchase or sell our commonstock in the amounts and at the times they wish. Trading volume in our commonstock tends to be modest relative to our total outstanding shares, and theprice of our common stock may fluctuate substantially (particularly inpercentage terms) without regard to news about us or general trends in thestock market.

 

In addition, the trading price of our common stock could become highlyvolatile and could be subject to wide fluctuations in response to variousfactors, some of which are beyond our control. These factors include thosediscussed in this “Risk Factors” section of this Annual Report onForm 10-K and others such as:

 

·                 quarterly variations in our consolidatedresults of operations or those of our competitors;

 

·                 changes in earnings estimates orrecommendations by securities analysts;

 

·                 announcements by us or our competitors of newproducts, significant contracts, commercial relationships, acquisitions orcapital commitments;

 

·                 developments with respect to intellectualproperty rights;

 

·                 our ability to develop and market new andenhanced products on a timely basis;

 

·                 commencement of, or involvement in,litigation;

 

·                 general market volatility;

 

·                 lack of capital to invest in Occam;

 

·                 changes in governmental regulations or in thestatus of our regulatory approvals;

 

·                 a slowdown in the telecom industry or generaleconomy; and

 

·                 continuation of the current economic andcredit crisis.

 

In recent years, the stock market in general, and the market fortechnology companies in particular, has experienced extreme price and volumefluctuations that have often been unrelated or disproportionate to theoperating performance of those companies. Broad market and industry factors mayseriously affect the market price of our common stock, regardless of our actualoperating performance. In addition, in the past, following periods ofvolatility in the overall market and the market price of a particular company’ssecurities, securities class action litigation has often been institutedagainst these companies. Any litigation that may be instituted against us couldresult in substantial costs and a diversion of our management’s attention andresources.

 

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***Provisions in our charter documentsand under Delaware law could discourage a takeover that stockholders mayconsider favorable.***

 

Provisions in our certificate of incorporation and bylaws, as amendedand restated, may have the effect of delaying or preventing a change of controlor changes in our management. These provisions include the following:

 

·                 our board of directors has the right to electdirectors to fill a vacancy created by the expansion of the board of directorsor the resignation, death or removal of a director, which prevents stockholdersfrom being able to fill vacancies on our board of directors;

 

·                 our stockholders may not act by writtenconsent or call special stockholders’ meetings; as a result, a holder, orholders, controlling a majority of our capital stock would not be able to takecertain actions other than at annual stockholders’ meetings or specialstockholders’ meetings called by the board of directors, the chairman of theboard, the chief executive officer or the president;

 

·                 our certificate of incorporation prohibitscumulative voting in the election of directors, which limits the ability ofminority stockholders to elect director candidates;

 

·                 stockholders must provide advance notice tonominate individuals for election to the board of directors or to proposematters that can be acted upon at a stockholders’ meeting, which may discourageor deter a potential acquiror from conducting a solicitation of proxies toelect the acquiror’s own slate of directors or otherwise attempting to obtaincontrol of our company; and

 

·                 our board of directors may issue, withoutstockholder approval, shares of undesignated preferred stock; the ability toauthorize undesignated preferred stock makes it possible for our board ofdirectors to issue preferred stock with voting or other rights or preferencesthat could impede the success of any attempt to acquire us.

 

As a Delaware corporation, we are also subject to certain Delawareanti-takeover provisions. Under Delaware law, a corporation may not engage in abusiness combination with any holder of 15% or more of its capital stock unlessthe holder has held the stock for three years or, among other things, the boardof directors has approved the transaction. Our board of directors could rely onDelaware law to prevent or delay an acquisition of us.

 

***We may be unable to raise additionalcapital to fund our future operations, and any future financings oracquisitions could result in substantial dilution to existing stockholders.***

 

While we anticipate our cash balances and any cash from operations,will be sufficient to fund our operations for at least the next 12 months,we may need to raise additional capital to fund operations in the future. Thereis no guarantee that we will be able to raise additional equity or debt fundingwhen or if it is required. The terms of any financing, if available, could beunfavorable to us and our stockholders and could result in substantial dilutionto the equity and voting interests of our 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.

 

***If securities or industry analystsdo not publish research or publish misleading or unfavorable research about ourbusiness, our stock price and trading volume could decline.***

 

The trading market for our common stock depends in part on the researchand reports that securities or industry analysts publish about us or ourbusiness. If no or few securities or industry analysts cover our company, thetrading price for our stock would be negatively impacted. If one or more of theanalysts who covers us downgrades our stock or publishes misleading orunfavorable research about our business, our stock price would likely decline.If one or more of these analysts ceases coverage of our company or fails topublish reports on us regularly, demand for our stock could decrease, whichcould cause or stock price or trading volume to decline.

 

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

 

None.

 

**ITEM 3.****                                               ****DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.****                                               ****REMOVED AND RESERVED**

 

**ITEM 5.****                                               ****OTHER INFORMATION**

 

None

 

**ITEM 6.****                                               ****EXHIBITS**

** **
| 2.1   |   | Agreement and Plan of  Merger and Reorganization, dated as of September 16, 2010, by and among  Occam Networks, Inc. and Calix, Inc., Ocean Sub I, Inc. and  Ocean Sub II, LLC (which is incorporated herein by reference to  Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed on  September 16, 2010). |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.21 |   | Form of Amendment to  Indemnification Agreement (which is incorporated herein by reference to  Exhibit 10.21 of the Registrant’s Current Report on Form 8-K filed  on August 13, 2010).                                                                                                                                                |
| 10.22 |   | Support Agreement dated as  of September 16, 2010, by and among Calix, Inc., Ocean Sub  I, Inc., Ocean Sub II, LLC and certain stockholders of Occam  Networks, Inc. (which is incorporated herein by reference to  Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed  on September 16, 2010).          |
| 10.23 |   | Form of Amendment to  Change of Control Severance Agreement (which is incorporated herein by  reference to Exhibit 10.2 of the Registrant’s Current Report on  Form 8-K filed on September 16, 2010).                                                                                                                                  |
| 31.01 |   | Certification of Chief  Executive Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                        |
| 31.02 |   | Certification of Chief  Financial Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                                                                                                                                         |
| 32.01 |   | Certifications 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, as amended, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Dated: October 28,  2010 | OCCAM NETWORKS, INC. |
|-------------------------------|---------------------------|
|                          |                      |   |
|                          |                      |   |
|                          | By:                       | /s/ JEANNE SEELEY |
|                          |                      | Jeanne Seeley |
|                          |                      | Senior Vice President and  Chief Financial Officer |
|                          |                      | (Principal Financial and  Accounting Officer) |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                                                                          |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |       | Agreement and Plan of  Merger and Reorganization, dated as of September 16, 2010, by and among  Occam Networks, Inc. and Calix, Inc., Ocean Sub I, Inc. and  Ocean Sub II, LLC (which is incorporated herein by reference to  Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed on  September 16, 2010). |
| 10.21               |       | Form of Amendment to  Indemnification Agreement (which is incorporated herein by reference to  Exhibit 10.21 of the Registrant’s Current Report on Form 8-K filed  on August 13, 2010).                                                                                                                                                |
| 10.22               |       | Support Agreement dated as  of September 16, 2010, by and among Calix, Inc., Ocean Sub  I, Inc., Ocean Sub II, LLC and certain stockholders of Occam  Networks, Inc. (which is incorporated herein by reference to  Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed  on September 16, 2010).          |
| 10.23               |       | Form of Amendment to  Change of Control Severance Agreement (which is incorporated herein by  reference to Exhibit 10.2 of the Registrant’s Current Report on  Form 8-K filed on September 16, 2010).                                                                                                                                  |
| 31.01               |       | Certification of Chief  Executive Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                        |
| 31.02               |       | Certification of Chief  Financial Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                                                                                                                                         |
| 32.01               |       | Certifications 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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