** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| x                                                                                                                                                                                                                                                                                                 | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                              | ** ** | ** **                                                                                               |
| **For the  three month period ended March 31, 2008**                                                                                                                                                                                                                                         |
| ** **                                                                                                                                                                                                                                                                                        |
| **OR**                                                                                                                                                                                                                                                                                            |
| ** **                                                                                                                                                                                                                                                                                        |
| o                                                                                                                                                                                                                                                                                                 | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                                                                                                                                                                                                                              | ** ** | ** **                                                                                               |
| **For the transition period  from                     to                     ** |

 

**Commission file number: 000-33069**

 

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**OCCAMNETWORKS, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**(State or other jurisdiction of   incorporation or organization)               | ** ** | **77-0442752**(I.R.S. Employer   Identification No.) |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------------|
| ** **                                                                                 | ** ** | ** **                                           |
| **6868 Cortona Drive   Santa Barbara, California**(Address of principal executive office)  | ** ** | **93117**(Zip Code)                                  |
| ** **                                                                                 | ** ** | ** **                                           |
| **(805) 692-2900**(Registrant’s telephone number, including area code)           |
| ** **                                                                                 |
| **N/A**(Former name, former address and former fiscal year,  if changed since last report) |

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during 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 bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See definitionof “large accelerated filer,” “accelerated filer” and “smaller reporting 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 bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o No x

 

As of April 25,2008, the number of shares outstanding of the registrant’s common stock was 19,783,941 shares.

 

 

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**INDEX**

 
| ** **                               | ** **                                                                                  | **Page** |
|------------------------------------------|---------------------------------------------------------------------------------------------|----------|
| PART I—FINANCIAL INFORMATION 1 |                                                                                        |
| Item 1.                             | Financial Statements                                                                        | 1        |
|                                     | Consolidated Balance Sheets                                                                 | 1        |
|                                     | Consolidated Statements of Operations                                                       | 2        |
|                                     | Consolidated Statements of Cash Flows                                                       | 3        |
|                                     | Notes to Consolidated Financial Statements                                                  | 4        |
| Item 2.                             | Management’s Discussion and Analysis of Financial Condition and  Results of Operations | 11       |
| Item 3.                                  | Quantitative and Qualitative Disclosures  About Market Risk                                 | 19       |
| Item 4.                                  | Controls and Procedures                                                                     | 19       |
| PART II—OTHER INFORMATION      | 22                                                                                          |
| Item 1.                                  | Legal Proceedings                                                                           | 22       |
| Item 1A.                            | Risk Factors                                                                                | 24       |
| Item 2.                                  | Unregistered Sales of Equity Securities and  Use of Proceeds                                | 38       |
| Item 3.                                  | Defaults Upon Senior Securities                                                             | 38       |
| Item 4.                                  | Submission of Matters to a Vote of Securityholders                                          | 38       |
| Item 5.                                  | Other Information                                                                           | 39       |
| Item 6.                                  | Exhibits                                                                                    | 39       |
| Signatures                               |                                                                                        | 40       |
| Exhibit Index                       |                                                                                        | 41       |

 

i

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**PART I—FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**OCCAM NETWORKS, INC. AND SUBSIDIARY**

 

**CONSOLIDATED BALANCE SHEETS**

(In thousands,except share data)

 
| ** **                                                                                                                                                                                    | ** ** | **March 31,   2008** | ** ** | **December 31,   2007*** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**                | ** ** | ** **                         | ** ** |
| **ASSETS**                                                                                                                                                                                    |       |                           |       |                               |       |
| Current assets:                                                                                                                                                                               |       |                           |       |                               |       |
| Cash and cash equivalents                                                                                                                                                                     |       | $                              | 33,404     |                               | $          | 37,637 |   |
| Restricted cash                                                                                                                                                                               |       | 15,808                         |       | 13,103                             |       |
| Accounts receivable, net                                                                                                                                                                      |       | 12,753                         |       | 14,819                             |       |
| Inventories, net                                                                                                                                                                              |       | 13,237                         |       | 13,371                             |       |
| Prepaid and other current assets                                                                                                                                                              |       | 2,442                          |       | 2,108                              |       |
| Total current assets                                                                                                                                                                          |       | 77,644                         |       | 81,038                             |       |
| Property and equipment, net                                                                                                                                                                   |       | 8,407                          |       | 8,874                              |       |
| Intangibles, net                                                                                                                                                                              |       | 100                            |       | 890                                |       |
| Other assets                                                                                                                                                                                  |       | 113                            |       | 83                                 |       |
| Total assets                                                                                                                                                                                  |       | $                              | 86,264     |                               | $          | 90,885 |   |
| ** **                                                                                                                                                                                    |       |                           |       |                               |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 |       |                           |       |                               |       |
| Current liabilities:                                                                                                                                                                          |       |                           |       |                               |       |
| Accounts payable                                                                                                                                                                              |       | $                              | 7,506      |                               | $          | 10,135 |   |
| Accrued expenses                                                                                                                                                                              |       | 7,328                          |       | 6,464                              |       |
| Deferred sales                                                                                                                                                                                |       | 13,221                         |       | 12,420                             |       |
| Deferred rent                                                                                                                                                                                 |       | 270                            |       | 237                                |       |
| Capital lease obligations                                                                                                                                                                     |       | 17                             |       | 17                                 |       |
| Total current liabilities                                                                                                                                                                     |       | 28,342                         |       | 29,273                             |       |
| Deferred rent, net of current portion                                                                                                                                                         |       | 1,267                          |       | 1,299                              |       |
| Capital lease obligations, net of current  portion                                                                                                                                            |       | 43                             |       | 47                                 |       |
| Total liabilities                                                                                                                                                                             |       | 29,652                         |       | 30,619                             |       |
| Commitments and contingencies (note 5)                                                                                                                                                   |       |                           |       |                               |       |
| Stockholders’ equity:                                                                                                                                                                    |       |                           |       |                               |       |
| Common stock, $0.001 par value, 250,000,000  shares authorized; 19,783,867 and 19,773,730 shares issued and  outstanding at March 31, 2008 and December 31, 2007, respectively |       | 289                            |       | 289                                |       |
| Additional paid-in capital                                                                                                                                                                    |       | 180,341                        |       | 179,455                            |       |
| Warrants                                                                                                                                                                                      |       | 331                            |       | 331                                |       |
| Accumulated deficit                                                                                                                                                                           |       | (124,349                       | )          | (119,809                           | )          |
| Total stockholders’ equity                                                                                                                                                               |       | 56,612                         |       | 60,266                             |       |
| Total liabilities and stockholders’ equity                                                                                                                                               |       | $                              | 86,264     |                               | $          | 90,885 |   |

 

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* Derived from auditedconsolidated financial statements included in its Annual Report on Form 10-K.

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

1

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(In thousands,except per share data)

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                    | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **                                                                    | ** ** | **(Unaudited)**                  | ** ** |
|                                                                          |       |                             |       |   |   |
| Sales                                                                         |       | $                                | 19,653     |   | $ | 18,987 |   |
| Cost of sales                                                                 |       | 11,220                           |       | 11,970 |   |
| Gross margin                                                                  |       | 8,433                            |       | 7,017 |   |
| Operating expenses:                                                           |       |                             |       |   |   |
| Research and development                                                      |       | 4,559                            |       | 2,700 |   |
| Sales and marketing                                                           |       | 4,978                            |       | 3,460 |   |
| General and administrative                                                    |       | 3,123                            |       | 1,601 |   |
| Total operating expenses                                                      |       | 12,660                           |       | 7,761 |   |
| Loss from operations                                                          |       | (4,227                           | )          | (744 | ) |
| Other income (expense), net                                                   |       | (654                             | )          | — |   |
| Interest income (expense), net                                                |       | 360                              |       | 773 |   |
| Income (loss) before provision for income  taxes                              |       | (4,521                           | )          | 29 |   |
| Provision for income taxes                                                    |       | 19                               |       | — |   |
| Net income (loss)                                                             |       | $                                | (4,540     | ) | $ | 29 |   |
| Net income (loss) per share available  (attributable) to common stockholders: |       |                             |       |   |   |
| Basic                                                                         |       | $                                | (0.23      | ) | $ | 0.00 |   |
| Diluted                                                                       |       | $                                | (0.23      | ) | $ | 0.00 |   |
| Weighted average shares:                                                      |       |                             |       |   |   |
| Basic                                                                         |       | 19,779                           |       | 19,739 |   |
| Diluted                                                                       |       | 19,779                           |       | 20,665 |   |
| Stock-based compensation included in:                                         |       |                             |       |   |   |
| Cost of sales                                                                 |       | $                                | 107        |   | $ | 102 |   |
| Research and development                                                      |       | 296                              |       | 236 |   |
| Sales and marketing                                                           |       | 187                              |       | 205 |   |
| General and administrative                                                    |       | 232                              |       | 170 |   |
| Total stock-based compensation                                                |       | $                                | 822        |   | $ | 713 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

2

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** **

**OCCAM NETWORKS, INC. AND SUBSIDIARY**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

 
| ** **                                                                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                            | ** ** | **March 31,   2008**   | ** ** | **March 31,   2007** | ** ** |
| ** **                                                                            | ** ** | **(Unaudited)**                  | ** ** |
| ** **                                                                            | ** ** | ** **                       | ** ** |
| **Operating activities**                                                              |       |                             |       |   |   |
| Net income (loss)                                                                     |       | $                                | (4,540     | ) | $ | 29 |   |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                         |       | 746                              |       | 319 |   |
| Stock-based compensation expense                                                      |       | 822                              |       | 713 |   |
| Accounts receivable reserves                                                          |       | 54                               |       | — |   |
| Inventory reserves                                                                    |       | (10                              | )          | 380 |   |
| Write-off of developed technology and  related inventory                              |       | 944                              |       | — |   |
| Changes in operating assets and  liabilities:                                         |       |                             |       |   |   |
| Accounts receivable                                                                   |       | 2,012                            |       | (1,712 | ) |
| Inventory                                                                             |       | (50                              | )          | 157 |   |
| Prepaid expenses and other assets                                                     |       | (364                             | )          | (476 | ) |
| Accounts payable and accrued expenses                                                 |       | (1,764                           | )          | (179 | ) |
| Deferred sales                                                                        |       | 801                              |       | (1,425 | ) |
| Net cash used in operating activities                                                 |       | (1,349                           | )          | (2,194 | ) |
| **Investing activities**                                                              |       |                             |       |   |   |
| Purchases of property and equipment                                                   |       | (239                             | )          | (462 | ) |
| Increase in restricted cash                                                           |       | (2,705                           | )          | — |   |
| Net cash used in investing activities                                                 |       | (2,944                           | )          | (462 | ) |
| **Financing activities**                                                              |       |                             |       |   |   |
| Common stock issuance costs                                                           |       | —                           |       | (32 | ) |
| Proceeds from the exercise of stock options                                           |       | 64                               |       | 194 |   |
| Proceeds from employee stock purchase plan                                            |       | —                           |       | 245 |   |
| Payments of capital lease obligations                                                 |       | (4                               | )          | — |   |
| Net cash provided by financing activities                                             |       | 60                               |       | 407 |   |
| Net decrease in cash and cash equivalents                                             |       | (4,233                           | )          | (2,249 | ) |
| Cash and cash equivalents, beginning of  period                                       |       | 37,637                           |       | 59,219 |   |
| Cash and cash equivalents, end of period                                              |       | $                                | 33,404     |   | $ | 56,970 |   |
| **Supplemental disclosure of cash flow  information:**                                |       |                             |       |   |   |
| Interest paid                                                                         |       | $                                | 19         |   | $ | — |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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** **

**OCCAM NETWORKS, INC. AND SUBSIDIARY**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**(All interim information relating to thethree-months periods ended March 31, 2008 and 2007 is unaudited)**

 

**1. Business and Basis of Presentation**

 

Occam Networks, Inc.(“Occam,” the “Company,” “we” or “us”) develops, markets and supportsinnovative broadband access products designed to enable telecom serviceproviders to offer bundled voice, video and high speed internet, or TriplePlay, services over both copper and Gigabit Point-to-point fiber opticnetworks. The Company’s Broadband Loop Carrier (BLC) is an integrated hardwareand software platform that uses Internet Protocol (IP) and Ethernettechnologies to increase the capacity of local access networks, enabling thedelivery of advanced Triple Play services.

 

The Company isthe successor corporation of the May 2002 merger of Occam Networks, Inc.,a private California corporation, with Accelerated Networks, Inc., apublicly-traded Delaware corporation. Occam Networks was incorporated inCalifornia in July 1999. Accelerated was incorporated in California in October 1996under the name “Accelerated Networks, Inc.” and was reincorporated inDelaware in June 2000. The May 2002 merger of these two entities wasstructured as a reverse merger transaction in which Accelerated Networkssucceeded to the business and assets of Occam Networks. In connection with themerger, Accelerated changed its name to Occam Networks, Inc., a Delawarecorporation. Unless the context otherwise requires, references to “OccamNetworks,” “Occam” or the “Company” refer to Occam Networks, Inc. as aDelaware corporation and include the predecessor businesses of Occam, theCalifornia corporation, and Accelerated Networks. As required by applicableaccounting rules, financial statements, data, and information for periods priorto May 2002 are those of Occam, the California corporation. Occam, theCalifornia corporation, as a predecessor business or corporation, is sometimesreferred to as “Occam CA.”

 

*Basis of Presentation*

 

Theaccompanying consolidated financial statements are unaudited. The consolidatedbalance sheet at December 31, 2007 is derived from Occam’s auditedconsolidated financial statements included in its Annual Report on Form 10-Kfor the year ended December 31, 2007. These consolidated financialstatements reflect all material adjustments, consisting only of normalrecurring adjustments, which, in the opinion of management, are necessary tofairly state our financial position, results of operations and cash flows forthe interim periods. The results of operations for the current interim periodsare not necessarily indicative of results to be expected for the entire year.

 

Theconsolidated 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 thoseestimates, and material effects on consolidated operating results andconsolidated financial position may result.

 

Theseconsolidated financial statements have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission or SEC. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted pursuant to such rules andregulations. These consolidated financial statements should be read inconjunction with the consolidated financial statements and the notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2007.

 

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

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and the accompanying notes. Actual results could differfrom those estimates and such differences may be material to the consolidatedfinancial statements.

 

4

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*Revenue Recognition*

 

Occamrecognizes sales when persuasive evidence of sales arrangements exist, deliveryhas occurred or services have been rendered, the buyer’s price is fixed ordeterminable and collection is reasonably assured. We allow credit for productsreturned within our policy terms.

 

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

 

·                  the delivered item(s) has valueto the customer on a stand-alone basis;

 

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

 

·                  the arrangement includes a generalright of return relative to the delivered item(s) and delivery orperformance of the undelivered item(s) is considered probable and substantiallyin our control.

 

If thesecriteria are not met, then sales are deferred until such criteria are met oruntil the period(s) over which the last undelivered element is delivered.If there is objective and reliable evidence of fair value for all units ofaccounting in an arrangement, the arrangement consideration is allocated to theseparate units of accounting based on each unit’s relative fair value.

 

In certaincircumstances, the Company enters into arrangements with customers who receivefinancing support in the form of long-term low interest rate loans from theUnited States Department of Agriculture’s Rural Utilities Service, or RUS. Theterms of certain RUS contracts provide that transfer of title of the Company’sproducts does not occur until customer acceptance. In these cases, the Companydoes not recognize a sale until payment has been received, assuming theremaining revenue recognition criteria are met. The Company believes payment,which contractually occurs after written customer acceptance, provides superiorassurance for revenue recognition purposes.

 

In certaincircumstances, the Company enters into transactions with value-added resellerswhere the resellers may not have the ability to pay for these sales independentof payment to them by the end-user. In these cases, the Company does notrecognize revenue until payment has been received, provided the remainingrevenue recognition criteria are met.

 

We warrant ourproducts for periods up to five years and record an estimated warranty accrualwhen sales is recognized.

 

**2. Inventories**

 

Inventoriesconsist of the following (in thousands):

 
| ** **         | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials      |       | $                        | 373        |                        | $          | 1,078 |   |
| Work-in-process    |       | 31                       |       | 14                          |       |
| Finished goods (1) |       | 12,833                   |       | 12,279                      |       |
|               |       | $                        | 13,237     |                        | $          | 13,371 |   |

 

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(1)            $7.6 million and $8.8million of finished goods inventory were shipped to customers as of March 31,2008 and December 31, 2007, respectively. The majority were sent to RUScontract customers and value-added resellers. Sales and related Cost of saleswere not recognized at the time of shipments as defined by the Company’srevenue recognition policy and therefore were included in inventories. For moreinformation regarding our revenue recognition policy, see Revenue Recognitionunder Note 1 to these financial statements.

 

5

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**3. Intangibles**

 

In October 2007,we purchased certain assets from Terawave Communications Inc., including abroadband passive optical network (BPON) line of business that addressedMetro-Ethernet/Telemetry applications. We intended to sell this line ofbusiness and recorded an intangible asset of approximately $0.8 million as ofthe asset acquisition date. During the quarter ended March 31, 2008, wewere unable to secure a feasible offer and therefore decided to terminate thesales efforts and instead focus on bringing new GPON technology to market. As aresult of this decision, we wrote-off both the intangible asset and the relatedinventory.

 

**4. Net Income (Loss) Per Share**

 

The followingtable sets forth the computation of basic and diluted net income (loss) pershare (in thousands, except per share data):

 
| ** **                                                                                           | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                           | ** ** | **March 31,   2008**   | ** ** | **March 31,  2007** | ** ** |
| ** **                                                                                           | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net income (loss) available (attributable)  to common stockholders                                   |       | $                                | (4,540     | ) | $ | 29 |   |
| Shares used in computation:                                                                          |       |                             |       |   |   |
| Weighted average common shares outstanding  used in computation of basic net income (loss) per share |       | 19,779                           |       | 19,739 |   |
| Dilutive effect of stock options                                                                     |       | —                           |       | 913 |   |
| Dilutive effect of common stock warrants                                                             |       | —                           |       | 13 |   |
| Shares used in computation of diluted net  income (loss) per share                                   |       | 19,779                           |       | 20,665 |   |
| Basic net income (loss) per share                                                                    |       | $                                | (0.23      | ) | $ | 0.00 |   |
| Diluted net income (loss) per share                                                                  |       | $                                | (0.23      | ) | $ | 0.00 |   |

 

**5. Commitments and Contingencies**

 

The Companyleases its office facilities and certain equipment under non-cancelableoperating lease agreements, which expire at various dates through 2015. Certainoperating leases contain escalation clauses with annual base rent adjustmentsor a cost of living adjustment. Total rent expense for the three months ended March 31,2008 and March 31, 2007, was $365,464 and $325,000, respectively.Approximate minimum annual lease commitments under non-cancelable operatingleases are as follows (in thousands):

 
| **Twelve Months Ending March 31,** | ** ** | ** ** | ** ** |
|--------------------------------------------------------|------------|------------|------------|
| 2009                                                   |       | $          | 1,349      |   |
| 2010                                                   |       | 1,407      |       |
| 2011                                                   |       | 1,442      |       |
| 2012                                                   |       | 1,478      |       |
| 2013                                                   |       | 1,515      |       |
| Thereafter                                             |       | 2,021      |       |
| Total Minimum Operating Lease Payments                 |       | $          | 9,212      |   |

 

During thethree months ended March 31, 2008, the Company entered into a newoperating lease in Fremont, California. The new lease will consolidate itsHayward, California and Milpitas, California facilities into one new location.The Company expects to complete the office consolidation in the second quarterof 2008. The lease term is 86 months beginning June 1, 2008.  The lease has an escalation clause withmonthly rent beginning at $32,040 increasing annually to $38,257 by the end ofthe lease term. Along with the rent, the Company will pay a portion of thebuilding’s operating expenses, insurance and real estate taxes which iscurrently $8,640 per month. A security deposit was made in the form of a $0.3million letter of credit backed by a certificate of deposit. In addition, wehave a construction commitment of $1.6 million for leasehold improvements onthe new facility.

 

6

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***Royalties***

 

From time totime, the Company may license certain technology for incorporation into itsproducts. Under the terms of these agreements, royalty payments will be madebased on per-unit sales of certain of the Company’s products. The Companyincurred $60,600 and $46,000 of royalty expenses for the three months ended March 31,2008 and 2007, respectively.

 

***Legal Proceedings***

 

*2007 Class Action Litigation*

 

On April 26,2007 and May 16, 2007, two putative class action complaints were filed inthe United States District Court for the Central District of California againstOccam and certain of its officers. The complaints allege that the defendantsviolated sections 10(b) and 20(a) of the Securities Exchange Actof 1934, or the Exchange Act, and SEC Rule 10b-5 promulgated thereunder bymaking false and misleading statements and omissions relating to our financialstatements and internal controls with respect to revenue recognition. Thecomplaints seek, on behalf of persons who purchased our common stock during theperiod from May 2, 2006 and April 17, 2007, damages of an unspecifiedamount.

 

On July 30,2007, Judge Christina A. Snyder consolidated these actions into a singleaction, appointed NECA-IBEW Pension Fund (The Decatur Plan) as lead plaintiff,and approved its selection of lead counsel. On November 16, 2007, the leadplaintiff filed a consolidated complaint. This consolidated complaint adds asdefendants certain of Occam’s current and former directors and officers, itscurrent and former outside auditors, the lead underwriter of its secondarypublic offering in November 2006, and two venture capital firms who wereearly investors in Occam. The consolidated complaint alleges that defendantsviolated sections 10(b), 20(a) and 20A of the Exchange Act and SEC Rule 10b-5promulgated thereunder, as well as sections 11 and 15 of the SecuritiesAct of 1933, or Securities Act, by making false and misleading statements andomissions relating to our financial statements and internal controls withrespect to revenue recognition that required restatement. The consolidatedcomplaint seeks, on behalf of persons who purchased Occam’s common stock duringthe period from April 29, 2004 to October 15, 2007, damages of anunspecified amount.

 

On January 25,2008, defendants filed motions to dismiss the consolidated complaint. Leadplaintiffs filed a consolidated opposition to these motions on March 25, 2008.Defendants filed reply briefs in support of their motions on April 24, 2008. Ahearing on the motions to dismiss the consolidated complaint is currently setfor May 19, 2008 before Judge Snyder.

 

Occam believesthat it has meritorious defenses in this action, and intends to defend itselfvigorously. Failure by Occam to obtain a favorable resolution of the claims setforth in the consolidated complaint could have a material adverse effect on itsbusiness, results of operations and financial condition. Currently, the amountof such material adverse effect cannot be reasonably estimated.

 

*IPO Allocation Litigation*

 

In June 2001,three putative stockholder class action lawsuits were filed against AcceleratedNetworks, certain of its then officers and directors and several investmentbanks that were underwriters of Accelerated Networks’ initial public offering.The cases, which have since been consolidated, were filed in the United StatesDistrict Court for the Southern District of New York. The Court appointed alead plaintiff on April 16, 2002, and plaintiffs filed a consolidatedamended class action complaint (the “Complaint”) 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 and Sections 10(b) and20(a) and Rule 10b-5 of the 1934 Act against one or both ofAccelerated Networks and the individual defendants. The claims were based onallegations that the underwriter defendants agreed to allocate stock inAccelerated Networks’ initial public offering to certain investors in exchangefor excessive and undisclosed commissions and agreements by those investors tomake additional purchases in the aftermarket at pre-determined prices.Plaintiffs alleged that the prospectus for Accelerated Networks’ initial publicoffering was false and misleading in violation of the securities laws becauseit did not disclose these arrangements. These lawsuits are part of the massive “IPOallocation” litigation involving the conduct of underwriters in allocatingshares of successful initial public offerings. We believe that over threehundred other companies have been named in more than one thousand similarlawsuits that have been filed by some of the same plaintiffs’ law firms. In October 2002,the plaintiffs voluntarily dismissed the individual defendants withoutprejudice. On February 1, 2003 a motion to dismiss filed by the issuerdefendants was heard and the court dismissed the 10(b), 20(a) and rule 10b-5claims against Occam. On October 13, 2004, the Court certified a class insix of the approximately 300 other nearly identical actions (the “focus” cases)and noted that the decision was intended to provide guidance to all partiesregarding class certification in the remaining cases. The underwriterdefendants appealed the decision and the Second Circuit 

 

7

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Court of Appeals vacated thedistrict court’s decision 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. OnOctober 3, 2007, the plaintiff filed a motion to certify a new class and asecond amended complaint based on the Second Circuit Appeals Court decision. Anopposition brief was filed by both underwriter defendants and the issuerdefendants on December 21, 2007, and a reply brief was filed on January 28,2008. The plaintiff’s have filed an amended reply brief March 28, 2008, insupport of their motion to certify the class of plaintiffs there is astipulation that the underwriter defendants and the issuer defendants haveuntil May 9, 2008, to file an answer to the amended complaint. The Courthas not ruled on the motion.

 

Prior to theSecond Circuit’s December 5, 2006 ruling, we agreed, together with overthree hundred other companies similarly situated, to settle with the plaintiffs.A settlement agreement and related agreements were submitted to the Court forapproval. The settlement would have provided, among other things, a release ofthe Company and of the individual defendants for the conduct alleged to bewrongful in the Complaint in exchange for a guarantee from the Company’sinsurers regarding recovery from the underwriter defendants and otherconsideration from the Company regarding its underwriters. In light of theSecond Circuit opinion, liaison counsel for the issuers informed the DistrictCourt that the settlement cannot be approved because the defined settlementclass, like the litigation class, cannot be certified. We cannot predictwhether we will be able to renegotiate a settlement that complies with theSecond Circuit’s mandate.

 

Due to theinherent uncertainties of litigation, we cannot accurately predict the ultimateoutcome of the matter. We have not recorded any accrual related to thisproposed settlement because Occam expects any settlement amounts to be coveredby its insurance policies.

 

*Threatened Litigation*

 

In late 2007,Occam received a letter from Vanessa Simmonds, a putative shareholder of theCompany, demanding that Occam investigate and prosecute a claim for allegedshort-swing trading in violation of Section 16(b) of the ExchangeAct, by the underwriter of its initial public offering (“IPO”) and certainunidentified directors, officers and shareholders of Occam (then known asAccelerated Networks). Occam evaluated the demand and declined to prosecute theclaim. On October 12, 2007, the putative shareholder commenced a civillawsuit in the U.S. District Court for the Western District of Washingtonagainst Credit Suisse Group, the lead underwriter of Occam’s IPO, allegingviolations of Section 16(b). The complaint alleges that the combinednumber of shares of Occam’s common stock beneficially owned by the leadunderwriter and certain unnamed officers, directors, and principal shareholdersexceeded ten percent of its outstanding common stock from the date of Occam’sIPO on June 23, 2000, through at least June 22, 2001. It 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). Occam was named as a nominaldefendant in the action, but has no liability for the asserted claims. Nodirectors or officers of Occam are named as defendants in this action.

 

On October 29,2007, the case was reassigned to Judge James L. Robart along with fifty-fourother Section 16(b) cases seeking recovery of short-swing profitsfrom underwriters in connection with various IPOs. The court is in discussionwith plaintiffs and defendants on how to proceed. Occam has waived service andwill vigorously defend the litigation.

 

Due to theinherent uncertainties of threatened litigation, we cannot accurately predictthe ultimate outcome of the matter, but we believe that the outcome of thislitigation will not have a material adverse impact on our consolidatedfinancial position and results of operations. We have not recorded any accrualsrelated to the demand letters or Section 16(b) litigation because we expectany resulting resolution to be covered by our insurance policies.

 

*Other Matters*

 

From time totime, the Company is subject to threats of litigation or actual litigation inthe ordinary course of business, some of which may be material. The Companybelieves that there are no currently pending matters that, if determinedadversely to the Company, would have a material effect on its business or thatwould not be covered by its existing liability insurance.

 

*Indemnifications and Guarantees*

 

The Companyenters into indemnification provisions under its agreements with othercompanies in the ordinary course of business, typically with its contractors,customers, channel partners, landlords and its agreements with certain investors.Under these provisions, the Company generally indemnifies and hold harmless theindemnified party for losses 

 

8

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suffered or incurred by the indemnified partyas a result of its activities or, in some cases, as a result of the indemnifiedparty’s activities under the agreement. These indemnification provisionsgenerally survive termination of the underlying agreement. The maximumpotential amount of future payments the Company could be required to make underthese indemnification provisions is generally unlimited. As of March 31,2008, the Company had not incurred material costs to defend lawsuits or settleclaims related to these indemnifications agreements and the Company has noliabilities recorded for these agreements as of March 31, 2008 and 2007.

 

*Purchase Orders*

 

Under theterms of Occam’s contract manufacturer agreements, Occam is required to placeorders with its contract manufacturers to provide inventory to meet itsestimated sales demand. Certain contract manufacturer agreements include lead-timeand cancellation provisions. At March 31, 2008, open purchase orders withcontract manufacturers were $15.4 million.

 

*Warranties*

 

Occam providesstandard warranties 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 revenue is recognized. Occam maintains product quality programs andprocesses including actively monitoring and evaluating the quality of itssuppliers. Occam quantifies and records an estimate for warranty related costsbased on Occam’s actual history, projected return and failure rates and currentrepair and replacement costs. The following table summarizes changes in Occam’saccrued warranty liability that is included in accrued liabilities (inthousands):

 
| ** **                                | ** ** | **March 31,  2008** | ** ** | **December 31,   2007** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | ** **               | ** ** | ** **                        | ** ** |
| Warranty liability at beginning of period |       | $                        | 3,470      |                              | $          | 1,862 |   |
| Accruals during period                    |       | 487                      |       | 3,497                             |       |
| Warranty utilization                      |       | (309                     | )          | (1,889                            | )          |
| Warranty liability at end of period       |       | $                        | 3,648      |                              | $          | 3,470 |   |

 

**6. Accrued Expenses**

 

The major components of accrued expenses are (in thousands):

 
| ** **                                  | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Warranty accruals                           |       | $                        | 3,648      |                        | $          | 3,470 |   |
| Payroll, paid time off and related accruals |       | 1,646                    |       | 1,032                       |       |
| Commissions                                 |       | 782                      |       | 250                         |       |
| Royalty accruals                            |       | 432                      |       | 368                         |       |
| Other accruals                              |       | 820                      |       | 1,344                       |       |
| Total                                       |       | $                        | 7,328      |                        | $          | 6,464 |   |

 

9

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**7. Stock Options, Stock Awards, EmployeeStock Purchase Plan, and Share-Based Compensation**

 

***Stock Options***

 

A summary ofthe Company’s stock options activities are as follows (in thousands):

 
| ** **                            | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 31, 2007 |       | 3,014      |       | $                                       | 7.17       |                                                 |       |                            |       |   |
| Granted                               |       | 33         |       | 5.21                                    |       |                                                 |       |                            |       |
| Exercised                             |       | (19        | )          | 3.53                                    |       |                                                 |       |                            |       |
| Forfeited or expired                  |       | (90        | )          | 9.01                                    |       |                                                 |       |                            |       |
| Outstanding at March 31, 2008    |       | 2,938      |       | $                                       | 7.11       |                                                 | 7.78       |                            | $          | 3,679 |   |
| Exercisable at March 31, 2008    |       | 1,382      |       | $                                       | 7.74       |                                                 | 6.27       |                            | $          | 1,341 |   |

 

During thethree months ended March 31, 2008, the Company reserved an additional593,212 shares of the Company’s common stock for issuance pursuant to the 2006 EquityIncentive Plan. The 2006 Equity Incentive Plan provides for annual increases inthe number of shares available for issuance thereunder on the first day of eachfiscal year, beginning with fiscal 2007, equal to the lesser of :

 

·                  3.0% of the outstanding shares of theCompany’s common stock on the first day of the fiscal year;

 

·                  750,000 shares; or

 

·                  such other amount as the Company’sboard of directors or a committee thereof may determine.

 

***Stock Awards***

 

A summary ofthe Company’s restricted stock unit activities are as follows (in thousands):

 
| ** **                            | ** ** | **Shares** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------|------------|------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 31, 2007 |       | 390        |       |                                                 |       |                            |       |
| Awarded                               |       | —     |       |                                                 |       |                            |       |
| Released                              |       | —     |       |                                                 |       |                            |       |
| Forfeited or expired                  |       | (2         | )          |                                                 |       |                            |       |
| Outstanding at Match 31, 2008    |       | 388        |       | 1.58                                                 |       | $                               | 1,631      |   |
|                                       |            |            |            |                                                      |            |                                 |            |  |

 

***Employee Stock Purchase Plan***

 

In March 2008,the Board of Directors approved an amendment to the 2006 Employee Stock PurchasePlan. The amendment increased the maximum number of shares of the Company’scommon stock that an eligible employee may purchase during each offering periodfrom 1,000 shares to 5,000 shares.

 

10

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***Stock-Based Compensation***

 

The followingtable summarizes the impact of SFAS 123(R) on stock-basedcompensation costs for employees on our Consolidated Statements of Operationsfor the three months ended March 31, 2008 and March 31, 2007 (inthousands):

 
| ** **                                                             | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                             | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **                                                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| **Employee stock-based compensation in:**                              |       |                             |       |   |   |
| Cost of sales                                                          |       | $                                | 107        |   | $ | 102 |   |
| Research and development                                               |       | 296                              |       | 236 |   |
| Sales and marketing                                                    |       | 187                              |       | 205 |   |
| General and administrative                                             |       | 232                              |       | 170 |   |
| Total SFAS 123(R) stock-based  compensation in operating expenses |       | 715                              |       | 611 |   |
| Total SFAS 123(R) stock-based compensation                        |       | $                                | 822        |   | $ | 713 |   |

 

As of March 31,2008, total unamortized stock-based compensation cost related to non-vestedstock options after accounting for estimated forfeitures was $5.4 million,which the Company expects to recognize over the remaining vesting period ofeach grant, up to the next 48 months.

 

Upon adoptionof SFAS 123(R), we selected the Black-Scholes option pricing model as themost appropriate model for determining the estimated fair value for stock-basedawards. The use of the Black-Scholes model requires the use of extensive actualemployee exercise behavior data and the use of a number of complex assumptionsincluding expected volatility, risk-free interest rate, forfeitures, andexpected dividends. The assumptions used to value options granted are asfollows:

 
| ** **              | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| Risk-free interest rate |       | 2.9                              | %          | 4.5 | % |
| Expected term (years)   |       | 4.9                              |       | 4.9 |   |
| Dividend yield          |       | 0                                | %          | 0 | % |
| Expected volatility     |       | 62                               | %          | 55 | % |

 

The risk-freeinterest rate is based on the U.S. Treasury yield curve in effect at the timeof grant. We do not anticipate declaring dividends in the foreseeable future.Expected volatility is based on the annualized weekly historical volatility ofour stock price and we believe it is indicative of future volatility. Weestimate the expected life of options granted based on historical exercise andpost-vesting cancellation patterns with consideration of our industry peers ofsimilar size with similar option vesting periods. Our analysis of stock pricevolatility and option lives involves management’s best estimates at the time ofdetermination. SFAS 123(R) also requires that we recognizecompensation expense for only the portion of options or stock units that areexpected to vest. Therefore, we apply an estimated forfeiture rate that isderived from historical employee termination behavior. If the actual number offorfeitures differs from those estimated by management, additional adjustmentsto compensation expense may be required in future periods.

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

 

*You should read the following discussion and analysis in conjunctionwith our condensed consolidated financial statements and the related notesthereto included in this Report on Form 10-Q and with Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in the Company’s Annual Report on Form 10-K for the year ended December 31,2007. The discussion in this Report contains both historical information andforward-looking statements. A number of factors affect our operating resultsand could cause our actual future results to differ materially from any forward-lookingresults discussed below. In some cases, you can identify forward-lookingstatements by terminology such as “anticipates,” “appears,” “believes,” “continue,”“could,” “estimates,” “expects,” “feels,” “goal,” “hope,” “intends,” “may,” “ourfuture success depends,” “plans,” “potential,” “predicts,” “projects,” “reasonably,”“seek to continue,” “should,” “thinks,” “will” or the negative of these termsor other comparable terminology. These statements are only predictions. Actualevents or results may differ materially. In addition, historical informationshould not be considered an indicator of future performance. Factors that couldcause or contribute to these differences include, but are not limited to, therisks discussed in Part II, Item 1A under the caption “Risk Factors.”These factors may cause our actual results to differ materially from anyforward-looking statements.*

 

*Although we believe that the expectations reflected in the forward-lookingstatements are reasonable, we cannot guarantee future results, levels ofactivity, performance or achievements. Moreover, we are under no duty to updateany of the forward-looking statements after the date of this Report on Form 10-Qto conform these statements to actual results. These forward-looking statementsare made in reliance upon the safe harbor provision of The Private SecuritiesLitigation Reform Act of 1995.*

 

11

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** **

**Overview**

 

We develop, market andsupport innovative broadband access products designed to enable telecom serviceproviders to offer bundled voice, video and high speed internet, or TriplePlay, services over both copper and Gigabit Point-to-point fiber opticnetworks. Our Broadband Loop Carrier, or BLC, is an integrated hardware andsoftware platform that uses Internet Protocol, or IP, and Ethernet technologiesto increase the capacity of local access networks, enabling our customers todeliver advanced services, including voice-over-IP, or VoIP, IP-basedtelevision, or IPTV, video-on-demand, or VoD, 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. In addition to providing our customers withincreased bandwidth, our products provide incremental value by offeringsoftware-based features to improve the quality, resiliency and security ofnetwork service offerings. We market our products through a combination ofdirect and indirect channels. Our direct sales efforts are focused on theincumbent local exchange providers, or ILECs, segment of the telecom serviceprovider market. As of March 31, 2008, we had shipped our BLC platform toover 280 service provider customers.

 

From our inception through March 31,2008, we have incurred cumulative net losses of approximately$124.3 million. We realized income from operations and were profitable ona net income basis during the quarters ended September 24, 2006 and December 31,2006 and for the year ended December 31, 2006. Previously, we had not beenprofitable on a quarterly or annual basis, excluding the quarter ended December 25,2005, in which we realized modest operating income of $3,000. We experiencedoperating and net losses in the second, third and fourth quarters of fiscal2007 and for fiscal 2007 as a whole.

 

In the second and thirdquarters of 2007, we experienced a softening in our business. We believe thissoftening was attributable in part to delays associated with our customers’evaluations of strategic investment decisions concerning their movement fromcopper wire to fiber, in part to a shift in our customer base toward longerterm loan projects funded by the U.S. Department of Agriculture’s RuralUtilities Service, or RUS program, and delays in our financial reporting. Inthe fourth quarter of 2007, we experienced an improvement in our business, withboth revenues and gross margin increasing significantly from the third quarter.In particular, we benefited from strong seasonal spending from our customerbase, a new customer in Guam, and an apparent increase in customer confidence,which we attribute in part to the completion of our restatement and our thenrequired SEC filings. While we expect the transition from copper wire to fiberto continue in 2008, we believe that the pace and impact of this transitionwill vary from quarter-to-quarter.

 

**Critical Accounting 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 sales andexpenses during the reporting period. On an ongoing basis, we evaluate ourestimates and judgments, including those related to revenue recognition,accounts receivable, inventories, litigation, warranty reserve, stock-basedcompensation, and valuation of deferred income tax assets. We base ourestimates and judgments on historical experience and on various other factorsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.

 

We included in our AnnualReport on Form 10-K for the year ended December 31, 2007 a discussionof our most critical accounting policies, which are those that are mostimportant to the portrayal of our financial condition and results of operationsand require management’s most difficult, subjective and complex judgments,often as a result of the need to make estimates about the effect of mattersthat are inherently uncertain. We did not make changes to such criticalaccounting policies during the three months ended March 31, 2008.

 

12

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**Results of Operations**

 

***Three months ended March 31, 2008 and 2007***

 

*Sales*

 
| ** ** | ** ** | **Three Months Ended** | ** ** |
|------------|------------|----------------------------------|------------|
| ** ** | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** ** | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Sales      |       | $                                | 19,653     |   | $ | 18,987 |   |
|            |            |                                  |            |  |  |  |  |

 

Our sales are principallycomprised of sales of our BLC 6000 system product line, cabinets and relatedaccessories. Sales increased by $0.7 million or 4% to $19.7 millionfor the three months ended March 31, 2008 as compared to sales of$19.0 million for the three months ended March 31, 2007. Sales forthe three months ended March 31, 2008, includes $1.0 million for alast-time-buy opportunity of BPON products to former Terawave customers.Excluding the last-time-buy promotion, sales were comparable to the same periodin 2007. In fiscal 2007, we experienced fluctuations in our business that webelieve are attributable to delays associated with our customers’ evaluationsof strategic investment decisions concerning their movement from copper wire tofiber. While we expect the transition from copper wire to fiber to continue, webelieve that the pace and impact of this transition will vary from quarter toquarter. We see modest growth in revenue relative to 2007.

 

*Cost ofsales and gross margin*

 
| ** **    | ** ** | **Three Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **    | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cost of sales |       | $                                | 11,220     |   | $ | 11,970 |   |
| Gross profit  |       | $                                | 8,433      |   | $ | 7,017 |   |
| Gross margin  |       | 43                               | %          | 37 | % |

 

Cost of sales includes thecost of products shipped for which sales were recognized, warranty costs, costsof any manufacturing yield problems, field replacements, re-work costs,manufacturing overhead, provision for inventory reserve and the cost ofpost-sales support. Cost of sales decreased by $0.8 million or 6% to$11.2 million for the three months ended March 31, 2008 as comparedto $12.0 million for the three months ended March 31, 2007. Thedecrease in cost of sales during the three months ended March 31, 2008 wasprimarily due toreductions in product manufacturing costs and inventory carrying costs,partially offset by post-sale customer service costs.

 

Gross profit increased to43% of sales for the three months ended March 31, 2008 compared to grossprofit of 37% of sales for the three months ended March 31, 2007. Cost ofsales and gross margin for the three months ended March 31, 2008 includeda provision for repair costs on certain new products which was less than theprovision for the three months ended March 31, 2007. As of March 31,2008 and March 31, 2007, we had accruals of $3.6 million and$2.1 million, respectively, to cover estimated repair costs on fieldunits. These accruals were based upon experience with failures of certain partsand based on estimated repair costs. Also included in cost of sales for the three monthsended March 31, 2008, was $0.6 million related to a last-time-buypromotion of BPON products to former Terawave customers.

 

We expect that our grossmargin will vary from quarter-to-quarter due in part to variations in productmix. To the extent that cabinets and other lower-margin products represent anincreased percentage of our total sales in any period, it will tend to reduceour gross margin.

 

*Researchand development expenses*

 
| ** **               | ** **             | **Three Months Ended** | ** ** |
|--------------------------|------------------------|----------------------------------|------------|
| ** **               | ** **

** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **               | ** **             | ** **                       | ** ** | ** ** | ** ** |
| Research and development |                   | $                                | 4,559      |   | $ | 2,700 |   |
| Percentage of sales      |                   | 23                               | %          | 14 | % |
|                          |                        |                                  |            |  |  |  |  |

 

13

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Research and developmentexpenses consist primarily of salaries and other personnel-related costs,prototype component and assembly costs, third-party design services andconsulting costs, and other costs related to design, development, and testingof our products. Research and development costs are expensed as incurred,except for capital expenditures, which are capitalized and depreciated overtheir estimated useful lives, generally two to five years. Research anddevelopment expenses increased by $1.9 million or 69% to $4.6 millionfor the three months ended March 31, 2008 as compared to $2.7 millionfor the three months ended March 31, 2007. The increase in research anddevelopment expenses was attributable to increased personnel-related costs andthird-party design and test costs associated with the development of our newand next-generation products. We expect research and development expenses tocontinue to increase in future periods as we continue to make investments inour products and technologies.

* *

*Sales andmarketing expenses*

 
| ** **          | ** ** | **Three Months Ended** | ** ** |
|---------------------|------------|----------------------------------|------------|
| ** **          | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **          | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Sales and marketing |       | $                                | 4,978      |   | $ | 3,460 |   |
| Percentage of sales |       | 25                               | %          | 18 | % |
|                     |            |                                  |            |  |  |  |  |

 

Sales and marketing expensesconsist primarily of salaries, sales commissions, and other personnel-relatedcosts, development and distribution of promotional materials, and other costsrelated to generating sales and conducting corporate marketing activities.Sales and marketing expenses increased by $1.5 million or 44% to$5.0 million for the three months ended March 31, 2008 as compared to$3.5 million for the three months ended March 31, 2007. This increasewas primarily due to increased headcount, commissions and other promotionalexpenses incurred in an effort to increase sales and market penetration. Inaddition, we changed our sales compensation plan from revenue-based commissionin 2007 to booking-based commission in 2008. We forecast sales and marketingexpenses to decrease slightly from their current levels through the end of2008.

 

*Generaland administrative expenses*

 
| ** **                 | ** ** | **Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **March 31,  2008**         | ** ** | **March 31,**

** 2007** | ** ** |
| ** **                 | ** ** | ** **                       | ** ** | ** ** | ** ** |
| General and administrative |       | $                                | 3,123      |   | $ | 1,601 |   |
| Percentage of sales        |       | 16                               | %          | 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. General andadministrative expenses increased by $1.5 million or 95% to approximately$3.1 million for the three months ended March 31, 2008 as compared to$1.6 million for the three months ended March 31, 2007. General andadministrative expenses increased primarily due to increased legal andaccounting fees, stock-based compensation charges, salaries and otherpersonnel-related costs. We expect ourgeneral and administrative expenses to remain consistent with currentexpenses as the Company continues to remediate and put in placecontrols deemed necessary to improve our processes and controls, add newfunctions, and improve our human resources capabilities in support of theon-going class actions suits.

* *

*Stock-basedcompensation expense*

 
| ** **                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| ** **                     | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **                     | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cost of sales                  |       | $                                | 107        |   | $ | 102 |   |
| Research and development       |       | 296                              |       | 236 |   |
| Sales and marketing            |       | 187                              |       | 205 |   |
| General and administrative     |       | 232                              |       | 170 |   |
| Total stock-based compensation |       | $                                | 822        |   | $ | 713 |   |

 

14

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Stock-based compensationexpense increased by $0.1 million or 15% to $0.8 million for thethree months ended March 31, 2008 as compared to approximately$0.7 million for the three months ended March 31, 2007. This increaseis primarily attributable to a decrease in the estimated forfeiture rate usedin our stock-based compensation expense calculations and grants of additionaloptions. We anticipate that the stock-based compensation expense calculatedunder SFAS No. 123(R) will continue to have a material effect on ourconsolidated statement of operations.

 

*Otherincome and expense*

 
| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **March 31,  2008**         | ** ** | **March 31,   2007** | ** ** |
| ** **                          | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Other income                        |       | $                                | 290        |   | $ | — |   |
| Other expense                       |       | (944                             | )          | — |   |
| Total other income and expense, net |       | $                                | (654       | ) | $ | — |   |

 

Other income and expense,net was $0.7 million for the three months ended March 31, 2008. Otherincome of $0.3 million represents payments received. These payments pertainedto accounts receivable that were purchased as part of the asset purchase ofTerawave Communications, Inc. which occurred in October 2007. At thedate of purchase, the accounts were deemed to be uncollectible and no value wasrecorded on our books. Other expenses were comprised of a write-off of anintangible and its related inventory. During the period ended March, 31, 2008,we wrote-off an intangible for technology developed for Metro-Ethernet/Telemetrytechnology of $0.8 million and its related inventory of approximately $0.2million. As part of the purchase of certain assets of Terawave Communications, Inc.on October 25, 2007, we received the intangible and the related inventory.Subsequent to the date of the asset purchase we had sought potential buyers forthe Metro-Ethernet/Telemetry technology to recover cash paid for the assets.However, by March 31, 2008, we decided to terminate efforts to sell the Metro-Ethernet/Telemetrytechnology and to focus instead on bringing to market GPON technology.

 

The decision to write-offthe intangible and its related inventory is based on our primary intent of theasset purchase which was to obtain intellectual property rights related toTerawave’s in-development GPON technology. As of the date of the assetpurchase, both Occam and Terawave were independently developing GPON products.Terawave’s product incorporated superior, proprietary hardware technology whileOccam’s product development was being built around a superior software packetengine. The purchase of Terawave was intended to allow Occam to match itssuperior packet engine with Terawave’s superior hardware technology in order tocreate a best-in-class product.

 

*Interestincome and expense*

 
| ** **                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **March 31,  2008**         | ** ** | **March 31,  2007** | ** ** |
| ** **                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Interest income                        |       | $                                | 393        |   | $ | 773 |   |
| Interest expense                       |       | (33                              | )          | — |   |
| Total interest income and expense, net |       | $                                | 360        |   | $ | 773 |   |

 

Interest income decreased by$0.4 million or 49% to $0.4 million for the three months ended March 31,2008 as compared to $0.8 million for the three months ended March 31,2007. This decrease in interest income was primarily attributable to loweraverage cash balances, resulting from the use of cash in the purchase ofcertain assets of Terawave completed during the three months ended December 31,2007, and, to a lesser extent, lower interest rates during 2008.

 

15

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*Income tax expense*

 

For income tax purposes, weconsider our projected annual income and the utilization of our net operatingloss carryforwards among other factors. For the three months ended March 31,2008 and 2007, we provided $19,000 and $0, respectively, for federal and stateincome taxes.

** **

**Liquidity and Capital Resources**

 

As of March 31, 2008,we had cash and cash equivalents of $33.4 million, stockholders equity of $56.6million, and working capital of $49.3 million, compared with cash and cashequivalents of $37.7 million, stockholders equity of $60.3 million, and workingcapital of $51.8 million as of December 31, 2007.

 

Net cash used in operatingactivities for the three months ended March 31, 2008, was $1.3 million comparedto $2.2 million during the same period ended 2007. The sum of our net loss andcertain non-cash expenses, such as depreciation and amortization, stock-basedcompensation, write-off of developed technology and related inventory resultedin an outflow of $2.0 million in the 2008 period, compared to an inflow of $1.4million in the 2007 period. The overall impact of change in certain operatingassets and liabilities on total operating cash flows resulted in a cash inflowof $0.7 million in the 2008 period compared to an outflow of $3.6 million inthe 2007 period.

 

Net cash used in investingactivities for the three months ended March 31, 2008, was $2.9 millioncompared to $0.5 million during the same period ended 2007. Cash used ininvesting activities for the three months ended, March 31, 2008, wasprimarily due to an increase of $2.7 million in restricted cash related toperformance bonds required in connection with our RUS contracts, compared to$0.5 million for purchases of property and equipment which was primarilyleasehold improvements for our new corporate headquarters in Santa Barbara,California during the same period in 2007.

 

Net cash provided byfinancing activities for the three months ended March 31, 2008, was lessthan $0.1 million compared to $0.4 million for the same period in 2007. Cashprovided by financing activities for the three months ended March 31,2008, was primarily from exercises of stock option of approximately $0.1million, compared to $0.4 million for exercises of options and purchases madeunder the ESPP Plan for the same period in 2007.

*** ***

***Working Capital***

 

Working capital decreased to$49.3 million as of March 31, 2008, compared to $51.8 million asof December 31, 2007.

 

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

 

·                  amount andtiming of revenue;

 

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

 

·                  extent to whichwe make acquisitions;

 

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

 

·                  cost and timingof marketing and selling activities; 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 next12 months. Although we believe these funds will be sufficient to maintainand expand our operations in accordance with our business strategy, we may needadditional funds in the future. If we are unable to raise additional financingwhen and if needed, we may be required to reduce certain discretionaryspending, which could have a material adverse effect on our ability to achieveour intended business objectives.

 

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***Contractual Obligations***

 

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

 

We lease certain officeequipment under capital leases.

 

The following tablesummarizes our minimum purchase commitments to our contract manufacturers, ourminimum commitments under non-cancelable operating leases and our commitmentunder capital leases as of March 31, 2008 (in thousands):

 
| ** **                  | ** ** | **Payments Due By Period** | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| **Contractual Obligations** |       |                                      |       |   |   |   |   |   |   |   |   |
| Purchase commitments(1)     |       | $                                         | 15,391     |   | $ | 15,391 |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases (2)        |       | $                                         | 9,212      |   | $ | 1,349 |   | $ | 2,849 |   | $ | 2,993 |   | $ | 2,021 |   |
| Capital leases              |       | $                                         | 68         |   | $ | 21 |   | $ | 44 |   | $ | 3 |   | $ | — |   |

 

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(1)                                  Under the termsof our agreement with our contract manufacturers, we issue purchase orders forthe production of our products. We are required to place orders in advance withour contract manufacturer to meet estimated sales demands. The agreementincludes certain lead-time and cancellation provisions. Future amounts payableto the contract manufacturer will vary based on the level of purchaserequirements.

 

(2)                                  During March 2008,we entered into an 86 month non-cancellable operating lease agreement that willbegin on June 1, 2008. The facility is located in Fremont, California. Asecurity deposit was made in the form of a $0.3 million letter of credit backedby a certificate of deposit. Our new lease will enable us to consolidate ouremployees from our Hayward, California and Milpitas, California facilities intoone location. In addition, we have a construction commitment of $1.6 millionfor leasehold improvements on the new facility.

 

***Off-Balance Sheet Arrangements***

 

As of March 31, 2008,we had no material off-balance sheet arrangements, other than operating leasesand certain purchase commitments described in the contractual obligations tablereferenced above.

 

***Indemnification Obligations***

 

We enter intoindemnification provisions under our agreements with other companies in ourordinary course of business, typically with our contractors, customers,landlords and our agreements with investors. Under these provisions, wegenerally indemnify and hold harmless the indemnified party for losses sufferedor incurred by the indemnified party as a result of our activities or, in somecases, as a result of the indemnified party’s activities under the agreement.These indemnification provisions generally survive termination of theunderlying agreement. The maximum potential amount of future payments we couldbe required to make under these indemnification provisions is generallyunlimited. As of March 31, 2008, we had not incurred material costs todefend lawsuits or settle claims related to these indemnifications agreementsand we have no liabilities recorded for these agreements as of March 31,2008.

 

***Recent Accounting Pronouncements***

 

In December 2007, theFASB issued Statement of Financial Accounting Standards No. 160, “NoncontrollingInterests in Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS 160”). SFAS 160 will change the accounting and reporting forminority interests which will be recharacterized as noncontrolling interestsand classified as a component of equity. SFAS 160 is effective for fiscalyears beginning on or after December 15, 2008. SFAS 160 requiresretroactive adoption of the presentation and disclosure requirements forexisting minority interests. We are currently assessing the impact thatSFAS 160 may have on our financial position, results of operations, and cashflows.

 

In December 2007, theFASB issued Statement of Financial Accounting Standards No. 141 (revised2007), “Business Combinations” (“SFAS 141R”). SFAS 141R changesaccounting for acquisitions that close beginning in 2009. More transactions andevents will qualify as business combinations and will be accounted for at fairvalue under the new standard. SFAS 141R promotes greater use of fairvalues in financial reporting. Some of the changes will introduce more 

 

17

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volatility into earnings. SFAS 141R iseffective for fiscal years beginning on or after December 15, 2008. Theadoption of SFAS 141R will have an impact on accounting for businesscombinations once adopted, but the effect on us will depend upon our level ofacquisition activity.

 

In December 2007, theSecurities and Exchange Commission issued Staff Accounting Bulletin No. 110(“SAB No. 110”), “Certain Assumptions Used in Valuation Methods.” SAB No. 110expresses the views of the staff regarding the use of a “simplified” method indeveloping an estimate of expected term of “plain vanilla” share options inaccordance with the Statement of Financial Accounting No. 123R, “Shared-BasedPayment.” Companies electing to use this method should apply it consistently toall “plain vanilla” employee share options, and disclose the use of the methodin the notes to the financial statements. We are currently evaluating theimpact of applying SAB No. 110 on our business and financial condition.

 

In May 2007, the FASBissued FSP No. FIN 48-1 “Definition of Settlement in FASBInterpretation No. 48,” (FSP FIN 48-1 amends FIN 48 to provideguidance on how an entity should determine whether a tax provision iseffectively settled for the purpose of recognizing previously unrecognized taxbenefits. The term “effectively settled” replaces the term “ultimately settled”when used to describe recognition, and the terms “settlement” or “settled”replace the terms “ultimate settlement” or “ultimately settled” when used todescribe measurement of a tax position under FIN 48. FSP FIN 48-1clarifies that a tax position can be effectively settled upon the completion ofan examination by a taxing authority without being legally extinguished. Fortax positions considered effectively settled, an entity would recognize thefull amount of tax benefit, even if the tax position is not considered morelikely than not to be sustained based solely on the basis of its technicalmerits and the statue of limitations remains open. We do not anticipate thatthe adoption of FSP FIN 48-1 will have a material effect on our results ofoperations or financial position, although we are continuing to evaluate thefull impact of the adoption of FSP FIN 48-1.

 

In February 2007, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities—Including an Amendment of FASB Statement No. 115”(SFAS 159). SFAS 159 expands the use of fair value accounting butdoes not affect existing standards which require assets or liabilities to becarried at fair value. Under SFAS 159, a company may elect to use fairvalue to measure accounts and loans receivable, available-for-sale andheld-to-maturity securities, equity method investments, accounts payable,guarantees and issued debt. Other eligible items include firm commitments forfinancial instruments that otherwise would not be recognized at inception andnon-cash warranty obligations where a warrantor is permitted to pay a thirdparty to provide warranty goods or services. If the use of fair value iselected, any upfront cost and fees related to the item must be recognized inearnings and cannot be deferred. The fair value election is irrevocable and generallymade on an instrument-by-instrument basis even if a company has similarinstruments that it elects not to measure at fair value. At the adoption date,unrealized gains and losses on existing items for which the fair value optionhas been elected are reported as a cumulative adjustment to beginning retainedearnings. Subsequent to the adoption of SFAS 159, changes to fair valueare recognized in earnings. SFAS 159 is effective for fiscal yearsbeginning after November 15, 2007 and is required to be adopted by Occamin the first quarter of 2008. We do not anticipate that SFAS No. 159 will havea material effect on our results of operations and financial position, althoughwe are continuing to evaluate the full impact of the adaption of SFAS No. 159.

 

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).SFAS No. 157 defines fair value, establishes a framework and givesguidance regarding the methods used for measuring fair value, and expandsdisclosures about fair value measurements. SFAS No. 157 is effective forfinancial statements issued for fiscal years beginning after November 15,2007 and interim periods of those fiscal years and is required to be adopted byOccam in the first quarter of 2008. We do not anticipate that SFAS No. 157will have a material effect on our results of operations and financialposition, although we are continuing to evaluate the full impact of theadoption of SFAS No. 157.

 

In September 2006, theSecurities and Exchange Commission issued SAB No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements.” SAB No. 108 provides guidance on theconsideration of the effects of prior year misstatements in quantifying currentyear misstatements for the purpose of a materiality assessment. SAB No. 108establishes an approach that requires quantification of financial statementerrors based on the effects of each of the Company’s balance sheets andstatement of operations and the related financial statement disclosures. SAB No. 108permits existing public companies to record the cumulative effect of initiallyapplying this approach in the first year ending after November 15, 2006 byrecording the necessary correcting adjustments to the carrying values of assetsand liabilities as of the beginning of that year with the offsetting adjustmentrecorded to the opening balance of retained earnings. Additionally, the use ofthe cumulative effect transition method requires detailed disclosure of thenature and amount of each individual error being corrected through thecumulative adjustment and how and when it arose. We implemented SAB No. 108effective January 1, 2006 and considered its effect on our financialposition, results of operations or cash flows for 2006. See Note 2, “Restatementof Consolidated Financial Statements,” of the Notes to Consolidated Statementsfor information regarding the restatement.

 

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**ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET 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 market risk due to changes in the general levelof United States interest rates relates primarily 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 primaryobjective of our investment activities is the preservation of principal whileminimizing risk. We do not hold financial instruments for trading orspeculative purposes. We do not use any derivatives or similar instruments tomanage our interest rate risk.

** **

**ITEM 4.   CONTROLSAND PROCEDURES**

*** ***

***(a)  Evaluation of Disclosure Controls and Procedures***

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we conducted an evaluation of the effectiveness ofthe design and operation of our disclosure controls and procedures, as definedin Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of March 31,2008, which we refer to as the Evaluation Date or the end of the period coveredby this Quarterly Report on Form 10-Q.

 

The purpose of thisevaluation was to determine whether as of the Evaluation Date our disclosurecontrols and procedures were effective to provide reasonable assurance that theinformation we are required to disclose in our filings with the Securities andExchange Commission, (i) is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and (ii) accumulatedand communicated to our management, including our Chief Executive Officer andChief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

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

 

An internal controldeficiency exists when the design or operation of a control does not allowmanagement or employees, in the normal course of performing their assignedfunctions, to prevent or detect misstatements on a timely basis. A “materialweakness” is a control deficiency, or combination of control deficiencies, thatresults in a more than a remote likelihood that a material misstatement of theannual or interim consolidated financial statements will not be prevented ordetected. A “significant deficiency” is a control deficiency, or combination ofcontrol deficiencies, that adversely affects a company’s ability to initiate,authorize, record, process or report external financial data reliably inaccordance with accounting principles generally accepted in the United States.In the case of a significant deficiency, a more-than-remote likelihood existsof a misstatement of the company’s annual or interim consolidated financialstatements that is more than inconsequential.

 

As more fully described in Part II,Item 5 of this Quarterly Report on Form 10-Q, our audit committeeinitiated an internal review of our revenue recognition practices. On September 12,2007, we announced that our audit committee had identified errors in revenuerecognition and that our board of directors, based on the recommendation of ouraudit committee, had concluded that we should restate our financial statementsfor fiscal years 2004 and 2005, the corresponding interim quarterly periods offiscal 2004 and fiscal 2005, and the first, second, and third quarters offiscal 2006. Our board of directors also concluded that our previously filedfinancial statements for those periods should not be relied on. On October 16,2007, we announced that our audit committee had concluded its investigation,and we announced the final restated financial information.

 

Our audit committeeconcluded that the restatement was required because of errors in our accountingfor (i) commitments to certain customers in connection with sales forfeatures or deliverables that were not available at the time revenue wasoriginally recognized, including commitments to prospectively provide freeproduct, software, training, and installation services, for which weprematurely recognized approximately $9.3 million in revenue from fiscal2004 to fiscal 2006; (ii) sales to value-added resellers where theresellers did not have the ability to pay us for these sales independent ofpayment to them by the end-user, for which we prematurely recognizedapproximately $20.2 million in revenue from fiscal 2004 to fiscal 2006;and (iii) for certain quarters ending on weekends, our use of a shippingvendor who picked up product for subsequent delivery to another shippingcompany where the terms and conditions of the shipments did not appropriately 

 

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transfer title or risk of loss at the time ofshipment, for which we prematurely recognized approximately $2.3 millionin revenue from fiscal 2004 to fiscal 2006. In addition, we prematurelyrecognized approximately $1.1 million of revenue from fiscal 2004 throughfiscal 2006 relating principally to errors in accounting for software andsoftware maintenance, customer credits, and undelivered free product.

 

Our audit committee determinedthat the foregoing errors resulted from deficiencies in our internal controls,in particular resulting from internal communication failures between ourfinance and sales departments, a lack of clear understanding by, andcommunication to, sales personnel of technical accounting rules, understaffedfinance functions, and on occasion, failure of finance personnel to applytechnical revenue recognition rules correctly. As part of its internalcontrol deficiencies letter dated October 15, 2007, our currentindependent registered public accounting firm also identified a materialweakness relating to revenue recognition. Our independent registered publicaccounting firm noted that we did not have policies and procedures in place toensure that modifications to, or side agreements associated with, our standardterms of contract were properly documented and approved. Our independentregistered public accounting firm also cited a lack of understanding of theaccounting consequences of modifications to standard terms by certain salesemployees and a lack of communication among our sales, engineering, and financedepartments to ensure that all sales transactions are properly tracked,documented, approved, and recorded.

 

In their October 2007letter, our independent registered public accounting firm identified additionalcontrol deficiencies that it determined to be significant deficiencies but thatit did not deem to be material weaknesses. In particular, it identified asignificant deficiency relating to segregation of duties, noting among otherthings that in certain instances journal entries and account reconciliationswere approved by the preparer of the entry or reconciliation. Our independentregistered public accounting firm also noted a significant deficiency relatingto post-closing adjusting journal entries and recommended that we reassess thetimeline of our financial statement process to ensure that we have reasonabletime to conclude a thorough financial statement closing process. Finally, ourindependent registered public accounting firm identified significantdeficiencies relating to recording certain purchase transactions, where partswere ordered and accepted by our engineering department, without approval orinvolvement of our finance department, and where fixed assets were not properlyclassified for depreciation purposes.

 

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

 

***(b)  Changes in Internal Control Over Financial Reporting***

 

On September 28, 2007,our audit committee presented the findings and recommendations of its internalinvestigation to our board of directors, including a proposed remediation planregarding internal control over financial reporting. Our board of directorsadopted the audit committee’s remediation plan, and we are in the process ofimplementing it. Remedying the material weakness and other control deficienciesdescribed above will require substantial management time and attention and willresult in our incurring substantial incremental expenses, including increasingthe size of our finance organization and retaining outside consultants toassist in the implementation of new internal controls. Any failure on our partto remedy our identified control deficiencies or any additional errors ordelays in our financial reporting would have a material adverse effect on ourbusiness and results of operations and could have a substantial adverse impacton the trading price of our common stock and our relationships with customers.

 

Subject to oversight by ourboard of directors, our chief executive officer and chief financial officerwill be responsible for implementing the internal control remediation planrecommended by our audit committee and approved by our board of directors. Wehave also engaged an outside consultant in connection with implementing theremediation plan.

 

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Our audit committee’sremediation plan consists of the following modifications and improvements inour internal controls relating to the sales and revenue- recognitiontransaction cycle. Modifications and improvements to our internal controlscompleted as of March 31, 2008 are also set forth below:

 
| ** **       | ** ** | **Implemented  as of  March 31,  2008**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Remediation Plan |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| ·           |       | adjust our reporting structure so that finance has direct oversight  of sales administration and the sales proposal generation management group;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   |  |
| ·           |       | reorganize our variable compensation plan to ensure that sales  personnel are not incentivized to attempt to influence the timing of revenue  recognition;                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |  |
| ·           |       | retain a senior revenue recognition specialist who will report  directly to our chief financial officer and will possess the appropriate  level of experience, authority, and seniority to independently serve as the  liaison between all levels of corporate functions and finance. This  individual should have some degree of managerial oversight of other “liaison”  areas (e.g., order entry personnel, sales administration, and sales  proposals generation) and be responsible for the review and reconciliation of  terms given to a customer in the bid/quote process as well as in the final  contract; |   |   |
|             |       | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | the revenue recognition specialist, or employees acting under his or  her supervision, should review all documentation relating to a transaction,  including purchase orders, special pricing approval forms, customer quotes,  letters of intent, emails, etc. to determine whether any of the terms will  result in the deferral of revenue; and |   |  |
|             |       | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | a revenue recognition checklist should accompany the financial  package for each transaction. |   |  |
| ·           |       | engage an outsourced internal audit group to review all significant  revenue transactions each quarter to ensure that transactions have been  recorded appropriately, to monitor the status of the remediation of control  structure, and report to the audit committee the progress achieved;                                                                                                                                                                                                                                                                                                                                      |   |  |
| ·           |       | implement formal training, which would include a signed  acknowledgement of all attendees certifying that they have attended and  understood the topics covered, from all finance, executive, sales, and sales  administration personnel, to ensure they understand that certain terms impact  revenue recognition, as well as understand how to document and receive  approval for such terms, as well as report them to finance;                                                                                                                                                                                                  |   |  |
| ·           |       | institute a formal communication process among marketing,  engineering, and finance to ensure that all functions understand that any  changes have potential accounting implications and to ensure that finance is  appropriately advised as to the impact on existing and future transactions;                                                                                                                                                                                                                                                                                                                                     |   |  |
| ·           |       | implement policies and procedures that delineate clear roles,  responsibilities, and authorization levels for all positions defined as “key”  to the revenue recognition transaction cycle;                                                                                                                                                                                                                                                                                                                                                                                                                               |   |  |
| ·           |       | implement a policies and procedure document that will be provided to  all sales and sales administration personnel, including an annual sign off  that they have received, read, understood, and complied with the materials,  that will ensure that all terms related to any transaction are evidenced in  the sales quotes and purchase orders, and that all transaction documentation  has been provided to the finance department prior to the recording of  revenue. Such policies and procedures may include:                                                                                                                 |   |   |
|             |       | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | standardized language on each customer’s quote and invoice, as well  as on the standard terms and conditions, stating that only those terms listed  by the customer on its purchase order will be deemed part of the final  agreement; |   |   |
|             |       | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | a central, virtual repository for all documentation relating to a  transaction, including quotes, emails, letters of intent, volume pricing  agreements, special pricing approval forms, and all other transaction  documents, which are uploaded by sales and sales administration personnel;  and |   |   |
|             |       | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | compliance with the stated order addendum process, to ensure that all  terms agreed upon with a customer following the issuance of the customer  quote or purchase order have been captured and provided to finance. |   |  |
| ·           |       | implement controls required to ensure that no items are shipped or  provided to the customer without being entered as separate line items in our  systems;                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |   |  |
| ·           |       | implement controls required to ensure that all requests for price  responses, contract closeout, acceptance documentation, and other delivery  information is provided to and reviewed by the finance department and is  received prior to recording of revenue;                                                                                                                                                                                                                                                                                                                                                                    |   |  |
| ·           |       | implement controls to ensure that single transactions with a customer  are not split into various contracts, purchase orders, or shipments, unless  these requests are approved by the finance department; and                                                                                                                                                                                                                                                                                                                                                                                                                      |   |  |
| ·           |       | implement procedures to ensure that credit checks are performed and  the decision-making process as to the credit limit is documented and  maintained.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |  |

 

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Many of the remainingremediation items are in various stages of design and implementation. Over thecoming quarters, we expect to invest substantial management time and attentionas well as financial resources to complete all of the modifications andimprovements necessary to improve our internal controls and related systems.

 

**PART II—OTHER INFORMATION**

 

**ITEM 1.  LEGALPROCEEDINGS**

* *

*2007 Class Action Litigation*

 

On April 26, 2007 and May 16,2007, two putative class action complaints were filed in the United StatesDistrict Court for the Central District of California against us and certain ofour officers. The complaints allege that the defendants violatedsections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b-5by making false and misleading statements and omissions relating to ourfinancial statements and internal controls with respect to revenue recognition.The complaints seek, on behalf of persons who purchased our common stock duringthe period from May 2, 2006 and April 17, 2007, damages of anunspecified amount.

 

On July 30, 2007, JudgeChristina A. Snyder consolidated these actions into a single action, appointedNECA-IBEW Pension Fund (The Decatur Plan) as lead plaintiff, and approved itsselection of lead counsel. On November 16, 2007, the lead plaintiff fileda consolidated complaint. This consolidated complaint adds as defendantscertain of our current and former directors and officers, our current andformer outside auditors, the lead underwriter of our secondary public offeringin November 2006, and two venture capital firms who were early investorsin us. The consolidated complaint alleges that defendants violatedsections 10(b), 20(a) and 20A of the Exchange Act and SEC Rule 10b-5promulgated thereunder, as well as sections 11 and 15 of the SecuritiesAct by making false and misleading statements and omissions relating to ourfinancial statements and internal controls with respect to revenue recognitionthat required restatement. The consolidated complaint seeks, on behalf ofpersons who purchased our common stock during the period from April 29,2004 to October 15, 2007, damages of an unspecified amount.

 

On January 25, 2008,defendants filed motions to dismiss the consolidated complaint. Lead plaintiffsfiled a consolidated opposition to these motions on March 25, 2008. Defendantsfiled reply briefs in support of their motions on April 24, 2008. A hearing onthe motions to dismiss the consolidated complaint is currently set for May 19,2008 before Judge Snyder.

 

We believe that we havemeritorious defenses in this action, and intend to defend ourselves vigorously.Failure by us to obtain a favorable resolution of the claims set forth in theconsolidated complaint could have a material adverse effect on our business,results of operations and financial condition. Currently, the amount of suchmaterial adverse effect cannot be reasonably estimated.

* *

*IPO Allocation Litigation*

 

In June 2001, threeputative stockholder class action lawsuits were filed against AcceleratedNetworks, certain of its then officers and directors and several investmentbanks that were underwriters of Accelerated Networks’ initial public offering.The cases, which have since been consolidated, were filed in the United StatesDistrict Court for the Southern District of New York. The Court appointed alead plaintiff on April 16, 2002, and plaintiffs filed a consolidatedamended class action complaint (the “Complaint”) 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 and Sections 10(b) and20(a) and Rule 10b-5 of the 1934 Act against one or both ofAccelerated Networks and the individual defendants. The claims were based onallegations that the underwriter defendants agreed to allocate stock inAccelerated Networks’ initial public offering to certain investors in exchangefor excessive and undisclosed commissions and agreements by those investors tomake additional purchases in the aftermarket at pre-determined prices.Plaintiffs alleged that the prospectus for Accelerated Networks’ initial publicoffering was false and misleading in violation of the securities laws becauseit did not disclose these arrangements. These lawsuits are part of the massive “IPOallocation” litigation involving the conduct of underwriters in allocatingshares of successful initial public offerings. We believe that over threehundred other companies have been named in more than one thousand similarlawsuits that have been filed by some of the same plaintiffs’ law firms. In October 2002,the plaintiffs voluntarily dismissed the individual defendants withoutprejudice. On February 1, 2003 a motion to dismiss filed by the issuerdefendants was heard and the court dismissed the 10(b), 20(a) and 

 

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rule 10b-5 claims against Occam. On October 13,2004, the Court certified a class in six of the approximately 300 other nearlyidentical actions (the “focus” cases) and noted that the decision was intendedto provide guidance to all parties regarding class certification in theremaining cases. The underwriter defendants appealed the decision and theSecond Circuit Court of Appeals vacated the district court’s decision grantingclass certification in those six cases on December 5, 2006. Plaintiffsfiled a motion for rehearing. On April 6, 2007, the Second Circuit deniedthe petition, but noted that plaintiffs could ask the District Court to certifya more narrow class than the one that was rejected. On October 3, 2007,the plaintiff filed a motion to certify a new class and a second amendedcomplaint based on the Second Circuit Appeals Court decision. An oppositionbrief was filed by both underwriter defendants and the issuer defendants on December 21,2007, and a reply brief was filed on January 28, 2008. The plaintiff’shave filed an amended reply brief March 28, 2008, in support of theirmotion to certify the class of plaintiffs there is a stipulation that theunderwriter defendants and the issuer defendants have until May 9, 2008,to file an answer to the amended complaint. The Court has not ruled on themotion.

 

Prior to the Second Circuit’sDecember 5, 2006 ruling, we agreed, together with over three hundred othercompanies similarly situated, to settle with the plaintiffs. A settlementagreement and related agreements were submitted to the Court for approval. Thesettlement would have provided, among other things, a release of the Companyand of the individual defendants for the conduct alleged to be wrongful in theComplaint in exchange for a guarantee from the Company’s insurers regardingrecovery from the underwriter defendants and other consideration from theCompany regarding its underwriters. In light of the Second Circuit opinion,liaison counsel for the issuers informed the District Court that the settlementcannot be approved because the defined settlement class, like the litigationclass, cannot be certified. We cannot predict whether we will be able torenegotiate a settlement that complies with the Second Circuit’s mandate.

 

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

 

*Threatened Litigation*

 

In late 2007, Occam receiveda letter from Vanessa Simmonds, a putative shareholder of the Company,demanding that Occam investigate and prosecute a claim for alleged short-swingtrading in violation of Section 16(b) of the Exchange Act, by the underwriterof its initial public offering (“IPO”) and certain unidentified directors,officers and shareholders of Occam (then known as Accelerated Networks). Occamevaluated the demand and declined to prosecute the claim. On October 12,2007, the putative shareholder commenced a civil lawsuit in the U.S. DistrictCourt for the Western District of Washington against Credit Suisse Group, thelead underwriter of Occam’s IPO, alleging violations of Section 16(b). Thecomplaint alleges that the combined number of shares of Occam’s 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 Occam’s IPO on June 23, 2000, through at leastJune 22, 2001. It further alleges that those entities and individuals werethus subject to the reporting requirements of Section 16(a) and theshort-swing trading prohibition of Section 16(b), and failed to complywith those provisions. The complaint seeks to recover from the lead underwriterany “short-swing profits” obtained by it in violation of Section 16(b).Occam was named as a nominal defendant in the action, but has no liability forthe asserted claims. No directors or officers of Occam are named as defendantsin this action.

 

On October 29, 2007,the case was reassigned to Judge James L. Robart along with fifty-four other Section 16(b) casesseeking recovery of short-swing profits from underwriters in connection withvarious IPOs. The court is in discussion with plaintiffs and defendants on howto proceed. Occam has waived service and will vigorously defend the litigation.

 

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

* *

*Other Matters*

 

From time to time, we aresubject to threats of litigation or actual litigation in the ordinary course ofbusiness, some of which may be material. We believe that, except as describedabove, there are no currently pending matters that, if determined adversely tous, would have a material effect on our business or that would not be coveredby our existing liability insurance maintained by us.

 

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** **

**ITEM 1A.  RISK FACTORS**

** **

*ThisQuarterly Report on Form 10-Q, or Form 10-Q, including anyinformation incorporated by reference herein, contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, referred to as the Securities Act, and Section 21E ofthe Securities Exchange Act of 1934, as amended, referred to as the ExchangeAct. 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. The forward-looking statementscontained in this Form 10-Q involve known and unknown risks, uncertaintiesand situations that may cause our or our industry’s actual results, level ofactivity, performance or achievements to be materially different from anyfuture results, levels of activity, performance or achievements expressed orimplied by these statements. These factors include those listed below in thisItem 1A and those discussed elsewhere in this Form 10-Q. We encourageinvestors to review these factors carefully. We may from time to time makeadditional written and oral forward-looking statements, including statementscontained in our filings with the SEC. We do not undertake to update anyforward-looking statement that may be made from time to time by or on behalf ofus.*

 

*Before youinvest in our securities, you should be aware that our business faces numerousfinancial and market risks, including those described below, as well as generaleconomic and business risks. The following discussion provides informationconcerning the material risks and uncertainties that we have identified andbelieve may adversely affect our business, our financial condition and ourresults of operations. Before you decide whether to invest in our securities,you should carefully consider these risks and uncertainties, together with allof the other information included in this Quarterly Report on Form 10-Q.*

 

**Risks Related to Our Restatement**

 

***Matters relating to or arising fromour recent restatement, errors in our historic revenue recognition practices,and weaknesses in our internal controls, including adverse publicity and potentialconcerns from our customers and prospective customers, regulatory inquiries,and litigation matters, could have a material adverse effect on our business,revenues, operating results, or financial condition.***

 

As more fully described in Part II,Item 5 of this Quarterly Report on Form 10-Q, in March 2007, ouraudit committee initiated a review of our historic revenue recognitionpractices that resulted in the restatement of our previously filed financialstatements for the fiscal years ended December 26, 2004 and December 25,2005, each of the interim quarterly periods of such fiscal years, and thefirst, second, and third quarters of the fiscal year ended December 31,2006. The audit committee conducted its investigation and review with theassistance of independent counsel and an independent forensic accountingadvisor. On October 16, 2007, we announced the completion of theinvestigation and filed our Annual Report on Form 10-K for the year ended December 31,2006, which included our consolidated financial statements for the year ended December 31,2006 and our restated financial statements for the years ended December 26,2004 and December 25, 2005. The circumstances and findings of the auditcommittee investigation are more fully described in Part II, Item 5of this Quarterly Report on Form 10-Q.

 

The investigation andresulting restatement could have a material adverse effect on our relationshipswith customers and customer prospects, has already resulted in the initiationof securities class action litigation, and could result in other civillitigation or formal or informal regulatory inquiries or litigation, any ofwhich could have a material adverse effect on our business, revenues, operatingresults, or financial condition. Under Delaware law, our bylaws, and certainindemnification agreements, we may have an obligation to indemnify certaincurrent and former officers and directors in relation to these matters. Suchindemnification may have a material adverse effect on our business, results ofoperations, and financial condition to the extent insurance does not cover ourcosts. The insurance carriers that provide our directors’ and officers’liability policies may seek to rescind or deny coverage with respect to thosepending investigations or actions in whole or in part, or we may not havesufficient coverage under such policies, in which case our business, results ofoperations, and financial condition may be materially and adversely affected.

* *

*Impact on our Business*

 

As a result of theinvestigation, we filed the Form 10-K for the year ended December 31,2006 approximately six and one-half months late, and we also failed until October 2007to file our Quarterly Report on Form 10-Q for the quarter ended March 31,2007, and our Quarterly Report on Form 10-Q for the quarter ended June 30,2007, which had been due in May 2007 and August 2007, respectively.Our non-compliance with public reporting obligations also subjected us todelisting proceedings from the NASDAQ Global Market, which have since beenresolved. Our prior delinquencies, the restatement, resulting litigation, anyregulatory inquiries, and other adverse publicity could continue to affect ourrelationships with 

 

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customers and customer prospects and could have a material adverseeffect on our business, revenues, operating results, and financial condition.In particular, in the second quarter of 2007, following the disclosure of ouraudit committee investigation and after we became subject to NASDAQ delistingproceedings, we identified a softening of our business that continued into thethird quarter of 2007. We believe this softening was attributable in part todelays associated with our customers’ evaluations of strategic investment decisionsconcerning their movement from copper wire to fiber, in part to a shift in ourcustomer base toward longer term loan projects funded by the U.S. Department ofAgriculture’s Rural Utilities Service, or RUS program, and in part to delays inour financial reporting. In the fourth quarter of 2007, we experienced animprovement in our business, with both revenues and gross margins increasingsignificantly from the third quarter. Our customers consist largely of small,conservatively managed telecommunications companies, and we expect that thesecustomers and customer prospects may continue to evaluate the results of therestatement and conclusions of the internal investigation when determiningwhether to initiate or continue purchasing from us. Moreover, we anticipatethat our competitors will seek to leverage the restatement and investigation toraise concerns about us in the minds of our customers and customer prospects.Any adverse publicity or customer uncertainty resulting from our announcementof the restatement, associated litigation, and any regulatory actions couldhave a material adverse effect on our business, revenues, results ofoperations, and financial condition.

 

As a result of the auditcommittee investigation, we have implemented personnel changes in our salesdepartment that could adversely affect our revenues and results of operationsin future periods if we are not successful in managing the transition ofrelationships with our existing customers and key prospects. In particular, wehave terminated two sales personnel, including a senior sales executive whomanaged a geographic region that generated a substantial portion of ourrevenues in recent years. In order to manage the customer transition aseffectively as possible, we have engaged the former sales executive to consultwith us on certain customer prospects. We believe personal relationshipsbetween our customers and our sales/customer support personnel are criticalfactors in winning new customers and maintaining existing customers, and lossof key sales and customer support personnel could have a material adverseeffect on our future business, revenues, results of operations, and financialcondition.

 

*Litigation and Regulatory Matters*

 

We, certain of our directorsand executive officers and others are defendants in a consolidated federalsecurities class action. The consolidated complaint alleges that defendantsviolated sections 10(b), 20(a) and 20A of the Exchange Act and SEC Rule 10b-5promulgated thereunder, as well as sections 11 and 15 of the SecuritiesAct by making false and misleading statements and omissions relating to ourfinancial statements and internal controls with respect to revenue recognitionthat required restatement. We cannot provide any assurances that the finaloutcome of this consolidated securities class action will not have a materialadverse effect on our business, results of operations, or financial condition.We may become subject to additional litigation, regulatory inquiries, includingpotential SEC inquiries, or other proceedings or actions arising out of theaudit committee review and the related restatement of our historic financialstatements. Litigation and any potential regulatory actions or proceedings canbe time-consuming and expensive and could divert management time and attentionfrom our business, which could have a material adverse effect on our revenuesand results of operations. The adverse resolution of any specific lawsuit orpotential regulatory action or proceeding could have a material adverse effecton our business, results of operations, and financial condition.

 

***If we fail to establish and maintainproper and effective internal controls, our ability to produce accuratefinancial statements on a timely basis could be impaired, which would adverselyaffect our consolidated operating results, our ability to operate our businessand our stock price.***

 

Ensuring that we haveadequate internal financial and accounting controls and procedures in place toproduce accurate financial statements on a timely basis is a costly andtime-consuming effort that needs to be re-evaluated frequently. Failure on ourpart to have effective internal financial and accounting controls would causeour financial reporting to be unreliable, could have a material adverse effecton our business, operating results, and financial condition and could cause thetrading price of our common stock to fall dramatically. We and our current andformer independent registered public accounting firms have identified controldeficiencies in the past, and in connection with its investigation anddetermination to restate our financial statements, our audit committee,management, and current independent registered public accounting firm haverecently identified deficiencies in our internal controls that contributed tothe need to restate our historic financial statements. As a result of theseidentified control deficiencies, our chief executive officer and chieffinancial officer have determined that, as of March 31, 2008, our internalcontrols over financial reporting were not effective to provide reasonableassurance regarding the reliability of our financial reporting and thepreparation of financial statements for external reporting in accordance withaccounting principles generally accepted in the United States of America.

 

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

 

In their October 2007letter, our independent registered public accounting firm identified additionalcontrol deficiencies that it determined to be significant deficiencies but thatit did not deem to be material weaknesses. In particular, it identified asignificant deficiency relating to segregation of duties, noting among otherthings that in certain instances journal entries and account reconciliationswere approved by the preparer of the entry or reconciliation. Our independentregistered public accounting firm also noted a significant deficiency relatingto post-closing adjusting journal entries and recommended that we reassess thetimeline of our financial statement process to ensure that we have reasonabletime to conclude a thorough financial statement closing process. Finally, ourindependent registered public accounting firm identified significantdeficiencies relating to recording certain purchase transactions, where partswere ordered and accepted by our engineering department, without approval orinvolvement of our finance department, and where fixed assets were not properlyclassified for depreciation purposes.

 

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

 

Remedying our materialweakness and other control deficiencies will require substantial managementtime and attention and will result in our incurring substantial incrementalexpenses, including with respect to increasing the size of our financeorganization and retaining outside consultants to assist in the implementationof new internal controls. Any failure to remedy our identified controldeficiencies or any additional errors or delays in our financial reporting,whether or not resulting from a failure to remedy the deficiencies thatresulted in the current restatement, would have a material adverse effect onour business and results of operations and could have a substantial adverseimpact on the trading price of our common stock and our relationships withcustomers.

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting to provide reasonable assurance regarding the reliabilityof our financial reporting and the preparation of financial statements forexternal purposes in accordance with accounting principles generally acceptedin the United States of America. Our management does not expect that ourinternal control over financial reporting will prevent or detect all errors andall fraud. A control system, no matter how well designed and operated, canprovide only reasonable, not absolute, assurance that the control system’sobjectives will be met. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any, within the company will have been detected. Asdiscussed in this Quarterly Report on Form 10-Q, our audit committee andmanagement, together with our current and former independent registered publicaccounting firms, have identified numerous control deficiencies in the past andmay identify additional deficiencies in the future.

 

We are required to complywith Section 404 of the Sarbanes-Oxley Act of 2002 in connection with ourAnnual Report on Form 10-K for our year ending December 31, 2008. Wehave expended significant resources in developing the necessary documentationand testing procedures required by Section 404 of the Sarbanes-Oxley Act.We cannot be certain that the actions we have taken and are taking to improveour internal controls over financial reporting will be sufficient or that wewill be able to implement our planned processes and procedures in a timelymanner. In addition, we may be unable to produce accurate financial statementson a timely basis. Any of the foregoing could cause investors to loseconfidence in the reliability of our consolidated financial statements, whichcould cause the market price of our common stock to decline and make it moredifficult for us to finance our operations and growth.

 

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**Risks Related to Our Business and Industry**

 

***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 salesefforts on the independent telephone operating companies, or IOCs, in NorthAmerica. These customers generally operate relatively small networks withlimited capital expenditure budgets. Accordingly, we believe the totalpotential sales volume for our products at any individual IOC is limited, andwe must identify and sell products to new IOC customers each quarter tocontinue to increase our sales. In addition, the spending patterns of many IOCsare characterized by small and sporadic purchases. Moreover, because our salesto IOCs are predominantly based on purchase orders rather than long-termcontracts, our customers may stop purchasing equipment from us with littleadvance notice. As a result, we have limited backlog, our future operatingresults are difficult to predict and we will likely continue to have limitedvisibility into future operating results.

 

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

 

A number of factors, many ofwhich are outside our control, may cause or contribute to significantfluctuations in our quarterly and annual operating results. These fluctuationsmay make financial planning and forecasting more difficult. In addition, thesefluctuations may result in unanticipated decreases in our available cash, whichcould limit our growth and delay implementation of our expansion plans. Factorsthat may cause or contribute to fluctuations in our operating results include:

 

·                  fluctuations indemand for our products, including the timing of decisions by our targetcustomers to upgrade their networks and deploy our products;

 

·                  delays incustomer orders as IOCs evaluate and consider their capital expenditures andinvestments in light of the industry transition from copper wire to fiber;

 

·                  increases inwarranty accruals and other costs associated with remedying any performanceproblems relating to our products;

 

·                  seasonalreductions in field work during the winter months and the impact of annualbudgeting cycles;

 

·                  the size andtiming of orders we receive and products we ship during a given period;

 

·                  delays inrecognizing revenue under applicable revenue recognition rules, particularlyfrom government-funded contracts, as a result of additional commitments we maybe required to make to secure purchase orders, or with respect to sales tovalue-added resellers where we cannot establish based on our credit analysisthat collectability is reasonably assured;

 

·                  introductionsor enhancements of products, services and technologies by us or ourcompetitors, and market acceptance of these new or enhanced products, servicesand technologies;

 

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

 

·                  quarter-to-quartervariations in our operating margins resulting from changes in our product mix.

 

As a consequence, operatingresults for a particular future period are difficult to predict and priorresults are not necessarily indicative of results to be expected in the future.Any of the foregoing factors may have a material adverse effect on ourconsolidated 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 significantlosses since our inception. As of March 31, 2008, we had an accumulateddeficit of $124.3 million. We incurred substantial losses in 2007. Weexpect to continue to incur losses in 2008. We cannot assure you that we willnot continue to incur losses or experience negative cash flow in the future. Wehave only generated operating 

 

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income in the quarters ended December 25, 2005, September 24,2006, and December 31, 2006. Our continued inability to generate positiveoperating income and cash flow would materially and adversely affect ourliquidity, consolidated results of operations and consolidated financialcondition.

 

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

 

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

 

Competition in our market isintense, and we expect competition to increase. The market for broadband accessequipment is dominated primarily by large, established suppliers such as ADTRAN, Inc.,Alcatel, and Tellabs, Inc. While these suppliers focus primarily on largeservice providers, they have competed, and may increasingly compete, in the IOCmarket segment. In addition, a number of emerging companies, including CalixNetworks, Inc., have developed, or are developing, products that competewith ours, including within our core IOC segment.

 

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

 

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

 

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

 

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

 

·                  our ability totimely introduce cost-effective new products;

 

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

 

·                  our ability togain customer acceptance of our products;

 

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

 

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

 

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

 

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

 

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

 

Many of our existing and potentialcompetitors are larger than we are and have greater financial resources andbetter-established brands and customer relationships. Unlike many of ourcompetitors, we do not provide financing to potential customers. In addition,many of our competitors have broader product lines than we do, so they canoffer bundled products, which may appeal to certain customers.

 

As the market for ourproducts is new and evolving, winning customers early in the growth of thismarket is critical to our ability to expand our business and increase sales.Because the products that we and our competitors sell require a substantialinvestment of time and funds to install, customers are typically reluctant toswitch equipment suppliers once a particular supplier’s product has beeninstalled. As a result, competition among equipment suppliers to securecontracts with potential customers is particularly intense and will continue toplace pressure on product pricing. Some of our competitors have in the past andmay in the future resort to offering substantial discounts to win new customersand generate cash flows. If we are forced to reduce prices in order to securecustomers, we may be unable to sustain gross margins at desired levels orachieve 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 asubstantial majority of our sales in recent years from our BLC 6000 productline. We expect that sales of this product line will continue to account for asubstantial majority of our sales for the foreseeable future. Any factorsadversely affecting the pricing of, or demand for, our BLC 6000 line, includingcompetition or technological change, could cause our sales to declinematerially and our business to suffer.

 

***If we fail to enhance our 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 characterizedby rapid technological advances, frequent new product introductions, evolvingindustry standards and recurring changes in end-user requirements. Our futuresuccess will depend significantly on our ability to anticipate and adapt tosuch changes and to offer, on a timely and cost-effective basis, products andfeatures that meet changing customer demands and industry standards. The timelydevelopment of new or enhanced products is a complex and uncertain process, andwe may not be able to accurately anticipate market trends or have sufficientresources to successfully manage long development cycles. We may alsoexperience design, manufacturing, marketing and other difficulties that coulddelay or prevent the development, introduction or marketing of new products andenhancements. The introduction of new or enhanced products also requires thatwe manage the transition from older products to these new or enhanced productsin order to minimize disruption in customer ordering patterns and ensure thatadequate supplies of new products are available for delivery to meetanticipated customer demand. If we are unable to develop new products orenhancements to our existing products on a timely and cost-effective basis, orif our new products or enhancements fail to achieve market acceptance, ourbusiness, consolidated financial condition and consolidated results ofoperations would be materially and adversely affected.

 

We recently enhanced our BLC6000 platform to support active Gigabit Ethernet fiber-to-the-premises, orFTTP, services. Although we have invested significant time and resources todevelop this enhancement, these FTTP-enabled products are relatively new, withlimited sales to date, and market acceptance of these products may fall belowour expectations. The introduction of new products is also expected to placepressure on our gross margins as most new products require time and increasedsales volumes to achieve cost-saving efficiencies in production. To the extentour new products and enhancements do not achieve broad market acceptance, wemay not realize expected returns on our investments, and we may lose currentand potential customers.

 

***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 andmarketing efforts have been focused on small and mid-sized IOCs. A key elementof our long-term strategy is to increase sales to large IOCs, competitive localexchange carriers, regional Bell operating companies and international telecomservice providers. We may be required to devote substantial technical,marketing and sales resources to the pursuit of these customers, who havelengthy equipment qualification and sales cycles. In particular, sales to thesecustomers may require us to upgrade our products to meet more stringentperformance criteria, develop new customer-specific features or adapt ourproduct to meet international standards. We may incur substantial technical,sales and marketing expenses and expend significant management effort withoutany assurance of generating sales. Because we have limited resources and largetelecom operators may be reluctant to purchase products from a relatively smallsupplier like us, we plan to target these customers in cooperation withstrategic resellers. These reseller relationships may not be available to us,and if formed, may include terms, such as exclusivity and non-competitionprovisions, that restrict our activities or impose onerous requirements on us.Moreover, in connection with these relationships, we may forego direct salesopportunities in favor of forming relationships with strategic resellers. If weare unable to successfully increase our sales to larger telecom operators orexpand our reseller relationships, we may be unable to implement our long-termgrowth strategy.

 

***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 almostall of our sales from customers in North America and have very limitedexperience marketing, selling and supporting our products and services outsideNorth America or managing the administrative aspects of a worldwide operation.While we intend to expand our international operations, we may not be able tocreate or maintain international market demand for our products. In addition,regulations or standards adopted by other countries may require us to redesignour existing products or develop new products suitable for sale in thosecountries. If we invest substantial time 

 

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and resources to expand our international operations and are unable todo so successfully and in a timely manner, our business, financial conditionand results of operations will suffer.

 

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

 

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

·                  greaterdifficulty supporting and localizing our products;

 

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

 

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

 

·                  limited orunfavorable intellectual property protection;

 

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

 

·                  restrictions onthe repatriation of earnings.

 

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

 

Our success depends, inlarge part, on the continued contributions of our key management, engineering,sales and marketing personnel, many of whom are highly-skilled and would bedifficult to replace. None of our senior management or key technical or salespersonnel is bound by a written employment contract to remain with us for aspecified period. In addition, we do not currently maintain key-man lifeinsurance covering our key personnel. If we lose the services of any keypersonnel, our business, financial condition and results of operations maysuffer.

 

Competition for skilledpersonnel, particularly those specializing in engineering and sales is intense.We cannot be certain that we will be successful in attracting and retainingqualified personnel, or that newly-hired personnel will function effectively,either individually or as a group. In particular, we must continue to expandour direct sales force, including hiring additional sales managers, to grow ourcustomer base and increase sales. Even if we are successful in hiringadditional sales personnel, new sales representatives require up to a year tobecome effective, and the recent loss of a senior sales executive could have anadverse impact on our ability to recruit and train additional sales personnel.In addition, our industry is characterized by frequent claims relating tounfair hiring practices. We may become subject to such claims and may incursubstantial costs in defending ourselves against these claims, regardless oftheir merits. If we are unable to effectively hire, integrate and utilize newpersonnel, the execution of our business strategy and our ability to react tochanging market conditions may be impeded, and our business, financialcondition and results of operations could suffer.

 

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

 

We have experiencedsignificant growth in our sales and operations in recent years. We expect toexpand our research and development, sales, marketing and support activities,including our activities outside the U.S. Our historical growth has placed, andplanned future growth is expected to continue to place, significant demands onour management, as well as our financial and operational resources, as requiredto:

 

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

 

·                  implementappropriate operational and financial systems;

 

·                  manage a largerorganization;

 

·                  expand ourmanufacturing and distribution capacity;

 

·                  increase oursales and marketing efforts; and

 

·                  broaden ourcustomer support capabilities.

 

In addition, as discussed inthis Form 10-Q under Part I, Item 3, our internal controls overfinancial reporting are currently ineffective, and we will need to expand ourfinance organization and retain outside advisors to implement adequate andeffective financial controls. If 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 internalmanufacturing capabilities and rely upon a small number of contractmanufacturers to build our products. In particular, we rely on FlashElectronics, Inc. for the manufacture of our BLC 6000 blade products. Ourreliance on a small number of contract manufacturers makes us vulnerable topossible capacity constraints and reduced control over component availability,delivery schedules, manufacturing yields and costs. We do not have long-termsupply contracts with our primary contract manufacturers. Consequently, thesemanufacturers are not obligated to supply products to us for any specificperiod, in any specific quantity or at any certain price, except as may beprovided by a particular purchase order. If any of our manufacturers wereunable or unwilling to continue manufacturing our products in required volumesand at high quality levels, we would have to identify, qualify and selectacceptable alternative manufacturers. It is possible that an alternate sourcemay not be available to us when needed or may not be in a position to satisfyour production requirements at commercially reasonable prices and quality. Anysignificant interruption in manufacturing would require us to reduce our supplyof products to our customers, which in turn could have a material adverseeffect on our customer relations, business, consolidated financial conditionand consolidated results of operations.

 

We recently moved a portionof our manufacturing to the overseas facilities of our primary contractmanufacturer. This transition presents a number of risks, including thepotential for a supply interruption or a reduction in manufacturing quality orcontrols, any of which would negatively impact our business, customerrelationships 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 andlimited source suppliers for key components of our products. Any of the solesource and limited source suppliers upon which we rely could stop producing ourcomponents, cease operations entirely, or be acquired by, or enter intoexclusive arrangements with, our competitors. We do not have long-term supplyagreements with our suppliers, and our purchase volumes are currently too lowfor us to be considered a priority customer by most of our suppliers. As aresult, these suppliers could stop selling components to us at commerciallyreasonable prices, or at all. Any such interruption or delay may force us toseek similar components from alternate sources, if available at all. Switchingsuppliers may require that we redesign our products to accommodate the newcomponent and may potentially require us to re-qualify our products with ourcustomers, which would be costly and time-consuming. Any interruption in thesupply of sole source or limited source components would adversely affect ourability to meet scheduled product deliveries to our customers and wouldmaterially and adversely affect our business, consolidated financial conditionand consolidated results of operations.

 

Periodically, we may berequired to license technology from third parties to develop new products orproduct enhancements. These third-party licenses may be unavailable to us oncommercially reasonable terms, if at all. Our inability to obtain necessarythird-party licenses may force us to obtain substitute technology of lowerquality or performance standards or at greater cost, any of which couldseriously harm the competitiveness of our products and which would result in amaterial and adverse effect on our business, consolidated financial conditionand 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 materialsand components that we order through our contract manufacturers may varysignificantly and depend on numerous factors, including the specific supplier,contract terms and market demand for a component at a given time. If weoverestimate our production requirements, our contract manufacturers maypurchase excess components and build excess inventory. If our contractmanufacturers purchase excess components that are unique to our products orbuild excess products, we could be required to pay for these excess parts orproducts and recognize related inventory write-down costs. If we underestimateour product requirements, our contract manufacturers may have inadequatecomponent inventory, which could interrupt manufacturing of our products andresult in delays or cancellation of sales. In prior periods we have experiencedexcess and obsolete inventory write-downs which impact the Company’s cost ofgoods sold. This may continue in the future, which would have an adverse effecton our gross margins, consolidated financial condition and consolidated resultsof operations.

 

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***If our products contain undetecteddefects, including errors and interoperability issues, we could incursignificant unexpected expenses to remedy the defects, which could have amaterial adverse effect on our sales, results of operations or financialcondition.***

 

Although our products aretested prior to shipment, they may contain software or hardware errors, defectsor interoperability issues (collectively described as “defects”) that can onlybe detected when deployed in live networks that generate high amounts ofcommunications traffic. We also continue to introduce new products that mayhave undetected software or hardware defects. Our customers may discoverdefects in our products after broad deployment and as their networks areexpanded and modified. Any defects in our products discovered in the future, orfailures of our customers’ networks, whether caused by our products or those ofanother vendor, could result in lost sales and market share and negativepublicity regarding our products. For example, during fiscal 2004, weexperienced unusually high repair costs related to the effect of lightningstrikes on selected BLC 6000 installations. As a result, we experienced higherthan anticipated costs of sales, which management believes were necessary tomaintain customer satisfaction. In 2007, we experienced higher than averagefailures of certain assemblies that were fabricated between October 2005and January 2006 and identified design issues associated with a transistorthat resulted in equipment disruption and that required a re-engineeringeffort. As a result, we increased our warranty accruals in 2007. Any similaroccurrences in the future could have a material adverse effect on our business,consolidated financial condition and consolidated results of operations.

 

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

 

Demand for our productsdepends on the magnitude and timing of capital spending by telecom serviceproviders as they construct, expand and upgrade their networks. The capitalspending patterns of telecom service providers are dependent on a variety offactors, including:

 

·                  competitivepressures, including pricing pressures;

 

·                  consumer demandfor new services;

 

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

 

·                  the timing ofannual budget approvals;

 

·                  evolvingindustry standards and network architectures;

 

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

 

·                  completion ofmajor network upgrades.

 

Beginning in late 2000 andcontinuing into 2004, the telecom industry experienced a severe downturn, andmany telecom service providers filed for bankruptcy. Those companies thatsurvived the downturn substantially reduced their investments in new equipment.In addition, uncertain and volatile capital markets depressed the market valuesof telecom service providers and restricted their access to capital, resultingin delays or cancellations of certain projects. More recently, we believecapital expenditures among IOCs have been adversely affected as our customersconsider their investment and capital expenditure decisions in light of theindustry transition from copper wire to fiber. Because many of our customersare IOCs, their revenues are particularly dependent upon intercarrier payments(primarily interstate and intrastate access charges) and federal and stateuniversal service subsidies. The FCC and some states are considering changes toboth intercarrier payments and universal service subsidies, and such changescould reduce IOC revenues. Furthermore, many IOCs use government-supported loanprograms or grants to finance capital spending. Changes to those programs, suchas the United States Department of Agriculture’s Rural Utility Service, couldreduce the ability of IOCs to access capital. Any decision by telecom serviceproviders to reduce capital expenditures, whether caused by economic cycles,changes in government regulations and subsidies, or other reasons, would have amaterial adverse effect on our business, consolidated financial condition andresults of operations.

 

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

*** ***

Demandfor our products is dependent on the success of our customers in deploying andselling services to their subscribers. Our BLC 6000 platform simultaneouslysupports IP-based services, such as broadband Internet, VoIP, IPTV and FTTP,and traditional voice services. If end-user demand for IP-based services doesnot grow as expected or declines and our customers are unable or unwilling todeploy and market these newer services, demand for our products may decrease orfail to grow at rates we anticipate.

 

Ourstrategy includes developing products for the local access network thatincorporate IP and Ethernet technologies. If these technologies are not widelyadopted by telecom service providers for use in local access networks, demand forour products may decrease or not grow. As a result, we may be unable to sellour products to recoup our expenses related to the development of theseproducts and our consolidated results of operations would be harmed.

 

***Changes in existing accounting or taxation rules orpractices may adversely affect our consolidated results of operations.***

 

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 usestock-based compensation as a significant component of our compensation packagefor existing and future employees. Accordingly, changes in accounting forstock-based compensation expense under the newer accounting method are expectedto have a material adverse affect on our reported results. Any similar changesin accounting or taxation rules or practices could have a material impacton our consolidated financial results.

 

***We may pursue acquisitions, which mayinvolve a 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.***

 

Wemay make acquisitions of businesses, products or technologies to expand our productofferings and capabilities, customer base and business. In October 2007,we acquired certain assets and assumed certain liabilities of TerawaveCommunications and we have evaluated, and expect to continue to evaluate, awide array of potential strategic transactions. We have limited experiencemaking such acquisitions. Any of these transactions could be material to ourconsolidated financial condition and results of operations. The anticipatedbenefit of acquisitions may never materialize. In addition, the process ofintegrating an acquired business, products or technologies may createunforeseen operating difficulties and expenditures. Some of the areas where wemay face acquisition-related risks include:

 

·                  diversion ofmanagement time and potential business disruptions;

 

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

 

·                  retaining andintegrating employees from any businesses we may acquire;

 

·                  issuance ofdilutive equity securities or incurrence of debt;

 

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

 

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

 

·                  difficultiesintegrating and supporting acquired products or technologies;

 

·                  unexpectedcapital equipment outlays and related costs;

 

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·                  insufficientrevenues to offset increased expenses associated with the acquisition;

 

·                  under-performanceproblems associated with acquisitions;

 

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

 

·                  becominginvolved in acquisition-related litigation.

 

Foreignacquisitions involve unique risks in addition to those mentioned above,including those related to integration of operations across different culturesand languages, currency risks and the particular economic, political andregulatory risks associated with specific countries. We cannot assure that wewill be able to address these risks successfully, or at all, without incurringsignificant costs, delay or other operating problems. Our inability to resolveany of such risks could have a material adverse impact on our business,consolidated financial condition and consolidated results of operations.

 

***Business combinations and other financialrestructurings by telecom service providers or our competitors could adverselyaffect our business.***

 

Inrecent years, the telecom service provider market has undergone substantialconsolidation, illustrated by the merger of SBC Communications Inc. withAT&T Inc., the merger of SBC Communications (now renamed AT&T)with BellSouth Corporation (now also renamed AT&T), and the merger of VerizonCommunications Inc. with MCI, Inc. Transactions such as thesegenerally have negative implications for equipment suppliers like us, includinga reduction in the number of potential customers for telecom equipmentproducts, a decrease in aggregate capital spending and greater pricing power byservice providers over equipment suppliers. Continued consolidation of thetelecom service provider industry, including among IOC customers which we focuson, could make it more difficult for us to grow our customer base, increasesales of our products and maintain adequate gross margins.

 

Thetelecommunications equipment industry is also characterized by frequent mergersand acquisitions, as illustrated by the merger of Alcatel with LucentTechnologies and the acquisition of Advanced Fibre Communications, Inc. byTellabs. An acquisition of one of our competitors, or merger between ourcompetitors, could harm our competitive position or cause our target customersto delay purchases of our products while they assess the impact of thecombination. If a larger company with more resources were to acquire acompetitor of ours, they may invest additional resources in developing,marketing and supporting competitive products, which would negatively impactour business, consolidated financial condition and consolidated results ofoperations.

 

***Our customers are subject to governmentregulation, and changes in current or future laws or regulations thatnegatively impact our customers could harm our business.***

 

Thejurisdiction of the Federal Communications Commission, or FCC, extends to theentire telecommunications industry, including our customers. Future FCCregulations affecting the broadband access industry, our customers, or theservice offerings of our customers, may harm our business. For example, FCCregulatory policies affecting the availability of data and Internet servicesmay impede the penetration of our customers into certain markets or affect theprices they may charge in such markets. Furthermore, many of our customers aresubject to FCC rate regulation of interstate telecommunications services, andare recipients of federal universal service subsidies implemented andadministered by the FCC. In addition, many of our customers are subject 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.

 

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

 

Themarkets for our products are characterized by a significant number of laws,regulations and standards, both domestic and international, some of which areevolving as new technologies are deployed. Our products are required to complywith these laws, regulations and standards, including those promulgated by theFCC. For example, the FCC recently required that all facilities-based providersof broadband Internet access and interconnect VoIP services meet the capabilityrequirements of the Communications Assistance for Law Enforcement Act by May 14,2007. Subject to certain statutory parameters, we are required to makeavailable to our customers, on a reasonably timely basis and at a reasonablecharge, such features or modifications as are necessary to permit our customersto meet those capability requirements. In some cases, we are required to obtaincertifications or authorizations before our products can be introduced,marketed or sold. There can be no assurance that we will be able to continue todesign our products to comply with all necessary requirements in the future.Accordingly, any of these laws, regulations and standards may directly affectour ability to market or sell our products.

 

Someof our operations are regulated under various federal, state and localenvironmental laws. Our planned international expansion will likely subject usto additional environmental and other laws. For example, the European UnionDirective 2002/96/EC on waste electrical and electronic equipment, known as theWEEE Directive, requires producers of certain electrical and electronicequipment, including telecom equipment, to be financially responsible for thespecified collection, recycling, treatment and disposal of past and presentcovered products placed on the market in the European Union. The European UnionDirective 2002/95/EC on the restriction of the use of hazardous substances inelectrical and electronic equipment, known as the RoHS Directive, restricts theuse of certain hazardous substances, including lead, in covered products.Failure to comply with these and other environmental laws could result in finesand penalties and decreased sales, which could adversely affect our plannedinternational expansion and our consolidated operating results.

 

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

 

Wedepend on our proprietary technology for our success and ability to compete. Wecurrently hold 24 issued patents and have several patent applications pending.We rely on a combination of patent, copyright, trademark and trade secret laws,as well as confidentiality agreements and licensing arrangements, to establishand protect our proprietary rights. Existing patent, copyright, trademark andtrade secret laws will afford us only limited protection. In addition, the lawsof some foreign countries do not protect proprietary rights to the same extent,as do the laws of the U.S. We cannot assure you that any pending patentapplications will result in issued patents, and issued patents could proveunenforceable. Any infringement of our proprietary rights could result insignificant litigation costs. Further, any failure by us to adequately protectour proprietary rights could result in our competitors offering similarproducts, resulting in the loss of our competitive advantage and decreasedsales.

 

Despiteour efforts to protect our proprietary rights, attempts may be made to copy orreverse engineer aspects of our products, or to obtain and use information thatwe regard as proprietary. Accordingly, we may be unable to protect ourproprietary 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 andconsolidated results of operations.

 

***We could become subject to litigationregarding intellectual property rights that could materially harm our business.***

 

Wemay be subject to intellectual property infringement claims that are costly todefend and could limit our ability to use some technologies in the future. Ourindustry is characterized by frequent intellectual property litigation based onallegations of infringement of intellectual property rights. From time to time,third parties have asserted against us and may assert against us in the futurepatent, copyright, trademark or other intellectual property rights totechnologies or rights that are important to our business. In addition, we haveagreed, and may in the future agree, to indemnify our customers for anyexpenses or liabilities resulting from claimed infringements of patents,trademarks or copyrights of third parties. Any claims asserting that ourproducts infringe, or may infringe on, the proprietary rights of third parties,with or without merit, could be time-consuming, resulting in costly litigationand diverting the efforts of our management. These claims could also result inproduct shipment delays or require us to modify our products or enter intoroyalty or licensing agreements. Such royalty or licensing agreements, if required,may not be available to us on acceptable terms, if at all.

 

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

 

Ourbusiness and operations depend on the extent to which our facilities andproducts are protected against damage from fire, earthquakes, power loss andsimilar events. Some of our key business activities currently take place inregions considered as high risk for certain types of natural disasters. Despiteprecautions we have taken, a natural disaster or other unanticipated problemcould, among other things, hinder our research and development efforts, delaythe shipment of our products and affect our ability to receive and fulfillorders. While we believe that our insurance coverage is comparable to those ofsimilar companies in our industry, it does not cover all natural disasters, inparticular, earthquakes and floods.

 

**Risks Related to Our Common Stock**

 

***Our executive officers, directors and theiraffiliates hold a large percentage of our stock and their interests may differfrom other stockholders.***

 

Asof December 31, 2007, our executive officers, directors and theiraffiliates beneficially owned, in the aggregate, approximately 31.3% of ouroutstanding common stock. Investment funds affiliated with U.S. VenturePartners and Norwest Venture Partners, collectively control approximately 27.7%of our outstanding common stock. Representatives of U.S. Venture Partners andNorwest Venture Partners are directors of Occam. These stockholders havesignificant influence over most matters requiring approval by stockholders,including the election of directors, any amendments to our certificate ofincorporation and significant corporate transactions.

 

***Our stock price may be volatile, and youmay not be able to resell shares of our common stock at or above the price youpaid.***

 

Ourshares of common stock began trading on The NASDAQ Global Market in November 2006.An active public market for our shares on The NASDAQ Global Market may not besustained. In particular, limited trading volumes and liquidity may limit theability of stockholders to purchase or sell our common stock in the amounts andat the times they wish. Trading volume in our common stock tends to be modestrelative to our total outstanding shares, and the price of our common stock mayfluctuate substantially (particularly in percentage terms) without regard tonews about us or general trends in the stock market.

 

Inaddition, the trading price of our common stock could become highly volatileand could be subject to wide fluctuations in response to various factors, someof which are beyond our control. These factors include those discussed in this “RiskFactors” section of this Quarterly Report on Form 10-Q and others such as:

 

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

 

·                  changes inearnings estimates or recommendations by securities analysts;

 

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

 

·                  developmentswith respect to intellectual property rights;

 

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

 

·                  commencementof, or involvement in, litigation;

 

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

 

·                  a slowdown inthe telecom industry or general economy.

 

Inrecent years, the stock market in general, and the market for technologycompanies in particular, has experienced extreme price and volume fluctuationsthat have often been unrelated or disproportionate to the operating performanceof those companies. Broad market and industry factors may seriously affect themarket price of our common stock, regardless of our actual operatingperformance. In addition, in the past, following periods of volatility in theoverall market and the market price of a particular company’s securities,securities class action litigation has often been instituted against thesecompanies. 

 

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We are currently a defendantin securities class action litigation arising from our restatement. Thislitigation or any additional litigation that may be instituted against us couldresult in substantial costs and a diversion of our management’s attention andresources.

 

***Provisions in our charter documents andunder Delaware law could discourage a takeover that stockholders may considerfavorable.***

 

Provisionsin our certificate of incorporation and bylaws, as amended and restated uponthe closing of this offering, may have the effect of delaying or preventing achange of control or changes in our management. These provisions include thefollowing:

 

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

 

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

 

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

 

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

 

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

 

Asa Delaware corporation, we are also subject to certain Delaware anti-takeoverprovisions. Under Delaware law, a corporation may not engage in a businesscombination with any holder of 15% or more of its capital stock unless theholder has held the stock for three years or, among other things, the board ofdirectors 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.***

 

Whilewe anticipate our cash balances and any cash from operations will be sufficientto fund our operations for at least the next 12 months, we may need toraise additional capital to fund operations in the future. There is noguarantee that we will be able to raise additional equity or debt funding whenor 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.

 

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

 

None.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

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

 

None.

 

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**ITEM 5.  OTHERINFORMATION**

 

**Internal Control Weaknesses and Remediation**

 

Asfurther discussed in Part I, Item 4 of this Form 10-Q under the caption“Controls and Procedures,” during the course of its investigation, our auditcommittee identified internal control weaknesses relating primarily to theapproval, documentation, communication and accounting for transactions withnon-standard terms or for commitments of future functionality or features ofthe products sold. Our audit committee determined that we lacked sufficientguidelines or processes concerning approval of non-standard terms and that wehad no consistent practice to ensure that non-standard terms and shippingmethods were consistently documented. Although our audit committee identifiedsome recent improvements in our internal controls, it found that controldeficiencies existed relating to the documentation of the terms of transactionsand the internal controls in place to ensure that such terms were accuratelyand completely communicated for revenue recognition purposes to our financedepartment. The audit committee also found weaknesses relating to the failureto apply, or misapplication of, technical accounting rules relating to thetiming of revenue recognition. Finally, certain of the control weaknessesrelated to accounting for VAR transactions and the manner in which we assessedand documented our evaluation of the creditworthiness of these resellers.

 

Inaddition, our audit committee received a letter dated March 10, 2008 fromour current independent registered public accounting firm identifying amaterial weakness relating to revenue recognition and significant deficienciesrelating to segregation of duties, post-closing adjusting journal entries, andaccounting for parts and fixed asset purchases. Our chief executive officer andour chief financial officer have further determined that, as of March 31,2008, our internal controls over financial reporting were not effective toprovide reasonable assurance regarding the reliability of our financial reportingand the preparation of our consolidated financial statements for externalpurposes in accordance with accounting principles generally accepted in theUnited States of America.

 

Ouraudit committee, with the assistance of special counsel to the audit committeeand reflecting input from our current independent registered public accountingfirm, developed a list of identified goals and directives to enhance ourinternal control over financial reporting, including development of meaningfuland comprehensive training programs and protocols for the communication andenforcement of our recently amended and restated code of ethics and conduct.These recommendations are described in greater detail in the discussion under Part I,Item 4, section (b) relating to changes in internal controls.Our full board of directors has adopted these recommendations, and we are inthe process of implementing them, in consultation with our independentregistered public accounting firm and an independent outside consultant we haveretained in connection with the development of our implementation plan for Section 404of the Sarbanes-Oxley Act of 2002.

 

**ITEM 6. EXHIBITS**

 

**A. Exhibits**

 

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

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                | OCCAM NETWORKS, INC. |
|---------------------|----------------------|
|                | (Registrant)         |
|                |                 |
|                | By:                  |  /s/ CHRISTOPHER B.  FARRELL |
|                |                 |  Christopher B.  Farrell |
|                |                 |  Chief Financial  Officer |
|                |                 |  (Principal Financial  and Accounting Officer) |
| Dated: May 12, 2008 |                 |

 

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**EXHIBITINDEX**

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

 

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