Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterly period ended September 30, 2009**

 

**Or**

 

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

 

**For the transition period from                    to                    **

 

**Commission file number: 001-33069**

 

**OCCAMNETWORKS, INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

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

 

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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o No o

 

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

 

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

 

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

 

Asof November 2, 2009, the number of shares outstanding of the registrant’scommon stock was 20,507,665 shares.

 

 

 

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**INDEX**

 
| ** **                              | ** **                                                                                  | **Page** |
|-----------------------------------------|---------------------------------------------------------------------------------------------|----------|
|                                    |                                                                                        |     |
| PART I—FINANCIAL  INFORMATION | 1                                                                                           |
|                                    |                                                                                        |     |
| Item 1.                                 | Financial Statements                                                                        | 1        |
|                                    |                                                                                        |     |
| Item 2.                                 | Management’s  Discussion And Analysis Of Financial Condition And Results Of Operations | 13       |
|                                    |                                                                                        |     |
| Item 3.                                 | Quantitative  And Qualitative Disclosures About Market Risk                                 | 24       |
|                                    |                                                                                        |     |
| Item 4.                                 | Controls And Procedures                                                                     | 24       |
|                                    |                                                                                        |     |
| PART II—OTHER  INFORMATION    | 28                                                                                          |
|                                    |                                                                                        |     |
| Item 1.                                 | Legal Proceedings                                                                           | 28       |
|                                    |                                                                                        |     |
| Item 1a.                                | Risk Factors                                                                                | 30       |
|                                    |                                                                                        |     |
| Item 2.                                 | Unregistered  Sales Of Equity Securities And Use Of Proceeds                                | 45       |
|                                    |                                                                                        |     |
| Item 3.                                 | Defaults Upon  Senior Securities                                                            | 45       |
|                                    |                                                                                        |     |
| Item 4.                                 | Submission Of  Matters To A Vote Of Security Holders                                        | 46       |
|                                    |                                                                                        |     |
| Item 5.                                 | Other Information                                                                           | 46       |
|                                    |                                                                                        |     |
| Item 6.                                 | Exhibits                                                                                    | 46       |

 

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**PART I—FINANCIAL INFORMATION**

 

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

 

**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                               | ** ** | **2009**               | ** ** | **2008 (*)**     | ** ** |
| ** **                                                                                                                                                                                               | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                               |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                          |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                |       | $                      | 38,843     |                  | $          | 30,368 |   |
| Restricted cash                                                                                                                                                                                          |       | 6,259                  |       | 13,771                |       |
| Accounts receivable, net                                                                                                                                                                                 |       | 16,142                 |       | 17,391                |       |
| Inventories                                                                                                                                                                                              |       | 10,173                 |       | 16,761                |       |
| Prepaid and other current assets                                                                                                                                                                         |       | 1,542                  |       | 3,290                 |       |
| Total current assets                                                                                                                                                                                     |       | 72,959                 |       | 81,581                |       |
| Property and equipment, net                                                                                                                                                                              |       | 9,111                  |       | 10,834                |       |
| Intangibles, net                                                                                                                                                                                         |       | 180                    |       | 251                   |       |
| Other assets                                                                                                                                                                                             |       | 106                    |       | 68                    |       |
| Total assets                                                                                                                                                                                             |       | $                      | 82,356     |                  | $          | 92,734 |   |
|                                                                                                                                                                                                     |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                           |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                     |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                         |       | $                      | 7,141      |                  | $          | 6,911 |   |
| Accrued liabilities                                                                                                                                                                                      |       | 8,514                  |       | 8,687                 |       |
| Deferred revenue                                                                                                                                                                                         |       | 12,197                 |       | 17,612                |       |
| Deferred rent                                                                                                                                                                                            |       | 361                    |       | 394                   |       |
| Capital lease obligations                                                                                                                                                                                |       | 25                     |       | 24                    |       |
| Total current liabilities                                                                                                                                                                                |       | 28,238                 |       | 33,628                |       |
| Deferred rent, net of current portion                                                                                                                                                                    |       | 1,681                  |       | 1,892                 |       |
| Capital lease obligations, net of current portion                                                                                                                                                        |       | 25                     |       | 43                    |       |
| Total liabilities                                                                                                                                                                                        |       | 29,944                 |       | 35,563                |       |
| Commitments and contingencies (See Note 6)                                                                                                                                                               |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                               |       |                   |       |                  |       |
| Common stock, $0.001 par value, 250,000,000 shares  authorized; and 20,496,347 shares issued and outstanding at  September 30, 2009 and 20,268,488 December 31,  2008, respectively. |       | 289                    |       | 289                   |       |
| Additional paid-in capital                                                                                                                                                                               |       | 186,726                |       | 183,409               |       |
| Accumulated deficit                                                                                                                                                                                      |       | (134,603               | )          | (126,527              | )          |
| Total stockholders’ equity                                                                                                                                                                          |       | 52,412                 |       | 57,171                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                          |       | $                      | 82,356     |                  | $          | 92,734 |   |

 

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***              **Derived fromaudited consolidated financial statements included in its Annual Report on Form 10-K.

 

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

 

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**    | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
| ** **                                                    | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                       |       | $                                | 21,673     |                            | $          | 25,131 |   | $ | 62,120 |   | $ | 67,610 |   |
| Cost of revenue                                               |       | 12,725                           |       | 14,380                          |       | 36,970 |   | 38,331 |   |
| Gross margin                                                  |       | 8,948                            |       | 10,751                          |       | 25,150 |   | 29,279 |   |
| Operating expenses:                                           |       |                             |       |                            |       |   |   |   |   |
| Research and product-development                              |       | 3,762                            |       | 5,004                           |       | 12,186 |   | 14,337 |   |
| Sales and marketing                                           |       | 4,459                            |       | 4,677                           |       | 13,404 |   | 14,760 |   |
| General and administrative                                    |       | 1,760                            |       | 2,050                           |       | 6,179 |   | 8,253 |   |
| Restructuring charges                                         |       | —                           |       | —                          |       | 213 |   | — |   |
| Loss on litigation settlement                                 |       | 1,700                            |       | —                          |       | 1,700 |   | — |   |
| Total operating expenses                                      |       | 11,681                           |       | 11,731                          |       | 33,682 |   | 37,350 |   |
| Loss from operations                                          |       | (2,733                           | )          | (980                            | )          | (8,532 | ) | (8,071 | ) |
| Other income (expense), net                                   |       | 43                               |       | —                          |       | 147 |   | (702 | ) |
| Interest income (expense), net                                |       | 38                               |       | 250                             |       | 274 |   | 885 |   |
| Loss before benefit from income taxes                         |       | (2,652                           | )          | (730                            | )          | (8,111 | ) | (7,888 | ) |
| Benefit from income taxes                                     |       | (21                              | )          | (71                             | )          | (35 | ) | (30 | ) |
| Net loss                                                      |       | $                                | (2,631     | )                               | $          | (659 | ) | $ | (8,076 | ) | $ | (7,858 | ) |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Net loss per share attributable to common  stockholders:      |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                             |       | $                                | (0.13      | )                               | $          | (0.03 | ) | $ | (0.40 | ) | $ | (0.40 | ) |
| Weighted average shares attributable to common  stockholders: |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                             |       | 20,273                           |       | 19,894                          |       | 20,214 |   | 19,826 |   |

 

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

 

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,  2009**    | ** ** | **September 30,  2008*** | ** ** |
| ** **                                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Operating activities**                                                     |       |                            |       |   |   |
| Net loss                                                                     |       | $                               | (8,076     | ) | $ | (7,858 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                            |       |   |   |
| Stock-based compensation                                                     |       | 2,685                           |       | 2,348 |   |
| Depreciation and amortization                                                |       | 2,501                           |       | 2,354 |   |
| Impairment of intangibles                                                    |       | —                          |       | 981 |   |
| Accounts receivable reserves                                                 |       | 176                             |       | (110 | ) |
| Inventory reserves                                                           |       | 160                             |       | (3 | ) |
| Loss from disposal of property and equipment                                 |       | —                          |       | 26 |   |
| Changes in operating assets and liabilities:                                 |       |                            |       |   |   |
| Accounts receivable                                                          |       | 1,073                           |       | (3,457 | ) |
| Inventories                                                                  |       | 6,428                           |       | (5,785 | ) |
| Prepaid expenses and other current assets                                    |       | 1,710                           |       | (1,113 | ) |
| Accounts payable                                                             |       | 230                             |       | (256 | ) |
| Accrued expenses                                                             |       | (173                            | )          | 664 |   |
| Deferred revenue                                                             |       | (5,415                          | )          | 3,436 |   |
| Deferred rent                                                                |       | (244                            | )          | 825 |   |
| Net cash provided by (used in) operating  activities                         |       | 1,055                           |       | (7,948 | ) |
| **Investing activities**                                                     |       |                            |       |   |   |
| Decrease (increase) in restricted cash                                       |       | 7,512                           |       | (3,806 | ) |
| Net purchases of property and equipment                                      |       | (707                            | )          | (4,438 | ) |
| Purchase of intangibles                                                      |       | —                          |       | (160 | ) |
| Net cash provided by (used in) investing  activities                         |       | 6,805                           |       | (8,404 | ) |
| **Financing activities**                                                     |       |                            |       |   |   |
| Exercise of stock options                                                    |       | 61                              |       | 69 |   |
| Payments of payroll taxes for vested restricted stock  units                 |       | —                          |       | (68 | ) |
| Capital lease obligations                                                    |       | (17                             | )          | 9 |   |
| Proceeds from employee stock purchase plan                                   |       | 571                             |       | 587 |   |
| Net cash provided by financing activities                                    |       | 615                             |       | 597 |   |
| Net increase (decrease) in cash and cash  equivalents                        |       | 8,475                           |       | (15,755 | ) |
| Cash and cash equivalents, beginning of period                               |       | 30,368                          |       | 37,637 |   |
| Cash and cash equivalents, end of period                                     |       | $                               | 38,843     |   | $ | 21,882 |   |
| **Supplemental disclosure of cash  flow information:**                       |       |                            |       |   |   |
| Income taxes paid                                                            |       | $                               | 202        |   | $ | 40 |   |
| Interest paid                                                                |       | $                               | 4          |   | $ | 35 |   |

 

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***              **Certain amountshave been reclassified to conform to current period’s presentation.

 

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

 

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**OCCAM NETWORKS, INC. AND SUBSIDIARY**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

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

 

*Basis ofPresentation*

 

The accompanying condensedconsolidated financial statements are unaudited.  The condensed consolidated balance sheet at December 31,2008 is derived from Occam’s audited consolidated financial statements includedin its Annual Report on Form 10-K for the year ended December 31,2008.  These unaudited condensedconsolidated financial statements reflect all material adjustments, consistingonly of normal recurring adjustments, which, in the opinion of management, arenecessary to fairly state our financial position, results of operations and cashflows for the interim periods.  Theresults of operations for the current interim periods are not necessarilyindicative of results to be expected for the entire year.

 

The unaudited condensedconsolidated financial statements include management’s estimates andassumptions that affect the reported amounts of assets and liabilities as ofthe date of the consolidated financial statements and the reported amounts ofrevenue and expenses during the reporting period.  Actual results could differ from those estimates,and material effects on consolidated operating results and consolidatedfinancial position may result.

 

The unaudited interimcondensed financial statements have been prepared in accordance with accountingprinciples generally accepted in the United States (“GAAP”) for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly,they do not include all of the information and notes required by GAAP forannual financial statements.  In theopinion of management, all adjustments consisting of normal and recurringentries considered necessary for a fair statement of the results for theinterim periods have been included in the Company’s financial position as of September 30,2009, the results of its operations for the three and nine months ended September 30,2009 and 2008, and its cash flow for the nine months ended September 30,2009 and 2008.

 

Certain amounts in the priorperiods presented have been reclassified to conform to the current period financialstatement presentation. These reclassifications had no effect on previouslyreported net income (loss).

 

*Use ofEstimates*

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the amounts reported in the consolidated financial statements andthe accompanying notes.  Actual resultscould differ from those estimates and such differences may be material to the consolidatedfinancial statements.

 

*RevenueRecognition*

 

Occam generally recognizesrevenue under SAB 104 in the period when all of the requirements of SAB 104have been met:

 

·      persuasiveevidence of sales arrangements,

·      delivery hasoccurred or services have been rendered,

·      the buyer’sprice is fixed or determinable and

·      collection isreasonably assured.

 

The Company enters intotransactions with value-added resellers where the resellers may not have theability to pay for these sales independent of payment to them by theend-user.  In these cases, the Companydoes not recognize revenue until payment has been received, provided theremaining revenue recognition criteria are met.

 

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The Company sells hardwareproducts that contain embedded operating system software, which the Company hasdetermined are “incidental” to the hardware products.  Revenue is recognized for these productsunder SAB 104.  The Company has one minorsoftware network management product which is a stand alone product notessential to the functionality of other products that the Company sells.Revenue is recognized for this product in accordance with FASB AccountingStandard Codification Topic 985, Software. The amount of sales of this productand the related revenue recognized to date by the Company have been immaterial.

 

In addition to theaforementioned general policy, the Company enters into transactions thatrepresent multiple-element arrangements, which may include training andpost-sales technical support and maintenance to our customers as needed toassist them in installation or use of our products, and makes provisions forthese costs in the periods of sale. Multiple-element arrangements are assessed to determine whether they canbe separated into more than one unit of accounting.  A multiple-element arrangement is separatedinto more than one unit of accounting if all of the following criteria are met:

 

·**                 **the delivereditem(s) has value to the customer on a stand-alone basis;

 

·**                 **there isobjective and reliable evidence of the fair value of the undelivered item(s);and

 

·**                 **the arrangementincludes a general right of return relative to the delivered item(s) anddelivery or performance of the undelivered item(s) is considered probableand substantially in our control.

 

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

 

Incertain circumstances, the Company enters into arrangements with customers whoreceive financing support in the form of long-term low interest rate loans fromthe United States Department of Agriculture’s Rural Utilities Service, or RUS.The terms of the RUS contracts provide that in certain instances transfer oftitle of the Company’s products does not occur until customer acceptance,however the Company waited for final cash payment on these contracts beforerecognizing revenue. Effective January 1, 2009 based on this historicalexperience, the Company has determined that revenue recognition on RUScontracts is appropriate upon customer acceptance, given the remaining revenuerecognition criteria, such as collectability, under SAB 104 have been met. As aresult the Company recognized approximately $3.9 million for the three monthsended September 30, 2009 and $4.6 million in revenue for the nine monthsended September 30, 2009 based on customer acceptance, not final cashpayment. We believe the impact of this determination on any annual period isnot material.

 

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

 

The Company has evaluatedthe financial statements for subsequent events through the date of the filingof this Form 10-Q.

 

**2.****   ****Fair ValueMeasurements**

 

Effective January 1,2008, the Company adopted the authoritative guidance on fair valuemeasurements. Fair value is defined as an exit price, representing the amountthat would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants.  As such, fair value is a market-basedmeasurement that should be determined based on assumptions that marketparticipants would use in pricing an asset or a liability.  As a basis for considering such assumptions,the guidance establishes a three-tier value hierarchy, which prioritizes theinputs used in the valuation methodologies in measuring fair value:

 

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

 

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

 

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

 

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

 

In accordance with thisguidance, we measure our cash equivalents at fair value.  Our cash equivalents are classified withinLevel 1.  Cash equivalents are valuedprimarily using quoted market prices utilizing market observable inputs.  At September 30, 2009, cash equivalentsconsisted of money market funds measured at fair value on a recurringbasis.  Fair value of our money marketfunds was $33.8 million at September 30, 2009.

 

Effective January 1, 2009, the Company adopted,the FASB staff position that delayed the guidance on fair value measurementsfor non financial assets and non financial liabilities. The adoption of thisguidance did not have a material impact on the Company’s consolidated financialstatements.

 

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

 

Inventories consist of thefollowing (in thousands):

 
| ** **         | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials      |       | $                            | 682        |                        | $          | 495 |   |
| Work-in-process    |       | 32                           |       | 4                           |       |
| Finished goods (1) |       | 9,459                        |       | 16,262                      |       |
|               |       | $                            | 10,173     |                        | $          | 16,761 |   |

 

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| (1) | $6.4 million and  $8.1 million of finished goods inventory were shipped to customers as of  September 30, 2009 and December 31, 2008, respectively.The majority were sent to  RUS contract customers and value-added resellers. Revenue and related Cost of  revenue were not recognized at the time of shipments as defined by the  Company’s revenue recognition policy and therefore were included in  inventories. For more information regarding our revenue recognition policy,  see Revenue Recognition under Note 1 to these unaudited condensed  consolidated financial statements. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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

 

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

 

In June 2008, wedetermined the intangible for customer relationships to be fully impaired andwrote-off the remaining unamortized balance of approximately $37,000. Valuationfor the intangible was based on estimated Broadband Passive Optical Network (“BPON”)revenues through 2009 from certain customers of Terawave Communications, Inc.With final shipments of our last-time-buy promotion of BPON products to formerTerawave customers during the period ended September 30, 2008, thesecustomer relationships ceased to have future value for the Company.

 

**5.****   ****Net LossPer Share Attributable to Common Stockholders**

 

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

 
| ** **                                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **                                                                                  | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008** | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
| ** **                                                                                  | ** ** | ** **                       | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss attributable to common stockholders                                                |       | $                                | (2,631     | )                            | $          | (659 | ) | $ | (8,076 | ) | $ | (7,858 | ) |
| **Shares used in computation:**                                                             |       |                             |       |                         |       |   |   |   |   |
| Weighted average common shares outstanding used in  computation of basic net loss per share |       | 20,273                           |       | 19,894                       |       | 20,214 |   | 19,826 |   |
| Dilutive effect of stock options                                                            |       | —                           |       | —                       |       | — |   | — |   |
| Dilutive effect of common stock warrants                                                    |       | —                           |       | —                       |       | — |   | — |   |
| Shares used in computation of diluted net income  (loss) per share                          |       | 20,273                           |       | 19,894                       |       | 20,214 |   | 19,826 |   |
| Basic  and diluted net loss per share                                                       |       | $                                | (0.  13)   |                         | $          | (0.03 | ) | $ | (0.40 | ) | $ | (0.  40) |   |

 

Basic and diluted net loss per share are identical because we hadlosses from continuing operations and the impact of common equivalent shareswas anti-dilutive and therefore excluded. The anti-dilutive weighted averagecommon stock equivalent from stock options that were excluded from the sharesused in computing diluted net loss per share for the three months ended September 30,2009 and September 30, 2008, amounted to approximately 3.5 million and 2.7million shares, respectively, and for the nine months ended September 30,2009 and September 30, 2008, amounted to approximately 3.3 million and 2.5million shares, respectively.

 

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**6.****   ****Commitmentsand Contingencies**

 

The Company leases itsoffice facilities and certain equipment under non-cancelable operating leaseagreements, which expire at various dates through 2015. Operating leasescontain escalation clauses with annual base rent adjustments or a cost ofliving adjustment. Total rent expense was $0.3 million for both the threemonths ended September 30, 2009 and September 30, 2008, and $0.9million and $1.0 million, for the nine months ended September 30, 2009 andSeptember 30, 2008 respectively.

 

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

 
| **Remainder of fiscal year,**        | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2009                                 |       | 329        |       |
| Fiscal year ending December 31, |       |       |       |
| 2010                                 |       | 1,447      |       |
| 2011                                 |       | 1,469      |       |
| 2012                                 |       | 1,505      |       |
| 2013                                 |       | 1,543      |       |
| 2014                                 |       | 639        |       |
| Thereafter                           |       | 328        |       |
| Total Minimum Lease Payments         |       | $          | 7,260      |   |
|                                      |            |            |            |  |

 

Royalties

 

From time to time, theCompany may license certain technology for incorporation into its products.Under the terms of these multi-year agreements, royalty payments will be madebased on per-unit sales of certain of the Company’s products. The Companyincurred royalty expense of $63,000 and $95,000 for the three months ended September 30,2009 and September 30, 2008, respectively. The Company incurred $171,000and $241,000 in royalty expenses for the nine months ended September 302009 and September 30, 2008, respectively.

 

**Legal Proceedings**

 

**2007 Class Action Litigation**

 

On April 26, 2007 and May 16, 2007, two putative class actioncomplaints were filed in the United States District Court for the CentralDistrict of California against us and certain of our officers. The complaintsallege that the defendants violated sections 10(b) and 20(a) ofthe Securities Exchange Act of 1934, or the Exchange Act, and SEC Rule 10b-5promulgated thereunder by making false and misleading statements and omissionsrelating to our financial statements and internal controls with respect torevenue recognition. The complaints seek, on behalf of persons who purchasedour common stock during the period from May 2, 2006 to April 17,2007, damages of an unspecified amount.

 

On July 30, 2007, Judge Christina A. Snyder consolidated theseactions into a single action, appointed NECA-IBEW Pension Fund (The DecaturPlan) as lead plaintiff, and approved its selection of lead counsel. On November 16,2007, the lead plaintiff filed a consolidated complaint. This consolidatedcomplaint added as defendants certain of our current and former directors andofficers, our current and former outside auditors, the lead underwriter of oursecondary public offering in November 2006, and two venture capital firmswho were early investors in us. The consolidated complaint alleged thatdefendants violated sections 10(b), 20(a) and 20A of the Exchange Actand SEC Rule 10b-5 promulgated thereunder, as well as sections 11 and15 of the Securities Act of 1933, or Securities Act, by making false andmisleading statements and omissions relating to our financial statements andinternal controls with respect to revenue recognition that requiredrestatement. The consolidated complaint seeks, on behalf of persons whopurchased, Occam’s 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 theconsolidated complaint. On July 1, 2008, Judge Snyder issued an ordergranting in part and denying in part defendants’ motions. This order dismissedall claims against certain of our current and former directors, the 20A claimin its entirety, the section 10(b) claim against the auditors andventure capital firms, and the section 11 claims against the venturecapital firms. On July 16, 2008, lead plaintiff filed an amended complaintto conform to the Court’s July 1, 2008 order. Defendants answered thisamended complaint on August 29, 2008. We believe that we have meritoriousdefenses in this action, and intend to defend ourselves vigorously.

 

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On September 10, 2009 weannounced that we and all but one defendant had entered into a memorandum ofunderstanding to settle and resolve this stockholder class action lawsuit filedon April 26th, 2007. On November 2, 2009 all parties including all defendantsfiled a binding Stipulation Agreement with the court and the court will enter apreliminary ruling on November 9, 2009. The total settlement amount of $13.9million has been agreed by all parties. We have agreed to contribute $1.7million with the balance to come from the Company’s insurers and all otherdefendants. We have recorded a charge of $1.7 million as a loss on settlementfor the quarter ended September 30, 2009. The class action settlement issubject to preliminary and following notice to class members, final approval bythe court.

 

Failure to achieve finalapproval of the settlement could result in recommencement of thelitigation.  If so, failure by theCompany to obtain a favorable resolution of the claims set forth in theconsolidated complaint could have a material adverse effect on the Company's business,results of operations and financial condition. Currently, the amount of suchmaterial adverse effect cannot be reasonably estimated.

 

**IPO Allocation Litigation**

 

In June 2001, three putative stockholder class action lawsuitswere filed against Accelerated Networks, certain of its then officers anddirectors and several investment banks that were underwriters of AcceleratedNetworks’ initial public offering. The cases, which have since beenconsolidated, were filed in the United States District Court for the SouthernDistrict of New York. The Court appointed a lead plaintiff on April 16,2002, and plaintiffs filed a Consolidated Amended Class Action Complaint(the “Complaint”) on April 19, 2002. The Complaint was filed on behalf ofinvestors who purchased Accelerated Networks’ stock between June 22, 2000and December 6, 2000 and alleged violations of Sections 11 and 15 ofthe 1933 Act and Sections 10(b) and 20(a) and Rule 10b-5 ofthe 1934 Act against one or both of Accelerated Networks and the individualdefendants. The claims were based on allegations that the underwriterdefendants agreed to allocate stock in Accelerated Networks’ initial publicoffering to certain investors in exchange for excessive and undisclosedcommissions and agreements by those investors to make additional purchases inthe aftermarket at pre-determined prices. Plaintiffs alleged that theprospectus for Accelerated Networks’ initial public offering was false andmisleading in violation of the securities laws because it did not disclosethese arrangements. These lawsuits are part of the massive “IPO allocation”litigation involving the conduct of underwriters in allocating shares ofsuccessful initial public offerings.

 

Webelieve that over three hundred other companies have been named in more thanone thousand similar lawsuits that have been filed by some of the sameplaintiffs’ law firms. In October 2002, the plaintiffs voluntarilydismissed the individual defendants without prejudice. On February 1, 2003a motion to dismiss filed by the issuer defendants was heard and the courtdismissed the 10(b), 20(a) and rule 10b-5 claims against Occam. On October 13,2004, the Court certified a class in six of the approximately 300 other nearlyidentical actions (the “focus” cases) and noted that the decision was intendedto provide guidance to all parties regarding class certification in theremaining cases. The Underwriter Defendants appealed the decision and theSecond Circuit Court of Appeals vacated the district court’s decision grantingclass certification in those six cases on December 5, 2006. 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.

 

Prior to the Second Circuit’s December 5, 2006 ruling, we agreed,together with over three hundred other companies similarly situated, to settlewith the Plaintiffs. A settlement agreement and related agreements weresubmitted to the Court for approval. The settlement would have provided, amongother things, a release of the Company and of the individual defendants for theconduct alleged to be wrongful in the Complaint in exchange for a guaranteefrom the Company’s insurers regarding recovery from the underwriter defendantsand other consideration from the Company regarding its underwriters. In lightof the Second Circuit opinion, liaison counsel for the issuers informed theDistrict Court that the settlement cannot be approved because the definedsettlement class, like the litigation class, cannot be certified.

 

OnOctober 3, 2007 Plaintiff has 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. On March 28, 2008, the plaintiffs filed an amended reply brief insupport of their motion to certify the class of plaintiffs. The UnderwriterDefendants and the issuer Defendants had until August 31, 2008 to file ananswer to the amended complaint. The Court has not ruled on the motion. Theinsurers, the underwriters and the Plaintiffs subsequently agreed to globalmediation in the interest of trying to resolve this case without the furtherneed for litigation. The mediation commenced in late June of 2008 andresulted in current settlement negotiations whereby the parties agreed to asettlement. The settlement has been approved including class certification bythe Court on October 5, 2009 subject to a thirty day period required forfiling of any appeals to the Court’s ruling which appeal period ends November 5,2009. Prior to November 5, 2009 two appeals have been filed objecting theCourt’s approval of the settlement and on October 26, 2009 certain individualswho objected to the Court’s October 5, 2009 Opinion and Order have requestedpermission to file an appeal in that the Court abused it’s discretionconcerning the class certification on the grounds that it was broader than theclass rejected by the Second Circuit Appeals Court. The Court has not ruled onthis request to date. The time to appeal has been stayed thirty (30) days fromthe date the Court files its final judgment which judgment is expected to befiled the week of November 9, 2009.

 

Due to the inherent uncertainties of litigation, we cannot accuratelypredict the ultimate outcome of the matter. We have not recorded any accrualrelated to this proposed settlement because Occam expects any settlementamounts to be covered by its insurance policies.

 

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**IPO Short Swing Profits Litigation**

 

In late 2007, we received a letter from Vanessa Simmonds, a putativeshareholder, demanding that we investigate and prosecute a claim for allegedshort-swing trading in violation of Section 16(b) of the SecuritiesExchange Act of 1934, 15 U.S.C. § 78p(b), by the underwriter of ourinitial public offering (“IPO”) and certain unidentified directors, officersand shareholders of us (then known as Accelerated Networks). We evaluated thedemand and declined to prosecute the claim. On October 12, 2007, theputative shareholder commenced a civil lawsuit in the U.S. District Court forthe Western District of Washington against Credit Suisse Group, the leadunderwriter of our IPO, alleging violations of Section 16(b). Thecomplaint alleges that the combined number of shares of our common stockbeneficially owned by the lead underwriter and certain unnamed officers,directors, and principal shareholders exceeded ten percent of its outstandingcommon stock from the date of Occam’s IPO on June 23, 2000, through atleast June 22, 2001. It further alleges that those entities andindividuals were thus subject to the reporting requirements of Section 16(a) andthe short-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). Wewere named as a nominal defendant in the action, but have no liability for theasserted claims. None of our directors or officers of Occam are named asdefendants in this action.

 

On October 29, 2007, the case was reassigned to Judge James L.Robart along with fifty-four other Section 16(b) cases seekingrecovery of short-swing profits from underwriters in connection with variousIPOs. The Underwriters and Issuers have filed a motion to dismiss the case andreply briefs have been filed. The Court heard oral argument on January 19,2009 from all parties. On March 12, 2009, the Court dismissed the 16 (b) complaintagainst the issuer defendants including Occam on both jurisdictional andstatute of limitation grounds. On March 31, 2009, the Plaintiffs filed aNotice of Appeal. Currently the Underwriters Reply in Support of theirCross-Appeal must be filed by November 17, 2009. Oral argument will be heardthereafter.

 

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

 

**Other Matters**

 

From time to time, we are subject to threats of litigation or actuallitigation in the ordinary course of business, some of which may be material.We believe that, except as described above, there are no currently pendingmatters that, if determined adversely to us, would have a material effect onour business or that would not be covered by our existing liability insurancemaintained by us.

 

*Indemnificationsand Guarantees*

 

TheCompany enters into indemnification provisions under its agreements with othercompanies in the ordinary course of business, typically with its contractors,customers, value-added resellers, and landlords. In connection with its 2006offering, the Company also agreed to indemnify the underwriters in the offeringand certain stockholders who sold shares as part of the offering with respectto certain liabilities arising from the offering. Under these provisions, theCompany generally indemnifies and hold harmless the indemnified party forlosses suffered or incurred by the indemnified party as a result of itsactivities or, in some cases, as a result of the indemnified party’s activitiesunder the agreement. These indemnification provisions generally survivetermination of the underlying agreement. The maximum potential amount of futurepayments the Company could be required to make under these indemnificationprovisions is generally unlimited. As of September 30, 2009, the Company did not have any material accruedliability relating to the defense of lawsuits or settlement of claims relatedto these indemnification agreements. As of September 30,2009, the Company had reimbursed Norwest Venture Partners for indemnificationexpenses in the aggregate amount of $176,460. As of September 30, 2009,the Company had also reimbursed U.S. Venture Partners for indemnificationexpenses in the aggregate amount of $240,050.

 

*PurchaseOrders*

 

Under the terms of Occam’scontract manufacturer agreements, Occam is required to place orders with itscontract manufacturers to provide inventory to meet its estimated sales demand.Certain contract manufacturer agreements include production forecast change,lead-time and cancellation provisions. At September 30, 2009, openpurchase orders with contract manufacturers were $19.9 million.

 

*Warranties*

 

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

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**    | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
| ** **                              | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of period          |       | $                                | 4,239      |                            | $          | 3,710 |   | $ | 4,326 |   | $ | 3,470 |   |
| Accruals for warranty during the period |       | 615                              |       | 625                             |       | 1,642 |   | 1,576 |   |
| Warranty utilization                    |       | (435                             | )          | (459                            | )          | (1,549 | ) | (1,170 | ) |
| Balance at end of period                |       | $                                | 4,419      |                            | $          | 3,876 |   | $ | 4,419 |   | $ | 3,876 |   |

 

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**7.****   ****AccruedLiabilities**

 

The major components ofaccrued liabilities are (in thousands):

 
| ** **                                  | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Warranty accruals                           |       | $                            | 4,419      |                        | $          | 4,326 |   |
| Payroll, paid time off and related accruals |       | 1,489                        |       | 2,727                       |       |
| Commissions                                 |       | 186                          |       | 316                         |       |
| Royalty accruals                            |       | 36                           |       | 41                          |       |
| Accrual on legal settlement                 |       | 1,700                        |       | —                      |       |
| Other accruals                              |       | 684                          |       | 1,277                       |       |
| Total                                       |       | $                            | 8,514      |                        | $          | 8,687 |   |

 

**8.****   ****StockOptions, Stock Awards, Employee Stock Purchase Plan, and Stock-BasedCompensation**

 

Stock option activity, underthe Company’s stock option plan for the nine months ended September 30,2009 is summarized as below (shares and intrinsic value in thousands):

 
| ** **                             | ** ** | **Options** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|-------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2009    |       | 3,015       |       | $                                           | 6.71       |                                                 | 7.11       |                            | $          | 15 |   |
| Granted                                |       | 1,269       |       |                                        |       |                                                 |       | —                          |       |
| Exercised                              |       | (18         | )          |                                        |       |                                                 |       | —                          |       |
| Forfeited or expired                   |       | (296        | )          |                                        |       |                                                 |       | —                          |       |
| Outstanding at September 30, 2009 |       | 3,970       |       | $                                           | 5.64       |                                                 | 7.35       |                            | $          | 1,308 |   |
| Exercisable at September 30, 2009 |       | 2,029       |       | $                                           | 7.40       |                                                 | 5.58       |                            | $          | 179 |   |

 

Included in the precedingtable are options for 312,000 common shares granted to our officers and certainemployees at exercise price of $3.76 that will become exercisable upon theachievement of certain performance criteria and the confirmation of suchachievement by the Company’s audit committee upon its approval of the Company’saudited financial statements for fiscal year 2009. The fair value of these performancebased options was $1.82.

 

The weighted-average fairvalue of options granted to employees on the date of the grant for the threemonths ended September 30, 2009 was $1.90 and for the nine months ended September 30,2009 was $1.37 per share.

 

The 2006 Equity IncentivePlan, or 2006 Plan, provides for automatic annual increases in the number ofshares available for issuance under the 2006 Plan effective as of the first dayof each fiscal year equal to the lesser of (a) 3% of the outstandingshares of the common stock on the first day of the applicable fiscal year; (b) 750,000shares; or (c) such other amount as the Board of Directors or a committeeof the board may determine. On April 1, 2009, the Board of Directorsapproved an increase of 608,055 shares reserved for issuance under the 2006Plan for fiscal 2009. This represents 3% of the outstanding common shares as ofJanuary 1, 2009. In addition the Board of Directors approved an amendmentto the 2006 Plan, subject to stockholder approval, to increase the number ofshares of common stock reserved for issuance under the Plan by 900,000 shares.On May 7, 2009, the stockholders approved the amendment to the 2006 plan.

 

***Stock Awards***

 

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

 
| ** **                             | ** ** | **Restricted Stock  Units** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2009    |       | 180                         |       | 1.44                                                 |       | $                               | 432        |   |
| Awarded                                |       | 252                         |       | —                                               |       | —                          |       |
| Released                               |       | (6                          | )          | —                                               |       | —                          |       |
| Forfeited or expired                   |       | (8                          | )          | —                                               |       | —                          |       |
| Outstanding at September 30, 2009 |       | 418                         |       | 1.06                                                 |       | $                               | 1,547      |   |

 

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Included in the precedingtable are restricted stock units of 69,000 common shares granted to ourofficers and certain employees that will become exercisable upon theachievement of certain performance criteria and the confirmation of suchachievement by the Company’s audit committee upon its approval of the Company’saudited financial statements for fiscal year 2009. The market value of theseperformance based units on the date of the grant was $3.32.

 

***Employee Stock Purchase Plan***

 

In March 2008, theBoard of Directors approved an amendment to our 2006 EmployeeStock Purchase Plan ~~(~~or the ~~“~~ESPP~~”)~~. The amendmentincreased the maximum number of shares of the Company’s common stock that aneligible employee may purchase during each offering period from 1,000 shares to5,000 shares. In connection with the ESPP, 126,582 shares were issued on February 17,2009 and 77,588 shares were issued on August 17, 2009. Both of these ESPPissuances were at a purchase price of $2.80.

 

The ESPP provides for anautomatic annual increases in the number of shares available for issuance underthe ESPP effective as of the first day of each fiscal year equal to the lesserof (a) 300,000 shares of common stock; (b) 1.5% of the outstandingshares of common stock on the first day of the applicable fiscal year; or (c) anamount determined by the Board of Directors. On April 1, 2009, the Boardof Directors approved an increase of 300,000 shares in the number of sharesreserved for issuance under the ESPP.

 

***Stock-Based Compensation***

 

The following tablesummarizes the stock-based compensation expense, for all share-basedawards to employees and directors, including employee stock options, restrictedstock units and employee stock purchase plan based on the estimated fair valueon our Consolidated Statements of Operations (in thousands):

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                           | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**    | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
| ** **                                           | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Employee stock-based  compensation in:**           |       |                             |       |                            |       |   |   |   |   |
| Cost of revenue                                      |       | $                                | 133        |                            | $          | 72 |   | $ | 326 |   | $ | 290 |   |
| Research and product development expense             |       | 297                              |       | 243                             |       | 778 |   | 868 |   |
| Sales and marketing expense                          |       | 248                              |       | 149                             |       | 692 |   | 557 |   |
| General and administrative expense                   |       | 373                              |       | 164                             |       | 889 |   | 633 |   |
| Total stock-based compensation in operating expenses |       | 918                              |       | 556                             |       | 2,359 |   | 2,058 |   |
| Total stock-based compensation                       |       | $                                | 1,051      |                            | $          | 628 |   | $ | 2,685 |   | $ | 2,348 |   |

 

As of September 30,2009, total unamortized stock-based compensation cost related to non-vestedstock options after accounting for estimated forfeitures was $3.2 million,which the Company expects to recognize over the remaining vesting period ofeach grant, up to the next 48 months. The stock-based compensation expenseincluded $0.3 million related to the performance based equity incentive awards,granted during this quarter.

 

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

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**    | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
| Risk-free interest rate |       | 2.41                             | %          | 3.3                             | %          | 2.87 | % | 3.2 | % |
| Expected term (years)   |       | 4.9                              |       | 4.9                             |       | 4.9 |   | 4.9 |   |
| Dividend yield          |       | 0                                | %          | 0                               | %          | 0 | % | 0 | % |
| Expected volatility     |       | 54%-57                           | %          | 59                              | %          | 54%-57 | % | 59 | % |

 

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

 

**9.             Restructuring**

 

OnMay 7, 2009, the Company implemented a reduction-in-force that resulted inthe termination of approximately 10% of its work-force. Affected employees werenotified on May 7, 2009, and the Company, substantially completed thereduction-in-force by the end of the second quarter of 2009. The purpose of theworkforce reduction was to reduce costs, streamline operations, and improve thecost structure in light of the current economic and operating environment.

 

During the quarter ended June 30,2009, the Company recorded approximately $213,000 of restructuring chargesrelated to termination benefits in connection with the reduction- in- force. Asummary of the Company’s accrued restructuring expenses is as follows for the ninemonths ended September 30, 2009 (in thousands):

 
| ** **                         | ** ** | **September 30,  2009** | ** ** |
|------------------------------------|------------|------------------------------|------------|
| Balance January 1, 2009       |       | $                            | —     |   |
| Severance related expenses accrued |       | 213                          |       |
| Severance related expenses paid    |       | (213                         | )          |
| Balance September 30, 2009    |       | $                            | —     |   |

 

**10.**          **SubsequentEvent: Bankruptcy of FairPoint Communications, Inc.**

 

OnOctober 26, 2009, FairPoint Communications, Inc. filed a bankruptcy petitionunder Chapter 11 of the United States Bankruptcy Code. According to thedocuments filed with the bankruptcy court, FairPoint’s plan is to restructureits debt and continue day to day operations under court supervision.  The Company has deferred approximately $1.3million, of revenue and related cost of revenue for the quarter ended September30, 2009, for which cash has not been collected. As of October 26, 2009 theCompany had an outstanding receivable balance of approximately $1.7 million.

 

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

 

You should read thefollowing discussion and analysis in conjunction with our condensedconsolidated financial statements and the related notes thereto included inthis Quarterly 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 31,2008. 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 anyforward-looking results discussed below. In some cases, you can identifyforward-looking statements by terminology such as “anticipates,” “appears,” “believes,”“continue,” “could,” “estimates,” “expects,” “feels,” “goal,” “hope,” “intends,”“may,” “our future success depends,” “plans,” “potential,” “predicts,” “projects,”“reasonably,” “seek to continue,” “should,” “thinks,” “will” or the negative ofthese terms or other comparable terminology. These statements are onlypredictions. Actual events or results may differ materially. In addition,historical information should not be considered an indicator of futureperformance. Factors that could cause or contribute to these differencesinclude, but are not limited to, the risks discussed in this Report in Part II,Item 1A under the caption “Risk Factors.” These factors may cause our actualresults to differ materially from any forward-looking statements.

 

Although we believe that theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements. Moreover, we are under no duty to update any of theforward-looking statements after the date of this Quarterly 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.

 

**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 fiber optic networks. Our Broadband LoopCarrier, or BLC, is an integrated hardware and software platform that usesInternet Protocol, or IP, and Ethernet technologies to increase the capacity oflocal access networks, enabling our customers to deliver advanced services,including voice-over-IP, or VoIP, IP-based television, or IPTV,video-on-demand, or VoD, and high-definition television, or HDTV. Our platformsimultaneously supports traditional voice and data services, enabling ourcustomers to leverage their existing networks and migrate to IP withoutdisruption. In addition to providing our customers with increased bandwidth,our products provide incremental value by offering software-based features toimprove the quality, resiliency and security of network service offerings. Wemarket our products through a combination of direct and indirect channels. Ourdirect sales efforts are focused on the incumbent local exchange providers, orILECs, segment of the telecom service provider market. As of September 30,2009, we had shipped our BLC platform to over 300 service provider customers.

 

Fromour inception through September 30, 2009, we have incurred cumulative netlosses of approximately $134.6 million. We realized income fromoperations and were profitable on a net income basis during the quarters ended December 31,2008, December 31, 2006, September 24, 2006, and for the year ended December 31,2006. Previously, we had not been profitable on a quarterly or annual basis,excluding the quarter ended December 25, 2005, in which we realized modestoperating income of $3,000. We experienced operating and net losses in the first,second and third quarters of fiscal 2008 and for fiscal 2008 as a whole. We donot believe that our return to profitability in the fourth quarter of fiscal2008 is indicative of future quarterly performance. During the current quarter,we experienced a resumption in capital spending by some of our customers.However, we cannot predict the continued improvement or timing effectsof thegovernment stimulus programs and how they may impact our future bookingactivity level.

 

**CriticalAccounting Policies and Estimates**

 

Management’s Discussion andAnalysis of Financial Condition and Results of Operations discusses ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these consolidated financial statements requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the consolidated financial statements and the reported amounts of revenueand expenses during the reporting period. On an ongoing basis, we evaluate ourestimates and judgments, including those related to revenue recognition,inventories, accounts receivable reserves, sales return reserves, litigation,warranty reserve, stock-based compensation, and valuation of deferred incometax assets. We base our estimates and judgments on historical experience and onvarious other factors that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources.

 

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Weincluded in our Annual Report on Form 10-K for the year ended December 31,2008 a discussion of our most critical accounting policies, which are thosethat are most important to the portrayal of our financial condition and resultsof operations and require management’s most difficult, subjective and complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain.

 

Incertain circumstances, we enter 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 the RUS contracts provide that in certain instances transfer of titleof our products does not occur until customer acceptance, however we waited forfinal cash payment on these contracts before recognizing revenue. Effective January 1,2009 based on this historical experience, we have determined that revenuerecognition on RUS contracts is appropriate upon customer acceptance, given theremaining revenue recognition criteria, such as collectability, under SAB 104have been met.

 

**Results ofOperations**

 

*Three-monthsended September 30, 2009 and 2008*

 

*Revenue(in thousands, except percentages)*

 
| ** ** | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** ** | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue    |       | $                                | 21,673     |                                                      | $          | 25,131 |   | $ | (3,458 | ) | (14 | )% |
|            |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Ourrevenue is principally comprised of our BLC 6000 series system product line,ONTs, cabinets and related accessories. Revenue decreased by $3.5 million or 14% to $21.6 million for the threemonths ended September 30, 2009 as compared to revenue of $25.1 millionfor the three months ended September 30, 2008. Revenue during the quarterincludes the impact of a deferral of $1.3 million related to FairPoint. Werecognized approximately $3.9 million of revenue during the quarter associatedwith RUS contracts based on customer acceptance rather than receipt of finalcash payment. We believe the decrease in revenue was primarily due to theglobal economic recession and credit contraction and a continued delay incustomer purchase decisions as they evaluate the timing and availability ofpotential government broadband stimulus funds. We expect some of the uncertainty surrounding the stimulus funds willresolve itself through the next several quarters, as the initial stimulus fundawards are expected to be announced commencing in December 2009.  In the short term we expect that bookingactivity may vary depending on our customer’s ability to make capitalinvestments using their own funds, access to credit facilities or other loanprogram funds.

 

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

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|-------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **              | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenue         |       | $                                | 12,725     |                                                      | $          | 14,380 |   | $ | (1,655 | ) | (12 | )% |
| Gross margin            |       | $                                | 8,948      |                                                      | $          | 10,751 |   | $ | (1,803 | ) | (17 | )% |
| Gross margin percentage |       | 41                               | %          | 43                                                        | %          |   |   |   |   |

 

Cost of revenue includes thecost of products shipped for which revenue was recognized, warranty provision,costs of any manufacturing yield problems, re-work costs, manufacturing overhead,provisions for obsolete inventory and the cost of post-sales support. The decrease incost of revenue during the three months ended September 30, 2009 wasprimarily attributable due to decreased revenue shipments and sales of ourproducts.

 

Gross margin was 41% ofrevenue for the three months ended September 30, 2009 and 43% of revenuefor the three months ended September 30, 2008. The decrease in the grossmargin was attributable to a higher percentage of product mix in ONTswith lower margin than other products.

 

We expect that our grossmargin will vary from quarter-to-quarter due in part to product mix, averageselling price changes and manufacturing cost changes.  To the extent that cabinets and otherlower-margin products represent an increased percentage of our total revenue inany period, it will tend to reduce our gross margin. Additionally, as weintroduce new products into the market, we anticipate our gross margin mayfluctuate as a function of our product mix

 

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

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                   | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                                   | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and product-development                             |       | $                                | 3,762      |                                                      | $          | 5,004 |   | $ | (1,242 | ) | (25 | )% |
| Research and product-development as a percentage  of revenue |       | 17                               | %          | 20                                                        | %          |   |   |   |   |
|                                                              |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Researchand product-development expenses consist primarily of salaries and otherpersonnel-related costs, prototype component and assembly costs, third-partydesign services and consulting costs, and other costs related to the design,development, and testing of our products. Research and product-development costs are expensed as incurred, exceptfor capital expenditures, which are capitalized and depreciated over theirestimated useful lives, generally two to three years.  Research and development expenses decreasedby $1.2 million or 25% to $3.8 million for the three months ended September 30,2009 as compared to $5.0 million for the three months ended September 30,2008. The decrease in research and product-development expenses was primarilyattributable to lower compensation expense attributed to a reduction in workforce and decreased development expenses attributable to our GigabitPassive Optical Networks (“GPON”) product, which was completed in June 2008.

 

We anticipate that theresearch and product-development expenses may increase in future periods as wecontinue to make investments in our products and technologies.

 

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

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                     | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                     | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales and marketing                            |       | $                                | 4,459      |                                                      | $          | 4,677 |   | $ | (218 | ) | (5 | )% |
| Sales and marketing as a percentage of revenue |       | 21                               | %          | 19                                                        | %          |   |   |   |   |
|                                                |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

Salesand marketing expenses consist primarily of salaries, sales commissions, andother personnel-related costs, development and distribution of promotionalmaterials, and other costs related to generating sales and conducting corporatemarketing activities.  Sales andmarketing expenses decreased by $0.2 million or 5% to $4.5 million for thethree months ended September 30, 2009 as compared to $4.7 million for thethree months ended September 30, 2008. The decrease was primarilyattributed to lower commission expense, lower compensation expense attributedto a reduction in force, and lower contractor expense, offset by an increase instock-based compensation expense, primarily related to the grant ofperformance based equity incentive awards. We currently expect salesand marketing expenses to be largely consistent with current expense levels,but may vary with levels of customer bookings.

 

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

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**                              | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                             | ** ** | ** **                       | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative                             |       | $                                | 1,760      |                                                      | $          | 2,050 |   | $ | (290 | ) | (14 | )% |
| General and administrative as a percentage of  revenue |       | 8                                | %          | 8                                                         | %          |   |   |   |   |
|                                                        |            |                                  |            |                                                           |            |  |  |  |  |  |  |  |

 

General and administrativeexpenses consist primarily of salaries and other personnel-related costs forexecutive, finance, human resources, and administrative personnel.Additionally, general and administrative expenses include professional fees,liability insurance and other general corporate costs such as rent, legal,utilities and accounting expenses. General and administrativeexpenses decreased by $0.3 million or 14% to $1.8 million for the three monthsended September 30, 2009 as compared to $2.1 million for the three monthsended September 30, 2008. General and administrative expenses decreasedprimarily due to lower legal fees due to insurance reimbursements, lowerconsultant expense offset by an increase in stock-based compensation expense,primarily related to the grant of performance based equity incentive awards.

 

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We currently expect generaland administrative expenses to be consistent with current expense levels butmay vary depending on the timing and the amount of legal fees incurred andinsurance reimbursements.

 

*Loss onlitigation settlement*

 

On September 10, 2009 weannounced that we and all but one defendant had entered into a memorandum ofunderstanding regarding the settlement of the April 26th, 2007 stockholderclass action lawsuit. On November 2, 2009 all parties including all defendantsfiled a binding Stipulation Agreement with the court and the court will enter apreliminary ruling on November 9, 2009. The total settlement amount of $13.9million has been agreed by all parties. We have agreed to contribute $1.7million, with the balance to come from our insurers and all other defendants.During the quarter ended September 30, 2009, we have recorded a charge of $1.7million associated with this settlement.

 

*Stock-basedcompensation (in thousands)*

 
| ** **                     | ** ** | **Three Months Ended**       | ** ** |
|--------------------------------|------------|------------------------------|------------|
| ** **                     | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
| ** **                     | ** ** | ** **                   | ** ** | ** ** | ** ** |
| Cost of sales                  |       | $                            | 133        |   | $ | 72 |   |
| Research and development       |       | 297                          |       | 243 |   |
| Sales and marketing            |       | 248                          |       | 149 |   |
| General and administrative     |       | 373                          |       | 164 |   |
| Total stock-based compensation |       | $                            | 1,051      |   | $ | 628 |   |

 

Stock-based compensationexpense increased by approximately $423,000 or 67% to $1.1 million for thethree months ended September 30, 2009 as compared to approximately $0.6million for the three months ended September 30, 2008. This increase is primarilyattributable to the stock-based compensation expense related to the performancebased equity incentive awards granted during the quarter.

 

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

 

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

* *
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Increase (Decrease) 2009 vs.  2008** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **September 30,  2009**     | ** ** | **September 30,  2008**                          | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                      |       | $                                | 38         |                                                  | $          | 254 |   | $ | (216 | ) | (85 | )% |
| Interest expense                     |       | —                           |       | (4                                                    | )          | 4 |   | — | % |
| Total interest income (expense), net |       | $                                | 38         |                                                  | $          | 250 |   | $ | (212 | ) | (85 | )% |

 

Interest income, netdecreased by $212,000 or 85% to $38,000 for the three months ended September 30,2009, as compared to $250,000 for the three months ended September 30,2008. The decrease in interest income was primarily attributable to lower  interest rates.

 

*Income taxbenefit*

 

For income tax purposes, we consider our projectedannual income and the utilization of our net operating loss carry forwardsamong other factors. For the three months ended September 30, 2009 and September 30,2008, we recorded a tax benefit of $21,000 and $71,000, respectively, for federaland state income taxes. The benefit is primarily related to the federalrefundable research and development credit.

 

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*SubsequentEvent: Bankruptcy of FairPoint Communications, Inc.*

 

On October 26, 2009,FairPoint Communications, Inc. filed a bankruptcy petition under Chapter 11 ofthe United States Bankruptcy Code. According to the documents filed with thebankruptcy court, FairPoint’s plan is to restructure its debt and continue dayto day operations under court supervision. We have deferred approximately $1.3million, of revenue and related cost of revenue for the quarter ended September30, 2009, for which cash has not been collected. As of October 26, 2009, we hadan outstanding receivable balance of approximately $1.7 million.  

 

We have reviewed thecourt filings, consulted with our advisors, and will take all measuresnecessary to safeguard our rights as unsecured creditors.  We believe we are a critical vendor toFairPoint and anticipate continuing our relationship during the post petitionperiod.  However there are manyuncertainties.  We cannot assure thatthere will not be material adverse impact on our future financial position orresults of operations including but not limited to uncollectible accountsreceivable and unusable inventory.

 

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Nine months ended September 30,2009 and September 30, 2008

 

*Revenue**(inthousands, except percentages)*

 
| ** ** | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **September 30,   2009**   | ** ** | **September 30,   2008**                             | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** ** | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue    |       | $                               | 62,120     |                                                      | $          | 67,610 |   | $ | (5,490 | ) | (8 | )% |
|            |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Revenuedecreased by $5.5 million or 8% to $62.1.million for the nine months ended September 30,2009 as compared to revenue of $67.6 million for the nine months ended September 30,2008. We recognized approximately $4.6 million of revenue during the ninemonths ended September 30, 2009 associated with RUS contracts based oncustomer acceptance rather than receipt of final cash payment. Revenue duringthe nine months ended September 30, 2009, includes the impact of adeferral of $1.3 million related to FairPoint. Revenue during the nine monthsended September 30, 2008, included approximately $1.0 million derived fromfinal one-time purchases of BPON products by former Terawave customers.

 

Duringthe quarter, we experienced increased bookings which we believe is associatedwith a resumption in capital spending by some of our customers.  However, beginning with the second quarter of2008 through the first quarter of 2009, we experienced quarterly decreasedbookings which we believe was the result of the macroeconomic condition and thecredit contraction as our customers delayed their purchase decisions and assome customers evaluated the timing and availability of the potentialgovernment broadband stimulus funds, among other factors. We expect some of theuncertainty surrounding the stimulus funds will resolve itself through the nextseveral quarters, as the initial stimulus fund awards are expected to beannounced commencing in December 2009. In the short term we expect that booking activity may vary depending onour customer’s ability to make capital investments using their own funds,access to credit facilities or other loan program funds.

 

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

 
| ** **              | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|-------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **September 30,   2009**   | ** ** | **September 30, 2008**                               | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **              | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenue         |       | $                               | 36,970     |                                                      | $          | 38,331 |   | $ | (1,361 | ) | (4 | )% |
| Gross margin            |       | $                               | 25,150     |                                                      | $          | 29,279 |   | $ | (4,129 | ) | (14 | )% |
| Gross margin percentage |       | 40                              | %          | 43                                                        | %          |   |   |   |   |

 

Cost of revenue decreased by$1.4 million or 4% to $37.0 million for the nine months ended September 30,2009 as compared to $38.3 million for the nine months ended September 30,2008. The decrease in cost of revenue during the nine months ended September 30,2009 was primarily attributable due to decreased revenue shipments and sales ofour products. Cost of revenue for the nine months ended September 30, 2008,benefited from a one time reversal of a warranty provision of $0.3 million.

 

Grossmargin decreased to 40% of revenue in the nine months ended September 30,2009 compared to gross margin of 43% of revenue for the nine months ended September 30,2008. The decrease in gross margin for the nine months ended September 30,2009 was primarily the result of product mix with a higher percentage of mix inONTs with lower margin than other products.

 

We expect that our grossmargin will vary from quarter-to-quarter due in part to product mix. To theextent that cabinets and other lower-margin products represent an increasedpercentage of our total revenue in any period, it will tend to reduce our grossmargin. Additionally, as we introduce new products into the market, weanticipate our gross margin may fluctuate as a function of our product mix.

 

*Research and product-developmentexpenses**(in thousands, except percentages)*

 
| ** **                                                     | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                     | ** ** | **September 30,   2009**   | ** ** | **September 30,   2008**                             | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                                     | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and product-development                               |       | $                               | 12,186     |                                                      | $          | 14,337 |   | $ | (2,151 | ) | (15 | )% |
| Research and product*-*development  as a percentage of revenue |       | 20                              | %          | 21                                                        | %          |   |   |   |   |
|                                                                |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

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Research andproduct-development expenses decreased by $2.2 million or 15% to$12.2 million for the nine months ended September 30, 2009 ascompared to $14.3 million for the nine months ended September 30,2008. The decrease in research and product-development expenses was primarilyattributable to lower compensation expense due to a reduction in work force andthe reduction of outside services.

 

We anticipate that theresearch and product-development expenses may increase in future periods as wecontinue to make investments in our products and technologies.

 

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

 
| ** **                                     | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                     | ** ** | **September 30,   2009**   | ** ** | **September 30,   2008**                             | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                     | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales and marketing                            |       | $                               | 13,404     |                                                      | $          | 14,760 |   | $ | (1,356 | ) | (9 | )% |
| Sales and marketing as a percentage of revenue |       | 22                              | %          | 22                                                        | %          |   |   |   |   |
|                                                |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

Salesand marketing expenses decreased by $1.4 million or 9% to$13.4 million for the nine months ended September 30, 2009 ascompared to $14.8 million for the nine months ended September 30, 2008. This decreasewas primarily due to lower commission expense due to the slow down in bookingsactivity and lower consultant expense, offset by an increase in stock-basedcompensation expense, primarily related to the grant of performance basedequity incentive awards.  Wecurrently expect sales and marketing expenses to be largely consistent withcurrent expense levels, but may vary with levels of customer bookings.

 

*General and administrativeexpenses**(in thousands, except percentages)*

 
| ** **                                             | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2009 vs. 2008** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30,   2009**   | ** ** | **September 30,   2008**                             | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                                             | ** ** | ** **                      | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative                             |       | $                               | 6,179      |                                                      | $          | 8,253 |   | $ | (2,074 | ) | (25 | )% |
| General and administrative as a percentage of  revenue |       | 10                              | %          | 12                                                        | %          |   |   |   |   |
|                                                        |            |                                 |            |                                                           |            |  |  |  |  |  |  |  |

 

General and administrativeexpenses decreased by $2.1 million or 25% to $6.2 million for thenine months ended September 30, 2009 as compared to $8.3 million for thenine months ended September 30, 2008. General and administrative expensesdecreased primarily due to lower consultant expense, lower compensation expenseand lower professional fees offset by an increase in stock-based compensationexpense, primarily related to the grant of performance based equity incentiveawards.

 

We currently expect generaland administrative expenses to be consistent with current expense levels butmay vary depending on the timing and the amount of legal fees incurred andinsurance reimbursements.

 

*Restructuring charges*

 

On May 7, 2009, weimplemented a reduction-in-force that resulted in the termination ofapproximately 10% of our work-force. Affected employees were notified on May 7,2009, and we, substantially completed the reduction-in-force during the secondquarter of 2009. The purpose of the workforce reduction was to reduce costs,streamline operations, and improve the cost structure in light of the currenteconomic and operating environment. During the quarter ended June 30,2009, we recorded approximately $213,000 of restructuring charges related totermination benefits in connection with the reduction in force.

 

*Loss onlitigation settlement*

 

On September 10, 2009we announced that we and all but one defendant had entered into a memorandum ofunderstanding regarding the settlement of the April 26th, 2007 stockholderclass action lawsuit. On November 2, 2009 all parties including alldefendants filed a binding Stipulation Agreement with the court and the courtwill enter a preliminary ruling on November 9, 2009. The total settlementamount of $13.9 million has been agreed by all parties. We have agreed to contribute $1.7million, with the balance to come from our insurers and all otherdefendants. Duringthe quarter ended September 30, 2009, we have recorded a charge of $1.7million associated with this settlement.

 

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*Stock-based compensation**(inthousands)*

 
| ** **                     | ** ** | **Nine Months Ended**    | ** ** |
|--------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **September 30,   2009** | ** ** | **September 30,   2008** | ** ** |
| ** **                     | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Cost of revenue                |       | $                                  | 326        |   | $ | 290 |   |
| Research and development       |       | 778                                |       | 868 |   |
| Sales and marketing            |       | 692                                |       | 557 |   |
| General and administrative     |       | 889                                |       | 633 |   |
| Total stock-based compensation |       | $                                  | 2,685      |   | $ | 2,348 |   |

 

Stock-based compensationexpenses increased by approximately $337,000 or 14% to $2.7 million forthe nine months ended September 30, 2009 as compared to approximately$2.3 million for the nine months ended September 30, 2008. This increaseis primarily attributable to the stock-based compensation expense related tothe performance based equity incentive awards granted during the quarter andincrease in the grant of additional options and awards.

 

We anticipate that thestock-based compensation expense calculated under FASB Accounting Standards CodificationTopic 718 will continue to have a material effect on our consolidatedstatement of operations.

 

*Other income (expense), net*

 

Other income, net was$0.1 million for the nine months ended September 30, 2009 as compared toother expense, net of $0.7 million for the nine months ended September 30,2008. During the period ended March, 31, 2008, we wrote-off an intangible fortechnology developed for Metro-Ethernet/Telemetry technology of $0.8 millionand its related inventory of approximately $0.2 million. As part of thepurchase of certain assets of Terawave Communications, Inc. on October 25,2007, we acquired the intangible and the related inventory. Subsequent to thedate of the asset purchase we had sought potential buyers for theMetro-Ethernet/Telemetry technology to recover cash paid for the assets.However, by March 31, 2008, we decided to terminate efforts to sell theMetro-Ethernet/Telemetry technology and to focus instead on bringing to marketGPON technology. Other income of $0.3 million represents payments received thatpertained to accounts receivable that were acquired as part of the purchase ofcertain assets of Terawave Communications, Inc. in October 2007. Atthe date of purchase, the accounts were deemed to be uncollectible and no valuewas recorded on our books.

 

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

 
| ** **                           | ** ** | **Nine Months Ended** | ** ** | **Increase (Decrease) 2009 vs.  2008** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **September 30,   2009**   | ** ** | **September 30,   2008**                         | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                           | ** ** | ** **                      | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                      |       | $                               | 278        |                                                  | $          | 946 |   | $ | (668 | ) | (71 | )% |
| Interest expense                     |       | (4                              | )          | (61                                                   | )          | 57 |   | 93 | % |
| Total interest income (expense), net |       | $                               | 274        |                                                  | $          | 885 |   | $ | (611 | ) | (69 | )% |

 

Interest income and expense,net decreased by $611,000 or 69% to $274,000 for the nine months ended September 30,2009, as compared to $885,000 for the nine months ended September 30,2008. The decrease in interest income was primarily attributable to lower cash balancesand lower interest rates.

 

*Income tax benefit*

 

For income tax purposes, weconsider our projected annual income and the utilization of our net operatingloss carry forwards among other factors. For the nine months ended September 30,2009 and 2008, we recorded a tax benefit of $35,000 and $30,000 respectively,for federal and state income taxes. The benefit was related primarily to the federalrefundable research and development credit.

 

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*SubsequentEvent: Bankruptcy of FairPoint Communications, Inc.*

 

OnOctober 26, 2009, FairPoint Communications, Inc. filed a bankruptcypetition under Chapter 11 of the United States Bankruptcy Code. According tothe documents filed with the bankruptcy court, FairPoint’s plan is torestructure its debt and continue day to day operations under courtsupervision. We have deferred approximately $1.3 million, of revenue andrelated cost of revenue for the quarter ended September 30, 2009, forwhich cash has not been collected. As of October 26, 2009, we had anoutstanding receivable balance of approximately $1.7 million.

 

Wehave reviewed the court filings, consulted with our advisors, and will take allmeasures necessary to safeguard our rights as unsecured creditors.  We believe we are a critical vendor toFairPoint and anticipate continuing our relationship during the post petitionperiod.  However there are manyuncertainties.  We cannot assure thatthere will not be material adverse impact on our future financial position orresults of operations including but not limited to uncollectible accountsreceivable and unusable inventory.

 

**Liquidityand Capital Resources**

 

As of September 30,2009, we had cash and cash equivalents of $38.8 million, restricted cash of$6.3 million, stockholders’ equity of $52.4 million, and working capital of$44.7 million, compared with cash and cash equivalents of $30.4 million,restricted cash of $13.8 million, stockholders’ equity of $57.2 million, andworking capital of $48.0 million as of December 31, 2008. The decrease inrestricted cash at September 30, 2009, was related to performance bondsrequired for our Rural Utilities Service, or RUS 397 contracts.

 

Netcash provided by the operating activities for the nine months ended September 30,2009, was $1.1 million compared to the net cash used in operating activities of$8.0 million during the same period ended 2008. The sum of our net loss andcertain non-cash expenses, such as stock-based compensation, depreciation andamortization, impairment of intangibles related to developed technology andcustomer relationships, accounts receivable reserves and inventory reservesresulted in an outflow of $2.5 million in the 2009 period, compared to anoutflow of $2.3 million in the nine months ended September 30, 2008. Thenet impact of the changes in certain operating assets and liabilities on totaloperating cash flows resulted in a cash inflow of $3.6 million in the ninemonths ended September 30, 2009 compared to a cash outflow of $5.7 millionin the nine months ended September 30, 2008.

 

Net cash provided byinvesting activities for the nine months ended September 30, 2009, was$6.8 million compared to $8.4 million used in investing activities, during thesame period ended September 30, 2008. Cash provided by investingactivities for the nine months ended September 30, 2009, was primarily dueto net decrease of $7.5 million in restricted cash, the result of net cashreleased in connection with our RUS contract performance bonds. This cashinflow was partially offset by $0.7 million for purchases of property andequipment. Cash used in investing activities for the nine months ended September 30,2008, was primarily due to an increase of $3.8 million in restricted cashrelated to performance bonds required in connection with our RUS contracts and$4.4 million for purchases of property and equipment of which $3.1 million wasfor our facility in Fremont, California.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2009 was$615,000 compared to $597,000 for the same period in 2008. Cash provided byfinancing activities for the nine months ended September 30, 2009, wasmainly due to proceeds from the sale of common stock under the ESPP of $571,000and exercise of stock options of $61,000 which was offset by the payment ofapproximately $17,000 for capital lease obligations for the nine months ended September 30,2009, as compared to the to proceeds from the sale of common stock under theESPP of $587,000,exercise of stock options of $69,000 offset by payments ofpayroll taxes for vested restricted stock units of $68,000, and payments ofcapital lease obligations of $9,000 for office equipment for the same period of2008.

 

**WorkingCapital**

 

Working capital decreased to$44.7 million as of September 30, 2009 compared to $48.0 million as of December 31,2008.

 

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

 

·                  collectabilityof accounts receivable;

 

·                  amount andtiming of revenue;

 

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

 

·                  extent to whichfunds are restricted due to performance bonds required in connection with ourRUS contracts;

 

·                  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 next 12months. Although we believe these funds will be sufficient to maintain andexpand 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.

 

**ContractualObligations**

 

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

 

The following tablesummarizes our minimum purchase commitments to our contract manufacturers, ourminimum commitments under non-cancelable operating leases, our commitment undercapital leases, our commitment under fixed assets and licensing agreements asof September 30, 2009 (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)    |       | $                                         | 19,901     |   | $ | 19,901 |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases            |       | $                                         | 7,260      |   | $ | 329 |   | $ | 4,421 |   | $ | 2,182 |   | $ | 328 |   |
| Capital leases              |       | $                                         | 53         |   | $ | 7 |   | $ | 46 |   | $ | — |   | $ | — |   |
| Licensing agreements        |       | $                                         | 170        |   | $ | 35 |   | $ | 135 |   | $ | — |   | $ | — |   |

 

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

 

The unrecognized taxliability of approximately $8.1 million related to unrecognized tax benefits isnot included in the table above due to the significant tax net loss andresearch tax credit carry forward position of the Company. If some or all ofthe unrecognized tax benefit liability became a recognized tax liability, itwould result in reduction of these net operating losses and tax credits andwould not result in the use of cash to satisfy the tax liability.

 

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*Off-BalanceSheet Arrangements*

 

As of September 30,2009, we had no material off-balance sheet arrangements, other than operatingleases and certain purchase commitments described in the contractualobligations table referenced above.

 

*IndemnificationObligations*

 

Weenter into indemnification provisions under our agreements with other companiesin our ordinary course of business, typically with our contractors, customers,and landlords. In connection with our 2006 public offering, we also agreed toindemnify the underwriters in the offering and certain stockholders who soldshares as part of the offering with respect to certain liabilities arising fromthe offering. Under these provisions, we generally indemnify and hold harmlessthe indemnified party for losses suffered or incurred by the indemnified partyas a result of our 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 we could be required to make under theseindemnification provisions is generally unlimited. As of September 30,2009, we did not have any material accruedliability relating to the defense of lawsuits or settlement of claims relatedto these indemnification agreements. As of September 30,2009, we had reimbursed Norwest Venture Partners for indemnification expensesin the aggregate amount of $176,460. As of September 30, 2009, we hadreimbursed U.S. Venture Partners for indemnification expenses in the aggregateamount of $240,050.

 

Recent AccountingPronouncements

 

In September 2009, the Emerging Issues Task Forcereleased a final consensus on Issue No. 08-1, Revenue Arrangements withMultiple Deliverables. Issue No. 08-1 enables entities to separatelyaccount for individual deliverables for many more revenue arrangements. Issue No. 08-1is effective for the Company beginning on January 1, 2011, with earlyadoption permitted. EITF 08-1 was codified into the Revenue Recognition topicof the FASB ASC. We are currently evaluating the impact the adoption of thisEITF will have on our financial statements.

 

In September 2009, the Emerging Issues Task Forcereleased a final consensus on a new revenue recognition standard, Issue No. 09-3,“Applicability of AICPA Statement of Position 97-2 to Certain Arrangements ThatContain Software Elements” (EITF 09- 3). EITF 09-3 amends the scope of AICPAStatement of Position 97-2, Software Revenue Recognition to exclude tangibleproducts that include software and non-software components that functiontogether to deliver the product’s essential functionality. This Issue shall beapplied on a prospective basis for revenue arrangements entered into ormaterially modified in fiscal years beginning on or after June 15, 2010.Earlier application is permitted as of the beginning of the company’s fiscalyear provided the company has not previously issued financial statements forany period within that year. An entity shall not elect early application ofthis Issue unless it also elects early application of Issue 08-1. We arecurrently evaluating the impact the adoption of this EITF will have on ourfinancial statements.

 

In June 2009, the FASB issued SFAS No. 168 “TheFASB Accounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles” (“SFAS 168”). SFAS 168 establishes the FASB AccountingStandards Codification (“Codification”) as the single source of authoritativeGAAP to be applied by nongovernmental entities, except for the rules andinterpretive releases of the SEC under authority of federal securities laws,which are sources of authoritative GAAP for SEC registrants. All guidancecontained in the Codification carries an equal level of authority. TheCodification does not change GAAP. SFAS 168 is effective for interim and annualperiods ending on or after September 15, 2009. The adoption of SFAS 168did not have a material impact on the Company’s consolidated results ofoperations and financial position. References to accounting standards in this Form 10-Qnow refer to the relevant ASC topic.

 

In May 2009, the FASBissued SFAS No. 165, “Subsequent Events.” SFAS No. 165 was issued inorder to establish principles and requirements for reviewing and reportingsubsequent events and requires disclosure of the date through which subsequentevents are evaluated and whether the date corresponds with the time at whichthe financial statements were available for issue (as defined) or were issued.SFAS No. 165 is effective for interim reporting periods ending after June 15,2009. The adoption of SFAS No. 165 did not have a material impact on ourfinancial position, results of operations, and cash flows. SFAS No. 165was codified in the ASC topic on Subsequent Events.

 

In April 2009, the FASB issued three related Staff Positions: (i) FSP157-4, Determining Fair Value When the Volume and Level of Activity for theAsset or Liability have Significantly Decreased and Identifying TransactionsThat Are Not Orderly, or FSP 157-4, (ii) SFAS 115-2 and SFAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments, or FSP 115-2and FSP 124-2, and (iii) SFAS 107-1 and APB 28-1, Interim Disclosuresabout Fair Value of Financial Instruments, or FSP 107 and APB 28-1, which areeffective for interim and annual periods ending after June 15, 2009. FSP157-4 provides guidance on how to determine the fair value of assets andliabilities under SFAS 157 in the current economic environment and reemphasizesthat the objective of a fair 

 

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valuemeasurement remains an exit price. If we were to conclude that there has been asignificant decrease in the volume and level of activity of the asset orliability in relation to normal market activities, quoted market values may notbe representative of fair value and we may conclude that a change in valuationtechnique or the use of multiple valuation techniques may be appropriate. FSP115-2 and FSP 124-2 modify the requirements for recognizingother-than-temporarily impaired debt securities and revise the existingimpairment model for such securities, by modifying the current intent and abilityindicator in determining whether a debt security is other-than-temporarilyimpaired. FSP 107 and APB 28-1 enhance the disclosure of instruments under thescope of SFAS 157 for both interim and annual periods. The above staffpositions did not have a material impact on our financial position, results ofoperations, and cash flows. The above staff positions and ABP 28-1 werecodified in the ASC topic on Financial Instruments

 

In April 2009, the FASBissued FSP No. 141R-1 Accounting for Assets Acquired and LiabilitiesAssumed in a Business Combination That Arise from Contingencies, or FSP 141R-1.FSP 141R-1 amends the provisions in Statement 141R for the initial recognitionand measurement, subsequent measurement and accounting, and disclosures for assetsand liabilities arising from contingencies in business combinations. The FSPeliminates the distinction between contractual and non-contractualcontingencies, including the initial recognition and measurement criteria inStatement 141R and instead carries forward most of the provisions in SFAS 141for acquired contingencies. FSP 141R-1 is effective for contingent assets andcontingent liabilities acquired in business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. We believe the adoption ofSFAS 141R will have an impact on accounting for business combinations onceadopted, but the effect on us will depend upon our level of acquisitionactivity. FAS 141R was codified in the ASC topic on Business Combinations.

 

**ITEM 3.****                       ****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Because our portfolio ofcash equivalents is of a short-term nature, we are not subject to significantmarket price risk related to investments. However, our interest income issensitive to changes in the general level of taxable and short-term U.S.interest rates.  Our exposure to marketrisk due to changes in the general level of United States interest ratesrelates primarily to our cash equivalents. We generally invest our surplus cash balances in money-market funds withoriginal or remaining contractual maturities of less than 90 days.  The primary objective of our investmentactivities is the preservation of principal while minimizing risk.  We do not hold financial instruments fortrading or speculative purposes.  We donot use any derivatives or similar instruments to manage our interest raterisk.

 

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

 

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

 

Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, as of September 30, 2009, which werefer to as the Evaluation Date or the end of the period covered by thisQuarterly Report on Form 10-Q.

 

The purpose of this evaluation was to determine whether as of theEvaluation Date our disclosure controls and procedures were effective toprovide reasonable assurance that the information we are required to disclosein our filings with the Securities and Exchange Commission, (i) isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms and (ii) accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

Based on their evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that as of September 30, 2009, the samematerial weakness that was previously reported as of December 31, 2007continued to exist with respect to revenue recognition policies and procedures.As a result, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures were not effective as ofthe Evaluation Date.

 

A deficiency in internal control over financial reporting exists whenthe design or operation of a control does not allow management or employees, inthe normal course of performing their assigned functions, to prevent or detectmisstatements on a timely basis.  A “materialweakness” is a deficiency, or a combination of deficiencies in internal controlover financial reporting, such that there is a reasonable possibility that amaterial misstatement of the company’s annual or interim financial statementswill not be prevented or detected on a timely basis. A “significant deficiency”is a deficiency, or a combination of deficiencies, in internal control overfinancial reporting that is less severe than a material weakness, yet importantenough to merit attention by those responsible for oversight of the company’sfinancial reporting.

 

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In March 2007, our audit committee initiated an internal review ofour revenue recognition practices. On September 12, 2007, we announcedthat our audit committee had identified errors in our revenue recognitionpractices 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 committee concluded that the restatement was required becauseof errors in our accounting for (i) commitments to certain customers inconnection with sales for features or deliverables that were not available atthe time revenue was originally recognized, including commitments toprospectively provide free product, software, training, and installation services,for which we prematurely recognized approximately $9.3 million in revenuefrom fiscal 2004 to fiscal 2006; (ii) sales to value-added resellers wherethe resellers 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 appropriatelytransfer title or risk of loss at the time of shipment, for which weprematurely recognized approximately $2.3 million in revenue from fiscal2004 to fiscal 2006. In addition, we prematurely recognized approximately$1.1 million of revenue from fiscal 2004 through fiscal 2006 relatingprincipally to errors in accounting for software and software maintenance,customer credits, and undelivered free product.

 

Our audit committee determined that the foregoing errors resulted fromdeficiencies in our internal controls, in particular resulting from internalcommunication failures between our finance and sales departments, a lack ofclear understanding by, and communication to, sales personnel of technicalaccounting rules, understaffed finance functions, and on occasion, failure offinance personnel to apply technical revenue recognition rules correctly.As part of its internal control deficiencies letter dated October 15,2007, our current independent registered public accounting firm also identifieda material weakness relating to revenue recognition. Our independent registeredpublic accounting firm noted that we did not have policies and procedures inplace to ensure that modifications to, or side agreements associated with, ourstandard terms of contract were properly documented and approved. Ourindependent registered public accounting firm also cited a lack ofunderstanding of the accounting consequences of modifications to standard termsby certain sales employees and a lack of communication among our sales,engineering, and finance departments to ensure that all sales transactions areproperly tracked, documented, approved, and recorded.

 

In their October 2007 letter, our independent registered publicaccounting firm identified additional control deficiencies that it determinedto be significant deficiencies but that it did not deem to be materialweaknesses. In particular, it identified a significant deficiency relating to segregationof duties, noting among other things that in certain instances journal entriesand account reconciliations were approved by the preparer of the entry orreconciliation. Our independent registered public accounting firm also noted asignificant deficiency relating to post-closing adjusting journal entries andrecommended that we reassess the timeline of our financial statement process toensure that we have reasonable time to conclude a thorough financial statementclosing process. Finally, our independent registered public accounting firmidentified significant deficiencies relating to recording certain purchasetransactions, where parts were ordered and accepted by our engineeringdepartment, without approval or involvement of our finance department, andwhere fixed assets were not properly classified for depreciation purposes.

 

In connection with the audit of our consolidated financial statementsfor the year ended December 31, 2007 and the effectiveness of our internalcontrol over financial reporting as of December 31, 2007, our independentregistered public accounting firm identified a material weakness and somesignificant deficiencies in our internal control over financial reporting in aletter dated March 10, 2008. Specifically, our independent registeredpublic accounting firm noted a continuing material weakness relating to revenuerecognition and our policies and procedures to ensure that modifications to, orside agreements associated with, our standard terms of contract were properlyapproved, documented, tracked and recorded.

 

In connection with the preparation and related audit of our financialstatements for the year ended December 31, 2008, our management againconcluded that a material weakness existed with respect to revenue recognitionat December 31, 2008. In addition, management identified significantdeficiencies relating to (i) approval processes for credit memos andspecial pricing terms and (ii) segregation of duties in our ordermanagement group. Management noted that each of the audit committee’s 2007recommendations had been completed but determined that a number of theseremediation efforts had not been in place or tested for a sufficient period toconclude that they were effective. In particular, we implemented standardizedterms and conditions for customer quotes, contracts, and invoices in the fourthquarter of fiscal 2008, but only a small portion of our revenues in 2008 weregenerated in transactions entered under these standardized terms. In addition,management concluded that the controls implemented to date have largely beenfocused on error detection and that we need to implement additionalpreventative controls designed to address potential errors before they occur.

 

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Any failure on our part to remedy identified control deficiencies, orany additional delays or errors in our financial reporting, whether or notresulting from the identified material weakness relating to revenue recognitionor any significant deficiencies, would have a material adverse effect on ourbusiness, results of operations, or financial condition and could have asubstantial adverse impact on the trading price of our common stock.

 

***(b)  Changes in InternalControl Over Financial Reporting***

 

*Changes in Internal Controls inthe Current Fiscal Quarter:*

 

Inthe third quarter of fiscal 2009, while there were no changes that havematerially affected or are reasonably likely to materially affect, our internalcontrol over financial reporting, we continued to assess and improve theoperating effectiveness of our internal controls. In the continuous effort tostrengthen our control environment, particularly in the revenue process,we also implemented process changes that we believe will contribute to amore balanced structure of controls with additional emphasis on earlyactivities and preventive controls.

 

*Changes in Internal Controls inPrior Fiscal Quarters:*

 

Althoughwe recently completed all remediation steps specifically recommended by ouraudit committee in 2007, management continues to test the newly implementedcontrols and has identified additional controls and procedures forimplementation in light of our continuing material weakness. In particular, weplan to implement further remedial actions, which have been approved by ouraudit committee, related to the 2008 material weakness, specifically:

 

·                  Monitor and test prior internal controlremediation;

 

·                  Implement additional controls focused onprevention (in contrast to the detection focus of previously implementedremedial controls); and

 

·                  Review and assess current sales process fromthe time of quote to the collection of receivables in an effort to process  orders in a more controlled environment.

 

In the first quarter offiscal 2009, we implemented control changes in our order management group toaddress identified control deficiencies relating to segregation of duties.  Specifically, we limited individual systemaccess in an effort to ensure that no single individual had the ability tobook, invoice, and ship orders.

 

In the second quarter offiscal 2009, while there were no changes that have materially affected or arereasonably likely to materially affect, our internal control over financialreporting, we enhanced the design and improved the operating effectiveness ofinternal controls in the revenue process. Specifically, we provided for a morecomprehensive process related to the issuance of and approval requirements forcredit memos. We also improved consistency in the documentation and retentionof written approvals of special pricing terms.

 

OnSeptember 28, 2007, our audit committee presented the findings andrecommendations of its internal investigation to our board of directors,including a proposed remediation plan regarding internal control over financialreporting. At that time, our board of directors adopted the audit committee’sremediation plan. In the fourth quarter of 2008, we completed implementationof all initial audit committee recommendations.

 

Our audit committee’s remediation plan consisted of the followingmodifications and improvements in our internal controls relating to the salesand revenue- recognition transaction cycle.

 
| ** ** | ** ** | ** **                                                                                                                                                 | ** ** | **Implemented  as of  December 31,  2008** |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|
| ·     |       | adjust  our reporting structure so that finance has direct oversight of sales  administration and the sales proposal generation management group;          |       | P                                               |
|       |       |                                                                                                                                                       |       |                                            |
| ·     |       | reorganize  our variable compensation plan to ensure that sales personnel are not  incentivized to attempt to influence the timing of revenue recognition; |       | P                                               |

 

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| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **Implemented  as of  December 31,  2008** |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|
| ·     |       | 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; |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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                                                                                                                                                                                                                                                                                 |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | a  revenue recognition checklist should accompany the financial package for each  transaction.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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;                                                                                                                                                                                                                                                                                                                                     |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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;                                                                                                                                                                                                 |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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;                                                                                                                                                                                                                                                                                                                                    |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | implement  policies and procedures that delineate clear roles, responsibilities, and  authorization levels for all positions defined as “key” to the revenue  recognition transaction cycle;                                                                                                                                                                                                                                                                                                                                                                                                                              |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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;                                                                                                                                                                                                                                                                                                                                                                                                               |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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;                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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;                                                                                                                                                                                                                                                                                                                                                                   |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | implement  procedures to ensure that credit checks are performed and the decision-making  process as to the credit limit is documented and maintained.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | 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:                                                                                                                |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | standardize  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; and                                                                                                                                                                                                                                                                                                                                                                                      |       | P                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |       |                                            |
| ·     |       | establish  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                                                                                                                                                                                                                                                                                                                            |       | P                                               |

 

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**PART II—OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

**Legal Proceedings**

 

**2007 Class Action Litigation**

 

On April 26, 2007 and May 16, 2007, two putative class actioncomplaints were filed in the United States District Court for the CentralDistrict of California against us and certain of our officers. The complaintsallege that the defendants violated sections 10(b) and 20(a) ofthe Securities Exchange Act of 1934, or the Exchange Act, and SEC Rule 10b-5promulgated thereunder by making false and misleading statements and omissionsrelating to our financial statements and internal controls with respect torevenue recognition. The complaints seek, on behalf of persons who purchasedour common stock during the period from May 2, 2006 to April 17,2007, damages of an unspecified amount.

 

On July 30, 2007, Judge Christina A. Snyder consolidated theseactions into a single action, appointed NECA-IBEW Pension Fund (The DecaturPlan) as lead plaintiff, and approved its selection of lead counsel. On November 16,2007, the lead plaintiff filed a consolidated complaint. This consolidatedcomplaint added as defendants certain of our current and former directors andofficers, our current and former outside auditors, the lead underwriter of oursecondary public offering in November 2006, and two venture capital firmswho were early investors in us. The consolidated complaint alleged thatdefendants violated sections 10(b), 20(a) and 20A of the Exchange Actand SEC Rule 10b-5 promulgated thereunder, as well as sections 11 and15 of the Securities Act of 1933, or Securities Act, by making false and misleadingstatements and omissions relating to our financial statements and internalcontrols with respect to revenue recognition that required restatement. Theconsolidated complaint seeks, on behalf of persons who purchased, Occam’scommon 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 theconsolidated complaint. On July 1, 2008, Judge Snyder issued an ordergranting in part and denying in part defendants’ motions. This order dismissedall claims against certain of our current and former directors, the 20A claimin its entirety, the section 10(b) claim against the auditors andventure capital firms, and the section 11 claims against the venturecapital firms. On July 16, 2008, lead plaintiff filed an amended complaintto conform to the Court’s July 1, 2008 order. Defendants answered thisamended complaint on August 29, 2008. We believe that we have meritoriousdefenses in this action, and intend to defend ourselves vigorously. Failure byus to obtain a favorable resolution of the claims set forth in the consolidatedcomplaint could have a material adverse effect on our business, results ofoperations and financial condition. Currently, the amount of such materialadverse effect cannot be reasonably estimated.

 

OnSeptember 10, 2009 we announced that we and all but one defendant hadentered into a memorandum of understanding to settle and resolve thisstockholder class action lawsuit filed on April 26th, 2007. On November 2,2009 all parties including all defendants filed a binding Stipulation Agreementwith the court and the court will enter a preliminary ruling on November 9,2009. The total settlement amount of $13.9 million has been agreed by all parties.We have agreed to contribute $1.7 million with the balance to come from theCompany’s insurers and all other defendants. We have recorded a charge of $1.7million as a loss on settlement for the quarter ended September 30, 2009.The class action settlement is subject to preliminary and following notice toclass members, final approval by the court.

 

Failureto achieve final approval of the settlement could result in recommencement ofthe litigation.  If so, failure by theCompany to obtain a favorable resolution of the claims set forth in theconsolidated complaint could have a material adverse effect on the Company’sbusiness, 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 lawsuitswere filed against Accelerated Networks, certain of its then officers anddirectors and several investment banks that were underwriters of AcceleratedNetworks’ initial public offering. The cases, which have since beenconsolidated, were filed in the United States District Court for the SouthernDistrict of New York. The Court appointed a lead plaintiff on April 16,2002, and plaintiffs filed a Consolidated Amended Class Action Complaint(the “Complaint”) on April 19, 2002. The Complaint was filed on behalf ofinvestors who purchased Accelerated Networks’ stock between June 22, 2000and December 6, 2000 and alleged violations of Sections 11 and 15 ofthe 1933 Act and Sections 10(b) and 20(a) and Rule 10b-5 ofthe 1934 Act against one or both of Accelerated Networks and the individualdefendants. The claims were based on allegations that the underwriterdefendants agreed to allocate stock in Accelerated Networks’ initial publicoffering to certain investors in exchange for excessive and undisclosedcommissions and agreements by those investors to make additional purchases inthe aftermarket at pre-determined prices. Plaintiffs alleged that theprospectus for Accelerated Networks’ initial public offering was false andmisleading in violation of the securities laws because it did not disclosethese arrangements. These lawsuits are part of the massive “IPO allocation”litigation involving the conduct of underwriters in allocating shares ofsuccessful initial public offerings.

 

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Webelieve that over three hundred other companies have been named in more thanone thousand similar lawsuits that have been filed by some of the sameplaintiffs’ law firms. In October 2002, the plaintiffs voluntarilydismissed the individual defendants without prejudice. On February 1, 2003a motion to dismiss filed by the issuer defendants was heard and the courtdismissed the 10(b), 20(a) and rule 10b-5 claims against Occam. On October 13,2004, the Court certified a class in six of the approximately 300 other nearlyidentical actions (the “focus” cases) and noted that the decision was intendedto provide guidance to all parties regarding class certification in theremaining cases. The Underwriter Defendants appealed the decision and theSecond Circuit Court of Appeals vacated the district court’s decision grantingclass certification in those six cases on December 5, 2006. 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.

 

Prior to the Second Circuit’s December 5, 2006 ruling, we agreed,together with over three hundred other companies similarly situated, to settlewith the Plaintiffs. A settlement agreement and related agreements weresubmitted to the Court for approval. The settlement would have provided, amongother things, a release of the Company and of the individual defendants for theconduct alleged to be wrongful in the Complaint in exchange for a guaranteefrom the Company’s insurers regarding recovery from the underwriter defendantsand other consideration from the Company regarding its underwriters. In lightof the Second Circuit opinion, liaison counsel for the issuers informed theDistrict Court that the settlement cannot be approved because the definedsettlement class, like the litigation class, cannot be certified.

 

OnOctober 3, 2007 Plaintiff has 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. On March 28, 2008, the plaintiffs filed an amended reply brief insupport of their motion to certify the class of plaintiffs. The UnderwriterDefendants and the issuer Defendants had until August 31, 2008 to file ananswer to the amended complaint. The Court has not ruled on the motion. Theinsurers, the underwriters and the Plaintiffs subsequently agreed to global mediationin the interest of trying to resolve this case without the further need forlitigation. The mediation commenced in late June of 2008 and resulted incurrent settlement negotiations whereby the parties agreed to a settlement. Thesettlement has been approved including class certification by the Court on October 5,2009 subject to a thirty day period required for filing of any appeals to theCourt’s ruling which appeal period ends November 5, 2009. Prior to November 5,2009 two appeals have been filed objecting the Court’s approval of thesettlement and on October 26, 2009 certain individuals who objected to theCourt’s October 5, 2009 Opinion and Order have requested permission tofile an appeal in that the Court abused it’s discretion concerning the classcertification on the grounds that it was broader than the class rejected by theSecond Circuit Appeals Court. The Court has not ruled on this request to date.The time to appeal has been stayed thirty (30) days from the date the Courtfiles its final judgment which judgment is expected to be filed the week of November 9,2009.

 

Due to the inherent uncertainties of litigation, we cannot accuratelypredict the ultimate outcome of the matter. We have not recorded any accrualrelated to this proposed settlement because Occam expects any settlementamounts to be covered by its insurance policies.

 

**IPO Short Swing Profits Litigation**

 

In late 2007, we received a letter from Vanessa Simmonds, a putativeshareholder, demanding that we investigate and prosecute a claim for allegedshort-swing trading in violation of Section 16(b) of the SecuritiesExchange Act of 1934, 15 U.S.C. § 78p(b), by the underwriter of ourinitial public offering (“IPO”) and certain unidentified directors, officersand shareholders of us (then known as Accelerated Networks). We evaluated thedemand and declined to prosecute the claim. On October 12, 2007, theputative shareholder commenced a civil lawsuit in the U.S. District Court forthe Western District of Washington against Credit Suisse Group, the leadunderwriter of our IPO, alleging violations of Section 16(b). Thecomplaint alleges that the combined number of shares of our common stockbeneficially owned by the lead underwriter and certain unnamed officers,directors, and principal shareholders exceeded ten percent of its outstandingcommon stock from the date of Occam’s IPO on June 23, 2000, through atleast June 22, 2001. It further alleges that those entities andindividuals were thus subject to the reporting requirements of Section 16(a) andthe short-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). Wewere named as a nominal defendant in the action, but have no liability for theasserted claims. None of our directors or officers of Occam are named asdefendants in this action.

 

On October 29, 2007, the case was reassigned to Judge James L. Robartalong with fifty-four other Section 16(b) cases seeking recovery ofshort-swing profits from underwriters in connection with various IPOs. TheUnderwriters and Issuers have filed a motion to dismiss the case and replybriefs have been filed. The Court heard oral argument on January 19, 2009from all parties. On March 12, 2009, the Court dismissed the 16 (b) complaintagainst the issuer defendants including Occam on both jurisdictional andstatute of limitation grounds. On March 31, 2009, the Plaintiffs filed aNotice of Appeal. Currently the Underwriters Reply in Support of theirCross-Appeal must be filed by November 17, 2009. Oral argument will beheard thereafter.

 

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

 

**Other Matters**

 

From time to time, we are subject to threats of litigation or actuallitigation in the ordinary course of business, some of which may be material.We believe that, except as described above, there are no currently pendingmatters that, if determined adversely to us, would have a material effect onour business or that would not be covered by our existing liability insurancemaintained by us.

 

**ITEM1A.  RISK FACTORS**

 

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

 

Before you invest in oursecurities, you should be aware that our business faces numerous financial andmarket risks, including those described below, as well as general economic andbusiness risks.  The following discussionprovides information concerning the material risks and uncertainties that wehave identified and believe may adversely affect our business, our financialcondition and our results of operations. Before you decide whether to invest in our securities, you shouldcarefully consider these risks and uncertainties, together with all of theother information included in this Quarterly Report on Form 10-Q, ourAnnual Report on Form 10-K for the year ended December 31, 2008 andin our other public filings.

 

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**Risks Related to Current Economic Environment and Our Future Revenues**

 

***Our business is substantially dependent on the capitalspending patterns of telecom operators and has recently been adversely affectedby reductions and delays in capital spending by our customers.  Any continued reductions or delays incustomer orders in response to macroeconomic conditions or otherwise, wouldadversely affect our business, operating results, and financial condition.***

*** ***

Demandfor our products depends on the magnitude and timing of capital spending bytelecom service providers as they construct, expand and upgrade theirnetworks.  In the fourth quarter of 2008,we identified a weakening in new order activity that has continued into2009.  We believe this weakening relatesto reductions in capital expenditures and capital equipment investment budgetsresulting from the worldwide financial crisis and economic downturn.   In addition, we believe that many of ourcustomers, particularly those that participate in government fundinginitiatives such as the Department of Agriculture’s Rural Utility Serviceprogram, may be delaying investment and purchase activity pending theiranalysis of the availability of funding under recently announced governmenteconomic stimulus programs.  Continuedreductions, delays, or cancellations in order activity by our customers wouldbe expected to adversely affect our future revenues by reducing the revenue werecognize in any quarter from orders booked and shipped in that quarter and byreducing the amount of deferred revenues that may become recognizable in futureperiods upon satisfaction of revenue recognition criteria.

 

Inaddition to the impact of macroeconomic factors, we believe capitalexpenditures among IOCs have also been adversely affected as our customersconsider their investment and capital expenditure decisions in light of theindustry transition from copper wire to fiber.

 

Other factors affectingthe capital spending patterns of telecom service providers include the following:

 

·                  competitive pressures, including pricingpressures;

 

·                  consumer demand for new services;

 

·                  an emphasis on generating sales fromservices delivered over existing networks instead of new network constructionor upgrades;

 

·                  the timing of annual budget approvals;

 

·                  evolving industry standards and networkarchitectures;

 

·                  free cash flow and access to externalsources of capital; and

 

·                  completion of major network upgrades.

 

Changesin government funding programs can also affect capital expenditures byIOCs.  Because many of our customers areIOCs, their revenues are particularly dependent upon intercarrier payments(primarily interstate and intrastate access charges) and federal and stateuniversal service subsidies.  The FederalCommunications Commission, or FCC, and some states are considering changes toboth intercarrier payments and universal service subsidies, and such changes couldreduce IOC revenues, which would be expected to have an adverse impact oncapital spending budgets.  Furthermore,many IOCs use government supported loan programs or grants to finance capitalspending.  Changes to those programs,such as the Department of Agriculture’s Rural Utilities Service loan program,could reduce the ability of IOCs to access capital.  Any decision by telecom service providers toreduce capital expenditures, whether caused by the economic downturn, changesin government regulations and subsidies, or other reasons, would have amaterial adverse effect on our business, consolidated financial condition andresults of operations.

 

***Our focus on independent telephone operating companieslimits our sales volume with individual customers and makes our futureoperating results difficult to predict.***

*** ***

Wecurrently focus our sales efforts on the independent telephone operatingcompanies, or IOCs, in North America. These customers generally operate relatively small networks with limitedcapital expenditure budgets. Accordingly, we believe the total potential sales volume for ourproducts at any individual IOC is limited, and we must identify and sellproducts to new IOC customers each quarter to continue to increase oursales.  In addition, the spendingpatterns of many IOCs are characterized by small and sporadic purchases.  Moreover, because our sales to IOCs arepredominantly based on purchase orders rather than long-term contracts, ourcustomers may stop purchasing equipment from us with little advancenotice.  As a result, we have limitedbacklog, our future operating results are difficult to predict and we willlikely continue to have limited visibility into future operating results.

 

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***We have had limitedexperience selling to larger telecommunication companies, and our ability torecognize revenue, if any, from contracts with these companies may be difficultto predict. In addition, FairPoint Communications, our only Tier-1 customer,recently filed for bankruptcy protection.***

 

In early 2008, we announced that we had been selectedas the lead access equipment provider for a substantial broadband upgrade byFairpoint Communications, Inc. in its network in Vermont, New Hampshire,and Maine. Fairpoint recently acquired these networks through its acquisitionsof certain assets of Verizon Communications, Inc. Fairpoint representedour first customer who is considered Tier 1 based on the number of telephonelines serviced. We have limited experience selling or servicing Tier 1customers, and our ability to recognize substantial revenue from the Fairpointrelationship or any other relationships we may establish with Tier 1 customerswill depend on several factors, including, among others, the timing of ordersand the terms and conditions of the orders, which can affect our ability tosatisfy revenue recognition criteria. We cannot currently predict with anyaccuracy the timing of orders from Fairpoint, and any delays or termination ofFairpoint’s anticipated upgrade of its northern New England network could havea material adverse effect on our future revenues and operating results. FairpointCommunications has publicly reported certain financial difficulties that it hasencountered related to the Northern New England network.

 

On October 26, 2009, Fairpoint announced that ithad filed a bankruptcy petition under chapter 11 of the United StatesBankruptcy Code. According to the documents filed with the bankruptcy court,FairPoint’s plan is to restructure its debt and continue day to day operationsunder court supervision. As of October 26, 2009, the Company had anoutstanding receivable balance of approximately $1.7 million, of which $1.4million was invoiced within 45 days of the bankruptcy petition filing and thiswould have the benefit of “reclamation claim” filing. We currently cannotpredict the extent to which these receivables may be paid. We have deferredapproximately $1.3 million, of revenue and related cost of revenue for thequarter ended September 30, 2009, for which cash has not been collected.

 

We cannot assure that the impact of Fairpoint’sbankruptcy will not have a material adverse effect on our business and ourresults of operations including the timing and amount of orders we may receivefrom them as well as the timing and amount of any revenue we might recognizerelated to such orders. In addition, debtors-in-possession or bankruptcytrustees could seek to recover payments made to us in the 90 day period priorto the bankruptcy filing on the grounds that these payments constituted“preferences” under applicable bankruptcy law. We believe we would have acomplete defense to any such claim in that payments to us have been made in theordinary course of business in exchange for newly purchased equipment. Howeverany litigation against us relating to a preference claim, if successful, wouldhave an adverse impact on our cash and cash equivalents.

 

***Fluctuations in our quarterly and annual operatingresults may adversely affect our business and prospects.***

*** ***

Anumber of factors, many of which are outside our control, may cause orcontribute to significant fluctuations in our quarterly and annual operatingresults.  These fluctuations may makefinancial planning and forecasting more difficult.  In addition, these fluctuations may result inunanticipated decreases in our available cash, which could limit our growth anddelay implementation of our expansion plans. Factors that may cause or contribute to fluctuations in our operatingresults include:

 

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

 

·                  delays in customer orders as IOCsevaluate and consider their capital expenditures and investments in light ofthe industry transition from copper wire to fiber;

 

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

 

·                  seasonal reductions in field work duringthe winter months and the impact of annual budgeting cycles;

 

·                  the size and timing of orders we receiveand products we ship during a given period;

 

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

 

·                  introductions or enhancements ofproducts, services and technologies by us or our competitors, and marketacceptance of these new or enhanced products, services and technologies;

 

·                  our ability to achieve targeted costreductions;

 

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·                  the amount and timing of our operatingcosts, including sales, engineering and manufacturing costs and capitalexpenditures; and

 

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

 

Asa consequence, operating results for a particular future period are difficultto predict and prior results are not necessarily indicative of results to beexpected in the future.  Any of theforegoing factors may have a material adverse effect on our consolidatedresults of operations.

 

***We have a history of losses and negative cash flow,and we may not be able to generate positive operating income and cash flows inthe future to support the expansion of our operations.***

*** ***

Wehave incurred significant losses since our inception. As of September 30,2009, we had an accumulated deficit of $134.6 million.  We incurred substantial losses in 2008.  We expect to continue to incur losses in2009.  We cannot assure you that we willnot continue to incur losses or experience negative cash flow in thefuture.  We have only generated operatingincome in the quarters ended December 25, 2005, September 24, 2006, December 31,2006 and December 31, 2008.  We donot believe our results of operations in the quarter ended December 31,2008 are indicative of our expected results in future near term quarters.  Our continued inability to generate positiveoperating income and cash flow would materially and adversely affect ourliquidity, consolidated results of operations and consolidated financialcondition.

 

Asignificant portion of our expenses is fixed, and we expect to continue toincur significant expenses for research and development, sales and marketing,customer support, and general and administrative functions.  Given the rate of growth in our customerbase, our limited operating history and the intense competitive pressures weface, we may be unable to adequately control our operating costs.  In order to achieve and maintainprofitability, we must increase our sales while maintaining control over ourexpense levels.

 

**Risks Related toOutstanding Litigation and Internal Controls**

** **

***An adverse resolution of outstanding litigationresulting from the restatement in October 2007 of our historical financialstatements could have a material adverse effect on our business, operatingresults, or financial condition.***

*** ***

OnOctober 16, 2007, following a seven month review of our historic revenuerecognition practices that was led by our audit committee, we filed our AnnualReport on Form 10 K for the year ended December 31, 2006, whichincluded our consolidated financial statements for the year ended December 31,2006 and which restated our financial statements for the years ended December 26,2004 and December 25, 2005, for each of the interim quarterly periods infiscal 2004 and 2005, and the first three interim quarterly periods of fiscal2006.  Following the announcement of thecommencement of the audit committee review in March 2007, we, certain ofour directors and executive officers and others became defendants in aconsolidated federal securities class action. The consolidated complaint alleges that the various defendants violatedsections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b 5promulgated thereunder, as well as sections 11 and 15 of the Securities Act, bymaking false and misleading statements and omissions relating to our financialstatements and internal controls with respect to revenue recognition.  We cannot provide any assurances that thefinal outcome of this consolidated securities class action will not have amaterial adverse effect on our business, results of operations, or financialcondition.  Litigation and any relatedproceedings can be time-consuming and expensive and could divert managementtime and attention from our business, which could have a material adverseeffect on our revenues and results of operations.  In addition, an adverse resolution of the outstandinglitigation could have a material adverse effect on our financial condition ifwe are required to use our available cash resources to settle the litigation orsatisfy any judgment. On September 10, 2009, we announced that we andall but one defendant had entered into a memorandum of understanding regardingthe settlement of the April 26th, 2007 stockholder class action lawsuit.On November 2, 2009 all parties including all defendants filed a bindingStipulation Agreement with the court and the court will enter a preliminaryruling on November 9, 2009.  Theclass action settlement is subject to preliminary and, following notice toclass members, final approval by the court. The total settlement amount of$13.9 million has been agreed by all parties. We have agreed to contribute $1.7million with the balance to come from our insurers and all other defendants. Wehave recorded a charge of $1.7 million as a loss on settlement for the quarterended September 30, 2009.

 

Failureto achieve final approval of the settlement could result in recommencement ofthe litigation.  If so, failure by theCompany to obtain a favorable resolution of the claims set forth in theconsolidated complaint could have a material adverse effect on the Company’sbusiness, results of operations and financial condition. Currently, the amountof such material adverse effect cannot be reasonably estimated.

 

***Potential indemnification obligations set forth in ourcharter documents or in contracts between us and various officers, directors,and third parties could have a material adverse effect on our business,operating results or financial condition.***

*** ***

UnderDelaware law, our bylaws, and indemnification agreements to which we are aparty, we may have an obligation to indemnify certain current and formerofficers and directors, as well as certain underwriters and stockholders, inrelation to outstanding litigation or other related matters, and we haverecently begun to reimburse certain expenses of some indemnified parties inconnection with outstanding litigation. Such indemnification may have a material adverse effect on our business,results of operations, and financial condition to the extent insurance does notcover our costs.  The insurance carriersthat provide our directors’ and officers’ liability policies may seek torescind or deny coverage, either in whole or part, with respect to pendinglitigation, or we may not have sufficient coverage under such policies, inwhich case our business, results of operations, and financial condition may bematerially and adversely affected.

 

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

*** ***

In connection with the 2007 audit committee reviewof our revenue recognition practices and our resulting financial restatement,we determined that we did not have adequate internal financial and accountingcontrols to produce accurate and timely financial statements.  Among weaknesses and deficiencies identifiedin our review, we determined that we had a material weakness with respect torevenue recognition.  Since therestatement was completed in October 2007, we have implemented newprocesses and procedures to improve our internal controls and have expanded ourfinance and accounting staff. Nevertheless, as of September 30, 2009, our chief executive officerand chief financial officer determined that our internal controls overfinancial reporting were not effective to provide reasonable assuranceregarding the reliability of our financial reporting and the preparation offinancial statements for external reporting in accordance with generallyaccepted accounting principles in the United States.  Failure on our part to have effective internalfinancial and accounting controls could cause our financial reporting to beunreliable, could have a material adverse effect on our business, operatingresults, and financial condition, and could adversely affect the trading priceof our common stock.

 

Ensuring that we have adequate internal financialand accounting controls and procedures in place to produce accurate financialstatements on a timely basis is a costly and time-consuming effort that needsto be re-evaluated frequently.  Our auditcommittee’s investigation of revenue recognition issues identified weaknessesand other control deficiencies relating principally to revenue recognition andthe processes and procedures associated with customer transactions andinteraction with and review by our finance department.  As part of its internal control deficienciesletter dated October 15, 2007, our current independent registered publicaccounting firm identified a material weakness relating to revenuerecognition.  Our independent registeredpublic accounting firm noted that we did not have policies and procedures inplace to ensure that modifications to, or side agreements associated with, ourstandard terms of contract are properly documented and approved.  Our independent registered public accountingfirm also cited a lack of understanding of the accounting consequences ofmodifications to standard terms by certain sales employees and a lack ofcommunication among our sales, engineering, and finance departments to ensurethat all sales transactions are properly tracked, documented, approved, andrecorded.

 

Intheir October 2007 letter, our independent registered public accountingfirm identified additional control deficiencies that it determined to besignificant deficiencies but that it did not deem to be materialweaknesses.  In particular, it identifieda significant 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 independent registered public accountingfirm also noted a significant deficiency relating to post-closing adjustingjournal entries and recommended that we reassess the timeline of our financialstatement process to ensure that we have reasonable time to conclude a thoroughfinancial statement closing process. Finally, our independent registered public accounting firm identifiedsignificant deficiencies relating to recording certain purchase transactions,where parts were ordered and accepted by our engineering department, withoutapproval or involvement of our finance department, and where fixed assets werenot properly classified for depreciation purposes.

 

Inconnection with the audit of our consolidated financial statements for the yearended December 31, 2007 and the effectiveness of our internal control overfinancial reporting as of December 31, 2007, our independent registeredpublic accounting firm again identified a material weakness and somesignificant deficiencies in our internal control over financial reporting in aletter 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.

 

Inconnection with the preparation and related audit of our financial statementsfor the year ended December 31, 2008, our management concluded that thesame material weakness reported on December 31, 2007 continued to exist onDecember 31, 2008 with respect to revenue recognition policies andprocedures.  In addition, managementidentified significant deficiencies relating to (i) approval processes forcredit memos and special pricing terms and (ii) segregation of duties inour order management group.  Managementnoted that each of the audit committee’s 2007 recommendations had beencompleted but determined that a number of these remediation efforts had notbeen in place or tested for a sufficient period to conclude that they wereeffective.  In particular, we implementedstandardized terms and conditions for customer quotes, contracts, and invoicesin the fourth quarter of fiscal 2008, but only a small portion of our revenuesin 2008 were generated in transactions entered under these standardizedterms.  In addition, management concludedthat the controls implemented to date have largely been focused on error detectionand that we need to implement additional preventative controls designed toaddress potential errors before they occur.

 

Anyfailure on our part to remedy identified control deficiencies, or anyadditional delays or errors in our financial reporting, whether or notresulting from the identified material weakness relating to revenue recognitionor any significant deficiencies, would have a material adverse effect on ourbusiness, results of operations, or financial condition and could have a substantialadverse impact on the trading price of our common stock.

 

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Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting to provide reasonable assurance regarding thereliability of our financial reporting and the preparation of financialstatements for external purposes in accordance with generally accepted accountingprinciples in the United States.  Ourmanagement does not expect that our internal control over financial reportingwill prevent or detect all errors and all fraud.  A control system, no matter how well designedand operated, can provide only reasonable, not absolute, assurance that thecontrol system’s objectives will be met. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that misstatements due toerror or fraud will not occur or that all control issues and instances offraud, if any, within our company will have been detected.  As discussed in our Annual Report on Form 10-Kand 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.

 

Wewere required to comply with Section 404 of the Sarbanes Oxley Act of 2002in connection with our Annual Report on Form 10-K for our year ending December 31,2008.  We have expended significantresources in developing the necessary documentation and testing proceduresrequired by Section 404 of the Sarbanes Oxley Act.  Our management and independent registeredpublic accounting firm concluded that we did not maintain effective controlover financial reporting as of December 31, 2008 based on the criteria inInternal Control Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. In this Quarterly Report on Form 10-Q, our management againconcluded that we did not maintain effective internal controls as of September 30,2009.  We cannot be certain that theactions we have taken and are taking to improve our internal controls overfinancial reporting will be sufficient or that we will be able to implement ourplanned processes and procedures in a timely manner.  In addition, we may be unable to produce accuratefinancial statements on a timely basis. Any of the foregoing could cause investors to lose confidence in thereliability of our consolidated financial statements, which could cause themarket price of our common stock to decline and make it more difficult for usto finance our operations and growth.

 

**Risks Related to OurBusiness and Industry**

** **

***Because our markets are highly competitive anddominated by large, well-financed participants, we may be unable to competeeffectively.***

*** ***

Competitionin our market is intense, and we expect competition to increase.  The market for broadband access equipment isdominated primarily by large, established suppliers such as Alcatel Lucent SA,Motorola, Tellabs and ADTRAN Inc.  Whilethese suppliers focus primarily on large service providers, they have competed,and may increasingly compete, in the IOC market segment.  In addition, a number of companies, includingCalix, Inc., have developed, or are developing, products that compete withours, including within our core IOC segment.

 

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

 

·                  the successful identification anddevelopment of new products for our core market;

 

·                  our ability to timely anticipate customerand market requirements and changes in technology and industry standards;

 

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

 

·                  our ability to timely introducecost-effective new products;

 

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

 

·                  our ability to gain customer acceptanceof our products;

 

·                  the performance of our products relativeto our competitors’ products;

 

·                  our ability to market and sell ourproducts through effective sales channels;

 

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

 

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

 

·                  our ability to attract and retainqualified technical, executive and sales personnel.

 

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Manyof our existing and potential competitors are larger than we are with longeroperating histories, and have substantially greater financial, technical,marketing or other resources; significantly greater name recognition; and alarger installed base of customers than we do. Unlike many of our competitors, we do not provide equipment financing topotential customers.  In addition, manyof our competitors have broader product lines than we do, so they can offerbundled products, which may appeal to certain customers.

 

Becausethe products that we and our competitors sell require a substantial investmentof time and funds to install, customers are typically reluctant to switchequipment suppliers once a particular supplier’s product has beeninstalled.  As a result, competitionamong equipment suppliers to secure contracts with potential customers isparticularly intense and will continue to place pressure on productpricing.  Some of our competitors have inthe past and may in the future resort to offering substantial discounts to winnew customers and generate cash flows. If we are forced to reduce prices in order to secure customers, we maybe unable to sustain gross margins at desired levels or achieve profitability.

 

***We have relied, and expect to continue to rely, on ourBLC 6000 product line for the substantial majority of our sales, and a declinein sales of our BLC 6000 line would cause our overall sales to declineproportionally.***

*** ***

Wehave derived a substantial majority of our sales in recent years from our BLC6000 product line.  We expect that salesof this product line will continue to account for a substantial majority of oursales for the foreseeable future.  Anyfactors adversely affecting the pricing of, or demand for, our BLC 6000 line,including competition or technological change, could cause our sales to declinematerially and our business to suffer.

 

***If we fail to enhance our existing products and developnew products and features that meet changing customer requirements and supportnew technological advances, our sales would be materially and adverselyaffected.***

*** ***

Ourmarket is characterized by rapid technological advances, frequent new productintroductions, evolving industry standards and recurring changes in end-userrequirements.  Our future success willdepend significantly on our ability to anticipate and adapt to such changes andto offer, on a timely and cost-effective basis, products and features that meetchanging customer demands and industry standards.  The timely development of new or enhancedproducts is a complex and uncertain process, and we may not be able toaccurately anticipate market trends or have sufficient resources to successfullymanage long development cycles.  We mayalso experience design, manufacturing, marketing and other difficulties thatcould delay or prevent the development, introduction or marketing of newproducts and enhancements.  Theintroduction of new or enhanced products also requires that we manage thetransition from older products to these new or enhanced products in order tominimize disruption in customer ordering patterns and ensure that adequatesupplies of new products are available for delivery to meet anticipatedcustomer demand.  If we are unable todevelop new products or enhancements to our existing products on a timely andcost-effective basis, or if our new products or enhancements fail to achievemarket acceptance, our business, consolidated financial condition andconsolidated results of operations would be materially and adversely affected.

 

Werecently enhanced our BLC 6000 platform to support active Gigabit Ethernetfiber-to-the-premises, or FTTP, services. Although we have invested significant time and resources to develop thisenhancement, these FTTP-enabled products are relatively new, with limited salesto date, and market acceptance of these products may fall below ourexpectations.  The introduction of newproducts is also expected to place pressure on our gross margins as most newproducts require time and increased sales volumes to achieve cost-savingefficiencies in production.  To theextent our new products and enhancements do not achieve broad marketacceptance, we may not realize expected returns on our investments, and we maylose current and potential customers.

 

***If our products contain undetected defects, includingerrors and interoperability issues, we could incur significant unexpectedexpenses to remedy the defects, which could have a material adverse effect onour sales, results of operations or financial condition.***

*** ***

Althoughour products are tested prior to shipment, they may contain software orhardware errors, defects or interoperability issues (collectively described as “defects”)that may only be detected when deployed in live networks that generate highamounts of communications traffic.  Inaddition, defects or other malfunctions or quality control issues may notappear until the equipment has been deployed for an extended period oftime.  We also continue to introduce newproducts that may have undetected software or hardware defects.  Our customers may discover defects in ourproducts at any time after deployment or as their networks are expanded andmodified.  Any defects in our productsdiscovered in the future, or failures of our customers’ networks, whethercaused by our products or those of another vendor, could result in lost salesand market share and negative publicity regarding our products.  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 higher than anticipated costs of sales,which management believes were necessary to maintain customersatisfaction.  In 2007, we experiencedhigher than average failures of certain assemblies that were fabricated betweenOctober 2005 and January 2006 and identified a design issuesassociated with a transistor that resulted in equipment 

 

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disruptionand that required a rework effort.  As aresult, we increased our warranty accruals in 2008.  Recently, we have identified malfunctions ordefects that we were required to repair under applicable warranties (or electedto repair for customer relations purposes) related to equipment that had beenin service for extended periods of times. Defects, malfunctions, or other performance issues relating to ourproducts could increase our warranty accruals and operating expenses, couldhave an adverse effect on market perceptions of our products, and could have amaterial adverse effect on our business, consolidated results of operations,and consolidated financial condition.

 

***Our efforts to increase our sales and marketingefforts to larger telecom operators, which may require us to broaden ourreseller relationships, may be unsuccessful.***

*** ***

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

 

***If we were to experience payment problems with eitherresellers or customers for whom we are unable to assess creditworthiness, itcould have an adverse impact on our business, operating results, or financialcondition.***

*** ***

Valueadded resellers, or VARs, account for a substantial portion of our revenue in aquarter.  Some of these VARs are not wellcapitalized, making collection of receivables from them uncertain.  In addition, in certain instances, we arelimited in our ability to evaluate the creditworthiness of direct customers whodecline to provide us with financial information.  In 2007, in connection with the restatementof our consolidated financial statements, we adopted a revenue recognitionpolicy that we would not recognize revenue from those resellers who lacked anindependent ability to pay us until we received cash payment.  Sales to VARs for whom we are not able torecognize revenue until we receive cash payment are reflected as deferredrevenue.  Any material collection issueswe may experience with these resellers or direct customers could have anadverse impact on our business, operating results, or financial condition andcould result in increases in bad debt expense or collection costs, inventoryimpairments, or adjustments to our reported revenues or deferred revenues.  Any of these could result in a decline in ourstock price.

 

***We rely on resellers to promote, sell, install andsupport our products to small customers in North America, and their failure todo so or our inability to recruit or retain resellers may substantially reduceour sales and thus seriously harm our business.***

*** ***

Werely on value added resellers who can provide high quality sales and supportservices.  We compete with othertelecommunications systems providers for our resellers’ business as ourresellers generally market competing products. If a reseller promotes a competitor’s products to the detriment of ourproducts or otherwise fails to market our products and services effectively, wecould lose market share.  In addition,the loss of a key reseller or the failure of resellers to provide adequatecustomer service could have a negative effect on customer satisfaction andcould cause harm to our business.  If wedo not properly train our resellers to sell, install and service our products,our business, financial condition and results of operations will suffer.

 

***We may be unable to successfully expand ourinternational operations.  In addition,our international expansion plans, if implemented, will subject us to a varietyof risks that may adversely affect our business.***

*** ***

Wecurrently generate almost all of our sales from customers in North America andhave very limited experience marketing, selling and supporting our products andservices outside North America or managing the administrative aspects of aworldwide operation.  While we intend toexpand our international operations, we may not be able to create or maintaininternational market demand for our products. In addition, regulations or standards adopted by other countries mayrequire us to redesign our existing products or develop new products suitablefor sale in those countries.  If weinvest substantial time and resources to expand our international operationsand are unable to do so successfully and in a timely manner, our business,financial condition and results of operations will suffer.  In the course of expanding our internationaloperations and operating overseas, we will be subject to a variety of risks,including:

 

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·                  differing regulatory requirements,including tax laws, trade laws, labor regulations, tariffs, export quotas,custom duties or other trade restrictions and changes thereto;

 

·                  greater difficulty supporting andlocalizing our products;

 

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

 

·                  challenges inherent in efficientlymanaging an increased number of employees over large geographic distances,including the need to implement appropriate systems, policies, benefits andcompliance programs;

 

·                  limited or unfavorable intellectualproperty protection;

 

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

 

·                  restrictions on the repatriation ofearnings.

 

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

*** ***

Oursuccess depends, in large part, on the continued contributions of our keymanagement, engineering, sales and marketing personnel, many of whom are highlyskilled and would be difficult to replace. None of our senior management or key technical or sales personnel isbound by a written employment contract to remain with us for a specifiedperiod.  In addition, we do not currentlymaintain key-man life insurance covering our key personnel.  If we lose the services of any key personnel,our business, financial condition and results of operations may suffer.

 

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

 

***We may have difficulty managing growth in ourbusiness, if any, which could limit our ability to increase sales and cashflow.***

*** ***

We expect to expand ourresearch and development, sales, marketing and support activities, includingour activities outside the U.S. depending on future business and economicconditions.  Our historical growth hasplaced, and is expected to continue to place, significant demands on ourmanagement, as well as our financial and operational resources, as required to:

 

·                  implement and maintain effectivefinancial disclosure controls and procedures, including the remediation ofinternal control deficiencies identified in our audit committee investigation;

 

·                  implement appropriate operational andfinancial systems;

 

·                  manage a larger organization;

 

·                  expand our manufacturing and distributioncapacity;

 

·                  increase our sales and marketing efforts;and

 

·                  broaden our customer supportcapabilities.

 

In addition, as discussedin this Quarterly Report on Form 10-Q under Part I, Item 4, ourinternal controls over financial reporting are currently ineffective, and wewill need to expand our finance organization and retain outside advisors toimplement adequate and effective financial controls.  If we cannot grow or manage our businessgrowth effectively, we may not be able to execute our business strategies andour business, consolidated financial condition and consolidated results ofoperations would suffer.

 

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***Because we depend upon a small number of outsidecontractors to manufacture our products, our operations could be disrupted ifwe encounter problems with any of these contractors.***

*** ***

Wedo not have internal manufacturing capabilities and rely upon a small number ofcontract manufacturers to build our products. In particular, we rely on Flash Electronics, Inc. for themanufacture of our BLC 6000 blade products. Our reliance on a small number of contract manufacturers makes usvulnerable to possible capacity constraints and reduced control over componentavailability, delivery schedules, manufacturing yields and costs.  We do not have long-term supply contractswith our primary contract manufacturers. Consequently, these manufacturers are not obligated to supply productsto us for any specific period, in any specific quantity or at any certainprice, except as may be provided by a particular purchase order.  If any of our manufacturers were unable orunwilling to continue manufacturing our products in required volumes and athigh quality levels, we would have to identify, qualify and select acceptablealternative manufacturers.  It ispossible that an alternate source may not be available to us when needed or maynot be in a position to satisfy our production requirements at commerciallyreasonable prices and quality.  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.

 

Aportion of our manufacturing was moved to the overseas facilities of ourprimary contract manufacturer.  Thistransition presents a number of risks, including the potential for a supplyinterruption or a reduction in manufacturing quality or controls, any of whichwould negatively impact our business, customer relationships and results ofoperations.

 

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

*** ***

Wedepend on sole source and limited source suppliers for key components of ourproducts.  We may from time to time enterinto original equipment manufacturer (OEM) and/or original design manufacturer(ODM) agreements to manufacture and/or design certain products.  Any of the sole source and limited sourcesuppliers, OEM and ODM 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 supply agreements with our suppliers, and ourpurchase volumes are currently too low for us to be considered a prioritycustomer by most of our suppliers.  As aresult, these suppliers could stop selling components to us at commercially reasonableprices, or at all.  Any such interruptionor delay may force us to seek similar components from alternate sources, ifavailable at all.  Switching suppliersmay require that we redesign our products to accommodate the new component andmay potentially require us to re-qualify our products with our customers, whichwould be costly and time-consuming.  Anyinterruption in the supply of sole source or limited source components wouldadversely affect our ability to meet scheduled product deliveries to ourcustomers and would materially and adversely affect our business, consolidatedfinancial condition and consolidated results of operations.

 

Periodically,we may be required to license technology from third parties to develop newproducts or product enhancements.  Thesethird party licenses may be unavailable to us on commercially reasonable terms,if at all.  Our inability to obtainnecessary third party licenses may force us to obtain substitute technology oflower quality 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 our manufacturingrequirements and manage our inventory, we could incur additional costs,experience manufacturing delays, or lose revenue.***

*** ***

Leadtimes for the materials and components that we order through our contractmanufacturers may vary significantly and depend on numerous factors, includingthe specific supplier, contract terms and market demand for a component at agiven time.  If we overestimate ourproduction requirements, our contract manufacturers may purchase excesscomponents and build excess inventory. If our contract manufacturers purchase excess components that are uniqueto our products or build excess products, we could be required to pay for theseexcess parts or products and recognize related inventory write-down costs.  If we underestimate our product requirements,our contract manufacturers may have inadequate component inventory, which couldinterrupt manufacturing of our products and result in delays or cancellation ofsales.  In prior periods we haveexperienced excess and obsolete inventory write downs which impact our cost ofrevenue.  This may continue in thefuture, which would have an adverse effect on our gross margins, consolidatedfinancial condition and consolidated results of operations.

 

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

*** ***

Demand for our productsis dependent on the success of our customers in deploying and selling servicesto their subscribers.  Our BLC 6000platform simultaneously supports 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.

 

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

 

***Changes in existing accounting or taxation rules orpractices may adversely affect our consolidated results of operations.  In addition, as we expand our business, we couldbecome subject to taxation in new states or jurisdictions, which will requireus to incur additional compliance costs and potential taxes and fees associatedwith complying with such tax laws.***

*** ***

Weare subject to numerous tax and accounting requirements, and changes inexisting 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 fiscal2006, we accounted for options granted to employees using the intrinsic valuemethod, which, given that we generally granted employee options with exerciseprices equal to the fair market value of the underlying stock at the time ofgrant, resulted in no compensation expense. Beginning in fiscal 2006, we began recording expenses for our stockbased compensation plans, including option grants to employees, using the fairvalue method, under which we expect our ongoing accounting charges related toequity awards to employees to be significantly greater than those we would haverecorded under the intrinsic value method. We expect to continue to use stock based compensation as a significantcomponent of our compensation package for existing and future employees.

 

Accordingly,changes in accounting for stock based compensation expense are expected to havea material adverse affect on our reported results.  Any similar changes in accounting or taxationrules or practices could have a material impact on our consolidatedfinancial results or the way we conduct our business.

 

Inrecent years, the geographic scope of our business has expanded, and suchexpansion requires us to comply with the tax laws and regulations of multiplejurisdictions.  Requirements as totaxation vary substantially among states and other jurisdictions.  We have recently expanded our internationalsales activity and may become subject to foreign tax laws as well, particularlyrelated to value added taxes.  Complyingwith the tax laws of these jurisdictions can be time consuming and expensiveand could subject us to penalties and fees if we inadvertently fail tocomply.  In the United States, taxauthorities in states where we believed we were not subject to sales tax couldassert jurisdiction and seek to collect sales taxes, which could result inincreased compliance expense as well as penalties and could adversely affectour customer relationships if it is determined we need to collect sales taxesfor prior transactions.  In the event wefail inadvertently to comply with applicable tax laws, it could have a materialadverse effect on our business, results of operations, and financial condition.

 

***The amount of our net operating loss carryforwards, orNOLs, is uncertain, and prior transactions to which we have been a party andfuture transactions to which we may become a party, including stock issuancesand certain shareholder stock transactions may jeopardize our ability to usesome or all of our NOLs.  In addition,California and certain states have recently suspended or are consideringsuspending, the ability to use net operating loss carryforwards in future yearsand this could adversely affect future operating results.***

*** ***

Basedon current tax law, we believe we have certain net operating losscarryforwards, or NOLs, for U.S. federal and state income tax purposes tooffset future taxable income.  As of September 30,2009, we had incurred significant losses in the United States.  Our ability to utilize these NOLs may besubject to significant limitations under Section 382 of the InternalRevenue Code if we have undergone, or undergo in the future, an ownershipchange.  An ownership change occurs forpurposes of Section 382 of the Internal Revenue Code if, among otherthings, stockholders who own or have owned, directly or indirectly, 5% or moreof our common stock (with certain groups of less-than-5% stockholders treatedas a single stockholder for this purpose) increase their aggregate percentageownership of our common stock by more than fifty percentage points above thelowest percentage of the stock owned by these stockholders at any time duringthe relevant three-year testing period. In the event of an ownership change, Section 382 imposes an annuallimitation, based upon our value at the time of the ownership change, on theamount of taxable income a corporation may offset with NOLs.  Any unused annual limitation may be carriedover to later years until the applicable expiration date for the respectiveNOLs.

 

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Webelieve that past events, such as the merger of Occam CA with AcceleratedNetworks, our private placements of preferred stock, and other equitytransactions (including our 2006 public offering) triggered an ownership changefor purposes of Section 382 of the Internal Revenue Code.  Even if certain of these prior transactionsdid not trigger an ownership change, they increased the likelihood that we mayundergo an ownership change in the future. Any such ownership change would limit, possibly significantly, ourability to use any U.S. federal and state NOLs as described above.

 

Tothe extent that these NOLs become significantly limited, we expect to be taxedon our income, if any, at the U.S. federal and state statutory rates.  As a result, any inability to utilize theseNOLs would adversely affect future operating results by the amount of thefederal or state taxes that would not have otherwise been payable, having anadverse impact on our operating results and financial condition.  In addition, inability to use NOLs wouldadversely affect our financial condition relative to our financial conditionhad the NOLs been available.  Inaddition, California and certain states have suspended use of NOLs, and otherstates are considering similar measures. As a result, we may incur higher state income tax expense in thefuture.  Depending on our future taxposition, continued suspension of our ability to use state NOLs could have anadverse impact on our operating results and financial condition.

 

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

*** ***

Wemay make acquisitions of businesses, products or technologies to expand ourproduct offerings and capabilities, customer base and business.  In October 2007, we acquired certainassets and assumed certain liabilities of Terawave Communications and we haveevaluated, and expect to continue to evaluate, a wide array of potentialstrategic transactions.  We have limited experiencemaking such acquisitions.  Any of thesetransactions could be material to our consolidated financial condition andresults of operations.  The anticipatedbenefit of acquisitions may never materialize. In addition, the process of integrating an acquired business, productsor technologies may create unforeseen operating difficulties andexpenditures.  Some of the areas where wemay face acquisition related risks include:

 

·                  diversion of management time and potential businessdisruptions;

 

·                  expenses, distractions and potential claims resultingfrom acquisitions, whether or not they are completed;

 

·                  retaining and integrating employees from anybusinesses we may acquire;

 

·                  issuance of dilutive equity securities or incurrenceof debt;

 

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

 

·                  incurring possible write-offs, impairment charges,contingent liabilities, amortization expense or write-offs of goodwill;

 

·                  difficulties integrating and supporting acquiredproducts or technologies;

 

·                  unexpected capital equipment outlays and relatedcosts;

 

·                  insufficient revenues to offset increased expensesassociated with the acquisition;

 

·                  under performance problems associated withacquisitions;

 

·                  opportunity costs associated with committing capitalto such acquisitions;, and

 

·                  becoming involved 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 we will be able toaddress these risks successfully, or at all, without incurring significant costs,delay or other operating problems.  Ourinability to resolve any of such risks could have a material adverse impact onour business, consolidated financial condition and consolidated results ofoperations.

 

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***Businesscombinations and other financial restructurings by telecom service providers orour competitors could adversely affect 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) withBellSouth Corporation (now also renamed AT&T), and the merger of VerizonCommunications Inc. with MCI, Inc. Transactions such as these generally have negative implications forequipment suppliers like us, including a reduction in the number of potentialcustomers for telecom equipment products, a decrease in aggregate capitalspending and greater pricing power by service providers over equipmentsuppliers.  Continued consolidation ofthe telecom service provider industry, including among IOC customers which wefocus on, could make it more difficult for us to grow our customer base,increase sales 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 ourcompetitors, or merger between our competitors, could harm our competitiveposition or cause our target customers to delay purchases of our products whilethey assess the impact of the combination. If a larger company with more resources were to acquire a competitor ofours, they may invest additional resources in developing, marketing andsupporting competitive products, which would negatively impact our business,consolidated financial condition and consolidated results of operations.

 

***Ourcustomers are subject to government regulation, and changes in current orfuture laws or regulations that negatively impact our customers could harm our business.***

*** ***

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

 

***If we fail tocomply with regulations and evolving industry standards, sales of our existingand future products could be adversely 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 comply with these laws, regulations andstandards, including those promulgated by the FCC.  For example, the FCC recently required thatall facilities based providers of broadband Internet access and interconnectVoIP services meet the capability requirements of the Communications Assistancefor 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 obtain certifications orauthorizations before our products can be introduced, marketed or sold.  There can be no assurance that we will beable to continue to design our products to comply with all necessaryrequirements in the future.  Accordingly,any of these laws, regulations and standards may directly affect our ability tomarket or sell our products.

 

Someof our operations are regulated under various federal, state and localenvironmental laws.  Our plannedinternational expansion will likely subject us to additional environmental andother laws.  For example, the EuropeanUnion Directive 2002/96/EC on waste electrical and electronic equipment, knownas the WEEE 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 Union Directive 2002/95/EC onthe restriction of the use of hazardous substances in electrical and electronicequipment, known as the RoHS Directive, restricts the use of certain hazardoussubstances, including lead, in covered products.  Failure to comply with these and otherenvironmental laws could result in fines and penalties and decreased sales,which could adversely affect our planned international expansion and ourconsolidated operating results.

 

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***Compliance withchanging regulation of corporate governance and public disclosure may result inadditional expenses.***

*** ***

Changing laws,regulations and standards relating to corporate governance and publicdisclosure may create uncertainty regarding compliance matters. New or changedlaws, regulations and standards are subject to varying interpretations in manycases. As a result, their application in practice may evolve over time. We arecommitted to maintaining high standards of corporate governance and public disclosure.Complying with evolving interpretations of new or changed legal requirementsmay cause us to incur higher costs as we revise current practices, policies andprocedures, and may divert management time and attention from revenuegenerating to compliance activities. If our efforts to comply with new orchanged laws, regulations and standards differ from the activities intended byregulatory or governing bodies due to ambiguities related to practice, ourreputation might also be harmed. Further, our board members, chief executiveofficer and chief financial officer could face an increased risk of personalliability in connection with the performance of their duties. As a result, wemay have difficulty attracting and retaining qualified board members andexecutive officers, which could harm our business.

 

***We may not be ableto protect our intellectual property, which could adversely affect our abilityto compete effectively.***

*** ***

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

 

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 our proprietary rights against unauthorized thirdparty copying or use.  Furthermore,policing the unauthorized use of our intellectual property would be difficultfor us.  Litigation may be necessary inthe future to enforce our intellectual property rights, to protect our tradesecrets or to determine the validity and scope of the proprietary rights of others.  Litigation could result in substantial costsand diversion of resources and could have a material adverse effect on ourbusiness, consolidated financial condition and consolidated results ofoperations.

 

***We could becomesubject to litigation regarding intellectual property rights that couldmaterially 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.  Our industry is characterized by frequentintellectual property litigation based on allegations of infringement ofintellectual property rights.  From timeto time, third parties have asserted against us and may assert against us inthe future patent, copyright, trademark or other intellectual property rightsto technologies or rights that are important to our business.  In addition, we have agreed, and may in thefuture agree, to indemnify our customers for any expenses or liabilities resultingfrom claimed infringements of patents, trademarks or copyrights of thirdparties.  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 in product shipment delays or require usto modify our products or enter into royalty or licensing agreements.  Such royalty or licensing agreements, ifrequired, may not be available to us on acceptable terms, if at all.

 

***Our business couldbe shut down or severely impacted if a natural disaster or other unforeseencatastrophe 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 businessactivities currently take place in regions considered as high risk for certaintypes 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 ourinsurance coverage is comparable to those of similar companies in our industry,it does not cover all natural disasters, in particular, earthquakes and floods.

 

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***Risks Related toOur Common Stock***

*** ***

***Our executiveofficers, directors and their affiliates hold a large percentage of our stockand their interests may differ from other stockholders.***

*** ***

Asof September 30, 2009, our executive officers, directors and theiraffiliates beneficially owned, in the aggregate, approximately 29% of ouroutstanding common stock, of this 28% is collectively owned by investment fundsaffiliated with U.S. Venture Partners and Norwest Venture Partners.  Representatives of U.S. Venture Partners andNorwest Venture Partners are directors of Occam.  These stockholders have significant influenceover most matters requiring approval by stockholders, including the election ofdirectors, any amendments to our certificate of incorporation and significantcorporate transactions.

 

***Our stock pricemay be volatile, and you may not be able to resell shares of our common stockat or above the price you paid.***

*** ***

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

 

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

 

·                  quarterly variations in our consolidated results ofoperations or those of our competitors;

 

·                  changes in earnings estimates or recommendations bysecurities analysts;

 

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

 

·                  developments with respect to intellectual propertyrights;

 

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

 

·                  commencement of, or involvement in, litigation;

 

·                  general market volatility;

 

·                  lack of capital to invest in Occam;

 

·                  changes in governmental regulations or in the statusof our regulatory approvals;

 

·                  a slowdown in the telecom industry or general economy;and

 

·                  continuation of the current economic and creditcrisis.

 

In recent years, thestock market in general, and the market for technology companies in particular,has experienced extreme price and volume fluctuations that have often beenunrelated or disproportionate to the operating performance of thosecompanies.  Broad market and industryfactors may seriously affect the market price of our common stock, regardlessof our actual operating performance.  Inaddition, in the past, following periods of volatility in the overall marketand the market price of a particular company’s securities, securities classaction litigation has often been instituted against these companies.  We are currently a defendant in securitiesclass action litigation arising from the restatement of our consolidatedfinancial statements.  This litigation orany additional litigation that may be instituted against us could result insubstantial costs and a diversion of our management’s attention and resources.

 

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***Provisions in ourcharter documents and under Delaware law could discourage a takeover thatstockholders may consider favorable.***

*** ***

Provisions in ourcertificate of incorporation and bylaws, as amended and restated, may have theeffect of delaying or preventing a change of control or changes in ourmanagement.  These provisions include thefollowing:

 

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

 

·                  our stockholders may not act by written consent orcall special stockholders’ meetings; as a result, a holder, or holders,controlling a majority of our capital stock would not be able to take certainactions other than at annual stockholders’ meetings or special stockholders’meetings called by the board of directors, the chairman of the board, the chiefexecutive officer or the president;

 

·                  our certificate of incorporation prohibits cumulativevoting in the election of directors, which limits the ability of minoritystockholders to elect director candidates;

 

·                  stockholders must provide advance notice to nominateindividuals for election to the board of directors or to propose matters thatcan be acted upon at a stockholders’ meeting, which may discourage or deter apotential acquiror from conducting a solicitation of proxies to elect theacquiror’s own slate of directors or otherwise attempting to obtain control ofour company; and

 

·                  our board of directors may issue, without stockholderapproval, shares of undesignated preferred stock; the ability to authorizeundesignated preferred stock makes it possible for our board of directors toissue preferred stock with voting or other rights or preferences that couldimpede the success of any attempt to acquire us.

 

As a Delawarecorporation, we are also subject to certain Delaware anti-takeoverprovisions.  Under Delaware law, acorporation may not engage in a business combination with any holder of 15% ormore of its capital stock unless the holder has held the stock for three yearsor, among other things, the board of directors has approved thetransaction.  Our board of directorscould rely on Delaware law to prevent or delay an acquisition of us.

 

***We may be unableto raise additional capital to fund our future operations, and any futurefinancings or acquisitions could result in substantial dilution to existingstockholders.***

*** ***

Whilewe anticipate our cash balances and any cash from operations, will besufficient to fund our operations for at least the next 12 months, we may needto raise additional capital to fund operations in the future.  There is no guarantee that we will be able toraise additional equity or debt funding when or if it is required.  The terms of any financing, if available,could be unfavorable to us and our stockholders and could result in substantialdilution to the equity and voting interests of our stockholders.  Any failure to obtain financing when and asrequired would have an adverse and material effect on our business,consolidated financial condition and consolidated results of operations.

 

***If securities orindustry analysts do not publish research or publish misleading or unfavorableresearch about our business, our stock price and trading volume could decline.***

*** ***

Thetrading market for our common stock depends in part on the research and reportsthat securities or industry analysts publish about us or our business.  If no or few securities or industry analystscover our company, the trading price for our stock would be negativelyimpacted.  If one or more of the analystswho covers us downgrades our stock or publishes misleading or unfavorableresearch about our business, our stock price would likely decline.  If one or more of these analysts ceases coverageof our company or fails to publish reports on us regularly, demand for ourstock could decrease, which could cause or stock price or trading volume todecline.

 

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

 

None.

 

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

 

None.

 

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

 

None

 

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

 

None

 

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

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

 

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**SIGNATURES**

 

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

 
| Dated: November 6,  2009 | OCCAM NETWORKS, INC. |
|-------------------------------|----------------------|
|                          |                 |
|                          | (Registrant)         |
|                          |                 |   |
|                          |                 |   |
|                          | By:                  | /s/ JEANNE SEELEY |
|                          |                 | Jeanne Seeley |
|                          |                 | Senior Vice President and  Chief Financial Officer |
|                          |                 | (Principal Financial and  Accounting Officer) |

 

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**EXHIBIT INDEX**

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

 

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