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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

COMMISSION FILE NUMBER: 000-24597

CARRIER ACCESS CORPORATION
(Exact name of registrant as specified in its charter)

5395 Pearl Parkway, Boulder, CO 80301
(Address of principal executive offices)
(Zip Code)

(303) 442-5455
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  X   No___

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

     The number of shares outstanding of the issuer’s common stock, par value $0.001, as of September 30, 2002 was 24,771,498 shares.

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CARRIER ACCESS CORPORATION

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARRIER ACCESS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)

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

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CARRIER ACCESS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share amounts)

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

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CARRIER ACCESS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

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

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CARRIER ACCESS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Business and Basis of Presentation

     We manufacture equipment for wireline and wireless telecommunications carriers, the government, and enterprise end-users. We focus on broadband access from the central office to the customer premises, voice and data service creation at end-user locations, and next-generation wireless infrastructure.

     Our Access Bank®, Wide Bank®, Access Navigator®, Adit™, Broadmore™, and Axxius™ products are connected to T1, digital subscriber line, digital radio, T3, OC12, and optical access networks to provide enhanced communications services for businesses, wireless and government networks. Our NetworkValet™ product, a software element management system, coordinates the provisioning, monitoring, and maintenance among the products and interfaces with other network management systems.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in our opinion, such condensed consolidated financial statements reflect all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of interim period results. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 29, 2002.

     The results of operations for the interim periods are not necessarily indicative of results to be expected for the entire year or for other future interim periods.

Note 2.Inventory

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

Note 3. Goodwill

     We first recorded goodwill and other related intangibles and their related amortization in connection with the acquisition of Millennia Systems, Inc. (“Millennia”) in August 2000 and the subsequent acquisition of certain product lines of Litton Network Access Systems, a division of Litton Systems, Inc. (“LNAS”), in October 2000. Goodwill and other related intangibles were amortized on a straight-line basis over the estimated useful lives ranging from three to five years. In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” SFAS 142 requires that goodwill no longer be amortized, but instead be reviewed for impairment on an on-going basis. Accordingly, the amortization of goodwill and other related intangibles ceased upon adoption of the SFAS 142 on January 1, 2002. We have determined that we have one reporting unit. As of the date of the adoption, we performed the test for impairment and no impairment was indicated. Due to our declining stock price, we reviewed our goodwill for impairment as of September 30, 2002 and determined that the entire carrying amount of our goodwill had been impaired. Therefore an asset impairment charge of $9.0 million was taken in the third quarter. The reconciliation of reported net loss and reported loss per share with adjusted net loss and adjusted loss per share representing the effect of adopting SFAS 142, is as follows (in thousands, except per share amounts):

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Note 4. Income taxes

     We account for our deferred tax assets pursuant to Statement of Financial Accounting Standards No. 109 (“SFAS No. 109”), “Accounting for Income Taxes.” Under SFAS No. 109, a deferred tax asset is recognized for differences that will result in tax deductions in future years and for tax credit carry forwards. For example, a temporary difference is created when an estimated amount is recorded as an expense for a financial reporting purpose that is not deductible in the current year for income tax purposes (e.g. warranty reserves, sales return reserves, inventory reserves, etc.). A deferred tax asset is recognized in the current year for the reduction in taxes payable in future years when the expenses are actually incurred. A valuation allowance is required if it is more likely than not that the deferred tax asset will not be realizable in the near future. In the second quarter of 2002, we analyzed the sources of the deferred tax asset and expected reversal periods of our deferred tax assets and established a valuation allowance for temporary deferred tax assets of $12.8 million. It is anticipated that a federal net operating loss will be generated in 2002 and be carried back to obtain a refund on prior taxes paid.

Note 5. Earnings per share

     Earnings per share (EPS) is presented in accordance with Statement of Financial Accounting Standards No. 128 (“SFAS 128”), “Earnings Per Share.” SFAS 128 requires the presentation of basic and diluted EPS. Under SFAS 128, basic EPS excludes dilution for common shares potentially issuable and is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted and resulted in the issuances of common stock. Diluted income per share excludes the impact of common stock options for the three and nine months ended September 30, 2002 and 2001, as the effect of any exercise of stock options would be antidilutive. Options exercisable for 1,168,652 shares of our common stock are excluded because they would be antidilutive.

Note 6. Comprehensive Income

     Comprehensive Income consists of unrealized gains or losses on marketable securities held for sale of $19,000.

Note 7. Commitments and contingencies

     On December 28, 2001, SCI, Inc., one of our manufacturers, filed a breach of contract claim for $4.5 million against us in Alabama Circuit Court based on an inventory-purchasing dispute. On September 18, 2002, we settled this claim for approximately $2.6 million in return for a major portion of the disputed inventory, which has a current valuation of approximately $600,000 net of reserves, and entered into a manufacturing arrangement for our Broadmore product. The settlement of this claim had no effect on the results of this quarter.

     On August 16, 2002, SMTC Manufacturing Corporation of Colorado filed a breach of contract claim and other related claims for a total of $13.4 million against us in District Court, County of Adams, Colorado, based on an inventory-purchasing dispute. On October 17, 2002, we filed a breach of contract counterclaim, and other related counterclaims, in District Court, County of Adams, Colorado, for $1.0 million. We intend to vigorously defend this lawsuit.

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Note 8. Recent accounting pronouncements

     In August 2001, FASB issued Statement of Financial Accounting Standards No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations.” SFAS 143 establishes accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. It also provides accounting guidance for legal obligations associated with the retirement of tangible long-lived assets. SFAS 143 is effective in fiscal years beginning after June 15, 2002, with early adoption permitted. We expect that the provisions of SFAS 143 will not have a material impact on our consolidated results of operations and financial position upon adoption. We plan to adopt SFAS 143 effective January 1, 2003.

     In April 2002, FASB issued Statement of Financial Accounting Standard No. 145 (“SFAS 145”), “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS 145 updates, clarifies and simplifies existing accounting pronouncements. SFAS 145 rescinds Statement 4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. Statement 64 amended Statement 4, and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Because the transition is complete, Statement 44 is no longer necessary. SFAS 145 amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions are accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with the FASB’s goal of requiring similar accounting treatment for transactions that have similar economic effects. SFAS 145 also makes technical corrections to existing pronouncements. SFAS 145 is effective for fiscal years beginning after May 15, 2002 with early adoption of the provisions related to the rescission of Statement 4 encouraged. We expect that the provisions of SFAS 145 will not have a material impact on our consolidated results of operations and financial position upon adoption. We plan to adopt SFAS 145 effective January 1, 2003.

     In June 2002, FASB issued Statement of Financial Accounting Standards No. 146 (“SFAS 146”), Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and nullifies the guidance of EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring), which recognized a liability for an exit cost at the date of an entity’s commitment to an exit plan. SFAS 146 requires that the initial measurement of a liability be at fair value. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 with early adoption encouraged. The Company plans to adopt SFAS 146 effective January 1, 2003 and does not expect that the adoption will have a material impact on its consolidated results of operations and financial position.

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

     Notice Concerning Forward-Looking Statements

     You should read the following discussion in conjunction with our consolidated financial statements. This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including forward-looking statements regarding inventory levels, sales of our new products, expectations regarding expenses and ability to meet operating requirements over the next few quarters, reliance upon and sales to certain customers, customer revenue mix, product mix, level of product orders, gross margins and operating costs, and expected capital expenditures. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “intends,” “plans,” “anticipates,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology. These forward-looking statements are based on current expectations and projections about our industry and assumptions made by the management and are not guarantees of future performance. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, these expectations or any of the forward-looking statements could prove to be incorrect, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to risks and uncertainties, including, but not limited to, the factors set forth below and in “Risk Factors” and elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update any such forward-looking statements or reasons why actual results may differ.

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Results of Operations

     Summary

     For the three months ended September 30, 2002, our loss from operations and net loss were $16.0 million and $14.9 million, respectively, compared to an operating loss and net loss of $14.1 million and $8.2 million, respectively, for the three months ended September 30, 2001. For the nine months ended September 30, 2002, our loss from operations and net loss were $44.1 million and $44.6 million, respectively, compared to an operating loss and net loss of $20.6 million and $11.1 million, respectively, for the nine months ended September 30, 2001. These losses were primarily caused by a decrease in the sale of existing products due to overall economic weakness and capital market constraints impacting telecommunication service providers, an increase in allowance for doubtful accounts, an increase in reserves for slow moving inventory, impairment of goodwill, and a lower gross margin. Operating expenses included a charge of $2.0 million taken in the second quarter 2002 related to a settlement for an inventory-purchasing dispute. Gross margins decreased in part due to decreases in the selling price of some of our products, an increase in reserves for slow moving and excess inventory, and low production levels. inventory position and decreased sales. Our net loss also increased for the nine months ended September 30, 2002, because of a non-cash charge of approximately $12.8 million as a provision for income taxes due to a valuation allowance related to our net operating loss carry forwards.

     We implemented an expense reduction program in July 2001 to focus on the largest opportunities in incumbent local exchange carrier (“ILEC”), wireless, and cable multi-service operator (“MSO”) markets. The program included quarterly reviews to align our operating expenses to our projections for future revenue. This process has resulted in reductions of our work force of approximately 241 positions from July 2001 to July 2002. As a result of our lower revenue in the September 2002 quarter combined with the continued reductions in spending within the telecommunications industry, we further reduced our work force in October 2002 by approximately 60 positions. We continue to monitor expenses through our business plan review process.

Net Revenue and Cost of Goods Sold

     Net revenue for the three months ended September 30, 2002 decreased to $10.5 million from $20.9 million reported for the three months ended September 30, 2001. Net revenue for the nine months ended September 30, 2002 decreased to $38.8 million from $79.2 million reported for the nine months ended September 30, 2001. These decreases were attributable to: (1) decreases in the sale of existing products through distribution channels and through direct sales due to capital expenditure reductions by carrier customers, and the continued constraints on technology spending and (2) reductions in prices for our products. We believe that our customer base is changing. In the past we relied upon two to five customers in the competitive local exchange carrier (“CLEC”) market for approximately half of our revenue. Currently, however, we rely upon a broader base of end-users in several markets for our revenue. We anticipate that in the future we may again rely on a small number of end-users primarily in the ILEC and wireless market for the majority of our revenue. Sales of the Axxius, Wide Bank and Adit products accounted for the majority of revenue in the third quarter of 2002. In order to execute our plan to increase sales substantially into the wireless market, particularly over the next six months, the major wireless carriers must accept and deploy our products. A delay in acceptance of our wireless products could have a material adverse effect on our operating results. See “Risk Factors — We Must Maintain and Expand Our Sales into Wireless, ILEC and Cable MSO Markets” and “—Our Growth Is Dependent on Our Introduction of New Products and Enhancements to Existing Products and Failure to Bring New Products to Markets and Any Delay in Customers’ Transition to Our New Products Could Adversely Affect Our Business.” The timing and quantities of orders for our products may continue to vary from quarter to quarter in the future, as they have in the past, due to factors such as demand for our products, economic conditions, and ordering patterns of distributors and direct customers. We believe that variances in orders will continue in the future, especially if the percentage of direct sales to large service provider customers increases.

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     During the nine month period ended September 30, 2002, approximately half of the sales of our products were made through distributors. Our success depends in part on the continued sales and customer support efforts of our network of distributors and increased sales to our direct customers. In the three months ended September 30, 2002, Walker & Associates, Inc. (“Walker”), one of our distributors, accounted for over 10% of net revenue. We expect that we will continue to sell our products through a small number of distributors. Accordingly, the loss of, or a reduction in sales to, any of our key distributors could have a material adverse effect on our business, as happened in the quarter ended June 30, 2002 when Walker’s sales decreased to below 10% of net revenue for the quarter. In addition to being dependent on a small number of distributors for approximately half of our net revenue, our products are also sold to a limited number of service provider customers. In the three months ended September 30, 2002, one of our wireless end-user customer, T-Mobile USA, accounted for over 10% of our net revenue. A decrease in sales to T-Mobile USA, or any other major customer, could have a significant adverse effect on our operating results, as happened in the quarter ended June 30, 2002 when sales to Adelphia Business Solutions, Inc. (“Adelphia”), a 10% customer in the quarter ended March 31, 2002, decreased to below 10% of net revenue for that subsequent quarter.

     Cost of goods sold for the three months ended September 30, 2002 decreased to $6.3 million compared to $13.6 million for the three months ended September 30, 2001. Costs of goods sold for the nine months ended September 30, 2002 decreased to $25.9 million compared to $41.8 million for the nine months ended September 30, 2001. This decrease was primarily attributable to decreased product shipments and partially affected by cost reductions in existing product platforms. The decrease was partially offset by increases in inventory reserves for slow moving and excess inventory as well as overhead expenses allocated over fewer product units due to low production levels.

Gross Margin

     Our gross margin for the three months ended September 30, 2002 increased to 40% from 35% reported for the three months ended September 30, 2001. Our gross margin for the nine months ended September 30, 2002 decreased to 33% from 47% reported for the nine months ended September 30, 2002. The decrease in year-to-date gross margin was driven primarily by charges taken for slow moving and excess inventory in the first and second quarters of 2002, as well as by changes in production levels. We increased our inventory reserves by $1.8 million in the quarter ended March 31, 2002 and by $1.2 million for the quarter ended June 30, 2002. We determined that no additional reserves were required for the quarter ended September 30, 2002. In estimating the reserve for slow moving and excess inventory, we considered the forecast by product for the next twelve months and other known trends and circumstances relating to our inventory. Gross margin also decreased in the nine-month period ended September 30, 2002 because we had low production levels due to our inventory position and decreased sales, which increased overhead expense not capitalized to inventory. The low production levels resulted in period expenses taken for overhead of $937,000 in the quarter ended March 31, 2002, $648,000 in the quarter ended June 30, 2002, and $867,000 in the quarter ended September 30, 2002. We also decreased the selling price of some of our products, which contributed to the decrease in our gross margins. In addition, our gross margins vary among products. The decrease in gross margins was partially offset by product cost reductions.

     We believe that gross margins could continue to decrease if additional pricing reductions occur in our products at a greater rate than anticipated cost reductions, if inventory reserves increase, or if production levels do not increase. New product introductions could also harm gross margins until production volumes increase. We believe that average selling prices and gross margins for our products will decline as such products mature, as volume price discounts in distributor contracts and direct sales relationships take effect, and as competition intensifies, among other factors. For example, the average selling price for the Wide Bank products and Adit products have decreased in the past two years. These decreases were due to unfavorable general economic conditions and the introduction of competitive products. In addition, discounts to distributors vary among products and are based on volume shipments, each of which affects gross margins. As a result, we believe that our gross margins are likely to fluctuate in the future based on product mix and channel mix. Furthermore, introduction of new products by competitors or us could reduce gross margins.

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Research and Development Expenses

     For the three months ended September 30, 2002, research and development expenses were $5.2 million, a decrease from $8.0 million reported for the three months ended September 30, 2001. For the nine months ended September 30, 2002, research and development expenses were $19.9 million, a decrease from $25.7 million reported for the nine months ended September 30, 2001. These decreases were primarily due to reductions in the research and development workforce and related lower volume trial products and regulatory expenses associated with these decreases. We anticipate that research and development expenses will decrease in the quarter ended December 31, 2002 compared to the quarter ended September 30, 2002 as a result of our reduction in research and development positions and related expenses.

Selling, General and Administrative Expenses

     Selling, general and administrative, and other expenses were $14.9 million for the three months ended September 30, 2002, up from $13.3 million reported for the three months ended September 30, 2001. Selling, general and administrative, and other expenses were $37.1 million for the nine months ended September 30, 2001, up from $32.3 million reported for the nine months ended September 30, 2001.

     Sales and marketing expenses decreased to $4.2 million for the three months ended September 30, 2002, from $6.1 million for the three months ended September 30, 2001. Sales and marketing expenses decreased to $14.2 million for the nine months ended September 30, 2002, down from $18.0 million for the nine months ended September 30, 2001. The decreases in marketing expenses were a result of a reduction in staff and reduced trade show expenses. The decreases in sales expenses were a result of a reduction in staff and decreases in commission expense due to lower revenues.

     General and administrative expenses, excluding goodwill amortization, decreased to $1.7 million for the three months ended September 30, 2002 from $1.9 million for the three months ended September 30, 2001. For the nine months ended September 30, 2002, general and administrative expenses, excluding goodwill amortization, increased to $13.6 million compared to $7.0 million for

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the nine months ended September 30, 2001. The increase was primarily due to an increase in our allowance for doubtful accounts of $5.4 million and a charge of $2.0 million related to the settlement of an inventory-purchasing dispute. We increased our accounts receivable reserve mainly for receivables due from two of our large CLEC customers, XO Communications, Inc. (“XO”) and Adelphia, which may become uncollectible due to their current financial situations. Both of these customers have announced plans to financially restructure and have filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code. We also increased our accounts receivable reserve for one of our distributors due to an increased risk in its customer base and the aging of its accounts receivable. In estimating the allowance for doubtful accounts, we considered the age of existing accounts and known trends and circumstances that we believe impact our credit risk and subsequent cash collections. As a result of cost control measures, including reductions in staff that began in July of 2001, we anticipate that selling, general and administrative expenses (excluding restructuring charges) will decrease over the next few quarters. In accordance with EITF Abstract Issue No. 94-3, we anticipate taking restructuring charges of between $2 million and $4 million in the fourth quarter of 2002. These charges relate to a plan being developed to dispose of excess assets, consolidate facilities and restructure operations.

Other Income, Net

     For the three months ended September 30, 2002, other income, net decreased to $128,000 from $350,000 for the three months ended September 30, 2001. Other income, net decreased to $592,000 for the nine months ended September 30, 2002 compared to $1.4 million for the same period in 2001. Both decreases are attributable to a decrease in interest income from decreased cash and marketable securities as well as a decrease in interest rates in 2002 compared to 2001. Cash and marketable securities totaled $23.3 million and $35.6 million for the quarters ending September 30, 2002 and 2001, respectively.

Provision for Income Taxes

     During the three months ending September 30, 2002 we recorded a tax benefit of $1.0 million. During this period we completed our 2001 income tax return and updated our income tax receivables for 2001. This adjustment resulted in a lower than historical income tax benefit for the quarter. We also re-evaluated our valuation allowance related to our deferred tax assets that we created during the second quarter of 2002 and believe there is no adjustment necessary at this time. This valuation allowance was established due to the uncertainty regarding the recognition of such assets. We will continue to monitor the realizability of our deferred tax assets each quarter and make adjustments as necessary.

Liquidity and Capital Resources

     At September 30, 2002, our principal sources of liquidity included cash and cash equivalents and marketable securities available for sale of approximately $23.3 million. At September 30, 2002, our working capital was approximately $61.9 million. We have no significant capital spending or purchase commitments other than facilities leases.

     Operating activities used net cash of approximately $13.7 million for the nine months ended September 30, 2002, compared to $12.1 million used by operating activities for the nine months ended September 30, 2001. The increase in cash used by operating activities was primarily due to our net loss incurred and decreases in accounts payable and was partially offset by reductions in our inventory and accounts receivable. As of the end of the third quarter 2002, we anticipated receiving approximately $12 million in income tax refunds, approximately $5.8 million from our income tax receivable and approximately $6.9 million of our deferred

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income taxes, prior to the end of 2003. As of November 13, 2002, we received approximately $5.1 million of these refunds, and continue to anticipate the remainder to be refunded by the end of 2003.

     Cash used by investing activities for the nine months ended September 30, 2002 was $571,000 compared to cash provided by investing activities of $571,000 for the nine months ended September 30, 2001. For the nine months ended September 30, 2002, we had net purchases of $986,000 of marketable securities compared to net sales of $5.1 million for the nine months ended September 30, 2001. Sales and dispositions of property and equipment for the nine months ended September 30, 2002 resulted in net cash provided of $415,000 compared to a cash outflow of $4.6 million for purchases of equipment to support research, development, and manufacturing activities for the nine months ended September 30, 2001. We believe our current facilities are sufficient to meet our current operating requirements. Capital expenditures during the remainder of 2002 are not expected to be significant.

     Net cash from financing activities provided $14,000 in cash for the nine months ended September 30, 2002, which was due to cash received upon the exercise of stock options, compared to $56,000 for the nine months ended September 30, 2001.

     Our net inventory levels decreased approximately $12.3 million to $24.7 million at September 30, 2002 from $36.5 million at December 31, 2001. We anticipate that inventory levels will continue to decline due to decreased purchasing for the remainder of 2002. We believe that our existing cash and investment balances, in addition to our expected income tax refunds of approximately $12 million, are adequate to fund our projected working capital and capital expenditure requirements for a period of greater than 12 months.

Recent Accounting Pronouncements

     In August 2001, the FASB issued SFAS 143, which establishes accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. It also provides accounting guidance for legal obligations associated with the retirement of tangible long-lived assets. SFAS 143 is effective in fiscal years beginning after June 15, 2002, with early adoption permitted. We expect that the provisions of SFAS 143 will not have a material impact on our consolidated results of operations and financial position upon adoption. We plan to adopt SFAS 143 effective January 1, 2003.

     In April 2002, the FASB issued SFAS 145, which updates, clarifies and simplifies existing accounting pronouncements. SFAS 145 rescinds Statement 4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. Statement 64 amended Statement 4, and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Because the transition is complete, Statement 44 is no longer necessary. SFAS 145 amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions are accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with the FASB’s goal of requiring similar accounting treatment for transactions that have similar economic effects. SFAS 145 also makes technical corrections to existing pronouncements. SFAS 145 is effective for fiscal years beginning after May 15, 2002 with early adoption of the provisions related to the rescission of Statement 4 encouraged. We expect that the provisions of SFAS 145 will not have a material impact on our consolidated results of operations and financial position upon adoption. We plan to adopt SFAS 145 effective January 1, 2003.

     In June 2002, FASB issued SFAS 146. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and nullifies the guidance of EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring), which recognized a liability for an exit cost at the date of an entity’s commitment to an exit plan. SFAS 146 requires that the initial measurement of a liability be at fair value. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 with early adoption encouraged. The Company plans to adopt SFAS 146 effective January 1, 2003 and does not expect that the adoption will have a material impact on its consolidated results of operations and financial position.

RISK FACTORS

     Investors should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones facing us. Additional risks not presently known to us, or that we currently believe to be immaterial may also impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks and investors may lose all or part of their investment. In assessing these risks, investors should also refer to other information contained in this Form 10-Q Report.

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We Have a Limited Operating History.

     We did not begin commercial deployment of our broadband digital access equipment until 1995. Prior to 1997, we recorded only nominal product revenue. Although we were profitable from 1997 through 2000, we had a net loss of $44.6 million in the nine months ended September 30, 2002 and an annual loss of $14.9 million in 2001. Accordingly, an investor in our common stock must evaluate the risks, uncertainties, and difficulties frequently encountered by smaller companies in rapidly evolving markets such as the communications equipment industry. Some of these risks include:

	•		significant fluctuations in quarterly operating results;
	•		the intensely competitive market for communications equipment;
	•		the expenses and challenges encountered in developing and maintaining our sales, marketing and research and development infrastructure;
	•		the risks related to our timely introduction of new products and product enhancements; and
	•		the risks associated with general economic conditions, particularly as they may affect the communications industry.

     Due to our limited operating history and experience with respect to these issues, we may not successfully implement any of our strategies or successfully address these risks and uncertainties.

Our Quarterly Results Fluctuate Significantly, and We May Not be Able to Maintain Our Historical Growth Rates.

     Although our revenues grew from fiscal 1998 to 2000, these growth rates have not been sustainable, as is evidenced by our decrease in revenue in 2001 and the first three quarters of 2002. Past results should not be used to predict future revenue or operating results. Additionally, we have experienced operating losses since the fourth quarter of 2000. We may have revenue shortfalls again in the future. Our quarterly and annual operating results have fluctuated in the past and may vary significantly in the future. Our future operating results will depend on many factors, many of which are outside of our control, and which have affected our results in the past and could again in the future, including the following:

	•		the size of the orders for our products, and the timing of such orders;
	•		the commercial success of our products, and our ability to ship enough products to meet customer demand;
	•		changes in the financial stability of our distributors, customers, or suppliers;
	•		changes in our pricing policies or the pricing policies of our competitors;
	•		fluctuations in ordering due to increased direct sales to customers;
	•		potential bad debt due to increased direct sales;
	•		inability of our service provider customers to obtain third party financing;
	•		seasonal fluctuations in the placement of orders;
	•		potential obsolescence of existing inventory;
	•		changes in the capital budgets of our service provider customers;
	•		changes in our distribution channels;
	•		potential delays or deferrals in our product implementation at customer sites;
	•		fluctuations in orders due to the amount of distributor inventory;
	•		technical problems in customizing or integrating our products with end-users’ systems, and potential product failures or errors;
	•		the outcome of litigation;
	•		certain government regulations; and
	•		general economic conditions as well as those specific to the communications industry.

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     A significant portion of our net revenue has been derived from a limited number of large orders, and we believe that this trend will continue in the future, especially if the percentage of direct sales to end-users increases. The timing of these orders and our ability to fulfill them can cause material fluctuations in our operating results, and we anticipate that such fluctuations will occur. Also, our distribution and purchase agreements generally allow our distributors and direct customers to postpone or cancel orders without penalty until a relatively short period of time prior to shipment. We have experienced cancellations and delays of orders in the past, and we expect to continue to experience order cancellations and delays from time to time in the future. Any shortfall in orders would harm our operating income for a quarter or series of quarters, especially because operating expenses in a quarter are relatively fixed. These fluctuations could affect our profitability and the market price of our common stock.

     Because most of our sales have historically been through indirect distribution channels, our ability to judge the timing and size of individual orders is more limited than for manufacturers who have been selling directly to the end-users of their products for longer periods of time. Moreover, the current downturn in general economic conditions has led to significant reductions in customer spending for telecommunications equipment, which has resulted in delays or cancellations of orders for our products. Our operating expenses are based on our expectations of future revenues and are relatively fixed in the short term. Due to these and other factors, if our quarterly or annual revenues continue to fall below the expectations of securities analysts and investors, the trading price of our common stock could significantly decline, as it has since the third quarter of 2000.

Expansion of the Market for Communications Services is Necessary for Our Future Growth.

     Our success also depends on continued growth in the market for communications services. The global communications marketplace is evolving, and it is difficult to predict our potential size or future growth rate, if any. We cannot assure you that this market will grow or that it will not contract. Moreover, increased regulation may present barriers to the sales of existing or future products. If this market contracts, fails to grow, or grows more slowly or in a different direction than we currently anticipate, our business would be harmed. In the last seven quarters, adverse economic conditions had a negative impact on the market for communications services. If the current economic slowdown continues or worsens, the market for communications services will continue to be affected, which would subsequently have an adverse effect on our business.

     In particular, during fiscal year 2001, the global telecommunications market deteriorated, reflecting a significant decrease in the CLEC market, which is currently going through a period of financial restructuring and consolidation, and a significant reduction in capital spending by established service providers. This trend has continued during the first three quarters of 2002 and is expected to continue at least throughout calendar 2002. As a result, our sales and results of operations have been adversely affected. If capital investment levels continue to decline, or if the telecommunications market does not improve or improves at a slower pace than we anticipate, our revenues and profitability will continue to be adversely affected. In addition, if the volume of our sales and products mix does not improve, our gross margin percentage may not improve as much as we expect, resulting in lower than expected results of operations. The significant slowdown in capital spending in our target markets has created uncertainty as to the level of demand in those markets. In addition, the level of demand can change quickly and can vary over short periods of time, including from month to month. As a result of the uncertainty and variations in our markets, accurately forecasting future results, earnings and cash flow is increasingly difficult.

Our Future Growth is Dependent on Maintaining and Expanding our Sales into Wireless, ILEC and Cable MSO Markets.

     Most of our existing sales come from the CLEC, ILEC, wireless, cable MSO and federal government markets. We cannot assure you that we will be able to maintain or increase our sales levels in all of these markets. In the past two years, adverse economic conditions have had a negative impact on all markets for communication services, particularly the CLEC sector which is going through a period of financial restructuring and consolidation. If this current economic slow down continues or worsens some markets for communications services may be more negatively affected. This could have an adverse effect on our business.

     Our historical customers have consisted primarily of CLEC customers, such as XO and Adelphia, which have recently announced plans to financially restructure and have both filed for bankruptcy protection. As a result of the financial difficulties surrounding the CLEC market, we have attempted to decrease our dependence on the CLECs. We developed a plan to focus our sales, marketing and product development efforts to focus on the ILEC, wireless, cable MSO and federal government markets. We cannot assure you that our efforts in this area will continue to win customers in these markets or that our efforts are timely or correctly focused.

Our Growth is Dependent on Our Introduction of New Products and Enhancements to Existing Products and Failure to Bring New Products to Market, and Any Delay in Customers’ Transition to Our New Products Could Adversely Affect Our Business.

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     Our success depends on our ability to enhance our existing products and to timely and cost-effectively develop new products including features that meet changing end-user requirements and emerging industry standards. However, we cannot assure you that we will be successful in identifying, developing, manufacturing, and marketing product enhancements or new products that will respond to technological change or evolving industry standards. We intend to continue to invest significantly in product and technology development. We have in the recent past experienced delays in the development and commencement of commercial shipment of new products and enhancements, resulting in delay or loss of net revenue. It is possible that we will experience similar or other difficulties in the future that could delay or prevent the successful development, production, or shipment of such new products or enhancements, or that our new products and enhancements will not adequately meet the requirements of the marketplace and achieve market acceptance. Announcements of currently planned or other new product offerings by our competitors or us have in the past caused, and may in the future cause, distributors or end-users to defer or cancel the purchase of our existing products. Our inability to develop, on a timely basis, new products or enhancements to existing products, or the failure of such new products or enhancements to achieve market acceptance, could harm our business.

     The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. Our introduction of new or enhanced products will require us to manage the transition from older products in order to minimize disruption in customer ordering patterns, avoid excessive levels of older product inventories, and ensure that adequate supplies of new products can be delivered to meet customer demand. We have historically reworked certain of our products in order to add new features that were included in subsequent releases of such product. We can give no assurance that these historical practices will not occur in the future and cause us to record lower revenue or negatively affect our gross margins.

     We believe that average selling prices and gross margins for our products will decline as such products mature and as competition intensifies. For example, the average selling price for the Wide Bank products and Adit products have decreased in the past two years. These decreases were due to general economic conditions and the introduction of competitive products. To offset declining selling prices, we believe that we must successfully reduce the costs of production of our existing products and introduce and sell new products and product enhancements on a timely basis at a low cost or sell products and product enhancements that incorporate features that enable them to be sold at higher average selling prices. We may not be able to achieve the desired cost savings. To the extent that we are unable to reduce costs sufficiently to offset any declining average selling prices or that we are unable to introduce enhanced products with higher selling prices, our gross margins will decline, and such decline would harm our business.

We Have Historically Depended on Emerging Service Providers for a Substantial Portion of Our Business.

     Our historical customer base has consisted primarily of competitive carriers and, to a lesser extent, long distance service providers, Internet service providers (“ISPs”), independent operating carriers, and wireless service providers. The market for the services provided by the majority of these service providers began to emerge with the passage of the Telecommunications Act of 1996 (the “1996 Act”). These new service providers require substantial capital for the development, construction, and expansion of their networks and the introduction of their services. The ability of these emerging service providers to fund such expenditures often depends on their ability to obtain sufficient financing. Recently, this financing has not been available to many of these emerging service providers on favorable terms, if at all, particularly due to recent negative market conditions in the United States. If our current or potential emerging service provider customers cannot successfully raise the necessary funds, or if they experience any other adverse effects with respect to their operating results or profitability, these service providers’ capital spending programs may be adversely impacted. If our current or potential service provider customers are forced to defer or curtail their capital spending programs, our sales and operating results will likely be harmed.

     In addition, many of the industries in which the service providers operate have recently experienced financial restructuring, consolidation, or bankruptcy. In particular, many telecommunication service providers have recently acquired, been acquired, or merged with ISPs or other service providers. The loss of one or more of our service provider customers, such as occurred in 2000, 2001, and the first three quarters of 2002, through industry consolidation or otherwise, could have a material adverse effect on our sales and operating results.

Our Customers are Subject to Heavy Government Regulation in the Telecommunications Industry, and Regulatory Uncertainty May Have a Material Adverse Effect on Our Business.

     CLECs are allowed to compete with ILECs in the provisioning of local exchange services primarily as a result of the adoption of regulations under the 1996 Act that impose new duties on ILECs to open their local telephone markets to competition. Although the 1996 Act was designed to expand competition in the telecommunications industry, the realization of the objectives of the 1996 Act is subject to many uncertainties. Such uncertainties include judicial and administrative proceedings designed to define rights and obligations pursuant to the 1996 Act, actions or inaction by ILECs or other service providers that affect the pace at which changes

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contemplated by the 1996 Act occur, resolution of questions concerning which parties will finance such changes, and other regulatory, economic, and political factors. Any changes to the 1996 Act or the regulations adopted thereunder, the adoption of new regulations by federal or state regulatory authorities apart from or under the 1996 Act, or any legal challenges to the 1996 Act could have a material adverse impact upon the market for our products.

     We are aware of certain litigation challenging the validity of the 1996 Act and local telephone competition rules adopted by the Federal Communications Commission (“FCC”) for the purpose of implementing the 1996 Act. Furthermore, Congress has indicated that it may hold hearings to gauge the competitive impact of the 1996 Act and we cannot assure you that Congress will not propose changes to the Act. This litigation and potential regulatory change may delay further implementation of the 1996 Act, which could negatively impact demand for our products. Moreover, our distributors or service provider customers may require that we modify our products to address actual or anticipated changes in the regulatory environment. Furthermore, we may decide to modify our products to meet anticipated changes. Our inability to modify our products in a timely manner or address such regulatory changes could harm our business.

Our Markets are Highly Competitive and Have Many Established Competitors.

     The market for our products is intensely competitive, with a large number of equipment suppliers providing a variety of products to diverse market segments within the telecommunications industry. Our existing and potential competitors include many large domestic and international companies, including certain companies that have substantially greater financial, manufacturing, technological, sales and marketing, distribution, and other resources. Our principal competitors for our products include ADC Telecommunications, Inc. (“ADC”), Adtran, Inc., Advanced Fibre Communications, Inc., Alcatel Alsthom Compagnie Generale d’Electricite, Cisco Systems, Inc., Kentrox, LLC, Lucent Technologies, Inc., NEC USA, Inc., Nortel Networks, Inc., Paradyne Corporation, Polycom, Siemens Aktiengesellschaft, Telect, Inc., Tellabs, Inc., Telco Systems, A BATM Company, VINA Technologies, Inc., Zhone Technologies, Inc. and other small independent systems integrators and small private companies. Most of these companies offer products competitive with one or more of our products. These equipment suppliers have products that compete with our solutions. We expect that our competitors who currently offer products that are competitive with only one of our products will eventually offer products that are competitive with several of our products. In addition, many start-up companies have recently begun to manufacture products similar to ours. Due to the rapidly evolving markets in which we compete, additional competitors with significant market presence and financial resources, including large telecommunications equipment manufacturers and computer hardware and software companies, may enter these markets through acquisition, thereby further intensifying competition. Additionally, one of our distributors is currently competing with us, and additional distributors may begin to develop or market products that compete with our products.

     Many of our current and potential competitors are substantially larger than we are and have significantly greater financial, sales and marketing, technical, manufacturing, and other resources and more established channels of distribution. As a result, such competitors may be able to respond more rapidly to new or emerging technologies and changes in customer requirements, or to devote greater resources than we can devote to the development, promotion, and sale of their products. Such competitors may enter our existing or future markets with solutions that may be less costly, provide higher performance or additional features, or be introduced earlier than our solutions. Many telecommunications companies have large internal development organizations that develop software solutions and provide services similar to our products and services. We expect our competitors to continue to improve the performance of their current products and to introduce new products or technologies that provide added functionality and other features. Successful new product introductions or enhancements by our competitors could cause a significant decline in sales or loss of market acceptance of our products. Competitive products may also cause continued intense price competition or render our products or technologies obsolete or noncompetitive.

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

We Are Substantially Dependent on Our Distribution Channels.

     To date, approximately half of the sales of our products have been made through distributors. Our distributors are responsible for warehousing products and fulfilling product orders as well as servicing potential competitive service provider customers and, in some cases, customizing and integrating our products at end-users’ sites. As a result, our success depends on maintaining good business

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relations with our distributors. Sales of our products that exceed 10% of net revenue historically have been made to a limited number of distributors and other direct customers, as follows:

	•		In the quarter ended September 30, 2002, sales to Walker accounted for over 10% of net revenue.
	•		In 2001, sales to Walker accounted for over 10% of net revenue.
	•		In 2000, sales to Walker and ADC each accounted for over 10% of net revenue.

     We expect that a significant portion of sales of our products will continue to be made to a small number of distributors. In 2001, sales to ADC decreased as a result of the divestiture of its Access Products Division. Accordingly, if we lose any of our key distributors, or experience reduced sales to such distributors, our business would be harmed.

     We have limited knowledge of the financial condition of certain of our distributors. We are aware, however, that some of our distributors have limited financial and other resources that could impair their ability to pay us. We recently increased our reserve for bad debt for one of our distributors due to increased risk in its customer base and the aging of its accounts receivable. Another one of our distributors recently filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code. Although we increased our reserves for bad debt, based upon these and other factors, we cannot assure you that any bad debts that we incur will not exceed our reserves or that the financial instability of one or more of our distributors will not harm our business, financial condition, or results of operations.

     We generally provide our distributors with limited stock rotation and price protection rights. Other than limited stock rotation rights, we do not provide our distributors with general product return rights. We have limited knowledge of the inventory levels of our products carried by our distributors. Distributors have, in the past, reduced planned purchases of our products due to overstocking and such reductions may occur again in the future. Moreover, distributors who have overstocked our products have, in the past, reduced their inventories of our products by selling such products at significantly reduced prices. This may occur again in the future. Any reduction in planned purchases or sales at reduced prices by distributors or in the future could reduce the demand for our products, create conflicts with other distributors, or otherwise harm our business. In addition, three times a year, certain distributors are allowed to exercise stock rotation rights up to a maximum of 15% of our unsold products for an equal dollar amount of new equipment. The products must have been held in stock by such distributor and must have been purchased within the four-month period prior to the return date. We cannot assure you that we will not experience significant returns in the future or that we will make adequate allowances to offset these returns.

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

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

We are Substantially Dependent on Our Direct Sales to End-User Customers.

     Currently, a significant portion of our product revenue is through direct sales. Therefore, our continued success depends on building and maintaining good relations with our direct customers. For the three months ended September 30, 2002, T-Mobile USA accounted for over 10% of net revenue.

     We have limited knowledge of the financial condition of certain of our direct customers. We are aware, however, that some of our direct customers, such as XO, Adelphia and Worldcom, have limited financial and other resources that could impair their ability to pay us. In the first half of 2002, we increased our accounts receivable reserve for receivables due from certain of our customers, including XO and Adelphia, which may become uncollectible due to their current financial situations. We cannot assure you that any bad debts that we incur in connection with direct sales will not exceed our reserves or that the financial instability of one or more of our direct customers will not harm our business, financial condition, or results of operations. In addition, it is likely that an increase in sales to our direct customers may increase our accounts receivable and our days sales outstanding.

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     Any reduction in planned purchases by direct customers could harm our business. XO and Adelphia, for example, are currently restructuring their operations and experiencing financial difficulty, and they may not be in a position in the future to continue their current purchase levels. In addition, we grant certain of our direct customers “most favored customer” terms, pursuant to which we have agreed to not knowingly provide another direct customer with similar terms and conditions or a better price than those provided to the existing direct customer, without offering the more favorable terms, conditions or prices to the existing direct customer. It is possible that these price protection and “most favored customer” clauses could cause a material decrease in the average selling prices and gross margins of our products, which could, in turn, harm our business.

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

Economic Conditions Could Continue to Harm our Business.

     We have become increasingly subject to adverse changes in economic conditions, which could result in reductions in capital expenditures by the end-user customers of our distributors and our direct sales customers, longer sales cycles, deferral or delay of purchase commitments for our products, and increased price competition. In particular, the communications industry has been experiencing a significant downturn. These factors materially impacted our business most severely in the fourth quarter of 2000, and all of 2001, and continue to have an impact in 2002. If the current economic slowdown continues or worsens, these factors would continue to adversely affect our business and results of operations. In addition, in the last year, some service providers that were among our principal customers experienced capital budget constraints resulting from their financial troubles. These financial troubles, combined with service delays, slowed the expected growth in this market. If service providers continue to experience problems, our business may continue to be adversely impacted.

Our Growth is Dependent Upon Successfully Maintaining and Expanding Our Distribution Channels and Direct Sales.

     Our future net revenue growth will depend in large part on the following factors:

	•		our success in maintaining our current distributor and direct sales relationships;
	•		diversifying our distribution channels by selling to new distributors and to new direct customers;
	•		improvement in general economic conditions and available funding for service providers; and
	•		increasing our sales into market segments that are financially stronger than our current market segments.

We Must Maintain and Expand Our Current Distribution Channel.

     Most of our existing distributors also currently distribute the products of our competitors. Some of our existing distributors may in the future distribute or use other competitive products. We cannot assure you that we will be able to attract and retain a sufficient number of our existing or future distributors and direct customers or that they will recommend, or continue to use, our products or that our distributors will devote sufficient resources to market and provide the necessary customer support for such products. In the event that any of our current distributors or direct customers reduce their purchases of our products, or that we fail to obtain future distributors or direct customers, our business could be harmed.

     In addition, it is possible that our distributors will give a higher priority to the marketing and customer support of competitive products or alternate solutions than to our products. Furthermore, we cannot assure you that our distributors will continue to offer our products. Our distributor relationships are established through formal agreements that generally (1) do not grant exclusivity, (2) do not prevent the distributor from carrying competing products, and (3) do not require the distributor to purchase any minimum dollar amount of our products. Additionally, our distribution agreements do not attempt to allocate certain territories for our products among our distributors. To the extent that different distributors target the same end-users of our products, distributors may come into conflict with one another, which could damage our relationship with, and sales to, such distributors.

Our Operating Results Are Substantially Dependent on Sole and Single Source Suppliers.

     Although we generally use standard parts and components for our products, many key parts and components are purchased from sole source vendors for which alternative sources are not currently available. We currently purchase approximately 140 key components from vendors for which there are currently no substitutes, and we purchase approximately 209 key components from single vendors. In addition, we rely on several independent manufacturers to provide certain printed circuit boards, chassis, and subassemblies for our products. Our inability to obtain sufficient quantities of these components has in the past resulted in, and may

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in the future result in, delays or reductions in product shipments, which could harm our business, financial condition, or results of operations. In the event of a reduction or interruption of supply, we may need as much as six months before we would begin receiving adequate supplies from alternative suppliers, if any. We cannot assure you that any such supplier would become available to us or that any such supplier would be in a position to satisfy our production requirements on a timely basis, if at all. In such event, our business would be materially harmed.

     In addition, manufacturing certain of these single or sole source components is extremely complex, and our reliance on the suppliers of these components, especially for newly designed components, exposes us to potential production difficulties and quality variations that the suppliers experience, which may negatively impact cost and timely delivery of our products. Any significant interruption in the supply, or degradation in the quality, of any such component could have a material adverse effect on our business, financial condition, or results of operations.

Our Ability to Meet Customer Demand Depends on the Availability of Our Components.

     Our distributors and direct customers frequently require rapid delivery after placing an order. Delays in shipment by one of our suppliers have led to lost sales and sales opportunities. Lead times for materials and components vary significantly and depend on many factors, some of which are beyond our control, such as specific supplier performance, contract terms, and general market demand for components. If distributor orders vary significantly from forecasts, we may not have enough inventories of certain materials and components to fill orders. Any shortages in the future, including those occasioned by increased sales, could result in delays in fulfillment of customer orders. Such delays could harm our business.

Our Dependence on Independent Manufacturers Could Result in Product Delivery Delays.

     We currently use several independent manufacturers to provide certain components, printed circuit boards, chassis, and subassemblies. Our reliance on independent manufacturers involves a number of risks, including the potential for inadequate capacity, the unavailability of, or interruptions in, access to certain process technologies, and reduced control over delivery schedules, manufacturing yields, and costs. Some of our manufacturers and suppliers are undercapitalized, and such manufacturers or suppliers may be unable in the future to continue to provide manufacturing services or components to us. If these manufacturers are unable to manufacture our components in required volumes, we will have to identify and qualify acceptable additional or alternate manufacturers, which could take in excess of nine months. We cannot assure you that any such source would become available to us or that any such source would be in a position to satisfy our production requirements on a timely basis, if available. Any significant interruption in our supply of these components would result in delays or in the allocation of products to customers, which in turn could have a material adverse effect on our business, financial condition, or results of operations. Moreover, since all of our final assembly and test operations are performed in one location, any fire or other disaster at our assembly facility would harm our business.

Our Executive Officers and Certain Key Personnel Are Critical to Our Business, and These Officers and Key Personnel May Not Remain With Us in the Future.

     Our success depends to a significant degree upon the continued contributions of our Chief Executive Officer, and key management, sales, engineering, finance, customer support, and product development personnel, many of whom would be difficult to replace. In particular, the loss of Roger L. Koenig, President and Chief Executive Officer, our co-founder, could harm us. We believe that our future success will depend in large part upon our ability to attract and retain highly skilled managerial, sales, customer support and product development personnel. Competition for qualified personnel in our industry and geographic location is intense, and we cannot assure you that we will be successful in attracting and retaining such personnel. We do not have employment contracts with any of our key personnel. The loss of the services of any such persons, the inability to attract or retain qualified personnel in the future, or delays in hiring required personnel, particularly engineering personnel and qualified sales personnel, could harm our business.

We Face Risks Associated with Acquisitions.

     In 2000, we acquired Millennia and LNAS. We may acquire or make similar such investments in complementary companies, products, or technologies in the future. If we buy a company, we could have difficulty integrating that company’s personnel and operations. Furthermore, the key personnel of the acquired company may decide not to work for us. If we make other types of acquisitions, we could have difficulty in assimilating the acquired technology or products into our operations. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses. We may have to incur debt, write-off software development costs or other assets, incur severance liabilities, or issue equity securities to pay for any future acquisitions. The issuance of equity securities could dilute our existing stockholders’ ownership.

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     We cannot assure you that we will be successful in overcoming these or any other significant risks encountered in any acquisition we may make. The failure to achieve the anticipated benefits of these or any future acquisitions, or to successfully integrate the acquired operations, could harm our business and results of operations.

Our Products May Suffer From Defects or Errors That May Subject Us to Product Returns and Product Liability Claims.

     Our products have contained in the past, and may contain in the future, undetected or unresolved errors when first introduced or when new versions are released. Despite our extensive testing, errors, defects, or failures are possible in our current or future products or enhancements. If such defects occur after commencement of commercial shipments, the following may happen:

	•		delay in or loss of market acceptance and sales;
	•		product returns;
	•		diversion of development resources resulting in new product development delay;
	•		injury to our reputation; or
	•		increased service and warranty costs.

     Significant delays in meeting deadlines for announced product introductions, or enhancements or performance problems with such products, could undermine customer confidence in our products, which would harm our customer relationships as well. Any of these results could have a material adverse effect on our business.

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

A Longer Than Expected Sales Cycle May Affect Our Revenues and Operating Results.

     The sale of our broadband digital access products averages approximately four to twelve months in the case of competitive carriers, but can take significantly longer in the case of ILECs and other end-users. This process is often subject to delays over which we have little or no control, including (1) a distributor’s or a service provider’s budgetary constraints, (2) distributor or service provider internal acceptance reviews, (3) the success and continued internal support of a service provider’s own development efforts, and (4) the possibility of cancellation or delay of projects by distributors or service providers. In addition, as service providers have matured and grown larger, their purchase process may have become more institutionalized, and thus it may become increasingly difficult, and may require more of our time and effort, to gain the initial acceptance and final adoption of our products by these end-users. Although we attempt to develop our products with the goal of facilitating the time to market of our service provider’s products, the timing of the commercialization of new distributor or service provider applications or services based on our products is primarily dependent on the success and timing of a service provider’s own internal deployment program. Delays in purchases of our products can also be caused by late deliveries by other vendors, changes in implementation priorities, and slower than anticipated growth in demand for our products. A delay in, or a cancellation of, the sale of our products could harm our business and cause our results of operations to vary significantly from quarter to quarter.

We Must Keep Pace with Rapid Technological Change to Remain Competitive.

     The communications marketplace is characterized by (1) rapidly changing technology, (2) evolving industry standards, (3) changes in end-user requirements, and (4) frequent new product introductions and enhancements, each of which may render our existing products obsolete. We expect that new packet-based technologies will emerge as competition in the communications industry increases and the need for higher volume and more cost efficient transmission equipment expands. Industry standards for multi-service digital access equipment and technology are still evolving. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. As standards and technologies evolve, we will be required to modify our products or develop and support new versions of our products. The failure of our products to comply, or delays in achieving compliance, with the various existing and evolving industry standards could harm sales of our current products or delay introduction of our future products.

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Failure to Meet Future Capital Needs May Adversely Affect Our Business.

     We require substantial working capital to fund our business. As of September 30, 2002, we had approximately $23.3 million dollars in cash and short-term investments. We believe that such cash and cash equivalents, together with cash generated by operations, if any, and our anticipated income tax refunds of approximately $12 million, of which approximately $5.1 million was received as of November 13, 2002, will be sufficient to meet our capital requirements for at least the next twelve months. Our capital requirements depend on several factors, however, including the rate of market acceptance of our products, the ability to expand our client base, the growth of sales and marketing, and other factors. If capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated. If additional funds are raised through the issuance of equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution, or such equity securities may have rights, preferences, or privileges senior to those of the holders of our common stock. Additional financing may not be available when needed on terms favorable to us or at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our services, take advantage of future opportunities, or respond to competitive pressures, which could harm our business.

Our Failure to Adequately Protect Our Proprietary Rights May Adversely Affect Us.

     We rely primarily on a combination of patent, copyright, trademark, and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. As of September 30, 2002, we have been issued a total of nine U.S. patents and had 23 U.S. patents pending. We have eleven international patent applications pending. We have 11 U.S. trademark applications pending, and seven international trademark applications pending, and have nine trademarks registered, one of which are registered internationally. One trademark application which is currently pending in the U.S. has been registered internationally. We have entered into confidentiality agreements with our employees and consultants, and non-disclosure agreements with our suppliers, customers, and distributors in order to limit access to and disclosure of our proprietary information. However, such measures may not be adequate to deter and prevent misappropriation of our technologies or independent third-party development of similar technologies.

     Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary. Furthermore, we may be subject to additional risks as we enter into transactions in foreign countries where intellectual property laws do not protect our proprietary rights as fully as do the laws of the United States. We cannot assure you that our competitors will not independently develop similar or superior technologies or duplicate any technology that we have. Any such events could harm our business.

     The telecommunications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As the number of entrants in our markets increases and the functionality of our products is enhanced and overlaps with the products of other companies, we may become subject to claims of infringement or misappropriation of the intellectual property rights of others. From time to time, third parties may assert patent, copyright, trademark, and other intellectual property rights to technologies that are important to us. We have no assurance that any future claims, if determined adversely to us, would not harm our business. In our distribution agreements, we agree to indemnify distributors and service provider customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks, or copyrights of third parties. In certain limited instances, the amount of such indemnities may be greater than the net revenue we may have received from the distributor.

     In the event litigation is required to determine the validity of any third-party claims, such litigation, whether or not determined in our favor, could result in significant expense to us, divert the efforts of our technical and management personnel, or cause product shipment delays. In the event of an adverse ruling in any litigation, we might be required to discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology, or obtain licenses from third parties. In the event of a claim or litigation against us, or our failure to develop or license a substitute technology on commercially reasonable terms, our business could be harmed.

Our Stock Price Has Been Highly Volatile.

     The market price of our common stock has been, and is likely to continue to be, subject to fluctuations in response to variations in operating results, announcements of technological innovations or new products by us or our competitors, changes in financial estimates or recommendations by securities analysts, regulatory developments, and other events or factors. In addition, the stock market in general, and the market prices of equity securities of many high technology companies in particular, have experienced extreme price fluctuations, which often have been unrelated to the operating performance of such companies. These broad market fluctuations may harm the market price of our common stock. Our stock price and the stock market in general have been particularly volatile in recent quarters.

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If We Are Unable to Maintain Our Nasdaq National Market Listing, the Liquidity of Our Common Stock Could Be Seriously Impaired.

     If our stock price falls below one dollar for thirty (30) consecutive trading days, and we are unable to cure such deficiency, we may be subject to delisting from the Nasdaq National Market. Additionally, if the market value of our publicly held shares falls below the minimum of $5,000,000 for thirty (30) consecutive trading days, and we are unable to cure such deficiency, we may be subject to delisting from the Nasdaq National Market.

     On August 30, 2002, we received notice from the Nasdaq National Market that our common stock had failed to maintain the Nasdaq National Market’s minimum bid price closing requirement of $1.00 for thirty (30) consecutive trading days. The notice also informed us that if we were unable to demonstrate compliance with this requirement by maintaining a closing bid price of at least $1.00 for ten (10) consecutive trading days during the ninety (90) calendar days ending November 29, 2002, our common stock may be subject to delisting from the Nasdaq National Market. In the event we are unable to demonstrate compliance in this time period, we have evaluated multiple options, including an appeal of any such determination, and will take appropriate actions.

     On September 24, 2002, we received notice from the Nasdaq National Market that the market value of publicly held shares had fallen below the minimum of $5,000,000 for thirty (30) consecutive trading days. The notice also informed us that if we were unable to demonstrate compliance with this requirement by maintaining a market value of a minimum of $5,000,000 for ten (10) consecutive trading days during the ninety (90) calendar days ending December 23, 2002, our common stock may be subject to delisting from the Nasdaq National Market. We believe that this calculation is incorrect and have requested that this determination be reviewed and retracted by the Nasdaq National Market.

     If our common stock is delisted from the Nasdaq National Market, it would seriously limit the liquidity of our common stock and could limit our potential to raise future capital through sale of our common stock, which could seriously harm our business.

We are Controlled by a Small Number of Stockholders.

     The members of our Board of Directors and executive officers, together with members of their families and entities that may be deemed affiliates of or related to such persons or entities, beneficially own approximately 53% of our outstanding shares of common stock. In particular, Mr. Roger L. Koenig and Ms. Nancy Pierce, each a Director and our President and Chief Executive Officer, and Secretary and Corporate Development Officer respectively, are married and together beneficially own approximately 52% of our outstanding shares of common stock. Accordingly, these two stockholders are able to elect all members of our Board of Directors and determine the outcome of all corporate actions requiring stockholder approval, such as mergers and acquisitions. This level of ownership by such persons and entities may delay, defer, or prevent a change in control and may harm the voting and other rights of other holders of our common stock.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Market risk represents the risk of loss that may impact the financial position, results of operations, or cash flows due to adverse changes in financial and commodity market prices and rates. Historically, and as of September 30, 2002, we have had little or no exposure to market risk in the area of changes in foreign currency exchange rates as measured against the United States dollar. Historically, and as of September 30, 2002, we have not used derivative instruments or engaged in hedging activities. Interest rate risk is not significant to our investments.

ITEM 4. CONTROLS AND PROCEDURES

a.		Evaluation of disclosure controls and procedures.
		Our chief executive officer and our chief financial officer, after evaluating our “disclosure controls and procedures” (as defined in Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-14(c) and 15d-14(c)) as of a date (the “Evaluation Date”) within ninety (90) days before the filing date of this Quarterly Report on Form 10-Q, have concluded that as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
b.		Changes in internal controls.
		Our review of our internal controls was made within the context of the relevant professional auditing standards defining “internal controls,” “significant deficiencies,” and “material weaknesses.” “Internal controls” are processes designed to provide reasonable assurance that our transactions are properly authorized, our assets are safeguarded against unauthorized or improper use, and our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with generally accepted accounting principles. “Significant deficiencies” are referred to as “reportable conditions,” or control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A “material weakness” is a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions. As part of our internal controls procedures, we also address other, less significant control matters that we or our auditors identify, and we determine what revision or improvement to make, if any, in accordance with our on-going procedures.
		Subsequent to the Evaluation Date, there were no significant changes in our internal controls or in other factors that could significantly affect our internal controls including any corrective actions with regard to significant deficiencies and material weaknesses.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     On December 28, 2001, SCI, Inc., one of our manufacturers, filed a breach of contract claim for $4.5 million against us in Alabama Circuit Court based on an inventory-purchasing dispute. On September 18, 2002, we settled this claim for approximately $2.6 million in return for a major portion of the disputed inventory, which has a current valuation of approximately $600,000 net of reserves, and entered into a manufacturing arrangement for our Broadmore product. The settlement of this claim had no effect on the results of this quarter.

     On August 16, 2002, SMTC Manufacturing Corporation of Colorado filed a breach of contract claim, and other related claims, for a total of $13.4 million against us in District Court, County of Adams, Colorado, based on an inventory-purchasing dispute. On October 17, 2002, we filed a breach of contract counterclaim, and other related counterclaims, in District Court, County of Adams, Colorado for $1.0 million. We intend to vigorously defend this lawsuit.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

     None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     None.

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

     None.

ITEM 5. OTHER INFORMATION

     None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

	a.		Exhibits.
			99.1 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.
	b.		Reports on Form 8-K.
			None.

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Signature

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

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CERTIFICATIONS

I, Roger L. Koenig, Chairman, President and Chief Executive Officer, certify that:

1.		I have reviewed this quarterly report on Form 10-Q of Carrier Access Corporation;
2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

	a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.

The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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CERTIFICATIONS

I, Timothy R. Anderson, Treasurer and Chief Financial Officer, certify that:

1.		I have reviewed this quarterly report on Form 10-Q of Carrier Access Corporation;
2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
3.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

4.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

	a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

5.

The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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EXHIBIT INDEX

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