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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number: 000-24597

CARRIER ACCESS CORPORATION

(303) 442-5455

Securities registered pursuant to 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.001 per share

(Title of Class)

         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 (the “Act”) 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 þ         No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o

         Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes o         No þ

         As of June 30, 2003 there were 24,798,060 shares of the Registrant’s common stock outstanding, and the aggregate market value of such shares held by non-affiliates of the Registrant (based upon the closing sale price of such shares on the Nasdaq National Market on June 30, 2003, the last business day of the second quarter of 2003) was $23,922,882. Shares of the Registrant’s common stock held by each executive officer and director and by each entity that owns 10% or more of the Registrant’s outstanding common stock have been excluded in that such persons or entities may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

         On March 1, 2004, there were 33,667,236 shares of the Registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

         Certain sections of the Registrant’s definitive Proxy Statement for the 2004 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K to the extent stated herein.

CARRIER ACCESS CORPORATION

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PART I

General

      Carrier Access designs, manufactures and sells broadband access equipment to communications service providers. Our products are used to upgrade capacity of wireline and wireless communications networks. Our products also enable our customers to offer voice and data services, which historically have been offered on separate networks, on a single converged network. We design our products to enable our customers to deploy new revenue-generating voice and data services, while lowering capital and operating costs.

      We sell our products directly to communications service providers and indirectly through a broad channel of global distributors and original equipment manufacturers, or OEMs, that provide voice and data communications infrastructure products. Our wireline and wireless customers include local and long distance carriers, cable operators, and international communications providers.

      On November 25, 2003, we completed the acquisition of Paragon Networks International Inc., a provider of products to wireless service providers. Paragon’s products are primarily used for upgrading the capacity of links between wireless cell sites and the wide network. We believe the addition of Paragon’s products complements our own product portfolio by increasing the breadth of our product offerings, as well as adding new customers.

      Our principal executive offices are located at 5395 Pearl Parkway, Boulder, CO 80301. Our telephone number at that location is 303-442-5455. Our website is www.carrieraccess.com; however, the information in, or that can be accessed through, our web site is not part of this report. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports are available, free of charge, on our web site as soon as reasonably practicable after we electronically file or furnish such materials with the Securities and Exchange Commission. We were incorporated in Colorado in September 1992 and were reincorporated in Delaware in June 1998.

Industry Overview

      The pervasive use of the Internet, the introduction of new bandwidth-intensive applications, and widespread adoption of numerous mobile communications devices capable of connecting to the Internet have fueled demand for media-rich Internet services, such as picture mail, music downloads, games, enhanced text messages, wireless web, and real-time video. Similarly, businesses are demanding new services customized to meet their personal communications needs, such as web conferencing, virtual private networks, or VPNs, which allow companies to extend their secure networks using the Internet, and voice over IP, or VoIP, which is the transmission of voice over the Internet. Broadband wireline and wireless Internet access is experiencing rapid growth as it becomes the primary means by which these services are enabled.

      We believe the rapid increase in broadband subscriber growth, coupled with widespread adoption of new media-rich Internet services, is driving service provider investment in new broadband access technologies. Although overall telecommunications capital expenditures have declined over the past three years, service providers continue to make significant investments to increase capacity at both the wireline portion of the network that links service providers and their end-user customers, which we refer to as the access portion of the network, and the wireless portion of the network that links cellular sites to the wired network, which we refer to as the wireless backhaul. In addition, service providers continue to focus capital expenditures on upgrading to IP-based technologies and delivering broader geographic coverage. With constrained capital expenditure budgets, communications service providers are implementing scalable and cost-efficient networking technologies.

      We believe the growth of Internet-enabled mobile communications devices and applications are driving a rapid expansion of the global wireless communications infrastructure. In response to continued subscriber growth and increasing demand for media-rich wireless services, we believe broadband service providers will need to cost-effectively upgrade their networks to support these new service offerings to remain competitive. In addition, this expansion is being accelerated by federal regulation, such as FCC mandated Enhanced 911, or E911, rules, which require public safety agencies to implement improved location detection of the wireless user.

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      We believe that the disparate networks that comprise the Internet, including corporate intranets, cable systems, broadband and wireless networks, and voice and video networks, will increasingly converge into a unified network. We also believe that to successfully address this trend, equipment vendors must be capable of providing a comprehensive suite of products that support voice and data services, expand network bandwidth, and reduce wired and wireless network upgrade costs using a variety of access technologies.

Our Approach

      We provide a broad platform of communications equipment, software, and services that enable wireless and wireline service providers to cost-effectively upgrade access capacity and implement converged IP voice and data services.

      Our wireless products allow wireless service providers to reduce the strain on backhaul portions of the network, which is the portion that links cell sites to the wired switching center. Our products increase wireless network capacity at our customers’ cell sites to enable the introduction of new wireless data services and provide data connections needed for cell site equipment management and E911 location identification.

      Our wireline products are primarily used to deliver converged IP voice and data services over broadband access connections, such as TI or Ethernet connections, to business or multiple dwelling units, such as apartments and condominiums. The embedded VoIP software in our products works in conjunction with certain network application software providers to deliver IP-based voice and data applications, including virtual private networks, or VPNs, that fully integrate voice and data, customized web-controlled voicemail, call screening and forwarding, and other personalized IP communications services.

      We believe that our products provide the following benefits to our customers:

      Revenue From Existing and Next-generation IP Services. Our equipment and software support multiple services. As a result, service providers using our products can offer a variety of revenue-generating services as customer needs evolve, without deploying dedicated equipment for each service. For example, our Adit products support the efficient delivery of data traffic with VoIP services, while supporting or converting existing customer telephone and data equipment. This is accomplished by deploying service cards that support multiple communications services and technologies within the Adit chassis, thus protecting both the service provider’s investment in access equipment and the end-user investment in enterprise communications equipment.

      Cost Effectiveness and Scalability. Our products are designed to enable our customers to cost-effectively add additional voice and data capacity as the demand for bandwidth and new services increases. Our products reduce unused bandwidth and lower service providers’ equipment upgrade and operating costs by allowing the easy installation of additional cards into an already installed product. These line cards enable a variety of new communications services without sacrificing existing infrastructure investments. In addition, our products are capable of performing a variety of communications networking functions in a single chassis. For example, our Axxius products integrate multiple services such as transport, routing, and service protection at the access point of wireless networks.

      Manageability and Flexibility. As voice and data network complexity increases, we believe service providers will require software and systems that provide end-to-end management of the communications services they offer to their customers. We develop and integrate software-based network management capabilities with our products that enable telecommunications equipment providers to more easily manage voice and data traffic and services within their networks. Our NetworkValet software remotely manages and provisions our products. This remote management capability reduces the overall cost of ownership by decreasing the need for on-site configuration, maintenance, and diagnostics.

Our Strategy

      Our objective is to become a leading provider of broadband access products for the wireless backhaul, the portion linking cell sites to the wired switching center, and products that provide converged voice and data

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      Pursue High Growth Market Opportunities. We will continue to apply our diverse product portfolio and research and development expertise to engineer, manufacture, and support innovative products for strategic, high growth markets, such as wireless backhaul and VoIP. For example, at the beginning of 2001, we derived minimal revenue from wireless backhaul products. At that time, we began dedicating significant resources to designing products serving the wireless backhaul and data integration market. We believe that we have successfully gained a position in this market, as evidenced by the fact that products deployed in the wireless market accounted for 57% of our total net revenue in the fourth quarter of 2003.

      Continue to Pursue and Leverage Global Strategic Relationships. We intend to maintain and expand our existing relationships and pursue new strategic relationship opportunities with leading global communications equipment vendors. We currently have strategic relationships with the following companies: Alcatel, for the distribution of our standard products and the OEM of our Exxtenz product line; Cisco, for the co-sale and joint sale partnering for certain of our products; Fujitsu Asia, for the distribution of our Adit 600 product in certain territories outside of the United States; Marconi, for the distribution of our Broadmore product through their Federal division, Marconi Federal, Inc.; and other OEM, private label, or resale customers. Several of these customers integrate our products with their own product offerings to provide a comprehensive offering to their service provider, residential, enterprise, or commercial customers. For example, we are supplying our Broadmore product to Marconi as part of a complete communications system, which they supply and support for U.S. Department of Defense agencies. These relationships are important to us because they allow us to combine product synergies for a more complete product portfolio. In addition, these relationships allow us to leverage our sales force with the sales and marketing personnel of our strategic partners and provide complete product offerings to our joint customers. However, these relationships are not currently material to us from a financial standpoint.

      Leverage our Technology and Customer Base to Expand our Product Portfolio. We believe that the demand for media-rich voice and data services is a key driver of our service provider customers’ growth. We intend to assure that our product portfolio and architectures continue to offer the performance and flexibility needed for the economical introduction of new services. We also believe that our expertise in a broad range of technologies, such as VoIP, data transport and routing, and management software provides us with a technology platform from which we can develop or enhance our products to address new markets and applications. For example, we leveraged our relationship with one supplier to introduce new service cards for the Adit and Axxius platforms that provided access cost savings in both wireless and wireline applications within their networks.

      Pursue Acquisitions. In addition to our internal research and development efforts, we continually evaluate acquisitions of companies and technologies that could extend our product offerings, technology expertise, industry knowledge, and global customer base. Since 1998, we have completed three acquisitions, including our recent acquisition of Paragon. These acquisitions have and will extend our ability to provide additional and enhanced products that enable the wireless backhaul and the delivery of converged voice and data services. We intend to pursue additional acquisitions in the future. However, we are not currently engaged in any negotiations with respect to any such transactions.

      The ability to achieve our objective to become a leading provider of broadband access products is subject to many challenges and uncertainties. In particular, our industry is highly competitive and there are many companies providing competitive products in the same market in which we sell our products. See “Business — Competition.”

Principal Products

      Since our founding in 1995, we have continually broadened our product line, through internal development and acquisitions, to serve the needs of customers in high-growth telecommunications markets. Currently, our products support traditional telecommunications technologies as well as emerging technologies such as VoIP and fiber-based broadband access, which is referred to as a passive optical network, or PON. Our current product portfolio features eight platforms that reside in a variety of locations, including the service providers’ central

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      Wireless Infrastructure. We provide equipment to wireless service providers for use in the backhaul portion of their networks. In addition, wireless infrastructure equipment providers have integrated our Adit and Axxius products and the Paragon MASTERseries and BROADway products as an important component to their system solution. Our products are used to terminate the wireline service at both the cell site location and at the wireless service provider’s switching center. Paragon’s products are primarily used for upgrading the capacity of the wireless backhaul. Our scalable products enable wireless carriers to cost-effectively offer new revenue-generating voice and data services, optimize wireless backhaul capacity, and lower network operating costs. We also provide equipment that is used by wireless service providers in their provisioning of FCC mandated E911 services.

      Converged Enterprise Voice/ Data Service Delivery. We provide products that integrate multiple voice and data access services that are both easy to install and easy to manage, while delivering the quality of service that end-users demand. Our products support the connection of customer voice and data equipment such as telephones, enterprise telephone networks, local area networks, point of sale terminals, video conferencing equipment, and installed data equipment to wide area network services. We also provide products that transmit voice communications over the Internet. Our VoIP products can be used to connect customers to a single network infrastructure for the transmission of data, voice, and video traffic as part of an IP communications service that fully integrates voice and data. These converged IP communications services provide new multimedia communications capabilities to end-users, while offering lower capital and operating costs for service providers.

      Fiber Access. We offer products that enable service providers to utilize PON technology to deliver new or enhanced services such as wire-speed Ethernet, voice, T1, and video services to businesses. Our Fiber Access products deliver these services in a cost-efficient manner by supporting up to 32 customer building connections from a single strand of fiber. PON technology offers a cost-effective means to deliver new services to both business and multi-dwelling residential customers. Our PON product is based on internationally accepted standards and delivered as part of an end-to-end offering with our strategic partners, such as Alcatel.

Product Details

      The Axxius 800 Access Integration Platform reduces network complexity, scalability, space, power, protection, and environmental constraints associated with delivering voice and data services in wireless networks. This product combines the functions of multiple products into one scalable, integrated and managed platform that enables our customers to deliver services at significantly lower costs.

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      The Axxius is used primarily at wireless cell sites and hub locations to optimize wireless backhaul traffic, provide remote access and management of cell site equipment, monitor T1 line performance, and enable service providers to add bandwidth and new revenue-generating services. In addition, the Axxius’ remote access capability allows cell site technicians to remotely manage their facility. The Axxius provides bandwidth capacities from our T1/ E1s to two DS3 circuits.

      The Adit 600 Multi-service Delivery Terminal helps wireline and wireless service providers to offer revenue-generating voice and data services. It provides converged voice, data, and Internet access in a scalable, modular platform. The Adit 600 delivers carrier-quality broadband voice and data services for a wide range of applications, while allowing service providers to lower their infrastructure hardware costs by replacing and consolidating traditional network access equipment.

      The Customer Media Gateway, or CMG, service card expands the Adit 600 platform’s capabilities beyond traditional communications applications to enable the transmission of media-rich applications over the Internet.

      The Adit 600 CMG enables gradual and seamless migration of voice and data services from traditional communication services to delivery over the Internet, while preserving existing equipment investments. The platform offers service providers and small- to medium-sized businesses a carrier-quality, cost-effective product that enables the integration of IP and traditional TDM voice services. In addition, the Adit 600 CMG is interoperable with all leading soft switch vendors, maintaining superior flexibility in the emerging VoIP market.

      The Exxtenz platform enables service providers to deliver enhanced services such as integrated high-speed data, Ethernet, voice and video services to businesses and multiple dwelling units. By utilizing PON technology, the Exxtenz platform has the ability to deliver these services at significantly lower capital costs. Our PON technology supports up to 32 Exxtenz devices from a single strand of fiber.

      The Wide Bank platform was engineered to significantly reduce size and power requirements for terminating communications circuits. Its design can handle multiple levels of electronics redundancy to assure service availability and management. The Wide Bank is used by both wireless and wireline service providers for a variety of communications applications.

      The Department of Defense and other government agencies utilize the Broadmore to improve their optical communications infrastructure. These logically provisioned circuits can be routed, tested, and restored at lower costs, higher network utilization and higher security levels than are associated with traditional circuit transportation methods. Recent enhancements include additional security features such as encryption and secure management and identification.

      The Access Navigator comes in three configurations that allow carriers to utilize existing resources more efficiently and enables the provisioning of services to a greater number of customers with minimal incremental infrastructure investments. With its small footprint and low power requirements, the Access Navigator is used in applications where traditional larger and more expensive communications infrastructure would be impractical. Combined with the Adit, the two devices provide an end-to-end offering for the delivery of enterprise or residential voice and Internet IP access.

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      NetworkValet is a software product that allows service providers to remotely manage, configure and provision our products. NetworkValet lowers the cost of ownership by significantly reducing configuration and maintenance costs and troubleshooting activities.

      The MASTERseries, which is typically located at a cell site, optimizes wireless backhaul traffic for analog and digital base stations, E911 location devices and data devices in a single, highly reliable platform. The MASTERseries provides bandwidth capacities from four to 32 T1/ E1 circuits.

      The BROADway product allows wireless service providers to connect their cell sites and mobile switch centers. The BROADway is used primarily at wireless hub locations to optimize backhaul, provide remote access and management of equipment, monitor T1 line performance, and enable service providers to add bandwidth and new revenue-generating services. Together with MASTERseries and MASTERview network management system, BROADway provides a broadband offering that addresses the needs for both network optimization and new services deployment.

Customers and Channels

      We sell our products directly through our sales force and indirectly through our OEM, private label, and other distribution partners. Our products are used by wireless service providers, local and long distance carriers, cable operators, and international communications providers to provide enhanced voice and high-speed data and Internet services to end-users.

      Since 2000, our products have been deployed in over 2,000 private networks. However, our net revenue has historically been concentrated among a small number of distributors and service provider customers. For the year ended December 31, 2003, we had four customers that each accounted for over 10% of our net revenue: T Mobile accounted for 17%, XO Communications accounted for 12%, Walker & Associates accounted for 11% and Nortel Networks, Inc. accounted for 11%. No other customer accounted for more than 10% of our net revenue for that period.

Sales, Marketing and Customer Support

      Our sales model consists of indirect sales to distributors and OEMs and direct sales to end-users. Our sales force works with distributors and OEMs to identify potential customers and provide pre- and post-sales support to our service provider customers and other end-users. For the year ended December 31, 2003, sales to distributors and OEMs accounted for 40% of our net revenue and direct sales to end-users accounted for 60% of our net revenue. For the year ended December 31, 2002, sales to distributors and OEMs accounted for 45% of our net revenue and direct sales to end-users accounted for 55% of our net revenue. We typically ship products soon after receipt of the customers’ orders and, accordingly, our backlog has typically not been significant.

      Sales to Distributors and OEMs. Our distributors and OEMs are responsible for fulfilling product orders, warehousing product, and identifying potential customers. We establish relationships with distributors and OEMs through written agreements that provide prices, discounts and other material terms and conditions under which the distributor or OEM is eligible to purchase our products for resale. Such agreements generally do not grant exclusivity to the distributors or OEMs, do not prevent the distributors from carrying competing product lines, and do not require the distributors to sell any particular dollar amount of our products.

      Sales Directly to End-Users. A significant portion of the sales of our products is made through direct sales to end-users. As a result, our continued success depends on building and maintaining good relations with our direct customers. We typically sell to these customers on credit.

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      Sales Force. Our sales force covers the continental U.S. and Mexico. It includes sales and sales engineering and is responsible for product configuration, evaluation, installation and telephone presales support activities. Our sales engineering strategy focuses on assisting service providers and end-users in rapidly integrating our products into their networks. The sales engineering support group identifies service provider and end-user leads and, based on initial presentations, provides evaluation units for trial in communication service provider and end-user networks. After successful trial and approval, the service provider or end-user is provided with product installation and maintenance training. Initially, our sales engineering support group is involved in educating service providers and end-users about the functionality and benefits that may be derived from using our products. Subsequently, members of both our sales engineering and research and development organizations are involved in providing the service provider or end-user with the required training and technical support to integrate our products into a new application or service.

      Marketing. Our marketing organization develops strategies for products and, along with the sales force, develops key account strategies and defines product and service functions and features. Our marketing group is responsible for sales support, handling requests for information, requests for quotes and requests for proposals, preparing in-depth product presentations, interfacing with operations, setting price levels, developing new services and business opportunities and writing proposals in response to customer requests for information or quotations. We engage in a number of marketing activities that include exhibiting products and customer applications at industry trade shows, advertising in selected publications aimed at targeted markets, taking part in public relations activities with trade and business press and distributing sales literature, technical specifications and documentation in order to create awareness, market demand and sales opportunities for our products.

      Customer Service and Support. Based on customer support calls, we believe that ongoing customer support is critical to maintaining and enhancing relationships with service providers, end-users and distributors. The service provider and end-user support group has five functions: new product development that provides for product ideas and enhancements based on customer requirements through the pre- and post-sales support effort; inbound technical support which focuses on pre- and post-sales calls made to us by our customers; outbound application support and response to proposed quotation requests; training, including installation and application development training for customers, sales engineers, and employees; and reporting and analysis based on the automated trouble ticket and returned material systems.

Competition

      There is intense competition in the telecommunications equipment market with a large number of suppliers providing a variety of products to diverse market segments. We believe that the principal competitive factors for products in our markets include:

	•	lower initial and lifetime costs;
	•	performance and reliability;
	•	flexibility, scalability and ease-of-use;
	•	service and support;
	•	breadth of features and benefits; and
	•	end-to-end management systems.

      We believe our products compete favorably with respect to each of these factors.

      Our principal competitors for our products include Adtran, Inc., Advanced Fibre Communications, Inc., Telco Systems, Inc., Cisco Systems, Inc., Eastern Research, Inc., Lucent Technologies, Inc., Tellabs, Inc., Zhone Technologies, Inc. and other small independent systems integrators and private and public companies. Most of these companies offer products competitive with one or more of our product lines. We expect that our competitors that currently offer products competitive with only one of our product lines will eventually offer products competitive with all of our products. Due to the rapidly evolving markets in which we compete, additional competitors with significant market presence and financial resources, including large telecommunications

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      We believe our competitive position is enhanced by our ability to adapt quickly to changes in the market, the capability to modify existing products to decrease their size and expense while maintaining functionality in order to meet customers’ demands, and our close connections with multiple markets through our customer base. Our competitive position may be negatively affected, however, by our relatively small size, which could inhibit our ability to fund research and development activities as aggressively as our competitors. This factor could in turn affect our ability to attract new customers that may choose to purchase from one of our competitors with a larger market share and product offering.

Manufacturing

      Our manufacturing operations consist of materials planning and procurement, final assembly, product assurance testing, quality control, and packaging and shipping. We currently use several independent manufacturers to provide certain printed circuit boards, chassis and subassemblies. We have developed a manufacturing process that enables our products to be configured to different customer hardware and software applications at the final assembly stage. This flexibility is designed to reduce both our manufacturing cycle time and our need to maintain a large inventory of finished goods. We also believe that the efficiency of our manufacturing process to date is largely due to our product architecture and our commitment to manufacturing process design.

      We spend significant engineering resources producing customized software and hardware to assure consistent high product quality. We test every product both during and after the assembly process using internally developed automated product assurance testing procedures. These procedures consist of automated board and automated system testing as well as environmental testing. Although we generally use standard parts and components for our products, many key components are purchased from sole or single source vendors for which alternative sources are not currently available. It is possible that we may experience supply problems in the future from any of our manufacturers or vendors. We believe that there may be seasonal fluctuations in the placement of orders that may cause us to experience supply problems.

Research and Product Development

      We focus our development efforts on providing enhanced functionality to our existing products, including total network offerings and performance and the development of additional software-based features and functionality. We obtain extensive product development input from our customers and our monitoring of end-user needs and changes in the marketplace. Our current product development focus has been on developing next-generation wireline and wireless broadband access products and completing new products. We believe that our success will depend, in part, on our ability to develop and introduce in a timely fashion new products and enhancements to our existing products. We have in the past made, and intend to continue making, significant investments in product and technological development. Our engineering, research and development expenditures totaled approximately $33.6 million in 2001, $23.7 million in 2002 and $11.0 million for the year ended December 31, 2003. We perform our research and product development activities at our offices in Boulder, Colorado, Tulsa, Oklahoma, Roanoke, Virginia and Brookfield, Connecticut. Our inability to develop new products or enhancements to existing products on a timely basis, or the failure of these new products or enhancements to achieve market acceptance, could have a material adverse effect on our business.

Intellectual Property

      As of December 31, 2003, we held a total of 13 issued U.S. patents and had approximately 18 pending U.S. patent applications. We have one U.S. trademark application pending and have 14 registered trademarks. A large number of patents and frequent litigation based on allegations of patent infringement exist within the telecommunications industry. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies that are important to us. If any such claims asserting that our products infringe on proprietary rights of third parties were determined adversely to us, it could have a material adverse effect on our business, financial condition or results of operations.

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      We rely upon 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. We have also entered into confidentiality agreements with our employees and consultants, and we enter into non-disclosure agreements with our suppliers and distributors so as 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. The laws of certain foreign countries in which our products are or may be developed, manufactured or sold may not protect our products or intellectual property rights to the same extent as do the laws of the U.S. and thus make the possibility of misappropriation of our technology and products more likely. Based on the effort and cost associated with enforcing foreign intellectual property protections as compared with the comparative value of such protections, we suspended our activities related to obtaining international trademark and patent registrations in the first quarter of 2003.

Employees

      As of December 31, 2003, we employed 238 full-time employees. No employees are covered by any collective bargaining agreements and we have never experienced a work stoppage. We believe that our relationships with our employees are good. During 2002, we resized our employee base to focus on the largest opportunities in the ILECs, wireless, and global service provider markets. This process included reducing our workforce from 443 full time employees at December 31, 2001 to 188 at February 28, 2003.

      Many of our employees are highly skilled, and our continued success depends in part upon our ability to attract and retain such employees. In an effort to attract and retain such employees, we continue to offer employee benefit programs that we believe are at least equivalent to those offered by our competitors. Despite these programs, in the past we have experienced difficulties in hiring certain skilled personnel. In critical areas, we have utilized consultants and contract personnel to fill these needs until full time employees could be recruited.

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RISK FACTORS

      Any investment in our common stock involves a high degree of risk. You should consider carefully the following information about these risks, together with the other information contained and incorporated in this prospectus, before you decide to invest in our common stock. If any of the following risks actually occur, our business, financial condition and results of operations would likely suffer. In these circumstances, the market price of our common stock could decline and you may lose all or part of your investment.

      Our quarterly and annual operating results have fluctuated significantly in the past and may continue to vary significantly in the future. For example, although we were profitable on an annual basis from 1997 to 2000, we experienced net losses of $14.9 million and $52.7 million in 2001 and 2002, respectively. In addition, our net revenue decreased from $148.1 million in 2000 to $100.7 million and $50.2 million in 2001 and 2002, respectively.

      We face a number of risks that could cause our future net revenue and operating results to experience similar fluctuations, including the following:

	•	the loss of, or significant reduction in purchases by, any of our large customers, four of whom were each responsible for more than 10% of our net revenue in the year ended December 31, 2003;
	•	reductions in capital spending for equipment by the telecommunications industry, a factor that resulted in a large decline in our product sales starting in 2000; and
	•	costs related to acquisitions of technologies or businesses such as our acquisition of Paragon Networks International Inc. in November 2003.

      A significant portion of the sales of our products are through distributors and OEMs, which generally are responsible for warehousing products, fulfilling product orders, servicing end-users and, in some cases, customizing and integrating our products at end-users’ sites. We rely on a limited number of distributors and OEMs to sell our products. For example, one distributor, Walker & Associates, Inc., accounted for 23%, 16% and 11% of our net revenue in 2001, 2002 and 2003, respectively. In addition, one OEM customer accounted for over 10% of our net revenue in the year ended December 31, 2003. We expect that, in the future, a significant portion of our products will continue to be sold to a small number of distributors and OEMs. Accordingly, if we lose any of our significant distributors and OEMs or experience reduced sales to such distributors and OEMs, our net revenue would decline, which would have an adverse effect on our operating results and could cause a decline in the price of our common stock.

      In the past, some of our distributors have experienced problems with their financial and other resources that have impaired their ability to pay us. For example, in 2002 we incurred bad debt of approximately $1.2 million from one of our distributors when it declared bankruptcy. Although we continually monitor and adjust our reserves for bad debts, we cannot assure you that any future bad debts that we incur will not exceed our reserves. Furthermore, we cannot assure you that the financial instability of one or more of our distributors will not result in decreased net revenue for us and a deterioration in our operating results. Distributors have, in the past, reduced planned purchases of our products due to overstocking and such reductions may occur again in the future.

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      We generally provide our distributors and OEMs with limited stock rotation rights. For example, three times a year, these customers can return up to 15% of our unsold products to us in return for an equal dollar amount of new products. The returned products must have been held in stock by such distributor or OEM and have been purchased within the four-month period prior to the return date. We cannot assure you that we will not experience significant returns of our products in the future or that we will make adequate allowances to offset these returns.

      We also provide certain distributors and OEMs with price protection rights in which we provide these customers with 60-days notice of price increases. Orders we receive from distributors or OEMs 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 and OEMs the difference in price for any stock they have in their inventory. In addition, we grant certain of our distributors and OEMs “most favored customer” terms, pursuant to which we have agreed not to knowingly grant another distributor or OEM the right to resell our products on terms more favorable than those granted to the existing distributor or OEM, without offering the more favorable terms to the existing distributor or OEM. 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 or OEM inventories, our business, financial condition, or results of operations.

      Our agreements with our distributors generally do not grant exclusivity, prevent the distributor from carrying competing products or 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.

      Most of our existing distributors also distribute the products of our competitors. Our distributors may not recommend or continue to use and offer our products, or our distributors may not devote sufficient resources to market and provide the necessary customer support for our products. In addition, it is possible that our distributors will give a higher priority to the marketing and customer support of competitive products or alternative solutions.

      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.

      A significant portion of our net revenue has been derived from a limited number of large orders to direct customers, and we believe that this trend will continue in the future. For example, for the year ended December 31, 2003, we sold directly to two customers that each accounted for over 10% of our net revenue. The majority of 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

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      In the past, some of our direct customers have experienced problems with their financial and other resources that have impaired their ability to pay us. For example, in 2002, one of our direct customers filed for bankruptcy protection, and, as a result, we incurred approximately $1.1 million in bad debt. Another direct customer, which accounted for 13.5% of our net revenues in 2002, has experienced financial difficulty and restructured its operations, and it may not be in a position in the future to continue its historic purchase levels. 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 continue to adversely affect future sales of our products or our ability to collect on accounts receivable for current sales of our products.

      In addition, we sell a moderate volume of products to competitive service providers. The competitive service provider market is overbuilt and is experiencing consolidation. Many of our competitive service provider customers do not have a strong financial position and have limited ability to access the public financial markets for additional funding for growth and operations. Neither equity nor debt financing may be available to these companies on favorable terms, if at all. To the extent that these companies are unable to obtain the financing they need, our ability to make future sales to these customers and realize revenue from any such sales could be harmed. In addition, if one or more of these competitive service providers fail, we could face a loss in revenue and an increased bad debt expense, due to their inability to pay outstanding invoices, as well as a corresponding decrease in customer base and future revenue. Furthermore, a significant portion of our sales to competitive service providers is made through independent distributors. The failure of one or more competitive service providers could cause a distributor to experience business failure and/or default on payments to us.

      In agreements with direct customers that contain “most favored customer” terms, 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 “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 an adverse effect on our operating results and financial condition.

      Our sales cycle averages approximately four to 18 months but can take longer in the case of incumbent local exchange carriers, or ILECs, and other end-users. This process is often subject to delays because of factors over which we have little or no control, including:

	•	a distributor’s, OEM’s or service provider’s budgetary constraints;
	•	a distributor’s, OEM’s or service provider’s internal acceptance reviews;
	•	a distributor’s, OEM’s or service providers staffing levels and availability of lab time for product testing;
	•	the success and continued internal support and development of a service provider’s product offerings; and

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	•	the possibility of cancellation or delay of projects by distributors, OEMs or service providers.

      In addition, as service providers have matured and grown larger, their purchase processes have typically become more institutionalized, requiring more of our time and effort to gain the initial acceptance and final adoption of our products by these customers. Although we attempt to develop our products with the goal of facilitating the time to market of our customer’s products, the timing of the commercialization of a new distributor or service provider applications or services based on our products is primarily dependent on the success and timing of a customer’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 cause our results of operations to vary significantly from quarter to quarter.

      In the industry in which we compete, a supplier must first obtain product approval from an ILEC or other carrier to sell its products to them. This process can last from four to 18 months or longer depending on the technology, the service provider, and the demand for the product from the service provider’s subscribers. Consequently, we are involved in a constant process of submitting for approval succeeding generations of products, as well as products that deploy new technology or respond to new technology demand from certain carriers or other end-users. We have been successful in the past in obtaining such approvals. However, we cannot be certain that we will obtain such approvals in the future or that sales of such products will continue to occur. Furthermore, the delay in sales until the completion of the approval process, the length of which is difficult to predict, could result in fluctuations of revenue and uneven operating results from quarter to quarter or year to year.

      Our customers consist primarily of communications service providers, including wireless service providers, local exchange carriers, multi-service cable operators, and competitive local and international communications providers. These service providers require substantial capital for the development, construction, and expansion of their networks and the introduction of their services. The general slowdown in the economy and the fact that an oversupply of communications bandwidth exists have resulted in a constraint on the availability of capital for these service providers and have had a material adverse effect on many of our customers, with numerous customers going out of business or substantially reducing their capital spending. If our current or potential customers cannot successfully raise necessary funds or if they experience any other adverse effects with respect to their operating results or profitability, their capital spending programs could continue to be adversely impacted. These conditions adversely impacted the sale of our products and our operating results most severely in the fourth quarter of 2000, and they continued to have an adverse impact throughout 2001, 2002, and 2003. These conditions may continue to result in longer sales cycles, deferral or delay of purchase commitments for our products, and increased price competition. In addition, to the extent we choose to provide financing to these prospective customers, we will be subject to additional financial risk which could increase our expenses.

      The communications industry is characterized by rapidly changing technology, evolving industry standards, changes in end-user requirements, and frequent new product introductions and enhancements, each of which may render our existing products obsolete or unmarketable. Our success depends on our ability to enhance our existing products and to timely and cost-effectively develop new products with features that meet changing end-user requirements and emerging industry standards. The development of new, technologically advanced products is an expensive, complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. We may not be successful in identifying, developing, manufacturing, and marketing product enhancements or new products that will respond to technological change or evolving industry standards. In the recent past, we have experienced delays in the development and shipment of new products and

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      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 the products, which generally resulted in reduced gross margins for those products until such time as production volumes of these new products increase. We can give no assurance that these historical practices will not occur in the future and cause us to record lower net 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 our Wide Bank products and Adit products has decreased substantially 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, in addition to reducing the costs of production of our existing products, we must introduce and sell new and enhanced products on a timely basis at a low cost or incorporate features in these products that enable them to be sold at higher average selling prices. 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 would decline, and such decline could adversely affect our operating results and the price of our common stock.

      As standards and technologies evolve, we will be required to modify our products or develop and support new versions of our products. Our research and development expenses decreased 54% to $11.0 million in 2003 from $23.7 million in 2002. As a result, we may not have sufficient resources allocated to the development of new and enhanced products to remain competitive. The failure of our products to comply, or delays in achieving compliance, with the various existing and evolving technological changes and industry standards could harm sales of our current products or delay introduction of our future products.

      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

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      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. In addition, such competitors may enter our existing or future markets with solutions, either developed internally or through acquisition, that may be less costly, provide higher performance or additional features, or be introduced earlier than our solutions. 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 could cause a decline in the price of our common stock.

      Competitive local exchange carriers, or 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 Telecommunications Act of 1996, or the 1996 Act, that imposed 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 actions by the Federal Communications Commission, or the FCC, 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 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 or repeal of new regulations by federal or state regulatory authorities apart from or under the 1996 Act, including the E911 FCC mandate 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 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 it is possible that Congress will propose changes to the 1996 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

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      Many key parts and components are purchased from sole source suppliers for which alternative sources are not currently available. We currently purchase approximately 380 key components from suppliers for which there are currently no substitutes, and we purchase approximately 89 key components from single source suppliers. 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 product orders vary significantly from forecasts, we may not have enough inventories of certain materials and components to fill orders. In addition, many companies utilize the same materials and supplies as we do in the production of their products. Companies with more resources than our own may have a competitive advantage in obtaining materials and supplies due to greater buying power. These factors can result in reduced supply, higher prices of certain materials, and delays in the receipt of certain of our key components, which in turn may generate increased costs, lower margins, and delays in product delivery. Furthermore, due to general economic conditions in the U.S. and globally, our suppliers may experience financial difficulties, which could result in increased delays, additional costs, or loss of a supplier. We attempt to manage these risks through developing alternative sources, through engineering efforts designed to obviate the necessity of certain components, and by building long-term relationships and maintaining close personal contact with each of our suppliers. However, delays in or failures of deliveries of key components, either to us or to our contract manufacturers, and consequent delays in product deliveries, may occur in the future.

      We currently do not have long-term supply contracts for many of our key components. Our suppliers may enter into exclusive arrangements with our competitors, be acquired by our competitors, stop selling their products or components to us at commercially reasonable prices, refuse to sell their products or components to us at any price, or be unable to obtain or have difficulty obtaining components for their products from their suppliers.

      Our distributors, OEMs and direct customers frequently require rapid delivery after placing an order. Our inability to obtain sufficient quantities of the components needed to fulfill such orders has in the past resulted in, and may in the future result in, delays or reductions in product shipments, which could have an adverse effect on sales and customer relationships, our business, financial condition, or results of operations. In the event of a reduction or interruption of supply, it could take up to nine months or more for us to begin receiving adequate supplies from alternative suppliers. Furthermore, we may not be able to engage an alternative supplier who could be in a position to satisfy our production requirements on a timely basis, if at all. Delays in shipment by one of our suppliers have led to lost or delayed sales and sales opportunities in the past and may do so again in the future. For example, in the third quarter of 2003, we were not able to fulfill all of our open purchase orders of our Axxius product due to unforecasted demand and an insufficient availability of parts.

      In addition, the manufacturing process for certain single or sole source components is extremely complex. Our reliance on suppliers for these components, especially for newly designed components, exposes us to potential production difficulties and quality variations that the suppliers experience. In the past, this reliance on outside suppliers for these components has negatively impacted cost and the timely delivery of our products to our customers.

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      We currently use several third-party manufacturers to provide certain components, printed circuit boards, chassis, and subassemblies. Our reliance on third-party manufacturers involves a number of risks, including the potential for inadequate capacity, the unavailability of, or interruptions in, access to certain process technologies, transportation interruptions, and reduced control over product quality delivery schedules, manufacturing yields, and costs. Some of our manufacturers are undercapitalized and may be unable in the future to continue to provide manufacturing services to us. If these manufacturers are unable to manufacture our components in required volumes, we will have to identify and qualify acceptable additional or alternative 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. Any significant interruption in our supply of these components would result in delays, the payment of damages for such delays, or reallocation of products to customers, all of which could have a material adverse effect on our ability to successfully sell and market our products and could result in a decline in our net revenue and operating results. Moreover, since a significant portion of our final assembly and test operations are performed in one location, any fire or other disaster at our assembly facility could also have an adverse effect on our net revenue and operating results.

      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 and our co-founder, could adversely affect our ability to manage our operations. 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. 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 adversely affect our ability to manage our operations and develop new products or enhancements to current products.

      Our products must comply with a significant number of voice and data regulations and standards, which vary between U.S. and international markets, and may also vary within specific foreign markets. We also need to ensure that our products are easily integrated with various telecommunications systems. Standards for new services continue to evolve, requiring us to continuously modify our products or develop new versions to meet new standards. Testing to ensure compliance and interoperability requires significant investments of time and money. If our systems fail to timely comply with evolving standards in U.S. and international markets, if we fail to obtain compliance on new features or if we fail to maintain interoperability with equipment from other companies, our ability to sell our products would be significantly impaired. We could thereby experience, among other things, customer contract penalties, delayed or lost customer orders and decreased revenues.

      We have maintained compliance with ISO 9001:2000 since we were first certified in May 2000, with Telcordia OSMINE since we were first certified in the fourth quarter of 2001 and with Network Equipment Building Standards Level 3 since we were first certified in April 1998. ISO 9001:2000 is a set of comprehensive standards that provide quality assurance requirements and quality management guidance. These standards act as a model for quality assurance for companies involved with the design, testing, manufacture, delivery and service of products. Telecordia, formerly known as Bellcore, developed the Osmine program, which is a process designed to

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      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. For example, in the first quarter of 2003, we discovered that a service card in one of our products contained a software defect when used in certain applications. We corrected this defect with a software upgrade to the service card which required us to incur additional costs and expend additional resources to develop and install the software upgrade. Despite our extensive testing, errors, defects, or failures are possible in our current or future products or enhancements. If such defects occur, we may be subject to:

	•	delays in or losses 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.

      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.

      Our agreements with our distributors, OEMs 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. It is also possible that our errors and omissions insurance may be inadequate to cover any potential product liability claim. 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. Product liability claims brought against us could harm our business.

      We recently completed the acquisition of Paragon Networks International Inc. The Paragon acquisition is the largest acquisition we have completed, and the complex process of integrating Paragon with our operations requires significant resources. We will also face ongoing business challenges that principally include the geographic dispersion of our operations and generating market demand for an expanded product line. Failure to achieve the anticipated benefit of this acquisition or to successfully integrate the operations of Paragon could harm our financial position and results of operations.

      We have incurred and expect to continue to incur significant costs and commit significant management time integrating Paragon’s operations, technology, development programs, products, information systems, customers and personnel. These costs have been, and will likely continue to be, substantial and include costs for:

	•	integrating and reorganizing operations, including combining teams, facilities and processes in various functional areas;
	•	fees and expenses of professionals and consultants involved in completing the integration process;

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	•	settling existing Paragon liabilities;
	•	integrating technology and products; and
	•	other transaction costs associated with the acquisition, including financial advisor, attorney, accountant and other fees.

      Some of these costs will result in an increase in our operating expenses, which, if not offset by an increase in net revenue if and when we are able to successfully sell and market the Paragon product line, would decrease our operating profits and adversely affect our cash flows and operating results, which could result in a decline in the price of our common stock.

      We have spent and may continue to spend significant resources identifying businesses to be acquired by us. The efficient and effective integration of any businesses we acquire into our organization is critical to our growth. Our acquisition of Paragon, and any future acquisitions, involves numerous risks including difficulties in integrating the operations, technologies and products of the acquired companies, the diversion of our management’s attention from other business concerns and the potential loss of key employees of the acquired companies. Failure to achieve the anticipated benefits of these and any future acquisitions or to successfully integrate the operations of the companies we acquire could also harm our business, results of operations and cash flows. Additionally, we cannot assure you that we will not incur material charges in future quarters to reflect additional costs associated with any future acquisitions we may make.

      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 December 31, 2003, we held a total of 13 issued U.S. patents and had approximately 18 pending U.S. patent applications. We have one U.S. trademark application pending and have 14 registered trademarks. We cannot assure you that our pending patent or trademark applications will be granted or, if granted, will be sufficient to protect our rights. 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 our products or 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 the laws of the U.S. Based on the effort and cost associated with enforcing foreign intellectual property protections as compared with the comparative value of such protections, we suspended our activities related to obtaining international trademark and patent registrations in the first quarter of 2003. We cannot assure that our competitors will not independently develop similar or superior technologies or duplicate any technology that we have. Any such events could harm our ability to sell and market our products, which could result in a decrease in net revenue and the price of our common stock.

      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

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      In our customer agreements, we agree to indemnify our 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 our customer.

      We are in the process of expanding into international markets, and we anticipate increased sales from these markets. A number of factors inherent to these markets expose us to significantly more risk than domestic business, including:

	•	local economic and market conditions;
	•	exposure to unknown customs and practices;
	•	potential political unrest;
	•	foreign exchange exposure;
	•	unexpected changes in or impositions of legislative or regulatory requirements;
	•	less regulation of patents or other safeguards of intellectual property; and
	•	difficulties in collecting receivables and inability to rely on local government aid to enforce standard business practices.

      Any of these factors, or others, of which we are not currently aware, could result in increased operating costs or loss of net revenue.

      We require substantial working capital to fund our business. As of December 31, 2003, we had approximately $36.5 million in cash and marketable securities. Subsequent to December 31, 2003 we completed a public stock offering, which generated additional cash of approximately $78.5 million. We believe that our cash and marketable securities, together with cash generated by operations, if any, will be sufficient to meet our capital requirements for at least the next 12 months. However, our capital requirements depend on several factors, including the rate of market acceptance of our products, our ability to expand our client base and the growth of sales and marketing. If our capital requirements vary materially from those currently forecasted, we may need to obtain additional financing. 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 would adversely affect our business and result in a decline in the price of our common stock.

      As of March 1, 2004, our 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 owned approximately 41% of our outstanding shares of common stock. In particular, Mr. Koenig, a director and our President and Chief Executive Officer, and Ms. Pierce, a director and our Secretary and Corporate Development Officer, are married. As of March 1, 2004, Mr. Koenig and Ms. Pierce together beneficially owned approximately 40% of our

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      Our principal administrative, sales and marketing, research and development, and support facilities consist of approximately 64,000 square feet of office space in Boulder, Colorado. We occupy these premises under two separate leases, one for approximately 37,000 square feet that expires on December 31, 2005, with an option to renew through December 31, 2008, and one for approximately 27,000 square feet that expires on March 31, 2009. As of December 31, 2003, the annual base rent for these facilities was approximately $849,993.

      We lease three other facilities in Boulder, Colorado. Approximately 7,500 square feet of space is our former office and is leased through June 30, 2007. This space is subject to a sublease for the remaining term of the master lease. We lease approximately 39,000 square feet of manufacturing and warehouse space in a facility located outside of Boulder under a lease that expires on November 30, 2005. We have a lease for a warehouse of approximately 57,000 square feet in Boulder, Colorado, which expires on November 22, 2005. We vacated this space in February 2003 and subleased it for the remaining term of the master lease on August 22, 2003.

      In addition, we lease facilities in three other states: Connecticut, Oklahoma and Virginia. We are currently occupying approximately 12,800 square feet in Brookfield, Connecticut, a Paragon lease with an expiration date of December 31, 2004. We also occupy approximately 10,100 square feet in Bethel, Connecticut, a Paragon lease, which is used for administration and manufacturing, with an expiration date of December 31, 2004. Our space in Tulsa, Oklahoma, is used for research and development and consists of approximately 16,000 square feet of space with an expiration date of April 30, 2005. We are currently occupying approximately 14,000 square feet of this space and are seeking a sublease for the remaining approximately 2,000 square feet. Our lease consists of approximately 17,000 square feet of space in Roanoke, Virginia, with an expiration date of November 30, 2007. We are currently occupying approximately 7,000 square feet of this space and are seeking to sublease the remaining approximate 10,000 square feet. We also occupy a 2,000 square foot sales office in Ottawa, Canada with an expiration date of June 30, 2005.

      In October 2002, we closed a research and development facility in Camarillo, California. The Camarillo lease consisted of approximately 14,500 square feet and expires on August 31, 2005. We are currently seeking to sublease that space.

      We lease one small office for our field sales and support organization located in Greensboro, North Carolina.

      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. On December 5, 2002, we amended our counterclaim to seek damages of $27.0 million. We are currently in the discovery phase of the litigation and have insufficient information to make an estimate of the outcome of this litigation. Therefore, no provision for any potential liability or asset that may result has been made in the consolidated financial statements. We intend to vigorously defend this lawsuit.

      We are involved in certain other disputes and legal actions arising in the ordinary course of our business. While it is not feasible to predict or determine the outcome of these proceedings, in our opinion, based on a review with legal counsel, none of these disputes and legal actions is expected to have a material effect on our consolidated financial position, results of operations, or cash flows. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.

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      No matters were submitted to a vote of security holders during the fourth quarter of 2003.

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EXECUTIVE OFFICERS OF THE REGISTRANT

      The names, ages and positions of all our executive officers as of March 1, 2004 are listed below, followed by a brief summary of their business experience. Executive officers are normally appointed annually by the Board of Directors at a meeting of the directors immediately following the Annual Meeting of Stockholders and serve until their successors are appointed. There are no family relationships among these officers, other than between Mr. Koenig and Ms. Pierce, who are married, or any arrangements or understandings between any officer and any other person pursuant to which an officer was selected.

      Roger L. Koenig. Mr. Koenig has served as our President, Chief Executive Officer and Chairman of the Board since we were incorporated in September 1992. Prior to co-founding the company, Mr. Koenig served as the President and Chief Executive Officer of Koenig Communications, Inc., an equipment systems integration and consulting firm, from 1987 to 1992. Prior to founding Koenig Communications, Mr. Koenig held a number of positions with IBM/ ROLM Europe, a telecommunications equipment manufacturer, including Engineering Section Manager for Europe. Mr. Koenig received a B.S. in Electrical Engineering from Michigan State University and an M.S. in Engineering Management from Stanford University.

      Nancy Pierce. Ms. Pierce has served as our Corporate Development Officer since April 2000 and has been a Director and Secretary since our incorporation in September 1992. Ms. Pierce also served as our Secretary and Corporate Controller, Chief Financial Officer, Vice President, Finance and Administration and Treasurer. Prior to co-founding the company, Ms. Pierce served as the Controller of Koenig Communications, Inc., a systems integration and consulting firm and held positions at IBM Corporation and ROLM Corporation. Ms. Pierce serves on the Board of Directors of Koala Corporation, a provider of commercial protection and activities products designed for infants and children. Ms. Pierce earned a B.S. degree from Colorado State University and an M.B.A. from California State University, Chico. In addition, Ms. Pierce holds an honorary doctorate degree in Commercial Science from St. Thomas Aquinas University.

      Timothy R. Anderson. Mr. Anderson has served as our Treasurer, Chief Financial Officer and Vice President of Administration since April 2000. Mr. Anderson has served as the Vice President of Finance since July 1999. Mr. Anderson previously held the position of our Corporate Controller from February 1996 to July 1999. Prior to joining the company, Mr. Anderson served as the Controller of RIK Medical LLC from September 1994 to February 1996. Mr. Anderson received a B.S. in finance and an M.B.A. in accounting from the University of Colorado and is a Certified Management Accountant.

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PART II

Price Range of Common Stock.

      Our initial public offering was held on July 30, 1998 at a price of $12.00 per share. Our common stock is listed on the Nasdaq National Market under the symbol “CACS.” The table below sets forth the high and the low closing sales prices per share as reported on the Nasdaq National Market for the periods indicated.

Holders of Common Stock

      On March 1, 2004, the last reported sale price of our common stock as reported on the Nasdaq National Market was $12.00 per share. As of March 1, 2004, there were approximately 146 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.

Dividends

      We have never declared cash dividends on our common stock. We currently intend to retain any earnings in our business and do not anticipate paying any cash dividends in the foreseeable future.

Sale of Unregistered Shares

      During the fourth quarter of 2003, we issued an aggregate of 1,334,521 shares of unregistered common stock to certain stockholders of Paragon Networks International, Inc. (“Paragon”) in connection with our acquisition of Paragon. The unregistered common stock had an aggregate value of $19,163,722. The shares of our common stock issued in connection with the acquisition were exempt from registration under the Securities Act of 1933, as amended, pursuant to Regulation D promulgated under Section 4(2) thereof, on the basis that the transaction did not involve a public offering.

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      The selected financial data for the years ended December 31, 1999, 2000, 2001, 2002 and 2003 have been derived from our audited consolidated financial statements. The information set forth below should be read in connection with our audited consolidated financial statements and the notes thereto and “Management’s Discussion and Analysis of the Financial Condition and Results of Operations” included elsewhere in this Report on Form 10-K.

Consolidated Financial Highlights

NOTICE CONCERNING FORWARD-LOOKING STATEMENTS

      This Management’s Discussion and Analysis contains “forward-looking statements” within the meaning of the federal securities laws, including forward-looking statements regarding future sales of our products to our customers, inventory levels, our anticipated product offerings, expectations regarding selling, general and administrative expenses, customer revenue mix, sources of revenue, gross margins, our tax liability and operating costs and expenses. 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 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, as well as any forward-looking statements, are subject to risks and uncertainties, including but not limited to the factors set forth under the heading “Risk Factors” in Item 1 of this report. All forward looking statements and reasons why results may differ included in this report are made as of the date hereof, and, unless required by law, we undertake no obligation to update any forward-looking statements or reasons why actual results may differ in this Report on Form 10-K.

Overview

      We design, manufacture and sell next-generation broadband access communications equipment to wireline and wireless communications service providers. We were incorporated in September 1992 as a successor company to Koenig Communications, Inc., an equipment systems integration and consulting company which had been in operation since 1986. In the summer of 1995, we ceased our systems integration and consulting business and commenced our main product sales with the commercial deployment of our first network access products,

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      During the late 1990s, a substantial number of service providers, including CLECs, invested heavily in network infrastructure and service delivery projects, which accelerated growth in the telecommunications equipment market. By 2000, when our annual net revenues reached $148.1 million, we relied on a limited number of CLECs for a significant portion of our net revenue. However, starting in late 2000, many of these CLECs encountered sharp declines in the amount of capital they had available to fund network infrastructure and service delivery projects. As a result, there was a significant decline in the demand for telecommunications equipment, including demand for our products.

      We have since broadened our product portfolio into new markets, including wireless service providers and incumbent wireline carriers. For example, in 2000, 62% of our net revenue was derived from CLECs, 13% from ILECs, and 5% from wireless service providers compared to 23%, 19% and 37%, respectively, in 2003. Currently, the wireless and ILEC markets are dominated by a small number of large companies, and we continue to rely upon a small number of customers in these markets for a significant portion of our revenue. For example, we believe that TMobile USA, Inc., a wireless service provider, both directly and indirectly through our OEM channel, accounted for 28% of our net revenue for the year ended December 31, 2003.

      When the downturn in the telecommunications industry adversely affected our net revenue and operating results in late 2000, we reduced our operating expenses in an effort to better position our business for the long term. In December 2002, we completed a restructuring plan designed to reduce our expenses and align our workforce and operations to be more in line with anticipated net revenues. As a result of the restructuring plan, we recorded a $2.0 million restructuring charge in the fourth quarter of 2002. This charge was comprised of $1.4 million for future rent payments related to facility closures and downsizing and $600,000 for salary-related expenses due to reductions in our workforce. Our objective has been to focus on cost controls while continuing to invest in the development of new and enhanced products, which we believe will position us to take advantage of sales opportunities as economic conditions improve and demand recovers, a trend that we have started to see over the past six months. However, we believe current economic conditions may continue to cause our customers and potential customers to defer and reduce capital spending.

      Historically, most of the sales of our products have been through a limited number of distributors. For example, as a percentage of net revenue, Walker & Associates accounted for 23% in 2001, 16% in 2002, and 11% in 2003. Recently, however, an increasing proportion of our products sales have been made directly to telecommunications service providers and OEMs. For example, for the year ended December 31, 2003, Nortel, an OEM, accounted for 11% of net revenue and we sold directly to two service providers, T Mobile and XO Communications, Inc., which accounted for 17% and 12% of our net revenue, respectively. We expect that the sale of our products will continue to be made to a small number of distributors, OEMs, and direct customers. As a result, the loss of, or reduction of sales to, any of these customers would have a material adverse effect on our business.

      Our net revenue continues to be affected by the timing and number of orders for our products, which continue to vary from quarter to quarter due to factors such as demand for our products, economic conditions, and the financial stability and ordering patterns of our direct customers, distributors, and OEMs. In addition, 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 OEM and direct sales to customers continues to increase since such customers typically place larger orders than our distributors. The timing of such orders and our ability to fulfill them have caused material fluctuations in our operating results, and we anticipate that such fluctuations will continue in the future.

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Recent Developments

      On November 25, 2003, we completed the acquisition of Paragon Networks International Inc., a provider of wireless transport products to mobile wireless operators worldwide. In exchange for all outstanding shares of Paragon capital stock, we issued 1,334,521 shares of our common stock and distributed $411,407 in cash to the Paragon stockholders. As of the closing of the acquisition, the aggregate value of the consideration that we issued to the Paragon stockholders was approximately $19.6 million. All outstanding Paragon options and warrants were cancelled as part of the transaction. We accounted for the acquisition using the purchase method of accounting. In addition to the consideration that we issued in exchange for the outstanding shares of Paragon capital stock, we will pay an aggregate of approximately $1.0 million in cash to Paragon employees.

Results of Operations

      Our net revenue for 2003 increased to $62.6 million from $50.2 million in 2002. The increase in net revenue in 2003 was due to increases in the number of units sold into the wireless market. We believe that the increase in units sold in 2003 was partially due to the deployment by some wireless carriers of our Axxius, Adit and MasterSeries products to comply with FCC mandated E911 location services and expand cell site bandwidth capacity. The acquisition of Paragon in November 2003 contributed to the increase in our wireless market revenue, primarily because of the MasterSeries product. Our net revenue also improved due to a slight economic recovery and the lessening of capital market constraints in the telecommunications sector in 2003.

      Our net revenue for 2002 decreased to $50.2 million from $100.7 million for the year ended December 31, 2001. The decrease in net revenue in 2002 was due to decreases in the number of units of our products sold and price decreases in some of our products, which were primarily caused by overall economic weakness and capital market constraints impacting telecommunication service providers and continued downturns in the telecommunications sector in 2002.

      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. In 2001, 2002 and 2003, 23% of our net revenue was derived from 15, 14 and 16 orders, respectively. Ten customers placed these orders over those years. These customers include ADC, Walker & Associates and XO, each of which contributed at least 10% of our net revenue in at least one of those periods. We have experienced a substantial decrease in the number of orders from some of these customers as a result of decreases in their capital spending budgets and the impact of adverse economic conditions both in general and in the telecommunications equipment industry in particular, which has resulted in decreased demand for telecommunications equipment during this period. In order to maintain or grow our net revenue, as well as offset the loss of anticipated net revenue from some of our prior customers, we will need to sell more products to both our remaining customers and new customers, and we can provide no assurance that we will be able to make such sales. Our net revenue was and continues to be affected by the timing and quantities of orders for our products which may 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, bankruptcies of our customers and distributors, and ordering patterns of distributors, OEMs and other direct customers. We believe that this trend could continue in the future, especially if the percentage of direct sales to end-users increases. The timing of customer orders and our ability to fulfill them can cause material fluctuations in our operating results, and we anticipate that such fluctuations will occur in the future.

      During 2003, approximately 40% of our revenue was derived from the sales of our products through our distributors and OEMs. Our success depends in part on the continued sales and customer support efforts of our

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      We believe that our revenue will increase in 2004 as we will have a full year of revenue from the Broadway and MasterSeries products acquired with the Paragon acquisition, and as wireless carriers continue their expansion of cell sites and continue to deploy data services into cell sites for E911 location services and other bandwidth intensive applications like pictures or streaming video. Additionally we believe the acceptance and deployment of voice over IP services will continue to increase throughout the year.

      Cost of goods sold for 2003 was $35.2 million compared to $33.1 million in 2002 and $54.1 million for 2001. The increase in 2003 was due to increased sales and was partially offset by charges of $3.0 million taken in 2002 for slow moving and excess inventory. The decrease in 2002 was primarily attributable to decreased product shipments, partially influenced by cost reductions in existing product platforms, and partially offset by charges taken in 2002 for slow moving and excess inventory.

      Gross profit in 2003 increased to $27.3 million from a gross profit of $17.1 million in 2002. This increase was caused by the increased shipments of our products in 2003 and by charges taken for slow moving and excess inventory in 2002. Gross margin increased to 44% in 2003 from 34% in 2002. Gross margin increases were also attributable to changes in product mix, as gross margins vary among products, product cost reductions and higher production volumes, and were partially offset by decreases in selling prices. Our gross profit for 2002 was $17.1 million, a decrease of $29.5 million from the gross profit of $46.6 million in 2001. Gross margin decreased to 34% in 2002 from 46% in 2001. The decrease in gross margin was driven primarily by reduced revenues and charges taken for slow moving and excess inventory. Gross margins were also impacted by changes in the mix of products sold, as gross margins vary among products, increased production volumes, decreases in selling prices, product cost reductions, and decreased overhead expenses.

      We believe that gross margins could continue to increase in 2004 if sales of our products increase and if we are able to reduce the cost of our products at a greater rate than anticipated price reductions, or if we are able to gain manufacturing efficiencies by consolidating our production facilities. New product introductions could potentially 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 has 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 product lines 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, gross margins may decrease from time to time as a result of new product introductions by our competitors and us.

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      Research and development expenses for 2003 decreased to $11.0 million from $23.7 million in 2002 mostly due to a $7.9 million decrease in personnel expense due to reductions in work force. There were also decreases of $1.7 million for depreciation expense, $1.4 million in expense for technical certification programs and $1.1 million decrease in prototyping expenses. Depreciation decreased as we took assets out of service in late 2002 and Telcordia certification decreased due to a one-time expense in 2002 related to our Wide Bank product. We believe that research and development expenses will increase in the first quarter of 2004 as we absorb the research and development department from the Paragon acquisition and as we continue to develop new product platforms and service cards for our existing platforms. Research and development expenses for 2002 decreased to $23.7 million from $33.6 million in 2001 primarily as a result of a $6.7 million decrease in personnel expense and a $2.0 million decrease in prototyping expense. Personnel expense in the past two years decreased as we reduced employees in order to reduce operating expenses. Prototyping expense decreased in the past two years as we completed and reduced the number of product development programs.

      Selling, general and administrative expense for 2003 decreased to $14.3 million from $45.6 million in 2002. Sales and marketing expense for 2003 decreased to $11.8 million from $18.3 million in 2002 primarily as a result of a $4.0 million decrease in personnel expense, a $618,000 decrease in travel and entertainment expense, a $449,000 decrease in expenses for demonstration equipment and a $315,000 decrease in communication expense. Most of the decreases in sales and marketing expenses were the result of the reduction in sales and marketing personnel that occurred in the early part of 2003 and the expenses related to their sales and marketing activities. We anticipate that sales and marketing expenses will increase in 2004 as we increased our sales and marketing department with the acquisition of Paragon . We are also increasing marketing activities in some targeted markets. General and administrative expense for 2003 decreased to $5.4 million from $9.8 million in 2002. The decrease was primarily attributable to a $2.2 million expense for legal and settlement costs incurred in 2002 as well as a $1.7 million decrease in personnel cost and a $233,000 decrease in professional fees. Bad debt expense went from a $5.6 million expense in 2002 to a $3.1 million recovery in 2003. In 2002, a number of our customers filed for bankruptcy and one of our distributors was experiencing financial difficulties which caused a significant amount of accounts receivables to become delinquent. In 2003, we were able to recover some of the delinquent receivables and part of the accounts receivable related to the bankruptcy. We also incurred an asset impairment charge related to goodwill of $9.8 million and a restructuring charge of $2.0 million in 2002.

      Selling, general and administrative expenses for 2002 increased to $45.6 million from $40.1 million in 2001. Sales and marketing expense for 2002 decreased to $18.3 million from $23.4 million in 2001 primarily as a result of a $2.0 million decrease in personnel expense, a $675,000 decrease in recruiting expense and a $564,000 decrease in advertising expense. General and administrative expenses for 2002 increased to $9.8 million from

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      Interest and other income, net for 2003 decreased to $353,000 from $714,000 in 2002. The decrease was due to lower interest income earned due to lower interest rates. We believe that net interest and other income will increase substantially in 2004 due to increased cash and cash equivalent balances from our public stock offering that we completed in February 2004, which resulted in net proceeds of $78.5 million.

      Interest and other income, net for 2002 decreased to $714,000 from $1.6 million in 2001. The decrease of $921,000 was due to interest income earned on lower cash and cash equivalent balances as well as lower interest rates.

      For 2003, our effective combined federal and state income tax rate was a negative 3.8% compared to an income tax rate of negative 2.1% and 41.6% for 2002 and 2001, respectively. In the second quarter of 2002, we determined that it was not “more likely than not,” based on our taxable losses, projections of future taxable income and the reversal of deferred tax liabilities, that our deferred tax assets would be realized. As a result, we recorded a valuation allowance of $12.8 million reducing the carrying amount of our deferred tax assets to zero. We recorded an additional valuation allowance of $4.3 million in the second half of 2002 and $20,000 in 2003 to reduce the additional deferred tax assets generated during that period. In 2001, we realized a tax benefit from research and experimentation tax credits, which increased the effective rate of the tax benefit in 2001. Although we may be profitable in 2004 , we do not believe that we will experience any income tax expense in 2004. Our net operating loss carryforwards may be used to offset up to $38.3 million of future taxable income for federal tax purposes and up to $58.9 million for state tax purposes. As these net operating loss carryforwards are utilized, we will reduce the related valuation allowance. Reductions in the valuation allowance, if any, will be recognized in our statements of operations as an income tax benefit, and may offset any current income tax expense. In addition, should we demonstrate a history of sustained profitability, we may reverse all or a significant portion of the remaining valuation allowance.

Liquidity and Capital Resources

      At December 31, 2003, our principal sources of liquidity included cash and cash equivalents and marketable securities available for sale of approximately $36.5 million. At December 31, 2003, our working capital was approximately $67.6 million. We have no significant capital spending or purchase commitments other than facilities leases. Subsequent to December 31, 2003, we completed a stock offering, which generated additional cash of approximately $78.5 million.

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      Cash provided by operations was $9.6 million for the year ended December 31, 2003 contrasted by $9.2 million used in operations in 2002. The $18.8 million change was primarily due to our net income in 2003 of $2.5 million combined with the receipt of our income tax refund of $7 million compared with our net loss of $52.7 million in 2002. This was partially offset by decreases in non-cash charges for depreciation, asset impairments, provisions for doubtful accounts and obsolete inventory, and deferred tax expense. Increases in accounts receivable were substantially offset by the increase in accounts payable.

      Cash used by investing activities for the year ended December 31, 2003 was $8.9 million compared to $644,000 for the year ended December 31, 2002. For the year ended December 31, 2003, we had net purchases of $8.5 million of marketable securities compared to net sales of $1.0 million for the year ended December 31, 2002. We acquired $1 million of cash in connection with our acquisition of Paragon, net of cash used for the acquisition. Our capital expenditures for the year ended December 31, 2003 were $770,000 for equipment to support research, development, and manufacturing activities compared to $1.7 million for the year ended December 31, 2002. We believe our current facilities are sufficient to meet our current operating requirements. Capital expenditures in 2004 are expected to exceed those of 2003 as we invest to support research, development and production tooling.

      Net cash from financing activities provided $1.6 million for the year ended December 31, 2003, which was the result of cash received upon the exercise of stock options, compared to $14,000 for the year ended December 31, 2002.

      Our net inventory levels increased approximately $2.0 million to $26.1 million at December 31, 2003 from $24.1 million at December 31, 2002. The increase was primarily the result of the fulfillment of a $7.0 million purchase commitment, which was satisfied in June of 2003, and $3.7 million from the acquisition of Paragon offset by the shipment of products. We anticipate that inventory levels will decline in 2004, as we have decreased our purchasing and continue to ship out of our current inventory.

      We believe that our existing cash and investment balances are adequate to fund our projected working capital and capital expenditure requirements for a period greater than 12 months. Although operating activities may provide cash in certain periods, to the extent we experience growth in the future, we anticipate that our operating and investing activities may use cash. We may consider using our capital to make strategic investments, acquisitions of companies, or to acquire or license technology or products. However, we cannot assure you that additional funds or capital will be available to us in adequate amounts and with reasonably acceptable terms.

Contractual Obligations

      The Company leases office space under various noncancelable-operating leases that expire through 2009. The Company also leases copiers under various capital leases which expire in 2006. The impact that our contractual obligations as of December 31, 2003 are expected to have on our liquidity and cash flow in future periods is as follows (in thousands):

      The Company records rent expense under noncancelable operating leases using the straight-line method after consideration of increases in rental payments over the lease term, and records the difference between actual payments and rent expense as deferred rent concessions.

      The Company has placed non-cancellable purchase orders for $12.7 million of inventory from certain of its vendors for delivery in 2004. Purchase orders are generally placed up to 4 months in advance based on the lead time of the inventory.

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      Rent expense for the years ended December 31, 2001, 2002, and 2003 totaled $1.5 million, and $1.9 million, and $1.6 million respectively.

Off-Balance Sheet Arrangements

      We do not have any off-balance sheet arrangements.

Critical Accounting Policies

      Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue and product returns, inventory valuations, allowance for doubtful accounts, intangible assets, deferred income taxes and warranty reserves. We use historical experience and various other assumptions that are believed to be reasonable under the circumstances as a basis for making estimates about the carrying value of assets and liabilities and other items that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We consider the following accounting areas to have the most significant impact on the reported financial results and financial position of our company.

      Revenue Recognition. We recognize revenue from product sales at the time of shipment and passage of title using guidance from SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements,” as amended by Staff Accounting Bulletin No. 104. Our revenue from sales of products is recognized upon shipment based upon our shipping terms, provided that we have evidence of an arrangement, the fee is fixed and collectibility is probable. We offer certain of our customers the right to return products for a limited time after shipment as part of a stock rotation program. We estimate future stock rotation returns based upon actual historical return rates and reduce our revenue by these estimated returns. If future returns exceed our estimates, revenue would be further reduced.

      Inventory Reserves. We value our inventory at the lower of the actual cost to purchase and/or manufacture or the current estimated net realizable value of inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than our estimates, then additional inventory write-downs may be required.

      Allowance for Doubtful Accounts. We perform ongoing credit evaluations of our customers and adjust open account status based upon payment history and the customer’s current creditworthiness, as determined by our review of current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon the age of outstanding invoices and any specific customer collection issues that we have identified. While such credit losses have usually been within our expectations and the provisions established, we did recover a significant portion of aged receivables in 2003 that we had previously provided for. This recovery amounted to approximately $3.1 million. We cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Because our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material impact on our ability to collect our accounts receivable and, accordingly, on our future operating results.

      Valuation of Intangible Assets. We regularly evaluate the potential impairment of goodwill and other intangible assets. In assessing whether the value of our goodwill and other intangibles has been impaired, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of these assets. If these estimates or their related assumptions change in the future, we may be required to record additional impairment charges.

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      Deferred Income Taxes. Current income tax expense (benefit) represents actual or estimated amounts payable or receivable on tax return filings each year. Deferred tax assets and liabilities are recorded for the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying balance sheets, and for operating loss and tax credit carryforwards. The change in deferred tax assets and liabilities for the period determines the deferred tax provision or benefit for the period. Effects of changes in enacted tax laws on deferred tax assets and liabilities are reflected as adjustments to the tax provision or benefit in the period of enactment. A valuation allowance is required to reduce the carrying amount of deferred tax assets if management cannot conclude that realization of such assets is more likely than not at the balance sheet date. Based upon our recent history of losses and an analysis of projected net taxable income for future operating periods, we determined that realization of our tax net operating loss carryforwards, tax credit carryforwards and other deferred tax assets is not sufficiently assured. Based upon this analysis, a valuation allowance was established.

      Warranty Reserves. We offer warranties of various lengths to our customers depending on the specific product and the terms of our customer purchase agreements. Our standard warranties require us to repair or replace defective product returned to us during the warranty period at no cost to the customer. We record an estimate for warranty related costs based on our actual historical return rates and repair costs at the time of sale. On an on-going basis, management reviews these estimates against actual expenses and makes adjustments when necessary. While our warranty costs have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same warranty return rates or repair costs that we have in the past. A significant increase in products return rates or the costs to repair our products could have a material adverse impact on our operating results.

      Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and interest rates. Historically, and as of December 31, 2003, we have had little or no exposure to market risk in the area of changes in foreign currency exchange rates and interest rates as measured against the United States dollar. Historically, and as of December 31, 2003, we have not used derivative instruments or engaged in hedging activities.

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Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule

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INDEPENDENT AUDITORS’ REPORT

      We have audited the accompanying consolidated balance sheets of Carrier Access Corporation and subsidiaries as of December 31, 2002 and 2003, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss) and cash flows for each of the years in the three year period ended December 31, 2003. These consolidated financial statements are the responsibility of Carrier Access Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Carrier Access Corporation and subsidiaries as of December 31, 2002 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

      As discussed in Note 5 to the consolidated financial statements, Carrier Access Corporation adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002.

KPMG LLP

Boulder, Colorado

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CARRIER ACCESS CORPORATION

See accompanying notes to consolidated financial statements.

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CARRIER ACCESS CORPORATION

See accompanying notes to consolidated financial statements.

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CARRIER ACCESS CORPORATION