UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED September 30, 2004

OR

COMMISSION FILE NUMBER: 000-24597

CARRIER ACCESS CORPORATION

(Exact name of registrant as specified in its charter)

5395 Pearl Parkway, Boulder, CO 80301

(Address of principal executive offices) (Zip Code)

(303) 442-5455

(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

     The number of shares outstanding of the issuer’s common stock, par value $0.001 per share, as of November 8, 2004 was 34,248,449 shares.

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CARRIER ACCESS CORPORATION

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

CARRIER ACCESS CORPORATION

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

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CARRIER ACCESS CORPORATION

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

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CARRIER ACCESS CORPORATION

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

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CARRIER ACCESS CORPORATION

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

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CARRIER ACCESS CORPORATION

Note 1. Summary of Significant Accounting Policies

     a. Business and Basis of Presentation. Carrier Access Corporation (the “Company”) is a provider of broadband digital access equipment to communications service providers, including incumbent local exchange carriers (“ILECs”), wireless service providers, competitive local exchange carriers (“CLECs”), interexchange carriers (“IXCs”), independent operating companies (“IOCs”), internet service providers (“ISPs”) and wireless service providers, which is used for the provisioning of enhanced voice and high-speed Internet services by service providers to end-users such as small and medium-sized businesses and government and educational institutions. The Company sells its products through distributors and directly to end-user customers. The Company operates in one business segment and substantially all of its sales and operations are domestic.

     The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC regulations. The unaudited condensed consolidated financial statements reflect all adjustments and disclosures that are, in the opinion of management, necessary for a fair presentation. All such adjustments are of a normal recurring nature. Certain amounts in the 2003 consolidated financial statements have been reclassified to conform to the 2004 presentation. Management does not believe the effects of such reclassifications are material. The results of operations for the interim period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the full fiscal year or any fiscal quarter. For further information, refer to the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

     The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

     b. Earnings Per Share. Basic earnings per share (“EPS”) is computed by dividing net income or loss by the weighted average number of common shares outstanding during the period. Diluted EPS reflects basic EPS adjusted for the potential dilution, computed using the treasury stock method, which could occur if securities or other contracts to issue common stock were exercised or converted and resulted in the issuance of common stock. For the three months ended September 30, 2004, all potentially dilutive securities are considered antidilutive due to the Company’s net loss and are therefore excluded from the computation of diluted earnings per share.

     A reconciliation of the weighted average shares used in computing basic and diluted earnings per share amounts is presented below. There were no adjustments to net income in order to determine diluted earnings per share.

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     c. Stock-Based Compensation. The following table summarizes relevant information regarding reported results under the intrinsic value method of accounting for stock awards, with supplemental information provided as if the fair value recognition provisions of SFAS No. 123, Accounting for Stock Based Compensation, had been applied for the three months and nine months ended September 30, 2004 and 2003 (in thousands, except per share amounts):

     The weighted average fair values of options granted during the three and nine months ended September 30, 2004 and 2003 were estimated using the Black-Scholes option-pricing model with the following assumptions:

     d. Exit and Disposal Activities. In December 2002, the Company completed a restructuring plan designed to reduce its expenses in accordance with anticipated reductions in revenue. Included in this plan were reductions in salary-related expenses, facility closures or downsizing, and disposal of excess or unused assets. As a result of these expense reductions, the Company took a charge in the fourth quarter of 2002 of $2.0 million. The Company paid $400,000 of this charge in the fourth quarter of 2002 and $1.1 million during 2003. During the first three quarters of 2004, the Company paid an additional $405,000 in connection with the restructuring plan. The remaining cash disbursements related to the restructuring plan are anticipated to be paid by the end of 2005. The Company has revised certain assumptions during the first nine months of 2004, relating to its ability to sublease one of its abandoned properties. The assumption change resulted in an increase in the restructuring reserve of $92,000.

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Restructuring reserve activity resulting from the 2002 fourth quarter restructuring plan for 2004 is detailed below (in thousands):

Note 2. Inventory

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

Note 3. Commitments and Contingencies

     On August 16, 2002, SMTC Manufacturing Corporation of Colorado (“SMTC”) filed a breach of contract claim and related claims against the Company in District Court, County of Adams, Colorado. The claim was based on an inventory-purchasing dispute and SMTC sought damages of $13.4 million. On October 17, 2002, the Company 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, the Company amended its counterclaim to seek damages of $27.0 million. The Company settled the SMTC lawsuit in September 2004 and as a result recorded a charge for the quarter ending September 30, 2004, in the amount of $2.1 million to reflect the settlement amount and legal expenses associated with the settlement.

Note 4. Subsequent Events

On October 13, 2004, the Company purchased its 5395 Pearl Parkway headquarters in Boulder Colorado for approximately $7.0 million.

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

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 expectations regarding selling, general and administrative expenses, customer revenue mix, sources of revenue, gross margins, our tax liability, operating costs and expenses, and our capital expenditures. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “intends,” “plans,” “anticipates,” “estimates,” “potential,” or “continue, “ or the negative thereof or other comparable terminology. These 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 2 of this Quarterly Report on Form 10-Q. 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 Quarterly Report on Form 10-Q.

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, which was followed by the introduction of our Wide Bank products in November 1997, Access Navigator products in January 1999, Adit products in December 1999, Broadmore products in October 2000, which we acquired from Litton Network Access Systems, Inc., and Axxius products in June 2002. In November 2003 we acquired the MASTERSeries and Broadway product lines through our acquisition of Paragon Networks International, Inc. (“Paragon”), a provider of wireless transport products to mobile wireless operators worldwide. In September 2004 we introduced the Adit 3000 product line.

     In November 2003, we completed the acquisition of Paragon. In exchange for all of the 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. During the first quarter of 2004, we began the integration of some of the operations of Paragon. By the end of the third quarter, we completed our scheduled integration of customer service and manufacturing of Paragon products into our Colorado operations.

     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 now sell our product portfolio into multiple markets, including wireless service providers and incumbent wireline carriers. In 2000, 62% of our net revenue was derived from CLECs, 13% from ILECs, and 5% from wireless service providers compared to 16%, 11% and 48%, respectively, for the third quarter of 2004. 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 the wireless markets for a significant portion of our revenue. Cingular Wireless, LLC, a wireless service provider, directly and indirectly through our original equipment manufacturer, or OEM, channel, accounted for over 20% of our net revenue for the quarter ended September 30, 2004.

     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 initiated a restructuring plan designed to reduce our expenses and align our workforce and operations to be more in line with anticipated net

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revenues. Our objective has been to focus on cost controls while continuing to invest in advancing our product line in wireless and enterprise broadband access. We believe this will position us to take advantage of sales opportunities as economic conditions improve and demand recovers. However, we believe current economic conditions could 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. As a percentage of net revenue, one distributor, Walker & Associates, accounted for 16% in 2002, 11% in 2003, and 10% in the third quarter of 2004. Recently, however, an increasing proportion of our product sales have been made directly to OEMs. For the quarter ended September 30, 2004, one OEM, Ericsson, Inc., accounted for over 10% of net revenue. 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.

     There has been and will continue to be consolidations in the telecommunications industry. Following the announcement of a consolidation, some of our customers may experience disruptions in their business operations. The effects of a consolidation involving any of our customers could result in postponed orders decreased orders or canceled orders. In the quarter ended September 30, 2004, market consolidation in the wireless industry relating to the merger of Cingular and AT&T Wireless and T-Mobile’s purchase of spectrum from Cingular resulted in reduced sales to our wireless customers and OEMs. Our net revenue continues to be affected by consolidation within the communications industry, 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. 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 has caused material fluctuations in our operating results, and we anticipate that such fluctuations will continue in the future.

Results of Operations

Net Revenue and Cost of Goods Sold

     Net revenue for the three months ended September 30, 2004 increased to $21.6 million from $15.9 million reported for the three months ended September 30, 2003. The increase in revenue was primarily due to sales of our MASTERSeries products as well as increased sales of our Broadmore products. Net revenue for the nine months ended September 30, 2004 increased to $81.0 million from $39.3 million reported for the nine months ended September 30, 2003. The increase in revenue was primarily due to increases in sales of our Axxius, Broadmore and MASTERSeries products. The increase in sales of these products was partially due to the deployment of these products by some wireless carriers to comply with FCC mandated E911 location services, the addition of new cell sites and expansion of cell site bandwidth capacity. We also saw sales increases in our Adit product line due to increased deployment of voice, data, and voice over IP, or VoIP, offerings by our wireline customers. As a result of our acquisition of Paragon, we started selling the MASTERSeries product in the fourth quarter of 2003. These increases were partially offset by decreases in sales of our Wide Bank and Navigator product lines. Our net revenue also improved due to improving economic conditions and the lessening of capital market constraints in the telecommunications sector.

     During the first nine months of 2004, approximately 49% 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 network of distributors and OEMs as well as increased sales to our direct customers. For the quarter ended September 30, 2004, Ericsson, Inc., an OEM, and Walker & Associates, a distributor, each acc