UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the transition period from       to

COMMISSION FILE NUMBER: 000-24597

CARRIER ACCESS CORPORATION

5395 Pearl Parkway, Boulder, CO 80301

(303) 442-5455

     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 þ 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 þ

     The number of shares outstanding of the issuer’s common stock, par value $0.001 per share, as of March 31, 2004 was 33,672,121 shares.

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CARRIER ACCESS CORPORATION

TABLE OF CONTENTS

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ITEM 1. 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
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (LOSS)
(In thousands)

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”), IOCs, 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 March 31, 2004 are not necessarily indicative of the results of the full fiscal year. 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, that could occur if securities or other contracts to issue common stock were exercised or converted and resulted in the issuance of common stock.

     A reconciliation of the weighted average shares used in computing basic and diluted earnings (loss) per share amounts is presented below. There were no adjustments to net income (loss) in order to determine diluted earnings (loss) 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 ended March 31, 2004 and 2003 (in thousands, except per share amounts):

The weighted average fair values of options granted during the three months ended March 31, 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 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 quarter of 2004, the Company paid an additional $101,000 in connection with the restructuring plan. The majority of the remaining cash disbursements related to the restructuring plan will be paid by December 31, 2004. The Company made no changes to its restructuring plan assumptions during the first quarter of 2004.

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

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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 is based on an inventory-purchasing dispute and SMTC is seeking 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 currently is in the discovery phase of the litigation and has insufficient information to make an estimate of the outcome of this litigation. Therefore, no provision for any potential liability that may result has been made in the consolidated financial statements. The Company intends to vigorously defend this lawsuit.

     The Company has placed certain non-cancellable purchase orders for $10.2 million of inventory from certain of its vendors for delivery in 2004. These orders are generally placed up to four months in advance based on the lead-time of the inventory.

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 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, 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 MASTER Series and Broadway product lines through our acquisition of Paragon Networks International, Inc. (“Paragon”) a provider of wireless transport products to mobile wireless operators worldwide.

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     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 first quarter, customer service, sales and most manufacturing of legacy Paragon products, had been integrated into our principal operations in Colorado

     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 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 13%, 11% and 68%, respectively, for the first 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 these markets for a significant portion of our revenue. For example, we believe that Cingular and TMobile USA, Inc., two wireless service providers, both directly and indirectly through our OEM channel, each accounted for over 20% of our net revenue for the quarter ended March 31, 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 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 recently. 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 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 quarter ended March 31, 2004, two OEMs, Ericsson and Nortel, each accounted for over 10% of net revenue and we sold directly to one service provider, T Mobile, which also accounted for over 10% of our 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.

     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. 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.

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Results of Operations

Net Revenue and Cost of Goods Sold

     Our net revenue for the quarter ended March 31, 2004 increased to $28.5 million from $11.2 million in the quarter ended March 31, 2003. The increase in net revenue was due to increases in the number of units sold into the wireless market. The increase in units sold in the first quarter of 2004 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, add new cell sites and expand cell site bandwidth capacity. Revenue also increased in the first quarter due to a full quarter’s worth of Paragon revenue. The acquisition of Paragon resulted in an expanded sales force selling a broader product portfolio that ranges from a low-cost nested channel service unit (“CSU”) replacement through an optical transport solution. Since our sales force can now offer a full range of solutions, we are unable to segregate sales that would have been realized without the acquisition. Our net revenue also improved due to improving economic conditions and the lessening of capital market constraints in the telecommunications sector.

     During the first quarter of 2004, approximately 52% 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 March 31, 2004, Ericsson and Nortel, two OEMs, each 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. Accordingly, the loss of, or a reduction in sales to, any of our key distributors or OEMs could have a material adverse effect on our business. In addition to being dependent on a small number of distributors and OEMs for a majority of our net revenue, we believe that our products are sold directly to a limited number of service provider customers. For the quarter ended March 31, 2004, we sold over 10% of our net revenue directly to one service provider, T Mobile. Cingular, another service provider customer, in the first quarter chose our MASTERseries product for the cell site backhaul solutions to support Cingular’s network expansion, and accounted for over 20% of revenue in the first quarter. A decrease in sales to these or other significant customers could have a material adverse effect on our business.

     Cost of goods sold for the quarter ended March 31, 2004 was $15.6 million compared to $6.2 million in the quarter ended March 31, 2003. The increase in 2004 was due to increased sales, remaining consistent at approximately 55% of revenue.

Gross Margins

     Gross profit for the quarter ended March 31, 2004 increased to $12.9 million from a gross profit of $5.0 million for the quarter ended March 31, 2003. This increase was caused by the increased shipments of our products in 2004. Gross margin remained at 45% for the quarter ended March 31, 2004 as compared to the quarter ended March 31, 2003. Gross margins were positively impacted by shifts in product mix to higher margin products, product cost reductions and higher production volumes, and were negatively offset by decreases in selling prices of some products.

     We believe that gross margins could 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. Conversely, new product introductions could potentially harm gross margins until production volumes increase.

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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 prices for the Wide Bank products and Adit products have decreased in the past two years. These decreases were due to unfavorable general economic conditions and the introduction of competitive products. In addition, discounts to distributors vary among 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.

Research and Development Expenses

     Research and development expenses for the first quarter of 2004 increased to $4.0 million from $2.6 million in the first quarter of 2003 primarily related to a $1.0 million increase in personnel expense as a result of the acquisition of Paragon and additions to R&D staff to support new product development. The increase in spending in research and development reflects our commitment to our customers and their product demands. We believe the recent increase in our revenue is a result of our commitment to this management philosophy. We believe that research and development expenses will increase in the second quarter of 2004 as we accelerate our development of new product platforms and service cards for our existing platforms.

Selling, General and Administrative Expenses

     Selling, general and administrative expense for the quarter ended March 31, 2004 increased to $6.5 million from $2.5 million in the quarter ended March 31, 2003. Sales and marketing expense for the quarter ended March 31, 2004 increased to $4.6 million from $2.7 million in the quarter ended March 31, 2003 primarily as a result of a $1.7 million increase in personnel expense and commissions, and a $129,000 increase in travel and entertainment expense. Most of the increases in sales and marketing expenses were the result of the addition in sales and marketing personnel that occurred in November of 2004 with the acquisition of Paragon. We believe that the expenses in this area are strategic in developing new channels and new markets. We anticipate that sales and marketing expenses will continue to increase in 2004 as we increase our sales and marketing activities in some targeted markets. General and administrative expense for the quarter ended March 31, 2004 increased to $1.7 million from $1.2 million in the quarter ended March 31, 2003. The increase was primarily attributable to an increase in personnel cost of $280,000 related to the acquisition of Paragon and costs associated with compliance with the Sarbanes Oxley Act. We recovered bad debt expense of $1.4 million for the quarter ended March 31, 2003 and $183,000 for the quarter ended March 31, 2004, as we continued to recover certain delinquent receivables from customers for which we had previously reserved.

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Other Income, Net

     Interest and other income, net for the quarter ended March 31, 2004 increased to $219,000 from $84,000 for the quarter ended March 31, 2003. The increase was interest earned on larger cash balances due to the proceeds from our public stock offering, which was partially offset by lower interest rates. We believe that net interest and other income will increase in 2004 over 2003 results 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.

Income Taxes

     We recorded an approximate $15,000 income tax provision in the first quarter of 2004, due primarily to estimated alternative minimum tax and state liabilities. The $89,000 benefit from income taxes in the first quarter of 2003 relates to refunds received in excess of previous estimates. However, our income tax provision has differed from the expense that would be expected using the federal statutory rate of 34% due to the fact that beginning in the second quarter of 2002, we recorded a valuation allowance against our deferred tax assets. While we have identified net operating loss carryforwards that 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, we cannot conclude that realization of the resulting deferred tax assets is more likely than not. As these net operating loss carryforwards are utilized, we will reduce the related valuation allowance. Reductions in the valuation allowance, if any, will generally 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. Although we may be profitable in 2004, we do not believe that we will experience significant income tax expense in 2004 due to the use of net operating loss carryforwards and the resulting reversal of valuation allowance. A portion of the valuation allowance relates to deferred tax assets obtained in connection with our acquisition of Paragon in 2003. Should we reverse the valuation allowance related to these acquired deferred tax assets, such reversal will result in an increase to the amount of acquired goodwill and will have no impact on our income tax provision.

Liquidity and Capital Resources