| CARRIER ACCESS CORP ITEM 1A RISK FACTORS Investors should carefully consider the risks described below before making an investment decision |
| The risks described below are not the only risks we face |
| Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations |
| Our business could be harmed by any or all of these risks |
| The trading price of our common stock could decline significantly due to any of these risks, and investors may lose all or part of their investment |
| In assessing these risks, investors should also refer to other information contained or incorporated by reference in this annual report on Form 10-K, including our consolidated financial statements and related notes |
| We experienced large net operating losses and decreases in net revenue in 2005, 2002 and 2001, which caused a significant decline in the market price of our common stock, and we could experience similar declines in net revenue in the future, which could negatively impact the market price of our common stock |
| 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 for our fiscal years ended December 31, 1997 through 2000, we incurred significant net losses of dlra14dtta9 million and dlra52dtta7 million in 2001 and 2002, respectively |
| Our quarterly revenues fluctuated in these periods as well |
| We cannot be certain that our annual and quarterly net revenues will not continue to fluctuate significantly in the future |
| We face a number of risks that could cause our future net revenues and operating results to experience similar fluctuations, including the following: • The loss of, or significant reduction in purchases by, any of our large customers, one of whom was responsible for approximately 42prca of our net revenues in the year ended December 31, 2005; • Overall movement toward industry consolidation among both our competitors and our customers, both wireless and wireline; • Reductions in capital spending for equipment by the telecommunications industry and reductions in capital spending for wireless equipment due to mergers and consolidation in the wireless market, a factor that resulted in a large decline in our product sales in 2001, 2002 and 2005; • Fluctuations in demand for our products and services, especially with respect to Internet businesses and telecommunications carriers, in part due to the changing global economic and regulatory environment; • Changes in sales and implementation cycles for our products and reduced visibility into our customers’ spending plans and associated revenue; • Price and product competition in the communications and networking industries, which can change rapidly due to technological innovation; • Costs related to acquisitions of technologies or businesses; • The timing, size, and mix of orders from customers; • The introduction and market acceptance of new technologies and products and our success in new markets; • Variations in sales channels, product costs, or mix of products sold; • The ability of our customers, channel partners, and suppliers to obtain financing or to fund capital expenditures; • Our ability to achieve targeted cost reductions and to execute on our strategy and operating plans; and • Potential difficulties in completing projects associated with in-process research and development |
| The unpredictability of our quarterly results may adversely affect the trading price of our common stock |
| Our net revenues and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control and any of which may cause our stock price to fluctuate |
| Generally, purchases by service providers of telecommunications equipment from manufacturers have been unpredictable and clustered, rather than steady, as the providers build out their networks |
| The primary factors that may affect our net revenues and results include the following: • Fluctuation in demand for our voice infrastructure products and the timing and size of customer orders; • The cancellation or deferral of existing customer orders or the renegotiation of existing contractual commitments; • Consolidation and/or reorganization post-merger of certain customers; • The failure of certain of our customers to successfully and timely reorganize their operations, including emerging from bankruptcy or post bankruptcy reorganization; • The length and variability of the sales cycle for our products; and • The timing of revenue recognition and amount of deferred revenues |
| 8 ______________________________________________________________________ [33]Table of Contents Our industry is highly competitive; if we fail to compete successfully against our competitors, our market share and product sales could be adversely affected, resulting in a decline in our net revenues and deterioration of our operating results |
| The market for our products is intensely competitive, with a large number of equipment suppliers providing a variety of products to diverse market segments within the telecommunications industry |
| Our existing and potential competitors include many large domestic and international companies, including companies that have longer operating histories, greater name recognition, larger customer bases and substantially greater financial, manufacturing, technological, sales and marketing, distribution, and other resources |
| Our principal competitors include Adtran, Inc, Audiocodes, Cisco Systems, Inc, Eastern Research, Inc, Lucent Technologies, Inc, Natural Microsystems, RAD, Telco Systems, Inc, Tellabs, Inc, Verilink Corporation, Zhone Technologies, Inc |
| and other small independent system 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 products 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 equipment manufacturers and computer hardware and software companies, may enter these markets through acquisition, thereby further intensifying competition |
| 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 profit margins, and loss of market share, any of which could cause a decline in the price of our common stock |
| Deterioration of the wireless infrastructure industry could lead to reductions in capital spending budgets by wireless operators and original equipment manufacturers, which could adversely affect our net revenues, gross profit margins and income |
| Our net revenues and gross profit margins will depend significantly on the overall demand for wireless infrastructure subsystems products |
| A reduction in capital spending budgets by wireless operators and OEMs caused by an economic downturn, consolidation within the industry such as the merger of Cingular and AT&T Wireless, and the merger of Sprint and Nextel, or otherwise could lead to a softening in demand or delay procurement of our products and services |
| Such factors resulted in a decrease in revenues and earnings in the third and fourth quarter of 2004 and during 2005, and could result in decreases in net revenues and earnings in future periods |
| We continue to rely on a limited number of direct customers, the loss of any of which could result in a decline in net revenues and the price of our common stock |
| A significant portion of our net revenues has been derived from a limited number of large direct customers, and we believe that this trend will continue in the future |
| For example, for the year ended December 31, 2005, we sold directly to Cingular, who accounted for approximately 42prca of our net revenues |
| 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 products that they order or forecast without penalty |
| We have experienced cancellations and delays of orders in the past and significant reductions in product forecasts, and we expect to continue to experience order cancellations and delays from time to time in the future |
| Any such termination, change, reduction or delay in orders would harm our business |
| The timing of customer orders and accuracy of customer forecasts and our ability to fulfill these forecasts and orders can cause material fluctuations in our operating results, and we anticipate that such fluctuations will continue in the future |
| We rely on a limited number of distributors and OEMs, the loss of any of which could cause a decline in our net revenue and have an adverse effect on our results of operations and the price of our common stock |
| 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 8prca, 7prca, and 11prca of our net revenues in 2005, 2004 and 2003, respectively |
| 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 |
| If our distributors are not successful both in terms of operating their own businesses and in selling our products to their customers, we could experience a decline in net revenue, an increase in inventory and bad debt, and deterioration in our operating results |
| 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 dlra1dtta1 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 revenues for us and 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 |
| Moreover, distributors who have overstocked our products have, in the past, reduced their inventories of our products by selling such products at significantly reduced prices |
| Any reduction in planned purchases or sales at reduced prices by distributors in the future could harm our business by, among other things, reducing the demand for our products and creating conflicts with other distributors and our direct sales efforts |
| Some of our distributors and OEMs have stock rotation, limited return, on time delivery and price protection rights which could cause a material decrease in the average selling prices and gross profit margins of our products, either of which would have an adverse effect on our operating results and financial condition |
| We generally provide our distributors and OEMs with limited stock rotation rights of return, on time delivery and price protection rights |
| Three times a year, pursuant to limited stock rotation rights, some of these customers can return on average up to 15prca of 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 be certain that we will not experience significant returns of our products, or ensure that our shipments in the future will be on time, which could result in a material decrease in our net revenues, average selling prices, gross margins and operating results |
| 9 ______________________________________________________________________ [34]Table of Contents We also provide certain distributors and OEMs with price protection rights in which we are required to provide 60-days’ advance notice of price decreases |
| Orders we receive from distributors or OEMs within the 60-day period are filled at the existing, lower product price |
| In the event of a price decrease, we may be 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 the same 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 profit margins of our products, which could in turn have a material adverse effect on distributor or OEM inventories, our business, net revenues, financial condition, and operating results |
| We do not have exclusive agreements with our distributors, who sell other broadband communications equipment that competes with our products |
| As a result, our distributors may not recommend or continue to use and offer our products or devote sufficient resources to market and support our products, which could result in a reduction in sales of our products |
| 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 recommend competitive products in place of our products and 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 |
| If our direct customers do not successfully operate their own businesses, their capital expenditures could be limited, which could result in a delay in payment for, or a decline in the purchase of, our products, which could result in a decrease in our net revenue and a deterioration of our operating results |
| In the past, some of our direct customers have experienced problems with their financial and other resources that have impaired or significantly delayed their ability to pay us |
| For example, in 2005 one of our direct customers experienced difficulty related to a change in their order processing system, which delayed payments to us |
| We cannot be certain 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 carriers |
| The competitive carrier market continues to experience consolidation and related post-consolidation reorganization |
| Many of our competitive carrier 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 |
| For example, one of our large customers must rely on funding from its parent to fund operating losses and meet its working capital, capital expenditure, debt service and other obligations |
| Neither equity nor debt financing may be available to these companies on favorable terms, if at all |
| In addition, if one or more of these competitive carriers fail, we could face a loss in net revenues and an increased bad debt expense, due to their inability to pay outstanding invoices, as well as a corresponding decrease in our customer base and future net revenues |
| Furthermore, a significant portion of our sales to competitive carriers is made through independent distributors |
| The failure of one or more competitive carriers could cause a distributor to experience business failure and/or default on payments to us |
| We grant certain of our direct customers “most favored customer” terms, which could cause a material decrease in the average selling prices and gross profit margins of our products, which would have an adverse effect on our operating results and financial condition |
| 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 profit margins of our products, which could, in turn, have an adverse effect on our operating results and financial condition |
| 10 ______________________________________________________________________ [35]Table of Contents A longer than expected sales cycle could cause our net revenues and operating results to vary significantly from quarter to quarter |
| Our sales cycle averages approximately four to 24 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 carrier’s budgetary constraints including the timing of expenditures; • consolidation and merger discussions between wireless and wireline carriers; • outsourcing of inventory management by a distributor or OEM customer; • changes to or problems with a distributor’s, OEM carrier’s internal order processing systems; • a distributor’s, OEM’s or carrier’s internal acceptance reviews; • a distributor’s, OEM’s or carrier’s staffing levels and availability of lab time for product testing; • the success and continued internal support and development of a carrier’s product offerings; • the possibility of cancellation or delay of projects by distributors, OEMs or carriers; and • the possibility of a regulatory investigation of our distributors, OEMs or carriers |
| In addition, as carriers have matured and grown larger both through internal growth and acquisitions, 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 carrier 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 |
| 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 our net revenues and uneven operating results from quarter to quarter or year to year |
| Communications carriers face capital constraints which have restricted and may continue to restrict their ability to buy our products, thereby resulting in longer sales cycles, deferral or delay of purchase commitments for our products, and increased price competition |
| Our customers consist primarily of communications carriers, including wireless carriers, local exchange carriers, multi-service cable operators, and competitive local and international communications providers |
| These carriers require substantial capital for the development, construction, and expansion of their networks and the introduction of their services |
| Although the economy has slightly improved, there is still an oversupply of communications bandwidth that has resulted in a constraint on the availability of capital for these carriers and has had a material adverse effect on many of our customers, who have substantially reduced 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 our sales and operating results throughout 2005, 2004, 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 extend trade credit to these prospective customers, we will be subject to additional financial risk that could increase our expenses |
| If we are unable to develop new or enhanced products that achieve market acceptance, we could experience a reduction in our future product sales, which would cause the market price of our common stock to decline |
| 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, 11 ______________________________________________________________________ [36]Table of Contents 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 enhancements, which has resulted in distributor and end-user frustration and delay or loss of net revenue |
| It is possible that we will experience similar or other difficulties in the future that could delay or prevent the successful development, production, or shipment of such new products or enhancements, or that our new products and enhancements will not adequately meet the requirements of the marketplace and achieve market acceptance |
| Announcements of currently planned or other new product offerings by our competitors or us have in the past caused, and may in the future cause, distributors or end-users to defer or cancel the purchase of our existing products |
| Our inability to develop new products or enhancements to existing products on a timely basis, or the failure of such new products or enhancements to achieve market acceptance, could result in a decline in our future product sales and the price of our common stock |
| The introduction of new or enhanced products could cause disruptions in our distribution channels and the management of our operations, which could cause us to record lower net revenues or adversely affect our gross profit margins |
| 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 profit 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 profit margins |
| We rely on the introduction of new or enhanced products to offset the declining sales prices and gross profit margins of our older products, and the failure of our new or enhanced products to achieve market acceptance could result in a decline in our net revenues and operating results |
| We believe that average selling prices and gross profit 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 with lower prices |
| 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 profit margins will decline and such decline could adversely affect our operating results and the price of our common stock |
| To develop new products or enhancements to our existing products, we will need to continue to invest in research and development, which could adversely affect our financial condition and operating results, especially if we need to increase the amount of our investment to successfully respond to developing industry standards |
| 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 have increased to 22prca of net revenues for the year ended December 31, 2005, from 19prca and 18prca in the years ended December 31, 2004 and 2003, respectively |
| We plan to continue to invest significant resources in research and development |
| As a result, we may experience periods of limited profitability due to the resources needed to develop 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 |
| 12 ______________________________________________________________________ [37]Table of Contents Our customers are subject to heavy government regulation in the telecommunications industry, and regulatory changes could adversely affect our customers’ capital expenditure budgets and result in reduced sales of our products and significant fluctuations 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, (“1996 Act”) that imposed new duties on ILECs to open their local telephone markets to competition |
| Although the FCC and federal district courts in various rulings in 2004 rejected efforts of several state regulators to subject certain VoIP services to intrastate telecommunications regulation, there are still uncertainties regarding other regulatory, economic, and political factors, particularly as VoIP service providers increase competitive pressures on the traditional carriers |
| 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 |
| Our distributors or carrier customers may require that we modify our products to address actual or anticipated changes in the regulatory environment, or we may voluntarily decide to make such modifications |
| In addition, the increasing demand for wireless communications has exerted pressure on regulatory bodies worldwide to adopt new standards for such products, generally following extensive investigation and deliberation over competing technologies |
| In the past, the delays inherent in this governmental approval process have caused, and may in the future cause, the cancellation or postponement of the deployment of new technologies |
| These delays could have a material adverse effect on our net revenues, gross profit margins and operating results |
| Our inability to modify our products in a timely manner or address such regulatory changes could cause a reduction in demand for our products, a loss of existing customers or the failure to attract new customers, which would result in lower than expected net revenues and a decline in the price of our common stock |
| Telecommunication industry carriers are currently experiencing a period of consolidation that may impact the timing of future capital expenditures, which could adversely affect the demand for our products |
| We are experiencing rapid consolidation in our customer base |
| During the past two years a number of large mergers in the telecommunications industry have been completed or announced, including the following: Cingular Wireless and AT&T wireless, Sprint and Nextel, SBC and AT&T, Alltel and Western Wireless, and Verizon |
| The integration of the operations of the entities involved in these acquisitions may take a long time, and this could cause delays in new capital expenditures until the merged entities budget for additions for their asset base |
| The effects of a consolidation involving any of our customers could result in postponed orders, decreased orders, or canceled orders |
| For instance, in the third and fourth quarters of 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 |
| In addition, industry consolidation may result in sole-source vendors by our customers, which in turn could have a material adverse effect on our business, operating results, and financial condition |
| In particular, consolidation in the telecommunication industry carriers will lead to fewer customers in that market and the loss of a major customer could have a material impact on results not anticipated in a customer marketplace composed of a larger number of participants |
| 13 ______________________________________________________________________ [38]Table of Contents We have limited supply sources for some key parts and components of our products, and our operations could be harmed by supply interruptions, component defects or unavailability of these parts and components |
| Many of our key parts and components are purchased from suppliers for which alternative sources of supply are not currently available |
| 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 result in increased costs, delays in product delivery, lower net revenues and lower profit margins |
| We attempt to manage these risks through development of alternative supply sources, through engineering efforts designed to remove the necessity for certain components, and by building long-term relationships and maintaining close personal contact with each of our suppliers |
| However, we have experienced delays in or failures of deliveries of key components in the past, either to us or to our contract manufacturers, and delays in product deliveries have occurred and 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 our net revenues 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 alternative suppliers to satisfy our production requirements on a timely basis, if at all |
| Delays in shipments by one of our suppliers have led to lost or delayed net revenues and sales opportunities in the past and may do so again in the future |
| For example, in the third quarter of 2004, we were not able to fulfill all of our open purchase orders of our Adit and BROADway products due to unforecasted demand and an inability to obtain the necessary parts on a timely basis |
| 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, the timely delivery of our products to our customers and consequently our net revenues and operating results |
| Our dependence on third-party manufacturers could result in product delivery delays, which would adversely affect our ability to successfully sell and market our products and could result in declines in our net revenues and operating results |
| 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 procurement of critical components, 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 twelve 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 declines in our net revenues 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 revenues and operating results |
| 14 ______________________________________________________________________ [39]Table of Contents If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results |
| As a result, our business could be harmed and current and potential stockholders could lose confidence in our financial reporting, which could negatively impact the trading price of our stock |
| Maintaining an effective system of internal control over financial reporting is necessary for us to provide reliable financial reports |
| If we cannot provide reliable financial reports, our business and operating results could be harmed |
| We have in the past discovered, and may in the future discover, areas of our internal control over financial reporting that need improvement, including control deficiencies that may constitute material weaknesses |
| As more fully described in Item 9A of this Annual Report on Form 10-K, as of December 31, 2004, our management concluded that we did not maintain effective controls over certain aspects of our review of our statements of cash flows and certain revenue recognition policies |
| These control deficiencies resulted in a restatement of our previously issued financial statements for the fiscal years ended December 31, 2003 and 2004 |
| A failure to implement and maintain effective internal control over financial reporting, including a failure to implement corrective actions to address a control deficiency, could result in a material misstatement of our financial statements or otherwise cause us to fail to meet our financial reporting obligations |
| This, in turn, could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price |
| Our executive officers and certain key personnel are critical to our business, and any failure to retain these employees could adversely affect our ability to manage our operations and develop new products or enhancements to current products |
| 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, finance, 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 customers are subject to numerous and changing regulations, interoperability requirements and industry standards |
| If the products they purchase from us do not meet these regulations or are not compatible with these standards or interoperate with the equipment solution selected by our customers, our ability to continue to sell our products could be seriously harmed |
| Our products must comply with a significant number of voice and data regulations and standards, which vary between US 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 |
| Our VoIP products currently interoperate with approximately eleven different product solutions and we are required to continually update our products based on our partners’ new releases of software for these products |
| If our systems fail to timely comply with evolving standards in US 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, decreased net revenues and operating results |
| We have maintained compliance with ISO 9001:2000 since we were first certified in May 2000, with Telcordia OSMINE when 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 ensure that all of the network equipment used by Regional Bell Operating Companies, or RBOCs, can be managed by the same software programs |
| NEBS, or Network Equipment Building Standards, are a set of performance, quality and safety requirements — which were developed internally at Bell Labs and later at Telcordia — for network switches |
| RBOCs and local exchange carriers rely on NEBS-compliant hardware for their central office telephone switching |
| We cannot assure that we will maintain these certifications |
| The failure to maintain any of these certifications may adversely impair the competitiveness of our products |
| 15 ______________________________________________________________________ [40]Table of Contents Our products may suffer from defects or errors that may subject us to product returns and product liability claims, which could adversely affect our reputation and seriously harm our results of operations |
| Our products have contained in the past, and may contain in the future, undetected or unresolved errors when first introduced or when new versions are released |
| Despite our extensive testing, errors, defects, or failures are possible in our current or future products or enhancements |
| If such defects occur, we may be subject to: • delays in or losses of market acceptance and sales; • penalties for network outages in our installed network base; • 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 |
| Difficulties in integrating past or future acquisitions could adversely affect our operating results and 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 |
| Acquisitions involve 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 our future acquisitions |
| If we have insufficient proprietary rights or if we fail to protect those rights we have, third parties could develop and market products that are equivalent to our own, which would harm our sales efforts and could result in a decrease in our net revenues and the price of our common stock |
| 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, 2005, we held a total of sixteen issued US patents and had approximately eight pending US patent applications |
| We have one US trademark application pending and have fifteen 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, partners, 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 US 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 |
| 16 ______________________________________________________________________ [41]Table of Contents We may face intellectual property infringement claims that could result in significant expense to us, divert the efforts of our technical and management personnel, or cause product shipment delays |
| The telecommunications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement |
| As the number of entrants in our markets increases and the functionality of our products is enhanced and overlaps with the products of other companies, we may become subject to claims of infringement or misappropriation of the intellectual property rights of others |
| From time to time, third parties may assert patent, copyright, trademark, and other intellectual property rights to technologies that are important to us |
| Any future third-party claims, whether or not such claims are determined adversely to us, could result in significant expense, divert the efforts of our technical and management personnel, or cause product shipment delays |
| In the event of an adverse ruling in any litigation, we might be required to discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology, or obtain licenses from third parties |
| In addition, any public announcements related to litigation or interference proceedings initiated or threatened against us, even if such claims are without merit, could cause our stock price to decline |
| In our customer agreements, we agree to indemnify our customers for any expenses or liabilities resulting from claimed infringements of our product patents, trademarks, or copyrights of third parties |
| In certain limited instances, the amount of such indemnities may be greater than the net revenues we may have received from our customers |
| Increased sales volume in international markets could result in increased costs or loss of revenue due to factors inherent in these markets |
| 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 US based business, including: • local economic and market conditions; • exposure to unknown customs and practices; • legal regulations and requirements in foreign countries; • potential political unrest; • foreign currency 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 |
| A small number of shareholders can exert significant influence on the outcome of matters requiring the approval of a majority of the outstanding shares of our common stock |
| As of March 1, 2006, 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 36prca of our outstanding shares of common stock |
| Koenig, a director and our President and Chief Executive Officer, and Ms |
| Pierce, a director and our former Secretary, former CFO and Corporate Development Officer, are married |
| As of March 1, 2006, Mr |
| Koenig and Ms |
| Pierce together beneficially owned approximately 36prca of our outstanding shares of common stock |
| Accordingly, these two stockholders can exert significant influence over the election of members of our Board of Directors and the outcome of all corporate actions requiring stockholder approval of a majority of the voting power held by our stockholders, such as mergers and acquisitions |
| This level of ownership by such persons and entities may delay, defer, or prevent a change in control and may harm the voting and other rights of other holders of our common stock |