Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Information

This Form 10-Q may contain certain forward-looking information within the meaning of the federal securities laws. The forward-looking information may include, among other information, (i) statements concerning our outlook for the future, (ii) statements of belief, anticipation or expectation, (iii) future plans, strategies or anticipated events, and (iv) similar information and statements concerning matters that are not historical facts. Such forward-looking information is subject to risks and uncertainties that may cause actual events to differ materially from our expectations. Factors that could cause or contribute to such differences include, but are not limited to, the level of sales to key customers, including distributors; timing of certain projects and purchases by key customers; the economic conditions affecting network service providers; corporate and/or government spending on information technology; actions by competitors; fluctuations in the price of raw materials (including optical fiber); our dependence on a single manufacturing facility; our ability to protect our proprietary manufacturing technology; market conditions influencing prices or pricing; our dependence on a limited number of suppliers; the loss of or conflict with one or more key suppliers or customers; an adverse outcome in litigation, claims and other actions, and potential litigation, claims and other actions against us; an adverse outcome in regulatory reviews and audits and potential regulatory reviews and audits; further adverse changes in laws and regulations associated with the extraterritorial income exclusion; adverse changes in state tax laws and/or positions taken by state taxing authorities affecting us; technological changes and introductions of new competing products; changes in end-user preferences of competing technologies, including copper cable and wireless, relative to fiber optic cable; economic conditions that affect the telecommunications sector, certain technology sectors or the economy as a whole; terrorist attacks or acts of war, particularly given the acts of terrorism against the United States and subsequent military responses by the United States, and any potential future military conflicts; changes in the level of military spending by the United States government; ability to retain key personnel; our ability to successfully implement planned changes to our information technology systems and manufacturing processes; the impact of changes in accounting policies, including those by the Securities and Exchange Commission and the Public Company Accounting Oversight Board; our ability to successfully comply with, and the cost of compliance with, the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 or any revisions to that act which apply to us; impact of future consolidation among competitors and/or among customers adversely affecting our position with our customers and/or our market position; actions by customers adversely affecting us in reaction to the expansion of our product offering in any manner, including, but not limited to, by offering products that compete with our customers, and/or by entering into alliances with, and/or making investments in or with, parties that compete with and/or have conflicts with customers of ours; impact of weather or natural disasters in the areas of the world in which we operate and market our products; changes in market demand, exchange rates, productivity, or market and economic conditions in the areas of the world in which we operate and market our products, and our success in managing the risks involved in the foregoing.

We caution readers that the foregoing list of important factors is not exclusive and we incorporate by reference those factors included in current reports on Form 8-K.

Dollar amounts presented in the following discussion have been rounded to the nearest hundred thousand, unless the amounts are less than one million, in which case the amounts have been rounded to the nearest thousand.

Overview

During the second quarter and the first half of our 2006 fiscal year, net sales and gross profit margin decreased when compared to the same periods last year. Net sales decreased 3.2% to $11.2 million during the second quarter of fiscal 2006, down from $11.6 million during the same period last year. However, net sales sequentially increased $1.4 million or 13.9% during the second quarter when compared to the first quarter of fiscal 2006. Gross profit margin decreased to 30.3% during the second quarter of fiscal 2006, compared to 40.7% during the same period last year, and compared to 33.4% during the first quarter of fiscal 2006. We reported a net loss of $309,000 during the second quarter of fiscal 2006, compared to net income of $364,000 for the comparable period last year.

17

Table of Contents

Net sales decreased 7.2% to $21.1 million for the six months ended April 30, 2006 compared to $22.7 million for the same period last year. Likewise, gross profit margin decreased to 31.7% for the six months ended April 30, 2006 compared to 41.0% for the same period last year. We reported a net loss of $529,000 during the first half of fiscal year 2006 compared to net income of $586,000 for the same period last year.

We believe a number of factors contributed to the decrease in net sales and gross profit margins during the three month and six month periods ended April 30, 2006 compared to the same periods last year. We experienced an increase in net sales in our commercial market (with relatively lower gross profit margins) compared to the same periods last year. This increase, however, was more than offset by decreases in net sales for certain of our specialty markets (with relatively higher gross profit margins). Further, net sales to customers outside the United States showed substantial strength during the first half of fiscal 2006, compared to the same period last year, while net sales to customers in the United States decreased due to lower sales in certain of our specialty markets. Generally, this is the continuation of a sales pattern we experienced during the first quarter of fiscal 2006. Despite the decrease in overall net sales, we believe our market share (based on fiber volume) of the multi-mode fiber optic cable produced in North America increased during the first calendar quarter of 2006.

We believe these product sales patterns are a result of a number of factors including the timing of projects and other factors affecting product demand in certain specialty markets and relatively consistent growth in our commercial market.

Also during the first and second quarters of fiscal 2006, we experienced what we believe to be a temporary increase in manufacturing lead times and a temporary decrease in manufacturing efficiencies in part resulting from the implementation of business process and system changes in connection with our new enterprise resource planning (“ERP”) system and other initiatives, which likely contributed to lower net sales and gross profit margins during the first and second quarters of fiscal 2006. While we identified and corrected a number of the issues impacting our manufacturing lead times and manufacturing efficiencies by the end of the second quarter, we cannot be certain of the impact on the second half of the year. Regardless of any further negative impact by these issues during the second half of fiscal year 2006, we continue to believe that our process and system changes ultimately will improve the scalability of our systems (and therefore our ability to better handle increased production volume), improve our plant efficiency, and improve our customer service.

We are continuing to evaluate to what extent the net sales and gross profit margin results during the first half of fiscal 2006 are indicative of expected results for the remainder of the year.

We are a leading manufacturer of fiber optic cables primarily sold into the enterprise market, and the premier manufacturer of military ground tactical fiber optic cable for the U.S. military.

Founded in 1983, Optical Cable Corporation pioneered the design and production of fiber optic cables for the most demanding military field applications, as well as of fiber optic cables suitable for both indoor and outdoor use. Our current broad product offering is built on the evolution of these fundamental technologies, and is designed to provide end-users with fiber optic cables that are easy and economical to install, provide a high degree of reliability and offer outstanding performance characteristics.

We sell our products worldwide for uses ranging from commercial and campus installations to customized products for specialty applications and harsh environments, including military applications. We manufacture our high quality fiber optic cables at our ISO 9001:2000 registered and MIL-STD-790F certified facility located in Roanoke, Virginia.

Our tight buffered fiber optic cables are used for high bandwidth transmission of data, video and audio communications. The enterprise market into which we sell includes local area network and premises markets. Our fiber optic cables are well-suited for use in various other short- to moderate-distance applications as well.

We sell our products internationally and domestically through our sales force to our customers, which include major distributors, regional distributors, various smaller distributors, original equipment manufacturers and value-added resellers. Net sales to customers located outside of the United States were 24% and 13% for the three months ended April 30, 2006 and 2005, respectively. Net sales to customers located outside of the United States were 24% and 14% of total net sales for the six months ended April 30, 2006 and 2005, respectively. Substantially all of our sales to customers located outside of the United States are denominated in U.S. dollars. We believe the increase in the percentage of net sales to customers located outside of the United States in the first six months of 2006 compared to the same period last year is primarily the result of certain organizational changes and increased sales efforts in certain international markets, as well as a large sale to one customer located outside of the United States during the first quarter of fiscal 2006. We can experience fluctuations in the percentage of net sales to customers outside of the United States from period to period based on the timing of large orders coupled with the impact of increases or decreases in sales to customers located in the United States.

18

Table of Contents

Net sales consist of gross sales of products less discounts, refunds and returns. Revenue is recognized at the time of product shipment or delivery to the customer (including distributors) provided that the customer takes ownership and assumes risk of loss, based on shipping terms. During the second quarters of fiscal years 2006 and 2005, respectively, 17.2% and 15.3% of our net sales were attributable to one major domestic distributor. For the six months ended April 30, 2006 and 2005, 16.2% and 14.3%, respectively, of net sales were attributable to this distributor. For the six months ended April 30, 2005, 10.2% of our net sales were attributable to another domestic customer. No other single customer accounted for more than 10% of our net sales during the second quarters of fiscal years 2006 or 2005 or the six months ended April 30, 2006.

A significant percentage of the selling price of our fiber optic cable is based on the cost of raw materials used. Single-mode fiber is less expensive than multimode fiber, and consequently single-mode fiber optic cables have a lower per unit selling price than comparable multimode fiber optic cables. We believe that while the long-haul, metropolitan and access markets are predominantly the users of single-mode fiber optic cable, that increasingly, single-mode fiber optic cable is also being used for short- to moderate-distance installations where higher bandwidth is required. However, any trend toward the use of single-mode fiber optic cables in such other installations may be slowed to the extent that 50 micron 1 gigabit and 10 gigabit multimode fiber optic cables are used to satisfy current bandwidth demands. To the extent that our sales mix shifts toward single-mode cables, we will have to increase the volume of our sales to maintain our current level of net sales.

Cable containing multimode fiber is generally used for communications over shorter distances where the higher bandwidth capacity and the higher transmission equipment cost of single-mode fiber is not required. Cable containing single-mode fiber is generally used for communications over longer distances and where higher bandwidth capacity is required.

Cost of goods sold consists of the cost of materials, product warranty costs and compensation costs, and overhead and other costs related to our manufacturing operations. The largest percentage of costs included in cost of goods sold is attributable to costs of materials which are variable costs as opposed to fixed costs.

Selling, general and administrative expenses, also referred to as “SG&A expenses,” consist of the compensation costs for sales and marketing personnel, shipping costs, trade show expenses, customer support expenses, travel expenses, advertising, bad debt expense, the compensation costs for administration and management personnel, legal and accounting fees, costs incurred to settle litigation or claims and other actions against us, and other costs associated with our operations.

Other income (expense), net consists of interest income, interest expense and other miscellaneous income and expense items not directly attributable to our operations.

Results of Operations

The following table sets forth and highlights fluctuations in selected line items from our condensed statements of operations for the periods indicated:

19

Table of Contents

Three Months Ended April 30, 2006 and 2005

Net Sales

Net sales decreased 3.2% to $11.2 million for the second quarter of fiscal year 2006 from $11.6 million for the same period in 2005. Sequentially, net sales for the second quarter of fiscal 2006 increased 13.9% compared to net sales of $9.9 million during the first quarter of fiscal 2006.

A number of factors contributed to the $370,000 decrease in net sales in the second quarter of 2006. While we continued to experience an increase in net sales in our commercial market compared to the same period last year, this increase was more than offset by decreases in net sales for certain of our specialty markets. Further, net sales to customers outside the United States showed substantial strength during the second quarter of fiscal 2006, compared to the same period last year, while net sales to customers in the United States decreased due to lower sales in certain of our specialty markets. Generally, this is the continuation of a sales pattern we experienced during the first quarter of fiscal 2006. Despite the decrease in overall net sales, we believe our market share (based on fiber volume) of the multi-mode fiber optic cable produced in North America increased during the first calendar quarter of 2006. We believe these product sales patterns are a result of a number of factors including, the timing of projects and other factors affecting product demand in certain specialty markets, and relatively consistent growth in our commercial market.

Also, during the second quarter of fiscal 2006, we continued the implementation of business process and system changes in connection with our new ERP system and certain other initiatives. Those changes, to some extent, adversely impacted our production efficiency as we continued the transition to new systems and processes. As expected, we continued to experience what we believe to be a temporary increase in manufacturing lead times during the second quarter, which likely contributed to lower net sales during the second quarter of fiscal 2006. While we identified and corrected a number of the issues impacting our manufacturing lead times and manufacturing efficiencies by the end of the second quarter, we cannot be certain of the impact on net sales during the second half of the year. We believe our process and system changes ultimately will improve the scalability of our systems (and therefore our ability to better handle increased production volume), improve our plant efficiency, and improve our customer service.

During fiscal year 2005, we did not experience the same seasonality pattern in net sales as experienced by us in fiscal years 2004 and 2003, and as previously expected during fiscal year 2005. Specifically, we typically expect net sales to be relatively lower in the first half of each fiscal year and relatively higher in the second half of each fiscal year. As we saw during fiscal year 2005, the effect of seasonality patterns can be altered by the timing of larger projects. We continue to evaluate whether typical seasonality patterns are a factor impacting our net sales in fiscal 2006.

Gross Profit

Gross profit decreased 28.1% to $3.4 million for the second quarter of 2006 from $4.7 million for the same period in 2005. Gross profit margin, or gross profit as a percentage of net sales, decreased to 30.3% for the second quarter of 2006 from 40.7% for the second quarter of 2005. By comparison, gross profit margin was 33.4% in the first quarter of 2006.

We believe a number of factors contributed to the decrease in gross profit margins during the three month period ended April 30, 2006 compared to the same period last year. We believe the decrease in the gross profit margin during the second quarter of 2006 resulted in part from the sale of a mix of products with lower margins. We experienced an increase in net sales in our commercial market (with relatively lower gross profit margins) compared to the same period last year. This increase, however, was more than offset by a decrease in net sales for certain of our specialty markets (with relatively higher gross profit margins). Product mix can vary as a result of changes in sales of products with different fiber types and fiber counts, and changes in sales to various markets that require different product types. Our gross profit margin percentages are heavily dependent upon product mix on a quarterly basis and may deviate from expectations based on both anticipated and unanticipated changes in product mix. We believe the product sales patterns during the second quarter are a result of a number of factors including, the timing of projects and other factors affecting product demand in certain specialty markets, and relatively consistent growth in our commercial market.

20

Table of Contents

Also during the second quarter of fiscal 2006, we experienced what we believe to be a temporary decrease in manufacturing efficiencies in part resulting from the continuing implementation of process and system changes in connection with our new ERP system and other initiatives, which likely contributed to lower gross profit margins during the second quarter of fiscal 2006. While we identified and corrected a number of the issues impacting our manufacturing efficiencies by the end of the second quarter, we cannot be certain of the impact on gross profit margins for the second half of fiscal 2006. Regardless of any further negative impact by these issues during the second half of fiscal year 2006, we continue to believe that our process and system changes ultimately will improve the scalability of our systems (and therefore our ability to better handle increased production volume), improve our plant efficiency, and improve our customer service.

We are continuing to evaluate to what extent the gross profit margin results during the second quarter of fiscal 2006 are indicative of expected results for the remainder of the year.

Selling, General, and Administrative Expenses

SG&A expenses decreased 5.9% to $3.9 million in the second quarter of fiscal year 2006 from $4.1 million for the same period last year. SG&A expenses as a percentage of net sales were 34.6% in the second quarter of 2006 compared to 35.6% in the second quarter of 2005. The decrease in SG&A expenses during the second quarter of fiscal 2006 compared to the same period last year was primarily due to decreased employee compensation costs, and decreased professional fees.

Compensation costs have decreased when comparing the second quarter of fiscal 2006 to the comparable period in fiscal 2005 largely as a result of decreases in commissions as net sales have decreased and decreases in employee incentives due to the fact that our financial results during the second quarter were less favorable than planned. The decreases in compensation costs were partially offset by an increase in severance expenses totaling approximately $285,000 before tax effects associated with certain changes within our sales organization implemented during the second quarter of fiscal 2006. The decreases in legal and professional fees were largely due to the timing of when certain costs were incurred.

Other Income (Expense), Net

We recognized other income, net in the second quarter of fiscal year 2006 of $8,000 compared to other expense, net of $21,000 in the second quarter of fiscal year 2005. The change was primarily due to a decrease in interest expense related to our credit facility. Although we did not need to use our credit facility during fiscal 2005, we recognized interest expense during the first two quarters of 2005 related to the amortization of the deferred financing costs associated with obtaining and amending our credit facility. During the second quarter of fiscal 2006, we incurred approximately $22,000 of deferred financing costs associated with amending and restating our existing credit facility and began amortizing these costs over a period not to exceed the term of the amended and restated credit facility. Although we incurred interest expense associated with borrowings under our credit facility during the second quarter of 2006, these borrowings and the amortization of the financing costs associated with amending and restating our credit facility were less than the amortization of the deferred financing costs associated with the original credit facility. Additional information describing our credit facility can be found in our discussion of “Liquidity and Capital Resources.”

21

Table of Contents

Income (Loss) Before Income Tax Expense (Benefit)

We reported a loss before income taxes of $482,000 for the second quarter of fiscal year 2006 compared to income before income taxes of $572,000 for the second quarter of fiscal year 2005. This change was primarily due to a decrease in gross profit of $1.3 million in the second quarter of fiscal year 2006, partially offset by the decrease in SG&A expenses totaling $245,000 in the second quarter of 2006 compared to the same period in 2005.

Income Tax Expense (Benefit)

Income tax benefit totaled $173,000 for the second quarter of fiscal year 2006 compared to income tax expense of $208,000 for the same period in fiscal year 2005. Our effective tax rate was 35.9% in the second quarter of fiscal 2006 compared to 36.4% in the second quarter of fiscal 2005. Fluctuations in our effective tax rates are primarily due to the amount and timing of various tax deductions and benefits, including our Extraterritorial Income Exclusion, (“EIE”), which exempts from federal income taxation a portion of the net profit realized from sales outside the United States of products manufactured in the United States. The EIE is calculated by a complex analysis of all export sales and profits for each tax year. Fluctuations in the ratio of export sales and profitability to total sales and profitability create changes in the EIE. Additionally, the EIE benefit continues to be phased out as described in more detail herein.

The World Trade Organization has ruled against the United States’ EIE regime. In the ruling, the World Trade Organization gave permission to the European Union to sanction tariffs on certain products manufactured in the United States if the EIE regime was not repealed. The American Jobs Creation Act of 2004, also referred to as the “Jobs Act”, generally repeals the EIE regime for transactions after December 31, 2004. The Jobs Act continues to extend EIE benefits at a reduced rate for two additional years, and continues EIE benefits indefinitely for transactions pursuant to a binding contract in effect on September 17, 2003. As passed, the Jobs Act provides transition relief by allowing taxpayers to retain a portion of their otherwise-applicable EIE benefits: 100% for transactions during calendar year 2004, 80% for transactions during calendar year 2005 and 60% for transactions during calendar year 2006. At the same time, the Jobs Act allows for a new deduction based on qualified domestic production activities. The impact of the phase out of the EIE benefit and phase in of the new deduction contributed to the increase in our effective tax rate during the first half of fiscal year 2006 compared to the same period last year. We may continue to experience a modest impact on our effective tax rate as the new deduction is phased in over the next six years and the EIE benefit continues to be phased out.

Net Income (Loss)

Net loss for the second quarter of fiscal year 2006 was $309,000 compared to net income of $364,000 for the second quarter of fiscal year 2005. This change was due primarily to the loss before taxes experienced in the second quarter of fiscal year 2006 compared to income before taxes for the comparable period last year, partially offset by the recognition of a tax benefit in the second quarter of 2006 compared to tax expense in the second quarter of fiscal year 2005.

Six Months Ended April 30, 2006 and 2005

Net Sales

Net sales decreased 7.2% to $21.1 million for the first half of fiscal year 2006 from $22.7 million for the same period in 2005. We are continuing to evaluate whether or not the decrease in net sales we experienced in the first half of fiscal 2006 is indicative of expected results for the second half of the year.

A number of factors contributed to the $1.6 million decrease in net sales in the first half of fiscal 2006. While we continued to experience an increase in net sales in our commercial market compared to the same period last year, this increase was more than offset by decreases in net sales for certain of our specialty markets. Further, net sales to customers outside the United States showed substantial strength during the first half of fiscal 2006, compared to customers to the same period last year, while net sales to customers in the United States decreased due to lower sales in certain of our specialty markets. Despite the decrease in overall net sales, we believe our market share (based on fiber volume) of the multi-mode fiber optic cable produced in North America increased during the first calendar quarter of 2006. We believe these product sales patterns are a result of a number of factors including the timing of projects and other factors affecting product demand in certain specialty markets, and relatively consistent growth in our commercial market.

22

Table of Contents

Also, during the first half of fiscal 2006, we began the implementation of business process and system changes in connection with our new ERP system and certain other initiatives. Those changes, to some extent, adversely impacted our production efficiency as we began the transition to new systems and processes. As expected, we experienced what we believe to be a temporary increase in manufacturing lead times, which likely contributed to lower net sales during the first half of fiscal 2006. While we identified and corrected a number of the issues impacting our manufacturing lead times and manufacturing efficiencies by the end of the second quarter, we cannot be certain of the impact on net sales during the second half of the year. We believe our process and system changes ultimately will improve the scalability of our systems (and therefore our ability to better handle increased production volume), improve our plant efficiency, and improve our customer service.

During fiscal year 2005, we did not experience the same seasonality pattern in net sales as experienced by us in fiscal years 2004 and 2003, and as previously expected during fiscal year 2005. Specifically, we typically expect net sales to be relatively lower in the first half of each fiscal year and relatively higher in the second half of each fiscal year. As we saw during fiscal year 2005, the effect of seasonality patterns can be altered by the timing of larger projects. We continue to evaluate whether typical seasonality patterns are a factor impacting our net sales in fiscal 2006.

Gross Profit

Gross profit decreased 28.1% to $6.7 million for the first half of fiscal 2006 from $9.3 million for the same period in 2005. Gross profit margin, or gross profit as a percentage of net sales, decreased to 31.7% in the first half of fiscal 2006 from 41.0% in the first half of fiscal 2005.

We believe a number of factors contributed to the decrease in gross profit margins during the six month period ended April 30, 2006 compared to the same period last year. We believe the decrease in the gross profit margin during the first half of fiscal 2006 resulted in part from the sale of a mix of products with lower margins. We experienced an increase in net sales in our commercial market (with relatively lower gross profit margins) compared to the same period last year. This increase, however, was more than offset by a decrease in net sales for certain of our specialty markets (with relatively higher gross profit margins). Product mix can vary as a result of changes in sales of products with different fiber types and fiber counts, and changes in sales to various markets that require different product types. Our gross profit margin percentages are heavily dependent upon product mix on a quarterly basis and may deviate from expectations based on both anticipated and unanticipated changes in product mix. We believe the product sales patterns during the first half of fiscal 2006 are a result of a number of factors including the timing of projects and other factors affecting product demand in certain specialty markets, and relatively consistent growth in our commercial market.

Also during the first half of fiscal 2006, we experienced what we believe to be a temporary decrease in manufacturing efficiencies in part resulting from the continuing implementation of process and system changes in connection with our new ERP system and other initiatives, which likely contributed to lower gross profit margins during the first half of fiscal 2006. While we identified and corrected a number of the issues impacting our manufacturing efficiencies by the end of the second quarter, we cannot be certain of the impact on the gross profit margins during the second half of fiscal 2006. Regardless of any further negative impact by these issues during the second half of fiscal year 2006, we continue to believe that our process and system changes ultimately will improve the scalability of our systems (and therefore our ability to better handle increased production volume), improve our plant efficiency, and improve our customer service.

We are continuing to evaluate to what extent the gross profit margin results during the first half of fiscal 2006 are indicative of expected results for the remainder of the year.

23

Table of Contents

Selling, General, and Administrative Expenses

SG&A expenses decreased 9.8% to $7.5 million in the first half of 2006 from $8.4 million for the same period last year. SG&A expenses as a percentage of net sales were 35.7% for the six months ended April 30, 2006 compared to 36.8% for the same period in 2005. The decrease in SG&A expenses during the first half of 2006 compared to the same period last year was primarily due to decreased employee compensation costs, decreased marketing expenses, decreased professional fees, and reduced costs associated with non-recurring quality certification fees.

Compensation costs have decreased when comparing the first half of fiscal 2006 to the comparable period in fiscal 2005 largely as a result of decreases in commissions as net sales have decreased and decreases in employee incentives due to the fact that our financial results during the first half of fiscal 2006 were less favorable than planned. The decreases in compensation costs were partially offset by an increase in severance expenses totaling approximately $285,000 before tax effects associated with certain changes within our sales organization implemented during the second quarter of fiscal 2006. The decreases in marketing expenses and professional fees were primarily due to the timing of when certain costs were incurred.

We experienced reduced costs associated with quality certification fees in the first half of fiscal 2006 when compared to the same period last year primarily due to non-recurring fees incurred in the first half of fiscal 2005 related to our efforts and ultimate achievement of certain qualifications and certifications.

Other Income (Expense), Net

We recognized other income, net of $21,000 in the first half of fiscal 2006 compared to other expense, net of $30,000 in the first half of 2005. The change was primarily due to a decrease in interest expense related to our credit facility. Although we did not need to use our credit facility during fiscal year 2005, we recognized interest expense during the first two quarters of 2005 related to the amortization of the deferred financing costs associated with obtaining and amending our credit facility. During the first half of fiscal 2006, we incurred approximately $22,000 of deferred financing costs associated with amending and restating our existing credit facility and began amortizing these costs over a period not to exceed the term of the amended and restated credit facility. Although we incurred interest expense associated with borrowings under our credit facility during the first half of fiscal 2006, these borrowings and the amortization of the financing costs associated with amending and restating our credit facility were less than the amortization of the deferred financing costs associated with the original credit facility. Additional information describing our credit facility can be found in our discussion of “Liquidity and Capital Resources.”

Income (Loss) Before Income Tax Expense (Benefit)

We reported a loss before income taxes of $824,000 for the first half of fiscal year 2006 compared to income before income taxes of $928,000 for the first half of fiscal year 2005. This change was primarily due to the decrease in gross profit of $2.6 million in the first half of fiscal year 2006, partially offset by the decrease in SG&A expenses totaling $818,000 in the first half of 2006.

24

Table of Contents

Income Tax Expense (Benefit)

Income tax benefit totaled $296,000 for the first half of fiscal year 2006 compared to income tax expense of $341,000 for the same period in fiscal 2005. Our effective tax rate was 35.9% in the first half of 2006 compared to 36.8% in the first half of 2005. Fluctuations in our effective tax rates are primarily due to the amount and timing of various tax deductions and benefits, including our Extraterritorial Income Exclusion, (“EIE”), which exempts from federal income taxation a portion of the net profit realized from sales outside the United States of products manufactured in the United States. The EIE is calculated by a complex analysis of all export sales and profits for each tax year. Fluctuations in the ratio of export sales and profitability to total sales and profitability create changes in the EIE. Additionally, the EIE benefit continues to be phased out as described in more detail herein.

The World Trade Organization has ruled against the United States’ EIE regime. In the ruling, the World Trade Organization gave permission to the European Union to sanction tariffs on certain products manufactured in the United States if the EIE regime was not repealed. The American Jobs Creation Act of 2004, also referred to as the “Jobs Act,” generally repeals the EIE regime for transactions after December 31, 2004. The Jobs Act continues to extend EIE benefits at a reduced rate for two additional years, and continues EIE benefits indefinitely for transactions pursuant to a binding contract in effect on September 17, 2003. As passed, the Jobs Act provides transition relief by allowing taxpayers to retain a portion of their otherwise-applicable EIE benefits: 100% for transactions during calendar year 2004, 80% for transactions during calendar year 2005 and 60% for transactions during calendar year 2006. At the same time, the Jobs Act allows for a new deduction based on qualified domestic production activities. The impact of the phase out of the EIE benefit and the phase in of the new deduction contributed to the increase in our effective tax rate during fiscal year 2006 compared to the same period last year. We may continue to experience a modest impact on our effective tax rate as the new deduction is phased in over the next six years and the EIE benefit continues to be phased out.

Net Income (Loss)

Net loss for the first half of 2006 was $529,000 compared to net income of $586,000 for the first half of fiscal 2005. This change was due primarily to the loss before taxes experienced in the first half of fiscal year 2006 compared to income before taxes for the comparable period last year, partially offset by the recognition of a tax benefit in the first half of fiscal year 2006 compared to tax expense in the first half of fiscal year 2005.

Financial Condition

Total assets decreased $453,000, or 1.3%, to $34.5 million at April 30, 2006, from $34.9 million at October 31, 2005. This decrease was primarily due to a $3.3 million decrease in cash. Further detail regarding the decrease in cash is provided in our discussion of “Liquidity and Capital Resources.” The decrease in cash was partially offset by a $1.6 million increase in inventories, a $396,000 increase in other assets, net, and a $510,000 increase in property and equipment, net. We continually make efforts to maintain optimal inventory levels based on current and anticipated customer demands. However, during the first half of fiscal year 2006, we made changes to certain production processes in conjunction with the implementation of our ERP system and those changes, to some extent, have resulted in increases in our work-in-process inventory levels as we work through the transition to the new system. Increases in raw materials inventory also contributed to the overall increase in inventories as the timing of certain purchases impacted the balances on hand at April 30, 2006.

Total liabilities decreased $241,000 or 4.3% to $5.4 million at April 30, 2006, from $5.6 million at October 31, 2005. This decrease was primarily due to a $1.3 million decrease in accrued compensation and payroll taxes as a result of the payment of certain incentive compensation related to fiscal year 2005 during the first half of fiscal 2006, and the fact that we did not meet financial performance requirements that would require the accrual of certain incentive compensation associated with the first half of fiscal 2006. This decrease was partially offset by a $707,000 increase in accounts payable and accrued expenses, largely due to timing of related payments when comparing the two periods, and a $427,000 increase in a note payable to our bank under our line of credit.

25

Table of Contents

Total shareholders’ equity at April 30, 2006 decreased $212,000, or less than 1% in the first half of fiscal 2006. The decrease resulted from a net loss of $529,000 partially offset by the impact of stock-based compensation totaling $314,000.

Liquidity and Capital Resources

Our primary capital needs during the first half of fiscal 2006 have been to fund working capital requirements, capital expenditures, and advances to an unaffiliated company described below. Our primary source of capital for these purposes has been cash provided from operations, cash on hand, and our bank line of credit. As of April 30, 2006, we had an outstanding loan balance of $427,000 under our bank line of credit. We had no outstanding balance under our bank line of credit at October 31, 2005.

We had $3,000 of cash on hand as of April 30, 2006, a decrease of $3.3 million compared to October 31, 2005. We maintain a sweep account arrangement with our bank, where at the end of each day all of our cash is used to paydown our outstanding note payable to the bank, if any. The decrease in cash for the six months ended April 30, 2006, primarily resulted from payments made for operating expenses during the period as well as capital expenditures made during the first half of fiscal year 2006 and advances under a note receivable (described further herein).

On April 30, 2006, we had working capital of $14.3 million compared to $15.2 million as of October 31, 2005. The ratio of current assets to current liabilities as of April 30, 2006, was 3.9 to 1, compared to 3.7 to 1 as of October 31, 2005. The decrease in working capital when comparing the periods was primarily due to the $3.3 million decrease in cash, partially offset by the $1.6 million increase in inventories.

Net cash used in operating activities was $2.0 million in the first half of fiscal year 2006, compared to net cash used in operating activities of $190,000 in the first half of 2005. Net cash used in operating activities during the first half of 2006 primarily resulted from our net loss of $529,000, an increase in inventories in the amount of $1.6 million and a decrease in accrued compensation and payroll taxes totaling $1.3 million, partially offset by adjustments to reconcile net loss to net cash used in operating activities, including depreciation and amortization of $624,000, an increase in accounts payable and accrued expenses of $753,000 and stock-based compensation expense of $314,000. Net cash used in operating activities during the first half of fiscal year 2005 primarily resulted from an increase in inventories of $1.6 million and a decrease in accounts payable and accrued expenses, including accrued compensation and payroll taxes totaling $828,000, partially offset by adjustments to reconcile net income to net cash used in operating activities, including depreciation and amortization of $588,000, and stock-based compensation expense of $225,000.

Net cash used in investing activities totaled $1.7 million in the first half of fiscal year 2006, compared to $1.1 million in the first half of fiscal year 2005. Net cash used in investing activities during the first half of fiscal year 2006 resulted primarily from the purchase of property and equipment, deposits for the purchase of property and equipment, and advances made to an unaffiliated company described further herein.

On April 22, 2005, we agreed to extend a loan to an unaffiliated start-up connector company, also referred to as the “Borrower,” specializing in the design, manufacture and sale of connectors and cable assemblies. The Borrower offers complementary products to our product offering and is still in the development stage. As a development stage company, the Borrower currently has limited revenues and assets and is incurring net losses. As of April 30, 2006, total assets of the Borrower, based on unaudited financial information, was equivalent to approximately 3% of our total assets and total revenues of the Borrower, based on unaudited financial information, for the three month and the six month periods ended April 30, 2006, was equivalent to approximately 5% of our net sales for the same periods.

This loan, and the related transactions described further herein, was part of a strategy designed to provide us with an option to expand our product line offering in market segments in which we currently sell our fiber optic cable products and to preserve channels to market for the Company’s existing product line offering over the longer term.

26

Table of Contents

The loan agreement, as amended, provides that the maximum aggregate principal amount that may be advanced to the Borrower is $2,500,000. Through April 30, 2006 and October 31, 2005, we advanced a total of $1.3 million and $815,000, respectively, to the Borrower. Subsequent to April 30, 2006, we made additional advances to the Borrower totaling $225,000. The note receivable, which matures July 31, 2007, is collateralized by all of the Borrower’s tangible and intangible property and bears interest at six percent (6%) per annum and is included in other assets, net, in our condensed balance sheet as of April 30, 2006. Two of the founders of the Borrower have also guaranteed amounts up to two-thirds of the principal balance outstanding on the note receivable plus two-thirds of any accrued interest related to the note receivable. In connection with the loan, we were issued a warrant by the Borrower which, as amended, gives us the right to purchase a fifty-six percent (56%) equity interest in the Borrower on a fully diluted, as converted basis, for a purchase price of $1,500,000. The warrant expires on July 31, 2007 if it has not been exercised. In addition, we were granted the right to purchase all other outstanding equity of the Borrower at various times from 2009 through 2012, at a fixed multiple of trailing earnings before interest and taxes (EBIT), conditioned upon our exercise of the warrant or the Borrower’s failure to repay the loan when due.

Net cash used in investing activities for the first half of fiscal year 2005 resulted primarily from the purchase of property and equipment and deposits for the purchase of property and equipment.

Net cash provided by financing activities totaled $407,000 in the first half of fiscal 2006 and resulted from proceeds from a note payable to our bank under our line of credit and proceeds received from the exercise of warrants, partially offset by payments for financing costs associated with amending and restating our existing credit facility. There was no cash provided by or used in financing activities for the first half of fiscal 2005.

We have a revolving credit facility with Wachovia Bank, National Association (“Wachovia”). The initial term of the loan agreement expired in April 2005 and was automatically extended through April 2006 pursuant to the terms of the agreement. Effective March 31, 2006, an agreement was reached with Wachovia to amend and restate the terms of the financing. The amended loan agreement expires on April 17, 2008; however we are engaged in active discussions with both the lender and other financial institutions to replace our credit facility with a credit facility with terms we believe will be more appropriate for our current financing needs. Upon completion of these negotiations, should we choose to enter into a separate agreement with either the lender or another financial institution, the amended loan agreement is cancelable upon 60 days advance notice without early termination penalties.

The credit facility pursuant to both the original agreement and the amended and restated loan agreement provides up to a maximum of $25 million and is collateralized by all of our tangible and intangible assets. Borrowings under the credit facility are subject to certain coverage ratios, advance limits and qualifications that are applied to our accounts receivable, inventory and fixed assets. Our ability to access the full amount of the credit facility depends on the future growth of our borrowing base. We maintain a sweep arrangement with our bank, where at the end of each day, all of our cash is used to paydown our outstanding note payable to the bank, if any.

As of April 30, 2006, we had outstanding borrowings in the amount of $427,000 under the credit facility, with approximately $7.8 million unused and available. As of October 31, 2005, we had no outstanding borrowings under the credit facility.

The credit facility bears interest at one-half of one percent (0.50%) per annum above the prime rate (facility rate of 8.25% as of April 30, 2006). The facility also provides a LIBOR based rate at our option.

In connection with obtaining and amending the initial credit facility, the Company incurred various costs. These financing costs, net of amortization, were deferred and were included in other assets, net in the condensed balance sheets of the Company for periods prior to the second quarter of 2005. These deferred financing costs

27

Table of Contents

were amortized to interest expense using the straight-line method, which approximates the effective interest method through April 2005 (the original term of the credit facility) and were fully amortized in fiscal year 2005. Although we did not need to use our credit facility during fiscal 2005, we recognized interest expense during the first two quarters of 2005 related to the amortization of the deferred financing costs associated with obtaining and amending our credit facility.

In connection with amending and restating the credit facility in March of 2006, the Company incurred various costs. These financing costs, net of amortization, have been deferred and are included in other assets, net in the condensed balance sheets of the Company for periods beginning in the second quarter of 2006. These deferred financing costs are being amortized to interest expense using the straight-line method, which approximates the effective interest method for a period not greater than the term of the amended loan agreement, as deemed appropriate.

We believe that our cash flow from operations, our cash on hand and our existing credit facility, as restated and amended, or any alternative credit facility we may obtain, will be adequate to fund our operations for at least the next twelve months.

We issued warrants to purchase 250,000 shares of our common stock at an exercise price per share of $4.88 as part of a consolidated class action lawsuit settlement agreement reached in September 2002. The warrants are exercisable for five years and will expire October 24, 2007. We have registered the shares issuable upon the exercise of the warrants under the Securities Act of 1933, as amended.

A prior distributor for us filed for protection from its creditors under bankruptcy laws in January 2001. We wrote off approximately $2.2 million for estimated uncollectible accounts receivable from this distributor for the year ended October 31, 2001. Subsequent recoveries from the bankrupt estate of this distributor, if any, will be recognized when payment is received, in accordance with U.S. generally accepted accounting principles.

From time to time, we are involved in various claims, legal actions and regulatory reviews arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.

Seasonality

Historically, net sales are relatively lower in the first half of each fiscal year and relatively higher in the second half of each fiscal year, which we believe may be partially due to construction cycles and budgetary considerations of our customers. For example, an average of approximately 45% of our net sales occurred during the first half of the fiscal year and an average of approximately 55% of our net sales occurred during the second half of the fiscal year for fiscal years 1996 through 2000. However, our net sales did not follow this pattern in fiscal year 2002 or 2001. In fiscal years 2002 and 2001, approximately 52% and 57% of our net sales occurred during the first half of the fiscal year, respectively, and approximately 48% and 43% of our net sales occurred during the second half of the fiscal year, respectively. We believe this shift in the pattern of our net sales appears to be related to overall economic conditions in the industry at the time. During fiscal years 2004 and 2003, approximately 46% and 47%, respectively, of our net sales occurred during the first half of the fiscal year and approximately 54% and 53%, respectively, of our net sales occurred during the second half of the fiscal year. While we believe the pattern of net sales we experienced during fiscal years 2004 and 2003 may have reflected a return to our historical seasonality pattern, we did not see this pattern during fiscal year 2005, as net sales during the first half of the fiscal year were approximately the same as net sales for the second half of the year. We believe the lack of seasonality pattern in fiscal 2005 was partially due to the timing of larger projects, which were weighted more heavily during the first half of the year. At this time, we have not yet determined whether we will see a return to a more typical seasonality pattern in fiscal year 2006.

28

Table of Contents

Contractual Obligations and Commitments

As of April 30, 2006, we have a note payable to our bank totaling $427,000 under the terms of our amended and restated loan agreement. The credit facility, as amended, will expire in April 2008. See further discussion under “Liquidity and Capital Resources.” As of April 30, 2006, we have no other disclosable contractual obligations and commitments that will significantly adversely impact our future liquidity.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations is based on the condensed financial statements and accompanying condensed notes that have been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting information and the instructions to Form 10-Q and Article 10 of Regulation S-X. The preparation of these condensed financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 1 to the financial statements filed with our Annual Report on Form 10-K for fiscal year 2005 provides a summary of our significant accounting policies. The following are areas requiring significant judgments and estimates due to uncertainties as of the reporting date: revenue recognition, trade accounts receivable and the allowance for doubtful accounts, inventories, long-lived assets, and commitments and contingencies.

Application of the critical accounting policies discussed in the section that follows requires management’s significant judgments, often as a result of the need to make estimates of matters that are inherently uncertain. If actual results were to differ materially from the estimates made, the reported results could be materially affected. We are not currently aware of any reasonably likely events or circumstances that would result in materially different results.

Revenue Recognition

Management views revenue recognition as a critical accounting estimate since we must estimate an allowance for sales returns for the reporting period. This allowance reduces net sales for the period and is based on our analysis and judgment of historical trends, identified returns and the potential for additional returns.

Trade Accounts Receivable and the Allowance for Doubtful Accounts

Management views trade accounts receivable and the related allowance for doubtful accounts as a critical accounting estimate since the allowance for doubtful accounts is based on judgments and estimates concerning the likelihood that individual customers will pay the amounts included as receivable from them. In determining the amount of allowance for doubtful accounts to be recorded for individual customers, we consider the age of the receivable, the financial stability of the customer, discussions that may have occurred with the customer and our judgment as to the overall collectibility of the receivable from that customer. In addition, we establish an allowance for all other receivables for which no specific allowances are deemed necessary. This general allowance for doubtful accounts is based on a percentage of total trade accounts receivable with different percentages used based on different age categories of receivables. The percentages used are based on our historical experience and our current judgment regarding the state of the economy and the industry.

Inventories

Management views the determination of the net realizable value of inventories as a critical accounting estimate since it is based on judgments and estimates regarding the salability of individual items in inventory and an estimate of the ultimate selling prices for those items. Individual inventory items are reviewed and adjustments are made based on the age of the inventory and our judgment as to the salability of that inventory in order for our inventories to be valued at the lower of cost or net realizable value.

29

Table of Contents

Long-lived Assets

Management views the determination of the carrying value of long-lived assets as a critical accounting estimate since we must determine an estimated economic useful life in order to properly depreciate our long-lived assets and because we must consider if the value of any of our long-lived assets have been impaired, requiring adjustment to the carrying value.

Economic useful life is the duration of time the asset is expected to be productively employed by us, which may be less than its physical life. Management’s assumptions on wear and tear, obsolescence, technological advances and other factors affect the determination of estimated economic useful life. The estimated economic useful life of an asset is monitored to determine if it continues to be appropriate in light of changes in business circumstances. For example, technological advances or excessive wear and tear may result in a shorter estimated useful life than originally anticipated. In such a case, we would depreciate the remaining net book value of an asset over the new estimated remaining life, thereby increasing depreciation expense per year on a prospective basis. We must also consider similar issues when determining whether or not an asset has been impaired to the extent that we must recognize a loss on such impairment.

Commitments and Contingencies

Management views accounting for contingencies as a critical accounting estimate since loss contingencies arising from product warranties and defects, claims, assessments, litigation, fines and penalties and other sources require judgment as to any probable liabilities incurred. For example, accrued product warranty costs recorded by us are based primarily on historical experience of actual warranty claims and costs as well as current information with respect to warranty claims and costs. Actual results could differ from the expected results determined based on such estimates.

Future Accounting Considerations

In May 2005, the Financial Accounting Standards Board, also referred to as the “FASB,” issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (“SFAS 154”) which replaces Accounting Principles Board, also referred to as “APB,” Opinion No. 20 Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28 . SFAS 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principal unless it is not practicable. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and is required to be adopted by us in the first quarter of fiscal year 2007. We are currently evaluating the impact of the application of SFAS 154 on our results of operations, financial position and liquidity.

In February 2006, the FASB issued Statement of Financial Standards No. 155, Accounting for Certain Hybrid Financial Instruments , (“SFAS 155”), an amendment of SFAS 133 and 140. This Statement resolves certain issues addressed in the implementation of SFAS 133 concerning beneficial interests in securitized financial assets. SFAS 155 permits fair value measurement for any hybrid financial instrument that contains an embedded derivative, clarifies which interest-only strips and principal-only strips are not subject to the requirement of SFAS 133, establishes a requirement to evaluate interests in securitized financial assets, clarifies the concentrations of credit risk, and eliminates the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument. The statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The adoption of the Statement is not expected to have a material impact on our results of operations, financial position and liquidity.

In March 2006, the FASB issued Statement of Financial Standards No. 156, “ Accounting for Servicing of Financial Assets — An Amendment of FASB Statement No. 140 ” (“SFAS 156”). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing

30

Table of Contents

liabilities at fair value. SFAS 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of the Statement is not expected to have a material impact on our results of operations, financial position or liquidity as we do not have servicing assets or servicing liabilities at this time.

As of June 1, 2006, there are no other new accounting standards issued, but not yet adopted by us, which are expected to be applicable to our financial position, operating results or financial statement disclosures.

31

Table of Contents