UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

~~WASHINGTON~~Washington, D.C. 20549

FORM 10-Q

~~x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15~~(dMark one) ~~OF THE SECURITIES EXCHANGE ACT OF 1934~~

~~FOR~~x ~~THE~~Quarterly ~~QUARTERLY~~Report ~~PERIOD~~Pursuant ~~ENDED~~to ~~SEPTEMBER~~Section ~~30,~~13 ~~2003~~or 15(d) of the Securities Exchange Act of 1934

For the fiscal quarter ended June 30, 2004

¨ ~~TRANSITION~~Transition ~~REPORT~~Report ~~PURSUANT~~Pursuant TOto ~~SECTION~~Section 13 ORor 15(d) OFof ~~THE~~the ~~SECURITIES~~Securities ~~EXCHANGE~~Exchange ~~ACT~~Act OFof 1934 ~~(NO FEE REQUIRED)~~

~~FOR~~Commission ~~THE~~file ~~TRANSITION~~No. ~~PERIOD~~000-28843 ~~FROM TO~~

~~COMMISSION~~Turnstone ~~FILE~~Systems, ~~NUMBER~~Inc. ~~000-28843~~

TURNSTONE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		77-0473640
(State or other jurisdiction ofincorporation or organization)		(IRS Employer Identification Number)

Delaware

~~2220~~(State ~~CENTRAL EXPRESSWAY,~~or ~~SANTA~~other ~~CLARA,~~jurisdiction ~~CALIFORNIA~~of ~~95050~~incorporation or organization)

~~(Address~~77-0473640 ~~of principal executive offices, including zip code)~~

(I.R.S. Employer Identification No.)

7650 MARATHON DRIVE, SUITE A, LIVERMORE, CALIFORNIA 94550

(Address of principal executive offices)

(408) 907-1400

(~~Registrant~~Issuer’s telephone number~~, including area code~~)

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in ~~Exchange Act~~ Rule 12b-2 of the Exchange Act). YES ~~Yes~~ x NO No ¨

~~There~~As ~~were~~of July 31, 2004, the Issuer had 63,~~117~~417,~~133~~130 shares of ~~the~~its ~~Registrant’s~~Common ~~common stock~~Stock, par value $0.001, ~~outstanding~~per onshare, ~~September~~issued ~~30,~~and ~~2003~~outstanding.

TURNSTONE SYSTEMS, INC.

TABLE OF CONTENTS

		Page No.
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002	3
	Condensed Consolidated Statements of Net Assets in Liquidation as of June 30, 2004 and December 31, 2003	3
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2003 and 2002	4
	Condensed Consolidated Statement of Changes in Net Assets in Liquidation for the Three and Six Months Ended June 30, 2004	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002	5
	Condensed Consolidated Statement of Operations for the Three and Six Months Ended June 30, 2003	5
	Notes to Condensed Consolidated Financial Statements	6
	Condensed Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2003	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Notes to Condensed Consolidated Financial Statements	7
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 4.	Controls and Procedures	34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	24
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	3525
Item 2.	Changes in Securities and Use of Proceeds	3826
Item 3.	Defaults Upon Senior Securities	3826
Item 4.	Submission of Matters to a Vote of Security Holders	3826
Item 5.	Other Information	3826
Item 6.	Exhibits and Reports on Form 8-K	3827
Signatures		4229
Exhibit Index		43
Certifications

TURNSTONE SYSTEMS, INC.

CONDENSED CONSOLIDATED ~~BALANCE~~STATEMENTS ~~SHEETS~~OF NET ASSETS IN LIQUIDATION

(IN THOUSANDS~~, EXCEPT PER SHARE AMOUNTS~~)

(UNAUDITED)

	September 30,2003				December 31,2002
	June 30,2004			December 31, 2003
Assets
Current assets:
Cash and cash equivalents	$	11,956		$	12,601
Cash and cash equivalents	$	187,970			$	103,358
Receivables and other current assets		94			221
Short-term investments		—				60,951
Total assets	$	12,050		$	12,822
Accounts receivable, net		—				314
Liabilities
Prepaid expenses and other current assets		3,226				767
Distribution payable to stockholders	$	10,781		$	—
Total current assets		191,196				165,390
Estimated litigation settlement costs		—			500
Long-term investments		—				47,301
Estimated costs to be incurred during liquidation		309			810
Restricted cash		—				3,639
Other current liabilities and accrued expenses		50			297
Property and equipment, net		—				1,495
Total liabilities	$	11,140		$	1,607
Assets held for sale		81				—
Net assets in liquidation	$	910		$	11,215
Total assets	$	191,277			$	217,825
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	37			$	621
Accrued compensation and benefits		343				784
Other current liabilities and accrued expenses		605				2,644
Deferred revenue		6				154
Total current liabilities		991				4,203
Other long-term liabilities		—				675
Total liabilities		991				4,878
Stockholders’ equity:
Convertible preferred stock, $.001 stated value, 5,000 shares authorized; none issued and outstanding at September 30, 2003 and December 31, 2002		—				—
Common stock, $.001 stated value, 200,000 shares authorized; 66,538 and 65,884 shares issued at September 30, 2003 and December 31, 2002, respectively		67				66
Treasury stock, at cost; 3,421 and 3,128 shares at September 30, 2003 and December 31, 2002, respectively		(10,630	)			(9,896	)
Additional paid-in capital		312,109				311,498
Deferred stock compensation		(14	)			(425	)
Accumulated other comprehensive income		—				424
Accumulated deficit		(111,246	)			(88,720	)
Total stockholders’ equity		190,286				212,947
Total liabilities and stockholders’ equity	$	191,277			$	217,825

See accompanying notes to condensed consolidated financial statements.

TURNSTONE SYSTEMS, INC.

CONDENSED CONSOLIDATED ~~STATEMENTS~~STATEMENT OF ~~OPERATIONS~~CHANGES IN NET ASSETS IN LIQUIDATION

(IN THOUSANDS~~, EXCEPT PER SHARE AMOUNTS~~)

(UNAUDITED)

	THE THREE MONTHS ENDEDSEPTEMBER 30,						THE NINE MONTHS ENDEDSEPTEMBER 30,
	Three months ended June 30, 2004			Six monthsendedJune 30, 2004
	2003			2002			2003			2002
Net assets in liquidation at beginning of period	$	11,571		$	11,215
Net revenues:
Adjust assets and liabilities to fair value		120			201
Product revenue	$	44		$	707		$	586		$	1,565
Estimated proceeds from licensing of intellectual property		—			275
Service revenue		8			351			152			1,129
Declared but unpaid distributions to stockholders		(10,781	)		(10,781	)
Sales returns reserve adjustment		—			—			—			167
Net assets in liquidation at June 30, 2004	$	910		$	910
Total net revenues		52			1,058			738			2,861
Cost of revenues:
Cost of product revenue		17			388			20			855
Cost of service revenue		—			91			—			277
Write-down of inventory		—			75			—			75
Total cost of revenues		17			554			20			1,207
Gross profit		35			504			718			1,654
Operating expenses:
Research and development (exclusive of non-cash compensation expense of $0 and $184 for the three months ended September 30, 2003 and 2002 and $65 and $745 for the nine months ended September 30, 2003 and 2002, respectively)		—			3,947			5,733			11,062
Sales and marketing (exclusive of non-cash compensation expense of $0 and $104 for the three months ended September 30, 2003 and 2002 and $19 and $416 for the nine months ended September 30, 2003 and 2002, respectively)		—			1,866			1,562			6,183
General and administrative (exclusive of non-cash compensation expense of $22 and $137 for the three months ended September 30, 2003 and 2002 and $108 and $549 for the nine months ended September 30, 2003 and 2002, respectively)		1,849			640			5,917			2,100
Amortization of deferred stock compensation		22			425			192			1,710
Lease termination penalty, net		—			—			11,377			—
Reversal of provision for loss on operating lease		—			—			(1,276	)		—
Asset impairment charge		—			—			655			—
Total operating expenses		1,871			6,878			24,160			21,055
Operating loss		(1,836	)		(6,374	)		(23,442	)		(19,401	)
Other income (expense)
Litigation settlement		—			—			(920	)		—
Interest income and other, net		463			1,507			2,045			4,596
Total other income		463			1,507			1,125			4,596
Loss before income tax		(1,373	)		(4,867	)		(22,317	)		(14,805	)
Income tax expense		29			64			209			78
Net loss	$	(1,402	)	$	(4,931	)	$	(22,526	)	$	(14,883	)
Basic net loss per share of common stock	$	(.02	)	$	(.08	)	$	(.36	)	$	(.24	)
Diluted net loss per share of common stock	$	(.02	)	$	(.08	)	$	(.36	)	$	(.24	)
Weighted-average shares of common stock outstanding used in computing basic net loss per share		63,057			62,736			62,912			63,188
Weighted-average shares of common stock outstanding used in computing diluted net loss per share		63,057			62,736			62,912			63,188

See accompanying notes to condensed consolidated financial statements.

TURNSTONE SYSTEMS, INC.

CONDENSED CONSOLIDATED ~~STATEMENTS~~STATEMENT OF ~~CASH~~OPERATIONS ~~FLOWS~~

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

	THE NINE MONTHSENDEDSEPTEMBER 30,
	Three months ended June 30, 2003			Six months endedJune 30, 2003
	2003			2002
Revenues:
Operating activities
Product revenue	$	274		$	542
Net loss	$	(22,526	)	$	(14,883	)
Service revenue		22			144
Adjustments to reconcile net loss to net cash used in operating activities:
Total net revenues		296			686
Asset impairment charge		655			—
Cost of revenues:
Depreciation		418			1,376
Cost of product revenue		1			3
Stock compensation expense		209			1,711
Total cost of revenues		1			3
Provision for doubtful accounts and sales returns		(5	)		(664	)
Gross profit		295			683
Loss on disposal of property and equipment		31			—
Operating expenses:
Effect of changes in foreign currency		(34	)		(113	)
Research and development (exclusive of non-cash compensation expense of $11 and $65 for the three and six months ended June 30, 2003, respectively)		1,370			5,733
Changes in assets and liabilities:
Sales and marketing (exclusive of non-cash compensation expense of $3 and $19 for the three and six months ended June 30, 2003, respectively)		343			1,562
Accounts receivable		319			933
General and administrative (exclusive of non-cash compensation expense of $32 and $86 for the three and six months ended June 30, 2003, respectively)		2,331			4,068
Inventory		—			412
Amortization of deferred stock compensation		46			170
Prepaid expenses and other assets		(2,454	)		501
Lease termination penalty, net		11,377			11,377
Accounts payable		(589	)		52
Reversal of provision for loss on operating lease		(1,276	)		(1,276	)
Accrued compensation and benefits		(441	)		(18	)
Asset impairment charge		655			655
Other current liabilities and accrued expenses		(2,039	)		(1,562	)
Total operating expenses		14,846			22,289
Other long-term liabilities		(675	)		(68	)
Operating loss		(14,551	)		(21,606	)
Deferred revenue		(148	)		218
Other income (expense)
Net cash used in operating activities		(27,279	)		(12,105	)
Litigation settlement		(920	)		(920	)
Investing activities
Interest income and other, net		569			1,582
Acquisition of property and equipment		—			(153	)
Total other income (expense)		(351	)		662
Proceeds from disposal of property and equipment		310			11
Loss before income tax		(14,902	)		(20,944	)
Purchases of available-for-sale investments, net		(1,250	)		(148,576	)
Income tax expense		155			180
Proceeds from sales and maturities of available-for-sale investments		109,078			182,363
Net loss	$	(15,057	)	$	(21,124	)
Decrease in restricted cash		3,639			—
Basic and diluted net loss per share of common stock	$	(.24	)	$	(.34	)
Net cash provided by investing activities		111,777			33,645
Weighted-average shares of common stock outstanding used in computing basic and diluted net loss per share		62,968			62,838
Financing activities
Net proceeds from issuance of common stock		814			236
Purchases of treasury stock		(734	)		(4,392	)
Principal payments of capital lease obligations		—			(41	)
Net cash provided (used) by financing activities		80			(4,197	)
Effect of exchange rate changes on cash and cash equivalents		34			100
Net increase in cash and cash equivalents		84,612			17,443
Cash and cash equivalents at beginning of period		103,358			92,633
Cash and cash equivalents at end of period	$	187,970		$	110,076
Supplemental disclosures of cash flow information:
Cash paid for income tax	$	254		$	175
Deferred stock compensation	$	219		$	45

See accompanying notes to condensed consolidated financial statements.

TURNSTONE SYSTEMS, INC.

~~NOTES TO~~ CONDENSED CONSOLIDATED ~~FINANCIAL~~STATEMENT ~~STATEMENTS~~OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

1. The Company and Recent Developments


	Six months ended June 30, 2003
Operating activities
Net loss	$	(21,124	)
Adjustments to reconcile net loss to net cash used in operating activities:
Asset impairment charge		655
Depreciation		418
Stock compensation expense		187
Provision for doubtful accounts and sales returns		(3	)
Loss on disposal of property and equipment		31
Effect of changes in foreign currency		(14	)
Changes in assets and liabilities:
Accounts receivable		(1	)
Prepaid expenses and other assets		(1,164	)
Accounts payable		(372	)
Accrued compensation and benefits		(149	)
Other current liabilities and accrued expenses		(904	)
Other long-term liabilities		(675	)
Deferred revenue		(140	)

Net cash used in operating activities		(23,255	)

Investing activities
Proceeds from disposal of property and equipment		18
Purchases of available-for-sale investments		(1,250	)
Proceeds from sales and maturities of available-for-sale investments		109,078
Decrease in restricted cash		3,639

Net cash provided by investing activities		111,485
Financing activities
Net proceeds from issuance of common stock		608
Purchases of treasury stock		(734	)

Net cash used in financing activities		(126	)
Effect of exchange rate changes on cash and cash equivalents		11
Net increase (decrease) in cash and cash equivalents		88,115
Cash and cash equivalents at beginning of period		103,358

Cash and cash equivalents at end of period	$	191,473

Supplemental disclosures of cash flow information:
Cash paid for income tax	$	98
Deferred stock compensation	$	(214	)

~~Turnstone~~See ~~Systems,~~accompanying ~~Inc.~~notes ~~(the Company) is a provider of hardware and software products that enable local exchange carriers~~ to ~~deploy and maintain copper~~condensed ~~local~~consolidated ~~loop~~financial ~~services~~statements. ~~The Company’s products include copper loop management and testing systems, signal splitters and remote line switching and service verification platforms.~~

On January 9, 2003, the Company announced that it was exploring various strategic alternatives, including possible merger and asset sale transactions, licensing arrangements and dissolution of the company and distribution of assets to stockholders. The Company also announced that it had engaged Goldman Sachs & Co. as its financial advisor. While a limited supply of the Company’s products remained available for sale, the Company generally ceased all direct sales efforts related to them, and the Company redirected its operating activities to focus primarily on in-process research and development related to the Company’s next generation copper automation products for incumbent local exchange carriers. In connection with those decisions, the Company reduced headcount by approximately 40%, or 29 employees, in January 2003.

On April 7, 2003, the Company entered into an agreement to restructure its lease agreement for its headquarters facility in Santa Clara, California. The previous lease covered approximately 62,500 square feet of facilities and expired in June 2010, and the Company had remaining rent obligations of approximately $32.0 million. The restructuring, effective May 1, 2003, reduced the Company’s facilities commitment to approximately 31,000 square feet and shortened the lease term to the end of 2003. Pursuant to the agreement, in April 2003, the Company made a lump sum cash payment of approximately $14.2 million, which included $3.6 million from its restricted cash and included prepaid rent through the end of 2003, the remaining facilities commitment under the restructured lease.

On April 24, 2003, the Company initiated actions to terminate most of its remaining employees except for a limited team of employees that continued to handle matters related to its previously announced exploration of strategic alternatives. These actions were initiated after management and the Company’s board of directors, following an extensive consideration of strategic alternatives, concluded that maintaining the Company’s research and development efforts related to next-generation copper automation products for incumbent local carriers was not necessary for any of the strategic alternatives under consideration at that time, and that the on-going expenditures related to continuing such efforts could potentially decrease total stockholder value.

On July 25, 2003, the U.S. District Court for the Northern District of California preliminarily approved a settlement of a class action suit that was brought against the Company, certain

ofTURNSTONE its officers and directors and its underwriters on behalf of persons who purchased common stock issued pursuant to the Company’s secondary stock offering in September 2000. The suit was settled for $7.0 millionSYSTEMS, ~~of which insurance for the Company’s directors and officers paid approximately $6~~INC.1 million and the Company contributed approximately $0.9 million in cash during September 2003. On October 9, 2003, the court granted final approval of the settlement and dismissed all claims against all defendants in the suit without any admission of liability by any party.

OnNOTES ~~August 6, 2003, the Company’s board of directors approved, subject to stockholder ratification at the Company’s~~TO ~~2003~~CONDENSED ~~Annual~~CONSOLIDATED ~~Meeting~~FINANCIAL ofSTATEMENTS Stockholders, a special cash distribution to stockholders of $2.77 per common share or such lesser amount as the board of directors may later determine to be appropriate. If the special distribution is ratified, the Company’s board of directors plans to set a record date and payment date for the special distribution and fix the actual amount of the special distribution. The board of directors also approved, subject to stockholder approval at the Company’s 2003 Annual Meeting of Stockholders scheduled for November 11, 2003, the Company’s liquidation and dissolution pursuant to a plan of complete liquidation and dissolution of Turnstone Systems, Inc. If the plan of dissolution is approved, the Company will file a certificate of dissolution of Turnstone Systems, Inc. with the Delaware Secretary of State, complete the liquidation of the Company’s remaining assets, satisfy the Company’s remaining obligations and make distributions to the Company’s stockholders of available liquidation proceeds.

2.(UNAUDITED) ~~Basis of Presentation~~

~~The accompanying unaudited condensed consolidated financial statements have been prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC)~~1. ~~Certain~~The information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments, except as otherwise indicated) necessary for a fair presentation of the Company’s financial position at September 30, 2003 and ~~December~~Recent 31, 2002, its operating results for the three and nine months ended September 30, 2003 and 2002 and its cash flows for the nine months ended September 30, 2003 and 2002. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K and filed with the SEC on March 18, 2003. The condensed consolidated balance sheet at December 31, 2002 has been derived from audited financial statements as of that date. Developments

On August 6, 2003, our board of directors approved, subject to stockholder approval at our 2003 Annual Meeting of Stockholders, the liquidation and dissolution of Turnstone Systems, Inc. pursuant to a plan of complete liquidation and dissolution. The ~~interim~~holders ~~financial~~of ~~statements~~a majority of our outstanding shares approved the plan of complete liquidation and dissolution on November 11, 2003. The key features of the plan are ~~not~~(1) ~~necessarily~~file ~~indicative~~a certificate of ~~results~~dissolution ~~that~~with the Secretary of State of the State of Delaware; (2) cease conducting normal business operations, except as may be ~~expected~~required ~~for~~to ~~any~~wind ~~other~~up ~~interim~~our ~~period~~business affairs; (3) attempt to convert all of our remaining assets into cash or cash equivalents in an orderly fashion; (4) pay or attempt to adequately provide for the ~~full~~payment ~~fiscal~~of ~~year~~all ~~ending~~of ~~December~~our ~~31,~~known ~~2003~~obligations and liabilities; and (5) distribute pro rata in one or more liquidating distributions all of our remaining assets to our stockholders as of the applicable record date.

~~These~~In connection with the adoption of the plan and the anticipated liquidation, we adopted the liquidation basis of accounting effective November 11, 2003, whereby assets are valued at their estimated net realizable cash ~~unaudited~~values ~~condensed~~and ~~consolidated~~liabilities ~~financial~~are ~~statements~~stated ~~contemplate~~at their estimated settlement amounts. Uncertainties as to the ~~realization~~precise net value of our non-cash assets, and the ~~satisfaction~~ultimate amount of our liabilities make it impracticable to predict the aggregate net value that may ultimately be distributable to stockholders. Claims, liabilities and future expenses for operations, although currently declining, will continue to be incurred with execution of the plan. These costs will reduce the amount of net assets available for ultimate distribution to stockholders. Although we do not believe that a precise estimate of those expenses can currently be made, we believe that available cash and cash equivalents and amounts received from sales of non-cash assets will be adequate to provide for our obligations, liabilities, operating costs and claims, and to make cash distributions to stockholders. If available cash and amounts received from sales of non-cash assets are not adequate to provide for our obligations, liabilities, operating costs and claims, estimated future distributions of cash to our stockholders will be reduced.

We filed our certificate of dissolution with the Secretary of State of the State of Delaware effective December 4, 2003. Pursuant to Delaware law, Turnstone Systems, Inc. will continue in existence until at least December 4, 2006. During this period, we will continue to convert our estimated net assets to cash for future distribution to our stockholders. We are not permitted to continue our business as a going concern.

At the close of business on December 4, 2003, we closed our stock transfer books, discontinued recording transfers of our common

~~liabilities~~stock, inand ~~the~~our ~~normal~~common ~~course~~stock ofwas ~~business.~~de-listed Onfrom ~~August 6, 2003,~~ the ~~Company’s~~Nasdaq ~~Board~~National ofMarket. ~~Directors~~Any ~~approved~~future adistributions ~~plan~~we make ofwill ~~complete~~be ~~dissolution~~made ~~and liquidation,~~solely ~~subject~~ to ~~approval~~the ~~by our~~ stockholders ~~at the Annual Meeting~~ of ~~Stockholders~~record ~~scheduled to be held on November 11, 2003. The Company’s stockholders have not~~ as of ~~yet voted on~~ the ~~plan~~close of ~~dissolution~~business ~~and~~on ~~liquidation,~~December ~~which is required under Delaware law~~4, ~~and therefore the accompanying unaudited condensed consolidated financial statements do not include any adjustments that might result from this uncertainty~~2003. IfWe ~~the~~intend, ~~plan~~in ~~of dissolution and liquidation is approved by~~ the ~~Company’s~~ ~~stockholders~~future, ~~the~~to ~~Company~~seek ~~would~~relief ~~present~~from ~~all financial activities using~~ the ~~liquidation~~Securities ~~basis of accounting. Under the liquidation basis of accounting, assets are stated at their estimated net realizable values~~ and ~~liabilities~~Exchange ~~are stated~~Commission atfrom ~~their anticipated settlement amount, if~~ the ~~amount~~reporting ~~can~~requirements ~~be reasonably estimated. If the Company’s financial statements were presented~~ under the ~~liquidation~~Exchange ~~basis of accounting as of September 30, 2003, total assets would be reduced from $191~~Act.~~3 million, to approximately $188.2 million, primarily due to a write down of prepaid expenses and other assets.~~

3Since we were de-listed from Nasdaq and closed our stock records on December 4, 2003, our shares have continued to trade in the Over the Counter Market’s “pink sheets”. ~~Summary~~From time to time, trading volume in our shares has been relatively high, and our shares have traded at prices in excess of ~~Significant~~the ~~Accounting~~highest ~~Policies~~price we have estimated for potential liquidation distributions. Traders in our shares are cautioned that our shares are highly speculative, and we cannot predict with any accuracy when, or if, additional liquidation distributions will be made.

~~Cash~~In June 2004, our board of directors approved a liquidating cash distribution of approximately $10.8 million, or $0.17 per common share, to our stockholders of record as of December 4, 2003. The distribution was completed on July 8, 2004. At the end of June 2004, we also terminated the employment of Albert Y. Liu, General Counsel & Director of Human Resources, and ~~Cash~~Eric ~~Equivalents~~S. Yeaman, Chief Executive Officer and Chief Financial Officer, our two remaining employees, and concurrently entered into consulting agreements with each of them to continue ongoing management of our liquidation. Compensation under these consulting agreements is based on actual hours of service at a fixed hourly rate. The agreements do not provide for minimum retainer payments or termination fees.

~~The~~We ~~Company~~may ~~considers~~at ~~all~~some ~~highly~~point ~~liquid~~determine ~~investments~~that ~~purchased~~the ~~with~~continued anliquidation ~~original~~of Turnstone ~~maturity~~may ofbe ~~less~~more ~~than~~efficiently ~~three~~handled ~~months~~by atretaining ~~the~~a ~~date~~third ofparty ~~purchase~~liquidator to bemanage ~~cash equivalents~~the liquidation process. ~~Cash~~In ~~equivalents~~particular, we may determine to do so at ~~September~~such ~~30,~~time ~~2003~~as ~~consisted~~our ~~primarily~~outstanding oflitigation ~~money~~and ~~market~~other ~~funds~~significant creditor claims have been resolved. ~~Cash~~We ~~equivalents~~cannot atpredict ~~December~~when ~~31,~~or ~~2002~~if ~~consisted~~these ~~primarily~~matters ofwill ~~U.S.~~be resolved, ~~state~~or ~~and~~when ~~municipal~~or ~~government~~if ~~obligations,~~we ~~corporate~~will ~~debt~~engage ~~securities~~a ~~and~~third ~~money~~party ~~market funds~~liquidator.

~~Short~~2. ~~and~~Summary ~~Long-Term~~of ~~Investments~~Significant Accounting Policies

~~The~~Basis ~~Company’s~~Of ~~short~~Presentation and long-term investments consist primarily of U.S., state and municipal government obligations and corporate debt securities. Investments with remaining maturities of less than or equal to one year are considered short-term, and investments with maturities in excess of one year are considered long-term. Management determines the appropriate classification of securities at the time of purchase and evaluates such designation as of each balance sheet date.

~~Stock-Based~~The ~~Compensation~~accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The unaudited interim financial statements, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation.

The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and complies with the disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Compensation expense on fixed stock options is based on the difference, if any, on the date of the grant, between the fair value of the Company’s stock and the exercise price of the option. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

~~SFAS~~These ~~No.~~financial ~~148,~~statements ~~Accounting for Stock-Based Compensation — Transition~~ and ~~Disclosure~~notes anshould ~~Amendment~~be ~~of FASB~~read ~~Statement~~in ~~No.~~conjunction ~~123,~~with ~~amended~~ the ~~disclosure~~Company’s ~~requirements~~audited consolidated ~~of SFAS No. 123 to require more prominent disclosures in both annual and interim~~ financial statements ~~regarding~~for the ~~method~~year ofended ~~accounting~~December ~~for~~31, ~~stock-based~~2003 ~~employee compensation~~ and ~~the effect~~footnotes ofthereto, ~~the~~included ~~method~~in ~~used on reported results. The pro forma information resulting from~~ the ~~use~~Company’s ofAnnual ~~the~~Report ~~fair~~on ~~value~~Form ~~based method under SFAS No~~10-K. ~~123 is as follows (in thousands except per share amounts):~~

	Three Months EndedSeptember 30,						Nine Months EndedSeptember 30,
	2003			2002			2003			2002
Net loss – as reported	$	(1,402	)	$	(4,931	)	$	(22,526	)	$	(14,883	)
Add: Stock-based employee compensation expense included in the reported net loss, net of related tax effects		22			425			192			1,710
Deduct: Stock-based employee compensation recovery (expense) using the fair value based method, net of related tax effects		2,537			(4,418	)		13,091			(15,105	)
Pro forma net income (loss)	$	1,157		$	(8,924	)	$	(9,243	)	$	(28,278	)
Basic net income (loss) per share
As reported	$	(0.02	)	$	(0.08	)	$	(0.36	)	$	(0.24	)
Pro forma	$	0.02		$	(0.14	)	$	(0.15	)	$	(0.45	)
Diluted net income (loss) per share
As reported	$	(0.02	)	$	(0.08	)	$	(0.36	)	$	(0.24	)
Pro forma	$	0.02		$	(0.14	)	$	(0.15	)	$	(0.45	)

The condensed consolidated financial statements for the three and six months ended June 30, 2003 were prepared on the going concern basis of accounting, which contemplates realization of assets and satisfaction of liabilities in the normal course of business. As a result of the stockholders’ approval of the Plan and the imminent nature of the liquidation, the Company adopted the liquidation basis of accounting effective November 11, 2003. This basis of accounting is considered appropriate when, among other things, liquidation of a company is probable and the net realizable value of assets are reasonably determinable. Under this basis of accounting, assets are valued at their estimated net realizable values and liabilities are stated at their estimated settlement amounts.

~~During~~The conversion from the ~~three~~going concern to liquidation basis of accounting required management to make significant estimates and judgments. In order to ~~nine~~record ~~months~~assets ~~ended~~at ~~September~~estimated ~~30,~~net ~~2003,~~realizable ~~adjustments~~value toand ~~eliminate~~liabilities ~~compensation~~at ~~cost~~estimated ~~previously~~settlement ~~recognized~~amounts ~~for~~under ~~options~~the ~~that~~liquidation ~~were~~basis ~~subsequently~~of ~~forfeited~~accounting, ~~due~~the toCompany ~~employee~~recorded ~~terminations~~the ~~exceeded~~following ~~compensation~~adjustments ~~cost~~to ~~recognized~~record ~~during~~its ~~that~~assets ~~same~~and ~~period~~liabilities ~~resulting~~to fair value as of inNovember a11, ~~net~~2003, ~~recovery~~the date of ~~stock-based~~adoption ~~compensation~~of ~~expense.~~the liquidation basis of accounting:

Recent Accounting Pronouncements


	(In thousands)
Adjust assets and liabilities to fair value:
Prepaid insurance expenses	$	(2,421	)
Prepaid rent expenses		(272	)
All other, net		(4	)

Total adjustments of assets and liabilities to fair value	$	(2,697	)

Accrued estimated net costs during liquidation:
Costs to be incurred during liquidation period		(1,063	)
Future interest income		189

Total estimated net costs during liquidation	$	(874	)

Accrued estimated litigation settlement costs	$	(500	)

Total adjustments	$	(4,070	)

InCash ~~July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses financial accounting~~ and ~~reporting for costs associated with exit or disposal activities and nullifies~~Cash ~~EITF~~Equivalents Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The principal difference between SFAS 146 and EITF 94-3 relates to SFAS 146’s timing for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as generally defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. The requirements of SFAS 146 were effective prospectively for exit or disposal activities initiated after December 31, 2002. Adoption of SFAS

The Company considers all highly liquid investments purchased with an original maturity of less than three months at the date of purchase to be cash equivalents. Cash equivalents at June 30, 2004 and December 31, 2003 consisted primarily of money market funds.

~~146~~Stock-Based ~~did~~Compensation ~~not have a significant effect on the Company’s financial position, results of operations, or cash flows.~~

InThe ~~November~~Company ~~2002,~~accounted ~~the~~for ~~FASB~~stock-based ~~issued~~employee ~~Interpretation~~compensation ~~No.~~arrangements 45in ~~(FIN~~accordance 45with the provisions of Accounting Principles Board (APB) Opinion No. 25, ~~Guarantor’s~~ Accounting ~~and~~for ~~Disclosure~~Stock ~~Requirements~~Issued ~~for~~to ~~Guarantees~~Employees. Beginning in fiscal 2003, ~~Including~~the ~~Indirect~~Company ~~Guarantees~~adopted the disclosure provisions of ~~Indebtedness~~Statement of ~~Others~~Financial Accounting Standards (SFAS) No. 148, ~~which~~Accounting ~~clarifies~~for ~~disclosure~~Stock-Based Compensation-Transition and ~~recognition/measurement~~Disclosure, ~~requirements~~an ~~related~~amendment to ~~certain~~SFAS ~~guarantees~~No. ~~The~~123, ~~disclosure requirements~~Accounting ~~are~~for ~~effective~~Stock-Based ~~for~~Compensation. ~~financial~~Compensation ~~statements~~expense ~~issued~~on ~~after~~fixed ~~December~~stock 15options was based on the difference, ~~2002~~if ~~and~~any, on the ~~recognition/measurement~~date ~~requirements~~of ~~are~~the ~~effective~~grant, onbetween athe ~~prospective~~fair ~~basis~~value of ~~for~~the ~~guarantees~~Company’s ~~issued~~stock orand ~~modified~~the ~~after~~exercise ~~December~~price ~~31,~~of ~~2002~~the option. The Company ~~has determined~~accounted ~~that~~for equity instruments issued to non-employees in accordance with the ~~requirements~~provisions of ~~FIN~~SFAS 45No. ~~apply~~123 toand ~~its~~Emerging ~~accrued~~Issues ~~warranty~~Task ~~and~~Force ~~standard~~(EITF) ~~indemnification~~96-18, ~~clauses~~Accounting ~~contained~~for Equity ~~within~~Instruments ~~its~~That ~~various~~Are ~~customer~~Issued ~~contracts~~to ~~(see~~Other ~~Note~~Than ~~11);~~Employees ~~however~~for ~~the~~Acquiring, ~~adoption~~or ofin ~~FIN~~Conjunction ~~No.~~with 45Selling, ~~did~~Goods ~~not~~or ~~have~~Services. aThe ~~material~~following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company’s ~~financial~~had ~~position,~~applied the ~~results~~fair value recognition provisions of ~~operations~~SFAS No. 123 to stock-based compensation (in thousands, orexcept ~~cash~~per ~~flows.~~share amounts):

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a material effect on the Company’s financial position, results of operations, or cash flows.


	Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
Net loss – as reported	$	(15,057	)	$	(21,124	)
Add: Stock-based employee compensation expense included in the reported net loss, net of related tax effects		46			187
Add: Stock-based employee compensation recovery using the fair value based method, net of related tax effects		4,222			10,554

Pro forma net loss	$	(10,789	)	$	(10,383	)

Basic net loss per share
As reported	$	(0.24	)	$	(0.34	)

Pro forma	$	(0.17	)	$	(0.17	)

Diluted net loss per share
As reported	$	(0.24	)	$	(0.34	)

Pro forma	$	(0.17	)	$	(0.17	)

~~In January~~During ~~2003,~~ the ~~FASB~~three ~~issued~~and six ~~Interpretation~~months ~~No.~~ended 46June ~~(FIN 46)~~30, ~~Consolidation of Variable Interest Entities~~2003, ~~which~~adjustments ~~addresses~~to ~~consolidation~~eliminate bycompensation acost ~~business~~previously ofrecognized ~~variable interest entities in which it is the primary beneficiary. FIN 46 is effective immediately~~ for ~~certain~~options ~~disclosure~~that ~~requirements~~were ~~and~~forfeited ~~variable~~due ~~interest~~to ~~entities~~employee ~~created~~terminations ~~after~~exceeded ~~January~~compensation ~~31,~~cost ~~2003,~~during ~~and~~that insame ~~the first interim or annual~~ period ~~beginning after June 15~~, ~~2003~~resulting ~~for~~in ~~all~~a ~~other~~net ~~variable~~recovery ~~interest entities entered into prior to~~of ~~January~~stock-based ~~31,~~compensation ~~2003~~expense. ~~The Company does not have any variable interest entities.~~

In November 2002, the EITF published EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, which requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting3. InNet ~~applying~~Loss ~~this~~Per EITF Issue 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values. This issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue 00-21 did not have a material effect on the Company’s financial position, results of operations, or cash flows. Share

Basic net loss per share was computed using the weighted-average number of outstanding shares of common stock excluding the weighted-average number of shares of restricted stock subject to repurchase. Diluted net loss per share was computed using the

Inweighted-average ~~January~~number ~~2003,~~of ~~the~~shares ~~FASB’s~~of ~~Emerging~~common ~~Issues~~stock ~~Task~~outstanding ~~Force~~and, ~~reached~~when ~~a consensus on EITF Issue 02-16~~dilutive, ~~Accounting~~ byshares ~~a Customer (Including a Reseller) for Certain Consideration Received from a Vendor. EITF Issue 02-16 provides guidance regarding how a reseller~~ of ~~a vendor’s products should account for cash consideration received from a~~restricted ~~vendor.~~common ~~The~~stock ~~provisions~~subject ~~of EITF Issue 02-16 apply~~ to ~~vendor arrangements entered into after December 31~~repurchase, ~~2002,~~potential ~~including~~shares ~~modifications~~ of ~~existing~~common ~~arrangements.~~stock ~~The~~from ~~adoption~~options ofand ~~EITF~~warrants ~~Issue~~using ~~02-16~~the ~~did~~treasury ~~not~~stock ~~have~~method aand ~~material~~from ~~effect~~convertible onsecurities using the ~~Company’s financial~~“as-if ~~position,~~converted ~~results of operations, or cash flows~~basis”.

In April 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In May 2003, FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities. The adoption of SFAS No. 150 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

4. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of outstanding shares of common stock excluding the weighted-average number of shares of restricted stock subject to repurchase. Diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, shares of restricted common stock subject to repurchase, potential shares of common stock from options and warrants using the treasury stock method and from convertible securities using the “as-if converted basis”.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
	2003			2002			2003			2002
Net loss	$	(15,057	)	$	(21,124	)
Net loss	$	(1,402	)	$	(4,931	)	$	(22,526	)	$	(14,883	)
Basic and diluted:
Basic and diluted:
Weighted average shares of common stock outstanding		62,984			62,871
Weighted average shares of common stock outstanding		63,060			63,429			62,935			63,995
Less: Weighted average shares subject to repurchase		(16	)		(33	)
Less: Weighted average shares subject to repurchase		(3	)		(693	)		(23	)		(807	)
Weighted average shares used in computing basic and diluted net loss per common share		62,968			62,838
Weighted average shares used in computing basic and diluted net loss per common share		63,057			62,736			62,912			63,188
Basic and diluted net loss per common share	$	(.24	)	$	(.34	)
Basic and diluted net loss per common share	$	(.02	)	$	(.08	)	$	(.36	)	$	(.24	)

Options to purchase 25,~~744~~141,000 shares of common stock ~~have~~and ~~been excluded from the computation of diluted net loss per share as of September 30~~12, ~~2003, as their effect would have been antidilutive. Options to purchase 10,074,~~000 shares of common stock ~~and 648,000 shares of common stock~~ subject to repurchase have been excluded from the computation of diluted net loss per share as of ~~September~~June 30, ~~2002~~2003, as their effect would have been antidilutive.

5.There ~~Comprehensive~~were ~~Loss~~no stock options outstanding or exercisable at June 30, 2004 since the Company had terminated its options plans, de-listed its stock and closed its transfer books.

4.	Comprehensive Loss

The components of comprehensive loss are as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
	2003			2002			2003			2002
Net loss	$	(15,057	)	$	(21,124	)
Net loss	$	(1,402	)	$	(4,931	)	$	(22,526	)	$	(14,883	)
Change in net unrealized gain on available-for-sale investments, net		(19	)		(424	)
Change in net unrealized gain on available-for-sale investments, net		—			(104	)		(424	)		(347	)
Total comprehensive loss	$	(15,076	)	$	(21,548	)
Total comprehensive loss	$	(1,402	)	$	(5,035	)	$	(22,950	)	$	(15,230	)

65. Segment Information

SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information, establishes standards for the manner in which public companies report information about operating segments, products and services, geographic areas and major customers in annual and interim financial statements. The method of determining what information to report is based on the way ~~that management organizes the operating segments within the enterprise for making operating decisions and assessing financial performance.~~

~~The~~11 Company’s chief operating decision maker is considered to be the Company’s Chief Executive Officer (CEO). The Company’s operations comprise one product line. The CEO reviews financial information on a single entity level basis for purposes of making operating decisions and assessing financial performance. The entity level financial information is the same as the information presented in the accompanying condensed consolidated statements of operations. Accordingly, the Company has determined that it is engaged in a single operating segment.

ForTable the three months ended September 30, 2003 and 2002, approximately 87.0% and 58.0%, respectively, of revenues were derived from sales to customers located outside the United States. For the nine months ended September 30, 2003 and 2002, approximately 64.1% and 46.6%, respectively, of revenues were Contents

that management organizes the operating segments within the enterprise for making operating decisions and assessing financial performance.

The Company’s chief operating decision maker is considered to be the Company’s Chief Executive Officer (CEO). Prior to the adoption of the Complete Plan of Liquidation and Dissolution on November 11, 2003, the Company’s operations comprised one product line. The CEO reviewed financial information on a single entity level basis for purposes of making operating decisions and assessing financial performance. The entity level financial information was the same as the information presented in the accompanying condensed consolidated statement of operations. Accordingly, the Company determined that it was engaged in a single operating segment.

For the three and six months ended June 30, 2003, approximately 92.8% and 62.4%, respectively, of revenues were derived from sales to customers located outside the United States. Product revenues for the three and six months ended June 30, 2003 were derived from sales of loop management products. Service revenues for the three and six months ended June 30, 2003 were derived primarily from the Company’s maintenance programs for loop management products.

6.	Restructuring and Related Costs

In January 2003, the company reduced its headcount by approximately 40%, or 29 employees, and incurred related severance costs of $367,000, which were included in operating expenses for the three months ended March 31, 2003.

In January 2003, in an effort to retain key employees, the Company entered into agreements with its officers and employees which entitle such officers and employees to receive certain retention bonus payments upon the completion of providing employment services to the Company for a specified period of time. The Company recorded retention bonuses of $816,000 to operating expenses in the three months ended March 31, 2003.

During the three months ended June 30, 2003, the Company terminated 39 employees, leaving only a limited number of personnel to continue to handle matters related to its previously announced exploration of strategic alternatives. Associated with these actions, the company recorded severance-related charges of approximately $434,000 for the three months ended June 30, 2003. Additionally, pursuant to retention agreements entered into with the affected employees in January 2003, the company made retention bonus payments to them of approximately $790,000 during the three months ended June 30, 2003.

In October 2003, the retention agreements for the Company’s two remaining employees expired and the Company paid the earned retention bonuses to these employees. Concurrently, the Company entered into an employment agreement with the two remaining employees which provides that in the event the Company terminates the employees without cause, the employees will be entitled to

~~derived~~receive ~~from~~a ~~sales~~severance topayment ~~customers~~equal ~~located~~to ~~outside~~six ~~the~~months ~~United~~annual ~~States~~base salary. ~~Product~~In ~~revenues~~June ~~for~~2004, the ~~three~~Company ~~and nine months ended September 30, 2003 and 2002 were~~terminated ~~substantially~~the ~~from~~employment ~~sales~~ of ~~loop management products. Service revenues for~~ the ~~three~~two ~~and~~remaining ~~nine~~employees ~~months ended September 30, 2003~~ and ~~2002~~paid ~~were~~them ~~derived~~the ~~primarily~~severance ~~from~~obligations ~~the~~under ~~Company’s~~their ~~maintenance~~employment ~~programs~~agreements, ~~for~~which ~~loop~~totaled ~~management products~~$165,000.

7. ~~Assets~~Other ~~Held for Sale~~Guarantees

InIndemnification ~~April~~Agreements 2003, the Company terminated most of its remaining employees and ceased its research and development activities. As a result of these actions, the Company’s property and equipment were no longer required for ongoing operating activities and the Company began actively marketing the assets through a third-party asset liquidator. The Company recorded a $655,000 asset impairment charge during the three months ended June 30, 2003 in order to state the assets at their fair value less estimated selling costs, as estimated by a third-party asset liquidator. At September 30, 2003 the assets are classified as held for sale. A reconciliation of the changes in assets held for sale for the three months ended September 30, 2003 follows (in thousands):

	Total
Balance at June 30, 2003	$	373
Cash proceeds from sale of assets		(292	)
Balance at September 30, 2003	$	81

The Company and the underwriters of its September 2000 secondary stock offering previously entered into an underwriting agreement, whereby each party agreed, under certain specific circumstances applicable to such party, to indemnify and reimburse the other party for litigation costs and expenses related to claims arising out of the secondary offering. During the second fiscal quarter of 2003, the Company received a request for reimbursement of approximately $250,000 in legal fees purportedly incurred by those underwriters in connection with their defense of a class action lawsuit filed against the Company, certain of its current officers and directors, and those underwriters which alleged that the defendants made false and misleading statements in violation of the Securities Act of 1933 as part of the September 2000 secondary stock offering. In February 2004, in exchange for the Company’s payment of $150,000 of legal fees incurred by the underwriters, the Company and the underwriters agreed to mutually release each other from any further indemnification and reimbursement obligations related to the secondary offering class action lawsuit.

8In addition to the indemnification provisions contained in our certificate of incorporation and bylaws, we have entered into separate indemnification agreements with each of our directors. ~~Other~~These ~~Current~~agreements ~~Liabilities~~require us, among other things, to indemnify such director against expenses (including attorneys’ fees), judgments, fines and ~~Accrued~~settlements ~~Expenses~~paid by such individual in connection with any action, suit or proceeding arising out of such individual’s status or service as our director or officer (other than such liabilities arising from willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest) and to advance expenses incurred by such individual in connection with any proceeding against such individual with respect to which such individual may be entitled to indemnification by us. In September 2003, we purchased a six-year directors and officers run-off insurance policy.

~~Other~~8. ~~current liabilities and accrued expenses consisted of the following (in thousands):~~ Litigation

	September 30,2003		December 31,2002
Litigation settlement	$	24	$	—
Income tax payable		28		55
Deferred rent		—		1,318
Accrued legal		283		63
Accrual for loss on operating lease		—		901
Accrued warranty		10		11
Other		260		296
Total	$	605	$	2,644

A. IPO Litigation

On November 9., ~~Restructuring~~2001, Arthur Mendoza filed a securities class action lawsuit in the United States District Court for the Southern District of New York alleging claims against the Company, certain of its current and ~~Related~~former ~~Costs~~officers and directors, and the underwriters of the Company’s initial public offering of stock as well as the Company’s secondary offering of stock. The complaint is purportedly brought on behalf of a class of individuals who purchased common stock in the Company’s

In January 2003, the Company reduced its headcount by approximately 40%, or 29 employees, and incurred related severance costs of $367,000, which were included in operating expenses for the three months ended March 31, 2003.

In January 2003, in an effort to retain key employees, the Company entered into agreements with its officers and certain employees which entitle such officers and employees to receive certain retention bonus payments upon the completion of providing employment services to the Company for a specified period of time. Retention bonus payments are accrued as earned.

During the three months ended June 30, 2003, the Company terminated 39 employees, leaving only a limited number of

initial public offering and secondary stock offering between January 31 and December 6, 2000. The ~~personnel~~complaint toalleges ~~continue~~generally tothat ~~handle~~the ~~matters~~prospectuses ~~related~~under which such securities were sold contained false and misleading statements with respect to ~~its~~discounts ~~previously~~and ~~announced~~commissions ~~exploration~~received ofby ~~strategic~~the ~~alternatives~~underwriters. ~~Associated~~The case has been coordinated for pre-trial purposes with ~~these~~over ~~actions,~~300 cases raising the ~~Company recorded~~same ~~severance-related~~or ~~charges~~similar issues and also currently pending in the Southern District of ~~approximately~~New ~~$434~~York. On April 18,~~000~~ ~~for~~2002, Michael Szymanowski was appointed lead plaintiff in the ~~three~~action. ~~months~~On ~~ended~~April ~~June~~22, 302002, ~~2003~~an amended complaint was filed. ~~Additionally~~On July 1, ~~pursuant~~2002, the underwriter defendants filed an omnibus motion to ~~retention~~dismiss. ~~agreements~~On ~~entered~~July ~~into~~15, 2002, the Company, collectively with the ~~affected~~other ~~employees~~issuer indefendants, ~~January~~also ~~2003~~filed an omnibus motion to dismiss. The lead plaintiff filed an opposition to the underwriters’ motion to dismiss on August 15, 2002 and to the ~~Company~~issuers’ ~~made~~motion ~~retention~~to ~~bonus~~dismiss ~~payments~~ on August 27, 2002. The underwriters’ reply to ~~them~~the ofopposition ~~approximately~~was ~~$790~~filed on September 13,~~000~~ ~~during~~2002, and the ~~three~~Company’s ~~months~~reply ~~ended~~to the ~~June~~opposition 30was filed on September 27, 2002. On February 19, 2003, the court issued an order denying the motions to dismiss with respect to substantially all of ~~which~~the ~~approximately~~plaintiffs’ ~~$591~~claims,~~000~~ ~~had~~including those against us. A proposal has been ~~accrued~~made asfor the settlement and release of ~~March~~claims 31against the issuer defendants, ~~2003~~including Turnstone. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the court. The underwriter defendants have opposed both the certification of a settlement class action and judicial approval of the settlement. If the settlement does not occur, and litigation against the Company continues, the Company believes it has meritorious defenses and intends to defend the case vigorously. The Company does not estimate that there will be future costs associated with this case and has not included costs associated with this case in estimated litigation settlement costs at June 30, 2004.

~~During the three months ended September 30, 2003, the Company terminated 5 employees, leaving only two employees as of September 30, 2003~~B. ~~Associated~~In ~~with these~~Re: ~~actions,~~Digital ~~the~~Broadband ~~Company recorded severance-related charges of approximately $146~~Communications,~~000~~ ~~for the three months ended September 30, 2003~~Inc. ~~Additionally, the Company made retention bonus payments to the terminated employees of approximately $366,000~~Bankruptcy ~~during the three months ended September 30, 2003, of which approximately $292,000 had been accrued as of June 30, 2003. Restructuring and related costs consisted of the following (in thousands):~~

	Severanceandrelatedcosts			Retentionbonus			Total
Costs incurred during the three months ended March 31, 2003	$	367		$	816		$	1,183
Cash payments		(367	)		—			(367	)
Balance at March 31, 2003		—			816			816
Costs incurred during the three months ended June 30, 2003		434			453			887
Cash payments		(434	)		(790	)		(1,224	)
Balance at June 30, 2003		—			479			479
Costs incurred during the three months ended September 30, 2003		146			169			315
Cash payments		(146	)		(391	)		(537	)
Balance at September 30, 2003	$	—		$	257		$	257

On August 12, 2002, the Official Committee of Unsecured Creditors of Digital Broadband Communications, Inc., one of our former customers that filed for Chapter 11 bankruptcy on December 27, 2000, filed a complaint in the United States Bankruptcy Court for the District of Delaware, seeking recovery of alleged preferential transfers to us in the aggregate amount of $3,522,714.85. Upon adoption of the liquidation basis of accounting, we accrued estimated litigation settlement costs of $500,000 related to this case. The estimate of litigation settlement costs was based on a settlement offer discussed and verbally agreed on March 4, 2004 by counsel for the Committee and the Company. The parties executed a formal stipulation of settlement in April 2004. In June 2004, the United States Bankruptcy Court, District of Delaware, approved the stipulation of settlement. Pursuant to the terms of the settlement, the Company paid the Committee $500,000 in June 2004. The Company does not estimate that there will be future costs associated with this case and has not included costs associated with this case in estimated litigation costs at June 30, 2004.

Accrued retention bonus is included in accrued compensation and benefits as of September 30, 2003.

In October, the retention agreements for the Company’s two remaining employees expired and the Company paid the earned retention bonuses to these employees. Concurrently, the Company entered into an employment agreement with the two remaining employees which provides that in the event the Company terminates the employees without cause, the employees will be entitled to receive a severance payment equal to six months annual base salary.

10. Leases

In April 2003, the Company entered into an agreement, effective May 1, 2003, that restructured the operating lease associated with its headquarters facility that previously expired June 2010.

~~Pursuant~~ITEM ~~to the agreement, the Company made a payment of $14.~~2 million, which included prepayment of rent through December 31, 2003, for approximately 31,000 square feet of the headquarters facility and a charge to terminate the remainder of the original lease commitment. A lease termination penalty of $11.4 million is included in operating expenses for the nine months ended September 30, 2003. Pursuant to the restructured operating lease, the Company is obligated to pay a proportional share of the facilityMANAGEMENT’sS ~~operating~~DISCUSSION ~~expenses.~~AND ~~Other~~ANALYSIS ~~than~~OF ~~this~~FINANCIAL ~~restructured lease~~CONDITION, ~~the~~AND ~~Company~~RESULTS ~~has~~OF ~~no other material facilities lease commitments as of September 30, 2003.~~ OPERATIONS

In ~~fiscal~~addition ~~2001,~~to the ~~Company~~other ~~recorded~~information ain ~~$2.7~~this ~~million~~report, ~~provision~~certain ~~for~~statements ~~estimated~~in ~~losses,~~the ~~net~~following Management’s Discussion and Analysis of Financial ~~estimated~~Condition ~~sub-lease~~and ~~income,~~Results onof ~~its~~Operation ~~headquarters~~(MD&A) ~~facility~~are ~~operating~~forward ~~lease.~~looking ~~The~~statements ~~provision~~within ~~related~~the tomeaning of the ~~portion~~safe harbor created by the Private Securities Litigation Reform Act of 1995 (the ~~Company’s~~“PSLRA”). ~~headquarters~~When used in this report, the words ~~facility~~“expects,” ~~that~~“anticipates,” it“estimates,” and similar expressions are intended to ~~sublease~~identify atforward ~~prevailing~~looking ~~market~~statements. ~~rates~~Statements reflecting our expectations, ~~which~~beliefs, ~~were~~intentions ~~less~~and ~~than~~strategies ~~the~~regarding ~~rates~~our ~~that~~liquidation and ~~the~~dissolution, ~~Company~~including, ~~was~~without ~~obligated~~limitation, tostatements ~~pay~~regarding ~~under~~the ~~its~~execution, ~~lease.~~timing Inand ~~connection~~expenses associated with ~~the~~our ~~restructuring~~complete plan of ~~the~~liquidation ~~headquarter~~and ~~lease~~dissolution, ~~the~~disposition ~~obligation~~of ~~for~~our ~~which~~existing assets, the resolution of outstanding creditor ~~provision~~claims ~~for~~and ~~loss~~the onongoing ~~operating~~litigation ~~lease~~against ~~was~~us, ~~recorded~~and ~~was~~liquidating ~~terminated~~distributions, if any, to our stockholders, constitute forward-looking statements within the meaning of the PSLRA. ~~The~~Such ~~remaining~~statements ~~balance~~are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the ~~accrual~~forward-looking ~~for~~statements ~~loss~~contained onherein. ~~operating~~Such ~~leases~~risks asand ofuncertainties ~~the~~are ~~effective~~set ~~date~~forth ofbelow under the ~~lease~~sections ~~restructuring~~entitled “Overview” and “Risk Factors,” on pp. 15 to 16, and 20 to 24, of $1this document, respectively.3 ~~million~~The ~~was~~following ~~recorded~~discussion asshould abe ~~reduction~~read toin ~~operating expenses~~conjunction ~~during~~with the ~~three~~Condensed ~~months~~Consolidated ~~ended~~Financial ~~June~~Statements ~~30,~~and ~~2003~~notes thereto included elsewhere in this report.

~~11.~~OVERVIEW ~~Warranty Obligations and Other Guarantees~~

~~For~~On ~~products~~August ~~sold on or after May 1~~6, 2003, ~~the~~our ~~Company~~board ~~provided~~of nodirectors ~~warranty~~approved, ~~coverage.~~subject ~~For products sold prior~~ to ~~May~~stockholder 1,ratification ~~2003, the Company provided limited~~at ~~warranties~~our on2003 ~~certain~~Annual Meeting of ~~its~~Stockholders, ~~products~~a ~~for~~special ~~periods~~cash ofdistribution up to ~~one~~stockholders ~~year. The Company recognizes warranty reserves when products are shipped based upon an estimate~~ of ~~total~~$2.77 ~~warranty~~per ~~costs,~~common ~~and~~share or such ~~reserves~~lesser ~~are~~amount ~~included~~as inthe ~~accrued~~board ~~liabilities. The estimate~~ of ~~such~~directors ~~costs~~might islater ~~based~~determine ~~upon~~to ~~historical~~be ~~and anticipated requirements~~appropriate. The ~~Company~~board ~~has adequate supply~~ of ~~products~~directors onalso ~~hand~~approved, ~~which~~subject ~~have previously been written down~~ to ~~zero value, to fulfill estimated warranty obligations. As such, the~~ ~~warranty~~stockholder ~~reserve~~approval at ~~September~~our ~~30,~~ 2003 isAnnual ~~minimal.~~Meeting ~~A reconciliation~~ of Stockholders, the ~~changes~~liquidation inand ~~accrued~~dissolution ~~warranty~~of ~~for~~Turnstone ~~the~~Systems, ~~nine~~Inc. ~~months~~pursuant ~~ended~~to ~~September~~a ~~30,~~plan ~~2003~~of ~~follows~~complete ~~(in~~liquidation ~~thousands):~~and dissolution.

		AccruedWarranty as of December 31,2002			Paymentsmadeunderwarrantyprogram			Productwarrantiesissued			Deductionsfor changein estimates			AccruedWarrantyas ofSeptember30, 2003
Warranty accrual		$	11		$	—		$	—		$	1		$	10

The special cash distribution was ratified by a majority of the shares present at the Annual Meeting on November 11, 2003. Following the Annual Meeting, our board of directors approved a special distribution of $2.77 per common share payable on November 28, 2003 to our stockholders of record as of November 21, 2003. The special cash distribution to stockholders, totaling $175.7 million, was paid on November 28, 2003.

~~Indemnification~~On ~~Agreements~~November 11, 2003, the holders of a majority of our outstanding shares approved the plan of dissolution. The key features of the plan are (1) file a certificate of dissolution with the Secretary of State of the State of Delaware; (2) cease conducting normal business operations, except as may be required to wind up our business affairs; (3) attempt to convert all of our remaining assets into cash or cash equivalents in an orderly fashion; (4) pay or attempt to adequately provide for the payment of all of our known obligations and liabilities; and (5) distribute pro rata in one or more liquidating distributions all of our remaining assets to our stockholders as of the applicable record date.

~~Company,~~We ~~certain~~filed ofour ~~its~~certificate ~~current~~of ~~officers~~dissolution ~~and~~with ~~directors,~~the ~~and~~Secretary ~~those~~of ~~underwriters~~State ~~which~~of ~~alleges that~~ the ~~defendants~~State ~~made~~of ~~false~~Delaware ~~and~~effective ~~misleading~~December ~~statements~~4, in2003. ~~violation~~Pursuant ofto ~~the~~Delaware ~~Securities~~law, ~~Act~~Turnstone ofSystems, ~~1933~~Inc. aswill ~~part~~continue ofin ~~the~~existence ~~September~~until ~~2000~~at ~~secondary~~least ~~stock~~December ~~offering~~4, 2006. ~~The~~During ~~Company~~this ~~recorded $250~~period,~~000~~ we will continue to ~~operating~~convert ~~expenses~~our ~~during~~estimated ~~the~~net ~~second~~assets ~~fiscal~~to ~~quarter~~cash offor ~~2003~~future distribution to ~~establish~~our anstockholders. ~~accrual~~We ~~for~~are ~~these~~not permitted ~~purported~~to ~~legal~~continue ~~expenses~~our business as a going concern.

~~The~~At ~~Company~~the ~~has~~close ~~standard~~of business ~~indemnification~~on ~~clauses~~December ~~contained within~~4, ~~its~~2003, ~~various~~we ~~customer~~closed ~~contracts.~~our Tostock ~~date~~transfer books, ~~there~~discontinued ~~have~~recording ~~been~~transfers noof ~~known~~our ~~events~~common orstock, ~~circumstances~~and ~~that~~our ~~have~~common ~~resulted~~stock inwas ~~an indemnification~~de-~~related~~listed ~~liability~~from the Nasdaq National Market. Any future distributions we make will be made solely to our stockholders of record as of the ~~Company~~close ~~pursuant~~of tobusiness ~~these~~on ~~customer~~December ~~contracts~~4, 2003.

12Under the plan of dissolution, we will liquidate our assets and make liquidating distributions to stockholders. ~~Litigation~~We have not established a firm timetable for liquidating distributions to stockholders, but we intend, subject to contingencies inherent in winding up our business, to make such liquidating distributions as promptly as practicable and periodically as we convert our remaining assets to cash.

OnIn March 282004, ~~2001,~~we ~~the~~licensed ~~Louisiana~~our ~~School~~Onyx ~~Employees’~~software ~~Retirement~~source ~~System~~code ~~filed~~to a ~~putative~~third ~~class~~party ~~action~~for ~~lawsuit against the Company~~$275,000 ~~certain~~pursuant ofto ~~its~~a ~~current~~non-exclusive, ~~and~~perpetual ~~former~~software ~~officers~~license ~~and~~agreement. ~~directors~~Under ~~and~~ the ~~underwriters~~ terms of the ~~Company’s~~ ~~September 21~~agreement, ~~2001~~we ~~secondary~~received ~~offering~~$69,000 ofupon ~~common~~execution ~~stock in the United States District Court for the Northern District~~ of ~~California. The complaint alleged that~~ the ~~defendants~~agreement ~~made false and misleading statements~~ in ~~the~~March ~~Company’s prospectus issued in connection with the secondary offering~~2004. AtWe orreceived ~~about~~ the ~~same~~remaining ~~time~~$206,000 ~~four~~in ~~other~~April ~~purported~~2004. ~~class~~We ~~action~~intend ~~lawsuits~~to ~~were~~continue ~~filed~~to ~~against~~try ~~the~~to ~~Company~~monetize ~~and~~our ~~certain~~assets ofthrough ~~its~~direct ~~current~~sales and/or ~~former~~licensing ~~officers~~arrangements, ~~and~~but ~~directors in the United States~~we ~~District~~cannot ~~Court~~assure ~~for~~you ~~the Northern District of California alleging~~ that ~~the~~we ~~defendants~~would ~~made~~be ~~false~~successful orin ~~misleading~~consummating ~~statements~~other ~~regarding the Company during the class period of June 5, 2000 through January 2, 2001~~transactions.

~~All~~In ~~five~~June ~~cases~~2004, ~~were~~our ~~consolidated~~board onof ~~October~~directors ~~26,~~approved ~~2001,~~a ~~and~~liquidating bycash ~~court~~distribution ~~order dated~~of ~~December~~approximately 3,$10.8 ~~2001~~million, ~~Radiant~~or ~~Advisors,~~$0.17 ~~LLC~~per ~~was~~common ~~designated~~share, asto ~~lead~~our ~~plaintiff~~stockholders ~~and the law firms~~ of ~~Bernstein~~record ~~Litowitz Berger & Grossman LLP and Bernstein Liebhard & Lifshitz, LLP were designated~~ as ~~co-lead~~of ~~counsel~~December ~~for the consolidated actions. Plaintiff filed a single amended complaint on September 13~~4, ~~2002~~2003. The ~~Company~~distribution ~~filed~~was acompleted ~~motion~~in toJuly ~~dismiss the amended complaint on October 8, 2002~~2004. ~~On February 7, 2003,~~ At the ~~court~~end ~~issued~~of anJune ~~order denying in part and granting in part~~2004, ~~with leave~~we toalso ~~amend,~~terminated the ~~Company’s~~employment ~~motion~~of toAlbert ~~dismiss~~Y. ~~On March 10~~Liu, ~~2003,~~General ~~plaintiff~~Counsel ~~filed~~& aDirector ~~Second Amended Complaint (“SAC”) against the Company, certain~~ of ~~its~~Human ~~current officers and directors~~Resources, and ~~the~~Eric ~~underwriters~~S. ~~of the Company’s September 21~~Yeaman, ~~2000~~Chief ~~secondary~~Executive ~~offering~~Officer ofand ~~stock~~Chief ~~alleging~~Financial ~~that~~Officer, ~~the~~our ~~defendants~~two ~~made~~remaining ~~false~~employees, and ~~misleading~~concurrently entered ~~statements~~into inconsulting ~~connection~~agreements with ~~the~~each ~~Company’s secondary offering in violation~~ of ~~Sections~~them ~~11,~~to 12continue ~~and~~ongoing 15management of ~~the~~our ~~Securities Act of 1933~~liquidation. ~~The Company~~Compensation ~~filed~~under anthese ~~answer~~consulting toagreements ~~the~~is ~~SAC~~based on ~~June~~actual ~~13,~~hours ~~2003. On July 25, 2003, the U.S. District Court for the Northern District~~ of ~~California~~service ~~preliminarily~~at ~~approved~~ a ~~settlement~~fixed ofhourly ~~this class action lawsuit~~rate. The ~~suit~~agreements ~~was~~do ~~settled~~not ~~for~~provide ~~$7.0 million, of which insurance~~ for the Company’s directors and officers paid approximately $6.1 million and the Company contributed approximately $0.9 million in cash during September 2003. On October 9, 2003, the court granted final approval of the settlement and ~~dismissed~~minimum ~~all~~retainer ~~claims~~payments ~~against~~or ~~all~~termination ~~defendants in the suit without any admission of liability by any party~~fees.

OnPrior ~~June~~to 1the decision to dissolve Turnstone Systems, ~~2001~~Inc., ~~nominal~~we ~~plaintiff~~were ~~Bert~~a ~~Okino~~provider ~~filed~~of ahardware ~~shareholder~~and ~~derivative~~software ~~lawsuit~~products inthat ~~the~~enabled ~~Santa~~local ~~Clara~~exchange ~~County~~carriers ~~Superior~~to ~~Court~~deploy and maintain copper local loop services. Our products included copper loop management and testing systems, signal splitters and remote line switching and service verification platforms.

CRITICAL ACCOUNTING ESTIMATES

In connection with the adoption of the plan of dissolution and the anticipated liquidation, we adopted the liquidation basis of accounting effective November 11, 2003, whereby assets are valued at their estimated net realizable cash values and liabilities are stated at

~~against~~their ~~the~~estimated ~~Company~~settlement ~~and~~amounts. ~~certain~~The preparation of ~~its~~consolidated ~~officers~~financial ~~and~~statements ~~directors,~~using ~~alleging that~~ the ~~individual~~liquidation ~~defendants~~basis ~~caused the Company harm by either making or permitting~~of ~~the~~accounting ~~Company~~requires us to make ~~false and misleading statements between June 5~~assumptions, ~~2000~~judgments and ~~January~~estimates 2,that ~~2001~~can ~~and~~have bya ~~permitting~~significant ~~certain~~impact ~~officers~~on toour ~~profit~~reported ~~from~~net ~~stock~~assets ~~sales~~in ~~during that period~~liquidation. ~~The~~We ~~complaint~~base ~~asserts~~our ~~claims against the individual defendants for breach of fiduciary duty~~assumptions, ~~waste~~judgments ~~of corporate assets, abuse of control~~ and ~~gross~~estimates ~~mismanagement~~on of the ~~Company.~~most ~~The~~recent ~~Company~~information ~~demurred~~available ~~to the complaint on July 9, 2001. On September 28, 2001, a court order was issued sustaining the demurrer~~ and ~~granting~~various ~~plaintiff~~other ~~limited~~factors ~~discovery.~~that Onwe ~~December~~believe ~~19, 2001, subsequent~~ to ~~the~~be ~~completion~~reasonable ofunder the ~~court-ordered~~circumstances. ~~discovery,~~Actual ~~the~~results ~~plaintiff~~could ~~filed~~differ amaterially ~~first~~from ~~amended~~these ~~derivative~~estimates ~~complaint~~under ~~alleging~~different ~~the~~assumptions ~~same~~or ~~causes of action asserted in the initial complaint~~conditions. ~~The Company~~On ~~filed~~ a ~~demurrer~~regular tobasis ~~the~~we ~~first~~evaluate ~~amended~~our ~~derivative complaint on January 10~~assumptions, ~~2002.~~judgments ~~On February 22, 2002, the Court issued an order sustaining the demurrer~~ and ~~granting plaintiff leave to amend its complaint. The plaintiff filed an amended~~estimates ~~complaint~~and onmake ~~March~~changes ~~19, 2002~~accordingly. ~~The~~We ~~Company~~believe ~~filed~~that ~~a demurrer to~~ the ~~second amended derivative complaint on April 22~~assumptions, ~~2002.~~judgments Onand ~~May~~estimates ~~28,~~involved ~~2002,~~in the ~~Court~~accounting ~~issued~~for anestimated ~~order~~costs ~~sustaining~~to ~~the~~be ~~demurrer~~incurred ~~and~~during ~~dismissing~~liquidation have the ~~complaint~~greatest ~~with~~potential ~~prejudice.~~impact ~~The plaintiff filed a notice of appeal~~ on ~~August~~our 1,consolidated ~~2002.~~financial ~~On April 4~~statements, ~~2003,~~so we ~~the~~consider ~~parties~~these ~~stipulated~~estimates to ~~the~~be ~~dismissal~~our ofcritical ~~the~~accounting ~~plaintiff’s~~policies. ~~appeal,~~We ~~and~~discuss onbelow ~~April 8, 2003,~~ the ~~court~~critical ~~entered~~accounting anestimates ~~order~~associated ~~terminating~~with ~~the~~these ~~litigation~~policies.

OnEstimated ~~November~~Costs 9, 2001, Arthur Mendoza filed a securities class action lawsuit in the United States District Court for the Southern District of New York alleging claims against the Company, certain of its current and former officers and directors, and the underwriters of the Company’s initial public offering of stock as well as its secondary offering of stock. The complaint is purportedly brought on behalf of a class of individuals who purchased common stock in the initial public offering and the secondary stock offering between January 31 and December 6, 2000. The complaint alleges generally that the prospectuses under which such securities were sold contained false and misleading statements with respect to ~~discounts~~be ~~and~~Incurred ~~commissions~~During ~~received~~Liquidation by the underwriters. The case has been coordinated for pre-trial purposes with over 300 cases raising the same or similar issues and also currently pending in the Southern District of New York. On April 18, 2002, Michael Szymanowski was appointed lead plaintiff in the action. On April 22, 2002, an amended complaint was filed. On July 1, 2002, the underwriter defendants filed an omnibus motion to dismiss. On July 15, 2002, the Company, collectively with the other issuer defendants, also filed an omnibus motion to dismiss. The lead plaintiff filed an opposition to the underwriters’ motion to dismiss on August 15, 2002 and to the issuers’ motion to dismiss on August 27, 2002. The underwriters’ reply to the opposition was filed on September 13, 2002, and the Company’s reply to the opposition was filed on September 27, 2002. On February 19, 2003, the court issued an order denying the motions to dismiss with respect to substantially all of the plaintiffs’ claims, including those against the Company. Limited discovery is currently underway. A proposal has been made for the settlement and release of claims against the issuer defendants, including the Company. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the court. If the settlement does not occur, and litigation against the Company

Under the liquidation basis of accounting, we accrue for the remaining costs to be incurred during liquidation, including consulting fees, fees of professional service providers and miscellaneous other costs, partially offset by estimated future interest earnings. Such costs were estimated at $309,000 at June 30, 2004. Our estimates are based on assumptions regarding our ability to settle outstanding obligations to creditors, resolve outstanding litigation, successfully petition the Securities and Exchange Commission for relief from public company reporting requirements, and the timing of distributions to stockholders. If there are delays, or we are not successful, in achieving these objectives, actual costs incurred during liquidation may increase, reducing net assets available in liquidation.

LIQUIDITY AND CAPITAL RESOURCES

Our primary objectives are to liquidate our assets in the shortest time period possible while realizing the maximum values for such assets. The actual nature, amount and timing of all future distributions will be determined by the Board in its sole discretion, and will depend in part upon our ability to convert certain remaining assets into cash and settle certain obligations. At June 30, 2004, we had net assets in liquidation of $910,000 or $.014 per common share.

As of June 30, 2004, our total assets were $12,050,000, consisting of $11,956,000 of cash and cash equivalents and $94,000 of receivables and other current assets. The following table summarizes the activity related to receivables and other current assets for the six months ended June 30, 2004 (in thousands):


	Assets held for sale			Security deposits			Tax refunds		Total
Balance at December 31, 2003	$	46		$	175		$	—	$	221
Cash proceeds		(17	)		(175	)		—		(192	)

Balance at March 31, 2004		29			—			—		29
Change in estimated fair value		—			—			82		82
Cash proceeds		(17	)		—			—		(17	)

Balance at June 30, 2004	$	12		$	—		$	82	$	94

~~continues~~At June 30, ~~the~~2004, ~~Company~~our ~~believes~~liabilities itconsisted ~~has~~of ~~meritorious~~$10,781,000 ~~defenses~~of distributions payable to stockholders, $309,000 of estimated costs to be incurred during liquidation, and ~~intends~~$50,000 of other current liabilities and accrued expenses. Distributions payable to ~~defend~~stockholders is related to a liquidating distribution to stockholders approved by the ~~case~~Board ~~vigorously~~of Directors in June 2004 and paid on July 8, 2004.

~~Such~~Estimated ~~matters~~costs ~~are subject~~ to ~~many~~be ~~uncertainties~~incurred ~~and outcomes are not~~during ~~predictable~~liquidation ~~with~~decreased ~~assurance.~~to ~~Consequently~~$309,000 ~~management~~at isJune ~~unable~~30, to2004 ~~estimate~~from ~~the~~$810,000 ~~ultimate~~at ~~aggregate~~December ~~amount of monetary liability~~31, ~~amounts~~2004. ~~which~~This ~~may~~decrease beis ~~covered~~attributable byto ~~insurance,~~net orcash ~~the~~payments ~~financial~~of ~~impact~~approximately ~~with~~$404,000 ~~respect~~related to ~~these~~wages, ~~matters~~severance ascosts, ofaccounting ~~September~~and ~~30, 2003.~~legal ~~However~~fees, ~~management~~and ~~believes~~other ~~that~~costs associated with the ~~final~~liquidation ~~resolution~~ of ~~these~~the ~~matters~~Company, ~~individually~~ and into ~~the aggregate, will not have~~ a ~~material~~decrease ~~adverse~~in ~~impact~~estimated ~~upon~~costs ~~the~~to ~~Company’s~~be ~~financial~~incurred ~~position,~~during ~~results~~liquidation of ~~operations or cash flows~~$97,000.

InOther ~~Re:~~current ~~Digital~~liabilities ~~Broadband~~and ~~Communications~~accrued expenses decreased to $50,000 ~~Inc~~at June 30, 2004 from $297,000 at December 31, 2003. ~~Bankruptcy~~This decrease is primarily attributable to cash payments of approximately $225,000 to settle other current liabilities and accrued expenses, and an adjustment of $22,000 to decrease other current liabilities and accrued expenses to fair value.

On ~~August~~November 1228, ~~2002~~2003, ~~the~~we ~~Official~~paid ~~Committee of Unsecured Creditors of Digital Broadband Communications~~$175, ~~Inc.~~665,000, ~~one~~or of$2.77 ~~the~~per ~~Company’s~~common ~~former~~share, ~~customers~~to ~~that~~stockholders ~~filed~~as ~~for~~a return-of-capital ~~Chapter~~distribution. 11On ~~bankruptcy~~July ~~on December 27~~8, ~~2000~~2004, ~~filed~~we apaid ~~complaint in the United States Bankruptcy Court for the District of Delaware~~$10,781,000, ~~seeking~~or ~~recovery of alleged preferential transfers to the Company in the aggregate amount of~~ $~~3,522,715~~0.17 ~~The~~per ~~Company~~common ~~filed its answer on September 10~~share, ~~2002.~~to ~~Limited~~stockholders ~~discovery~~as isa ~~currently~~liquidating ~~under~~cash ~~way~~distribution.

~~This~~THREE ~~matter~~AND isSIX ~~subject~~MONTHS toENDED ~~many~~JUNE uncertainties and the outcome is not predictable with assurance. Consequently, management is unable to estimate the ultimate aggregate amount of monetary liability or the financial impact with respect to this matter as of September 30, 2003. ~~However, management believes that the final resolution of this matter will not have a material adverse impact upon the Company’s financial position, results of operations or cash flows.~~

NET REVENUES

In connection with the adoption of the plan of dissolution, we will not generate revenues from our products or services in the future. We have ceased all sales and marketing efforts related to our products, and have no supply of product available for sale.

Net revenues for the three and six months ended June 30, 2003 consisted of product revenue and service revenue. Product revenue for the three and six months ended June 30, 2003 of $274,000 and $542,000, respectively, consisted primarily of sales of our CX100 loop management products and, to a lesser extent, our MX500 Copper CrossConnect^® and SX Smart Splitter^® products and our Crossworks^™ and ONYX automation software licenses. Service revenue for the three and six months ended June 30, 2003 of $22,000 and $144,000, respectively, was derived primarily from our product maintenance programs.

For the three months ended June 30, 2003, one customer contributed 92% of total revenues. For the six months ended June 30, 2003, one customer contributed greater than 10% of total revenues, for a total of 60%. Revenue from international customers during the three and six months ended June 30, 2003 totaled 92.8 and 62.4%, respectively, of our net revenues.

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

In addition to the other information in this report, certain statements in the following Management’s Discussion and Analysis of Financial Condition and Results of Operation (MD&A) are forward looking statements within the meaning of the safe harbor created by the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). When used in this report, the words “expects,” “anticipates,” “estimates,” and similar expressions are intended to identify forward looking statements. Statements reflecting the Company’s expectations, beliefs, intentions and strategies regarding the Company’s future and the future of its business operations, including, without limitation, statements regarding anticipated headcount reductions, estimated payments to affected employees, estimated impairment charges, proposed litigation settlements, the currently proposed liquidation and dissolution, exploration of possible strategic alternatives, business outlook or expected performance or developments constitute forward-looking statements within the meaning of the PSLRA. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements contained herein. Such risks and uncertainties are set forth below under the sections entitled “Overview” and “Risk Factors Affecting Future Results,” on pp. 19 to 20, and 28 to 32, of this document, respectively. The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and notes thereto included elsewhere in this report.

OVERVIEW

We are a provider of hardware and software products that enable local exchange carriers to deploy and maintain copper local loop services. Our products include copper loop management and testing systems, signal splitters and remote line switching and service verification platforms.

On January 9, 2003, we announced that we were exploring various strategic alternatives, including possible merger and asset sale transactions, licensing arrangements and dissolution of the company and distribution of assets to stockholders. We also announced that we had engaged Goldman Sachs & Co. as our financial advisor. While a limited supply of our products remained available for sale, we generally ceased all direct sales efforts related to them, and redirected our operating activities to focus primarily on in-process research and development related to our next generation copper automation products for incumbent local exchange carriers. In connection with those decisions, we reduced headcount by approximately 40%, or 29 employees, in January 2003.

On April 7, 2003, we entered into an agreement to restructure our lease agreement for our headquarters facility in Santa Clara, California. The previous lease covered approximately 62,500 square feet of facilities and expired in June 2010, and we had remaining rent obligations of approximately $32.0 million. The restructuring, effective May 1, 2003, reduced our facilities commitment to approximately 31,000 square feet and shortened the lease term to the end of 2003. Pursuant to the agreement, in April 2003, we made a lump sum cash payment of approximately $14.2 million, which included $3.6 million from our restricted cash and included prepaid rent through the end of 2003, the remaining facilities commitment under the restructured lease.

On April 24, 2003, we initiated actions to terminate most of our remaining employees except for a limited team of employees that continued to handle matters related to our previously announced exploration of strategic alternatives. These actions were initiated after our management and board of directors, following an extensive consideration of strategic alternatives, concluded that maintaining our research and development efforts related to next-generation copper automation products for incumbent local carriers was not necessary for any of the strategic alternatives under consideration at that time, and that the on-going expenditures related to continuing such efforts could potentially decrease total stockholder value.

On July 25, 2003, the U.S. District Court for the Northern District of California preliminarily approved a settlement of a purported class action suit that was brought against us, certain of our officers and directors and the underwriters on behalf of persons who purchased common stock issued pursuant to our secondary stock offering in September 2000. The suit was settled for $7.0 million, of which insurance for our directors and officers paid approximately $6.1 million and we contributed approximately $0.9 million in cash during September 2003. On October 9, 2003, the court granted final approval of the settlement and dismissed all claims against all defendants in the suit without any admission of liability by any party.

On August 6, 2003, our board of directors approved, subject to stockholder ratification at our 2003 Annual Meeting of Stockholders, a special cash distribution to stockholders of $2.77 per common share or such lesser amount as the board of directors may determine to be appropriate. If the special distribution is ratified, our board of directors plans to set a record date and payment date for the special distribution and will fix the actual amount of the special distribution. The board of directors also approved, subject to stockholder approval at our 2003 Annual Meeting of Stockholders, our liquidation and dissolution pursuant to a plan of complete liquidation and dissolution of Turnstone Systems, Inc. If the plan of dissolution is approved, we will file a certificate to dissolve Turnstone Systems with the Delaware Secretary of State, complete the liquidation of our remaining assets, satisfy our remaining obligations and make distributions to our stockholders of available liquidation proceeds. Our 2003 Annual Meeting of Stockholders is scheduled for November 11, 2003.

As of September 30, 2003, we had only two remaining employees.

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

NET REVENUES

Net revenues consist of product revenue and service revenue. Product revenue for the periods presented consists primarily of sales of our CX100 loop management products and, to a lesser extent, our MX500 Copper CrossConnect® and SX Smart Splitter® products and our Crossworks™ and ONYX automation software licenses. Service revenue is derived primarily from our product maintenance programs.

While a limited supply of our products remains available for sale, we have generally ceased all direct sales efforts related to them, and do not expect to generate material revenues from them in the future.

Product revenue decreased to $44,000 for the quarter ended September 30, 2003 from $707,000 for the comparable quarter in 2002. Product revenue decreased to $586,000 for the nine months ended September 30, 2003 from $1.6 million for the comparable period in 2002. Service revenue for the three months ended September 30, 2003 was $8,000 compared to $351,000 for the comparable quarter in 2002. Service revenue decreased to $152,000 for the nine months ended September 30, 2003 from $1.1 million for the comparable period in 2002. Decreases in product and service revenues are primarily attributable to reduced direct sales efforts related to them.

Sales returns reserve adjustment of $167,000 for the nine months ended September 30, 2002 represents a reduction in the sales returns reserve based on revised estimates of potential product returns.

Revenue from international customers totaled 87% of our net revenues for the three months ended September 30, 2003 compared to 58% for the comparable period in 2002. For the nine months ended September 30, 2003 and 2002, approximately 64% and 47%, respectively, of revenues were derived from sales to customers located outside the United States.

Our revenue to date has been recognized from a small number of customers. For the three months ended September 30, 2003 and 2002, two customers and four customers, respectively, each contributed greater than 10% of total revenues, for combined totals of 84% and 70%, respectively. For the nine months ended September 30, 2003 and 2002, one customer and two customers, respectively, each contributed greater than 10% of total revenues, for combined totals of 56% and 46% of total revenues, respectively.

COST OF REVENUES

~~Cost~~In ofconnection ~~product~~with ~~revenue includes~~the ~~amounts~~adoption ~~paid~~of to our ~~third~~plan ~~party~~of ~~contract~~dissolution, ~~manufacturer~~we ~~and~~will ~~related~~not ~~overhead~~generate ~~expenses,~~revenues ~~consisting~~from ~~primarily~~our ofproducts ~~salary~~ and ~~other~~services ~~expenses for personnel engaged~~ in ~~procurement~~the future, ~~vendor management~~ and, ~~quality~~therefore, ~~assurance.~~will ~~Cost~~not ~~of service revenue~~incur ~~includes~~cost ~~costs to maintain our customer support group, consisting primarily~~ of ~~salaries~~revenues ~~for~~in ~~customer~~the ~~support personnel and costs associated with technical support and training activities~~future.

Cost of product revenue decreased to $17,000, or 38% of product revenue, for the quarter ended September 30, 2003 from $388,000 or 55% of product revenue for the comparable period of 2002. Cost of product revenue decreased to $20,000 for the nine months ended September 30, 2003 from $855,000 in the comparable period in 2002. During the three and ~~nine~~six months ended ~~September~~June 30, 2003, we utilized written-down inventory to fulfill ~~customer~~ demand, ~~incurring only minimal rework costs,~~ resulting in aminimal ~~decrease of~~ cost of product revenue. ~~as a~~

percentage of product revenue. We had previously written inventory down in its entirety due to our decreased sales and marketing efforts associated with these products and the lack of estimated future demand. We have generally ceased all direct sales and marketing efforts related to our products, and do not expect material revenues from them in the future. We may experience limited demand from existing customers who desire to purchase additional product before such products become unavailable. Any such demand will generally be fulfilled from existing quantities of written-off inventory and we would expect cost of product revenue to remain low as a percentage of product revenue.

Cost of service revenue for the quarter ended September 30, 2003 was zero compared to $91,000 for the three months ended September 30, 2002. Cost of service revenue decreased to zero for the nine months ended September 30, 2003 from $277,000 in the comparable period in 2002. This decrease was attributable to headcount reductions in our customer support organization that were made during January 2003.

RESEARCH AND DEVELOPMENT

~~Research~~We will not incur research and development expenses, ~~net~~in the future. Research and development expenses of ~~non-cash~~$1.4 ~~compensation~~million ~~expense~~and $5.7 million for the three and six months ended June 30, ~~consist~~2003, respectively, consisted primarily of salaries and related personnel expenses, retention bonuses, ~~severance costs,~~ fees paid to consultants and outside service providers, and material costs related to the design, development, testing and enhancement of our products. Non-cash compensation expense for the three months ended September 30, 2003 was zero, compared to $184,000 for the comparable period in 2002. Non-cash compensation expense for the nine months ended September 30, 2003 was $65,000, compared to $745,000 for the comparable period in 2002.

Research and development expenses decreased to zero for the three months ended September 30, 2003, from $3.9 million in the comparable period in 2002. This decrease is attributable to our April 2003 termination of all research and development personnel and the discontinuation of all research and development activities. Research and development expenses decreased to $5.7 million for the nine months ended September 30, 2003 from $11.1 million in the comparable period in 2002. This decrease is primarily attributable to a decrease in the number of research and development personnel in 2003 compared to 2002, a decrease in materials costs as a result of reduced research and development activities related to our next generation copper automation products for incumbent local exchange carriers and a decrease in depreciation expense related to assets that have been reclassified as held for sale.

We not expect to conduct research and development activities in the future and do not expect to incur research and development expenses.

SALES AND MARKETING

~~Sales~~We ~~and~~will ~~marketing~~not ~~expenses,~~incur ~~net~~sales ~~of non-cash compensation expense, consist primarily of salaries, retention bonuses, commissions, severance~~ and ~~related~~marketing expenses ~~for~~in ~~personnel~~the ~~engaged~~future. inSales ~~sales,~~and marketing, ~~and~~expenses ~~customer~~of ~~support activities~~$343,000 ~~as well as trade shows~~ and ~~promotional expenses~~$1.6 ~~Non-cash~~million ~~compensation expense~~ for the three and six months ended ~~September~~June 30, 2003 ~~was zero compared to $104~~,~~000~~ respectively, ~~for~~consisted ~~the~~primarily ~~comparable~~of ~~period in 2002. Non-cash compensation expense for the nine months ended September 30~~salaries, ~~2003~~retention ~~was $19~~bonuses,~~000,~~ ~~compared~~and torelated ~~$416,000~~expenses for ~~the~~personnel ~~comparable~~engaged ~~period~~ in ~~2002~~marketing and sales activities.

Sales and marketing expenses decreased to zero for the three months ended September 30, 2003 from $1.9 million in the comparable period of 2002. The decrease is attributable to our April 2003 termination of

all sales and marketing personnel and the discontinuance of all sales and marketing activities. Sales and marketing expenses decreased to $1.6 million for the nine months ended September 30, 2003 from $6.2 million in the comparable period in 2002. This decrease is primarily due to a decrease in the number of sales, sales support and marketing personnel domestically and internationally in 2003 compared to 2002.

We do not expect to conduct sales and marketing activities in the future and do not expect to incur sales and marketing expenses.

GENERAL AND ADMINISTRATIVE

~~General~~In ~~and administrative~~connection ~~expenses,~~with ~~net~~the adoption of ~~non-cash~~the ~~compensation~~liquidation ~~expense,~~basis ~~consist~~of ~~primarily~~accounting ofon ~~salaries~~November 11, ~~retention bonuses~~2003, ~~severance~~we ~~and~~accrued ~~related~~estimated ~~expenses~~costs ~~for~~to ~~executive,~~be ~~finance~~incurred ~~and~~during ~~administrative~~liquidation. ~~personnel,~~Included ~~financial~~in ~~advisory~~estimated ~~fees,~~costs ~~legal~~to ~~fees,~~be ~~and~~incurred ~~other~~during liquidation ~~general~~are ~~corporate~~future ~~expenses.~~expenditures ~~Non-cash~~that, ~~compensation~~prior ~~expense~~to ~~for~~ the ~~three~~adoption ~~months~~of ~~ended~~the ~~September~~liquidation ~~30,~~basis ~~2003~~of ~~was $22~~accounting,~~000~~ ~~compared~~would tohave ~~$137,000~~been ~~for~~included ~~the~~in ~~comparable~~general ~~period~~and administrative expenses in ~~2002~~future periods. ~~Non-cash~~As ~~compensation~~such, ~~expense~~no ~~for~~general ~~the~~and ~~nine~~administrative ~~months~~expenses ~~ended~~will ~~September~~be ~~30,~~incurred ~~2003~~in future ~~was~~periods. ~~$108,000,~~Future ~~compared~~adjustments in estimated costs to ~~$549,000~~be ~~for~~incurred ~~the~~in ~~comparable~~liquidation ~~period~~will be reflected as changes in ~~2002~~net assets in liquidation.

General and administrative expenses ~~increased~~of to $12.83 million ~~for the three months ended September 30, 2003 from $640,000 in the comparable period in 2002. General~~ and ~~administrative expenses increased to~~ $54.91 million for the ~~nine~~three and six months ended ~~September~~June 30, 2003, ~~from~~respectively, ~~$2.1~~consisted ~~million in the comparable period in 2002. These increases are~~ primarily ~~attributable~~of tosalaries, retention bonuses ~~earned~~and ~~pursuant~~related toexpenses ~~agreements~~for ~~entered into in January 2003~~executive, ~~severance~~finance ~~payments made to general~~ and administrative personnel ~~terminated during the first nine months of 2003~~, ~~and~~ financial advisory ~~and~~fees, legal fees, ~~related~~and toother ~~the~~general ~~exploration~~corporate ~~of strategic alternatives~~expenses.

We expect to incur significant legal fees, financial advisory fees, and other general and administrative expenses associated with the exploration and possible execution of various strategic alternatives, including implementation of the proposed special distribution and plan of liquidation and dissolution, which may cause general and administrative expenses to increase in future periods.

AMORTIZATION OF DEFERRED STOCK COMPENSATION

AsIn ofconnection ~~September~~with ~~30,~~the ~~2003,~~adoption ~~deferred~~of ~~stock~~the ~~compensation~~liquidation ~~totaled~~basis ~~$14~~of accounting,~~000.~~ ~~We amortized~~ deferred stock compensation ofwas ~~approximately~~written ~~$22,000~~down into ~~the~~its ~~three~~net ~~months~~realizable ~~ended~~value ~~September~~of ~~30,~~zero. ~~2003~~There ~~compared~~will tobe ~~$425,000~~no deferred instock ~~the~~compensation ~~comparable period~~ in ~~2002~~future periods. ~~Amortization~~We ofamortized deferred stock compensation ~~was~~of approximately $~~192~~46,000 ~~for~~and $170,000 in the ~~nine~~three and six months ended ~~September~~June 30, 2003, ~~and $1~~respectively.7 ~~million for the comparable period in 2002.~~

LEASE TERMINATION PENALTY, NET

In April 2003, we entered into an agreement, effective May 1, 2003, that restructured the operating lease associated with our headquarters facility. Pursuant to the agreement, we made a payment of $14.2 million, which included prepayment of rent through December 31, 2003, for approximately 31,000 square feet of the headquarters facility and a charge to terminate the remainder of the original lease commitment. The lease termination penalty of $11.4 million was offset by the reduction in the accrual for deferred rent of $1.4 million.

RECOVERY OF PROVISION FOR LOSS ON OPERATING LEASE

In fiscal 2001, we recorded a $2.7 million provision for estimated losses, net of estimated sub-lease income, on our headquarters facility operating lease, which had an original expiration date in June 2010. The provision relates to the portion of our headquarters facility that we intended to sublease at prevailing market rates, which were less than the rates that we were obligated to pay under the lease.

In connection with the lease restructuring agreement entered into in April 2003, we recorded a reversal of the remaining balance in the accrual for loss on operating lease of $1.3 million, which was recorded as a reduction to operating expenses during the second fiscal quarter of 2003.

ASSET IMPAIRMENT CHARGE

During the three months ended June 2003, we terminated most of our remaining employees and ceased research and development activities. As a result of these actions, our plant and equipment were no longer required for ongoing operating activities and we began actively marketing the assets through a third-party asset liquidator. For the three months ended June 30, 2003, we recorded an asset impairment charge of $655,000 to adjust the assets to their fair value less estimated selling costs, as estimated by a third-party asset liquidator. At September 30, 2003 the assets are classified as held for sale and are no longer depreciated.

OTHER INCOME (EXPENSE)

Other income (expense) ~~includes~~included the litigation settlement expense and interest income and other, net consisting primarily of income from our cash investments, and to a lesser extent the net gain or loss from foreign currency translation gains and losses, and net gains or losses on disposal of property and equipment~~, and expenses related to our lease financing obligations~~. Total other income (expense) of $~~463~~351,000 for the three months ended ~~September~~ June 30, 2003 ~~consisted~~was ~~primarily of interest income and other, net~~ attributable to ~~income~~the ~~from~~litigation ~~our~~settlement ~~cash investments. Total other income (~~expense) ~~was~~of $~~1.5~~920,000 ~~million~~ for the ~~comparable~~class ~~period~~action ~~in 2002~~lawsuit, ~~which~~partially ~~consisted~~offset ~~solely~~by of interest income and other, net ~~primarily attributable to income from our cash investments. The decrease in interest income and other, net is primarily due to lower average rate~~ of ~~returns on our investments as well as lower total cash and investment balances~~$569,000.

~~Total~~19 other income (expense) of $1.1 million for the nine months ended September 30, 2003 was attributable to interest income and other, net of $2.0 million offset by the class action litigation settlement expense of $920,000. Total other income (expense) was $4.6 million for the comparable period in 2002, which consisted solely of interest income and other, net. The decrease in interest income and other, net is primarily due to lower average rate of returns on our investments as well as lower total cash and investment balances. In future periods, we expect interest income and other, net to vary depending upon changes in interest rates and the amount and mix of interest-bearing investments. In particular, the aggregate dollar value of interest income would be expected to decrease substantially if the special distribution to shareholders is paid.

Total other income (expense) of $662,000 for the six months ended June 30, 2003 was attributable to interest income and other, net of $1.6 million offset by the litigation settlement expense of $920,000 for the class action lawsuit.

INCOME TAX EXPENSE

Income tax expense of $29155,000 ~~for the three months ended September 30, 2003~~ and $64180,000 for the ~~comparable~~three ~~period in 2002 was primarily attributable to state~~ and ~~foreign~~six ~~income tax. Income tax increased to $209,000 for the nine~~ months ended ~~September~~June 30, 2003 ~~from~~consisted ~~$78,000~~primarily inof state income taxes.

24RISK FACTORS

In addition to other information in this Form 10-Q, the following risk factors should be carefully considered in evaluating us and our liquidation and dissolution because such factors may have a significant impact on the execution of our plan of dissolution and the timing and mount of liquidating distributions, if any, to our stockholders. As a result of the risk factors set forth below and elsewhere in this Form 10-Q, and the risks discussed in our other Securities and Exchange Commission Filings, actual results could differ materially from those projected in any forward-looking statements.

We cannot assure you of the exact amount or timing of any future distribution to our stockholders under the plan of dissolution.

The liquidation and dissolution process is subject to numerous uncertainties and may not result in any remaining capital for future distribution to our stockholders. The precise nature, amount and timing of any future distribution to our stockholders will depend on and could be delayed by, among other things, sales of our non-cash assets, claim settlements with creditors, resolution of outstanding litigation matters, and unexpected or greater than expected expenses. Furthermore, we cannot provide any assurances that we will actually make additional distributions. The estimates we have provided are based on currently available information, and actual payments, if any, could be substantially less than the range we have estimated. Any amounts to be distributed to our stockholders may be less than the price or prices at which our common stock has recently traded or may trade in the future.

Our common stock is continuing to trade even though we are in the process of liquidation and liquidating distributions, if any, may be below any trading price.

Until December 4, 2003, when our certificate of dissolution became effective and we voluntarily de-listed our common stock and closed our transfer books, our common stock was traded on the Nasdaq National Market under the symbol “TSTN.” Since the de-listing, our common stock has been trading in the Over the Counter Market’s “pink sheets” under the symbol “TSTN.PK.” It has been trading under “due-bill” contractual obligations between the seller and purchaser of the stock, who negotiate and rely on themselves with respect to the allocation of stockholder proceeds arising from ownership of the shares. No assignments or transfers of our common stock were recorded or will be recorded after December 4, 2003. Trading in our stock is highly speculative and the market for our stock is highly illiquid. The

only value associated with our shares is the right to receive further distributions as part of the liquidation process. Because of the ~~comparable~~difficulty ~~period~~in estimating the amount and timing of ~~2002~~the ~~primarily~~liquidating distributions, and due to ~~state~~the ~~income~~other ~~tax~~risk ~~audit~~factors ~~adjustments~~discussed ~~paid~~herein, ~~during~~our ~~2003~~common ~~related~~stock may be subject to ~~previous~~significant ~~tax~~volatility ~~years~~and may trade above the amount of any liquidating distribution that is made.

LIQUIDITY AND CAPITAL RESOURCES

Our principal source of liquidity as of September 30, 2003 consisted of $188.0 million in cash and cash equivalents.

During the nine months ended September 30, 2003, we used $27.3 million in operating activities, primarily from our net loss of $22.5 million, and to a lesser extent, increases in prepaid expenses and other assets and decreases in other current liabilities and accrued expenses, accounts payable, other long-term liabilities and accrued compensation and benefits. Non-cash charges consisted principally of an asset impairment charge, depreciation expense and amortization of deferred stock compensation.

Net cash provided by investing activities for the nine months ended September 30, 2003 was $111.8 million, primarily due to proceeds from sales and maturities of available-for-sale investments of $109.1 million and to a lesser extent a $3.6 million decrease in restricted cash. Under our original operating lease, we were required to maintain a standby letter of credit, which was classified as restricted cash on our consolidated balance sheet. The letter of credit was released as part of the restructured lease during April 2003. These increases were partially offset by purchases of available-for-sale investments in the amount of $1.3 million.

Net cash provided by financing activities for the nine months ended September 30, 2003 was $80,000, primarily due to proceeds of $814,000 from stock option exercises, partially offset by purchases of treasury stock totaling $734,000. Our purchases of treasury stock were made pursuant to a stock repurchase program approved by the board of directors in October 2001. This program permitted the purchase of up to $15.0 million of our common stock over the subsequent twelve-month period. In October 2002, the stock repurchase program was extended for an additional twelve-month period. We do not expect to purchase additional shares of our common stock under this program.

We expect to devote capital and operating resources in future periods to complete our currently proposed plan of liquidation and dissolution. On August 6, 2003, the Company’s Board of Directors approved, subject to stockholder ratification at the Annual Meeting of Stockholders to be held on November 11, 2003, a special distribution of $2.77 per common share, or approximately $174.8 million in total, or such lesser amount as deemed appropriate by the Board of Directors on the distribution date.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The principal difference between SFAS 146 and EITF 94-3 relates to SFAS 146’s timing for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as generally defined in EITF 94-3 was

recognized at the date of an entity’s commitment to an exit plan. The requirements of SFAS 146 were effective prospectively for exit or disposal activities initiated after December 31, 2002. Adoption of SFAS 146 did not have a significant effect on the Company’s financial position, results of operations, or cash flows.

In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which clarifies disclosure and recognition/measurement requirements related to certain guarantees. The disclosure requirements are effective for financial statements issued after December 15, 2002 and the recognition/measurement requirements are effective on a prospective basis for guarantees issued or modified after December 31, 2002. The Company has determined that the requirements of FIN 45 apply to its accrued warranty and standard indemnification clauses contained within its various customer contracts (see Note 11); however the adoption of FIN No. 45 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, which addresses consolidation by a business of variable interest entities in which it is the primary beneficiary. FIN 46 is effective immediately for certain disclosure requirements and variable interest entities created after January 31, 2003, and in the first interim or annual period beginning after June 15, 2003 for all other variable interest entities entered into prior to January 31, 2003. The Company does not have any variable interest entities.

In November 2002, the EITF published EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, which requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying this EITF Issue 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values. This issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue 00-21 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In January 2003, the FASB’s Emerging Issues Task Force reached a consensus on EITF Issue 02-16, Accounting by a Customer (Including a

Reseller) for Certain Consideration Received from a Vendor. EITF Issue 02-16 provides guidance regarding how a reseller of a vendor’s products should account for cash consideration received from a vendor. The provisions of EITF Issue 02-16 apply to vendor arrangements entered into after December 31, 2002, including modifications of existing arrangements. The adoption of EITF Issue 02-16 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In April 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

RISK FACTORS AFFECTING FUTURE RESULTS

Investing in our common stock involves a high degree of risk. The risks described below are not exhaustive of the risks that might affect our business. Other risks, including those we currently deem immaterial, may also impact our business. Any of the following risks could materially adversely affect our business operations, results of operations and financial condition and could result in a complete loss of your investment.

If our stockholders vote against the plan of dissolution of Turnstone Systems, it would be very difficult for us to continue our business operations.

If our stockholders do not approve the plan of dissolution and liquidation of Turnstone Systems, Inc. at our 2003 annual meeting of stockholders, we would have to continue our business operations from a difficult position, in light of our announced intent to liquidate and dissolve. We are not actively marketing or selling any of our products, and have generally ceased normal business operations, terminated substantially all of our employees and severed all of our supplier and customer relationships. Prospective employees, suppliers, customers and other third parties may refuse to form relationships or conduct business with us if they do not believe we will continue to operate as a going concern.

The amount of the proposed special cash distribution to stockholders, $2.77 per common share, is only an estimate and is subject to stockholder ratification and subsequent adjustment by our board of directors.

If our stockholders do not ratify the proposed special cash distribution to stockholders of $2.77 per common share at the 2003 annual meeting of stockholders, then we will not make the special distribution. Even if we receive stockholder ratification for the special distribution, our board of directors may determine, prior to the record date for the special distribution, that a distribution of an amount less than $2.77 per common share would be appropriate to increase our remaining cash to satisfy potential liabilities.

We cannot assure you of the exact amount or timing of any distribution to our stockholders under the plan of dissolution.

Assuming we receive stockholder approval to dissolve Turnstone Systems, the liquidation and dissolution process is subject to numerous uncertainties, may fail to create value to our stockholders and may not result in any remaining capital for distribution to our stockholders. The precise nature, amount and timing of any distribution to our stockholders will depend on and could be delayed by, among other things, sales of our non-cash assets, claim settlements with creditors, resolution of outstanding litigation matters, and unexpected or greater than expected expenses. Furthermore, any amounts to be distributed to our stockholders may be less than the price or prices at which our common stock has recently traded or may trade in the future.

We may not be able to settle all of our obligations to creditors and resolve all of our outstanding litigation.

If we do not settle all of our obligations to creditors and resolve all of our outstanding litigation, we may be prevented from completing our plan of dissolution. Our obligations to creditors include, among other things, long-term contractual obligations to certain customers, including certain product warranties, and contractual obligations to certain of our vendors. Our outstanding litigation includes federal securities class action litigation and litigation arising out of our ordinary course of business. As part of the wind down process, we will attempt to settle our obligations with our creditors and resolve all of the outstanding litigation. In particular, we have reached a tentative settlement of the federal securities class action lawsuit related to our initial public offering that we believe will not require any contribution from us. The proposed settlement is still subject to a number of conditions, including final court approval. The underwriter defendants have opposed both the certification of a settlement class action and judicial approval of the settlement. Plaintiffs in the class action lawsuit have claimed damages in the hundreds of millions of dollars. Our inability to reach settlement with our creditors and resolve outstanding litigation could delay or even prevent us from completing the plan of dissolution. Moreover, amounts required to settle our obligations to creditors and resolve any outstanding litigation will reduce the amount of remaining capital available for future distribution to stockholders.

28Some of our customers have filed or may file for bankruptcy protection, and as a result, we may be required to return some or all of the payments we received from them as part of the bankruptcy proceedings.

~~Table~~Because of ~~Contents~~their inability to obtain additional financing or generate sufficient revenues to fund their operations, a number of our customers that previously purchased loop management products from us have filed or may file for bankruptcy protection. The bankruptcy court may require us, or we may agree as part of a settlement, to return some or all of the payments we have received or will receive in the future from such customers prior to their initiation of bankruptcy proceedings, which would negatively affect our financial results.

our plan of dissolution. Our obligations to creditors include, among other things, long-term contractual obligations to certain customers, including certain product warranties, and contractual obligations to certain of our vendors. Our outstanding litigation includes federal securities class action litigation and litigation arising out of our ordinary course of business. As part of the wind down process, we will attempt to settle our obligations with our creditors and resolve all of the outstanding litigation. In particular, we have reached a tentative settlement of the federal securities class action lawsuit related to our initial public offering that we believe will not require any contribution from us. The proposed settlement is still subject to a number of conditions, including final court approval. Plaintiffs in the class action lawsuit have claimed damages in the hundreds of millions of dollars. Our inability to reach settlement with our creditors and resolve outstanding litigation could delay or even prevent us from completing the plan of dissolution. Moreover, amounts required to settle our obligations to creditors and resolve any outstanding litigation will reduce the amount of remaining capital available for distribution to stockholders.

We will continue to incur claims, liabilities and expenses that will reduce the amount available for distribution out of the liquidation to stockholders.

Claims, liabilities and expenses from operations, such as operating costs, ~~salaries,~~ directors’ and officers’ insurance, payroll and local taxes, legal, accounting and consulting fees and miscellaneous office expenses, will continue to be incurred as we wind down. These expenses will reduce the amount of assets available for ~~ultimate~~future distribution out of the liquidation to stockholders. If available cash and amounts received on the sale of non-cash assets are not adequate to provide for ~~our obligations, liabilities, expenses and claims, we~~ ~~may not be able to distribute out of the liquidation meaningful cash, or any cash at all, to our stockholders.~~

our obligations, liabilities, expenses and claims, we may not be able to distribute out of the liquidation meaningful cash, or any cash at all, to our stockholders.

Distribution of assets out of the liquidation, if any, to our stockholders could be delayed.

Although our board of directors has not established a firm timetable for distributions to our stockholders out of the liquidation, the board of directors intends, subject to contingencies inherent in winding down our business, to make such distributions as promptly as practicable as creditor and litigant claims are paid or settled. However, we are currently unable to predict the precise timing of any such distributions. The timing of such distributions will depend on and could be delayed by, among other things, the timing of sales of our non-cash assets, claim settlements with creditors and the settlement of any outstanding litigation matters. Additionally, a creditor could seek an injunction against the making of such distributions to our stockholders on the ground that the amounts to be distributed were needed to provide for the payment of our liabilities and expenses. Any action of this type could delay or substantially diminish the amount available for such distribution to our stockholders.

If we fail to create an adequate contingency reserve for payment of our expenses and liabilities, each stockholder could be held liable for payment to our creditors of his or her pro rata share of amounts owed to creditors in excess of the contingency reserve, up to the amount actually distributed to such stockholder.

IfWe ~~the~~filed ~~plan~~our certificate of dissolution iswith ~~approved~~the bySecretary ~~our~~of ~~stockholders~~State of the State of Delaware effective December 4, 2003. Pursuant to the Delaware General Corporation Law, we will ~~file~~continue ato exist for three years after the certificate of dissolution ~~with~~is filed or for such longer period as the ~~State~~Delaware Court of Chancery shall direct, for the purpose of prosecuting and defending suits against us and enabling us gradually to close our business, to dispose of our property, to discharge our liabilities and to distribute to our stockholders any remaining assets. Under the Delaware ~~dissolving~~General Corporation Law, in the event we fail to create during this three-year period an adequate contingency reserve for payment of our expenses and liabilities, each stockholder could be held liable for payment to our creditors of such stockholder’s pro rata share of amounts owed to creditors in excess of the contingency reserve, up to the amount actually distributed to such stockholder.

Turnstone Systems. Pursuant to the Delaware General Corporation Law, we will continue to exist for three years after the certificate of dissolution is filed or for such longer period as the Delaware Court of Chancery shall direct, for the purpose of prosecuting and defending suits against us and enabling us gradually to close our business, to dispose of our property, to discharge our liabilities and to distribute to our stockholders any remaining assets. Under the Delaware General Corporation Law, in the event we fail to create during this three-year period an adequate contingency reserve for payment of our expenses and liabilities, each stockholder could be held liable for payment to our creditors of such stockholder’s pro rata share of amounts owed to creditors in excess of the contingency reserve, up to the amount actually distributed to such stockholder.

Although the liability of any stockholder is limited to the amounts previously received by such stockholder from us (and from any liquidating trust or trusts) in the dissolution, this means that a stockholder could be required to return all distributions previously made to such stockholder and receive nothing from us under the plan of dissolution. Moreover, in the event a stockholder has paid taxes on amounts previously received, a repayment of all or a portion of such amount could result in a stockholder incurring a net tax cost if the stockholder’s repayment of an amount previously distributed does not cause a commensurate reduction in taxes payable. While we will endeavor to make adequate reserves for all known, contingent, and unknown liabilities, there is no guarantee that the reserves established by us will be adequate to cover all such expenses and liabilities.

~~Our~~22 stock transfer books will close on the date we file the Certificate of Dissolution with the Delaware Secretary of State, after which it will not be possible for stockholders to publicly trade our stock.

We intend to close our stock transfer books and discontinue recording transfers of our common stock at the close of business on the date we file the Certificate of Dissolution with the Delaware Secretary of State, referred to as the “final record date.” Thereafter, certificates representing our common stock shall not be assignable or transferable on our books except by will, intestate succession or operation of law. The proportionate interests of all of our stockholders shall be fixed on the basis of their respective stock holdings at the close of business on the final record date, and, after the final record date, any distributions made by us shall be made solely to the stockholders of record at the close of business on the final record date, except as may be necessary to reflect subsequent transfers recorded on our books as a result of any assignments by will, intestate succession or operation of law.

We will continue to incur the expenses of complying with public company reporting requirements.

We have an obligation to continue to comply with the applicable reporting requirements of the Securities Exchange Act of 1934, as amended, referred to as the “Exchange Act,” even though compliance with such reporting requirements is economically burdensome. We intend to file our Annual Report on Form 10-K for the fiscal year ending December 31, 2003. In order to curtail expenses, we also intend to, after filing our Certificate of Dissolution, seek relief from the Securities and Exchange Commission from the reporting requirements under the Exchange Act. We anticipate that, if such relief were granted, we would continue to file current reports on Form 8-K to disclose material events relating to our liquidation and dissolution along with any other reports that the Securities and Exchange Commission might require.

~~However,~~We ~~the~~will ~~Securities~~continue ~~and~~to ~~Exchange~~incur ~~Commission~~the ~~may~~expenses ~~not~~of ~~grant~~complying ~~any~~with ~~such~~public ~~relief~~company reporting requirements.

IfWe wehave ~~fail~~an obligation to ~~retain~~continue to comply with the ~~services~~applicable reporting requirements of the ~~certain~~Securities ~~key~~Exchange ~~personnel~~Act of 1934, as amended, referred to as the ~~plan~~“Exchange ofAct,” even though compliance with such reporting requirements is economically burdensome. We intend to seek relief from the Securities and Exchange Commission from the reporting requirements under the Exchange Act at such time in the future as active trading in our shares has ceased. We anticipate that, if such relief were granted, we would continue to file current reports on Form 8-K to disclose material events relating to our liquidation and dissolution along with any other reports that the Securities and Exchange Commission might require. However, the Securities and Exchange Commission may not ~~succeed~~grant any such relief, and we do not anticipate we will be able to request relief while active trading of our shares is continuing.

The success of the plan of dissolution depends in large part upon our ability to retain the services of certain of our current officers. The retention of Eric S. Yeaman, our Chief Executive Officer and Chief Financial Officer, and Albert Y. Liu, our General Counsel and Director of Human Resources, is particularly important under our current circumstances. Failure to retain these personnel could harm the implementation of the plan of dissolution. If we fail to retain these personnel, we will need to hire others to oversee our liquidation and dissolution, which could involve additional compensation expenses, if such other personnel are available at all.

Our board of directors may at any time turn management of the liquidation of Turnstone Systems over to a third party, and some or all of our directors may resign from our board at that time.

Our board of directors may at any time turn our management over to a third party to complete the liquidation of our remaining assets and distribute the available proceeds to our stockholders, and some or all of our directors may resign from our board at that time. Our board of directors currently consists of Eric S. Yeaman, our Chief Executive Officer and Chief Financial Officer, and Albert Y. Liu, our General Counsel and Director of Human Resources, who are overseeing our liquidation. If management is turned over to a third party and all of our directors resign from our board, the third party would have sole control over the liquidation process, including the sale or distribution of any remaining assets.

If we are deemed to be an investment company, we may be subject to substantial regulation that would cause us to incur additional expenses and reduce the amount of assets available for distribution.

If we invest our cash and/or cash equivalents in investment securities, we may be subject to regulation under the Investment Company Act of 1940. If we are deemed to be an investment company under the Investment Company Act because of our investment securities holdings, we must register as an investment company under the Investment Company Act. As a registered investment company, we would be subject to the further regulatory oversight of the Division of Investment Management of the Securities and Exchange Commission, and our activities would be subject to substantial regulation under the Investment Company Act. Compliance with these regulations ~~will~~would cause us to incur additional expenses, which ~~will~~ would reduce the amount of assets available for distribution to our stockholders. To avoid these compliance costs, we intend to invest our cash proceeds in money market funds and government securities, which are exempt from the Investment Company Act but which currently provide a very modest return.

~~Our~~23 ~~common stock may be delisted from the Nasdaq Stock Market prior to the final record date if we are unable to meet Nasdaq’s requirements for continued listing.~~

If our stockholders approve the plan of dissolution, we intend to set a final record date and close our stock transfer books and delist our stock from Nasdaq on that date, after which trading in our common stock will cease. In the interim, we intend to continue to list our common stock on Nasdaq. In order to be eligible for continued listing, we must, among other things, meet certain minimum requirements with respect to net tangible assets, market value of our securities held by non-affiliates and minimum bid prices per share, and must also maintain an operating business. As a result of the cessation of our operations and the anticipated decrease in our assets that will result from the special distribution, Nasdaq may take action to delist our common stock prior to the final record date. Trading, if any, in our common stock

would thereafter be conducted in the over-the-counter market or on the NASD’s electronic bulletin board, which could adversely affect the ability of our stockholders to sell their shares of our common stock.

Some of our customers have filed or may file for bankruptcy protection, and as a result, we may be required to return some or all of the payments we receive from them as part of the bankruptcy proceedings.

Because of their inability to obtain additional financing or generate sufficient revenues to fund their operations, a number of our customers that previously purchased loop management products from us have filed or may file for bankruptcy protection. For example, in August 2002 the Official Committee of Unsecured Creditors of Digital Broadband Communications, Inc., one of our former customers that filed for Chapter 11 bankruptcy, filed a complaint in the United States Bankruptcy Court for the District of Delaware, seeking recovery of alleged preferential transfers to us in the aggregate amount of $3,522,714.85. The bankruptcy court may require us, or we may agree as part of a settlement, to return some or all of the payments we have received or will receive in the future from such customers prior to their initiation of bankruptcy proceedings, which would negatively affect our financial results.

Because our products have been deployed in complex environments, they may have errors or defects that are found only after they have been fully deployed, which could result in liability claims against us.

Because our products are designed to provide critical services in large and complex networks, if errors, defects or failures are discovered in our products, we may be exposed to significant legal claims. Any claims, with or without merit, could increase our expenses, ~~impair~~and ~~our~~reduce ~~operating~~assets ~~results~~available ~~and prevent~~for usdistribution ~~from~~in ~~consummating strategic alternatives~~liquidation. Although we maintain product liability insurance covering some damages arising from implementation and use of our products, our insurance may not fully cover claims brought against us. Liability claims could require us to spend significant time and money in litigation or to pay significant damages.

Our products incorporate numerous component parts designed and manufactured by third parties. We cannot assure you that these third-party parts are free of defects or errors. Given the complex nature of our products and our dependence on a large number of highly intricate third-party component parts, our products may contain defects or errors not detectable during our quality assurance and testing procedures. Any such defects or errors could result in legal claims against us.

Control by our existing stockholders may limit your ability to influence matters requiring stockholder approval and could delay or prevent a change in control, which could prevent you from realizing a premium in the market price of our common stock.

The concentration of ownership of our common stock by existing stockholders could delay or prevent a change in our control or discourage a potential acquirer from attempting to obtain control of us, which could cause the market price of our common stock to fall or prevent our stockholders from realizing a premium in the market price associated with an acquisition. As of September 30, 2003, our executive officers, directors and principal stockholders and their affiliates owned 29,107,576 shares, or approximately 46.2%, of the outstanding shares of common stock. These stockholders, acting together, would be able to significantly influence all matters requiring approval by our

stockholders, including the election of directors and the approval or disapproval of any strategic business transactions.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

~~The~~At ~~primary~~June objective of our investment activities is to preserve principal. We attempt to maximize the income we receive from our investments without significantly increasing risk. Some of the securities in which we have invested may be subject to market risk. This means that a change in prevailing interest rates may cause the value of the investment to fluctuate. For example30, if2004 ~~we hold a security that was issued with a fixed interest rate at the then-prevailing rate~~ and ~~the~~December ~~prevailing interest rate later rises~~31, ~~the value of the investment will probably decline. To mitigate this risk~~2003, we ~~maintain~~held our entire portfolio ~~of cash equivalents and investments~~ in ~~a variety of securities, including~~ money market funds, ~~commercial~~which ~~paper and government and non-government debt securities. In general, money market funds~~ are not subject to market risk ~~because the interest paid on such funds fluctuates with the prevailing interest rate~~. ~~In addition, the majority of our investment portfolio is invested in securities maturing within one year.~~

The following table presents the amounts of cash equivalents, short-term investments and long-term investments that are subject to market risk by range of expected maturity and weighted-average interest rates as of December 31, 2002. This table does not include money market funds because those funds are not subject to market risk. At September 30, 2003, the company held its entire portfolio in money market funds.

	MATURINGIN THREEMONTHS ORLESS			MATURINGBETWEENTHREEMONTHSAND ONEYEAR			MATURINGGREATERTHAN ONEYEAR			TOTAL
	(in thousands, except for percentages)
AT DECEMBER 31, 2002
Included in cash and cash equivalents	$	79,456		$	—		$	—		$	79,456
Weighted average interest rate		1.45	%		—			—			1.45	%
Included in short-term investments	$	15,001		$	45,950		$	—		$	60,951
Weighted average interest rate		3.70	%		1.99	%		—			2.41	%
Included in long-term investments	$	—		$	—		$	47,301		$	47,301
Weighted average interest rate		—			—			2.88	%		2.88	%
Total portfolio	$	94,457		$	45,950		$	47,301		$	187,708
Weighted average interest rate		1.81	%		1.99	%		2.88	%		2.13	%

EXCHANGE RATE SENSITIVITY

Currencies held in other than the U.S. dollar in our subsidiaries have been insignificant. As such, we have not had any material exposure to foreign currency rate fluctuations.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Our significant personnel reductions during 2003 have affected the overall control environment. As of ~~September~~July 301, ~~2003~~2004, ~~there~~we ~~are~~had ~~only~~no ~~two~~ remaining employees. ~~One employee,~~ Eric S. Yeaman, a consultant, is the Chief Executive Officer and Chief Financial Officer. However, management does not believe that these personnel reductions have had a significant impact on the effectiveness of the design and operation of the Company’s disclosure controls and procedures.

Changes in Internal ~~Control~~Controls Over Financial Reporting

There has been no change in our internal ~~control~~controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected or is reasonably likely to materially affect, our internal ~~control~~controls over financial reporting.

3424

PART II.

OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

We dispute, but cannot assure you that we will be successful in our defense of, the outstanding ~~shareholder~~ lawsuits against us, ~~which are~~ described below. If we are unsuccessful, these lawsuits could have a material adverse effect on our ~~business,~~ financial condition and ~~results~~on the amount of ~~operations~~assets available for distribution to stockholders. Even if we are successful in defending against these claims, the litigation could result in substantial costs ~~and divert management’s attention and resources, which could adversely affect the results and profitability of our business~~.

OnIPO ~~March~~Litigation 28, 2001, the Louisiana School Employees’ Retirement System filed a putative class action lawsuit against the Company, certain of its current and former officers and directors and the underwriters of the Company’s September 21, 2001 secondary offering of common stock in the United States District Court for the Northern District of California. The complaint alleged that the defendants issued false and misleading statements in the Company’s prospectus issued in connection with the secondary offering. At or about the same time, four other purported class action lawsuits were filed against the Company and certain of its current and former officers and directors in the United States District Court for the Northern District of California alleging that the defendants made false or misleading statements regarding the Company during the class period of June 5, 2000 through January 2, 2001.

~~All~~On ~~five~~November ~~cases~~9, ~~were~~2001, ~~consolidated~~Arthur Mendoza filed a securities class action ~~before~~lawsuit ~~Judge~~in ~~Saundra~~the B.United ~~Armstrong~~States onDistrict ~~October~~Court ~~26,~~for ~~2001,~~the ~~and~~Southern byDistrict ~~court~~of ~~order~~New ~~dated~~York ~~December~~alleging 3,claims ~~2001~~against us, ~~Radiant~~certain ~~Advisors,~~of ~~LLC~~our ~~was~~current ~~designated~~and asformer ~~lead~~officers ~~plaintiff~~and directors, and the ~~law~~underwriters ~~firms~~ of ~~Bernstein~~our ~~Litowitz~~initial ~~Berger~~public &offering ~~Grossman~~of ~~LLP~~stock. ~~and~~The ~~Bernstein~~complaint ~~Liebhard &~~is ~~Lifshitz,~~purportedly ~~LLP~~brought ~~were~~on ~~designated~~behalf asof ~~co-lead~~a ~~counsel~~class ~~for~~of ~~the~~individuals ~~consolidated~~who ~~actions.~~purchased ~~Plaintiff~~common ~~filed~~stock ain ~~consolidated~~the ~~First~~initial ~~Amended~~public ~~Complaint~~offering ~~(“FAC”)~~between onJanuary ~~September~~31 13and December 6, ~~2002~~2000. The ~~FAC~~complaint alleges generally that wethe ~~and~~prospectus ~~the~~under ~~other~~which ~~defendants~~such ~~made~~securities were sold contained false and misleading statements inwith ~~connection~~respect to discounts and commissions received by the underwriters. The case has been coordinated for pre-trial purposes with over 300 cases raising the ~~Company’s~~same ~~secondary~~or ~~offering~~similar issues and also currently pending in ~~violation~~the Southern District of ~~Sections~~New 11York. On April 18, 122002, ~~and~~Michael 15Szymanowski ofwas appointed lead plaintiff in the ~~Securities~~action. ~~Act~~On ofApril ~~1933~~22, ~~and~~2002, ~~also~~an ~~that~~amended wecomplaint ~~and~~was filed. On July 1, 2002, the ~~other~~underwriter defendants ~~made~~filed ~~false~~an ~~and~~omnibus ~~misleading~~motion ~~statements~~to dismiss. ~~during~~On July 15, 2002, we, collectively with the ~~class~~other ~~period~~issuer ~~in violation~~defendants, ofalso ~~Sections~~filed ~~10(b)~~an ~~and~~omnibus ~~20(a)~~motion ofto dismiss. The lead plaintiff filed an opposition to the ~~Securities~~underwriters’ ~~Exchange~~motion ~~Act~~to ofdismiss ~~1934~~on August 15, 2002 and ~~Rule~~to ~~10b-5~~the ~~promulgated~~issuers’ motion ~~thereunder~~to dismiss on August 27, 2002. WeThe ~~and~~underwriters’ reply to the ~~other~~opposition ~~defendants~~was ~~moved~~filed toon ~~dismiss~~September 13, 2002, and our reply to the ~~FAC~~opposition was filed on ~~October~~September 827, 2002. On February 719, 2003, the court issued an order denying inthe ~~part~~motions to dismiss with respect to substantially all of the plaintiffs’ claims, including those against us. A proposal has been made for the settlement and ~~granting~~release inof ~~part~~claims against the issuer defendants, ~~with~~including ~~leave~~Turnstone. The settlement is subject to ~~amend~~a number of conditions, ~~our~~including ~~motion~~approval of the proposed settling parties and the court. The underwriter defendants have opposed both the certification of a settlement class action and judicial approval of the settlement. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to ~~dismiss~~defend the case vigorously. We did not estimate that there will be future costs associated with this case and have not included costs associated with this case in estimated litigation settlement costs at June 30, 2004.

On March 10, 2003, plaintiff filed a Second Amended Complaint (“SAC”) against us, certain of our current officers and directors, and the underwriters of our September 21, 2000 secondary offering of stock alleging that we and the other defendants made false and misleading statements in connection with our secondary offering in violation of Sections 11, 12 and 15 of the Securities Act of 1933. We filed our answer to the SAC on June 13, 2003. On July 25, ~~2003, the U.S. District~~

Court for the Northern District of California preliminarily approved a settlement of this class action lawsuit. The suit was settled for $7.0 million, of which insurance for our directors and officers paid approximately $6.1 million and we contributed approximately $0.9 million in cash during September 2003. On October 9, 2003, the court granted final approval of the settlement and dismissed all claims against all defendants in the suit without any admission of liability by any party.

On June 1, 2001, nominal plaintiff Bert Okino filed a shareholder derivative lawsuit in of the Santa Clara County Superior Court, against the Company and certain of its officers and directors, alleging that the individual defendants caused the Company harm by either making or permitting the Company to make false and misleading statements between June 5, 2000 and January 2, 2001 and by permitting certain officers to profit from stock sales during that period. The complaint asserts claims against the individual defendants for breach of fiduciary duty, waste of corporate assets, abuse of control and gross mismanagement of the Company. The Company demurred to the complaint on July 9, 2001. On September 28, 2001, a court order was issued sustaining the demurrer and granting plaintiff limited discovery. On December 19, 2001, subsequent to the completion of the court-ordered discovery, the plaintiff filed a first amended derivative complaint alleging the same causes of action asserted in the initial complaint. The Company filed a demurrer to the first amended derivative complaint on January 10, 2002. On February 22, 2002, the Court issued an order sustaining the demurrer and granting plaintiff leave to amend its complaint. The plaintiff filed an amended complaint on March 19, 2002. The Company filed a demurrer to the second amended derivative complaint on April 22, 2002. On May 28, 2002, the Court issued an order sustaining the demurrer and dismissing the complaint with prejudice. The plaintiff filed a notice of appeal on August 1, 2002. On April 4, 2003, the parties stipulated to the dismissal of plaintiff’s appeal, and on April 8, 2003, the court entered an order terminating the litigation.

On November 9, 2001, Arthur Mendoza filed a securities class action lawsuit in the United States District Court for the Southern District of New York alleging claims against the Company, certain of its current and former officers and directors, and the underwriters of the Company’s initial public offering of stock as well as our secondary offering of stock. The complaint is purportedly brought on behalf of a class of individuals who purchased common stock in our initial public offering and our secondary stock offering between January 31 and December 6, 2000. The complaint alleges generally that the prospectuses under which such securities were sold contained false and misleading statements with respect to discounts and commissions received by the underwriters. The case has been coordinated for pre-trial purposes with over 300 cases raising the same or similar issues and also currently pending in the Southern District of New York. On April 18, 2002, Michael Szymanowski was appointed lead plaintiff in the action. On April 22, 2002, an amended complaint was filed. On July 1, 2002, the underwriter defendants filed an omnibus motion to dismiss. On

July 15, 2002, the Company, collectively with the other issuer defendants, also filed an omnibus motion to dismiss. The lead plaintiff filed an opposition to the underwriters’ motion to dismiss on August 15, 2002 and to the issuers’ motion to dismiss on August 27, 2002. The underwriters’ reply to the opposition was filed on September 13, 2002, and the Company’s reply to the opposition was filed on September 27, 2002. On February 19, 2003, the court issued an order denying the motions to dismiss with respect to substantially all of the plaintiffs’ claims, including those against the Company. Limited discovery is currently underway. A proposal has been made for the settlement and release of claims against the issuer defendants, including Turnstone. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the court. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to defend the case vigorously.

In Re: Digital Broadband Communications, Inc. Bankruptcy

On August 12, 2002, the Official Committee of Unsecured Creditors of Digital Broadband Communications, Inc., one of ~~the~~our ~~Company’s~~ former customers that filed for Chapter 11 bankruptcy on December 27, 2000, filed a complaint in the United States Bankruptcy Court for the District of Delaware, seeking recovery of alleged preferential transfers to ~~the~~us ~~Company~~ in the aggregate amount of $3,522,714.85. ~~The Company filed its answer on September 10, 2002. Limited discovery is currently underway.~~

37In March 2004, we and counsel for the Committee discussed and verbally agreed on a settlement proposal pursuant to which we would make a payment of $500,000 to the Committee in exchange for a mutual release of all claims related to this matter. The parties executed a formal stipulation of settlement in April 2004. In June 2004, the United States Bankruptcy Court, District of Delaware, approved the stipulation of settlement. Pursuant to the terms of the settlement, we paid the Committee $500,000 in June 2004.

ITEM 2.

CHANGES IN SECURITIES AND USE OF PROCEEDS

Use of Proceeds

On February 1, 2000, we completed our initial public offering and on September 26, 2000, we completed our secondary offering, which resulted in total net proceeds of approximately $257.6 million. To date, we have used a portion of the net proceeds from our offerings to fund general business operations. Amounts not used to fund operations have been invested in money market funds, certificates of deposit, and other investment grade securities.

In November 2003, we made a special cash distribution to stockholders totaling $175.7 million. In December 2003, we filed our certificate of dissolution with the Secretary of State of the State of Delaware. In July 2004, we made a liquidating cash distribution to stockholders totaling $10.8 million. Pursuant to our plan of dissolution, we anticipate that we will distribute all of our remaining assets, including any remaining net proceeds from our offerings, to our stockholders.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5.

OTHER INFORMATION

In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, (the “Act”), as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are required to disclose the non-audit services approved by the Company’s Audit Committee to be performed by the Company’s external auditorNone. Non-audit services are defined in the Act as services other than those provided in connection with an audit or review of the financial statements of a company. The non-audit services performed by the Company’s external auditor during the three months ended September 30, 2003 were each approved by the Audit Committee. The Audit Committee has approved the engagement of KPMG LLP, the Company’s external auditor in 2003, for the following non-audit services: preparation of federal and state income tax returns; tax consultation services related to state tax audits; and tax consultation services associated with the Company’s exploration and evaluation of strategic alternatives.

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

EXHIBIT NO.		DESCRIPTION
3.1(1)		Amended and Restated Certificate of Incorporation of Turnstone Systems
3.2(1)		Amended and Restated Bylaws of Turnstone Systems
3.2(2)		Amended and Restated Bylaws of Turnstone Systems
4.1(1)		Form of Common Stock certificate
4.1(3)		Form of Common Stock certificate
4.2(1)		Registration Rights Agreement, dated January 12, 1998, by and among Turnstone Systems and certain stockholders of Turnstone Systems named herein, as amended as of January 12, 1999 and November 21, 1999
10.1(3)		Form of Indemnification Agreement entered into by Turnstone Systems with each of its directors and executive officers
10.14(4)		Consulting Agreement, dated as of May 12, 2003, between Turnstone Systems, Inc. and P. Kingston Duffie
10.15(5)		Consulting Agreement, dated as of July 31, 2003, between Turnstone Systems, Inc. and Carl Hubbard
10.16(6)		Consulting Agreement, dated as of August 31, 2003, between Turnstone Systems, Inc. and Richard N. Tinsley
10.17(7)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Albert Y. Liu
10.18(8)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Eric S. Yeaman
10.19(9)		Consulting Agreement, dated as of July 1, 2004, between Turnstone Systems, Inc. and Albert Y. Liu
10.20(10)		Consulting Agreement, dated as of July 1, 2004, between Turnstone Systems, Inc. and Eric S. Yeaman
31.1		Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
31.2		Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.1		Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

38(1) Incorporated herein by reference to Exhibit 3.1 of our Annual Report on Form 10-K filed on March 10, 2004 with the Securities and Exchange Commission.

4.3(2)		Form of Founder’s Restricted Stock Purchase Agreement entered into as of January 2, 1998, between Turnstone Systems and each of P. Kingston Duffie, M. Denise Savoie and Richard N. Tinsley
10.1(1)		Form of Indemnification Agreement entered into by Turnstone Systems with each of its directors and executive officers
10.2(1)		1998 Stock Plan and forms of agreement thereunder
10.3(3)		Amended and Restated 2000 Stock Plan
10.4(1)		2000 Nonstatutory Stock Plan and forms of agreement thereunder
10.5(4)		Amended and Restated 2000 Employee Stock Purchase Plan
10.6(2)		Manufacturing Agreement dated as of October 16, 1998, between Turnstone Systems and A-Plus Manufacturing Corporation
10.7(2)		OEM Purchase Agreement, dated effective as of September 1, 1999, between Turnstone Systems and Lucent Technologies Inc., as amended as of September 28, 1999 and December 9, 1999
10.8(1)		Lease dated April 28, 2000, between Turnstone Systems and South Bay/San Tomas Associates
10.11(5)		OEM Purchase Agreement, dated effective as of June 1, 2001, between Turnstone Systems, Inc. and Alcatel
10.12(6)		Form of Executive Retention Agreement entered into by Turnstone Systems with each of Messrs. Duffie, Graf, Hubbard, Liu, Tinsley, White and Yeaman, its executive officers, in January 2003
10.13(7)		First Amendment to Lease Agreement, dated as of April 7, 2003, between Turnstone Systems, Inc. and BRE/San Tomas I L.L.C.
10.14(8)		Consulting Agreement, dated as of May 12, 2003, between Turnstone Systems, Inc. and P. Kingston Duffie
10.15(9)		Consulting Agreement, dated as of July 31, 2003, between Turnstone Systems, Inc. and Carl Hubbard
10.16(10)		Consulting Agreement, dated as of August 31, 2003, between Turnstone Systems, Inc. and Richard N. Tinsley
10.17(11)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Albert Y. Liu

(2)	Incorporated herein by reference to Exhibit 3.2 of our Annual Report on Form 10-K filed on March 10, 2004 with the Securities and Exchange Commission.

39(3) Incorporated herein by reference to the Registration Statement on Form S-1 and all amendments thereto filed on November 22, 1999 with the Securities and Exchange Commission (No. 333-45130).

(4)	Incorporated herein by reference to Exhibit 10.14 of our Quarterly Report on Form 10-Q filed on May 15, 2003 with the Securities and Exchange Commission.

(5)	Incorporated herein by reference to Exhibit 10.15 of our Quarterly Report on Form 10-Q filed on August 11, 2003 with the Securities and Exchange Commission.

(6)	Incorporated herein by reference to Exhibit 10.16 of our Current Report on Form 8-K filed on September 2, 2003 with the Securities and Exchange Commission.

(7)	Incorporated herein by reference to Exhibit 10.17 of our Current Report on Form 8-K filed on October 10, 2003 with the Securities and Exchange Commission.

(8)	Incorporated herein by reference to Exhibit 10.18 of our Current Report on Form 8-K filed on October 10, 2003 with the Securities and Exchange Commission.

(9)	Incorporated herein by reference to Exhibit 10.19 of our Current Report on Form 8-K filed on June 28, 2004 with the Securities and Exchange Commission.

(10)	Incorporated herein by reference to Exhibit 10.20 of our Current Report on Form 8-K filed on June 28, 2004 with the Securities and Exchange Commission.

(b)

Reports on Form 8-K

None.

10.18(12)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Eric S. Yeaman
31.1		Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
32.1		Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1) Incorporated herein by reference to the Registration Statement on Form S-1 and all amendments thereto filed on November 22, 1999 with the Securities and Exchange Commission (No. 333-45130).

(2) Confidential treatment requested and received as to certain portions. These exhibits are incorporated herein by reference to the Registration Statement on Form S-1 and all amendments thereto filed on November 22, 1999 with the Securities and Exchange Commission (No. 333-45130).

(3) Incorporated herein by reference to Exhibit 10.5 of our Quarterly Report on Form 10-Q filed on November 13, 2001 with the Securities and Exchange Commission.

(4) Incorporated herein by reference to Exhibit 10.5 of our Quarterly Report on Form 10-Q filed on November 13, 2001 with the Securities and Exchange Commission.

(5) Confidential treatment requested as to certain portions. This exhibit is incorporated herein by reference to Exhibit 10.11 of our Quarterly Report on Form 10-Q filed on August 13, 2001 with the Securities and Exchange Commission.

(6) Incorporated herein by reference to Exhibit 10.12 of our Annual Report on Form 10-K filed on March 18, 2003 with the Securities and Exchange Commission.

(7) Incorporated herein by reference to Exhibit 10.13 of our Quarterly Report on Form 10-Q filed on May 15, 2003 with the Securities and Exchange Commission.

(8) Incorporated herein by reference to Exhibit 10.14 of our Quarterly Report on Form 10-Q filed on May 15, 2003 with the Securities and Exchange Commission.

(9) Incorporated herein by reference to Exhibit 10.15 of our Quarterly Report on Form 10-Q filed on August 11, 2003 with the Securities and Exchange Commission.

(10) Incorporated herein by reference to Exhibit 10.16 of our Current Report on Form 8-K filed on September 2, 2003 with the Securities and Exchange Commission.

(11) Incorporated herein by reference to Exhibit 10.17 of our Current Report on Form 8-K filed on October 10, 2003 with the Securities and Exchange Commission.

(12) Incorporated herein by reference to Exhibit 10.18 of our Current Report on Form 8-K filed on October 10, 2003 with the Securities and Exchange Commission.

(b) (i) The Company filed a report on Form 8-K on July 29, 2003, in Item 7 and Item 12 of which the Company incorporated by reference the contents of a press release issued by the Company on the same date announcing the Company’s financial results for the fiscal quarter ended June 30, 2003. A copy of the press release was filed as Exhibit 99.1 thereto.

(ii) The Company filed a report on Form 8-K on August 7, 2003, in Item 5 of which the Company incorporated by reference the contents of a press release issued by the Company on the same date. A copy of the press release was filed as Exhibit 99.1 thereto.

(iii) The Company filed a report on Form 8-K on September 2, 2003, in Item 5 of which the Company incorporated by reference the contents of a press release issued by the Company on the same date. A copy of the press release was filed as Exhibit 99.1 thereto.

(iv) The Company filed a report on Form 8-K on September 16, 2003, in Item 5 of which the Company incorporated by reference a consulting agreement, dated as of August 31, 2003, between the Company and Richard N. Tinsley. A copy of the consulting agreement was filed as Exhibit 10.16 thereto.

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned.

	TURNSTONE SYSTEMS, INC.		~~TURNSTONE SYSTEMS, INC.~~
Date: November 4, 2003			By:	/s/ Eric S. Yeaman
Date: August 9, 2004	By:	/s/ Eric S. Yeaman
				Eric S. Yeaman Chief Executive Officer and Chief Financial Officer (Principal Executive Officer and Principal Financial and Accounting Officer)
		Eric S. Yeaman
		Chief Executive Officer and Chief Financial Officer
		(Principal Executive, Financial and Accounting Officer)

4229

EXHIBIT INDEX

EXHIBIT NO.		DESCRIPTION
3.1(1)		Amended and Restated Certificate of Incorporation of Turnstone Systems
3.2(1)		Amended and Restated Bylaws of Turnstone Systems
3.2(2)		Amended and Restated Bylaws of Turnstone Systems
4.1(1)		Form of Common Stock certificate
4.1(3)		Form of Common Stock certificate
4.2(1)		Registration Rights Agreement, dated January 12, 1998, by and among Turnstone Systems and certain stockholders of Turnstone Systems named herein, as amended as of January 12, 1999 and November 21, 1999
10.1(3)		Form of Indemnification Agreement entered into by Turnstone Systems with each of its directors and executive officers
4.3(2)		Form of Founder’s Restricted Stock Purchase Agreement entered into as of January 2, 1998, between Turnstone Systems and each of P. Kingston Duffie, M. Denise Savoie and Richard N. Tinsley
10.14(4)		Consulting Agreement, dated as of May 12, 2003, between Turnstone Systems, Inc. and P. Kingston Duffie
10.1(1)		Form of Indemnification Agreement entered into by Turnstone Systems with each of its directors and executive officers
10.15(5)		Consulting Agreement, dated as of July 31, 2003, between Turnstone Systems, Inc. and Carl Hubbard
10.2(1)		1998 Stock Plan and forms of agreement thereunder
10.16(6)		Consulting Agreement, dated as of August 31, 2003, between Turnstone Systems, Inc. and Richard N. Tinsley
10.3(3)		Amended and Restated 2000 Stock Plan
10.17(7)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Albert Y. Liu
10.4(1)		2000 Nonstatutory Stock Plan and forms of agreement thereunder
10.18(8)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Eric S. Yeaman
10.5(4)		Amended and Restated 2000 Employee Stock Purchase Plan
10.19(9)		Consulting Agreement, dated as of July 1, 2004, between Turnstone Systems, Inc. and Albert Y. Liu
10.6(2)		Manufacturing Agreement dated as of October 16, 1998, between Turnstone Systems and A-Plus Manufacturing Corporation
10.20(10)		Consulting Agreement, dated as of July 1, 2004, between Turnstone Systems, Inc. and Eric S. Yeaman
10.7(2)		OEM Purchase Agreement, dated effective as of September 1, 1999, between Turnstone Systems and Lucent Technologies Inc., as amended as of September 28, 1999 and December 9, 1999
31.1		Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
10.8(1)		Lease dated April 28, 2000, between Turnstone Systems and South Bay/San Tomas Associates
31.2		Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
10.11(5)		OEM Purchase Agreement, dated effective as of June 1, 2001, between Turnstone Systems, Inc. and Alcatel
32.1		Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
10.12(6)		Form of Executive Retention Agreement entered into by Turnstone Systems with each of Messrs. Duffie, Graf, Hubbard, Liu, Tinsley, White and Yeaman, its executive officers, in January 2003
10.13(7)		First Amendment to Lease Agreement, dated as of April 7, 2003, between Turnstone Systems, Inc. and BRE/San Tomas I L.L.C.

43(1) Incorporated herein by reference to Exhibit 3.1 of our Annual Report on Form 10-K filed on March 10, 2004 with the Securities and Exchange Commission.

10.14(8)		Consulting Agreement, dated as of May 12, 2003, between Turnstone Systems, Inc. and P. Kingston Duffie
10.15(9)		Consulting Agreement, dated as of July 31, 2003, between Turnstone Systems, Inc. and Carl Hubbard
10.16(10)		Consulting Agreement, dated as of August 31, 2003, between Turnstone Systems, Inc. and Richard N. Tinsley
10.17(11)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Albert Y. Liu
10.18(12)		Executive Employment Agreement, dated as of October 10, 2003, between Turnstone Systems, Inc. and Eric S. Yeaman
31.1		Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
32.1		Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(2)	Incorporated herein by reference to Exhibit 3.2 of our Annual Report on Form 10-K filed on March 10, 2004 with the Securities and Exchange Commission.

(13) Incorporated herein by reference to the Registration Statement on Form S-1 and all amendments thereto filed on November 22, 1999 with the Securities and Exchange Commission (No. 333-45130).

(24) ~~Confidential~~Incorporated ~~treatment~~herein ~~requested~~by ~~and~~reference ~~received as~~ to ~~certain~~Exhibit ~~portions~~10.14 ~~These~~of ~~exhibits~~our ~~are~~Quarterly ~~incorporated~~Report ~~herein by reference to the Registration Statement~~ on Form S10-1Q ~~and all amendments thereto~~ filed on ~~November~~May 2215, ~~1999~~2003 with the Securities and Exchange Commission ~~(No~~. ~~333-45130).~~

(35) Incorporated herein by reference to Exhibit 10.515 of our Quarterly Report on Form 10-Q filed on ~~November~~August 1311, ~~2001~~2003 with the Securities and Exchange Commission.

(46) Incorporated herein by reference to Exhibit 10.516 of our ~~Quarterly~~Current Report on Form 108-QK filed on ~~November~~September 132, ~~2001~~2003 with the Securities and Exchange Commission.

(57) ~~Confidential~~Incorporated ~~treatment requested as to certain portions. This exhibit is incorporated~~ herein by reference to Exhibit 10.1117 of our ~~Quarterly~~Current Report on Form 108-QK filed on ~~August~~October 1310, ~~2001~~2003 with the Securities and Exchange Commission.

(68) Incorporated herein by reference to Exhibit 10.1218 of our ~~Annual~~Current Report on Form 108-K filed on ~~March~~October 1810, 2003 with the Securities and Exchange Commission.

44(9) Incorporated herein by reference to Exhibit 10.19 of our Current Report on Form 8-K filed on June 28, 2004 with the Securities and Exchange Commission.

~~Table~~(10) Incorporated herein by reference to Exhibit 10.20 of ~~Contents~~our Current Report on Form 8-K filed on June 28, 2004 with the Securities and Exchange Commission.

~~(7)~~31 ~~Incorporated herein by reference to Exhibit 10.13 of our Quarterly Report on Form 10-Q filed on May 15, 2003 with the Securities and Exchange Commission.~~

(8) Incorporated herein by reference to Exhibit 10.14 of our Quarterly Report on Form 10-Q filed on May 15, 2003 with the Securities and Exchange Commission.

(9) Incorporated herein by reference to Exhibit 10.15 of our Quarterly Report on Form 10-Q filed on August 11, 2003 with the Securities and Exchange Commission.

(10) Incorporated herein by reference to Exhibit 10.16 of our Current Report on Form 8-K filed on September 2, 2003 with the Securities and Exchange Commission.

(11) Incorporated herein by reference to Exhibit 10.17 of our Current Report on Form 8-K filed on October 10, 2003 with the Securities and Exchange Commission.

(12) Incorporated herein by reference to Exhibit 10.18 of our Current Report on Form 8-K filed on October 10, 2003 with the Securities and Exchange Commission.

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