Tableof Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                              | ** ** | ** **                                                                                                    |
|-------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|
| ** **                                                  | ** ** | ** **                                                                                                    |
| **x**                                                       | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|                                                        |       |                                                                                                          |
| **For the quarterly period ended  September 30, 2008** |
| ** **                                                  | ** ** | ** **                                                                                                    |
| **or**                                                      |
| ** **                                                  | ** ** | ** **                                                                                                    |
| **o**                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition periodfrom                 to                 **

 

**Commission File Number: 001-33511**

 

**STARENTNETWORKS, CORP.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    | ** ** | **04-3527533**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**30 International PlaceTewksbury, MA 01876**

(Address of principal executive offices) (zipcode)

 

**(978) 851-1100**(Registrant’s telephone number, including area code)

 

 

(Former name, former address and formerfiscal year, if changed since last report)

 

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

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer x  (Do not check if a  smaller reporting  company) |   | Smaller reporting company o |
|--------------------------------|--------|--------------------------|--------|------------------------------------------------------------------------------------|--------|----------------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). o  Yes    x  No

As of November 4, 2008, there were 70,085,178 shares of theregistrant’s $0.001 par value per share common stock outstanding.

 

 

 

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**STARENT NETWORKS, CORP.**

 

**QUARTERLY REPORT ON FORM 10-Q**

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,2008**

 

**Table of Contents**

 
| **Item**                           | ** **                                                                                                             | **Page**   |
|------------------------------------|------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                         | ** **                                                                                                             | ** ** |
| PART I. FINANCIAL INFORMATION | 3                                                                                                                      |
|                               |                                                                                                                   |       |
| ITEM 1.                            | Condensed Consolidated Financial Statements (unaudited)                                                                | 3          |
|                               |                                                                                                                   |       |
|                               | Condensed Consolidated Balance Sheets as of  September 30, 2008 and December 31, 2007                        | 3          |
|                               |                                                                                                                   |       |
|                               | Condensed Consolidated Statements of  Operations for the Three and Nine Months Ended September 30, 2008 and  2007 | 4          |
|                               |                                                                                                                   |       |
|                               | Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended September 30, 2008 and 2007            | 5          |
|                               |                                                                                                                   |       |
|                               | Notes to  Condensed Consolidated Financial Statements                                                                  | 6          |
|                               |                                                                                                                   |       |
| ITEM 2.                            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                            | 13         |
|                               |                                                                                                                   |       |
| ITEM 3.                            | Quantitative and Qualitative Disclosures  About Market Risk                                                            | 25         |
|                               |                                                                                                                   |       |
| ITEM 4T.                           | Controls and Procedures                                                                                                | 25         |
|                               |                                                                                                                   |       |
| PART II. OTHER INFORMATION    | 26                                                                                                                     |
|                               |                                                                                                                   |       |
| ITEM 1.                            | Legal Proceedings                                                                                                      | 26         |
|                               |                                                                                                                   |       |
| ITEM 1A.                           | Risk Factors                                                                                                           | 27         |
|                               |                                                                                                                   |       |
| ITEM 2.                            | Unregistered Sales of Equity Securities and  Use of Proceeds                                                           | 38         |
|                               |                                                                                                                   |       |
| ITEM 6.                            | Exhibits                                                                                                               | 38         |

 

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**PART I.FINANCIAL INFORMATION**

 

**ITEM1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**STARENT NETWORKS, CORP.**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 

**(unaudited and in thousands, except share andper share data)**

 
| ** **                                                                                                                                                                                   | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                   |       |                         |       |                        |       |
| Current assets:                                                                                                                                                                              |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                            | 356,387    |                        | $          | 223,987 |   |
| Short-term investments                                                                                                                                                                       |       | —                       |       | 9,612                       |       |
| Accounts receivable                                                                                                                                                                          |       | 56,183                       |       | 56,363                      |       |
| Inventories                                                                                                                                                                                  |       | 42,527                       |       | 29,638                      |       |
| Deferred tax assets, net                                                                                                                                                                     |       | 2,463                        |       | —                      |       |
| Prepaid expenses and other current assets                                                                                                                                                    |       | 4,932                        |       | 6,656                       |       |
| Total current assets                                                                                                                                                                         |       | 462,492                      |       | 326,256                     |       |
|                                                                                                                                                                                         |       |                         |       |                        |       |
| Property and equipment, net                                                                                                                                                                  |       | 29,158                       |       | 20,452                      |       |
| Deferred tax assets, net                                                                                                                                                                     |       | 6,274                        |       | —                      |       |
| Other assets                                                                                                                                                                                 |       | 2,031                        |       | 1,955                       |       |
| Restricted cash                                                                                                                                                                              |       | 738                          |       | 716                         |       |
|                                                                                                                                                                                         |       |                         |       |                        |       |
| Total assets                                                                                                                                                                                 |       | $                            | 500,693    |                        | $          | 349,379 |   |
|                                                                                                                                                                                         |       |                         |       |                        |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                                                         |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                             |       | $                            | 9,752      |                        | $          | 7,448 |   |
| Accrued expenses                                                                                                                                                                             |       | 7,316                        |       | 6,163                       |       |
| Accrued payroll and related expenses                                                                                                                                                         |       | 14,777                       |       | 15,568                      |       |
| Accrued income taxes                                                                                                                                                                         |       | 2,844                        |       | 1,075                       |       |
| Current portion of deferred revenue                                                                                                                                                          |       | 143,333                      |       | 52,733                      |       |
| Total current liabilities                                                                                                                                                                    |       | 178,022                      |       | 82,987                      |       |
|                                                                                                                                                                                         |       |                         |       |                        |       |
| Deferred revenue, net of current portion                                                                                                                                                     |       | 6,973                        |       | 10,670                      |       |
| Other long-term liabilities                                                                                                                                                                  |       | 2,515                        |       | 783                         |       |
|                                                                                                                                                                                         |       |                         |       |                        |       |
| Commitments and contingencies (Note 7)                                                                                                                                                  |       |                         |       |                        |       |
|                                                                                                                                                                                         |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                   |       |                         |       |                        |       |
| Preferred stock, $0.001 par value, 5,000,000  shares authorized and no shares outstanding                                                                                                    |       | —                       |       | —                      |       |
| Common stock, $0.001 par value, 250,000,000  shares authorized, 69,757,366 and 68,252,858 shares issued and outstanding at  September 30, 2008 and December 31, 2007, respectively |       | 70                           |       | 68                          |       |
| Additional paid-in capital                                                                                                                                                                   |       | 364,144                      |       | 348,917                     |       |
| Accumulated other comprehensive income                                                                                                                                                       |       | —                       |       | 2                           |       |
| Accumulated deficit                                                                                                                                                                          |       | (51,031                      | )          | (94,048                     | )          |
| Total stockholders’ equity                                                                                                                                                              |       | 313,183                      |       | 254,939                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                              |       | $                            | 500,693    |                        | $          | 349,379 |   |

 

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

 

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**STARENT NETWORKS, CORP.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(unaudited and in thousands, except per sharedata)**

 
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Product                                                                          |       | $                                                    | 55,450     |                                                | $          | 31,588 |   | $ | 156,497 |   | $ | 81,160 |   |
| Service                                                                          |       | 10,611                                               |       | 5,103                                               |       | 26,960 |   | 14,026 |   |
| Total revenues                                                                   |       | 66,061                                               |       | 36,691                                              |       | 183,457 |   | 95,186 |   |
| Cost of revenues:                                                                |       |                                                 |       |                                                |       |   |   |   |   |
| Product                                                                          |       | 10,151                                               |       | 7,422                                               |       | 28,697 |   | 18,176 |   |
| Service                                                                          |       | 4,107                                                |       | 2,723                                               |       | 11,823 |   | 6,052 |   |
| Total cost of revenues                                                           |       | 14,258                                               |       | 10,145                                              |       | 40,520 |   | 24,228 |   |
| Gross profit                                                                     |       | 51,803                                               |       | 26,546                                              |       | 142,937 |   | 70,958 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Operating expenses:                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Research and development                                                         |       | 13,750                                               |       | 10,612                                              |       | 38,594 |   | 28,263 |   |
| Sales and marketing                                                              |       | 17,894                                               |       | 11,940                                              |       | 52,918 |   | 27,876 |   |
| General and administrative                                                       |       | 6,129                                                |       | 4,164                                               |       | 17,215 |   | 10,405 |   |
| Total operating expenses                                                         |       | 37,773                                               |       | 26,716                                              |       | 108,727 |   | 66,544 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss) from operations                                                    |       | 14,030                                               |       | (170                                                | )          | 34,210 |   | 4,414 |   |
| Interest income                                                                  |       | 1,940                                                |       | 2,038                                               |       | 6,232 |   | 3,637 |   |
| Foreign currency exchange gain (loss)                                            |       | (1,308                                               | )          | 84                                                  |       | (556 | ) | (6 | ) |
| Income before income tax benefit (expense)                                       |       | 14,662                                               |       | 1,952                                               |       | 39,886 |   | 8,045 |   |
| Income tax benefit (expense)                                                     |       | 4,926                                                |       | (329                                                | )          | 3,131 |   | (736 | ) |
| Net income                                                                       |       | 19,588                                               |       | 1,623                                               |       | 43,017 |   | 7,309 |   |
| Accretion of redeemable convertible  preferred stock                             |       | —                                               |       | —                                              |       | — |   | (3,445 | ) |
| Income allocated to preferred stockholders                                       |       | —                                               |       | —                                              |       | — |   | (1,703 | ) |
| Net income applicable to common  stockholders                                    |       | $                                                    | 19,588     |                                                | $          | 1,623 |   | $ | 43,017 |   | $ | 2,161 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net income per share applicable to common  stockholders (Note 3):           |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                            |       | $                                                    | 0.28       |                                                | $          | 0.03 |   | $ | 0.62 |   | $ | 0.07 |   |
| Diluted                                                                          |       | $                                                    | 0.26       |                                                | $          | 0.02 |   | $ | 0.58 |   | $ | 0.06 |   |
| Weighted-average shares used in computing  net income per common share (Note 3): |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                            |       | 69,683                                               |       | 64,039                                              |       | 69,328 |   | 32,108 |   |
| Diluted                                                                          |       | 74,192                                               |       | 70,685                                              |       | 74,343 |   | 38,260 |   |

 

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

 

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**STARENT NETWORKS, CORP.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 

**(unaudited and in thousands)**

 
| ** **                                                                                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash  flows from operating activities:**                                                  |       |                                                |       |   |   |
| Net income                                                                                  |       | $                                                   | 43,017     |   | $ | 7,309 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities |       |                                                |       |   |   |
| Depreciation and amortization expense                                                       |       | 8,090                                               |       | 4,343 |   |
| Share-based compensation                                                                    |       | 12,430                                              |       | 8,520 |   |
| Foreign currency losses (gains)                                                             |       | 695                                                 |       | (118 | ) |
| Loss on disposal of fixed assets                                                            |       | 36                                                  |       | — |   |
| Benefit from deferred income taxes, net                                                     |       | (6,622                                              | )          | — |   |
| Changes in operating assets and  liabilities:                                               |       |                                                |       |   |   |
| Accounts receivable                                                                         |       | (390                                                | )          | (21,227 | ) |
| Inventories                                                                                 |       | (12,901                                             | )          | (10,008 | ) |
| Prepaid expenses and other current assets                                                   |       | 1,133                                               |       | (2,433 | ) |
| Other assets                                                                                |       | (116                                                | )          | (307 | ) |
| Accounts payable                                                                            |       | 2,399                                               |       | 5,375 |   |
| Accrued expenses                                                                            |       | 753                                                 |       | 6,081 |   |
| Accrued income taxes                                                                        |       | 1,821                                               |       | 306 |   |
| Deferred revenue                                                                            |       | 86,920                                              |       | (13,900 | ) |
|                                                                                        |       |                                                |       |   |   |
| Net cash provided by (used in) operating  activities                                        |       | 137,265                                             |       | (16,059 | ) |
|                                                                                        |       |                                                |       |   |   |
| **Cash  flows from investing activities:**                                                  |       |                                                |       |   |   |
| Purchases of property and equipment                                                         |       | (16,820                                             | )          | (11,749 | ) |
| Purchases of short-term investments                                                         |       | —                                              |       | (18,896 | ) |
| Proceeds from maturities of short-term  investments                                         |       | 9,610                                               |       | 40,380 |   |
| Change in restricted cash                                                                   |       | (43                                                 | )          | 451 |   |
|                                                                                        |       |                                                |       |   |   |
| Net cash (used in) provided by investing  activities                                        |       | (7,253                                              | )          | 10,186 |   |
|                                                                                        |       |                                                |       |   |   |
| **Cash flows from financing activities:**                                                   |       |                                                |       |   |   |
| Proceeds from public offerings, net of  expenses                                            |       | (87                                                 | )          | 115,955 |   |
| Proceeds from exercises of stock options                                                    |       | 2,683                                               |       | 1,314 |   |
| Proceeds from issuance of restricted common  stock                                          |       | —                                              |       | 347 |   |
|                                                                                        |       |                                                |       |   |   |
| Net cash provided by financing activities                                                   |       | 2,596                                               |       | 117,616 |   |
|                                                                                        |       |                                                |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                               |       | (208                                                | )          | 189 |   |
|                                                                                        |       |                                                |       |   |   |
| Net increase in cash and cash equivalents                                                   |       | 132,400                                             |       | 111,932 |   |
|                                                                                        |       |                                                |       |   |   |
| Cash and cash equivalents, beginning of  period                                             |       | 223,987                                             |       | 24,010 |   |
|                                                                                        |       |                                                |       |   |   |
| Cash and cash equivalents, end of period                                                    |       | $                                                   | 356,387    |   | $ | 135,942 |   |

 

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

 

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**STARENT NETWORKS, CORP.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.             Overview**

 

***Business Description***

 

Starent Networks, Corp. (“Starent” or the “Company”) was incorporatedin Delaware on August 11, 2000 and is a leading provider of infrastructurehardware and software products and services that enable mobile operators todeliver multimedia services to their subscribers. The Company’s products andservices integrate multiple network functions and services needed for thedelivery of advanced multimedia services, such as video, Internet access,voice-over-IP, e-mail, mobile TV, photo sharing and gaming.

 

***Basis ofPresentation***

 

The accompanying interim condensed consolidated financial statementspresented herein have been prepared by the Company, are unaudited and, in theopinion of management, include all adjustments, consisting only of normal,recurring adjustments and accruals, necessary for a fair statement of theCompany’s financial position at September 30, 2008, results of operationsfor the three and nine months ended September 30, 2008 and 2007 and cashflows for the nine months ended September 30, 2008 and 2007 in accordancewith accounting principles generally accepted in the United States. Interimresults are not necessarily indicative of results for any other interim periodor a full year. The condensed consolidated balance sheet presented as of December 31,2007 has been derived from the audited consolidated financial statements as ofthat date.

 

The condensed consolidated financial statements and notes are presentedas permitted by Form 10-Q and do not contain all of the information thatis included in the annual financial statements and notes of the Company. Thecondensed consolidated financial statements and notes presented herein shouldbe read in conjunction with the financial statements and notes included in theCompany’s Annual Report on Form 10-K for the year ended December 31,2007.

 

***SignificantEstimates and Assumptions***

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets, liabilities,revenues and expenses, and disclosures of contingent assets and liabilities.Management evaluates these estimates and assumptions on an ongoing basis.Significant estimates and assumptions relied upon by management in preparingthese financial statements include revenue recognition, allowances for doubtfulaccounts, net realizable value of inventories, expensing and capitalization ofresearch and development costs for software, the determination of fair value ofshare-based compensation and the recoverability of the Company’s net deferredtax assets and related valuation allowance.

 

Although the Company regularly assesses these estimates, actual resultscould differ materially from these estimates. Changes in estimates are recordedin the period in which they become known. The Company bases its estimates onhistorical experience and various other assumptions that it believes to bereasonable under the circumstances. Actual results could differ from management’sestimates if past experience or other assumptions do not turn out to besubstantially accurate.

 

***Concentrations ofRisk and Off-Balance-Sheet Risk***

 

The Company has no significant off-balance-sheet risk such as foreignexchange contracts, option contracts or other foreign hedging arrangements. Financialinstruments that potentially subject the Company to concentrations of creditrisk are principally cash and cash equivalents, short-term investments,accounts receivable and inventories. The Company’s cash equivalents and itsshort-term investments are principally maintained with one commercial bank.

 

The Company had two customers for the three and nine months ended September 30,2008, respectively, that each accounted for more than 10% of revenues and inthe aggregate accounted for 79% and 80% of revenues for each of the respectiveperiods. The Company had four customers for the three and nine months ended September 30,2007 that accounted for more than 10% of revenues and in the aggregateaccounted for 88% of revenues for each of the respective periods.

 

At September 30, 2008, the Company had one customer that accountedfor 45% of accounts receivable. At December 31, 2007, the Company had twocustomers that accounted for 74% of accounts receivable.

 

The Company relies on a single contract manufacturer to manufacture andassemble its products. The Company has no long-term supply arrangements withthis manufacturer and accordingly no obligation exists for the manufacturer tosupply products to the Company in specific quantities or within specific time frames.

 

In addition, certain of the components included in the Company’sproducts are sourced from single or limited sources and lead times for some ofthese components may be significant. The Company has no long-term contracts topurchase these components.

 

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**2.             Share-BasedCompensation**

 

In December 2004,the Financial Accounting Standards Board, or FASB, issued Statement ofFinancial Accounting Standard, or SFAS, 123 (Revised),*Share-Based Payment*, which is a revisionof SFAS 123,*Accounting for Stock-BasedCompensation*. SFAS 123R supersedes Accounting Principles Board,or APB, Opinion 25,*Accounting for Stock Issuedto Employees* and SFAS 123 and amends SFAS 95,*Statement of Cash Flows*. Generally, theapproach in SFAS 123R is similar to the approach described inSFAS 123. However, SFAS 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in theincome statement based on their grant date fair value. The Company adoptedSFAS 123R effective January 1, 2006 utilizing the prospectivetransition method, which requires the Company to apply the provisions of SFAS 123Ronly to new awards granted, and to awards modified, repurchased or cancelled onor after January 1, 2006.

 

The fair value of options granted for the three and nine months ended September 30,2008 and 2007 was estimated at the date of grant using the followingassumptions:

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free interest rates |       | 3.30                                                 | %          | 4.50                                                | %          | 3.01% - 3.30 | % | 4.50 – 4.76 | % |
| Expected dividend yield  |       | 0                                                    | %          | 0                                                   | %          | 0 | % | 0 | % |
| Expected life            |       | 6.25 years                                           |       | 6.25 years                                          |       | 6.25 years |   | 6.25 years |   |
| Expected volatility      |       | 56                                                   | %          | 62                                                  | %          | 54% - 56 | % | 62 - 68 | % |

 

The expected life wascalculated based on the simplified method as permitted by the SEC’s StaffAccounting Bulletin 110, *Share-Based Payment*.During the third quarter of 2008, the computation of expected volatility wasbased on the historical trading activity of the Company’s common stock, impliedvolatility and an analysis of comparable companies from a representative peergroup selected based on industry and market capitalization in order to derivean expected volatility. Prior to the third quarter of 2008, the computation ofexpected volatility was based on the historical volatility of comparablecompanies from a representative peer group selected based on industry andmarket capitalization. The risk-free interest rate was based on a U.S. Treasuryinstrument whose term is consistent with the expected life of the stockoptions. In addition to the assumptions above, as required underSFAS 123R, management made an estimate of expected forfeitures and isrecognizing compensation costs only for those equity awards expected to vest.

 

The results for the periods set forth below included share-basedcompensation expense in the following expense categories of the condensedconsolidated statements of operations (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Share-based compensation included in:                 |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenues                                      |       | $                                                    | 376        |                                                | $          | 221 |   | 1,070 |   | $ | 419 |   |
| Total share-based compensation in cost of  revenues   |       | 376                                                  |       | 221                                                 |       | 1,070 |   | 419 |   |
|                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Research and development                              |       | 1,594                                                |       | 1,947                                               |       | 4,701 |   | 4,088 |   |
| Sales and marketing                                   |       | 1,457                                                |       | 650                                                 |       | 3,750 |   | 1,643 |   |
| General and administrative                            |       | 1,115                                                |       | 948                                                 |       | 2,909 |   | 2,370 |   |
| Total share-based compensation in operating  expenses |       | 4,166                                                |       | 3,545                                               |       | 11,360 |   | 8,101 |   |
| Total share-based compensation                        |       | $                                                    | 4,542      |                                                | $          | 3,766 |   | $ | 12,430 |   | $ | 8,520 |   |
|                                                       |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

**3.             NetIncome per Share**

 

Basic and diluted net income per share applicable to commonstockholders is presented in conformity with SFAS 128, *Earnings per Share* and the relatedinterpretation in Emerging Issues Task Force 03-06,*Participating Securities and the Two-Class Method under FASBStatement No. 128.*  Basicnet income per share applicable to common stockholders is computed by dividingnet income applicable to common stockholders by the weighted-average number ofcommon shares outstanding during the period, excluding the dilutive effects ofcommon stock equivalents. Income applicable to common stockholders includesaccretion of redeemable convertible preferred stock and earnings allocated toparticipating preferred stockholders. Common stock equivalents include stockoptions, restricted stock and, in certain circumstances, convertible securitiessuch as the convertible preferred stock. Diluted net income per share assumesthe conversion of the convertible preferred stock using the “if converted”method, if dilutive, and includes the dilutive effect of stock options andrestricted stock under the treasury stock method. The following table presentsthe calculation of basic and diluted net income per share (in thousands, exceptper share data):

 

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| ** **                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                                  |       | $                                                    | 19,588     |                                                | $          | 1,623 |   | $ | 43,017 |   | $ | 7,309 |   |
| Accretion of redeemable convertible  preferred stock        |       | —                                               |       | —                                              |       | — |   | (3,445 | ) |
| Income allocated to preferred stockholders                  |       | —                                               |       | —                                              |       | — |   | (1,703 | ) |
| Net income applicable to common  stockholders               |       | $                                                    | 19,588     |                                                | $          | 1,623 |   | $ | 43,017 |   | $ | 2,161 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average common shares outstanding –  basic    |       | 69,683                                               |       | 64,039                                              |       | 69,328 |   | 32,108 |   |
| Dilutive effect of stock options and  restricted stock      |       | 4,509                                                |       | 6,646                                               |       | 5,015 |   | 6,152 |   |
| Weighted-average common shares outstanding –  dilutive |       | 74,192                                               |       | 70,685                                              |       | 74,343 |   | 38,260 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net income per share:                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                       |       | $                                                    | 0.28       |                                                | $          | 0.03 |   | $ | 0.62 |   | $ | 0.07 |   |
| Diluted                                                     |       | $                                                    | 0.26       |                                                | $          | 0.02 |   | $ | 0.58 |   | $ | 0.06 |   |

 

The following outstanding options, restricted common stock subject torepurchase and convertible preferred stock were excluded from the computationof diluted net income per common share for the periods presented becauseincluding them would have had an anti-dilutive effect (in thousands):

 
| ** **                                                                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Options to purchase common stock and  restricted common stock subject to repurchase |       | 3,361                                                |       | 587                                                 |       | 2,544 |   | 896 |   |
| Convertible preferred stock (as converted  basis)                                   |       | —                                               |       | —                                              |       | — |   | 25,308 |   |

 

**4.             FairValue Measurements**

 

On January 1, 2008,the Company adopted the provisions of SFAS 157 (“SFAS 157”), *Fair Value Measurements,* for its financial assets andliabilities. As permitted by FASB Staff Position No. SFAS 157-2,*Effective Date of FASB Statement No. 157*,the Company elected to defer until January 1, 2009 the adoption ofSFAS 157 for all non-financial assets and non-financial liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis. The adoption of this accounting pronouncementdid not have a material effect on the Company’s consolidated financialstatements for financial assets and liabilities and any other assets andliabilities carried at fair value. The Company is currently in the process ofevaluating the impact of adopting this pronouncement for other non-financialassets or liabilities. SFAS 157 provides a framework for measuring fairvalue under generally accepted accounting principles in the United States andrequires expanded disclosures regarding fair value measurements. SFAS 157defines fair value as the exchange price that would be received for an asset orpaid to transfer a liability (an exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date. SFAS 157 also establishesa fair value hierarchy that requires an entity to maximize the use ofobservable inputs, where available, and minimize the use of unobservable inputswhen measuring fair value. The standard describes three levels of inputs thatmay be used to measure fair value:

 
| Level 1 |   | Quoted prices in active markets for identical assets or liabilities.  At September 30, 2008, the Company’s Level 1 assets and liabilities  included the Company’s money market funds included in cash and cash  equivalents. |
|--------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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| Level 2 |   | Observable inputs other than Level 1 prices, such as quoted  prices for similar assets or liabilities; quoted prices in markets that are  not active; or other inputs that are observable or can be corroborated by  observable market data for substantially the full term of the assets or  liabilities. At September 30, 2008, the Company had no Level 2  assets or liabilities. |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                                                                                                                                                                |
| Level 3 |   | Unobservable inputs that are supported by little or no market  activity and that are significant to the fair value of the assets or  liabilities. At September 30, 2008, the Company had no Level 3  assets or liabilities.                                                                                                                                                               |

 

At September 30, 2008, the Company’s financial assets andliabilities that were measured at fair value on a recurring basis includedmoney market funds of $333.1 million, which were level 1 financialassets. The Company did not have any non-financial assets or liabilities that weremeasured or disclosed at fair value on a recurring basis at September 30,2008. As required by SFAS 157, assets and liabilities measured at fairvalue are classified in their entirety based on the lowest level of input thatis significant to the fair value measurement. The Company’s assessment of thesignificance of a particular input to the fair value measurement in itsentirety requires judgment and considers factors specific to the asset orliability.

 

**5.             Inventories**

 

Inventories are stated at the lower of cost (first-in, first-out) ormarket (net realizable value). Inventories principally included the cost of rawmaterials, subassemblies, the cost of third-party contract manufacturers andcost of sales related to deferred revenue (which is included in finishedgoods). Inventories consisted of the following (in thousands):

 
| ** **      | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                            | 2,065      |                        | $          | 4,632 |   |
| Work in process |       | 7,114                        |       | 5,551                       |       |
| Finished goods  |       | 33,348                       |       | 19,455                      |       |
|            |       | $                            | 42,527     |                        | $          | 29,638 |   |

 

**6.             IncomeTaxes**

 

On January 1, 2007, the Company adopted the provisions of FASBInterpretation, or FIN, No. 48, *Accounting for Uncertaintyin Income Taxes*, an interpretation of SFAS 109. The new standarddefines the threshold for recognizing the benefits of tax return positions inthe financial statements as “more-likely-than-not” to be sustained by thetaxing authorities based solely on the technical merits of the position.

 

The Company’s income tax provision for the three and nine months ended September 30,2008 included (i) a tax benefit of $6.6 million recorded upon the Company’sdecision in the third quarter of 2008 to release a substantial portion of thevaluation allowance recorded against net deferred tax assets and (ii) aprovision of $0.2 million to reserve an uncertain tax position in a foreignjurisdiction under FIN 48. Excluding the effect of this one-time tax benefitand tax reserve, the Company’s remaining income tax provisions for the threeand nine months ended September 30, 2008 and 2007 were primarily attributableto federal and state income taxes in the U.S. and taxes related to foreignjurisdictions. The federal and state tax provisions for those periods includedamounts in relation to the Company’s income generated in the U.S., partiallyreduced by the utilization of available net operating loss (NOL) carryforwardsand tax credits that were recorded on its balance sheet with a full valuationallowance prior to their utilization.

 

At June 30, 2008, a full valuation allowance was recorded againstthe Company’s net deferred tax assets. Based upon the Company’s operatingresults over recent years and through September 30, 2008 as well as anassessment of the Company’s expected future results of operations, the Companydetermined in the third quarter of 2008 that it had become “more likely thannot” that a substantial portion of its deferred tax assets will berealized.  As a result, the Companyreduced the valuation allowance during the quarter ended September 30,2008, resulting in recognition of a deferred tax asset of $8.6 million, aone-time income tax benefit of $6.6 million (noted above) and a $2.0 millionreserve for uncertain tax positions in the U.S., which is recorded in otherlong-term liabilities.

 

As of the end of the third quarter of 2008, the Company has a remainingvaluation allowance of $5.2 million which will be released in the fourthquarter of 2008 in accordance with the requirements under SFAS 109 to use anannualized effective tax rate for each interim period during the year in whicha valuation allowance release has occurred, including any interim period afterthe valuation allowance release has been released.

 

**7.             Litigation**

 

The Company is presently defending two patent infringement lawsuitsbrought against it by UTStarcom, Inc. In February 2005, UTStarcomfiled a complaint against the Company in the United States District Court forthe Northern District of California seeking unspecified damages and injunctiverelief. The complaint alleges infringement by the Company of UTStarcom’s U.S.Patent No. 6,829,473, entitled “Roaming and Hand-Off Support for PrepaidBilling for Wireless Data Networks,” which the Company refers 

 

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to as the ‘473 patent. In May 2005, the Company answered thecomplaint, denied the infringement allegations contained in the complaint, andfiled counterclaims against UTStarcom seeking a declaratory judgment that theCompany did not infringe the ‘473 patent and that the ‘473 patent was invalidand unenforceable. In July 2005, the Company filed an amended answer andcounterclaims to the ‘473 patent complaint. In December 2006, UTStarcomfiled a reissue patent application relating to the ‘473 patent. In January 2007,by agreement of the parties, the District Court stayed the case pending theoutcome of UTStarcom’s reissue application relating to the ‘473 patent. In June 2007,the Company filed a request for*inter partes*  re-examination of all claims of the ‘473patent with the United States Patent and Trademark Office on sixteen differentgrounds. In August 2007, the Patent and Trademark Office granted theCompany’s request for*inter partes*re-examination of all claims on all sixteen grounds. In November 2007, thePatent and Trademark Office merged the reissue and re-examination proceedings.A first office action has not yet been issued. The Company believes that it hasmeritorious defenses against any resulting reissued patent, and the Company isprepared to vigorously defend the ‘473 patent case through trial.

 

In May 2007, UTStarcom filed an additional complaint against theCompany and a number of its employees and former employees in the United StatesDistrict Court for the Northern District of Illinois alleging violations of theIllinois trade secrets act, infringement of five patents assigned to UTStarcom,intentional interference with UTStarcom’s business relations and declarationsof ownership relating to one of the Company’s patents and three of its patentapplications. The complaint contains allegations, among others, that a numberof former employees of a business unit UTStarcom acquired, who subsequentlyworked for the Company, took UTStarcom’s trade secrets with them and improperlyused those trade secrets to develop, manufacture and market the Company’s 3Gwireless products, and that such products incorporate various UTStarcomconfidential technical information, including UTStarcom’s proprietary virtualprivate network and EV-DO features. UTStarcom further alleges that the Companyhas disclosed UTStarcom’s trade secrets in one of its patents and three of itspatent applications, and that this patent and these patent applications legallybelong to UTStarcom based on the inventors’ previous work at the business unitacquired by UTStarcom. In August 2007, the Company and the current andformer employee defendants filed their answers to the complaint. The Companyalso filed counterclaims for tortious interference with prospective economicadvantage, malicious prosecution, a declaration that the patents-in-suit areinvalid and not infringed, and a declaration that one of the patents-in-suit isunenforceable due to inequitable conduct. In December 2007, UTStarcomfiled an amendment to the complaint, which added new claims for declaration ofownership of four more of the Company’s patent applications, copyrightinfringement, breach of restrictive covenants against the employee and formeremployee defendants, and aiding and abetting the employee and former employeedefendants’ breaches of the duty of loyalty and the employment agreements. Theamendment to the complaint also added another employee as a defendant. On January 4,2008, the Company filed a motion to dismiss, or in the alternative for a moredefinite statement regarding, the trade secret, copyright, breaches ofrestrictive covenants, and aiding and abetting claims of the amendment to thecomplaint. UTStarcom filed its opposition to this motion on January 22,2008, and the Company filed its reply on January 29, 2008. On May 20,2008 the Court granted the Company’s motion, in-part, and ordered UTStarcom toprovide a more definite statement of its claims. On May 30, 2008,UTStarcom filed a Third Amended Complaint. On June 9, 2008, the Companymoved to dismiss the trade secret, copyright, breaches of restrictivecovenants, and aiding and abetting claims (Counts I, VI, and VIII-XV) of theThird Amended Complaint, for failure to comply with the Court’s Order toprovide a more definite statement of those claims. On July 23, 2008, theCourt granted the Company’s motion and dismissed those claims. On August 1,2008, UTStarcom filed a “Motion for Leave to Amend the Complaint to Provide aMore Definite Statement and Clarification of the 7/23 Order. On August 11,2008, the Court granted UTStarcom leave to file a Fourth AmendedComplaint.  UTStarcom filed a FourthAmended Complaint on August 27, 2008. In addition, on August 26, 2008, the Company filed a motion forsummary judgment of noninfringement of U.S. Patent No. 7,173,905, whichthe Court has taken under advisement.  OnAugust 27, 2008, UTStarcom filed a motion to dismiss Starent’s third,fourth, and fifth counterclaims for unenforceability of the asserted patents,tortious interference with prospective economic advantage, and maliciousprosecution, respectively.

 

The Company filed a motion to strike and dismiss the Fourth AmendedComplaint on September 15, 2008. The Court granted the Company’s motion to strike the Fourth AmendedComplaint on September 24, 2008, and, on the same day, granted UTStarcomleave to re-file the version of the Fourth Amended Complaint which waspreviously attached as an exhibit to its motion for leave to amend thecomplaint filed on August 1, 2008. UTStarcom re-filed this version of its Fourth Amended Complaint on September 25,2008.  The Company filed a motion todismiss certain counts of UTStarcom’s latest Fourth Amended Complaint on October 14,2008.  The Court set a briefing schedulefor the motions to dismiss filed by UTStarcom and the Company, and stated thatit would rule on the  motions on December 3,2008.  Discovery is proceeding. No trialdate has been set. In this lawsuit, UTStarcom seeks unspecified monetarydamages, punitive damages, injunctive relief, declarations of ownershiprelating to the specified patent and patent applications owned by the Company,findings of misappropriation of trade secrets, patent infringement andcopyright infringement, costs and attorneys fees. The Company believes it hasmeritorious defenses to each of UTStarcom’s claims in this lawsuit and it isprepared to vigorously defend the lawsuit.

 

In addition, the Company is subject to other legal proceedings, claimsand litigation arising in the ordinary course of business. Defending lawsuitsrequires significant management attention and financial resources and theoutcome of any litigation, including the matters described above, is inherentlyuncertain. The Company does not, however, currently expect that the ultimatecosts to resolve pending matters will have a material adverse effect on itsconsolidated financial position, results of operations or cash flows.

 

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**8.             BusinessSegments**

 

SFAS 131, *Disclosures About Segments of an Enterprise andRelated Information*, establishes standards for reporting informationabout operating segments in annual financial statements and requires selectedinformation of segments to be presented in financial reports issued tostockholders. Operating segments are defined as components of an enterpriseabout which separate financial information is available and that is evaluatedregularly by the chief operating decision maker, or decision making group, indetermining how to allocate resources and assess performance. The Company’schief operating decision maker, as defined under SFAS 131, is the chiefexecutive officer. The Company views its operations and manages its business asone operating segment.

 

Revenue by geography is based on the billing address of the customer.The following tables set forth revenue and long-lived assets by geographic area(in thousands):

 

**Revenues**

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **               | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States and Canada |       | $                                                    | 54,977     |                                                | $          | 26,863 |   | $ | 164,619 |   | $ | 63,799 |   |
| Japan                    |       | 6,788                                                |       | 4,522                                               |       | 11,927 |   | 18,046 |   |
| Korea                    |       | 3,427                                                |       | 4,129                                               |       | 5,501 |   | 10,402 |   |
| Rest of world            |       | 869                                                  |       | 1,177                                               |       | 1,410 |   | 2,939 |   |
| Total                    |       | $                                                    | 66,061     |                                                | $          | 36,691 |   | $ | 183,457 |   | $ | 95,186 |   |

 

**Long-lived Assets**

 
| ** **    | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------|------------|------------------------------|------------|-----------------------------|------------|
| United States |       | $                            | 21,083     |                        | $          | 15,614 |   |
| India         |       | 7,553                        |       | 4,676                       |       |
| Rest of world |       | 522                          |       | 162                         |       |
| Total         |       | $                            | 29,158     |                        | $          | 20,452 |   |

 

**9.****     ComprehensiveIncome**

 

Comprehensive income consists of the following (in thousands):

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                           |       | $                                                    | 19,588     |                                                | $          | 1,623 |   | $ | 43,017 |   | $ | 7,309 |   |
| Change in unrealized loss on short-term  investments |       | —                                               |       | 3                                                   |       | (2 | ) | (4 | ) |
| Comprehensive income                                 |       | $                                                    | 19,588     |                                                | $          | 1,626 |   | $ | 43,015 |   | $ | 7,305 |   |

 

**10.  RecentAccounting Pronouncements**

 

The Company adopted theprovisions of SFAS 159, *The Fair ValueOption for Financial Assets and Financial Liabilities, including an amendmentof FASB Statement No. 115,* on January 1, 2008.SFAS 159 permits entities to choose, at specified election dates, tomeasure eligible items at fair value (the “fair value option”). Under thispronouncement, a business entity must report unrealized gains and losses onitems for which the fair value option has been elected in earnings at eachsubsequent reporting period. The Company has not elected the fair value optionfor any items on its balance sheet.

 

In June 2008, theFASB issued FASB Staff Position (FSP) EITF 03-6-1, *Determining Whether Instruments Granted in Share-Based PaymentTransactions Are Participating Securities.* This FSP provides thatunvested share-based payment awards that contain nonforfeitable rights todividends or dividend equivalents (whether paid or unpaid) are participatingsecurities and shall be included in the computation of earnings per sharepursuant to the two-class method. Upon adoption, a company is required toretrospectively adjust its earnings per share data (including any amountsrelated to interim periods, summaries of earnings and selected financial data) 

 

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to conform withthe provisions in this FSP. This FSP will be effective for the Company on January 1,2009. The Company has not yet determined the impact, if any, of this FSP on itsconsolidated financial statements.

 

In May 2008, theFASB released SFAS 162, *The Hierarchy of GenerallyAccepted Accounting Principles.* SFAS 162 establishes the GAAPhierarchy and identifies the sources of accounting principles and the frameworkfor selecting principles used in the preparation of financial statements. SFAS162 will be effective for the Company on November 15, 2008*.*The Company has not yet determined the impact, if any, ofthis statement on its consolidated financial statements.

 

In December 2007,the FASB released SFAS 141 (revised 2007), *Business Combinations*. This statement will significantlychange the accounting for business combinations in a number of areas includingthe treatment of contingent consideration, contingencies, acquisition costs, inprocess research and development and restructuring costs. In addition, underthis statement, changes in deferred tax asset valuation allowances and acquiredincome tax uncertainties in a business combination after the measurement periodwill impact income tax expense. This statement will be effective for theCompany on January 1, 2009 and will change its accounting treatment forbusiness combinations on a prospective basis.

 

In December 2007,the FASB released SFAS 160, *NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51*.This statement will change the accounting and reporting for minority interests,which will be recharacterized as noncontrolling interests and classified as acomponent of equity. This new consolidation method will significantly changethe accounting for transactions with minority interest holders. This statementwill be effective for the Company on January 1, 2009. As of September 30,2008, the Company did not have any minority interests.

 

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

 

**Cautionary Statement**

 

This Quarterly Report on Form 10-Q,including the information incorporated by reference herein, contains, inaddition to historical information, forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. These forward-looking statements arebased on our current expectations, assumptions, estimates and projectionsregarding our business and industry, and we do not undertake an obligation toupdate our forward-looking statements to reflect future events orcircumstances. We may, in some cases, use words such as “project,” “believe,” “anticipate,”“plan,” “expect,” “estimate,” “intend,” “continue,” “should,” “would,” “could,”“potentially,” “will,” “may” or similar words and expressions that conveyuncertainty of future events or outcomes to identify these forward-lookingstatements. Forward-looking statements in this Quarterly Report on Form 10-Qmay include statements about:

 

·*our ability to attract and retain customers;*

 

·*our financial performance;*

 

·*our development activities;*

 

·*the advantages of our technology as compared to thatof others;*

 

·*our ability to establish and maintain intellectualproperty rights;*

 

·*our ability to retain and hire necessary employeesand appropriately staff our operations;*

 

·*our ability to manage growth, both in the UnitedStates and internationally;*

 

·*the spending of our proceeds from public offeringsof our common stock; and*

 

·*our cash needs.*

 

The outcome of the eventsdescribed in these forward-looking statements is subject to known and unknownrisks, uncertainties and other factors, including the factors set forth in Part IIItem 1A “Risk Factors” in this Quarterly Report on Form 10-Q, thatcould cause actual results to differ materially from the results anticipated bythese forward-looking statements. You should read these factors and the risksdescribed in other documents that we file from time to time with the SEC inconjunction with the unaudited condensed consolidated financial statements andrelated notes included elsewhere in this Quarterly Report on Form 10-Q andin the audited consolidated financial statements in our Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

**Overview**

 

Starent Networks is a leading provider of infrastructure hardware andsoftware products and services that enable mobile operators to delivermultimedia services to their subscribers. We have created hardware and softwareproducts that provide network functions and services, including access from awide range of radio networks to the operator’s packet core network. Ourproducts and services also provide management of subscriber sessions movingbetween networks and application of billing and other session policies. Ourproducts and services provide high performance and system intelligence bycombining significant computing power, memory and traffic handling capabilitieswith a flexible, high availability operating system and other proprietarysoftware. Our products integrate multiple network functions and services neededfor the delivery of advanced multimedia services, such as video, Internetaccess, voice-over-IP, e-mail, mobile TV, photo sharing and gaming.

 

Our products consist of both hardware and software and can beconfigured to meet a number of customer needs. We sell our products andservices to mobile operators around the world both directly and indirectlythrough our relationships with original equipment manufacturers, or OEMs,system integrators and distributors.

 

In June 2007, we completed an initial public offering of ourcommon stock in which we sold and issued 10,580,226 shares of our common stockat a price of $12.00 per share. We raised a total of $127.0 million ingross proceeds from the initial public offering, or $116.0 million in netproceeds after deducting underwriting discounts and commissions of$8.9 million and other offering expenses of approximately$2.1 million. In connection with the initial public offering, alloutstanding shares of our convertible preferred stock automatically converted intoan aggregate of 44,287,985 shares of our common stock.

 

In November 2007, we completed an underwritten public offering of8,000,000 shares of our common stock at a price to the public of $24.00 pershare. We received total net proceeds from the November 2007 publicoffering of approximately $88.1 million, after deducting underwritingdiscounts and commissions and estimated offering expenses.

 

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We maintain our corporate headquarters in Tewksbury, Massachusetts, andhave sales and development offices in various locations worldwide. We conductour research and development activities at two locations in India and twolocations in the United States. As of September 30, 2008, we had 739employees worldwide. Our revenues for the year ended December 31, 2007were $145.8 million, and $66.1 million and $183.5 million for thethree and nine months ended September 30, 2008, respectively. Our netincome for the year ended December 31, 2007 was $11.5 million, and$19.6 million and $43.0 million for the three and nine months ended September 30,2008, respectively.

 

***Revenues***

 

Our revenues consist of both product revenues and service revenues. Wederive product revenues from the sale of our hardware products and thelicensing of our software. Service revenues are generated from:

 

·maintenance and technical support associated with our software;

 

· hardwarerepair and maintenance services; and

 

·implementation, training and professional services.

 

We recognize revenue inaccordance with Statement of Position, or SOP, 97-2, *Software Revenue Recognition* and SOP 98-9, *Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions*. Accordingly,revenue is recognized when persuasive evidence of an arrangement exists,delivery has occurred, the price is fixed or determinable and collection isprobable.

 

Mobile operators can purchase our products and license our software invarious configurations, depending on their requirements for capacity, featuresand protocols. Typically, a mobile operator will use a small amount ofequipment for testing and trial purposes and, once testing is complete, willpurchase the necessary products to meet their initial capacity and featurerequirements. As their capacity requirements increase, operators may purchaseadditional hardware or license additional software. The level of our sales issignificantly influenced by the extent to which mobile operators make capitalinvestments to enhance and expand their networks to provide multimediaservices. Mobile operators’ capital investments will be influenced by thedemand for multimedia services by their customers.

 

We offer our products and services through our direct sales force tomobile operators and indirectly through relationships with OEMs, systemintegrators and distributors. The OEMs, system integrators and distributorsgenerally purchase our products after they have received a purchase order fromtheir customers and do not maintain an inventory of our products inanticipation of sales to their customers.

 

In 2004, we entered into OEM agreements with Nortel Networks relatingto the CDMA and GSM/UMTS markets. Sales to Nortel Networks, all of which weremade under the CDMA agreement, accounted for more than 40% of our revenues in2006. In December 2006, we terminated both OEM agreements. Under the termsof the CDMA agreement, Nortel Networks has a right to continue to purchase ourCDMA products for delivery through December 2008. Although the terminationof the CDMA agreement could disrupt our relationships with CDMA mobileoperators formerly serviced by Nortel Networks, we have established and willcontinue to seek to establish additional direct sales relationships with someof the CDMA operators formerly serviced by Nortel Networks. In addition, in May 2008,we established a new reseller relationship with Nortel Networks. As a result,we do not believe that the termination of the Nortel Networks OEM agreementswill significantly impact our revenues.

 

We believe our revenues will vary significantly from period-to-periodas a result of the following:

 

·*Fluctuations in the timing of customer orders.*  Mobileoperators require significant lead times to incorporate changes andenhancements into their networks to ensure the various network components areinteroperable. These lead times and interoperability testing requirementsresult in an extended sales cycle and can lead to uneven purchasing patterns.In addition, our reliance on a relatively small number of customers contributesto the variability of our revenues.

 

·*The timing of revenue recognition in relation to theshipment of products.*  Our products contain software whichis not incidental to our products. Therefore, we recognize revenue pursuant tothe requirements of SOP 97-2.  Those requirements often cause us to deferrecognition of revenue for a significant period of time after shipment, as aconsequence of certain features of our customer arrangements (such as customeracceptance provisions) as well as the requirement that we establishcompany-specific evidence of the fair values of our products and services.

 

The variability of our revenues directly impacts our operatingperformance in any particular period since a significant portion of ouroperating costs, such as personnel costs, depreciation expense and salescommissions, are either fixed in the short-term or may not vary proportionatelywith recorded revenues.

 

***Cost of Revenues***

 

Cost of revenues consists of costs of products sold and servicesprovided. Cost of products consists primarily of payments to a third partymanufacturer for purchased materials and services and internal costs, such assalaries and benefits related to personnel, 

 

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provision for inventory obsolescence and related overhead. The use ofan outsourced manufacturer enables us to conserve working capital, adjust tofluctuations in demand and provide for timely delivery to our customers. Costof services consists primarily of salaries and benefits related to professionalservices and technical support personnel, product repair costs, depreciationand related overhead.

 

***Gross Profit***

 

Our gross profit has been, and will be, affected by many factors,including the demand for our products and services, the average selling priceof our products, which in turn depends on the mix of product configurationssold, new product introductions, the region of the world in which our customersare located and the volume and costs of manufacturing our hardware products.

 

***Operating Expenses***

 

Our operating expenses consist primarily of personnel costs, includingsalaries, commissions, bonuses, share-based compensation and related benefitsand taxes; prototype costs related to the design and development of newproducts and enhancement of existing products; and consulting, travel anddepreciation expenses. The expenses are classified into the followingcategories for reporting purposes: research and development, sales andmarketing and general and administrative. The following is a brief descriptionof the key types of expenses in each of these categories:

 

· Researchand development expense consists primarily of personnel costs, prototype costs,consulting services and depreciation. Research and development activities,including hardware and software development and quality assurance testing,primarily occur at two locations in the United States and two locations inIndia.

 

· Salesand marketing expense consists primarily of personnel costs, consultingservices, travel and marketing programs such as trade shows. Commissions are asignificant component of our sales personnel costs and are recorded as expensewhen earned, which is not necessarily directly proportionate to the amount ofrevenues recorded.

 

· Generaland administrative expense consists primarily of personnel costs related to ourexecutive, finance, legal, human resource and information technologyorganizations, professional fees, insurance and other related overhead.

 

***Other Income(Expense)***

 

Other income (expense) primarily consists of interest income earned oncash and short-term investments. We have historically invested our cash inmoney market funds and other short-term, high-grade investments.

 

Other income (expense) also includes gains (losses) from foreigncurrency transactions with international customers and our foreignsubsidiaries. The functional currency of our foreign operations is the U.S.dollar. Accordingly, all assets and liabilities, except certain long-termassets, of these international subsidiaries are remeasured into U.S. dollarsusing the exchange rates in effect at the balance sheet date. Revenues andexpenses of these international subsidiaries are generally remeasured into U.S.dollars at the average rates in effect during the year.

 

**Application of Critical Accounting Policiesand Use of Estimates**

 

Our financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements and related disclosures require us to makeestimates, assumptions and judgments that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. We base our estimates on historical experience andon various other assumptions that we believe to be reasonable under thecircumstances. We evaluate our estimates and assumptions on an ongoing basis.Our actual results may differ significantly from these estimates underdifferent assumptions or conditions.

 

We believe that of our significant accounting policies, which aredescribed in note 2 to the consolidated financial statements included inour Annual Report on Form 10-K for the year ended December 31, 2007,the following accounting policies involve a greater degree of judgment andcomplexity. Accordingly, we believe these are the most critical to fullyunderstand and evaluate our financial condition and results of operations.

 

***Revenue Recognition***

 

Generally, our revenues are generated through fulfillment ofcontractual arrangements that contain multiple elements, including equipmentwith embedded software and services, such as installation, training, consultingand maintenance and support, or M&S. We recognize revenue in accordancewith SOP 97-2 and SOP 98-9. Accordingly, revenue is recognized whenpersuasive evidence of an arrangement exists, delivery has occurred, the priceis fixed or determinable and collection is probable. Certain of theserequirements, most notably the customer acceptance terms generally included inour contracts and our need to establish fair values of our products andservices based on facts specific to our operations, are critical to the timingand extent of our revenue recognition. As a result of these factors, asignificant majority of our contractual arrangements result in the deferral ofrevenue and the time period for deferral 

 

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may be significant. In addition, in certain circumstances, pricingconsiderations must be assessed to determine whether the price is fixed ordeterminable.

 

Product revenues consist of revenues from sales of our hardware andlicensing of our software. Product sales generally include a perpetual licenseto our software. Product revenues are generally recognized at shipment or uponcustomer acceptance, if contractually required, assuming all other revenuerecognition criteria are met. Substantially all of our products have been soldin conjunction with product support services, which consist of software updatesand product support. Software updates provide customers with rights tounspecified software product upgrades and to maintenance releases and patchesreleased during the term of the support period. Revenues for support servicesare recognized on a straight-line basis over the service contract term, which isgenerally 12 to 15 months.

 

Pursuant to SOP 97-2, revenue is allocated to deliverables basedon vendor specific objective evidence of fair value, or VSOE, when VSOE exists.Generally, all revenue for an arrangement is initially deferred when VSOE doesnot exist for any undelivered element and is subsequently recognized ratablyover the contractual M&S period when M&S is the only undeliveredelement. If VSOE exists for the undelivered elements, but not the deliveredelements, revenue is recognized under the residual method set forth inSOP 98-9, which provides that revenue is recognized based on thedifference between the total arrangement fee and the VSOE of the undeliveredelements. Revenue for the undelivered elements is then recorded as those elementsare delivered. When we defer revenue in an arrangement, the related productcosts are also deferred, subject to their realizability, and recognized in orover the same period as the related revenue.

 

The determination of VSOE is highly judgmental and is a key factor indetermining whether revenue may be recognized or must be deferred and theextent to which it may be recognized once the various elements of anarrangement are delivered. We assess VSOE based on previous sales of productsand services, the type and size of customer, renewal rates in contracts and thegeographic location of the customer. We monitor VSOE on an ongoing basis. Asnoted above, most of our arrangements include multiple elements, some of whichare delivered in or over future periods. Therefore, a change in our assessmentof, or our inability to establish, VSOE for products or services may result insignificant variation in our revenues and operating results.

 

In arrangements wherecash consideration is paid to a customer, the payments are recorded inaccordance with Emerging Issues Task Force, or EITF, 01-9,*Accounting for Consideration Given by a Vendor to aCustomer (Including a Reseller of the Vendor’s Products)*, whichgenerally requires the consideration be recorded as a reduction of revenues.

 

***Share-BasedCompensation***

 

Prior to January 1,2006, we accounted for our stock-based awards to employees using the intrinsicvalue method prescribed in Accounting Principles Board, or APB, Opinion 25,*Accounting for Stock Issued to Employees*,and related interpretations. Under the intrinsic value method, compensationexpense is measured on the date of the grant as the difference between thedeemed fair value of our common stock and the exercise or purchase pricemultiplied by the number of stock options or restricted stock awards granted.In addition, through December 31, 2005, we accounted for share-basedcompensation expense for non-employees using the fair value method prescribedby Statement of Financial Accounting Standards, or SFAS, 123,*Accounting for Stock-Based Compensation,*applying the Black-Scholes option-pricing model, and recorded the fair value,for financial reporting purposes, of non-employee stock options as an expenseover either the vesting term of the option or the service period.

 

In December 2004,the Financial Accounting Standards Board, or FASB, issued SFAS 123R, *Share-Based Payment*, which requirescompanies to expense the fair value of employee stock options and other formsof share-based compensation. We adopted SFAS 123R effective January 1,2006. SFAS 123R requires nonpublic companies that used the minimum valuemethod in SFAS 123 for either recognition or pro forma disclosures toapply SFAS 123R using the prospective-transition method. As such, we willcontinue to apply APB Opinion 25 in future periods to equity awards outstandingprior to the date of our adoption of SFAS 123R. In accordance withSFAS 123R, we will recognize the compensation cost of share-based awardson a graded-vesting basis over the vesting period of the award. Effective withthe adoption of SFAS 123R, we elected to use the Black-Scholes optionpricing model to determine the weighted average fair value of stock optionsgranted or modified.

 

Since January 1, 2006, we account for equity instruments issued tononemployees in accordance with the provisions of SFAS 123R (therequirements of which are consistent with those previously utilized underSFAS 123) and EITF Issue 96-18,*Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services*.

 

Several key assumptionsare made in determining the grant date fair value of our stock options,including: the grant date market value of our common stock, the rate ofvolatility, the risk-free interest rate and the rate of expected forfeitures.As there was no public market for our common stock prior to our initial publicoffering, the determination of the fair market value of our common stock wasdetermined by our board of directors. Due to the limited trading history of ourcommon stock, we have determined the volatility for options granted after January 1,2006 based on an analysis of reported data for a peer group of companies thatissued options with substantially similar terms. The expected volatility ofoptions granted has been determined using an average of the historical tradingactivity of our common stock, implied volatility and the historical volatilitymeasures of this peer group of companies. The expected life of options has beendetermined utilizing the “simplified” method as prescribed by the SEC’s StaffAccounting Bulletin No. 110,*Share-Based Payment*, resulting in an expected life for the three andnine months ended September 30, 2008 and 2007 of 6.25 years. Therisk-free interest rate is based on a U.S. treasury instrument whose term isconsistent with the expected life of the stock options. We have not paid, anddo not anticipate paying, cash dividends on our shares of common stock;therefore, the expected dividend yield 

 

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was assumed to bezero. In addition, SFAS 123R requires companies to utilize an estimatedforfeiture rate when calculating the expense for the period. As a result, weapplied an estimated forfeiture rate of 3%, based on a review of our historicalforfeitures, to determine the expense recorded in our consolidated statementsof operations. Significant changes in these assumptions, especially theexpected life of options, forfeiture rate and volatility could have asignificant impact on our results of operations.

 

For the three and nine months ended September 30, 2008, werecorded expense of $4.5 million and $12.4 million in connection withshare-based awards. As of September 30, 2008, we had $22.6 million ofunrecognized expense related to non-vested options that is expected to berecognized over a weighted average period of 1.5 years.

 

***Inventory***

 

We carry our inventory at the lower of historical cost or netrealizable value assuming inventory items are consumed on a first-in, first-outbasis. We recognize inventory losses based on obsolescence and levels in excessof forecasted demand. In these cases, inventory is written down to estimatedrealizable value based on historical usage and expected demand. Inherent in ourestimates of market value in determining inventory valuation are estimatesrelated to economic trends, future demand for our products and technicalobsolescence of our products. If future demand or market conditions are lessfavorable than our projections, additional inventory write-downs could berequired and would be reflected in the cost of revenues in the period therevision is made. To date, we have not been required to revise any of ourassumptions or estimates used to determine our inventory valuations.

 

When products have been delivered, but the product revenues associatedwith the arrangement have been deferred as a result of not meeting the revenuerecognition criteria required by SOP 97-2, we defer the related inventorycosts for the delivered items.

 

***Income Taxes***

 

We are subject to incometaxes in both the United States and foreign jurisdictions and we use estimatesin determining our provisions for income taxes. We account for income taxes inaccordance with SFAS 109,*Accountingfor Income Taxes*, which is the asset and liability method foraccounting and reporting for income taxes. Under SFAS 109, deferred taxassets and liabilities are recognized based on temporary differences betweenthe financial reporting and income tax bases of assets and liabilities usingstatutory rates.  We provide for incometaxes during interim periods based on the estimated effective tax rate for thefull fiscal year, and record a cumulative adjustment to the tax provision in aninterim period in which a change in the estimated annual effective tax rate isdetermined.

 

For the three and nine months ended September 30, 2008, oureffective tax rates were (33.6%) and (7.8%), respectively. The net tax benefitrecorded in the three and nine months ended September 30, 2008 wasprimarily due to (i) a tax benefit of $6.6 million recorded upon ourdecision in the third quarter of 2008 to release a substantial portion of thevaluation allowance recorded against net deferred tax assets and (ii) aprovision of $0.2 million to reserve an uncertain tax position in a foreignjurisdiction. For the three and nine months ended September 30, 2007, oureffective tax rates were 16.9% and 9.1%, respectively. Those effective taxrates were lower than the statutory federal income tax rate of 35% dueprimarily to our use of net operating loss carryforwards, or NOLs, and researchand development tax credits to offset our U.S. taxable income (which reduced thevaluation allowance we had previously recorded against those NOLs), partiallyoffset by the impact of taxes owed in relation to the income generated by ourforeign subsidiaries.

 

As of the end of the second quarter of 2008, a full valuation allowancewas recorded against our net deferred tax assets. Based upon our operatingresults over recent years and through September 30, 2008 as well as anassessment of our expected future results of operations, we determined in thethird quarter of 2008 that it had become “more likely than not” that we willrealize a substantial portion of our deferred tax assets in the U.S. As aresult, we reduced our valuation allowance during the third quarter of 2008,which resulted in recognition of a deferred tax asset of $8.6 million, aone-time income tax benefit of $6.6 million (noted above) and a $2.0 millionreserve for uncertain tax positions in the U.S., which is recorded in otherlong-term liabilities.

 

As of the end of the third quarter of 2008,we have a remaining valuation allowance of $5.2 million which will be releasedin the fourth quarter of 2008 in accordance with the requirements under SFAS109 to use an annualized effective tax rate for each interim period during theyear in which a valuation allowance release has occurred, including any interimperiod after the valuation allowance release has been released.

 

Income tax expense related to our international subsidiaries generallyresults from taxable income generated by the subsidiary pursuant tointercompany service agreements. We believe the compensation associated withthese service agreements is reasonable in light of the level and nature ofservices performed by our subsidiaries. However, if a foreign tax jurisdictionor the Internal Revenue Service were to challenge these arrangements, we couldbe subject to additional income tax expense either in the United States or theforeign jurisdiction.

 

We have accumulated significant net operating losses from our inceptionin August 2000. Since the net operating losses have been and will beutilized to reduce taxable income, all of our tax years remain open toexamination by the major taxing jurisdictions to which we are subject.

 

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On January 1, 2007,we adopted the provisions of FASB Interpretation, or FIN, No. 48, *Accounting for Uncertainty in Income Taxes*,*an interpretation of SFAS 109*.The new standard defines the threshold for recognizing the benefits of taxreturn positions in the financial statements as “more-likely-than-not” to besustained by the taxing authorities based solely on the technical merits of theposition. If the recognition threshold is met, the tax benefit is measured andrecognized as the largest amount of tax benefit, in our judgment, which isgreater than 50% likely to be realized. We did not recognize any change in ourreserves for uncertain tax positions as a result of the adoption of thisstandard. At the adoption date of January 1, 2007, we had $0.1 million ofunrecognized tax benefits, the benefit of which, if recognized, would favorablyaffect the income tax rate in future periods. At September 30, 2008, wehad a liability of approximately $2.5 million of unrecognized tax benefits. Ifrecognized, the benefit of $1.9 million of this amount would favorably affectthe income tax rate in future periods.

 

We recognize interest and penalties related to uncertain tax positionsin income tax expense. Upon our adoption of FIN 48 and at September 30,2008, we had an immaterial amount of accrued interest and penalties associatedwith our uncertain tax positions.

 

***Research andDevelopment Expense***

 

Research and development expense includes costs incurred to developintellectual property. Research and development costs are charged to operationsas incurred. The costs to develop new software and substantial enhancements toexisting software are expensed as incurred until technological feasibility hasbeen established, at which time any additional costs would be capitalized. Wehave determined technological feasibility is established at the time a workingmodel of software is completed. The time period during which costs could becapitalized, from the point of reaching technological feasibility until thetime of general product release, is short. Consequently, the amounts that couldbe capitalized are not material to our financial position or results ofoperations and therefore have been charged to expense as incurred.

 

**Results of Operations**

 

*Revenues*

 

The following table sets forth our revenues by type and geographiclocation of our customers.

 
| ** **                     | ** ** | **Three Months Ended September 30,** | ** ** | ** **    | ** ** | ** **           | ** ** |
|--------------------------------|------------|----------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                     | ** ** | **2008**                                                 | ** ** | **2007**      | ** ** | **Period-to-Period** | ** ** |
| ** **                     | ** ** | ** **                                               | ** ** | **% of** | ** ** | ** **           | ** ** | **% of** | ** ** | **Change** | ** ** |
| ** **                     | ** ** | **Amount**                                               | ** ** | **Revenues**  | ** ** | **Amount**           | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**                     | ** ** |
| **Revenues:**                  |       |                                                     |       |          |       |                 |       |   |   |   |   |   |   |
| Product                        |       | $                                                        | 55,450     |          | 84         | %                    |       | $ | 31,588 |   | 86 | % |   | $ | 23,862 |   | 76 | % |   |
| Service                        |       | 10,611                                                   |       | 16            |       |                 | 5,103      |   | 14 |   |   | 5,508 |   | 108 |   |   |
| Total revenues                 |       | $                                                        | 66,061     |          | 100        | %                    |       | $ | 36,691 |   | 100 | % |   | $ | 29,370 |   | 80 | % |   |
|                           |       |                                                     |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| **Revenues by Customer Type:** |       |                                                     |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| Direct                         |       | $                                                        | 54,070     |          | 82         | %                    |       | $ | 26,076 |   | 71 | % |   | $ | 27,994 |   | 107 | % |   |
| Indirect                       |       | 11,991                                                   |       | 18            |       |                 | 10,615     |   | 29 |   |   | 1,376 |   | 13 |   |   |
| Total revenues                 |       | $                                                        | 66,061     |          | 100        | %                    |       | $ | 36,691 |   | 100 | % |   | $ | 29,370 |   | 80 | % |   |
|                           |       |                                                     |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| **Revenues by Geography:**     |       |                                                     |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| United States and Canada       |       | $                                                        | 54,977     |          | 83         | %                    |       | $ | 26,863 |   | 73 | % |   | $ | 28,114 |   | 105 | % |   |
| Japan                          |       | 6,788                                                    |       | 10            |       |                 | 4,522      |   | 12 |   |   | 2,266 |   | 50 |   |   |
| Korea                          |       | 3,427                                                    |       | 5             |       |                 | 4,129      |   | 11 |   |   | (702 | ) | (17 | ) |   |
| Rest of world                  |       | 869                                                      |       | 1             |       |                 | 1,177      |   | 3 |   |   | (308 | ) | (26 | ) |   |
| Total revenues                 |       | $                                                        | 66,061     |          | 100        | %                    |       | $ | 36,691 |   | 100 | % |   | $ | 29,370 |   | 80 | % |   |

 

Revenues increased $29.4 million, or 80%, in the quarter ended September 30,2008 compared to the same quarter in 2007, primarily due to increased productrevenues of $23.9 million. Product revenues increased primarily due to productshipments in the United States and Canada for which we received customeracceptances and recognized revenue in the third quarter of 2008 versus the sameperiod of 2007 and to a lesser extent due to the higher sales price of our ST40platform as compared to our ST16 platform. Japan revenues increased $2.3million, or 50%, in the quarter ended September 30, 2008 compared to thesame quarter in 2007, primarily due to customer acceptances received in thecurrent quarter.

 

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The $5.5 million increase in service revenues in the third quarterof 2008 compared to the same period in 2007 was due to an increased amount ofour products installed at mobile operators, which is generally the basis ofmaintenance and service fees, as compared to the same period in 2007.

 

Indirect revenue increased $1.4 million, or 13%, in the third quarterof 2008 compared to the third quarter of 2007 due primarily to an increase inOEM sales.

 
| ** **                 | ** ** | **Nine Months Ended September 30,** | ** ** | ** **    | ** ** | ** **           | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                 | ** ** | **2008**                                                | ** ** | **2007**      | ** ** | **Period-to-Period** | ** ** |
| ** **                 | ** ** | ** **                                              | ** ** | **% of** | ** ** | ** **           | ** ** | **% of** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                              | ** ** | **Revenues**  | ** ** | **Amount**           | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**                    | ** ** |
| **Revenues:**              |       |                                                    |       |          |       |                 |       |   |   |   |   |   |   |
| Product                    |       | $                                                       | 156,497    |          | 85         | %                    |       | $ | 81,160 |   | 85 | % |   | $ | 75,337 |   | 93 | % |   |
| Service                    |       | 26,960                                                  |       | 15            |       |                 | 14,026     |   | 15 |   |   | 12,934 |   | 92 |   |   |
| Total revenues             |       | $                                                       | 183,457    |          | 100        | %                    |       | $ | 95,186 |   | 100 | % |   | $ | 88,271 |   | 93 | % |   |
|                       |       |                                                    |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| **Revenues by Type:**      |       |                                                    |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| Direct                     |       | $                                                       | 163,391    |          | 89         | %                    |       | $ | 55,169 |   | 58 | % |   | $ | 108,222 |   | 196 | % |   |
| Indirect                   |       | 20,066                                                  |       | 11            |       |                 | 40,017     |   | 42 |   |   | (19,951 | ) | (50 | ) |   |
| Total revenues             |       | $                                                       | 183,457    |          | 100        | %                    |       | $ | 95,186 |   | 100 | % |   | $ | 88,271 |   | 93 | % |   |
|                       |       |                                                    |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| **Revenues by Geography:** |       |                                                    |       |          |       |                 |       |   |   |   |   |   |   |   |   |   |
| United States and Canada   |       | $                                                       | 164,619    |          | 90         | %                    |       | $ | 63,799 |   | 67 | % |   | $ | 100,820 |   | 158 | % |   |
| Japan                      |       | 11,927                                                  |       | 7             |       |                 | 18,046     |   | 19 |   |   | (6,119 | ) | (34 | ) |   |
| Korea                      |       | 5,501                                                   |       | 3             |       |                 | 10,402     |   | 11 |   |   | (4,901 | ) | (47 | ) |   |
| Rest of world              |       | 1,410                                                   |       | 1             |       |                 | 2,939      |   | 3 |   |   | (1,529 | ) | (52 | ) |   |
| Total revenues             |       | $                                                       | 183,457    |          | 100        | %                    |       | $ | 95,186 |   | 100 | % |   | $ | 88,271 |   | 93 | % |   |

 

Revenues increased $88.3 million, or 93%, in the nine months endedSeptember 30, 2008 as compared to the same period in 2007, primarily dueto increased product sales to existing customers. Product revenues, whichinclude hardware and software sales, increased $75.3 million for the ninemonths ended September 30, 2008 as compared to the same period in 2007 dueprimarily to increased sales to major mobile operators in the United States andCanada. The increase in revenues was partially offset by the decrease inrevenues in Japan and Korea.  Thedecreases in Japan and Korea were related primarily to lower acceptances andshipments in the current year.

 

*Cost of Revenues and Gross Profit*

 

The following table sets forth our cost of revenues and gross profit.

 
| ** **             | ** ** | **Three Months Ended September 30,** | ** ** | ** **    | ** ** | ** ** | ** ** |
|------------------------|------------|----------------------------------------------------------|------------|---------------|------------|------------|------------|
| ** **             | ** ** | **2008**                                                 | ** ** | **2007**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | ** **                                               | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** | **Period-to-Period** | ** ** |
| ** **             | ** ** | ** **                                               | ** ** | **Related**   | ** ** | ** ** | ** ** | **Related** | ** ** | **Change** | ** ** |
| ** **             | ** ** | **Amount**                                               | ** ** | **Revenues**  | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **             | ** ** | **(dollars in thousands)**                     | ** ** |
| **Cost of revenues:**  |       |                                                     |       |          |       |       |       |   |   |   |   |   |   |
| Product                |       | $                                                        | 10,151     |          | 18         | %          |       | $ | 7,422 |   | 23 | % |   | $ | 2,729 |   | 37 | % |   |
| Services               |       | 4,107                                                    |       | 39            |       |       | 2,723      |   | 53 |   |   | 1,384 |   | 51 |   |   |
| Total cost of revenues |       | $                                                        | 14,258     |          | 22         | %          |       | $ | 10,145 |   | 28 | % |   | $ | 4,113 |   | 41 | % |   |
| **Gross Profit:**      |       |                                                     |       |          |       |       |       |   |   |   |   |   |   |   |   |   |
| Product                |       | $                                                        | 45,299     |          | 82         | %          |       | $ | 24,166 |   | 77 | % |   | $ | 21,133 |   | 87 | % |   |
| Services               |       | 6,504                                                    |       | 61            |       |       | 2,380      |   | 47 |   |   | 4,124 |   | 173 |   |   |
| Total gross profit     |       | $                                                        | 51,803     |          | 78         | %          |       | $ | 26,546 |   | 72 | % |   | $ | 25,257 |   | 95 | % |   |

 

Product gross margin increased 5 percentage points to 82% in the thirdquarter of 2008 as compared to the same period in 2007. Both periods includedhigher levels of software-only transactions, resulting in gross margins higherthan our historical amounts.

 

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Service gross margin increased 14 percentage points to 61% in the thirdquarter of 2008 as compared to the same period in 2007. The increase was due toa 108% increase in service revenues compared to a 51% increase in expenses.During the third quarter of 2008, the $1.4 million, or 51%, increase in cost ofservices was primarily due to higher personnel and overhead costs associatedwith additional customer support and training personnel that were added sincethe third quarter of 2007. We anticipate cost of services will increase infuture periods as we continue to expand our customer support organizationgeographically in future periods.

 
| ** **             | ** ** | **Nine Months Ended September 30,** | ** ** | ** **    | ** ** | ** ** | ** ** |
|------------------------|------------|---------------------------------------------------------|------------|---------------|------------|------------|------------|
| ** **             | ** ** | **2008**                                                | ** ** | **2007**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | ** **                                              | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** | **Period-to-Period** | ** ** |
| ** **             | ** ** | ** **                                              | ** ** | **Related**   | ** ** | ** ** | ** ** | **Related** | ** ** | **Change** | ** ** |
| ** **             | ** ** | **Amount**                                              | ** ** | **Revenues**  | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **             | ** ** | **(dollars in thousands)**                    | ** ** |
| **Cost of revenues:**  |       |                                                    |       |          |       |       |       |   |   |   |   |   |   |
| Product                |       | $                                                       | 28,697     |          | 18         | %          |       | $ | 18,176 |   | 22 | % |   | $ | 10,521 |   | 58 | % |   |
| Services               |       | 11,823                                                  |       | 44            |       |       | 6,052      |   | 43 |   |   | 5,771 |   | 95 |   |   |
| Total cost of revenues |       | $                                                       | 40,520     |          | 22         | %          |       | $ | 24,228 |   | 25 | % |   | $ | 16,292 |   | 67 | % |   |
| **Gross Profit:**      |       |                                                    |       |          |       |       |       |   |   |   |   |   |   |   |   |   |
| Product                |       | $                                                       | 127,800    |          | 82         | %          |       | $ | 62,984 |   | 78 | % |   | $ | 64,816 |   | 103 | % |   |
| Services               |       | 15,137                                                  |       | 56            |       |       | 7,974      |   | 57 |   |   | 7,163 |   | 90 |   |   |
| Total gross profit     |       | $                                                       | 142,937    |          | 78         | %          |       | $ | 70,958 |   | 75 | % |   | $ | 71,979 |   | 101 | % |   |

 

Product gross margin increased 4 percentagepoints as a percentage of revenue in the first nine months of 2008 as comparedto the same period in 2007 due primarily to a higher proportion of softwarerevenue and to a lesser extent the higher average sales price of our ST40.

 

The $5.8 million increase in cost ofservices was primarily due to higher personnel costs, depreciation expense andoverhead costs associated with additional customer support and trainingpersonnel that were added during 2008 and in the second half of 2007. Weanticipate cost of services will increase in future periods as we continue toincrease the number of customer support personnel we employ and continue toexpand our customer support testing facilities.

 

Gross profit on services decreased 1% duringthe first nine months of 2008 as a result of the increased costs of servicesdescribed above.

 

*Operating Expenses*

 

The following table sets forth our operating expenses.

* *
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** | ** **    | ** ** | ** **           | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                 | ** ** | **2008**                                                 | ** ** | **2007**      | ** ** | **Period-to-Period** | ** ** |
| ** **                 | ** ** | ** **                                               | ** ** | **% of** | ** ** | ** **           | ** ** | **% of** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                               | ** ** | **Revenues**  | ** ** | **Amount**           | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**                     | ** ** |
| Research and development   |       | $                                                        | 13,750     |          | 21         | %                    |       | $ | 10,612 |   | 29 | % |   | $ | 3,138 |   | 30 | % |   |
| Sales and marketing        |       | 17,894                                                   |       | 27            |       |                 | 11,940     |   | 33 |   |   | 5,954 |   | 50 |   |   |
| General and administrative |       | 6,129                                                    |       | 9             |       |                 | 4,164      |   | 11 |   |   | 1,965 |   | 47 |   |   |
| Total operating expenses   |       | $                                                        | 37,773     |          | 57         | %                    |       | $ | 26,716 |   | 73 | % |   | $ | 11,057 |   | 41 | % |   |

* *
| ** **                 | ** ** | **Nine Months Ended September 30,** | ** ** | ** **    | ** ** | ** **           | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                 | ** ** | **2008**                                                | ** ** | **2007**      | ** ** | **Period-to-Period** | ** ** |
| ** **                 | ** ** | ** **                                              | ** ** | **% of** | ** ** | ** **           | ** ** | **% of** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                              | ** ** | **Revenues**  | ** ** | **Amount**           | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**                    | ** ** |
| Research and development   |       | $                                                       | 38,594     |          | 21         | %                    |       | $ | 28,263 |   | 30 | % |   | $ | 10,331 |   | 37 | % |   |
| Sales and marketing        |       | 52,918                                                  |       | 29            |       |                 | 27,876     |   | 29 |   |   | 25,042 |   | 90 |   |   |
| General and administrative |       | 17,215                                                  |       | 9             |       |                 | 10,405     |   | 11 |   |   | 6,810 |   | 65 |   |   |
| Total operating expenses   |       | $                                                       | 108,727    |          | 59         | %                    |       | $ | 66,544 |   | 70 | % |   | $ | 42,183 |   | 63 | % |   |

 

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*PersonnelCosts.*    Personnel costs are our largestexpense, representing 63% and 64% of our total operating expenses for the threeand nine months ended September 30, 2008, respectively. These costsconsist of cash and stock components. The cash component of compensationincluded in each expense category is set forth below.

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                 | ** ** |
| Research and development                   |       | $                                                    | 6,177      |                                                | $          | 5,162 |   | $ | 1,015 |   | $ | 18,761 |   | $ | 14,631 |   | $ | 4,130 |   |
| Sales and marketing                                  |       | 11,172                                               |       | 7,433                                               |       | 3,739 |   | 33,217 |   | 16,966 |   | 16,251 |   |
| General and administrative                           |       | 2,097                                                |       | 1,313                                               |       | 784 |   | 5,762 |   | 3,579 |   | 2,183 |   |
| Total cash-based compensation in operating  expenses |       | $                                                    | 19,446     |                                                | $          | 13,908 |   | $ | 5,538 |   | $ | 57,740 |   | $ | 35,176 |   | $ | 22,564 |   |

 

The increases inpersonnel costs above were due primarily to a higher number of employees andhigher sales commissions in the three and nine months ended September 30,2008 compared to the same periods of 2007. We added 164 employees since September 30,2007, 80 in research and development (primarily in India), 37 in sales andmarketing, 27 in support, 15 in general and administrative and 5  in operations, resulting in total employeesof 739 at September 30, 2008. The increase in commissions was due to ourhigh sales volume in the latter half of 2007 for which commissions were earnedduring 2008 and our higher level of sales activity in 2008. We anticipate salescommissions as a percentage of revenues to decrease in the fourth quarter of2008.

 

In addition to cashcompensation, we grant equity instruments to our employees, resulting in therecognition of share-based compensation in accordance with SFAS 123R,which is a significant portion of our personnel costs. The share-basedcompensation included in each expense category is set forth below.

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                            | ** ** | **(dollars in thousands)**                 | ** ** |
| Research and development                              |       | $                                                    | 1,594      |                                                | $          | 1,947 |   | $ | (353 | ) | $ | 4,701 |   | $ | 4,088 |   | $ | 613 |   |
| Sales and marketing                                   |       | 1,457                                                |       | 650                                                 |       | 807 |   | 3,750 |   | 1,643 |   | 2,107 |   |
| General and administrative                            |       | 1,115                                                |       | 948                                                 |       | 167 |   | 2,909 |   | 2,370 |   | 539 |   |
| Total share-based compensation in operating  expenses |       | $                                                    | 4,166      |                                                | $          | 3,545 |   | $ | 621 |   | $ | 11,360 |   | $ | 8,101 |   | $ | 3,259 |   |

 

These charges amounted to6% of revenues for the three and nine months ended September 30, 2008. Theincrease in the share-based compensation expense in the 2008 period as comparedto the same periods of 2007 was due primarily to the increase in the fair valueof our common stock at the time the share-based awards were granted and ourhigher number of employees.

 

*Research and development.*    Researchand development expenses increased $3.1 million, or 30%, in the thirdquarter of 2008 compared to the same quarter in 2007. The increase was due toincreases in cash compensation of $1.0 million, higher depreciationexpense of $1.5 million and higher consulting expense of $0.9 million,partially offset by a decrease in share-based compensation of $0.4million.  The increase in cashcompensation was primarily due to the addition of employees, as discussedabove. The increase in consulting expenses was due primarily to theinteroperability testing of our products with other vendors’ network elements.The increase in depreciation was due to our research and development capitalexpenditures primarily utilized in our quality assurance and customer labtesting facilities.

 

Research and developmentexpenses increased $10.3 million, or 37%, for the nine months ended September 30,2008 compared to the same period in 2007. The increase was due to increases incash and share-based compensation of $4.1 million and $0.6 million,respectively, higher depreciation expense of $4.0 million, higherconsulting expense of $2.0 million and a $1.3 million decrease related toreimbursements for non-recurring engineering projects which are recorded as areduction of research and development expense, partially offset by lowerprototype and related equipment expenses of $2.6 million. The increase in cashcompensation was primarily due to the addition of employees, as discussedabove. The increases in consulting and depreciation are due largely to the samereasons noted above.

 

We intend to continue toinvest significantly in our research and development efforts, which we believeare essential to maintaining our competitive position. Accordingly, weanticipate personnel costs and depreciation expense will increase during theremainder of 2008 as we continue to add product development and qualityassurance personnel and to increase our test lab facilities.

 

*Salesand marketing.*    Sales and marketingexpenses increased $6.0 million, or 50%, in the third quarter of 2008 ascompared to the same period in 2007 and decreased as a percentage of revenues.This increase was due primarily to higher cash compensation of$3.7 million and share-based compensation of $0.8 million and travelexpenses of $0.2 million. Cash compensation increased primarily due to theaddition of employees, as discussed above.

 

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Sales and marketingexpenses increased $25.0 million, or 90%, for the nine months ended September 30,2008 as compared to the same period in 2007, but remained consistent as apercentage of revenues. This increase was due primarily to higher cash compensationof $16.3 million and share-based compensation of $2.1 million, consultingexpense of $2.1 million, demonstration expenses of $0.7 million and travelexpenses of $0.9 million. Cash compensation increased primarily due to theaddition of employees, as discussed above. Consulting expenses increased due toarrangements we have with third party consultants whose fees are earned as wereceive orders from specific customers, and the increase in travel expense wasdue primarily to our employee additions. Demonstration expenses increased as a result of the expansion of oursales activities geographically.

 

We anticipate continuingto increase the number of sales and marketing personnel we employ in futureperiods to expand our geographic presence, to address specific customeropportunities and to increase our revenues. The commission portion of salespersonnel costs may vary significantly if our customer orders differ materiallyfrom the quotas established for our sales personnel. In addition, we expect tocontinue to incur additional expenses such as demonstration andinteroperability testing associated with our products in existing and newmarkets.

 

*Generaland administrative.*    General andadministrative expenses increased $2.0 million, or 47%, in the thirdquarter of 2008 as compared to the same period in 2007 due primarily to highercash compensation of $0.8 million and share-based compensation of $0.2 millionand professional fees of $0.9 million. The increase in cash compensation wasprimarily due to the addition of employees, as discussed above. The increasesin professional fees were due primarily to the UTStarcom litigation and feesassociated with the compliance requirements of Section 404 of theSarbanes-Oxley Act of 2002.

 

General andadministrative expenses increased $6.8 million, or 65%, for the ninemonths ended September 30, 2008 as compared to the same period in 2007 dueprimarily to higher cash compensation of $2.2 million and share-basedcompensation of $0.5 million and professional fees of $3.5 million. Theincrease in cash compensation was primarily due to the addition of employees,as discussed above. The increase in professional fees was due primarily to costsassociated with our defense in the UTStarcom litigation.

 

We expect general andadministrative expense to increase in future periods as we invest ininfrastructure to support continued growth and incur additional costs relatedto operating as a publicly traded company, including increased audit and legalfees, costs of compliance with securities and other regulations, investorrelations and higher insurance premiums. In addition, we expect to continue toincur costs associated with patent litigation discussed in Part II—Item 1“Legal Proceedings”.

 

*Interestincome.*    Interest income consisted ofincome generated from the investment of our cash balances and short-terminvestments. Interest income decreased $0.1 million in the third quarterof 2008, primarily due to lower rates of return, as compared to the same periodin 2007.  Interest income increased $2.6million for the nine months ended September 30, 2008, primarily due tohigher average cash and investment balances during 2008 partially offset bylower rates of return as compared to the same periods in 2007. The increase inour cash and short-term investment balances was due primarily to the receipt ofapproximately $204.1 million of net proceeds from public offerings of ourcommon stock in 2007 and cash generated from operations.

 

*Income tax expense.*    Forthe three and nine months ended September 30, 2008, we recorded an incometax benefit of $4.9 million and $3.1 million, respectively, compared to incometax expense of $0.3 million and $0.7 million in the same periods of 2007. Thenet tax benefit recorded in the three and nine months ended September 30,2008 was primarily due to a one-time tax benefit of $6.6 million recorded basedon our decision in the third quarter of 2008 to release a substantial portionof the valuation allowance recorded against net deferred tax assets in the U.S.as well as a tax provision of $0.2 million to reserve an uncertain tax positionin a foreign jurisdiction. Our effective tax rates for the three and ninemonths ended September 30, 2008 were lower than the statutory federalincome tax rate of 35% due primarily to the one-time tax items noted above aswell as our use of net operating loss carryforwards, or NOLs, and research anddevelopment tax credits to offset our U.S. taxable income, partially offset bythe impact of taxes owed in relation to the income generated by our foreignsubsidiaries. Our effective tax rates for the three and nine months ended September 30,2007 were lower than the statutory federal income tax rate of 35% due primarilyto the use of NOLs and research and development tax credits to offset our U.S.taxable income (which reduced the valuation allowance we had previouslyrecorded against those NOLs), partially offset by the impact of taxes owed in relationto the income generated by our foreign subsidiaries.

 

We expect that our effective tax rate for the fourth quarter of 2008will remain relatively consistent with our effective tax rate (excluding theimpact of discrete items) of the third quarter and first nine months of 2008,as we will release our remaining tax asset valuation allowance of $5.2 millionin the fourth quarter of 2008 in accordance with the requirements of SFAS 109to use an annualized effective tax rate for each interim period during the yearin which a valuation allowance release has occurred.

 

*ForeignCurrency Exchange Gain (Losses).*    Forthe three months ended September 30, 2008, we recorded foreign currencylosses of $1.3 million, compared to a foreign currency gain of $84,000 in thesame period of 2007.  For the nine monthsended September 30, 2008, we recorded foreign currency losses of $0.6million, compared to a foreign currency loss of $6,000 in the same 

 

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period of 2007.The difference in the 2008 periods was due to an increase in the amount of ourassets, primarily cash and accounts receivable, denominated in foreigncurrencies, primarily Euros, which are translated at the end of the reportingperiod and to the weakening of the US dollar that occurred in the three andnine months ended September 30, 2008.

 

*Net income.*    Netincome increased approximately $18.0 million and $35.7 million for thethree and nine months ended September 30, 2008, respectively, compared tothe same period of 2007 due to the items discussed above.

 

**Liquidity and Capital Resources**

 

***Resources***

 

We funded our operationsfrom 2000 through 2004 primarily with net proceeds of issuances of convertiblepreferred stock of approximately $100.0 million. Since 2005, we havefunded our operations principally with cash provided by operating activities,which was driven mainly by our revenue growth. In June and November 2007,we completed public offerings of our common stock, which raised approximately$204.1 million in net proceeds.

 

*Cash,cash equivalents and short-term investments.*    Ourcash and cash equivalents at September 30, 2008 of $356.4 millionwere held for working capital purposes and were invested primarily in moneymarket funds. We do not enter into investments for trading or speculativepurposes. Restricted cash, which totaled $0.7 million at September 30,2008 and December 31, 2007, respectively, was not included in cash andcash equivalents and was held as collateral for letters of credit related tovendor and lease agreements.

 

Our net cash flows fromoperating, investing and financing activities for the periods indicated in thetable below were as follows (in thousands):

 
| ** **                                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Net cash provided by (used in) operating  activities |       | $                                                   | 137,265    |   | $ | (16,059 | ) |
| Net cash provided by (used in) investing  activities |       | $                                                   | (7,253     | ) | $ | 10,186 |   |
| Net cash provided by financing activities            |       | $                                                   | 2,596      |   | $ | 117,616 |   |

 

*Operatingactivities.*    Cash from operatingactivities consists of significant components of the statements of operationsadjusted for changes in various working capital items including deferredrevenues, accounts receivable, inventories, accounts payable, prepaid expensesand various accrued expenses.

 

*Nine months ended September 30, 2008compared to Nine months ended September 30, 2007.*

 

For the nine months endedSeptember 30, 2008, net cash provided by operating activities was$137.3 million as compared to cash used in operating activities of$16.1 million for the same period in 2007. Cash received from customersincreased $209.0 million in the first nine months of 2008 to$270.7 million from $61.7 million in the same period of 2007. Thisincrease was due primarily to the timing of billing and collections of customerorders. This increase was partially offset by an increase in cash paid forpayroll and related expenses of $33.1 million, which totaled $65.4 millionin the first nine months of 2008 compared to $32.3 million for the same periodin 2007, and higher cash paid for inventories of $25.9 million, whichtotaled $54.2 million in the first nine months of 2008 compared to $28.3million for the same period in 2007. The increase in payroll and relatedexpenses was due primarily to our increased headcount and sales commissions, asdiscussed above. The increase in cash paid for inventories was due primarily toour purchases to meet our higher level of customer orders, which resulted inhigher inventory balances as compared to December 31, 2007.

 

*Investingactivities.*    Cash from investingactivities consisted primarily of capital expenditures and purchases and salesof short-term investments associated with our investment balances. The $7.3million of cash used in investing activities during the first nine months of2008 consisted primarily of capital expenditures of $16.8 million partiallyoffset by maturities of short-term investments of $9.6 million. The$10.2 million of cash provided by investing activities in the nine monthsended September 30, 2007 was due primarily to proceeds from maturities ofshort-term investments of $40.4 million partially offset by capitalexpenditures of $11.7 million and $18.9 million of net purchases ofshort-term investments.

 

*Financingactivities.*    Cash from financingactivities for the nine months ended September 30, 2008 consistedprimarily of $2.7 million of cash received from the exercise of stockoptions. The $117.6 million of cash from financing activities for the ninemonths ended September 30, 2007 was due primarily to the net proceeds fromour initial public offering of $116.0 million.

 

At September 30,2008 and December 31, 2007, we had no long-term debt outstanding and ourrestricted cash was our only asset pledged as collateral.

 

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We believe our existingcash and cash equivalents, and cash flows from operating activities will besufficient to finance our planned growth, enhance our products and fundanticipated capital expenditures for the foreseeable future.

 

We may use the net proceeds from our public offerings for workingcapital and other general corporate purposes, to finance accelerated growth,develop new product lines and fund acquisitions and strategic investments.These future working capital requirements will depend on many factors,including the rate of our revenues growth, our introduction of new products andenhancements and our expansion of sales and marketing and product developmentactivities. To the extent our existing resources are insufficient to fund theseactivities we may need to raise additional funds through bank creditarrangements or public or private equity or debt financings. We also may needto raise additional funds in the event we determine in the future to effect oneor more acquisitions of businesses, technologies and products that complementour existing operations. In the event additional funding is required, we maynot be able to obtain bank credit arrangements or complete an equity or debtfinancing on terms acceptable to us or at all.

 

***Requirements***

 

*Capitalexpenditures.*    We have made capitalexpenditures primarily for testing and evaluation systems and equipment tosupport product development and customer service, as well as for leaseholdimprovements and other general purposes to support our growth. Our capitalexpenditures totaled $16.8 million in the nine months ended September 30,2008. We expect capital expenditures to be approximately $20-25 millionfor the full year of 2008, primarily related to purchases of test equipment,equipment to support product development and customer service, leasehold improvementsand other general purposes to support our growth.

 

*Contractualobligations and requirements.*    As of September 30,2008, our commitments under operating leases and purchase obligations were asset forth below. For purposes of the table below, purchase obligations aredefined as agreements to purchase goods or services that are enforceable andlegally binding and that specify all significant terms, including fixed orminimum quantities to be purchased, fixed, minimum or variable pricing provisions,and the approximate timing of transactions.

 
| ** **           | ** ** | **Total**                            | ** ** | **Remainder of  2008** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **More than  5 Years** | ** ** |
|----------------------|------------|--------------------------------------|------------|-----------------------------|------------|----------------|------------|----------------|------------|----------------------------------|------------|
| ** **           | ** ** | **(dollars in thousands)** | ** ** |
| Operating leases     |       | $                                    | 5,437      |                        | $          | 677            |       | $              | 4,429      |                             | $          | 331 |   | $ | — |   |
| Purchase obligations |       | 17,557                               |       | 17,213                      |       | 344            |       | —         |       | —                           |       |
| Total                |       | $                                    | 22,994     |                        | $          | 17,890         |       | $              | 4,773      |                             | $          | 331 |   | $ | — |   |

 

The table above does notreflect unrecognized tax benefits of $2.5 million, the timing of which isuncertain.

 

***Off-Balance-SheetArrangements***

 

In the normal course ofbusiness, we may enter into agreements with our customers which require us tosecure performance bonds that guarantee our execution of certain obligationsunder the agreements. For the three and nine months ended September 30,2008, we had one bank guarantee in the amount of €3.0 million ($4.3 million).The bank guarantee is required to be renewed each year during the term of theagreement, which expires in July 2013. At the end of each calendar year,both parties to the agreement will discuss waiver of the bank guarantee.

 

We do not have anyinterests in entities referred to as variable interest entities, which includesspecial purpose entities and other structured finance entities.

 

***Recent AccountingPronouncements***

 

We have adopted theprovisions of SFAS 159, *The Fair ValueOption for Financial Assets and Financial Liabilities, including an amendmentof FASB Statement No. 115,* on January 1, 2008.SFAS 159 permits entities to choose, at specified election dates, tomeasure eligible items at fair value (the “fair value option”). Under thispronouncement, a business entity must report unrealized gains and losses onitems for which the fair value option has been elected in earnings at eachsubsequent reporting period. We have not elected the fair value option for anyitems on our balance sheet.

 

In June 2008, theFASB issued FASB Staff Position (FSP) EITF 03-6-1, *Determining Whether Instruments Granted in Share-Based PaymentTransactions Are Participating Securities.* This FSP provides thatunvested share-based payment awards that contain nonforfeitable rights todividends or dividend equivalents (whether paid or unpaid) are participatingsecurities and shall be included in the computation of earnings per sharepursuant to the two-class method. Upon adoption, a company is required toretrospectively adjust its earnings per share data (including any amountsrelated to interim periods, summaries of earnings and selected financial data) toconform with the provisions in this FSP. This FSP will be effective for us on January 1,2009. We have not yet determined the impact, if any, of this FSP on ourconsolidated financial statements.

 

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In May 2008, theFASB released SFAS 162, *The Hierarchy of GenerallyAccepted Accounting Principles.* SFAS 162 establishes the GAAPhierarchy and identifies the sources of accounting principles and the frameworkfor selecting principles used in the preparation of financial statements. SFAS162 will be effective for us on November 15, 2008*.*Wehave not yet determined the impact, if any, of this statement on ourconsolidated financial statements.

 

In December 2007, the FASB released SFAS 141 (revised 2007), *Business Combinations*. This statement willsignificantly change the accounting for business combinations in a number ofareas including the treatment of contingent consideration, contingencies,acquisition costs, in process research and development and restructuring costs.In addition, under this statement, changes in deferred tax asset valuationallowances and acquired income tax uncertainties in a business combinationafter the measurement period will impact income tax expense. This statementwill be effective for us on January 1, 2009 and will change our accountingtreatment for business combinations on a prospective basis.

 

In December 2007,the FASB released SFAS 160, *NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51*.This statement will change the accounting and reporting for minority interests,which will be recharacterized as noncontrolling interests and classified as acomponent of equity. This new consolidation method will significantly changethe accounting for transactions with minority interest holders. This statementwill be effective for us on January 1, 2009. As of September 30,2008, we did not have any minority interests.

 

**ITEM 3.    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk representsthe risk of loss that may impact our financial position due to adverse changesin financial market prices and rates. Our market risk exposure is primarily aresult of fluctuations in foreign exchange rates and interest rates. We do nothold or issue financial instruments for trading purposes.

 

***Foreign CurrencyExchange Risk***

 

Our internationalcustomer transactions are predominantly denominated in either U.S. dollars orEuro. Accordingly, we have exposure to changes in the exchange rates betweenthe U.S. Dollar and the Euro. We currently do not enter into foreign currencyhedging transactions. In addition, the functional currency of our foreignoperations in Europe, Asia and South America is the U.S. dollar. Accordingly,all assets and liabilities of these foreign subsidiaries are remeasured intoU.S. dollars using the exchange rates in effect at the balance sheet date withthe exception of certain non-monetary items which are remeasured at historicalrates. Revenues and expenses of these foreign subsidiaries are remeasured intoU.S. dollars at the average rates in effect during the period. Any differencesresulting from the remeasurement of assets, liabilities and operations of thesesubsidiaries are recorded within other income (expense) in our consolidatedstatements of operations. If the foreign currency exchange rates had fluctuatedby 10% as of September 30, 2008 and December 31, 2007, our foreignexchange gain or loss would have fluctuated by approximately $1.2 millionand $0.2 million, respectively.

 

***Interest Rate Risk***

 

At September 30,2008, we had unrestricted cash and cash equivalents totaling $356.4 million. AtDecember 31, 2007, we had unrestricted cash and cash equivalents andshort-term investments totaling $233.6 million. These amounts wereinvested primarily in money market funds and high quality corporate andgovernment securities. In periods of financial market volatility, we may hold agreater proportion of our unrestricted cash and cash equivalents in moneymarket funds that invest solely in government securities, which may result inlower yields on these balances. The unrestricted cash and cash equivalents wereheld for working capital purposes. We do not enter into investments for tradingor speculative purposes. Due to the short-term nature of these investments, webelieve that we do not have any material exposure to changes in the fair valueof our investment portfolio as a result of changes in interest rates. Declinesin interest rates, however, would reduce future investment income.

 

**ITEM 4T.    CONTROLS ANDPROCEDURES**

 

Our management, with theparticipation of our chief executive officer and chief financial officer,evaluated the effectiveness of our disclosure controls and procedures as of September 30,2008. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms. Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure.Management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and management necessarily applies its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of 

 

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September 30,2008, our chief executive officer and chief financial officer concluded that,as of such date, our disclosure controls and procedures were effective at thereasonable assurance level.

 

No change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) occurred during the fiscal quarter endedSeptember 30, 2008 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**ITEM 1.    LEGALPROCEEDINGS**

 

We are presentlydefending two patent infringement lawsuits brought against us by UTStarcom, Inc.In February 2005, UTStarcom filed a complaint against us in the UnitedStates District Court for the Northern District of California seekingunspecified damages and injunctive relief. The complaint alleges infringementby us of UTStarcom’s U.S. Patent No. 6,829,473, entitled “Roaming andHand-Off Support for Prepaid Billing for Wireless Data Networks,” which werefer to as the ‘473 patent. In May 2005, we answered the complaint,denied the infringement allegations contained in the complaint, and filedcounterclaims against UTStarcom seeking a declaratory judgment that we did notinfringe the ‘473 patent and that the ‘473 patent was invalid andunenforceable. In July 2005, we filed an amended answer and counterclaimsto the ‘473 patent complaint. In December 2006, UTStarcom filed a reissuepatent application relating to the ‘473 patent. In January 2007, byagreement of the parties, the District Court stayed the case pending theoutcome of UTStarcom’s reissue application relating to the ‘473 patent. In June 2007,we filed a request for*inter partes*  re-examination of all claims of the ‘473patent with the United States Patent and Trademark Office on sixteen differentgrounds. In August 2007, the Patent and Trademark Office granted ourrequest for*inter partes*  re-examination of all claims on all sixteengrounds. In November 2007, the Patent and Trademark Office merged thereissue and re-examination proceedings. A first office action has not yet beenissued. We believe that we have meritorious defenses against any resultingreissued patent, and we are prepared to vigorously defend the ‘473 patent casethrough trial.

 

In May 2007,UTStarcom filed an additional complaint against us and a number of ouremployees and former employees in the United States District Court for theNorthern District of Illinois alleging violations of the Illinois trade secretsact, infringement of five patents assigned to UTStarcom, intentionalinterference with UTStarcom’s business relations and declarations of ownershiprelating to one of our patents and three of our patent applications. Thecomplaint contains allegations, among others, that a number of former employeesof a business unit UTStarcom acquired, who subsequently worked for us, tookUTStarcom’s trade secrets with them and improperly used those trade secrets todevelop, manufacture and market our 3G wireless products, and that suchproducts incorporate various UTStarcom confidential technical information,including UTStarcom’s proprietary virtual private network and EV-DO features.UTStarcom further alleges that we have disclosed UTStarcom’s trade secrets inone of our patents and three of our patent applications, and that this patentand these patent applications legally belong to UTStarcom based on theinventors’ previous work at the business unit acquired by UTStarcom. In August 2007,we and the current and former employee defendants filed our answers to thecomplaint. We also filed counterclaims for tortious interference withprospective economic advantage, malicious prosecution, a declaration that thepatents-in-suit are invalid and not infringed, and a declaration that one ofthe patents-in-suit is unenforceable due to inequitable conduct. In December 2007,UTStarcom filed an amendment to the complaint, which added new claims fordeclaration of ownership of four more of our patent applications, copyrightinfringement, breach of restrictive covenants against the employee and formeremployee defendants, and aiding and abetting the employee and former employeedefendants’ breaches of the duty of loyalty and the employment agreements. Theamendment to the complaint also added another employee as a defendant. On January 4,2008, we filed a motion to dismiss, or in the alternative for a more definitestatement regarding, the trade secret, copyright, breaches of restrictivecovenants, and aiding and abetting claims of the amendment to the complaint.UTStarcom filed its opposition to our motion on January 22, 2008, and wefiled our reply on January 29, 2008. On May 20, 2008, the Courtgranted our motion, in-part, and ordered UTStarcom to provide a more definitestatement of its claims. On May 30, 2008, UTStarcom filed a Third AmendedComplaint.  On June 9, 2008, wemoved to dismiss the trade secret, copyright, breaches of restrictivecovenants, and aiding and abetting claims (Counts I, VI, and VIII-XV) of theThird Amended Complaint, for failure to comply with the Court’s Order toprovide a more definite statement of those claims. On July 23, 2008, theCourt granted our motion and dismissed the claims that were the subject of themotion. On August 1, 2008, UTStarcom filed a “Motion for Leave to Amendthe Complaint to Provide a More Definite Statement and Clarification of the7/23 Order.” On August 11, 2008, the Court granted UTStarcom leave to filea Fourth Amended Complaint.  UTStarcomfiled a Fourth Amended Complaint on August 27, 2008.  In addition, on August 26, 2008, wefiled a motion for summary judgment of noninfringement of U.S. Patent No. 7,173,905,which the Court has taken under advisement. On August 27, 2008, UTStarcom filed a motion to dismiss our third,fourth, and fifth counterclaims for unenforceability of the asserted patents,tortious interference with prospective economic advantage, and maliciousprosecution, respectively. We filed a motion to strike and dismiss the FourthAmended Complaint on September 15, 2008.  The Court granted our motion to strike theFourth Amended Complaint on September 24, 2008, and, on the same day,granted UTStarcom leave to re-file the version of the Fourth Amended Complaintwhich was previously attached as an exhibit to its motion for leave to amendthe complaint filed on August 1, 2008. UTStarcom re-filed this 

 

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version of itsFourth Amended Complaint on September 25, 2008.  We filed a motion to dismiss certain countsof UTStarcom’s latest Fourth Amended Complaint on October 14, 2008.  The Court set a briefing schedule for motionsto dismiss filed by the parties and stated that it would rule on themotions on December 3, 2008. Discovery is proceeding. No trial date hasbeen set. In this lawsuit, UTStarcom seeks unspecified monetary damages,punitive damages, injunctive relief, declarations of ownership relating to thespecified patent and patent applications owned by us, findings ofmisappropriation of trade secrets, patent infringement and copyrightinfringement, costs and attorneys fees. We believe we have meritorious defensesto each of UTStarcom’s claims in this lawsuit and we are prepared to vigorouslydefend the lawsuit.

 

In addition, we aresubject to other legal proceedings, claims and litigation arising in theordinary course of business. Defending lawsuits requires significant managementattention and financial resources and the outcome of any litigation, includingthe matters described above, is inherently uncertain. We do not, however,currently expect that the ultimate costs to resolve pending matters will have amaterial adverse effect on our consolidated financial position, results ofoperations or cash flows.

 

**ITEM 1A.    RISK FACTORS**

 

These are risks anduncertainties that could cause actual results to differ materially from theresults contemplated by the forward-looking statements contained in this QuarterlyReport on Form 10-Q. Because of the these factors, as well as othervariables affecting our operating results, past financial performance shouldnot be considered as a reliable indicator of future performance and investorsshould not use historical trends to anticipate results or trends in futureperiods. These risks are not the only ones facing the Company. Please also see “CautionaryStatement” in Part I, Item 2 of this Quarterly Report on Form 10-Q.

 

**Risks Related to Our Business and Industry**

 

***Disruptions infinancial markets may adversely impact availability and cost of credit andbusiness and consumer spending patterns.***

 

Disruptions in thefinancial markets have had and may continue to have an adverse effect on theU.S. and world economy, which could negatively impact business and consumerspending patterns. Current tightening of credit in financial markets alsoadversely affects the ability of our customers and suppliers to obtainfinancing for significant purchases and operations and could result in adecrease in or cancellation of orders for our products.  In particular,the availability of financing may be critical to the expansion plans of mobileoperators. Further, changes in employment and consumer spending patternsmay slow the adoption of data-enabled wireless devices and reduce thegrowth of data traffic for mobile operators, which could result in delays orcancellations of upgrades and new purchases of our products.  Thereis no assurance that government responses to the disruptions in the financialmarkets will restore business and consumer confidence, stabilize the markets orincrease liquidity and the availability of credit.

 

***We compete in newand rapidly evolving markets and have a limited operating history, which makesit difficult to predict our future operating results.***

 

We were incorporated in August 2000,and deployed our first commercial product in the first quarter of 2003. We havea limited operating history in an industry characterized by rapid technologicalchange, changing customer needs, evolving industry standards and frequentintroductions of new products and services. We believe our limited operatinghistory and the characteristics of our industry make it difficult to forecastour future operating results. You should consider and evaluate our prospects inlight of risks faced by companies such as ours, which include challenges inaccurate financial planning as a result of limited historical data and theuncertainties resulting from a relatively limited time period in which toimplement and evaluate our business strategies, as compared to companies withlonger operating histories.

 

***Our past operatingresults have fluctuated significantly, and likely will continue to fluctuatesignificantly, which makes it difficult to predict our operating results andcould cause our operating results to fall below expectations.***

 

Our operating resultshave historically fluctuated significantly from period to period and we expectour operating results to continue to fluctuate due to a variety of factors,many of which are outside of our control. As a result, comparing our operatingresults on a period-to-period basis may not be meaningful. You should not relyon our past results as an indication of our future performance. If our revenuesor operating results fall below the expectations of investors or securitiesanalysts or below any guidance we may provide to the market, the price of ourcommon stock could decline.

 

In addition to other risk factors listed in this “Risk Factors”section, factors that may affect our operating results include:

 

·fluctuations in demand, sales cycles and prices for our products and services;

 

·reductions in customers’ budgets for mobile network infrastructure purchasesand delays in their purchasing decisions;

 

· thetiming of recognizing revenue in any given period as a result of softwarerevenue recognition rules;

 

· the saleof our products in the timeframes we anticipate, including the number and sizeof orders in each period;

 

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· thelevel of our customer concentration and our ability to generate purchases inany particular period from large customers;

 

· ourability to develop, introduce and ship in a timely manner new products andproduct enhancements that meet customer requirements;

 

· thetiming of product releases or upgrades by us or by our competitors;

 

· anysignificant changes in the competitive dynamics of our markets, including newentrants or substantial discounting of products;

 

· ourability to control costs, including our operating expenses and the costs of thecomponents we purchase; and

 

· generaleconomic conditions in our domestic and international markets.

 

***We depend on alimited number of customers for a substantial portion of our revenues. The lossof a key customer or any significant adverse change in the size or terms oforders from a key customer could significantly reduce our revenues.***

 

We derive a substantialportion of our revenues from a limited number of customers partly due to thenature of the mobile communications industry. For example, in the nine monthsended September 30, 2008, we had two customers that each accounted formore than 10% of our revenues and in the aggregate represented 79% of ourrevenues. In addition, we do not have long-term volume purchase contracts withour customers or other commitments that ensure future sales of our products toexisting customers. The loss of any key customer, or our inability to generateanticipated revenue from them, would significantly and adversely affect ourbusiness, financial condition and results of operations. In addition, a changein the timing or size of a purchase by any one of our key customers can resultin significant variations in our revenue and operating results from period toperiod. Our operating results for the foreseeable future will continue todepend on our ability to effect sales to a small number of customers. Anyrevenue growth will depend on our success selling additional products to ourlarge customers and expanding our customer base to include additional customersthat deploy our products in large-scale networks serving significant numbers ofsubscribers.

 

Moreover, many of our keycustomers are large mobile operators that have substantial purchasing power andleverage in negotiating contractual arrangements with us. These customers mayrequire us to agree to terms and conditions that could result in increasedcosts and decreased revenues that could adversely affect our operating results.

 

***We rely on a singleline of products focused on a single market. If the market for those productsdoes not develop as we anticipate, our revenues may decline or fail to grow,which would adversely affect our operating results.***

 

We derive, and expect tocontinue to derive, all of our revenues from a single line of products thatprovide network functions and services to mobile operators’ packet corenetworks. The market for our products is relatively new and still evolving, andit is uncertain whether our products will achieve and sustain high levels ofdemand and market acceptance. Our success will depend to a substantial extenton the willingness of mobile operators to continue to implement packet-based,multimedia network infrastructure. Factors that could impair the rate of growthof multimedia networks include:

 

· lowerthan anticipated demand by subscribers for multimedia services;

 

·budgetary constraints of mobile operators;

 

·uncertainties on the part of mobile operators as to the particular 3G or 4Gaccess technologies they select for deployment in their networks; and

 

· delaysin the development or availability of all the network elements necessary forthe mobile operator to deploy its next-generation multimedia network.

 

If mobile operators do not continue to implement packet core networks,the market for our products may not continue to develop or may develop moreslowly than we expect, either of which would significantly adversely affect ourrevenues and profitability.

 

***The market in whichwe compete is highly competitive and competitive pressures from existing andnew companies may have a material adverse effect on our business, revenues,growth rates and market share.***

 

We compete in a highlycompetitive industry that is influenced by many factors, including customerdemands for:

 

·reliable, high performance products;

 

·system ability to handle increasing amounts of network traffic and serviceintegration capabilities;

 

·system intelligence;

 

·breadth of network interoperability, access independence and standards support;

 

·high levels of customer support and customer interaction; and

 

·competitive pricing.

 

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We expect competition inthe mobile network infrastructure industry to intensify significantly in thefuture. Other companies may introduce new products in the markets we serve orintend to enter. This competition could result in increased pricing pressure,reduced profit margins, increased sales and marketing expenses and failure toincrease, or the loss of, market share, any of which would likely seriouslyharm our business, operating results or financial condition.

 

Competitive products mayin the future have better performance, lower prices and broader acceptance thanour products. Our primary competitors include Cisco Systems, Inc., HuaweiTechnologies Co., Ltd., LM Ericsson Telephone Co., Nokia SiemensNetworks B.V. and UTStarcom, Inc., each of which has a longeroperating history, greater name recognition, a larger customer base andsignificantly greater financial, technical, sales, marketing and other resourcesthan we do. Potential customers may prefer to purchase from their existingsuppliers rather than a new supplier regardless of product performance orfeatures. In addition, many of our competitors have a broader range of productsand may be able to offer concessions to potential customers on bundledpurchases that we are not able to match because we currently offer only asingle line of products. We also face competition from a number of companieswith more limited market share either generally or by geography and newermarket entrants.

 

If our market continues to develop and expand, we could face increasedcompetition from other established companies, as well as emerging companies.For example, OEMs, system integrators and distributors currently selling ourproducts could market products and services that compete with our products andservices. In addition, some of our competitors have made acquisitions orentered into partnerships or other strategic relationships with one another tooffer a more comprehensive solution than they individually had offered. Weexpect this trend to continue as companies attempt to strengthen or maintaintheir market positions in an evolving industry and as companies enter intopartnerships, or are acquired. Many of the companies driving this consolidationtrend have significantly greater financial, technical and other resources thanwe do and are better positioned to acquire and offer complementary products andtechnologies. The companies resulting from these possible consolidations maycreate more compelling product offerings and be able to offer greater pricingflexibility, making it more difficult for us to compete effectively, includingon the basis of price, sales and marketing programs, technology or productfunctionality. Continued industry consolidation may adversely impact customers’perceptions of the viability of smaller and even medium-sized technologycompanies and consequently customers’ willingness to purchase from suchcompanies. These pressures could materially adversely affect our business,operating results and financial condition.

 

***Our sales cycles canbe long and unpredictable, and our sales efforts require considerable time andexpense.***

 

Our sales cycles typically are long and unpredictable, and our salesefforts require considerable time and expense. Our sales efforts involveeducating our customers about the use and benefit of our products, includingtheir technical capabilities and potential cost savings. Customers typicallyundertake a significant evaluation process before making a purchase, in somecases over twelve months. We spend substantial time and resources in our salesefforts without any assurance that our efforts will produce any sales. Inaddition, product purchases are frequently subject to budget constraints,multiple approvals, and unplanned administrative, processing and other delays.Our long sales cycle may cause our revenues and operating results to fluctuatesignificantly.

 

***Demand for ourproducts depends on the rate that mobile operators expand and enhance theirmobile networks in order to provide multimedia services.***

 

Our future success as a provider of network infrastructure products andservices for mobile operators ultimately depends on the continued growth of themobile communications industry and, in particular, the continued deployment andexpansion of mobile multimedia services. Increased demand by mobile subscribersfor voice communications and multimedia services delivered over mobile networksystems will be necessary to justify capital expenditure commitments by mobileoperators to invest in the improvement and expansion of their networks. Demandfor multimedia services might not continue to increase if there is limitedavailability or market acceptance of mobile devices designed for such services,the multimedia content offered through mobile networks does not attractwidespread interest or the quality of service available through mobile networksdoes not meet customer expectations. If long-term expectations for mobilemultimedia services are not realized or do not support a sustainable businessmodel, operators may not commit significant capital expenditures to upgradetheir networks to provide these services, the demand for our products andservices will decrease, and we may not be able to sustain or increase ourlevels of revenues or profitability in the future.

 

***A significantportion of our future revenues depends on our ability to further penetrate theGSM/UMTS market and our failure to do so could significantly interfere with ourfuture growth.***

 

The two principal radio access interfaces in use today for mobilecommunications are Code Division Multiple Access, or CDMA, and Global Systemfor Mobile Communications/Universal Mobile Telecommunications System, orGSM/UMTS. To date, we have achieved our highest number of deployments in theCDMA market, which has transitioned faster to high-bandwidth networks. However,significantly more operators worldwide currently utilize GSM/UMTS than CDMAtechnologies. In order to continue our growth, we believe it is important thatwe continue to expand into the GSM/UMTS market. To date, we have establishedrelationships with a small number of GSM/UMTS operators, and we intend todevote significant sales and marketing resources to further penetrate 

 

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the GSM/UMTS market. If GSM/UMTS operators do not transition or delaytheir transition to high-bandwidth networks, or if we are unable to establishrelationships with additional GSM/UMTS operators, we may not be able to growour business as expected and our results of operations will be adverselyaffected.

 

***We rely on OEMs,system integrators and distributors to sell some of our products, and ourfailure to develop and manage our distribution channels could adversely affectour business.***

 

For our sales to mobile operators, we rely in part on establishing andmaintaining successful relationships with original equipment manufacturers, orOEMs, system integrators and distributors. A significant amount of our revenuesis derived through these indirect sales. Accordingly, our revenues depend inpart on the effective performance of these distribution relationships. Byutilizing these indirect sales channels we may have less contact with the endusers of our products, thereby potentially making it more difficult for us toestablish brand awareness, ensure proper delivery and installation of ourproducts, service ongoing customer requirements and respond to evolvingcustomer needs. Developing relationships with qualified OEMs, systemintegrators and distributors and training them in our technology and productofferings requires significant time and resources. In order to develop andexpand our distribution channels, we must continue to scale and improve ourprocesses and procedures that support our OEM, system integrator anddistributor relationships, including investment in systems and training. Wehave no minimum purchase commitments with any of our OEMs, system integratorsor distributors, and our contracts with them do not prohibit them from offeringproducts or services that compete with ours. Our competitors may be effectivein providing incentives to existing and potential OEMs, system integrators anddistributors to favor their products or to prevent or reduce sales of ourproducts. Our OEMs, system integrators and distributors may choose not to offerour products exclusively or at all. Our failure to establish and maintainsuccessful relationships with our OEMs, system integrators and distributorswould likely materially adversely affect our business, operating results andfinancial condition.

 

***We have asignificant accumulated deficit, and we may not be able to maintainprofitability.***

 

As a result of our net losses in years prior to 2005 we had anaccumulated deficit of $51.0 million as of September 30, 2008. Wewill need to generate significant revenues and control our operating expensesand other expenditures to maintain profitability. If we are unable to remainprofitable, the market price of our common stock could decline.

 

***If network functionsand services similar to those offered by our products are incorporated intoexisting or new mobile network infrastructure products, demand by mobileoperators for our products may diminish.***

 

Mobile network infrastructures are continually evolving with changingindustry standards and the introduction of new technologies and networkelements. Network functions and services provided by our products located onthe packet core network may be provided by different network elements withinthese networks. Other providers of mobile network infrastructure products mayadd network functions and services provided by our products to their existingproducts or offer new products with similar characteristics for different partsof the network infrastructure.

 

The inclusion of, or the announcement of an intent to include,functionality and services perceived to be similar to those offered by ourproducts in competitor products within or outside the packet core network couldhave an adverse effect on our ability to market and sell our products.Furthermore, even if the network functions and services offered by ourcompetitors are more limited than those provided by our products, a significantnumber of customers may elect to accept limited functionality or services inlieu of adding our products to their network. The adoption of these competitiveproducts or different approaches to their network infrastructure by mobileoperators could have an adverse effect on our business, operating results andfinancial condition.

 

***The applications ofexisting or future accounting standards could result in significantfluctuations in our operating results.***

 

We recognize our productsoftware license revenue in accordance with AICPA Statement of Position, orSOP, 97-2, *Software Revenue Recognition*,and related amendments and interpretations and SOP 98-9,*Modification of SOP 97-2, Software RevenueRecognition with Respect to Certain Transactions*. Under theseaccounting standards, even if we deliver products to, and collect cash from, acustomer in a given fiscal period, we may be required to defer recognizingrevenue from the sale of such product until a future period when all theconditions necessary for revenue recognition have been satisfied. Conditionsthat can cause delays in revenue recognition include software arrangements thathave undelivered elements for which we have not yet established vendor specificobjective evidence of fair value; requirements that we deliver services forsignificant enhancements or modifications to customize our software for aparticular customer; or material customer acceptance criteria. Our customercontracts typically include one or more of these types of conditions.Therefore, we often must defer revenue recognition for a period of time afterour products are delivered and billed to a customer, and such deferral mayextend over one or more fiscal quarters. The period of deferral, if any,depends on the specific terms and conditions of each customer contract, andtherefore it is difficult for us to predict with accuracy at the beginning ofany fiscal period the amount of revenues that we will be able to recognize fromanticipated customer shipments in that period. Moreover, any changes ininterpretations and guidance as to SOP 97-2 could have a significanteffect on our reported financial results.

 

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***We may havedifficulty acquiring new customers due to the high costs of switching mobilenetwork infrastructure providers or equipment.***

 

Mobile network operators typically make substantial investments whendeploying a mobile network infrastructure. Once a mobile network operator hasdeployed a mobile network infrastructure for a particular portion of theirnetwork, it is often difficult and costly to switch to another vendor’sinfrastructure. Unless we are able to persuasively demonstrate that ourproducts offer performance, functionality or cost advantages that materiallyoutweigh a customer’s expense of switching from a competitor’s product, it willbe difficult for us to generate sales once that competitor’s equipment has beendeployed. Accordingly, if a customer has already deployed a competitor’sproduct for their network infrastructure, it may be difficult for us to sellour products to that customer.

 

***Our ability to sellour products is highly dependent on the quality of our support and servicesofferings, and our failure to offer high quality support and services wouldhave a material adverse effect on our sales and results of operations.***

 

Once our products are deployed within our customers’ networks, ourcustomers depend on our support organization to resolve issues relating to ourproducts. A high level of support is critical for the successful marketing andsale of our products and future enhancements. If we, or our OEMs, systemintegrators or distributors, do not effectively assist our customers indeploying our products, help our customers quickly resolve post-deploymentissues, and provide effective ongoing support, it would adversely affect ourability to sell our products to existing customers and could harm ourreputation with potential customers. In addition, as we expand our operationsinternationally, our support organization will face additional challenges,including those associated with delivering support, training and documentationin languages other than English. As a result, our failure to maintain highquality support and services could have a material adverse effect on ourbusiness, operating results and financial condition.

 

***The mobile networkinfrastructure industry is, and likely will continue to be, characterized byrapid technological changes in networks and standards, which will require us todevelop new products and product enhancements, and could render our existingproducts obsolete.***

 

Mobile operators have been aggressively upgrading their networks, andnew industry standards for access technologies, such as third generation, or3G, and more advanced fourth generation, or 4G, technologies continue toevolve. Continuing technological changes in the mobile communications industryand in the mobile network infrastructure industry could undermine ourcompetitive position or make our products obsolete, either generally or forparticular types of services. Our future success will depend upon our abilityto accurately predict and respond to new technology standards. We must developand introduce a variety of new capabilities and enhancements to our existingproduct offerings, as well as introduce new product offerings, to address thechanging standards and technological needs of the network infrastructuremarket. A failure to accurately predict and respond to evolving technologies,to introduce on a timely basis new products and enhancements in response toevolving technologies and standards, or to address changing needs in our currentmarkets or expand into new markets may cause existing and potential customersto forego purchases of our products or purchase from our competitors. Theintroduction of new products embodying new technologies or the emergence of newindustry standards could render our existing products uncompetitive from apricing standpoint, obsolete or unmarketable.

 

***Our products arecomplex and may take longer to develop than anticipated and we may notrecognize revenues from new products or product enhancements until after wehave incurred significant development costs.***

 

Some of our products must be tailored to meet customer specifications.As a result, we often develop new features and enhancements to our products.These product enhancements often take substantial time to develop because oftheir complexity and because customer specifications sometimes change duringthe development cycle. We often do not recognize revenue from our new productsor enhancements until we have incurred significant development costs, and ouroperating results will suffer if sales of new products or enhancements fail tomeet our expectations.

 

***There is noassurance that our research and development investments will lead to successfulnew products or enhancements.***

 

We will continue to invest in research and development for theintroduction of new products and enhancements to existing products designed toimprove the capacity, data processing rates and features of our products andservices. We must also continue to develop new features and functionality forour products based on specific customer requests and anticipated market needs.However, research and development in the mobile network infrastructure industryis complex, expensive and subject to uncertainty. We believe that we mustcontinue to dedicate a significant amount of resources to our research anddevelopment efforts to maintain our competitive position. If we continue toexpend a significant amount of resources on research and development and ourefforts do not lead to the successful introduction of products or productenhancements that are competitive in the marketplace, there could be a materialadverse effect on our business, operating results, financial condition andmarket share. We may not be able to anticipate market needs and developproducts and product enhancements that meet those needs, and any new productsor product enhancements that we introduce may not achieve any significantdegree of market acceptance.

 

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***If our products donot interoperate with our customers’ networks, installations will be delayed orcancelled, which would harm our business.***

 

Our products must interoperate with our customers’ existing networks,which often have different specifications, utilize multiple protocol standardsand products from multiple vendors and contain multiple generations of productsthat have been added over time. If we find errors in the existing software ordefects in the hardware used in our customers’ networks or problematic networkconfigurations or settings, as we have in the past, we may have to modify oursoftware or hardware so that our products will interoperate with our customers’networks. This could cause longer installation times for our products or ordercancellations and could harm our relationship with existing and futurecustomers, any of which would adversely affect our business, operating resultsand financial condition.

 

In addition, our customers may require that we demonstrate that ourproducts interoperate with network elements offered by our competitors, and wemay need our competitors’ cooperation to conduct such testing and validation.Any unwillingness of our competitors to cooperate with us in performing theseinteroperability tests or our inability to demonstrate interoperability wouldlikely have an adverse effect on our ability to market our products.

 

***Our products arehighly technical and may contain undetected software or hardware errors, whichcould cause harm to our reputation and adversely affect our business.***

 

Our products are highly technical and complex. When deployed, they arecritical to the mobile operator networks. Our products have contained and maycontain undetected errors, defects or security vulnerabilities. Some errors inour products may only be discovered after a product has been installed and usedby mobile operators. Any errors, defects or security vulnerabilities discoveredin our products after commercial release could result in loss of revenues ordelay in revenue recognition, loss of customers and increased service cost, anyof which could adversely affect our business, operating results and financialcondition. In addition, we could face claims for product liability, tort orbreach of warranty, including claims relating to changes to our products madeby our OEMs, system integrators or distributors. Our contracts with customersgenerally contain provisions relating to warranty disclaimers and liabilitylimitations, which may be ineffective. Defending a lawsuit, regardless of itsmerit, is costly and may divert management’s attention away from the businessand adversely affect the market’s perception of us and our products. Inaddition, if our business liability insurance coverage is inadequate or futurecoverage is unavailable on acceptable terms or at all, our operating resultsand financial condition could be adversely impacted.

 

***We are susceptibleto shortages or price fluctuations in our supply chain. Any shortages or pricefluctuations in components used in our products could delay shipment of ourproducts, which could materially adversely affect our business.***

 

Shortages in components that we use in our products are possible andour ability to predict the availability of such components may be limited. Someof these components are available only from single or limited sources ofsupply. The process of qualifying alternate sources for components, ifavailable at all, may be time consuming, difficult and costly. In addition, thelead times associated with certain components are lengthy and preclude rapidchanges in quantity requirements and delivery schedules. Any growth in ourbusiness or the economy is likely to create greater pressures on us and oursuppliers to project overall component demand accurately and to establishappropriate component inventory levels. In addition, increased demand by thirdparties for the components we use in our products may lead to decreasedavailability and higher prices for those components. We carry very littleinventory of our products and product components, and we rely on our suppliersto deliver necessary components to our contract manufacturer in a timely mannerbased on forecasts we provide. We generally rely on purchase orders rather thanlong-term contracts with our suppliers. As a result, even if available, we maynot be able to secure sufficient components at reasonable prices or ofacceptable quality to build products in a timely manner, which would seriouslyimpact our ability to deliver products to our customers, and our business,operating results and financial condition would be adversely affected.

 

***We depend on asingle contract manufacturer with whom we do not have a long-term supplycontract, and changes to this relationship may result in delays or disruptionsthat could harm our business.***

 

We depend on Plexus Corp., an independent contract manufacturer, tomanufacture and assemble our products. We rely on purchase orders with ourcontract manufacturer and do not have long-term supply arrangements in place.As a result, our contract manufacturer is not obligated to supply products tous for any specific period, quantity or price. Our orders may represent arelatively small percentage of the overall orders received by our contractmanufacturer from its customers. As a result, fulfilling our orders may not beconsidered a priority by our contract manufacturer in the event the contractmanufacturer is constrained in its ability to fulfill all of its customerobligations in a timely manner.

 

It is time consuming and costly to qualify and implement a contractmanufacturer relationship. Therefore, if our contract manufacturer suffers aninterruption in its business, or experiences delays, disruptions or qualitycontrol problems in its manufacturing 

 

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operations, or we have to change or add additional contract manufacturers,our ability to ship products to our customers would be delayed and ourbusiness, operating results and financial condition would be adverselyaffected.

 

***If we fail topredict accurately our manufacturing requirements, we could incur additional costsor experience manufacturing delays that could harm our business.***

 

We provide demand forecasts to our contract manufacturer. If weoverestimate our requirements, our contract manufacturer may assess charges orwe may have liabilities for excess inventory, each of which could negativelyaffect our gross margins. Conversely, because lead times for required materialsand components vary significantly and depend on factors such as the specificsupplier, contract terms and the demand for each component at a given time, ifwe underestimate our requirements, our contract manufacturer may haveinadequate materials and components required to produce our products, whichcould interrupt manufacturing of our products and result in delays in shipmentsand deferral or loss of revenues.

 

***If we fail to retainour key personnel, we may not be able to achieve our anticipated level ofgrowth and our business could suffer.***

 

Our future depends, in part, on our ability to attract and retain keypersonnel, including the continued contributions of our executive officers andother key technical personnel, each of whom would be difficult to replace. Inparticular, Ashraf M. Dahod, our president, chief executive officer andchairman is critical to the management of our business and operations, as wellas the development of our strategic direction. The loss of services of Mr. Dahodor other executive officers or key personnel or the inability to continue toattract qualified personnel could have a material adverse effect on our business.Mr. Dahod is not a party to an employment agreement with us and,therefore, may terminate his employment with us at any time, with no advancenotice. The replacement of Mr. Dahod would involve significant time andexpense and may significantly delay or prevent the achievement of our businessobjectives.

 

***Competition for ouremployees is intense, and we may not be able to attract and retain the highlyskilled employees that we need to support our business.***

 

Competition for highly skilled technical personnel is extremely intenseand we continue to face difficulty identifying and hiring qualified personnelin many areas of our business. In particular, we face significant challengeshiring and retaining personnel in India for research and development activitiesbecause the market for such personnel is increasingly competitive. We may notbe able to hire and retain such personnel at compensation levels consistentwith our existing compensation and salary structure. Many of the companies withwhich we compete for hiring experienced employees have greater resources thanwe have and may be able to offer more attractive terms of employment. Inaddition, we invest significant time and expense in training our employees,which increases their value to competitors who may seek to recruit them. If wefail to retain our employees, we could incur significant expenses replacingemployees and the quality of our products and services and our ability toprovide such products and services could diminish, resulting in a material adverseaffect on our business. Furthermore, in making employment decisions,particularly in high-technology industries, candidates often consider the valueof the equity they are to receive in connection with their employment.Therefore, significant volatility in the price of our stock may adverselyaffect our ability to attract or retain personnel.

 

***Our internationalsales and operations subject us to additional risks that may adversely affectour operating results.***

 

Over the last several years, we derived a significant portion of ourrevenues from customers outside the United States, and we continue to expandour international operations. As of September 30, 2008, approximately 62%of our employees were located outside of the United States, including 386 employeeslocated in India. In addition, we have sales and technical support personnel innumerous countries worldwide. We expect to continue to add personnel inadditional countries. Any continued expansion into international markets willrequire significant resources and management attention and will subject us tonew regulatory, economic and political risks, and we cannot be sure that anyfurther international expansion will be successful. Among the risks we believeare most likely to affect us with respect to our international operations are:

 

· thedifficulty of managing and staffing international offices and the increasedtravel, infrastructure and legal compliance costs associated with multipleinternational locations;

 

·difficulties in enforcing contracts and collecting accounts receivable andlonger payment cycles, especially in emerging markets;

 

· ourability to comply with differing technical standards and certificationrequirements outside North America;

 

·unexpected changes in regulatory requirements;

 

· reducedprotection for intellectual property rights in some countries;

 

· new anddifferent sources of competition;

 

·fluctuations in exchange rates; and

 

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· tariffsand trade barriers, import/export controls and other regulatory or contractuallimitations on our ability to sell or develop our products in certain foreignmarkets.

 

As we continue to expand our business globally, our success willdepend, in large part, on our ability to anticipate and effectively managethese and other risks associated with our international operations. Our failureto manage any of these risks successfully could harm our internationaloperations and reduce our international sales, adversely affecting ourbusiness, operating results and financial condition.

 

***We may needadditional capital in the future, which may not be available to us on favorableterms, or at all, and may dilute your ownership of our common stock.***

 

We have historically relied on outside financing and cash fromoperations to fund our operations, capital expenditures and expansion. We mayrequire additional capital from equity or debt financing in the future to:

 

· takeadvantage of strategic opportunities including more rapid expansion of ourbusiness or the acquisition of complementary products, technologies orbusinesses; and

 

· developnew products or enhancements to existing products.

 

We may not be able to secure timely additional financing on favorableterms, or at all. The terms of any additional financing may place limits on ourfinancial and operating flexibility. If we raise additional funds throughfurther issuances of equity, convertible debt securities or other securitiesconvertible into equity, our existing stockholders could suffer significantdilution in their percentage ownership of our company, and any new securitieswe issue could have rights, preferences and privileges senior to those of holdersof our common stock. If we are unable to obtain adequate financing or financingon terms satisfactory to us, if and when we require it, our ability to grow orsupport our business and to respond to business challenges could besignificantly limited.

 

***We may engage infuture acquisitions that could disrupt our business, cause dilution to ourstockholders and harm our business, operating results or financial condition.***

 

While we currently have no acquisitions of other businesses pending orplanned, we have, from time to time, evaluated acquisition opportunities andmay pursue acquisition opportunities in the future. We have very littleexperience consummating acquisitions, and therefore our ability as anorganization to make acquisitions is unproven. We may not be able to findsuitable acquisition candidates and we may not be able to complete acquisitionson favorable terms, if at all. If we do complete acquisitions, we may notultimately strengthen our competitive position or achieve our goals, or suchacquisitions may be viewed negatively by customers, financial markets orinvestors. In addition, any acquisitions that we make could lead todifficulties in integrating personnel and operations from the acquiredbusinesses and in retaining and motivating key personnel from these businesses.Acquisitions may disrupt our ongoing operations, divert management fromday-to-day responsibilities, increase our expenses or adversely impact ourbusiness, operating results and financial condition. Future acquisitions may reduceour cash available for operations and other uses and could result in anincrease in amortization expense related to identifiable assets acquired,potentially dilutive issuances of equity securities or the incurrence of debt,which could harm our business, operating results and financial condition.

 

***If we fail to managefuture growth effectively, our business could be harmed.***

 

We have expanded our operations significantly since inception andanticipate that further significant expansion will be required. For example,our revenues increased from $59.7 million in 2005 to $145.8 millionin 2007, and $183.5 million for the nine months ended September 30, 2008,and the number of our employees increased from 200 at the beginning of 2005 to739 as of September 30, 2008. This growth has placed significant demandson our management, as well as our financial and operational resources. If we donot effectively manage our future growth, the efficiency of our operations andthe quality of our products could suffer, which could adversely affect ourbusiness and operating results. To effectively manage this growth, we will needto continue to:

 

·implement appropriate operational, financial and management controls, systemsand procedures, including continued implementation of our enterprise-widefinancial system;

 

· expandour manufacturing capacity and scale of production;

 

· expandour sales, marketing and distribution infrastructure and capabilities, in theUnited States and internationally; and

 

· provideadequate training and supervision to maintain high quality standards.

 

***We have incurred,and will continue to incur, significant increased costs as a result ofoperating as a public company, and our management will be required to devotesubstantial time to new compliance initiatives.***

 

As a public company, we have incurred, and will continue to incur,significant legal, accounting and other expenses that we did not incur as aprivate company. In addition, the Sarbanes-Oxley Act of 2002, and rules subsequentlyimplemented by the Securities 

 

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and Exchange Commission and the NASDAQ Stock Market, impose additionalrequirements on public companies, including requiring changes in corporategovernance practices. Our management and other personnel will need to devote asubstantial amount of time to these compliance initiatives. Moreover, these rules andregulations will increase our legal and financial compliance costs and willmake some activities more time-consuming and costly. For example, we expectthese rules and regulations to make it more difficult and more expensivefor us to obtain director and officer liability insurance, and we may berequired to accept reduced policy limits and coverage or incur substantialadditional costs to maintain the same or similar coverage. These rules andregulations could also make it more difficult for us to attract and retainqualified persons to serve on our board of directors, our board committees oras executive officers.

 

In addition, the Sarbanes-Oxley Act requires, among other things, thatwe maintain effective internal control over financial reporting and disclosurecontrols and procedures. In particular, for the year ending December 31,2008, we must perform system and process evaluation and testing of our internalcontrol over financial reporting to allow management and our independentregistered public accounting firm to report on the effectiveness of ourinternal control over financial reporting, as required by Section 404 ofthe Sarbanes-Oxley Act. Our testing, or the subsequent testing by ourindependent registered public accounting firm, may reveal deficiencies in ourinternal control over financial reporting that are deemed to be materialweaknesses. Our compliance with Section 404 will require that we incursubstantial expense and expend significant management time oncompliance-related issues. We will need to hire additional accounting andfinancial staff with appropriate public company experience and technicalaccounting knowledge. Moreover, if we are not able to comply with therequirements of Section 404 in a timely manner, or if we or ourindependent registered public accounting firm identify deficiencies in ourinternal control over financial reporting that are deemed to be materialweaknesses, the market price of our stock could decline and we could be subjectto sanctions or investigations by the NASDAQ Stock Market, the Securities andExchange Commission or other regulatory authorities, which would requireadditional financial and management resources.

 

***We are subject togovernmental export and import controls that could subject us to liability orimpair our ability to compete in international markets.***

 

Our products are subject to United States export controls and may beexported outside the United States only with the required level of exportlicense or through an export license exception, because we incorporateencryption technology into our products. In addition, various countriesregulate the import of certain encryption technology and have enacted laws thatcould limit our ability to distribute our products or could limit our customers’ability to implement our products in those countries. Changes in our productsor changes in export and import regulations may create delays in theintroduction of our products in international markets, prevent our customerswith international operations from deploying our products throughout theirnetworks or, in some cases, prevent the export or import of our products tocertain countries altogether. Any change in export or import laws andregulations, shifts in approach to the enforcement or scope of existing lawsand regulations, or change in the countries, persons or technologies targetedby such regulations, could result in decreased use of our products by, or inour decreased ability to export or sell our products to, existing or potentialcustomers with international operations. Any decreased use of our products orlimitation on our ability to export or sell our products would likely adverselyaffect our business, operating results and financial condition.

 

***Compliance withenvironmental matters and worker health and safety laws could be costly, andnoncompliance with these laws could have a material adverse effect on ourresults of operations, expenses and financial condition.***

 

Some of our operations use substances regulated under various federal,state, local and international laws governing the environment and worker healthand safety, including those governing the discharge of pollutants into theground, air and water, the management and disposal of hazardous substances andwastes, and the cleanup of contaminated sites. Some of our products are subjectto various federal, state, local and international laws governing chemicalsubstances in electronic products. We could be subject to increased costs,fines, civil or criminal sanctions, third-party property damage or personalinjury claims if we violate or become liable under environmental and/or workerhealth and safety laws.

 

In January 2003, the European Union, or EU, issued two directivesrelating to chemical substances in electronic products. The Waste Electricaland Electronic Equipment Directive, referred to as WEEE, requires producers ofelectrical goods to pay for specified collection, recycling, treatment anddisposal of past and future covered products. The deadline for enacting andimplementing the WEEE directive was August 13, 2004, although extensionswere granted in some countries. Producers became financially responsible underWEEE related legislation beginning in August 2005. The other directive,the Restriction on the use of certain Hazardous Substances, referred to asRoHS, restricts lead and other hazardous substances in electronic equipmentplaced on the EU market after July 1, 2006. If we fail to comply withthese directives, we may suffer a loss of revenues, be unable to sell ourproducts in certain markets and countries, be subject to penalties and fines orsuffer a competitive disadvantage. Similar legislation could be enacted inother jurisdictions, including in China, Japan or the United States, and thescope of new legislation with respect to currently unregulated substances isuncertain. Costs to comply with WEEE or RoHS related legislation or similarfuture legislation, if applicable, could include costs associated withmodifying our products, recycling and other waste processing costs, legal and 

 

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regulatory costs and insurance costs. We are currently in compliancewith these directives; however, we have incurred significant costs related tocompliance with current requirements. The costs to comply with current andfuture environmental and worker health and safety laws may have a materialadverse effect on our results of operations, expenses and financial condition.

 

**Risks Related to Our Intellectual Property**

 

***Our ability tocompete and the success of our business could be jeopardized if we are unableto rely on our patent rights.***

 

Our success and ability to compete depends in part upon our ability toobtain protection in the United States and other countries for our products byestablishing and maintaining intellectual property rights relating to orincorporated into our technology and products. We own a variety of patents andpatent applications in the United States and corresponding patents and patentapplications in foreign jurisdictions. However, we have not obtained patentprotection in each market in which we plan to compete. To date, our patentportfolio has not prevented other companies from competing against us, and wedo not know how successful we would be if we sought to enforce our patentrights against suspected infringers. Our pending and future patent applicationsmay not issue as patents or, if issued, may not issue in a form that will beadvantageous to us. Even if issued, patents may be challenged, narrowed,invalidated or circumvented, which could limit our ability to stop competitorsfrom marketing similar products or limit the length of term of patentprotection we may have for our products. Changes in either patent laws or ininterpretations of patent laws in the United States and other countries maydiminish the value of our intellectual property or narrow the scope of ourpatent protection. Any circumstance or change that results in patent protectionnot being available for our products could adversely affect our business,financial condition and results of operations.

 

***If we are unable toprotect the confidentiality of our unpatented proprietary information andknow-how, the value of our technology and products could be adversely affected.***

 

In addition to patented technology, we rely upon unpatented proprietarytechnology, processes and know-how. We generally seek to protect thisinformation in part by confidentiality agreements with our employees,consultants and third parties. These agreements may be breached, and we may nothave adequate remedies for any such breach. In addition, our trade secrets mayotherwise become known or be independently developed by competitors. If we areunable to protect the confidentiality of our proprietary information andknow-how, the value of our technology and products could be adversely affected,which could in turn adversely affect our business, financial condition andresults of operations.

 

***Claims by othersthat we infringe their proprietary technology could force us to incursignificant costs.***

 

Third parties have asserted, and may assert in the future, claims thatour products infringe patents or patent applications under which we do not holdlicenses or other rights. Third parties may own or control these patents andpatent applications in the United States and abroad. These third parties havebrought, and could in the future bring, claims against us that would cause usto incur substantial expenses and, if successfully asserted against us, couldcause us to pay substantial damages. Further, if a patent infringement suitwere brought against us, we could be forced to stop or delay manufacturing orsales of the product that is the subject of the suit. In addition, we could be forcedto redesign the product that uses any allegedly infringing technology.

 

We are presently defending two patent infringement lawsuits brought byUTStarcom, Inc. In February 2005, UTStarcom filed a lawsuit assertinginfringement of a patent in the United States District Court for the NorthernDistrict of California relating to a prepaid billing function we provided toone of our customers. This patent lawsuit by UTStarcom has been stayed pendinga reissue proceeding of the patent asserted in the case. Such a reissueproceeding may take a year or longer to complete. After the reissue proceeding,the stay of the lawsuit likely will be lifted and the lawsuit may proceed. Ifthis occurs, we will continue to defend ourselves in this litigation, whichwill require a significant investment of time and financial resources. Afinding that we have infringed this patent may require us to pay damages basedon our past sale of the prepaid billing function and, in addition, may force usto limit or cease development, manufacturing and sales of the prepaid billingfunction. This could adversely affect our business, financial condition andresults of operations.

 

In May 2007, UTStarcom filed a lawsuit against us and a number ofour employees and former employees in the United States District Court for theNorthern District of Illinois.  UTStarcomhas amended its complaint several times and, as amended, alleges in there-filed version if its Fourth Amended Complaint violations of the Illinoistrade secrets act, infringement of patents assigned to UTStarcom, intentionalinterference with UTStarcom’s business relations and declarations of ownershiprelating to one of  our patents andcertain of our patent applications, copyright infringement, breach ofrestrictive covenants against the employee and former employee defendants, andaiding and abetting the employee and former employee defendants’ breach offiduciary duty of loyalty and the employment agreements. The complaint containsallegations, among others, that a number of former employees of a business unitUTStarcom acquired, who subsequently worked for us, took UTStarcom’s tradesecrets with them and improperly used those trade 

 

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secrets to develop, manufacture and market our 3G wireless products,and that such products incorporate UTStarcom confidential technicalinformation, including UTStarcom’s proprietary virtual private network andEV-DO features. UTStarcom further alleges that we have disclosed UTStarcom’strade secrets in one of our patents and three of our patent applications, andthat this patent and these patent applications legally belong to UTStarcombased on the inventors’ previous work at the business unit acquired byUTStarcom. In this lawsuit, UTStarcom seeks unspecified monetary damages,punitive damages, injunctive relief, declarations of ownership relating to thespecified patent and patent applications owned by us, findings ofmisappropriation of trade secrets, patent infringement and copyrightinfringement, costs and attorneys fees. We will vigorously defend ourselves inthis litigation. The defense of this lawsuit and the prosecution of ourcounterclaims will require significant investment of time and financialresources. A finding in UTStarcom’s favor in this lawsuit may require us to paysubstantial damages based on the past sales of our ST16 product, may force usto pay royalties on past or future sales of our ST16 or ST40 products, mayforce us to limit or cease development, manufacturing and sales of the ST16 andST40, which are our only product platforms, may require that key employees betransferred to other positions or functions, or temporarily prohibited fromworking for us, and may result in the loss or assignment of ownership of aspecified patent and seven patent applications owned by us. This couldadversely affect our business, financial condition and results of operations.

 

As a result of patent infringement claims, or in order to avoidpotential claims, we may choose or be required to seek a license from the thirdparty and be required to pay license fees or royalties or both. These licensesmay not be available on acceptable terms, or at all. Even if we were able toobtain a license, the rights may be nonexclusive, which could result in ourcompetitors gaining access to the same intellectual property. Ultimately, wecould be forced to cease some aspect of our business operations if, as a resultof actual or threatened patent infringement claims, we are unable to enter intolicenses on acceptable terms. This could significantly and adversely affect ourbusiness, financial condition and results of operations.

 

In addition to infringement claims against us, we may become a party toother types of patent litigation and other proceedings, including interferenceproceedings declared by the United States Patent and Trademark Office andopposition proceedings in the European Patent Office, regarding intellectualproperty rights with respect to our products and technology. The cost to us ofany patent litigation or other proceeding, even if resolved in our favor, couldbe substantial. Some of our competitors may be able to sustain the costs ofsuch litigation or proceedings more effectively than we can because of theirgreater financial resources. Uncertainties resulting from the initiation andcontinuation of patent litigation or other proceedings could have a materialadverse effect on our ability to compete in the marketplace. Patent litigationand other proceedings may also require significant commitments of time by ourmanagement.

 

***Our use of opensource could impose limitations on our ability to commercialize our products.***

 

We incorporate open source software into our products. Although wemonitor our use of open source software closely, the terms of many open sourcelicenses to which we are subject have not been interpreted by United States orforeign courts, and there is a risk that such licenses could be construed in amanner that imposes unanticipated conditions or restrictions on our ability tocommercialize our products. In such event, we could be required to seeklicenses from third parties in order to continue offering our products, tore-engineer our products or to discontinue sales of our products, any of whichcould materially adversely affect our business.

 

***We rely on theavailability of licenses for intellectual property from third parties, and ifthese licenses are not available to us on commercially reasonable terms,product sales and development may be delayed.***

 

We incorporate certain third-party technologies, including softwareprograms, into our products and may need to utilize additional third-partytechnologies in the future. However, licenses to relevant third-partytechnology may not continue to be available to us on commercially reasonableterms, or at all. Therefore, we could face delays in product releases untilalternative technology can be identified, licensed or developed, and integratedinto our current products. These delays, if they occur, could materiallyadversely affect our business.

 

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**ITEM 2.    UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

(b) Use of Proceedsfrom Public Offerings of Common Stock

 

In June 2007, we completed an initial public offering of commonstock pursuant to a Registration Statement on Form S-1 (Registration No. 333-141092)which the SEC declared effective on June 5, 2007. Pursuant to theregistration statement, we registered the offering and sale of an aggregate of12,115,067 shares of our common stock, of which 10,580,226 shares were sold byus including 1,580,226 shares sold in connection with the underwriters’ optiondescribed below, and 1,534,841 shares were sold by certain stockholders, at aprice of $12.00 per share. The underwriters exercised their option to purchasethe additional 1,580,226 shares of our common stock at the initial publicoffering price of $12.00 per share on June 8, 2007 and the offering closedon June 11, 2007. The underwriters for the offering were Goldman, Sachs &Co., Lehman Brothers, JPMorgan and Thomas Weisel Partners LLC.

 

We raised a total of $127.0 million in gross proceeds from theinitial public offering, or approximately $116.0 million in net proceedsafter deducting underwriting discounts and commissions of $8.9 million andother estimated offering costs of approximately $2.1 million. The sellingstockholders received a total of approximately $18.4 million in grossproceeds from the initial public offering or approximately $17.1 millionof net proceeds after deducting the underwriting discounts. We have investedthe remaining net proceeds in cash and cash equivalents, primarily money-marketmutual funds. None of the remaining net proceeds were paid, directly orindirectly, to directors, officers, persons owning ten percent or more of ourequity securities, or any of our other affiliates.

 

In October 2007, we completed a public offering of common stockpursuant to a Registration Statement on Form S-1 (Registration No. 333-146717)which the SEC declared effective on October 31, 2007. Pursuant to theregistration statement, we registered the offering and sale of an aggregate of8,000,000 shares of our common stock, of which 3,880,000 shares were sold by usand 4,120,000 shares were sold by certain stockholders, at a price of $24.00per share. The underwriters for the offering were Goldman, Sachs &Co., Lehman Brothers, JPMorgan and Thomas Weisel Partners LLC.

 

We raised a total of $93.1 million in gross proceeds from thepublic offering, or approximately $88.1 million in net proceeds afterdeducting underwriting discounts and commissions of $4.4 million and otherestimated offering costs. The selling stockholders received a total ofapproximately $98.9 million in gross proceeds from the public offering orapproximately $94.2 million of net proceeds after deducting theunderwriting discounts. We have invested the remaining net proceeds in cash andcash equivalents, primarily money-market mutual funds. None of the remainingnet proceeds were paid, directly or indirectly, to directors, officers, personsowning ten percent or more of our equity securities, or any of our otheraffiliates.

 

**ITEM 6.    EXHIBITS**

 

The following in an index of the exhibits included in this report:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                     |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                          |
| 31.1                 |       | Certification of Chief Executive Officer, pursuant to Securities  Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                |
| 31.2                 |       | Certification of Chief Financial Officer, pursuant to Securities  Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                |
| 32.1                 |       | Certification of 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.          |

 

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

 
| ** **                  | **STARENT NETWORKS, CORP.** |
|-----------------------------|-----------------------------|
| * *                    | *(Registrant)*              |
| Date: November 7, 2008 |                        |   |
|                        |                        |   |
|                        | By:                         | /s/ ASHRAF M. DAHOD |
|                        |                        | Ashraf M. Dahod |
| * *                    | * *                    | *President and Chief Executive Officer* |
| * *                    | * *                    | *(Principal Executive Officer)* |
| Date: November 7, 2008 |                        |   |
|                        |                        |   |
|                        | By:                         | /s/ PAUL J. MILBURY |
|                        |                        | Paul J. Milbury |
| * *                    | * *                    | *Vice President, Operations and* |
| * *                    | * *                    | *Chief Financial Officer* |
| * *                    | * *                    | *(Principal Financial Officer)* |
| Date: November 7, 2008 |                        |   |
|                        |                        |   |
|                        | By:                         | /s/ GEORGE W. HALE |
|                        |                        | George W. Hale |
| * *                    | * *                    | *Vice President, Finance and* |
| * *                    | * *                    | *Corporate Controller* |
| * *                    | * *                    | *(Principal Accounting Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                     |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                          |
| 31.1                 |       | Certification of Chief Executive Officer, pursuant to Securities  Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                |
| 31.2                 |       | Certification of Chief Financial Officer, pursuant to Securities  Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                |
| 32.1                 |       | Certification of 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.          |

 

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