**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM10-Q**

**(Mark One)**

**x****                             ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended June 30, 2007**

**Or**

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe transition periodfrom                     to                     **

**CommissionFile Number: 001-33511**

**STARENTNETWORKS, CORP.**

(Exact name ofregistrant as specified in its charter)

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

 

**30International Place**

**Tewksbury,MA 01876**

(Address ofprincipal executive offices) (zip code)

**(978)851-1100**

(Registrant’stelephone number, including area code)

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

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  o Yes      x  No

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

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o Yes  x  No

As of August 6, 2007, there were 64,545,751 shares of the registrant’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 JUNE 30, 2007**

**Tableof Contents**
| Item                           | ** ** | ** **                                                                                                  | ** ** | **Page** |
|--------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|----------|
|                           |       |                                                                                                        |       |     |
| PART I. FINANCIAL  INFORMATION |       | 3                                                                                                           |
|                           |       |                                                                                                        |       |     |
| ITEM 1.                        |       | Condensed Consolidated  Financial Statements (unaudited)                                                    |       | 3        |
|                           |       |                                                                                                        |       |     |
|                           |       | Condensed  Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006                            |       | 3        |
|                           |       |                                                                                                        |       |     |
|                           |       | Condensed  Consolidated Statements of Operations for the Three and Six Months Ended June  30, 2007 and 2006 |       | 4        |
|                           |       |                                                                                                        |       |     |
|                           |       | Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007  and 2006           |       | 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                                                 |       | 26       |
|                           |       |                                                                                                        |       |     |
| ITEM 4.                        |       | Controls and  Procedures                                                                                    |       | 27       |
|                           |       |                                                                                                        |       |     |
| PART II. OTHER INFORMATION     |       | 28                                                                                                          |
|                           |       |                                                                                                        |       |     |
| ITEM 1.                        |       | Legal Proceedings                                                                                           |       | 28       |
|                           |       |                                                                                                        |       |     |
| ITEM 1A.                  |       | Risk  Factors                                                                                               |       | 28       |
|                           |       |                                                                                                        |       |     |
| ITEM 2.                        |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                |       | 44       |
|                           |       |                                                                                                        |       |     |
| ITEM 3.                        |       | Defaults  upon Senior Securities                                                                            |       | 44       |
|                           |       |                                                                                                        |       |     |
| ITEM 4.                        |       | Submission  of Matters to a Vote of Security Holders                                                        |       | 44       |
|                           |       |                                                                                                        |       |     |
| ITEM 5.                        |       | Other Information                                                                                           |       | 44       |
|                           |       |                                                                                                        |       |     |
| ITEM  6.                       |       | Exhibits                                                                                                    |       | 44       |

 

2

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**PARTI. FINANCIAL INFORMATION**

**ITEM 1. CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**STARENTNETWORKS, CORP.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(unaudited and inthousands, except share and per share data)**

|                                                                                                                                                                                                   | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                        |       |                    |       |                        |       |
| Current assets                                                                                                                                                                                    |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                         |       | $                       | 136,400    |                        | $          | 24,010 |   |
| Short-term investments                                                                                                                                                                            |       | 20,765                  |       | 36,144                      |       |
| Accounts receivable                                                                                                                                                                               |       | 16,694                  |       | 13,619                      |       |
| Inventories                                                                                                                                                                                       |       | 16,853                  |       | 14,578                      |       |
| Prepaid expenses and other current assets                                                                                                                                                         |       | 4,119                   |       | 3,193                       |       |
| Total current assets                                                                                                                                                                              |       | 194,831                 |       | 91,544                      |       |
|                                                                                                                                                                                              |       |                    |       |                        |       |
| Property and  equipment, net                                                                                                                                                                      |       | 18,201                  |       | 10,839                      |       |
| Other assets                                                                                                                                                                                      |       | 1,085                   |       | 845                         |       |
| Restricted cash                                                                                                                                                                                   |       | 592                     |       | 1,039                       |       |
| Total assets                                                                                                                                                                                      |       | $                       | 214,709    |                        | $          | 104,267 |   |
| ** **                                                                                                                                                                                        | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **Liabilities,  redeemable convertible preferred stock and stockholders’ equity (deficit)**                                                                                                  |       |                    |       |                        |       |
| Current  liabilities                                                                                                                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Accounts payable                                                                                                                                                                                  |       | $                       | 8,053      |                        | $          | 4,249 |   |
| Accrued expenses                                                                                                                                                                                  |       | 3,910                   |       | 2,675                       |       |
| Accrued payroll and related expenses                                                                                                                                                              |       | 7,762                   |       | 7,977                       |       |
| Income taxes payable                                                                                                                                                                              |       | 552                     |       | 232                         |       |
| Current portion of deferred revenue                                                                                                                                                               |       | 35,113                  |       | 57,106                      |       |
| Total current liabilities                                                                                                                                                                         |       | 55,390                  |       | 72,239                      |       |
|                                                                                                                                                                                              |       |                    |       |                        |       |
| Deferred  revenue, net of current portion                                                                                                                                                         |       | 5,829                   |       | 6,562                       |       |
| Refundable  exercise price of restricted common stock                                                                                                                                             |       | 1,046                   |       | 707                         |       |
|                                                                                                                                                                                              |       |                    |       |                        |       |
| Commitments and  contingencies (Note 7)                                                                                                                                                           |       |                    |       |                        |       |
|                                                                                                                                                                                              |       |                    |       |                        |       |
| Redeemable  convertible preferred stock                                                                                                                                                           |       | —                  |       | 130,270                     |       |
|                                                                                                                                                                                              |       |                    |       |                        |       |
| Stockholders’  equity (deficit)                                                                                                                                                              |       |                    |       |                        |       |
| Common stock, $0.001 par value, 250,000,000 and  120,000,000 shares authorized, 63,969,483 and 7,456,672 shares issued and  outstanding at June 30, 2007 and December 31, 2006, respectively |       | 64                      |       | 7                           |       |
| Additional paid-in capital                                                                                                                                                                        |       | 252,220                 |       | —                      |       |
| Accumulated other comprehensive loss                                                                                                                                                              |       | (9                      | )          | (1                          | )          |
| Accumulated deficit                                                                                                                                                                               |       | (99,831                 | )          | (105,517                    | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                         |       | 152,444                 |       | (105,511                    | )          |
| Total  liabilities, redeemable convertible preferred stock and stockholders’ equity  (deficit)                                                                                               |       | $                       | 214,709    |                        | $          | 104,267 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

3

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**STARENTNETWORKS, CORP.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited and inthousands, except per share data)**
| ** **                                                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                              | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues:                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Product                                                                                 |       | $                                               | 25,121     |                                          | $          | 17,744 |   | $ | 49,573 |   | $ | 29,466 |   |
| Service                                                                                 |       | 5,733                                           |       | 2,645                                         |       | 8,923 |   | 5,357 |   |
| Total revenues                                                                          |       | 30,854                                          |       | 20,389                                        |       | 58,496 |   | 34,823 |   |
| Cost of  revenues:                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Product                                                                                 |       | 6,316                                           |       | 3,401                                         |       | 10,754 |   | 7,294 |   |
| Service                                                                                 |       | 1,942                                           |       | 363                                           |       | 3,329 |   | 704 |   |
| Total cost of revenues                                                                  |       | 8,258                                           |       | 3,764                                         |       | 14,083 |   | 7,998 |   |
| Gross profit                                                                            |       | 22,596                                          |       | 16,625                                        |       | 44,413 |   | 26,825 |   |
|                                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Operating  expenses:                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Research and development                                                                |       | 7,585                                           |       | 6,064                                         |       | 17,651 |   | 9,705 |   |
| Sales and marketing                                                                     |       | 8,867                                           |       | 7,584                                         |       | 15,936 |   | 12,745 |   |
| General and administrative                                                              |       | 3,398                                           |       | 1,983                                         |       | 6,242 |   | 3,499 |   |
| Total operating expenses                                                                |       | 19,850                                          |       | 15,631                                        |       | 39,829 |   | 25,949 |   |
|                                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Income from  operations                                                                 |       | 2,746                                           |       | 994                                           |       | 4,584 |   | 876 |   |
| Interest income                                                                         |       | 890                                             |       | 495                                           |       | 1,598 |   | 912 |   |
| Foreign currency  exchange loss                                                         |       | (91                                             | )          | (28                                           | )          | (89 | ) | (23 | ) |
| Other income  (expenses)                                                                |       | —                                          |       | (39                                           | )          | — |   | (41 | ) |
| Income before income tax expense                                                        |       | 3,545                                           |       | 1,422                                         |       | 6,093 |   | 1,724 |   |
| Income tax  expense                                                                     |       | (164                                            | )          | (92                                           | )          | (407 | ) | (143 | ) |
|                                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Net income                                                                              |       | $                                               | 3,381      |                                          | $          | 1,330 |   | $ | 5,686 |   | $ | 1,581 |   |
|                                                                                    |       |                                            |       |                                          |       |   |   |   |   |
| Net income  (loss) per share applicable to common stockholders (Note 3):                |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                                   |       | $                                               | 0.03       |                                          | $          | (0.10 | ) | $ | 0.04 |   | $ | (0.35 | ) |
| Diluted                                                                                 |       | $                                               | 0.03       |                                          | $          | (0.10 | ) | $ | 0.03 |   | $ | (0.35 | ) |
| Weighted-average  shares used in computing net income (loss) per common share (Note 3): |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                                   |       | 23,919                                          |       | 6,821                                         |       | 15,864 |   | 6,838 |   |
| Diluted                                                                                 |       | 30,197                                          |       | 6,821                                         |       | 21,769 |   | 6,838 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

4

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**STARENTNETWORKS, CORP.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited and inthousands)**
| ** **                                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| **Cash  flows from operating activities:**                                                 |       |                                          |       |   |   |
| Net income                                                                                 |       | $                                             | 5,686      |   | $ | 1,581 |   |
| Adjustments to  reconcile net income to net cash provided by(used in) operating activities |       |                                          |       |   |   |
| Depreciation expense                                                                       |       | 2,788                                         |       | 1,305 |   |
| Share-based compensation                                                                   |       | 4,754                                         |       | 232 |   |
| Foreign currency losses                                                                    |       | (26                                           | )          | 7 |   |
| Changes in operating assets and liabilities                                                |       |                                          |       |   |   |
| Accounts receivable                                                                        |       | (3,066                                        | )          | (9,746 | ) |
| Inventories                                                                                |       | (2,271                                        | )          | (569 | ) |
| Prepaid expenses and other current assets                                                  |       | (878                                          | )          | (876 | ) |
| Other assets                                                                               |       | (240                                          | )          | (4 | ) |
| Accounts payable                                                                           |       | 3,780                                         |       | 2,030 |   |
| Accrued expenses                                                                           |       | 897                                           |       | 2,032 |   |
| Income taxes payable                                                                       |       | 327                                           |       | (215 | ) |
| Deferred revenue                                                                           |       | (22,727                                       | )          | 15,201 |   |
|                                                                                       |       |                                          |       |   |   |
| Net cash provided by (used in) operating activities                                        |       | (10,976                                       | )          | 10,978 |   |
| ** **                                                                                 |       |                                          |       |   |   |
| **Cash  flows from investing activities:**                                                 |       |                                          |       |   |   |
| Purchases of property and equipment                                                        |       | (10,138                                       | )          | (3,748 | ) |
| Purchases of short-term investments                                                        |       | (11,208                                       | )          | (19,833 | ) |
| Proceeds from maturities of short-term investments                                         |       | 26,580                                        |       | 17,545 |   |
| Change in restricted cash                                                                  |       | 452                                           |       | 33 |   |
|                                                                                       |       |                                          |       |   |   |
| Net cash provided by (used in) investing activities                                        |       | 5,686                                         |       | (6,003 | ) |
| ** **                                                                                 |       |                                          |       |   |   |
| **Cash  flows from financing activities:**                                                 |       |                                          |       |   |   |
| Proceeds from Initial Public Offering, net of  expenses                                    |       | 116,037                                       |       | — |   |
| Repayment of long-term debt                                                                |       | —                                        |       | (33 | ) |
| Proceeds from exercise of stock options                                                    |       | 1,208                                         |       | 109 |   |
| Proceeds from issuance of restricted common stock                                          |       | 347                                           |       | — |   |
|                                                                                       |       |                                          |       |   |   |
| Net cash provided by financing activities                                                  |       | 117,592                                       |       | 76 |   |
|                                                                                       |       |                                          |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                              |       | 88                                            |       | 10 |   |
|                                                                                       |       |                                          |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                       |       | 112,390                                       |       | 5,061 |   |
|                                                                                       |       |                                          |       |   |   |
| Cash and cash  equivalents, beginning of period                                            |       | 24,010                                        |       | 20,036 |   |
|                                                                                       |       |                                          |       |   |   |
| Cash and cash  equivalents, end of period                                                  |       | $                                             | 136,400    |   | $ | 25,097 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

5

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STARENT NETWORKS,CORP.

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

**1.**              Overview

***Business Description***

Starent Networks, Corp. (“Starent” or the “Company”) was incorporated inDelaware on August 11, 2000 and is a leading provider of infrastructure hardwareand software products and services that enable mobile operators to delivermultimedia services to their subscribers. The Company’s products and servicesintegrate multiple network functions and services needed for the delivery ofadvanced multimedia services, such as video, Internet access, voice-over-IP,e-mail, mobile TV, photo sharing and gaming.

***Basis of Presentation***

The accompanying interim condensed consolidated financial statementspresented herein have been prepared by Starent, 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 June 30, 2007, results of operations for thethree and six month periods ended June 30, 2007 and June 30, 2006 and cashflows for the six month periods ended June 30, 2007 and June 30, 2006 inaccordance with accounting principles generally accepted in the United States.Interim results are not necessarily indicative of results for any other interimperiod or a full year. The condensed consolidated balance sheet presented as ofDecember 31, 2006 has been derived from the audited consolidated financialstatements as of that 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 Registration Statement on Form S-1 declared effective by theSecurities and Exchange Commission, or SEC, (File No. 333-141092) on June 5,2007.

***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 andliabilities.  Management evaluates these estimates and assumptions on anongoing basis.  Significant estimates and assumptions relied upon bymanagement in preparing these financial statements include revenue recognition,allowances for doubtful accounts, net realizable value of inventories,expensing and capitalization of research and development costs for software,the determination of fair value of share-based compensation and therecoverability of the Company’s net deferred tax assets and related valuationallowance.

Although the Company regularly assesses these estimates, actual resultscould differ materially from these estimates.  Changes in estimates arerecorded in the period in which they become known.  The Company bases itsestimates on historical experience and various other assumptions that itbelieves to be reasonable under the circumstances.  Actual results coulddiffer from management’s estimates if past experience or other assumptions donot turn out to be substantially accurate.

***Concentrations of Risk 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.Financial instruments that potentially subject the Company to concentrations ofcredit risk are principally cash and cash equivalents, short-term investments,accounts

6

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receivable and inventories. The Company’s cash equivalents and itsshort-term investments are principally maintained with one commercial bank.

TheCompany had three and four customers for the three and six months ended June30, 2007, respectively, that each accounted for more than 10% of revenues andin the aggregate accounted for 89% and 90%, of revenues for each of therespective periods.  The Company had twoand one 10% customers for the three and six months ended June 30, 2006,respectively, that accounted for 84% and 65% of revenues for the respectiveperiods.

AtJune 30, 2007, the Company had three customers that accounted for 71% ofaccounts receivable. At December 31, 2006, the Company had three customerswho accounted for 76% 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 timeframes.

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.

**2.**            Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board, orFASB, issued Statement of Financial Accounting Standard, or SFAS, 123(Revised),*Share-Based Payment*, which is a revisionof SFAS 123, *Accounting for Stock-Based Compensation*.SFAS 123R supersedes Accounting Principles Board, or APB, Opinion 25, *Accounting for Stock Issued to Employees* and SFAS 123 andamends SFAS 95, *Statement of Cash Flows*.  Generally, the approach in SFAS 123R issimilar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their grant date fair value.    The Company adopted SFAS 123R effectiveJanuary 1, 2006 utilizing the prospective transition method, which requires theCompany to apply the provisions of SFAS 123R only to new awards granted, and toawards modified, repurchased or cancelled on of after January 1, 2006.

The fair value of options granted for the three and six months endedJune 30, 2007 and 2006 was estimated at the date of grant using the followingassumptions:
| ** **                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Risk-free  interest rates |       | 4.76                                            | %          | 4.99                                          | %          | 4.61-4.76 | % | 4.55-4.99 | % |
| Expected  dividend yield  |       | 0                                               | %          | 0                                             | %          | 0 | % | 0 | % |
| Expected life             |       | 6.25 years                                      |       | 6.25 years                                    |       | 6.25 years |   | 6.25 years |   |
| Expected volatility       |       | 64                                              | %          | 68                                            | %          | 64-68 | % | 68 | % |

 

The expected life was calculated based on the simplified method aspermitted by the SEC’s Staff Accounting Bulletin 107, *Share-BasedPayments*.  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 freeinterest rate was based on a treasury instrument whose term is

7

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consistent with the expected life of the stock options.  In addition to the assumptions above, asrequired under SFAS 123R, management made an estimate of expected forfeituresand is recognizing compensation costs only for those equity awards expected tovest.

The results for the periods set forth below includedshare-based compensation expense in the following expense categories of thecondensed consolidated statements of operations (in thousands): 
| ** **                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Share based  compensation included in:               |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenue                                      |       | $                                               | 130        |                                          | $          | 8 |   | $ | 198 |   | $ | 8 |   |
| Total share-based compensation in cost of revenue    |       | 130                                             |       | 8                                             |       | 198 |   | 8 |   |
|                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Research and development                             |       | 1,660                                           |       | 66                                            |       | 2,141 |   | 82 |   |
| Sales and marketing                                  |       | 644                                             |       | 86                                            |       | 993 |   | 98 |   |
| General and administrative                           |       | 847                                             |       | 44                                            |       | 1,422 |   | 44 |   |
| Total share-based compensation in operating expenses |       | 3,151                                           |       | 196                                           |       | 4,556 |   | 224 |   |
| Total share-based  compensation                      |       | $                                               | 3,281      |                                          | $          | 204 |   | $ | 4,754 |   | $ | 232 |   |

 

**3.**              Net Income (Loss) perShare

Basic and dilutednet income (loss) per share applicable to common stockholders is presented inconformity with SFAS 128, *Earnings perShare* and the related interpretation in Emerging Issues TaskForce 03-06, *ParticipatingSecurities and the Two-Class Method under FASB Statement No. 128.*Basic net income (loss) per share applicable to common stockholders is computedby dividing net income (loss) applicable to common stockholders by the weighted-averagenumber of common shares outstanding during the period, excluding the dilutiveeffects of common stock equivalents. Income applicable to common stockholdersincludes accretion of redeemable convertible preferred stock and earningsallocated to participating preferred stockholders. Common stock equivalentsinclude stock options, restricted stock and, in certain circumstances,convertible securities such as the convertible preferred stock. Diluted netincome (loss) per share assumes the conversion of the convertible preferredstock using the “if converted” method, if dilutive, and includes the dilutiveeffect of stock options and restricted stock under the treasury stock method.The following table presents the calculation of basic and diluted net income(loss) per share (in thousands, except per share data):

|                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net income                                                 |       | $                                               | 3,381      |                                          | $          | 1,330 |   | $ | 5,686 |   | $ | 1,581 |   |
| Accretion on redeemable convertible preferred stock        |       | (1,448                                          | )          | (1,997                                        | )          | (3,445 | ) | (3,994 | ) |
| Income allocated to preferred stockholders                 |       | (1,108                                          | )          | —                                        |       | (1,583 | ) | — |   |
| Net  income (loss) applicable to common stockholders       |       | $                                               | 825        |                                          | $          | (667 | ) | $ | 658 |   | $ | (2,413 | ) |
|                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Weighted-average common shares outstanding – basic    |       | 23,919                                          |       | 6,821                                         |       | 15,864 |   | 6,838 |   |
| Dilutive effect of stock options and restricted stock      |       | 6,278                                           |       | —                                        |       | 5,905 |   | — |   |
| Weighted average common shares outstanding – dilutive |       | 30,197                                          |       | 6,821                                         |       | 21,769 |   | 6,838 |   |
|                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss) per share:                               |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                      |       | $                                               | 0.03       |                                          | $          | (0.10 | ) | $ | 0.04 |   | $ | (0.35 | ) |
| Diluted                                                    |       | $                                               | 0.03       |                                          | $          | (0.10 | ) | $ | 0.03 |   | $ | (0.35 | ) |

 

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The following outstanding options, restricted common stock subject torepurchase and convertible preferred stock were excluded from the computationof diluted net income (loss) per common share for the periods presented becauseincluding them would have had an antidilutive effect (in thousands):
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Options to purchase common stock and common stock subject  to repurchase |       | 66                                              |       | 6,173                                         |       | 66 |   | 6,255 |   |
| Convertible preferred stock (as converted basis)                         |       | 32,121                                          |       | 44,288                                        |       | 38,171 |   | 44,288 |   |

 

**4.**              Inventories

Inventories are stated at the lower of cost (first-in, first-out) ormarket (net realizable value). Inventories principally included the cost of raw materials,subassemblies, the cost of third-party contract manufacturers and cost of salesrelated to deferred revenue which is included in finished goods.  Inventories consisted of the following (inthousands):
|                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                       | 4,387      |                        | $          | 1,617 |   |
| Work in process |       | 4,903                   |       | 2,950                       |       |
| Finished goods  |       | 7,563                   |       | 10,011                      |       |
|            |       | $                       | 16,853     |                        | $          | 14,578 |   |

 

**5.**              Redeemable ConvertiblePreferred Stock and Stockholders’ Equity

**Redeemable ConvertiblePreferred Stock**

The following table summarizes redeemable convertible preferred activityduring the six months ended June 30, 2007 (in thousands):
|                                            | ** ** | **Series A** | ** ** | **Series B** | ** ** | **Series C** | ** ** | **Series D** | ** ** | **Series E** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-----------|------------|
|                                       |       |              |       |              |       |              |       |              |       |              |       |      |       |
| Balance at  December 31, 2006              |       | $                 | 15,307     |              | $          | 31,591            |       | $                 | 30,491     |              | $          | 32,750    |       | $ | 20,131 |   | $ | 130,270 |   |
| Accretion of  dividends on preferred stock |       | 350               |       | 759               |       | 794               |       | 921               |       | 621               |       | 3,445     |       |
| Conversion of  preferred stock             |       | (15,657           | )          | (32,350           | )          | (31,285           | )          | (33,671           | )          | (20,752           | )          | (133,715  | )          |
| Balance at June 30,  2007                  |       | $                 | —     |              | $          | —            |       | $                 | —     |              | $          | —    |       | $ | — |   | $ | — |   |

 

In June 2007, the Company completed an initial publicoffering of its common stock in which it sold and issued 10,580,226 shares ofits common stock, including 1,580,226 shares pursuant to the underwriters’ fullexercise of their over-allotment option, at a price of $12.00 per share.  The offering raised a total of $127.0 millionin gross proceeds and $116.0 million in net proceeds after deductingunderwriting discounts and commissions of $8.9 million and other offeringexpenses of approximately $2.1 million. In connection with the offering, alloutstanding shares of the Company’s redeemable convertible preferred stockautomatically converted into an aggregate of 44,287,985 shares of the Company’scommon stock.

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**ReverseStock Split**

On April 26,2007, the board of directors of the Company approved, and on April 30,2007, the stockholders of the Company approved, a 2-for-3 reversestock split of the Company’s common stock, which was effective on May 1,2007. All share data shown in the accompanying condensed consolidated financialstatements and related notes have been retroactively revised to reflect thereverse stock split.

**6.**              Income Taxes

On January 1,2007, the Company adopted the provisions of FASB Interpretation, or FIN,No. 48, *Accounting for Uncertainty inIncome Taxes,* an interpretation of SFAS 109, *Accounting for Income Taxes*. The new standard defines thethreshold for recognizing the benefits of tax return positions in the financialstatements as “more-likely-than-not” to be sustained by the taxing authoritiesbased solely on the technical merits of the position. If the recognitionthreshold is met, the tax benefit is measured and recognized as the largestamount of tax benefit, in the Company’s judgment, which is greater than 50%likely to be realized. The Company did not recognize any change in its reservefor uncertain tax positions as a result of the adoption of this standard. Atthe adoption date of January 1, 2007, the Company had approximately $134,000of unrecognized tax benefits the benefit of which, if recognized, wouldfavorably affect the income tax rate in future periods.  At June 30, 2007, the Company had a liabilityof approximately $134,000 related to unrecognized tax benefits.

The Company recognizesinterest and penalties related to uncertain tax positions in income taxexpense. Upon adoption of FIN 48 and at June 30, 2007, the Company had animmaterial amount of accrued interest and penalties associated with itsuncertain tax positions.

The Company hasaccumulated significant losses from its inception in August 2000. Sincethe net operating losses may potentially be utilized in future years to reducetaxable income, all of the Company’s tax years remain open to examination bythe major taxing jurisdictions to which it is subject.

AtDecember 31, 2006, the Company had U.S. federal net operating losscarryforwards of $63.1 million that expire beginning in 2022 and state netoperating loss carryforwards of $65.5 million that expire beginning in 2007.  The Company also had U.S. federal tax creditsof $3.0 million that expire beginning in 2020 and state research anddevelopment credits of $652,000 that expire beginning in 2018. The InternalRevenue Code contains provisions that may limit the net operating losses andtax credit carryforwards available to be used in any given year in the event ofcertain circumstances, including significant changes in ownership interests.

**7.**              Litigation

In February, 2005,UTStarcom filed a complaint against the Company in the United States DistrictCourt Northern District of California seeking unspecified damages andinjunctive relief. The complaint alleges infringement by the Company ofUTStarcom’s U.S. Patent No. 6,829,473, entitled “Roaming and Hand-OffSupport for Prepaid Billing for Wireless Data Networks,” which is referred toas the “473 patent. UTStarcom notified the Company that it had served thecomplaint on May 6, 2005. On May 31, 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. On July 27, 2005, the Company filed an amended answerand counterclaims to the “473 patent complaint. A claim construction hearinghad been scheduled on February 14, 2007, however, on December 7,2006, UTStarcom filed a reissue patent application on the “473 patent. OnJanuary 29, 2007, by agreement of the parties, the Court stayed the casepending the outcome of the reissue application. The Company believes that ithas meritorious

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defenses againstany resulting reissued patent, and is prepared to vigorously defend the “473patent case through trial.

In May 2007,UTStarcom filed an additional complaint against the Company and a number of itsemployees and former employees with the United States District Court for theNorthern District of Illinois alleging violations of the Illinois trades secretact, infringement of five patents assigned to UTStarcom, intentionalinterference with UTStarcom’s business relations and declarations of ownershiprelating to one of the Company’s patents and three patent applications. Thecomplaint contains allegations, among others, that a number of former employeesof a business unit UTStarcom acquired, who subsequently worked for the Company,took UTStarcom’s trade secrets with them and improperly used those tradesecrets to develop, manufacture and market the Company’s 3G wireless products,and that such products incorporate UTStarcom confidential technicalinformation, including UTStarcom’s proprietary virtual private network and EV-DO features.UTStarcom further alleges that the Company has disclosed UTStarcom’s tradesecrets in one of its patents and three of its patent applications, and thatthese patent applications legally belong to UTStarcom based on the inventors’previous work at the business unit acquired by UTStarcom. The complaint seeksunspecified monetary damages, injunctive relief, declarations of ownershiprelating to the specified patent and three patent applications owned by theCompany, costs and attorneys fees. On July 25, 2007, in lieu of filing answersto the complaint, the Company and the individual defendants named in thecomplaint filed a motion to dismiss all state law claims asserted in thecomplaint. If successful, only the patent infringement allegations against theCompany would remain in the case. On July 30, 2007, UTStarcom filed a pleadingin response to this motion, and the District Court has taken the issues raisedunder advisement. The Company believes it has meritorious defenses to each ofUTStarcom’s claims in this lawsuit and is prepared to vigorously defend thelawsuit.

In addition, theCompany is subject to other legal proceedings, claims and litigation arising inthe ordinary course of business. While the outcomes of these matters, includingthe matters described above, are currently not determinable, the Company doesnot expect that the ultimate costs to resolve these matters will have amaterial adverse effect on its consolidated financial position, results ofoperations or cash flows.

**8.**              Business Segments

SFAS 131, *Disclosures About Segmentsof an Enterprise and Related Information*, establishes standards forreporting information about operating segments in annual financial statementsand requires selected information of segments to be presented in financialreports issued to stockholders. Operating segments are defined as components ofan enterprise about which separate financial information is available and thatis evaluated regularly by the chief operating decision maker, or decisionmaking group, in determining how to allocate resources and assess performance.The Company’s chief operating decision maker, as defined under SFAS 131,is the chief executive officer. The Company views its operations and managesits business as one 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).

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**Revenues**
|                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States  and Canada |       | $                                               | 16,317     |                                          | $          | 16,462 |   | $ | 36,936 |   | $ | 27,353 |   |
| Japan                     |       | 12,828                                          |       | 806                                           |       | 13,524 |   | 2,144 |   |
| Korea                     |       | 539                                             |       | 162                                           |       | 6,273 |   | 324 |   |
| Rest of world             |       | 1,170                                           |       | 2,959                                         |       | 1,763 |   | 5,002 |   |
| Total                     |       | $                                               | 30,854     |                                          | $          | 20,389 |   | $ | 58,496 |   | $ | 34,823 |   |

 

**Long-livedAssets**
|               | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------|------------|-------------------------|------------|-----------------------------|------------|
| United States |       | $                       | 14,530     |                        | $          | 8,396 |   |
| India         |       | 3,482                   |       | 2,231                       |       |
| Rest of world |       | 189                     |       | 212                         |       |
| Total         |       | $                       | 18,201     |                        | $          | 10,839 |   |

 

**9.**              Comprehensive Income

Comprehensive income consists of the following (in thousands):
|                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                        | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                        |       | $                                               | 3,381      |                                          | $          | 1,330 |   | $ | 5,686 |   | $ | 1,581 |   |
| Unrealized gain  (loss) on short-term investments |       | (3                                              | )          | (2                                            | )          | (8 | ) | 5 |   |
| Comprehensive income                              |       | $                                               | 3,378      |                                          | $          | 1,328 |   | $ | 5,678 |   | $ | 1,586 |   |

 

**10.**       Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS 157, *Fair ValueMeasurement*, which provides guidance for using fair value to measureassets and liabilities. In addition, SFAS 157 also provides guidance forexpanded information about the extent to which companies measure assets andliabilities at fair value, the information used to measure fair value and theeffect of fair value measurements on earnings. SFAS 157 applies wheneverother standards require (or permit) assets or liabilities to be measured atfair value, but does not expand the use of fair value in any new circumstances.The provisions of SFAS 157 will be effective for the Company beginningJanuary 1, 2008. The Company is in the process of determining the effect,if any, the adoption of SFAS 157 will have on its consolidated financialstatements.

In February 2007, the FASB issued SFAS 159, *The Fair Value Option for Financial Assets andFinancial Liabilities, Including an Amendment of FASB Statement No. 115*.SFAS 159 allows entities to measure many financial instruments and certainother assets and liabilities at fair value on an instrument-by-instrument basis(the fair value option). The fair value option represents a step in theevolution of financial reporting because it considerably expands the ability ofentities to select the measurement attribute for certain assets andliabilities. The Company will be required to adopt the provisions ofSFAS 159 on January 1, 2008. The Company is in the process ofdetermining the effect, if any, the adoption of SFAS 159 will have on itsconsolidated financial statements.

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**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL**

**CONDITIONAND RESULTS OF OPERATIONS**

**CautionaryStatement**

*ThisQuarterly Report on Form 10-Q, including the information incorporated byreference herein, contains, in addition to historical information,forward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934. Theseforward-looking statements are based on our current expectations, assumptions,estimates and projections regarding our business and industry, and we do notundertake an obligation to update our forward-looking statements to reflectfuture events or circumstances. 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 expressionsthat convey uncertainty of future events or outcomes to identify theseforward-looking statements. Forward-looking statements in this Quarterly Reporton Form 10-Q may 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;*

·                  *the spending of our proceeds from our initial publicoffering; and*

·                  *our cash needs.*

*Theoutcome of the events described in these forward-looking statements is subjectto known and unknown risks, uncertainties and other factors including thefactors set forth in Item 1A “Risk Factors” in this Quarterly Report on Form10-Q, that could cause actual results to differ materially from the resultsanticipated by these forward-looking statements. You should read such factorsand risks in conjunction with the unaudited condensed consolidated financialstatements and related notes included elsewhere in this Quarterly Report onForm 10-Q, and in conjunction with the audited consolidated financialstatements contained in our**Registration Statement on Form S-1 declared effective by the SEC (FileNo. 333-141092) on June 5, 2007.You should also read such factors and risks described in other documents thatwe file from time to time with the Securities and Exchange Commission, or SEC.*

**Overview**

Starent Networks is a leading provider of infrastructurehardware and software products and services that enable mobile operators todeliver multimedia services to their subscribers. We have created hardware andsoftware products that provide network functions and services, including accessfrom a wide 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 andcan be configured 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.

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InJune 2007, we completed an initial public offering of our common stock in whichwe sold and issued 10,580,226 shares of our common stock, including 1,580,226shares sold by us pursuant to the underwriters’ full exercise of theirover-allotment option, at a price of $12.00 per share.  We raised a total of $127.0 million in grossproceeds from the initial public offering, or $116.0 million in net proceedsafter deducting underwriting discounts and commissions of $8.9 million andother offering expenses of approximately $2.1 million. In connection with theoffering, all outstanding shares of our convertible preferred stock automaticallyconverted into an aggregate of 44,287,985 shares of our common stock.

We maintain our corporate headquarters in Tewksbury,Massachusetts, and have sales and development offices in various locationsworldwide. We conduct our research and development activities at two locationsin India and two locations in the United States. As of June 30, 2007, we had501 employees worldwide. Our revenues for the year ended December 31, 2006 were$94.4 million, and $30.9 million and $58.5 million for the three andsix months ended June 30, 2007. Our net income for the year ended December 31,2006 was $3.6 million, and $3.4 million and $5.7 million for thethree and six months ended June 30, 2007.

***Revenues***

Our revenues consist of both product revenues and servicerevenues. We derive product revenues from the sale of our hardware products andthe licensing of our software. Service revenues are generated from:

·                  maintenance andtechnical support associated with our software;

·                  hardware repairand maintenance services; and

·                  implementation,training and professional services.

We recognize revenue in accordance with Statement ofPosition, or SOP, 97-2, *Software RevenueRecognition*and SOP 98-9,*Modification of SOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions*. Accordingly, revenue is recognized when persuasiveevidence of an arrangement exists, delivery has occurred, the price is fixed ordeterminable and collection is probable.

Mobile operators can purchase our products and licenseour software in various configurations, depending on their requirements forcapacity, features and protocols. Typically, a mobile operator purchases asmall amount of equipment for testing and trial purposes and, once testing iscomplete, purchases the necessary products to meet their initial capacity andfeature requirements. As their capacity requirements increase, operators maypurchase additional hardware or license additional software. The level of oursales is significantly influenced by the extent to which mobile operators makecapital investments 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 directsales force to mobile operators and indirectly through relationships with OEMs,system integrators and distributors. The OEMs, system integrators anddistributors generally purchase our products after they have received apurchase order from their customers and do not maintain an inventory of ourproducts in anticipation of sales to their customers.

In 2004, we entered into OEM agreements with NortelNetworks relating to the CDMA and the GSM/UMTS markets. Sales to NortelNetworks, all of which were made under the CDMA agreement, accounted for morethan 40% of our revenues in 2006. In December 2006, we terminated both OEMagreements. Under the terms of the CDMA agreement, Nortel Networks has a rightto continue to purchase our CDMA products for delivery throughDecember 2008. Although the termination of the CDMA agreement coulddisrupt our relationships with CDMA mobile operators formerly serviced byNortel Networks, we have established and continue seeking to establishadditional direct sales relationships with some of the CDMA operators formerlyserviced by Nortel Networks.  Inaddition, we are currently in

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discussions to establish a new reseller relationship with NortelNetworks.  As a result, we do not believethat the termination of the Nortel Networks OEM agreements will significantlyimpact our revenues.

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

·                  *Fluctuations in the timing of customer orders.*  Mobile operators require significant lead timesto incorporate changes and enhancements into their networks to ensure thevarious network components are interoperable. These lead times andinteroperability testing requirements result in an extended sales cycle and canlead to uneven purchasing patterns. In addition, our reliance on a relativelysmall number of customers contributes to the variability of our revenues.

·                  *The timing of revenue recognition in relation to the shipment ofproducts.* Our productscontain software which is not incidental to our products. Therefore, werecognize revenue pursuant to the requirements of SOP 97-2. Due to theserequirements, certain features of our customer arrangements, such as customeracceptance terms in many of our customer contracts and the need for us to establishfair values of our products and services based on facts specific to ouroperations, we often defer recognition of revenue for a significant period oftime after shipment.

The variability of our revenues directly impacts ouroperating performance in any particular period since a significant portion ofour operating costs, such as prototypes and related equipment 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 andservices provided. Cost of products consists primarily of payments to a thirdparty manufacturer for purchased materials and services and internal costs,such as salaries and benefits related to personnel, provision for inventoryobsolescence and related overhead. The use of an outsourced manufacturerenables us to conserve working capital, adjust to fluctuations in demand andprovide for timely delivery to our customers. Cost of services consistsprimarily of salaries and benefits related to professional services andtechnical support personnel, product repair costs, depreciation and relatedoverhead.

***Gross Profit***

Our gross profit has been, and will be, affected by manyfactors, including the demand for our products and services, the averageselling price of our products, which in turn depends on the mix of productconfigurations sold, new product introductions, the region of the world inwhich our customers are located and the volume and costs of manufacturing ourhardware products.

***Operating Expenses***

Our operating expenses consist primarily of personnelcosts, including salaries, commissions, bonuses, share-based compensation andrelated benefits and taxes; prototype costs related to the design anddevelopment of new products and enhancement of existing products; andconsulting, travel and depreciation expenses. The expenses are classified into the following categories for reportingpurposes: research and development, sales and marketing and general and administrative.  Following is a brief description of the keytypes 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.

·                  Sales and marketing expense consists primarily ofpersonnel costs, travel and marketing programs such as trade shows. Commissionsare a significant component of our sales personnel

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costs and are recorded as expense when earned which isnot necessarily directly proportionate to the amount of revenues recorded sincecommissions are generally earned at the time we accept customer orders andrevenue is recorded once all revenue recognition criteria have been met.

·                 General and administrative expenseconsists primarily of personnel costs related to our executive, finance, humanresource and information technology organizations, professional fees, insuranceand other related overhead.

***Other Income (Expense)***

Other income (expense) primarily consists of interestincome earned on cash and short-term investments. We have historically investedour cash in money market funds and other short-term, high-grade investments.

Other income (expense) also includes gains (losses) fromforeign currency transactions of our foreign subsidiaries. The functionalcurrency of our foreign operations is the U.S. dollar. Accordingly, all assetsand liabilities, except certain long-term assets, of these internationalsubsidiaries are remeasured into U.S. dollars using the exchange rates ineffect at the balance sheet date. Revenues and expenses of these internationalsubsidiaries are generally remeasured into U.S. dollars at the average rates ineffect during the year.

**Application of Critical Accounting Policies and Use ofEstimates**

Our financial statements are prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these financial statements and related disclosures require us tomake estimates, assumptions and judgments that affect the reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances. We evaluate our estimates and assumptions on anongoing basis. Our actual results may differ significantly from these estimatesunder different assumptions or conditions.

We believe that of our significant accounting policies,which are described in note 3 to the consolidated financial statementsincluded in our Registration Statement on Form S-1 declared effective by theSecurities and Exchange Commission, or SEC, (File No. 333-141092) on June 5,2007, the following accounting policies involve a greater degree of judgmentand complexity. 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 fulfillmentof contractual 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 when persuasiveevidence of an arrangement exists, delivery has occurred, the price is fixed ordeterminable and collection is probable. Certain of these requirements, mostnotably the customer acceptance terms generally included in our contracts andour need to establish fair values of our products and services based on factsspecific to our operations, are critical to the timing and extent of ourrevenue recognition. As a result of these factors, a significant majority ofour contractual arrangements result in the deferral of revenue and the timeperiod for deferral may be significant. In addition, in certain circumstances,pricing considerations must be assessed to determine whether the price is fixedor determinable.

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Product revenues consist of revenues from sales of ourhardware and licensing of our software. Product sales generally include aperpetual license to our software. Product revenues are generally recognized atshipment or upon customer acceptance, assuming all other revenue recognitioncriteria are met. Substantially all of our products have been sold inconjunction 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, whichis generally 12 to 15 months.

Pursuant to SOP 97-2, revenue is allocated todeliverables based on vendor specific objective evidence of fair value, orVSOE, when VSOE exists. Generally, all revenues for an arrangement are deferredwhen VSOE does not exist for any undelivered element. However, revenue isrecognized ratably over the contractual M&S period when M&S is the onlyundelivered element. If VSOE exists for the undelivered elements, but not thedelivered elements, revenue is recognized under the residual method set forthin SOP 98-9, which provides that revenue is recognized based on the differencebetween the total arrangement fee and the VSOE of the undelivered elements.Revenue for the undelivered elements is then recorded as those elements aredelivered. When we defer revenue in an arrangement, the related product costsare also deferred, subject to their realizability, and recognized over the sameperiod as the related revenue.

The determination of VSOE is highly judgmental and is akey factor in determining whether revenue may be recognized or must be deferredand the extent 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 where cash consideration is paid to acustomer, the payments are recorded in accordance with Emerging Issues TaskForce, or EITF, 01-9, *Accounting forConsideration Given by a Vendor to a Customer (Including a Reseller of theVendor’s Products)*, which generally requires the consideration berecorded as a reduction of revenues.

***Share-Based Compensation***

Prior to January 1, 2006, we accounted for our stock-basedawards to employees using the intrinsic value method prescribed in AccountingPrinciples Board, or APB, Opinion 25, *Accountingfor Stock Issued to Employees*, and related interpretations. Under theintrinsic value method, compensation expense is measured on the date of thegrant as the difference between the deemed fair value of our common stock andthe exercise or purchase price multiplied by the number of stock options orrestricted stock awards granted. In addition, through December 31, 2005,we accounted for share-based compensation expense for non-employees usingthe fair value method prescribed by SFAS 123, applying the Black-Scholesoption-pricing model, and recorded the fair value, for financialreporting purposes, of non-employee stock options as an expense over either thevesting term of the option or the service period.

In December 2004, the Financial Accounting StandardsBoard, or FASB, issued SFAS 123R, *Share-BasedPayment*, which requires companies to expense the fair value ofemployee stock options and other forms of share-based compensation. Weadopted SFAS 123R effective January 1, 2006. SFAS 123R requiresnonpublic companies that used the minimum value method in SFAS 123 foreither recognition or pro forma disclosures to apply SFAS 123R using theprospective-transition method. As such, we will continue to apply APBOpinion 25 in future periods to equity awards outstanding prior to the date ofour

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adoption of SFAS 123R. In accordance with SFAS 123R, we willrecognize the compensation cost of stock-based awards on a graded-vestingbasis over the vesting period of the award. Effective with the adoption ofSFAS 123R, we elected to use the Black-Scholes option pricing modelto determine the weighted average fair value of stock options granted ormodified.

For the three and six months ended June 30, 2007, werecorded expense of $3.3 million and $4.8 million, respectively, inconnection with stock-based awards. As of June 30, 2007, we had $14.8million of unrecognized expense related to non-vested options that isexpected to be recognized over a weighted average period of 1.2 years.

***Inventory***

We carry our inventory at the lower of historical cost ornet realizable value assuming inventory items are consumed on a first-in,first-out basis. We recognize inventory losses based on obsolescence and levelsin excess of forecasted demand. In these cases, inventory is written down toestimated realizable value based on historical usage and expected demand.Inherent in our estimates of market value in determining inventory valuationare estimates related to economic trends, future demand for our products andtechnical obsolescence of our products. If future demand or market conditionsare less favorable than our projections, additional inventory write-downscould be required and would be reflected in the cost of revenues in the periodthe revision 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 productrevenues associated with the arrangement have been deferred as a result of notmeeting the revenue recognition criteria required by SOP 97-2, we defer therelated inventory costs for the delivered items.

***Income Taxes***

We are subject to income taxes in both the United Statesand foreign jurisdictions and we use estimates in determining our provisionsfor income taxes. We account for income taxes in accordance with SFAS 109,*Accounting for Income Taxes*,which is the asset and liability method for accounting and reporting for incometaxes. Under SFAS 109, deferred tax assets and liabilities are recognizedbased on temporary differences between the financial reporting and income taxbases of assets and liabilities using statutory rates.

As of December 31, 2006, we had U.S. federal netoperating loss carryforwards for income tax purposes of $63.1 million thatexpire beginning in 2022 and state net operating loss carryforwards of$65.5 million that expire beginning in 2007. We also had U.S. federal taxcredits of $3.0 million that expire beginning in 2020 and state researchand development credits of $652,000 that expire beginning in 2018. The InternalRevenue Code contains provisions that limit the net operating losses and taxcredit carryforwards available to be used in any given year in the event ofcertain circumstances, including significant changes in ownership interests, asdefined.

Our income tax expense consists primarily of provisionsassociated with various state and foreign jurisdictions as well as federalalternative minimum tax. Income tax expense related to our internationalsubsidiaries generally results from taxable income generated by the subsidiarypursuant to intercompany service agreements. We believe the compensationassociated with these service agreements is reasonable in light of the leveland nature of services performed by our subsidiaries. However, if a foreign taxjurisdiction or the Internal Revenue Service were to challenge thesearrangements, we could be subject to additional income tax expense either inthe United States or the foreign jurisdiction.

Due to the uncertainty surrounding the realization of ourdeferred tax assets, based principally on operating losses, we have provided afull valuation allowance against our various tax attributes. We will

18

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assess the level of valuation allowance required in future periods.Should more positive than negative evidence regarding the realizability of taxattributes exist at a future point in time, the valuation allowance may bereduced or eliminated altogether. Reduction of the valuation allowance, inwhole or in part, would result in a non-cash reduction in income taxexpense during the period of reduction.

OnJanuary 1, 2007, we adopted the provisions of FASB Interpretation, or FIN,No. 48, *Accounting for Uncertainty inIncome Taxes*,  an interpretation of SFAS 109. The newstandard defines the threshold for recognizing the benefits of tax returnpositions in the financial statements as “more-likely-than-not” to be sustainedby the taxing authorities based solely on the technical merits of the position.If the recognition threshold is met, the tax benefit is measured and recognizedas the largest amount of tax benefit, in our judgment, which is greater than50% likely to be realized. We did not recognize any change in our reserves foruncertain tax positions as a result of the adoption of this standard. At theadoption date of January 1, 2007, we had approximately $134,000 ofunrecognized tax benefits the benefit of which, if recognized, would favorablyaffect the income tax rate in future periods. At June 30, 2007, we had a liability of approximately $134,000 relatedto unrecognized tax benefits.

Werecognize interest and penalties related to uncertain tax positions in incometax expense. Upon our adoption of FIN 48 and at June 30, 2007, we had animmaterial amount of accrued interest and penalties associated with ouruncertain tax positions.

Wehave accumulated significant losses from our inception in August 2000.Since the net operating losses may potentially be utilized in future years toreduce taxable income, all of our tax years remain open to examination by themajor taxing jurisdictions to which we are subject.

***Research and Development Expense***

Research and development expense includes costs incurredto develop intellectual property. Research and development costs are charged tooperations as incurred. The costs to develop new software and substantialenhancements to existing software are expensed as incurred until technologicalfeasibility has been established, at which time any additional costs would becapitalized. We have determined technological feasibility is established at thetime a working model of software is completed. The time period during whichcosts could be capitalized, from the point of reaching technologicalfeasibility until the time of general product release, is short. Consequently,the amounts that could be capitalized are not material to our financialposition or results of operations and therefore have been charged to expense asincurred.

**Results of Operations**

*Revenues*

The following table sets forth our revenues by type andgeographic location of our customers.
| ** **                  | ** ** | **Three Months Ended June 30,** | ** ** | ** **              | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **2007**                                            | ** ** | **2006**                | ** ** | **Period-to-Period  Change** | ** ** |
| ** **                  | ** ** | **Amount**                                          | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                  | ** ** | **(dollars in thousands)**                | ** ** |
| **Revenues:**               |       |                                                |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                     |       | $                                                   | 25,121     |                    |       | 81 | % |   | $ | 17,744 |   |   | 87 | % |   | $ | 7,377 |   |   | 42 | % |   |
| Service                     |       | 5,733                                               |       |                    | 19         |   |   | 2,645 |   |   | 13 |   |   | 3,088 |   |   | 117 |   |   |
| Total revenues              |       | $                                                   | 30,854     |                    |       | 100 | % |   | $ | 20,389 |   |   | 100 | % |   | $ | 10,465 |   |   | 51 | % |   |
| ** **                  |       |                                                |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Revenues  by Type:**      |       |                                                |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct                      |       | $                                                   | 11,111     |                    |       | 36 | % |   | $ | 18,286 |   |   | 90 | % |   | $ | (7,175 | ) |   | (39 | )% |   |
| Indirect                    |       | 19,743                                              |       |                    | 64         |   |   | 2,103 |   |   | 10 |   |   | 17,640 |   |   | 839 |   |   |
| Total revenues              |       | $                                                   | 30,854     |                    |       | 100 | % |   | $ | 20,389 |   |   | 100 | % |   | $ | 10,465 |   |   | 51 | % |   |
|                        |       |                                                |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Revenues  by Geography:** |       |                                                |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States and Canada    |       | $                                                   | 16,317     |                    |       | 53 | % |   | $ | 16,462 |   |   | 81 | % |   | $ | (145 | ) |   | (1 | )% |   |
| Japan                       |       | 12,828                                              |       |                    | 41         |   |   | 806 |   |   | 4 |   |   | 12,022 |   |   | 1,492 |   |   |
| Korea                       |       | 539                                                 |       |                    | 2          |   |   | 162 |   |   | 1 |   |   | 377 |   |   | 233 |   |   |
| Rest of world               |       | 1,170                                               |       |                    | 4          |   |   | 2,959 |   |   | 14 |   |   | (1,789 | ) |   | (60 | ) |   |
| Total revenues              |       | $                                                   | 30,854     |                    |       | 100 | % |   | $ | 20,389 |   |   | 100 | % |   | $ | 10,465 |   |   | 51 | % |   |

 

19

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Revenues increased $10.5 million, or 51%, in thequarter ended June 30, 2007 as compared to the same quarter in 2006, primarilydue to increased product sales to existing customers. Product revenues, whichinclude hardware and software sales, increased $7.4 million in the secondquarter of 2007 as compared to the same quarter of 2006 due primarily toincreased sales in Japan. The increase in revenues from Japan was due primarilyto the recognition of revenue deferred in prior periods since we deliveredpreviously committed software functionality during the quarter ended June 30, 2007.

The $3.1 million increase in service revenues in thesecond quarter of 2007 was due to an increased amount of our products installedat mobile operators which is generally the basis of maintenance and servicesfees as compared to the same period in 2006.
| ** **                      | ** ** | **Six Months Ended June 30,** | ** ** | ** **              | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **2007**                                          | ** ** | **2006**                | ** ** | **Period-to-Period  Change** | ** ** |
| ** **                      | ** ** | **Amount**                                        | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**              | ** ** |
| **Revenues:**                   |       |                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                         |       | $                                                 | 49,573     |                    |       | 85 | % |   | $ | 29,466 |   |   | 85 | % |   | $ | 20,107 |   |   | 68 | % |   |
| Service                         |       | 8,923                                             |       |                    | 15         |   |   | 5,357 |   |   | 15 |   |   | 3,566 |   |   | 67 |   |   |
| Total revenues                  |       | $                                                 | 58,496     |                    |       | 100 | % |   | $ | 34,823 |   |   | 100 | % |   | $ | 23,673 |   |   | 68 | % |   |
|                            |       |                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Revenues  by Customer Type:** |       |                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct                          |       | $                                                 | 29,094     |                    |       | 50 | % |   | $ | 29,886 |   |   | 86 | % |   | $ | (792 | ) |   | (3 | )% |   |
| Indirect                        |       | 29,402                                            |       |                    | 50         |   |   | 4,937 |   |   | 14 |   |   | 24,465 |   |   | 496 |   |   |
| Total revenues                  |       | $                                                 | 58,496     |                    |       | 100 | % |   | $ | 34,823 |   |   | 100 | % |   | $ | 23,673 |   |   | 68 | % |   |
| ** **                      |       |                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Revenues  by Geography:**     |       |                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States and Canada        |       | $                                                 | 36,936     |                    |       | 63 | % |   | $ | 27,353 |   |   | 79 | % |   | $ | 9,583 |   |   | 35 | % |   |
| Japan                           |       | 13,524                                            |       |                    | 23         |   |   | 2,144 |   |   | 6 |   |   | 11,380 |   |   | 531 |   |   |
| Korea                           |       | 6,273                                             |       |                    | 11         |   |   | 324 |   |   | 1 |   |   | 5,949 |   |   | 1,836 |   |   |
| Rest of world                   |       | 1,763                                             |       |                    | 3          |   |   | 5,002 |   |   | 14 |   |   | (3,239 | ) |   | (65 | ) |   |
| Total revenues                  |       | $                                                 | 58,496     |                    |       | 100 | % |   | $ | 34,823 |   |   | 100 | % |   | $ | 23,673 |   |   | 68 | % |   |

 

Revenues increased $23.7 million, or 68%, in the sixmonths ended June 30, 2007 as compared to the same period in 2006, primarilydue to increased product sales to existing customers. Product revenues, whichinclude hardware and software sales, increased $20.1 million in the firsthalf of 2007 as compared to the same period in 2006 due primarily to increasedsales to major mobile operators in the United States and Canada and theincrease related to Japan discussed above. The increase in revenues from Koreawas due primarily to the recognition of approximately $5.5 million thatwas deferred at December 31, 2006 due to the delivery of specific softwarefunctionality during the first quarter of 2007.

20

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*Cost of Revenues and Gross Profit*
| ** **             | ** ** | **Three Months Ended June 30,** | ** ** | ** **                       | ** ** |
|------------------------|------------|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **             | ** ** | **2007**                                            | ** ** | **2006**                         | ** ** | **Period-to-Period  Change** | ** ** |
| ** **             | ** ** | **Amount**                                          | ** ** | **% of  Related  Revenues** | ** ** | **Amount** | ** ** | **% of  Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **             | ** ** | **(dollars in thousands)**                | ** ** |
| **Cost of  revenues:** |       |                                                |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                |       | $                                                   | 6,316      |                             |       | 25 | % |   | $ | 3,401 |   |   | 19 | % |   | $ | 2,915 |   |   | 86 | % |   |
| Services               |       | 1,942                                               |       |                             | 34         |   |   | 363 |   |   | 14 |   |   | 1,579 |   |   | 435 |   |   |
| Total cost of revenues |       | $                                                   | 8,258      |                             |       | 27 | % |   | $ | 3,764 |   |   | 18 | % |   | $ | 4,494 |   |   | 119 | % |   |
| **Gross  Profit:**     |       |                                                |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                |       | $                                                   | 18,805     |                             |       | 75 | % |   | $ | 14,343 |   |   | 81 | % |   | $ | 4,462 |   |   | 31 | % |   |
| Services               |       | 3,791                                               |       |                             | 66         |   |   | 2,282 |   |   | 86 |   |   | 1,509 |   |   | 66 |   |   |
| Total gross  profit    |       | $                                                   | 22,596     |                             |       | 73 | % |   | $ | 16,625 |   |   | 82 | % |   | $ | 5,971 |   |   | 36 | % |   |

 

Product gross margin decreased six percentage points inthe second quarter of 2007 as compared to the same period in 2006 due primarilyto the impact of equipment provided to our customers for testing purposes andthe second quarter of 2006 included a higher proportion of software licenserevenue. We anticipate our gross product margin to be somewhat lower during theremainder of 2007 due primarily to our anticipated mix of product shipments.

During the second quarter of 2007, the $1.6 millionincrease in cost of services was primarily due to higher personnel costs,depreciation expense and overhead costs associated with additional customersupport and training personnel that were added during late 2006 and in 2007. Weanticipate cost of services will increase in future periods as we continue toexpand our customer support testing facilities during the remainder of 2007.
| ** **             | ** ** | **Six Months Ended June 30,** | ** ** | ** **                       | ** ** |
|------------------------|------------|---------------------------------------------------|------------|----------------------------------|------------|
| ** **             | ** ** | **2007**                                          | ** ** | **2006**                         | ** ** | **Period-to-Period  Change** | ** ** |
| ** **             | ** ** | **Amount**                                        | ** ** | **% of  Related  Revenues** | ** ** | **Amount** | ** ** | **% of  Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **             | ** ** | **(dollars in thousands)**              | ** ** |
| **Cost of  revenues:** |       |                                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                |       | $                                                 | 10,754     |                             |       | 22 | % |   | $ | 7,294 |   |   | 25 | % |   | $ | 3,460 |   |   | 47 | % |   |
| Services               |       | 3,329                                             |       |                             | 37         |   |   | 704 |   |   | 13 |   |   | 2,625 |   |   | 373 |   |   |
| Total cost of revenues |       | $                                                 | 14,083     |                             |       | 24 | % |   | $ | 7,998 |   |   | 23 | % |   | $ | 6,085 |   |   | 76 | % |   |
| **Gross  Profit:**     |       |                                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                |       | $                                                 | 38,819     |                             |       | 78 | % |   | $ | 22,172 |   |   | 75 | % |   | $ | 16,647 |   |   | 75 | % |   |
| Services               |       | 5,594                                             |       |                             | 63         |   |   | 4,653 |   |   | 87 |   |   | 941 |   |   | 20 |   |   |
| Total gross  profit    |       | $                                                 | 44,413     |                             |       | 76 | % |   | $ | 26,825 |   |   | 77 | % |   | $ | 17,588 |   |   | 66 | % |   |

 

Product gross margin increased three percentage points inthe first six months of 2007 as compared to the same period in 2006 dueprimarily to a higher proportion of software revenue in the first quarter of2007.

The $2.6 million increase in cost of services wasprimarily due to higher personnel costs, depreciation expense and overheadcosts associated with additional customer support and training personnel thatwere added during 2006 and in the first half of 2007. We anticipate cost ofservices will increase in future periods as we continue to increase the numberof customer support personnel we employ and continue to expand our customersupport testing facilities.

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Gross profit on services increased 20% during the firstsix months of 2007 as a result of the increase in our installed base though theincrease was at a lower rate than the growth in service revenue due to theincreased costs of services described above.

We believe our overall gross margin for the remainder of2007 will decrease somewhat from the 76% achieved in the first half of 2007.

*Operating Expenses*
| ** **                  | ** ** | **Three Months Ended June 30,** | ** ** | ** **              | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **2007**                                            | ** ** | **2006**                | ** ** | **Period-to-Period  Change** | ** ** |
| ** **                  | ** ** | **Amount**                                          | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                  | ** ** | **(dollars in thousands)**                | ** ** |
| Research and  development   |       | $                                                   | 7,585      |                    |       | 25 | % |   | $ | 6,064 |   |   | 30 | % |   | $ | 1,521 |   |   | 25 | % |   |
| Sales and  marketing        |       | 8,867                                               |       |                    | 29         |   |   | 7,584 |   |   | 37 |   |   | 1,283 |   |   | 17 |   |   |
| General and  administrative |       | 3,398                                               |       |                    | 11         |   |   | 1,983 |   |   | 10 |   |   | 1,415 |   |   | 71 |   |   |
| Total operating  expenses   |       | $                                                   | 19,850     |                    |       | 64 | % |   | $ | 15,631 |   |   | 77 | % |   | $ | 4,219 |   |   | 27 | % |   |

 
| ** **                  | ** ** | **Six Months Ended June 30,** | ** ** | ** **              | ** ** |
|-----------------------------|------------|---------------------------------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **2007**                                          | ** ** | **2006**                | ** ** | **Period-to-Period  Change** | ** ** |
| ** **                  | ** ** | **Amount**                                        | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| ** **                  | ** ** | **(dollars in thousands)**              | ** ** |
| Research and  development   |       | $                                                 | 17,651     |                    |       | 30 | % |   | $ | 9,705 |   |   | 28 | % |   | $ | 7,946 |   |   | 82 | % |   |
| Sales and  marketing        |       | 15,936                                            |       |                    | 27         |   |   | 12,745 |   |   | 37 |   |   | 3,191 |   |   | 25 |   |   |
| General and  administrative |       | 6,242                                             |       |                    | 11         |   |   | 3,499 |   |   | 10 |   |   | 2,743 |   |   | 78 |   |   |
| Total operating  expenses   |       | $                                                 | 39,829     |                    |       | 68 | % |   | $ | 25,949 |   |   | 75 | % |   | $ | 13,880 |   |   | 53 | % |   |

 

*Personnel Costs.*  As discussed above, personnel costs are ourlargest expense representing 75% and 65% of our total operating expenses forthe three and six months ended June 30, 2007, respectively.  These costs include a cash component and astock component.  The cash component ofcompensation included in each expense category is set forth below.
| ** **                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **Change** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**            | ** ** |
| Research and  development                            |       | $                                               | 4,890      |                                          | $          | 3,125 |   | $ | 1,765 |   | $ | 9,468 |   | $ | 6,275 |   | $ | 3,193 |   |
| Sales and  marketing                                 |       | 5,471                                           |       | 5,149                                         |       | 322 |   | 9,535 |   | 8,410 |   | 1,125 |   |
| General and  administrative                          |       | 1,305                                           |       | 692                                           |       | 613 |   | 2,266 |   | 1,323 |   | 943 |   |
| Total cash-based  compensation in operating expenses |       | $                                               | 11,666     |                                          | $          | 8,966 |   | $ | 2,700 |   | $ | 21,269 |   | $ | 16,008 |   | $ | 5,261 |   |

 

The increases in personnel costs above were due primarilyto a higher number of employees in the three and six month periods ended June30, 2007 compared to June 30, 2006.  Weadded 115 research and development employees, 31 sales and marketing employeesand 15 general and administrative employees since June 30, 2006 resulting intotal employees of 501 at June 30, 2007.

In addition to cash compensation, we provide share-basedcompensation to our employees which is a significant portion of our personnelcosts.  These charges increasedsignificantly in the three and six month periods ended June 30, 2007 ascompared to the same periods of 2006 due primarily to the increase in the fairvalue of our common stock at the time the share-based awards were granted andour higher number of employees.  Theshare-based compensation included in each expense category is set forth below.

22

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| ** **                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                            | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **Change** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change** | ** ** |
| Research and  development                             |       | $                                               | 1,660      |                                          | $          | 66 |   | $ | 1,594 |   | $ | 2,141 |   | $ | 82 |   | $ | 2,059 |   |
| Sales and  marketing                                  |       | 644                                             |       | 86                                            |       | 558 |   | 993 |   | 98 |   | 895 |   |
| General and  administrative                           |       | 847                                             |       | 44                                            |       | 803 |   | 1,422 |   | 44 |   | 1,378 |   |
| Total share-based  compensation in operating expenses |       | $                                               | 3,151      |                                          | $          | 196 |   | $ | 2,955 |   | $ | 4,556 |   | $ | 224 |   | $ | 4,332 |   |

 

*Research and development.*  Researchand development expenses increased $1.5 million, or 25%, in the secondquarter of 2007 from the same quarter in 2006. The increase was due to the increases in personnel costs of$3.4 million described above which were partially offset by $1.4 millionof reimbursements associated with non-recurring engineering projects recorded as a reduction of expense during thesecond quarter of 2007 and lower prototype costs.

Research and development expenses increased $7.9 million,or 82%, in the first half of 2007 from the same period in 2006, and thepercentage of these costs to revenues also increased.  In addition to the increases in personnelcosts of $5.3 million described above, prototype costs were $1.6 million higherin the first half of 2007 as compared to the same period of 2006 due primarilyto the timing of testing of our ST40 platform.

We intend to continue to invest significantly in ourresearch and development efforts, which we believe are essential to maintainingour competitive position. Accordingly, we anticipate personnel costs anddepreciation expense to increase during the remainder of 2007 as we continue toadd quality assurance personnel and increase our test lab facilities.

*Sales and marketing.*  Sales andmarketing expenses increased $1.3 million, or 17%, in the second quarterof 2007 as compared to the same period in 2006 but were lower as a percentageof revenues. This spending increase was due primarily to $880,000 of higherpersonnel costs and higher travel expenses of $436,000.  Travel expenses increased primarily due toour higher number of sales personnel.

For the first half of 2007, these expenses increased$3.2 million, or 25%, as compared to the same period in 2006, but werelower as a percentage of revenues.  Thespending increase was due primarily to higher personnel costs of $2.0 million,higher travel expenses of approximately $514,000 and higher rent and facilitiesexpense.

We anticipate continuing to increase the number of salesand marketing personnel we employ in future periods to expand our geographicpresence, to address specific customer opportunities and to increase ourrevenues. The commission portion of sales personnel costs may varysignificantly if our customer orders differ materially from the quotasestablished for our sales personnel. In addition, we expect to incur additionalexpenses such as demonstration and interoperability testing associated with ourST40 platform in existing and new markets.

*General and administrative.*  Generaland administrative expenses increased $1.4 million, or 71%, in the secondquarter of 2007 as compared to the same period in 2006 due primarily to higherpersonnel costs.

For the six months ended June 30, 2007, theseexpenses increased $2.7 million, or 78%, as compared to the same period in2006 due primarily to the higher cash and share-based personnel costs discussedabove and higher consulting expenses of $494,000 related to enhancements to ourenterprise financial system.

We expect general and administrative expense to increasein future periods as we invest in infrastructure to support continued growthand incur additional costs related to operating as a

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publicly-traded company, including increased audit and legal fees,costs of compliance with securities and other regulations, investor relationsand higher insurance premiums. In addition, we expect to incur additional costsassociated with our pending litigation.

*Interest income.*  Interestincome consists of income generated from the investment of our cash balancesand short-term investments. Interest income increased $395,000 and $686,000,respectively, for the three and six month periods ended June 30, 2007 due tohigher average balances and higher rates of return during these periods of2007.  In June 2007, our cash andshort-term investment balance increased approximately $116.0 million due to thereceipt of the net proceeds of our initial public offering.

*Income tax expense.*  For thethree and six months ended June 30, 2007, we recorded income tax expense of$164,000 and $407,000, respectively, compared to $92,000 and $143,000 in thesame respective periods of 2006. The increases in 2007 periods were dueprimarily to us being subject to federal alternative minimum tax in 2007 and notin 2006. We anticipate that we will be subject to state and foreign incometaxes and federal alternative minimum tax in future years. We have significantnet operating loss carryforwards and other deferred tax assets, but haverecorded a valuation allowance against them due to the uncertainty surroundingthe timing and extent of realization of these tax attributes.

*Net income.*  Net income increasedapproximately $2.1 million for the three months ended June 30, 2007compared to the same period of 2006 and $4.1 million for the six months endedJune 30, 2007 compared to the same period of 2006 due to the items discussedabove.

**Liquidity and Capital Resources**

***Resources***

We funded our operations from 2000 through 2004 primarilywith approximately $100.0 million of net proceeds from issuances ofconvertible preferred stock. Since 2005, we have funded our operationsprincipally with cash provided by operating activities, which was driven mainlyby our revenue growth.

*Cash, cash equivalents and short-terminvestments.*  Our cash, cash equivalents and short terminvestments at June 30, 2007 of $157.2 million were held for workingcapital purposes and were invested primarily in money market funds. We do notenter into investments for trading or speculative purposes. Restricted cash,which totaled $592,000 at June 30, 2007 and $1.0 million atDecember 31, 2006, was not included in cash and cash equivalents and washeld as collateral for letters of credit related to vendor and leaseagreements.

Our net cash flows from operating, investing andfinancing activities for the periods indicated in the table below were asfollows:
|                                                      | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Net cash  provided by (used in) operating activities |       | $                                             | (10,976    | ) | $ | 10,978 |   |
| Net cash provided  by (used in) investing activities |       | $                                             | 5,686      |   | $ | (6,003 | ) |
| Net cash provided by  financing activities           |       | $                                             | 117,592    |   | $ | 76 |   |

 

*Operating activities.*  Cash fromoperating activities consists of significant components of the statements ofoperations adjusted for changes in various working capital items includingdeferred revenues, accounts receivable, inventories, accounts payable, prepaidexpenses and various accrued expenses.

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*Six months ended June 30, 2007 compared to Six monthsended June 30, 2006.*

For the first six months of 2007, net cash used inoperating activities was $11.0 million as compared to cash provided byoperating activities of $11.0 million in the same period in 2006. Cashreceived from customers decreased $7.9 million in the first half of 2007to $34.4 million from $42.3 million in the same period of 2006. Thisreduction was due primarily to lower accounts receivable at the beginning ofthe 2007 period. In addition, cash paid for payroll and related expensesincreased $7.3 million totaling $21.5 million in 2007 compared to thesame period in 2006, and cash paid for inventories was approximately$5.4 million higher in the 2007 period as compared to 2006. The increasein payroll and related expenses was due primarily to our increased headcount asdiscussed above.  The increase in cashpaid for inventories was due primarily to our purchases of components relatedto the introduction of our ST40 platform.

*Investing activities.*  Cash from investing activities consistedprimarily of capital expenditures and purchases and sales of short-terminvestments associated with our investment balances. The $5.7 million of cashprovided by investing activities during the first half of 2007 consistedprimarily of maturities of short-term investments partially offset by$10.1 million of capital expenditures. The $6.0 million cash used ininvesting activities in the six months ended June 30, 2006 was due primarily tocapital expenditures of $3.7 million and $2.3 million of netpurchases of short-term investments

*Financing activities.*  Cash from financing activities consistedprimarily of $127.0 million of cash received from the issuance of 10,580,226shares of our common stock at $12.00 per share in our initial public offeringreduced by $8.9 million of discounts and commissions and approximately $2.1million of other costs associated with the offering.

AtJune 30, 2007 and December 31, 2006, we had no long-term debt outstandingand our restricted cash was our only asset pledged as collateral.

Webelieve our existing cash and cash equivalents, short-term investments and cashflows from operating activities will be sufficient to finance our plannedgrowth, enhance our products and fund anticipated capital expenditures for theforeseeable future.

We mayuse the net proceeds from our initial public offering for working capital andother general corporate purposes, to finance accelerated growth, develop newproduct lines and fund acquisitions and strategic investments. These futureworking capital requirements will depend on many factors, including the rate ofour revenues growth, our introduction of new products and enhancements and ourexpansion of sales and marketing and product development activities. To theextent our existing resources are insufficient to fund these activities we mayneed to raise additional funds through bank credit arrangements or public orprivate equity or debt financings. We also may need to raise additional fundsin the event we determine in the future to effect one or more acquisitions ofbusinesses, technologies and products that complement our existing operations.In the event additional funding is required, we may not be able to obtain bankcredit arrangements or complete an equity or debt financing on terms acceptableto us or at all.

***Requirements***

*Capital expenditures.*  We have made capital expenditures primarilyfor testing and evaluation systems and equipment to support product developmentand customer service, as well as for leasehold improvements and other generalpurposes to support our growth.  Ourcapital expenditures totaled $10.1 million in the first six months of 2007. Weexpect capital expenditures to be approximately $18–20 million for the fullyear of 2007, primarily related to purchases of test equipment, equipment tosupport product development and customer service, leasehold improvements andother general purposes to support our growth.

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*Contractual obligations and requirements.*  As of June 30, 2007, our commitments underoperating leases and purchase obligations were as set forth below. For purposesof the table below, purchase obligations are defined as agreements to purchasegoods or services that are enforceable and legally binding and that specify allsignificant terms, including, fixed or minimum quantities to be purchased, fixed,minimum or variable pricing provisions, and the approximate timing oftransactions.
| ** **           | ** ** | **Total**                            | ** ** | **Remainder  of 2007** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **More than  5 Years** | ** ** |
|----------------------|------------|--------------------------------------|------------|-----------------------------|------------|----------------|------------|----------------|------------|----------------------------------|------------|
| ** **           | ** ** | **(dollars in thousands)** | ** ** |
| Operating leases     |       | $                                    | 6,410      |                        | $          | 1,132          |       | $              | 3,616      |                             | $          | 1,662 |   | $ | — |   |
| Purchase obligations |       | 8,547                                |       | 7,772                       |       | 775            |       | —         |       | —                           |       |
| Total                |       | $                                    | 14,957     |                        | $          | 8,904          |       | $              | 4,391      |                             | $          | 1,662 |   | $ | — |   |

 

***Off-Balance-Sheet Arrangements***

We donot engage in any off balance sheet financing activities. We do not have anyinterest in entities referred to as variable interest entities, which includesspecial purpose entities and other structured finance entities.

**ITEM 3. Quantitative and QualitativeDisclosures About Market Risk**

Market risk represents the risk of loss that may impactour financial position due to adverse changes in financial market prices andrates. Our market risk exposure is primarily a result of fluctuations inforeign exchange rates and interest rates. We do not hold or issue financialinstruments for trading purposes.

***Foreign Currency Exchange Risk***

To date, substantially all of our international customertransactions have been denominated in U.S. dollars. Accordingly, we havelimited exposure to foreign currency exchange rates and do not enter intoforeign currency hedging transactions. 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. Revenuesand expenses of these foreign subsidiaries are remeasured into U.S. dollars atthe average rates in effect during the year. Any differences resulting from theremeasurement of assets, liabilities and operations of these subsidiaries arerecorded within other income (expense) in our consolidated statements ofoperations. If the foreign currency exchange rates fluctuated by 10% as of June30, 2007, our foreign exchange gain or loss would have fluctuated byapproximately $147,000.

***Interest Rate Risk***

At June 30, 2007, we had unrestricted cash and cashequivalents and short-term investments totaling $157.2 million. Theseamounts were invested primarily in money market funds and high qualitycorporate and government securities. The unrestricted cash and cash equivalentswere held for working capital purposes. We do not enter into investments fortrading or speculative purposes. Due to the short-term nature of theseinvestments, we believe that we do not have any material exposure to changes inthe fair value of our investment portfolio as a result of changes in interestrates. Declines in interest rates, however, would reduce future investmentincome.

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**ITEM 4. CONTROLS AND PROCEDURES**

Our management,with the participation of our chief executive officer and chief financialofficer, evaluated the effectiveness of our disclosure controls and proceduresas of June 30, 2007. The term “disclosure controls and procedures,” as definedin Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls andother procedures of a company that are designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported, withinthe time periods specified in the SEC’s rules and forms. Disclosure controlsand procedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. Management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving their objectives and management necessarily applies its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Based on the evaluation of our disclosure controls and procedures as of June30, 2007, our chief executive officer and chief financial officer concludedthat, as of such date, our disclosure controls and procedures were effective atthe reasonable assurance level.

Nochange in our internal control over financial reporting (as defined in Rules13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscalquarter ended June 30, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II. OTHERINFORMATION**

**ITEM 1.****                  LEGAL PROCEEDINGS**

We arepresently defending two patent infringement lawsuits brought by UTStarcom, Inc.In February, 2005, UTStarcom filed a complaint against us in the United StatesDistrict Court Northern District of California seeking unspecified damages andinjunctive relief. The complaint alleges infringement by us of UTStarcom’s U.S.Patent No. 6,829,473, entitled “Roaming and Hand-Off Support for PrepaidBilling for Wireless Data Networks,” which is referred to as the “473 patent.UTStarcom notified us that it had served the complaint on May 6, 2005. OnMay 31, 2005, we answered the complaint, denied the infringementallegations contained in the complaint, and filed counterclaims againstUTStarcom seeking a declaratory judgment that we did not infringe the “473patent and that the “473 patent was invalid and unenforceable. On July 27,2005, we filed an amended answer and counterclaims to the “473 patentcomplaint. A claim construction hearing had been scheduled on February 14,2007, however, on December 7, 2006, UTStarcom filed a reissue patentapplication on the “473 patent. On January 29, 2007, by agreement of theparties, the Court stayed the case pending the outcome of the reissueapplication. We believe that we have meritorious defenses against any resultingreissued patent, and are prepared to vigorously defend the “473 patent casethrough trial.

In May2007, UTStarcom filed an additional complaint against us and a number of ouremployees and former employees with the United States District Court for theNorthern District of Illinois alleging violations of the Illinois trades secretact, 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 UTStarcom confidential technical information, includingUTStarcom’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 these patentapplications legally belong to UTStarcom based on the inventors’ previous workat the business unit acquired by UTStarcom. The complaint seeks unspecifiedmonetary damages, injunctive relief, declarations of ownership relating to thespecified patent and three patent applications owned by us, costs and attorneysfees. On July 25, 2007, in lieu of filing answers to the complaint, we and theindividual defendants named in the complaint filed a motion to dismiss allstate law claims asserted in the complaint. If successful, only the patentinfringement allegations against us would remain in the case. On July 30, 2007,UTStarcom filed a pleading in response to this motion, and the District Courthas taken the issues raised under advisement. We believe we have meritoriousdefenses to each of UTStarcom’s claims in this lawsuit and are prepared tovigorously defend the lawsuit.

In addition, weare subject 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 don 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. RISKFACTORS**

*Theseare risks and uncertainties that could cause actual results to differmaterially from the results contemplated by the forward-looking statementscontained in this Quarterly Report on Form 10-Q.*

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*Becauseof the these  factors, as well as other variables affecting our operatingresults, past financial performance should not be considered as a reliableindicator of future performance and investors should not use historical trendsto anticipate results or trends in future periods. These risks are not the onlyones facing the Company. Please also see “Cautionary Statement” of thisQuarterly Report on Form 10-Q.*

**Risks Related to Our Business and Industry**

***We compete in new and rapidlyevolving markets and have a limited operating history, which makes it difficultto predict our future operating results.***

We were incorporated in August 2000, and deployedour first commercial product in the first quarter of 2003. We have a limitedoperating history in an industry characterized by rapid technological change,changing customer needs, evolving industry standards and frequent introductionsof new products and services. We believe our limited operating history and thecharacteristics of our industry make it difficult to forecast our futureoperating results. You should consider and evaluate our prospects in light ofrisks faced by companies such as ours, which include challenges in accuratefinancial planning as a result of limited historical data and the uncertaintiesresulting from a relatively limited time period in which to implement andevaluate our business strategies, as compared to companies with longeroperating histories.

***Our past operating results havefluctuated significantly, and likely will continue to fluctuate significantly,which makes it difficult to predict our operating results and could cause ouroperating results to fall below expectations.***

Our operating results have historically fluctuatedsignificantly from period to period and we expect our operating results tocontinue to fluctuate due to a variety of factors, many of which are outside ofour control. As a result, comparing our operating results on a period-to-periodbasis may not be meaningful. You should not rely on our past results as anindication of our future performance. If our revenues or operating results fallbelow the expectations of investors or securities analysts or below anyguidance we may provide to the market, the price of our common stock coulddecline.

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

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

·                  reductionsin customers’ budgets for mobile network infrastructure purchases and delays intheir purchasing decisions;

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

·                  thesale of our products in the timeframes we anticipate, including the number andsize of orders in each period;

·                  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

·                  general economicconditions in our domestic and international markets.

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***We depend on a limited number ofcustomers for a substantial portion of our revenues. The loss of a key customeror any significant adverse change in the size or terms of orders from a keycustomer could significantly reduce our revenues.***

We derive a substantial portion of our revenues from alimited number of customers partly due to the nature of the mobilecommunications industry. During any given fiscal period, a small number ofcustomers may account for a significant percentage of our revenues. Forexample, in 2006 we had two customers that each generated more than 10% of ourrevenues and in the aggregate represented 83% of our revenues and for the three months ended June 30, 2007, we hadthree customers that each accounted for more than 10% of our revenues and fromwhich, in the aggregate, we derived 89% of our revenues. In addition, we do nothave long-term volume purchase contracts with our customers or othercommitments that ensure future sales of our products to existing customers. Theloss of any key customer, or our inability to generate anticipated revenue fromthem, would significantly and adversely affect our business, financialcondition and results of operations. In addition, a change in the timing orsize of a purchase by any one of our key customers can result in significantvariations in our revenue and operating results from period to period. Ouroperating results for the foreseeable future will continue to depend on ourability to effect sales to a small number of customers and any revenue growthwill depend on our success selling additional products to our large customersand expanding our customer base to include additional customers that deploy ourproducts in large-scale networks serving significant numbers ofsubscribers.

Moreover, many of our key customers are large mobileoperators that have substantial purchasing power and leverage in negotiatingcontractual arrangements with us. These customers may require us to agree toterms and conditions that could result in increased costs and decreasedrevenues that could adversely affect our operating results.

***We rely on a single line of productsfocused on a single market. If the market for those products does not developas we anticipate, our revenues may decline or fail to grow, which wouldadversely affect our operating results.***

We derive, and expect to continue to derive, all of ourrevenues from a single line of products that provide network functions andservices to mobile operators’ packet core networks. The market for our productsis relatively new and still evolving, and it is uncertain whether our productswill achieve and sustain high levels of demand and market acceptance. Oursuccess will depend to a substantial extent on the willingness of mobileoperators to continue to implement packet-based, multimedia networkinfrastructure. Factors that could impair the rate of growth of multimedianetworks include:

·                  lowerthan anticipated demand by subscribers for multimedia services;

·                  budgetaryconstraints of mobile operators;

·                  uncertaintieson the part of mobile operators as to the particular 3G or 4G access technologiesthey select for deployment in their networks; and

·                  delays in thedevelopment or availability of all the network elements necessary for themobile 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.

***If our new platform, the ST40, doesnot achieve widespread market acceptance, our operating results will suffer.***

In April 2007, we announced our ST40 platform, which hasrecently become generally available for customer shipments. We expect to beginrecording revenues from shipments of the ST40 in the fourth quarter of 2007,and a significant portion of our anticipated revenues in the fourth quarter of2007 and beyond are expected to be generated from sales of the ST40. Our futuresales and operating results will depend, to a significant extent, on the successfulintroduction and marketing of the ST40. In order to achieve market penetrationfor the ST40, we may be required to incur additional expenses in marketing andsales in advance of the realization of actual sales. There can be no assurancethat the ST40 will achieve widespread 

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acceptance in the market. If we incur delays in the manufacture andshipment of the ST40 or customer testing and verification takes longer thananticipated, the ST40 does not achieve our planned levels of sales or the ST40does not achieve performance specifications, our operating results will sufferand our competitive position could be impaired. Also, some customers may delayorders for the ST16 as a result of the anticipated availability of the ST40 andany such delays could increase fluctuations in our quarterly operating results.

***The market in which we compete ishighly competitive and competitive pressures from existing and new companiesmay have a material adverse effect on our business, revenues, growth rates andmarket share.***

We compete in a highly competitive industry that isinfluenced by many factors, including customer demands for:

·                  reliable,high performance products;

·                  systemability to handle increasing amounts of network traffic and service integrationcapabilities;

·                  systemintelligence;

·                  breadthof network interoperability, access independence and standards support;

·                  highlevels of customer support and customer interaction; and

·                  competitivepricing.

We expect competition in the mobile networkinfrastructure industry to intensify significantly in the future. Othercompanies may introduce new products in the same markets we serve or intend toenter. This competition could result in increased pricing pressure, reducedprofit margins, increased sales and marketing expenses and failure to increase,or the loss of, market share, any of which would likely seriously harm ourbusiness, operating results or financial condition.

Competitive products may in the future have betterperformance, lower prices and broader acceptance than our products. Our primarycompetitors include Cisco Systems, Inc., LM Ericsson Telephone Co., NokiaCorporation and UTStarcom, Inc., each of which has a longer operatinghistory, greater name recognition, a larger customer base and significantlygreater financial, technical, sales, marketing and other resources than we do.Potential customers may prefer to purchase from their existing suppliers ratherthan a new supplier regardless of product performance or features. In addition,many of our competitors have a broader range of products and may be able tooffer concessions to potential customers on bundled purchases that we are notable to match because we currently offer only a single line of products. Wealso face competition from a number of companies with more limited market sharegenerally or by geography and newer market entrants.

If our market continues to develop and expand, we couldface increased competition from other established companies, as well asemerging companies. For example, OEMs, system integrators and distributorscurrently selling our products could market products and services that competewith our products and services. In addition, some of our competitors have madeacquisitions or entered into partnerships or other strategic relationships withone another to offer a more comprehensive solution than they individually hadoffered. We expect this trend to continue as companies attempt to strengthen ormaintain their market positions in an evolving industry and as companies enterinto partnerships, or are acquired. Many of the companies driving thisconsolidation trend have significantly greater financial, technical and otherresources than we do and are better positioned to acquire and offercomplementary products and technologies. The companies resulting from thesepossible consolidations may create more compelling product offerings and beable to offer greater pricing flexibility, making it more difficult for us tocompete effectively, including on the basis of price, sales and marketingprograms, technology or product functionality. Continued industry consolidationmay adversely impact customers’ perceptions of the viability of smaller andeven medium-sized technology companies and consequently customers’willingness to 

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purchase from such companies. These pressures could materially adverselyaffect our business, operating results and financial condition.

***Our sales cycles can be long andunpredictable, and our sales efforts require considerable time and expense.***

Our sales cycles typically are long and unpredictable,and our sales efforts require considerable time and expense. Our sales effortsinvolve educating our customers about the use and benefit of our products,including their technical capabilities and potential cost savings. Customerstypically undertake a significant evaluation process before making a purchase,in some cases over twelve months. We spend substantial time and resources inour sales efforts without any assurance that our efforts will produce anysales. In addition, product purchases are frequently subject to budgetconstraints, multiple approvals, and unplanned administrative, processing andother delays. Our long sales cycle may cause our revenues and operating resultsto fluctuate significantly.

***Demand for our products depends onthe rate that mobile operators expand and enhance their mobile networks inorder to provide multimedia services.***

Our future success as a provider of networkinfrastructure products and services for mobile operators ultimately depends onthe continued growth of the mobile communications industry and, in particular,the continued deployment and expansion of mobile multimedia services. Increaseddemand by mobile subscribers for voice communications and multimedia servicesdelivered over mobile network systems will be necessary to justify capitalexpenditure commitments by mobile operators to invest in the improvement andexpansion of their networks. Demand for multimedia services might not continueto increase if there is limited availability or market acceptance of mobiledevices designed for such services, the multimedia content offered throughmobile networks does not attract widespread interest or the quality of serviceavailable through mobile networks does not meet customer expectations. Iflong-term expectations for mobile multimedia services are not realized or donot support a sustainable business model, operators may not commit significantcapital expenditures to upgrade their networks to provide these services, thedemand for our products and services will decrease, and we may not be able tosustain or increase our levels of revenues or profitability in the future.

***Asignificant portion of our future revenues depends on our ability to furtherpenetrate the GSM/UMTS market and our failure to do so could significantlyinterfere with our future growth.***

The two principal radio access interfaces in use todayfor mobile communications are Code Division Multiple Access, or CDMA, andGlobal System for Mobile Communications/Universal Mobile TelecommunicationsSystem, or GSM/UMTS. To date, we have achieved our highest number ofdeployments in the CDMA market, which has transitioned faster to high-bandwidthnetworks. However, significantly more operators worldwide currently utilizeGSM/UMTS than CDMA technologies. In order to continue our growth, we believe itis important that we continue to expand into the GSM/UMTS market. To date, wehave established a relationship with a major GSM/UMTS operator, and we intendto devote significant sales and marketing resources to further penetrate theGSM/UMTS market. If GSM/UMTS operators do not transition or delay theirtransition 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 integratorsand distributors to sell some of our products, and our failure to develop andmanage our distribution channels could adversely affect our business.***

For our sales to mobile operators, we rely in part onestablishing and maintaining successful relationships with original equipmentmanufacturers, or OEMs, system integrators and distributors. A significantamount of our revenues is derived through these indirect sales. Accordingly,our revenues 

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depend in large part on the effective performance of these distributionrelationships. By relying on these indirect sales channels we may have lesscontact with the end users of our products, thereby potentially making it moredifficult for us to establish brand awareness, ensure proper delivery andinstallation of our products, service ongoing customer requirements and respondto evolving customer needs. Developing relationships with qualified OEMs,system integrators and distributors and training them in our technology andproduct offerings requires significant time and resources. In order to developand expand 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 terminated our OEM relationshipswith Nortel Networks. If we are unable to establish strong relationships withthe mobile operators formerly serviced by Nortel Networks under our CDMAagreement, our business will be harmed.***

We had two OEM agreements with Nortel Networks, onerelating to the CDMA market and one relating to the GSM/UMTS market. Weterminated the agreement relating to the CDMA market effective March 2007because we were no longer strategically aligned with Nortel Networks on futurepacket core products for mobile operators and to allow specific major mobileoperators to purchase directly from us. Under the terms of the agreement Nortel Networks has a right to continueto purchase our CDMA products for delivery through December 2008. Thetermination of the CDMA agreement could disrupt our relationships with CDMAmobile operators formerly serviced by Nortel Networks. We have establisheddirect relationships with some of the CDMA operators formerly serviced byNortel Networks and we are currently seeking to establish additional directsales relationships with other CDMA operators formerly serviced by NortelNetworks. We are also currently exploring a new reseller relationship withNortel Networks to continue to service other CDMA operators. Our business maybe harmed if we are unable to directly or indirectly continue selling ourproducts to the other CDMA operators formerly serviced by Nortel Networks. Inaddition, our business may be adversely affected if we are unable to enter intoa new CDMA reseller relationship with Nortel Networks.

We also terminated the agreement relating to the GSM/UMTSmarket effective December 2006 because there was a lack of strategic alignmenton future packet core products for mobile operators between us and NortelNetworks and because there had been no sales of our products under thatagreement. Nortel Networks had previously disputed our right to terminate thatagreement, however this dispute was resolved in July 2007.  The growth of our business may be limited ifwe are unable to establish a direct or indirect sales relationships with otherGSM/UMTS mobile operators.

***Wehave a significant accumulated deficit, and we may not be able to maintainprofitability.***

Although we were profitable in 2005 and 2006 and for thesix months ended June 30, 2007, we incurred net losses for the preceding threeyears. Our net losses were approximately $25.8 million in 2002,$26.4 million in 2003 and $14.0 million in 2004. As a result of ournet losses, we had an accumulated deficit of $99.8 million as of June 30,2007. We will need to generate significant revenues and control our operatingexpenses and other expenditures to maintain profitability. If we are unable toremain profitable, the market price of our common stock could decline.

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***If network functions and servicessimilar to those offered by our products are incorporated into existing or newmobile network infrastructure products, demand by mobile operators for ourproducts may diminish.***

Mobile network infrastructures are continually evolvingwith changing industry standards and the introduction of new technologies andnetwork elements. Network functions and services provided by our productslocated on the packet core network may be provided by different networkelements within these networks. Other providers of mobile networkinfrastructure products may add network functions and services provided by ourproducts to their existing products or offer new products with similarcharacteristics for different parts of the network infrastructure.

The inclusion of, or the announcement of an intent toinclude, functionality and services perceived to be similar to those offered byour products in competitor products within or outside the packet core networkcould have 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 mobile operatorscould have an adverse effect on our business, operating results and financialcondition.

***The applications of existing orfuture accounting standards could result in significant fluctuations in ouroperating results.***

We recognize our product software license revenue inaccordance with AICPA Statement of Position, or SOP, 97-2, *Software Revenue Recognition*, and relatedamendments and interpretations and SOP 98-9, *Modificationof SOP 97-2, Software Revenue Recognition with Respect to CertainTransactions*. Under these accounting standards, even if we deliverproducts to, and collect cash from, a customer in a given fiscal period, we maybe required to defer recognizing revenue from the sale of such product until afuture period when all the conditions necessary for revenue recognition havebeen satisfied. Conditions that can cause delays in revenue recognition includesoftware arrangements that have undelivered elements for which we have not yetestablished vendor specific objective evidence of fair value; requirements thatwe deliver services for significant enhancements or modifications to customizeour software for a particular customer; or material customer acceptancecriteria. Our customer contracts typically include one or more of these typesof conditions. Therefore, we often must defer revenue recognition for a periodof time after our products are delivered and billed to a customer, and suchdeferral may extend over one or more fiscal quarters. The period of deferral,if any, depends on the specific terms and conditions of each customer contract,and therefore it is difficult for us to predict with accuracy at the beginningof any fiscal period the amount of revenues that we will be able to recognizefrom anticipated customer shipments in that period. Moreover, any changes ininterpretations and guidance as to SOP 97-2 could have a significant effect onour reported financial results.

***Wemay have difficulty acquiring new customers due to the high costs of switchingmobile network infrastructure providers or equipment.***

Mobile network operators typically make substantialinvestments when deploying a mobile network infrastructure. Once a mobilenetwork operator has deployed a mobile network infrastructure for a particularportion of their network, it is often difficult and costly to switch to anothervendor’s infrastructure. Unless we are able to persuasively demonstrate thatour products offer performance, functionality or cost advantages thatmaterially outweigh a customer’s expense of switching from a competitor’sproduct, it will be difficult for us to generate sales once that competitor’sequipment has been deployed. Accordingly, if a customer has already deployed acompetitor’s product for their network infrastructure, it may be difficult forus to sell our products to that customer.

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***Our ability to sell our products ishighly dependent on the quality of our support and services offerings, and ourfailure to offer high quality support and services would have a materialadverse effect on our sales and results of operations.***

Once our products are deployed within our customers’networks, our customers depend on our support organization to resolve issuesrelating to our products. A high level of support is critical for thesuccessful marketing and sale of our products and future enhancements. If we,or our OEMs, system integrators or distributors, do not effectively assist ourcustomers in deploying our products, help our customers quickly resolvepost-deployment issues, and provide effective ongoing support, it wouldadversely affect our ability to sell our products to existing customers andcould harm our reputation with potential customers. In addition, as we expandour operations internationally, our support organization will face additionalchallenges, including those associated with delivering support, training anddocumentation in languages other than English. As a result, our failure tomaintain high quality support and services could have a material adverse effecton our business, operating results and financial condition.

***The mobile network infrastructureindustry is, and likely will continue to be, characterized by rapidtechnological 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 theirnetworks, and new industry standards for access technologies, such as thirdgeneration, or 3G, and more advanced fourth generation, or 4G, technologiescontinue to evolve. Continuing technological changes in the mobilecommunications industry and in the mobile network infrastructure industry couldundermine our competitive position or make our products obsolete, eithergenerally or for particular types of services. Our future success will dependupon our ability to accurately predict and respond to new technology standards.We must develop and introduce a variety of new capabilities and enhancements toour existing product offerings, as well as introduce new product offerings, toaddress the changing standards and technological needs of the networkinfrastructure market. A failure to accurately predict and respond to evolvingtechnologies, to introduce on a timely basis new products and enhancements inresponse to evolving technologies and standards, or to address changing needsin our current markets or expand into new markets may cause existing andpotential customers to forego purchases of our products or purchase from ourcompetitors. The introduction of new products embodying new technologies or theemergence of new industry standards could render our existing productsuncompetitive from a pricing standpoint, obsolete or unmarketable.

***Ourproducts are complex and may take longer to develop than anticipated and we maynot recognize revenues from new products or product enhancements until after wehave incurred significant development costs.***

Some of our products must be tailored to meet customerspecifications. As a result, we often develop new features and enhancements toour products. These product enhancements often take substantial time to developbecause of their complexity and because customer specifications sometimeschange during the development cycle. We often do not recognize revenue from ournew products or enhancements until we have incurred significant developmentcosts, and our operating results will suffer if sales of new products orenhancements fail to meet our expectations.

***There is no assurance that ourresearch and development investments will lead to successful new products orenhancements.***

We will continue to invest in research and developmentfor the introduction of new products and enhancements to existing productsdesigned to improve the capacity, data processing rates and features of ourproducts and services. We must also continue to develop new features andfunctionality for our products based on specific customer requests andanticipated market needs. However, research and development in 

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the mobile network infrastructure industry is complex, expensive andsubject to uncertainty. In 2006, our research and development expenses were$26.0 million, or approximately 28% of our total revenues and for the sixmonths ended June 30, 2007 these expenses were $17.7 million, orapproximately 30% of our total revenues. We believe that we must continue todedicate a significant amount of resources to our research and developmentefforts to maintain our competitive position. If we continue to expend asignificant amount of resources on research and development and our efforts donot lead to the successful introduction of products or product enhancementsthat are competitive in the marketplace, there could be a material adverseeffect on our business, operating results, financial condition and marketshare. We may not be able to anticipate market needs and develop products andproduct enhancements that meet those needs, and any new products or productenhancements that we introduce may not achieve any significant degree of marketacceptance.

***If our products do not interoperatewith our customers’ networks, installations will be delayed or cancelled, whichwould harm our business.***

Our products must interoperate with our customers’existing networks, which often have different specifications, utilize multipleprotocol standards and products from multiple vendors, and contain multiplegenerations of products that have been added over time. If we find errors inthe existing software or defects in the hardware used in our customers’networks or problematic network configurations or settings, as we have in thepast, we may have to modify our software or hardware so that our products willinteroperate with our customers’ networks. This could cause longer installationtimes for our products or order cancellations and could harm our relationshipwith existing and future customers, any of which would adversely affect ourbusiness, operating results and financial condition.

In addition, our customers may require that wedemonstrate that our products interoperate with network elements offered by ourcompetitors, and we may need our competitors’ cooperation to conduct suchtesting and validation. Any unwillingness of our competitors to cooperate withus in performing these interoperability tests or our inability to demonstrateinteroperability would likely have an adverse effect on our ability to marketour products.

***Ourproducts are highly technical and may contain undetected software or hardwareerrors, which could cause harm to our reputation and adversely affect ourbusiness.***

Our products are highly technical and complex. Whendeployed, they are critical to the mobile operator networks. Our products havecontained and may contain undetected errors, defects or securityvulnerabilities. Some errors in our products may only be discovered after aproduct has been installed and used by mobile operators. Any errors, defects orsecurity vulnerabilities discovered in our products after commercial releasecould result in loss of revenues or delay in revenue recognition, loss ofcustomers and increased service and warranty cost, any of which could adverselyaffect our business, operating results and financial condition. In addition, wecould face claims for product liability, tort or breach of warranty, includingclaims relating to changes to our products made by our OEMs, system integratorsor distributors. Our contracts with customers generally contain provisionsrelating to warranty disclaimers and liability limitations, which may beineffective. Defending a lawsuit, regardless of its merit, is costly and maydivert management’s attention away from the business and adversely affect themarket’s perception of us and our products. In addition, if our businessliability insurance coverage is inadequate or future coverage is unavailable onacceptable terms or at all, our operating results and financial condition couldbe adversely impacted.

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***We are susceptible to shortages orprice fluctuations in our supply chain. Any shortages or price fluctuations incomponents used in our products could delay shipment of our products, whichcould materially adversely affect our business.***

Shortages in components that we use in our products arepossible and our ability to predict the availability of such components may belimited. Some of these components are available only from single or limitedsources of supply. The process of qualifying alternate sources for components,if available at all, may be time consuming, difficult and costly. In addition,the lead times associated with certain components are lengthy and precluderapid changes in quantity requirements and delivery schedules. Any growth inour business 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 a single contractmanufacturer with whom we do not have a long-term supply contract, and changesto this relationship may result in delays or disruptions that could harm ourbusiness.***

We depend on Plexus Corp., an independent contractmanufacturer, to manufacture and assemble our products. We rely on purchaseorders with our contract manufacturer and do not have long-term supplyarrangements in place. As a result, our contract manufacturer is not obligatedto supply products to us for any specific period, quantity or price. Our ordersmay represent a relatively small percentage of the overall orders received byour contract manufacturer from its customers. As a result, fulfilling our ordersmay not be considered a priority by our contract manufacturer in the event thecontract manufacturer is constrained in its ability to fulfill all of itscustomer obligations in a timely manner.

It is time consuming and costly to qualify and implementa contract manufacturer relationship. Therefore, if our contract manufacturersuffers an interruption in its business, or experiences delays, disruptions orquality control problems in its manufacturing operations, or we have to changeor add additional contract manufacturers, our ability to ship products to ourcustomers would be delayed and our business, operating results and financialcondition would be adversely affected.

***Ifwe fail to predict accurately our manufacturing requirements, we could incur additionalcosts or experience manufacturing delays that could harm our business.***

We provide demand forecasts to our contract manufacturer.If we overestimate our requirements, our contract manufacturer may assesscharges or we may have liabilities for excess inventory, each of which couldnegatively affect our gross margins. Conversely, because lead times forrequired materials and components vary significantly and depend on factors suchas the specific supplier, contract terms and the demand for each component at agiven time, if we underestimate our requirements, our contract manufacturer mayhave inadequate materials and components required to produce our products,which could interrupt manufacturing of our products and result in delays inshipments and deferral or loss of revenues.

***If we fail to retain our keypersonnel, we may not be able to achieve our anticipated level of growth andour business could suffer.***

Our future depends, in part, on our ability to attractand retain key personnel, including the continued contributions of ourexecutive officers and other key technical personnel, each of whom would bedifficult to replace. In particular, Ashraf M. Dahod, our president, chiefexecutive officer and chairman is critical to the management of our businessand operations, as well as the development of our strategic direction. The 

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loss of services of Mr. Dahod or other executive officers or keypersonnel or the inability to continue to attract qualified personnel couldhave a material adverse effect on our business. Mr. Dahod is not a partyto an employment agreement with us and, therefore, may terminate his employmentwith us at any time, with no advance notice. The replacement of Mr. Dahodwould involve significant time and expense and may significantly delay orprevent the achievement of our business objectives.

***Competitionfor our employees is intense, and we may not be able to attract and retain thehighly skilled employees that we need to support our business.***

Competition for highly skilled technical personnel isextremely intense and we continue to face difficulty identifying and hiringqualified personnel in many areas of our business. In particular, we facesignificant challenges hiring and retaining personnel in India for research anddevelopment activities because the market for such personnel is increasinglycompetitive. We may not be able to hire and retain such personnel atcompensation levels consistent with our existing compensation and salarystructure. Many of the companies with which we compete for hiring experiencedemployees have greater resources than we have and may be able to offer moreattractive terms of employment. In addition, we invest significant time andexpense in training our employees, which increases their value to competitorswho may seek to recruit them. If we fail to retain our employees, we couldincur significant expenses replacing employees and the quality of our productsand services and our ability to provide such products and services coulddiminish, resulting in a material adverse affect on our business. Furthermore,in making employment decisions, particularly in high-technology industries,candidates often consider the value of the equity they are to receive inconnection with their employment. Therefore, significant volatility in theprice of our stock after this offering may adversely affect our ability toattract or retain personnel.

***Ourinternational sales and operations subject us to additional risks that mayadversely affect our operating results.***

Over the last several years, we derived a significantportion of our revenues from customers outside the United States, and wecontinue to expand our international operations. As of June 30, 2007,approximately 59% of our employees were located abroad, including 250 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;

·                  difficultiesin enforcing contracts and collecting accounts receivable, and longer paymentcycles, especially in emerging markets;

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

·                  unexpectedchanges in regulatory requirements;

·                  reducedprotection for intellectual property rights in some countries;

·                  newand different sources of competition;

·                  fluctuationsin exchange rates; and

·                  tariffs andtrade 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, oursuccess will depend, in large part, on our ability to anticipate andeffectively manage these and other risks associated with our internationaloperations. Our 

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failure to manage any of these risks successfully could harm ourinternational operations and reduce our international sales, adverselyaffecting our business, operating results and financial condition.

***We may need additional capital in thefuture, which may not be available to us on favorable terms, or at all, and maydilute your ownership of our common stock.***

We have historically relied on outside financing and cashfrom operations to fund our operations, capital expenditures and expansion. Wemay require 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

·                  develop newproducts or enhancements to existing products.

We may not be able to secure timely additional financingon favorable terms, or at all. The terms of any additional financing may placelimits on our financial and operating flexibility. If we raise additional fundsthrough further issuances of equity, convertible debt securities or othersecurities convertible into equity, our existing stockholders could suffersignificant dilution in their percentage ownership of our company, and any newsecurities we issue could have rights, preferences and privileges senior tothose of holders of our common stock, including shares of common stock sold inthis offering. If we are unable to obtain adequate financing or financing onterms 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.

***Wemay engage in future acquisitions that could disrupt our business, causedilution to our stockholders and harm our business, operating results orfinancial condition.***

While we currently have no acquisitions of otherbusinesses pending or planned, we have, from time to time, evaluatedacquisition opportunities and may pursue acquisition opportunities in thefuture. We have very little experience consummating acquisitions, and thereforeour ability as an organization to make acquisitions is unproven. We may not beable to find suitable acquisition candidates and we may not be able to completeacquisitions on favorable terms, if at all. If we do complete acquisitions, wemay not ultimately strengthen our competitive position or achieve our goals, orsuch acquisitions 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 mayreduce our 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.

***Ifwe fail to manage future growth effectively, our business could be harmed.***

We have expanded our operations significantly sinceinception and anticipate that further significant expansion will be required.For example, our revenues increased from $34.4 million in 2004 to$94.4 million in 2006, and the number of our employees increased from 117at the beginning of 2004 to 501 as of June 30, 2007. This growth has placedsignificant demands on our management, as well as our financial and operationalresources. If we do not effectively manage our future growth, the efficiency ofour operations and the quality of our products could suffer, which couldadversely affect our business and operating results. To effectively manage thisgrowth, we will need to continue to:

·                  implementappropriate operational, financial and management controls, systems andprocedures, including continued implementation of our enterprise-wide financialsystem;

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·                  expandour manufacturing capacity and scale of production;

·                  expandour sales, marketing and distribution infrastructure and capabilities; and

·                  provide adequatetraining and supervision to maintain high quality standards.

***We will incur significant increasedcosts as a result of operating as a public company, and our management will berequired to devote substantial time to new compliance initiatives.***

As a public company, we will incur significant legal,accounting and other expenses that we did not incur as a private company. Inaddition, the Sarbanes-Oxley Act of 2002, and rules subsequentlyimplemented by the Securities and Exchange Commission and the Nasdaq StockMarket, impose additional requirements on public companies, including requiringchanges in corporate governance practices. Our management and other personnelwill need to devote a substantial amount of time to these complianceinitiatives. Moreover, these rules and regulations will increase our legal andfinancial compliance costs and will make some activities more time-consumingand costly. For example, we expect these rules and regulations to make it moredifficult and more expensive for us to obtain director and officer liabilityinsurance, and we may be required to accept reduced policy limits and coverageor incur substantial additional costs to maintain the same or similar coverage.These rules and regulations could also make it more difficult for us to attractand retain qualified persons to serve on our board of directors, our boardcommittees or as executive officers.

In addition, the Sarbanes-Oxley Act requires, amongother things, that we maintain effective internal control over financialreporting and disclosure controls and procedures. In particular, for the yearending December 31, 2008, we must perform system and process evaluationand testing of our internal control over financial reporting to allow managementand our independent registered public accounting firm to report on theeffectiveness of our internal control over financial reporting, as required bySection 404 of the Sarbanes-Oxley Act. Our testing, or thesubsequent testing by our independent registered public accounting firm, mayreveal deficiencies in our internal control over financial reporting that aredeemed to be material weaknesses. Our compliance with Section 404 willrequire that we incur substantial expense and expend significant managementtime on compliance-related issues. We will need to hire additionalaccounting and financial staff with appropriate public company experience andtechnical accounting 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.

***Weare subject to governmental export and import controls that could subject us toliability or impair our ability to compete in international markets.***

Our products are subject to United States export controlsand may be exported outside the United States only with the required level ofexport license 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 

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or limitation on our ability to export or sell our products would likelyadversely affect our business, operating results and financial condition.

***Compliance with environmental mattersand worker health and safety laws could be costly, and noncompliance with theselaws could have a material adverse effect on our results of operations,expenses and financial condition.***

Some of our operations use substances regulated undervarious federal, state, local and international laws governing the environmentand worker health and safety, including those governing the discharge ofpollutants into the ground, air and water, the management and disposal ofhazardous substances and wastes, and the cleanup of contaminated sites. Some ofour products are subject to various federal, state, local and internationallaws governing chemical substances in electronic products. We could be subjectto increased costs, fines, civil or criminal sanctions, third-partyproperty damage or personal injury claims if we violate or become liable underenvironmental and/or worker health and safety laws.

In January 2003, the European Union, or EU, issuedtwo directives relating to chemical substances in electronic products. TheWaste Electrical and Electronic Equipment Directive, referred to as WEEE,requires producers of electrical goods to pay for specified collection,recycling, treatment and disposal of past and future covered products. Thedeadline for enacting and implementing the WEEE directive was August 13,2004, although extensions were granted in some countries. Producers becamefinancially responsible under WEEE related legislation beginning inAugust 2005. The other directive, the Restriction on the use of certainHazardous Substances, referred to as RoHS, restricts lead and other hazardoussubstances in electronic equipment placed on the EU market after July 1,2006. If we fail to comply with these directives, we may suffer a loss ofrevenues, be unable to sell our products in certain markets and countries, besubject to penalties and fines or suffer a competitive disadvantage. Similarlegislation could be enacted in other jurisdictions, including in China, Japanor the United States, and the scope of new legislation with respect tocurrently unregulated substances is uncertain. Costs to comply with WEEE orRoHS related legislation or similar future legislation, if applicable, couldinclude costs associated with modifying our products, recycling and other wasteprocessing costs, legal and regulatory costs and insurance costs. We arecurrently in compliance with these directives; however, we have incurredsignificant costs related to compliance with current requirements. The costs tocomply with current and future environmental and worker health and safety lawsmay have a material adverse effect on our results of operations, expenses andfinancial condition.

**Risks Related toour Intellectual Property**

***Our ability to compete and the successof our business could be jeopardized if we are unable to rely on our patentrights.***

Our success and ability to compete depends in part uponour ability to obtain protection in the United States and other countries forour products by establishing and maintaining intellectual property rightsrelating to or incorporated into our technology and products. We own a varietyof patents and patent applications in the United States and correspondingpatents and patent applications in foreign jurisdictions. However, we have notobtained patent protection in each market in which we plan to compete. To date,our patent portfolio has not prevented other companies from competing againstus, and we do not know how successful we would be if we sought to enforce ourpatent rights against suspected infringers. Our pending and future patentapplications may not issue as patents or, if issued, may not issue in a formthat will be advantageous to us. Even if issued, patents may be challenged,narrowed, invalidated or circumvented, which could limit our ability to stopcompetitors from marketing similar products or limit the length of term ofpatent protection we may have for our products. Changes in either patent lawsor in interpretations of patent laws in the United States and other countriesmay diminish the value of our intellectual property or narrow the scope of ourpatent protection. Any circumstance or change that results in patent protectionnot 

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being available for our products could adversely affect our business,financial condition and results of operations.

***If we are unable to protect theconfidentiality of our unpatented proprietary information and know-how, thevalue of our technology and products could be adversely affected.***

In addition to patented technology, we rely uponunpatented proprietary technology, processes and know-how. We generally seek toprotect this information in part by confidentiality agreements with ouremployees, consultants and third parties. These agreements may be breached, andwe may not have adequate remedies for any such breach. In addition, our tradesecrets may otherwise become known or be independently developed bycompetitors. If we are unable to protect the confidentiality of our proprietaryinformation and know-how, the value of our technology and products could beadversely affected, which could in turn adversely affect our business,financial condition and results of operations.

***Claimsby others that we infringe their proprietary technology could force us to incursignificant costs.***

Third parties have asserted, and may assert in thefuture, claims that our products infringe patents or patent applications underwhich we do not hold licenses or other rights. Third parties may own or controlthese patents and patent applications in the United States and abroad. Thesethird parties have brought, and could in the future bring, claims against usthat would cause us to incur substantial expenses and, if successfully assertedagainst us, could cause us to pay substantial damages. Further, if a patentinfringement suit were brought against us, we could be forced to stop or delaymanufacturing or sales of the product that is the subject of the suit. Inaddition we could be forced to redesign the product that uses any allegedlyinfringing technology.

We are presently defending two patent infringementlawsuits brought by UTStarcom, Inc. In February 2005, UTStarcom fileda lawsuit asserting infringement of a patent in the United States DistrictCourt for the Northern District of California relating to a prepaid billingfunction we provided to one of our customers. This patent lawsuit by UTStarcomhas been stayed pending a reissue proceeding of the patent asserted in thecase. Such a reissue proceeding may take a year or longer to complete. After thereissue proceeding, the stay of the lawsuit likely will be lifted and thelawsuit may proceed. If this occurs, we will continue to defend ourselves inthis litigation, which will require a significant investment of time andfinancial resources. A finding that we have infringed this patent may requireus to pay damages based on our past sale of the prepaid billing function and,in addition, may force us to limit or cease development, manufacturing andsales of the prepaid billing function. This could adversely affect ourbusiness, financial condition and results of operations.

In May 2007, UTStarcom filed a lawsuit against usand a number of our 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 our patents and three of our patentapplications. The complaint contains allegations, among others, that a numberof former employees of a business unit UTStarcom acquired, who subsequentlyworked for us, took UTStarcom’s trade secrets with them and improperly usedthose trade secrets to develop, manufacture and market our 3G wirelessproducts, 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 these patent applications legally belong to UTStarcom based on theinventors’ previous work at the business unit acquired by UTStarcom. In thelawsuit, UTStarcom seeks unspecified monetary damages, injunctive relief,declarations of ownership relating to the specified patent and patentapplications owned by us, costs and attorneys fees. We will vigorously defendourselves in this litigation, which will require significant investment of timeand financial resources. A finding in UTStarcom’s favor in this lawsuit mayrequire us to 

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pay substantial damages based on the past sales of our ST16 product, 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 three 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 toavoid potential claims, we may choose or be required to seek a license from thethird party and be required to pay license fees or royalties or both. Theselicenses may not be available on acceptable terms, or at all. Even if we wereable to obtain a license, the rights may be nonexclusive, which could result inour competitors gaining access to the same intellectual property. Ultimately,we could be forced to cease some aspect of our business operations if, as aresult of actual or threatened patent infringement claims, we are unable toenter into licenses on acceptable terms. This could significantly and adverselyaffect our business, financial condition and results of operations.

In addition to infringement claims against us, we maybecome a party to other types of patent litigation and other proceedings,including interference proceedings declared by the United States Patent andTrademark Office and opposition proceedings in the European Patent Office,regarding intellectual property rights with respect to our products andtechnology. The cost to us of any patent litigation or other proceeding, evenif resolved in our favor, could be substantial. Some of our competitors may beable to sustain the costs of such litigation or proceedings more effectivelythan we can because of their greater financial resources. Uncertaintiesresulting from the initiation and continuation of patent litigation or otherproceedings could have a material adverse effect on our ability to compete inthe marketplace. Patent litigation and other proceedings may also requiresignificant commitments of time by our management.

***Ouruse of open source could impose limitations on our ability to commercialize ourproducts.***

We incorporate open source software into our products.Although we monitor our use of open source software closely, the terms of many opensource licenses to which we are subject have not been interpreted by UnitedStates or foreign courts, and there is a risk that such licenses could beconstrued in a manner that imposes unanticipated conditions or restrictions onour ability to commercialize our products. In such event, we could be requiredto seek licenses from third parties in order to continue offering our products,to re-engineer our products or to discontinue sales of our products, any ofwhich could materially adversely affect our business.

***Werely on the availability of licenses for intellectual property from thirdparties, and if these licenses are not available to us on commerciallyreasonable terms, product sales and development may be delayed.***

We incorporate certain third-party technologies,including software programs, into our products and may need to utilizeadditional third-party technologies in the future. However, licenses torelevant third-party technology may not continue to be available to us oncommercially reasonable terms, or at all. Therefore, we could face delays inproduct releases until alternative technology can be identified, licensed ordeveloped, and integrated into our current products. These delays, if theyoccur, could materially adversely affect our business.

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

*(a)**       Sales of UnregisteredSecurities*

During the quarter endedJune 30, 2007, we granted stock options to purchase an aggregate of1,365,471 shares of common stock to our employees and directors under our 2000Stock Incentive Plan at exercise prices ranging from $8.25 to $12.00 per share. During this period, we also issued 8,101 shares of restricted stock underour 2000 Stock Incentive Plan and an aggregate of 505,658 shares of commonstock to employees and directors pursuant to the exercise of stock options forcash consideration with aggregate exercise proceeds of approximately $566,000.These issuances were undertaken in reliance upon the exemption fromregistration requirements of Rule 701 or Section 4(2) of the SecuritiesAct of 1933. The recipients of securities in each transaction represented theirintentions to acquire the securities for investment only and not with a view toor for sale in connection with any distribution and appropriate legends wereaffixed to the share certificates issued in these transactions. All recipientshad adequate access, through their relationships with us, to information aboutus.

*(b)**   Use of Proceeds from Public Offering of CommonStock*

In June 2007, we completed an initial public offeringof common stock pursuant to a Registration Statement on Form S-1 (RegistrationNo. 333-141092) which the SEC declared effective on June 5, 2007. Pursuant to the registration statement, we registered the offering and sale ofan aggregate of 12,115,067 shares of our common stock, of which 10,580,226shares were sold by us including 1,580,226 shares sold in connection with theunderwriters’ option described below, and 1,534,841 shares were sold by certainstockholders, at a price of $12.00 per share.   The underwritersexercised their option to purchase the additional 1,580,226 shares of ourcommon stock at the initial public offering price of $12.00 per share on June8, 2007 and the offering closed on June 11, 2007.  The underwriters for the offering wereGoldman, Sachs & Co., Lehman Brothers, JPMorgan and Thomas Weisel PartnersLLC.

We raised a total of$127.0 million in gross proceeds from the initial public offering, orapproximately $116.0 million in net proceeds after deducting underwritingdiscounts and commissions of $8.9 million and other estimated offering costs ofapproximately $2.1 million. The selling stockholders received a total ofapproximately $18.4 million in gross proceeds from the initial public offeringor approximately $17.1 million of net proceeds after deducting the underwritingdiscounts. We have invested the net proceeds in cash and cash equivalents,primarily money-market mutual funds. None of the remaining net proceeds werepaid, directly or indirectly, to directors, officers, persons owning tenpercent or more of our equity securities, or any of our other affiliates.

**ITEM3.    Defaults Upon Senior Securities.**

None.

**ITEM4.    Submission of Matters to a Vote of Security Holders.**

None.

**ITEM5.    Other Information.**

None.

**ITEM 6.    EXHIBITS**

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

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                      |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Form of Non-Employee Director Nonstatutory Stock  Option Agreement under the 2007 Stock Incentive Plan (Initial Grant)                                                               |
|        |       |                                                                                                                                                                                 |
| 10.2        |       | Form of Non-Employee Director Nonstatutory Stock  Option Agreement under the 2007 Stock Incentive Plan (Annual Grant)                                                                |
|        |       |                                                                                                                                                                                 |
| 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                      | ** ** | **STARENT NETWORKS, CORP.** |
|----------------------|------------|-----------------------------|
|                 | ** ** | *(Registrant)*              |
|                 |       |                        |   |   |
|                 | * *   | *By:*                       |   | /s/ Ashraf  M. Dahod |
| Date: August 9, 2007 |       | * *                    | * * | Ashraf M. Dahod*President and Chief Executive Officer  (Principal Executive Officer)* |
| ** **           | ** ** | ** **                  | ** ** | ** ** |
| Date: August 9, 2007 |       | By:                         |   | /s/ Paul J.  Milbury |
|                 |       | * *                    | * * | Paul J. Milbury*Vice President, Operations and  Chief Financial Officer  (Principal Financial Officer)* |
|                 |       |                        |   |   |
| Date: August 9, 2007 |       | By:                         |   | /s/ George  W. Hale |
|                 |       | * *                    |   | George W. Hale*Vice President, Finance and  Corporate Controller  (Principal Accounting Officer)* |

 

46

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**EXHIBITINDEX**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                      |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Form of Non-Employee Director Nonstatutory Stock  Option Agreement under the 2007 Stock Incentive Plan (Initial Grant)                                                               |
|        |       |                                                                                                                                                                                 |
| 10.2        |       | Form of Non-Employee Director Nonstatutory Stock  Option Agreement under the 2007 Stock Incentive Plan (Annual Grant)                                                                |
|        |       |                                                                                                                                                                                 |
| 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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