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EX-31.1 - EXHIBIT 31.1 - AIRVANA INCc91829exv31w1.htm
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EX-32.1 - EXHIBIT 32.1 - AIRVANA INCc91829exv32w1.htm
EX-31.2 - EXHIBIT 31.2 - AIRVANA INCc91829exv31w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-33576
 
Airvana, Inc.
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
  04-3507654
(I.R.S. Employer
Identification Number)
19 Alpha Road
Chelmsford, Massachusetts 01824
(Address of Principal Executive Offices including Zip Code)
(978) 250-3000
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares of the registrant’s common stock, par value $0.001, outstanding as of October 30, 2009 was 62,583,295.
 
 

 

 


 

AIRVANA, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED September 27, 2009
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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PART I. Financial Information
Item 1.  
Condensed Consolidated Financial Statements (unaudited)
AIRVANA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share and per share amounts)
                 
    December 28,     September 27,  
    2008     2009  
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 30,425     $ 12,819  
Investments
    197,941       163,484  
Restricted investments
          210  
Accounts receivable
    3,354       18,436  
Deferred product cost, current
    1,913       3,017  
Prepaid taxes
          11,664  
Deferred tax assets, current, net
    2,168       17,245  
Prepaid expenses and other current assets
    2,758       3,861  
 
           
 
               
Total current assets
    238,559       230,736  
 
               
Property and equipment
    14,425       17,822  
Less: accumulated depreciation and amortization
    9,603       12,039  
 
           
 
               
 
    4,822       5,783  
 
               
Investments, long-term
          29,023  
Prepaid tax, long-term
          3,408  
Deferred service cost
    1,300       4,865  
Deferred tax assets, long term, net
    956       350  
Restricted investments
    193       193  
Goodwill and intangible assets, net
    11,096       10,295  
Other assets
    410       877  
 
           
 
               
Total assets
  $ 257,336     $ 285,530  
 
           
 
               
Liabilities and stockholders’ equity
               
Current liabilities:
               
Accounts payable
  $ 4,455     $ 3,159  
Accrued expenses and other current liabilities
    14,365       12,074  
Accrued income taxes
    1,897       954  
Deferred revenue, current
    61,310       124,260  
 
           
 
               
Total current liabilities
    82,027       140,447  
 
               
Deferred revenue, long-term
    5,550       14,447  
Accrued income taxes, long-term
    5,703       6,025  
Other liabilities
    1,174       783  
 
           
 
               
Total long-term liabilities
    12,427       21,255  
 
               
Commitments and Contingencies (Note 8)
           
Stockholders’ equity:
               
Preferred stock, $0.001 par value per share: 10,000,000 shares authorized, no shares issued
           
Common stock, $0.001 par value per share: 350,000,000 shares authorized, 62,931,171 and 62,554,501 shares issued and outstanding at December 28, 2008 and September 27, 2009, respectively (Note 9)
    63       63  
Additional paid-in capital
    186,824       185,861  
Accumulated deficit
    (24,005 )     (62,096 )
 
           
 
               
Total stockholders’ equity
    162,882       123,828  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 257,336     $ 285,530  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements

 

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AIRVANA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
                                 
    Three Months Ended     Nine Months Ended  
    September 28,     September 27,     September 28,     September 27,  
    2008     2009     2008     2009  
Revenue:
                               
Product
  $ 5,362     $ 242     $ 65,679     $ 8,518  
Service
    2,885       2,484       9,225       8,351  
 
                       
 
                               
Total revenue
    8,247       2,726       74,904       16,869  
 
                               
Cost of revenue:
                               
Product
    426       359       1,860       1,227  
Service
    2,226       2,541       6,032       7,622  
 
                       
 
                               
Total cost of revenue
    2,652       2,900       7,892       8,849  
 
                               
Gross profit (loss)
    5,595       (174 )     67,012       8,020  
 
                               
Operating expenses:
                               
Research and development
    18,859       18,443       56,209       54,202  
Selling and marketing
    3,809       4,245       11,212       12,345  
General and administrative
    2,281       3,438       6,675       8,311  
 
                       
 
                               
Total operating expenses
    24,949       26,126       74,096       74,858  
 
                       
 
                               
Operating loss
    (19,354 )     (26,300 )     (7,084 )     (66,838 )
 
                               
Interest and other income, net
    1,505       426       5,882       3,092  
 
                       
 
                               
Loss before income taxes
    (17,849 )     (25,874 )     (1,202 )     (63,746 )
 
                               
Income tax (benefit) expense
    (5,404 )     (9,019 )     2,354       (25,655 )
 
                       
 
                               
Net loss
  $ (12,445 )   $ (16,855 )   $ (3,556 )   $ (38,091 )
 
                       
 
                               
Net loss per share:
                               
Basic
  $ (0.19 )   $ (0.27 )   $ (0.06 )   $ (0.61 )
Diluted
  $ (0.19 )   $ (0.27 )   $ (0.06 )   $ (0.61 )
 
                               
Weighted average common shares outstanding:
                               
Basic
    64,965       62,341       64,487       62,417  
Diluted
    64,965       62,341       64,487       62,417  
The accompanying notes are an integral part of these condensed consolidated financial statements

 

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AIRVANA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
                                 
    Three Months Ended     Nine Months Ended  
    September 28,     September 27,     September 28,     September 27,  
    2008     2009     2008     2009  
Operating activities
                               
Net loss
  $ (12,445 )   $ (16,855 )   $ (3,556 )   $ (38,091 )
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
                               
Depreciation
    814       832       2,435       2,410  
Amortization of intangible assets
    267       267       801       801  
Stock-based compensation
    1,278       1,687       3,542       4,500  
Deferred tax provision (benefit)
    (5,404 )     (14,823 )     2,354       (14,365 )
Excess tax benefit related to exercise of stock options
    (481 )     (892 )     (1,978 )     (1,792 )
Amortization of investments
    (971 )     477       (3,381 )     5  
Amortization of leasehold incentive
    (130 )     (131 )     (391 )     (391 )
Unrealized gain (loss) on forward foreign currency exchange contracts
          513             (188 )
Changes in operating assets and liabilities:
                               
Accounts receivable
    152       (8,943 )     6,078       (15,082 )
Deferred product and service costs
    (1,043 )     (1,390 )     (1,347 )     (4,669 )
Prepaid taxes
    (8,877 )     5,170       (8,762 )     (13,386 )
Prepaid expenses and other current assets
    (960 )     121       (177 )     (915 )
Accounts payable
    1,027       413       (1,187 )     (1,296 )
Accrued expenses and other current liabilities
    4,535       (734 )     2,624       (2,286 )
Accrued income taxes
    (125 )     415       (15,901 )     (621 )
Deferred revenue
    34,738       28,522       32,156       71,847  
 
                       
 
                               
Net cash provided by (used in) operating activities
    12,071       (5,351 )     13,310       (13,519 )
 
                               
Investing activities
                               
Purchases of property and equipment
    (534 )     (784 )     (1,567 )     (3,371 )
Purchases of investments
    (72,834 )     (53,793 )     (248,627 )     (192,861 )
Maturities of investments
    83,490       52,500       231,299       198,290  
Proceeds from sale of investments
                16,631        
Decrease (increase) in other assets and restricted investments
    32       (456 )     51       (677 )
 
                       
 
                               
Net cash provided by (used in) by investing activities
    10,154       (2,533 )     (2,213 )     1,381  
 
                               
Financing activities
                               
Payments on long-term debt
    (7 )           (119 )      
Payments of cash dividend
    (21 )           (71 )     (5 )
Purchase of treasury stock
    (3,547 )     (369 )     (3,547 )     (9,291 )
Excess tax benefit related to exercise of stock options
    481       892       1,978       1,792  
Proceeds from exercise of stock options
    733       870       2,219       2,036  
 
                       
 
                               
Net cash (used in) provided by financing activities
    (2,361 )     1,393       460       (5,648 )
Effect of exchange rate changes on cash and cash equivalents
    144             216        
 
                       
 
                               
Net increase (decrease) in cash and cash equivalents
    20,008       (6,491 )     11,773       (17,606 )
Cash and cash equivalents at beginning of period
    35,312       19,310       43,547       30,425  
 
                       
 
                               
Cash and cash equivalents at end of period
  $ 55,320     $ 12,819     $ 55,320     $ 12,819  
 
                       
 
                               
Supplemental Disclosure of Cash Flow Information
                               
Cash paid for income taxes
  $ 9,025     $ 217     $ 24,603     $ 2,430  
The accompanying notes are an integral part of these condensed consolidated financial statements

 

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AIRVANA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(dollars in thousands, except share and per share amounts)
1. Operations
Business Description
Airvana, Inc. (the “Company”) is a leading provider of network infrastructure products used by wireless operators to provide mobile broadband services. The Company’s high-performance technology and products, from emerging comprehensive femtocell solutions to core mobile network infrastructure, enable operators to deliver compelling and consistent broadband services to mobile subscribers, wherever they are. These services include Internet access, e-mail, music downloads, video, IP-TV, gaming, push-to-talk and voice-over-IP (“VOIP”). The Company’s products are deployed in over 70 commercial networks on six continents. The Company is headquartered in Chelmsford, Massachusetts and has offices worldwide, including development centers in Bangalore, India and Cambridge, United Kingdom.
On January 14, 2009 (the “filing date”), Nortel Networks Corporation announced that it, Nortel Networks Limited, and certain of its other Canadian subsidiaries filed for creditor protection under the Companies’ Creditors Arrangement Act in Canada. Also, on January 14, 2009, some of Nortel Networks Corporation’s U.S. subsidiaries, including Nortel Networks Inc. (“Nortel Networks”), filed Chapter 11 voluntary petitions in the State of Delaware. On July 28, 2009, United States and Canadian bankruptcy courts approved a bid by Telefon AB L.M. Ericsson (“Ericsson”) to purchase Nortel Networks’ CDMA business, subject to satisfaction of regulatory and other conditions. Substantially all of the Company’s current billings and revenue are derived from Nortel Networks. Refer to Note 13 for a discussion of the impact of these actions on the Company.
2. Summary of Significant Accounting Policies
The accompanying condensed consolidated financial statements reflect the application of certain accounting policies as described in this note and elsewhere in the accompanying condensed consolidated financial statements. The Company believes that a significant accounting policy is one that is both important to the portrayal of the Company’s financial condition and results of operations and requires management’s most difficult, subjective or complex judgments, often as the result of the need to make estimates about the effect of matters that are inherently uncertain.
These condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States applicable to interim periods, and in the opinion of management, include all normal and recurring adjustments that are necessary to present fairly the results of operations for the reported periods. These financial statements and notes should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 28, 2008, which was filed with the Securities and Exchange Commission (the “SEC”) on February 24, 2009.
Unaudited Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to such SEC rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements and notes have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting of normal, recurring adjustments) necessary for the fair presentation of the Company’s financial position at September 27, 2009 and results of operations and cash flows for the three and nine months ended September 28, 2008 and September 27, 2009. The interim results are not necessarily indicative of the results that may be expected for any other interim period or the full year.
Any material subsequent events have been considered for disclosure and recognition through November 4, 2009, the filing date of this Form 10-Q.
Use of Estimates
The preparation of financial statements in conformity with GAAP in the United States requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions by management affect the Company’s timing of revenue recognition for multiple element arrangements, expensing or capitalizing research and development costs for software, expected future cash flows used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of intangible assets and goodwill, amortization methods and periods, certain accrued expenses, stock-based compensation, contingent liabilities, the assessment of uncertain tax positions and the related tax reserves and recoverability of the Company’s net deferred tax assets and related valuation allowance.

 

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Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from management’s estimates if past experience or other assumptions do not turn out to be substantially accurate predictors.
The Company is subject to a number of risks similar to those of other companies of similar size in its industry, including, but not limited to: a highly concentrated customer base, sales volatility, dependency on particular air interface standards, rapid technological changes, competition from substitute products and services from larger companies, limited number of suppliers, the current crisis affecting world financial markets, future sales or issuances of its common stock, government regulations, management of international activities, protection of proprietary rights, patent litigation, and dependence on key individuals.
Fiscal Year
The Company’s fiscal year ends on the Sunday nearest to December 31. The Company’s fiscal quarters end on the Sunday nearest to the last day of the third calendar month of the quarter.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid instruments with maturities of three months or less at the date of purchase. Cash equivalents are carried at cost, which approximates their fair market value. See Note 5 for further discussion of cash equivalents.
Investments and Restricted Investments
The Company determines the appropriate categorization of investments in securities at the time of purchase. As of December 28, 2008 and September 27, 2009, the Company’s investments were categorized as held-to-maturity and are presented at their amortized cost. See Note 3. The Company classifies securities on its balance sheet as short-term or long-term based on the date it reasonably expects the securities to mature or liquidate.
As of December 28, 2008, the Company had classified $193 as long-term restricted investments on its condensed consolidated balance sheets. As of September 27, 2009, the Company had classified $210 as short-term restricted investments and $193 as long-term restricted investments on its condensed consolidated balance sheets. Refer to Note 5 for a discussion of these restricted investments.
Deferred Product and Service Cost
When the Company’s products have been delivered, but the product revenue associated with the arrangement has been deferred as a result of not meeting the revenue recognition criteria in Accounting Standards Codification (“ASC”) 985-605, Software Revenue Recognition (“ASC 985-605”), the Company also defers the related inventory costs for the delivered items in accordance with ASC 330-10, Inventory (“ASC 330-10”), which primarily relates to third party royalties. For development costs incurred in connection with specified upgrades, the Company expenses these costs as incurred.
When the Company performs development services that are essential to the functionality of the initial delivery of a new product where the associated revenues have been deferred due to the fact that they do not qualify as units of accounting separate from the delivery of software, the Company defers direct and incremental development costs in accordance with ASC 310-20, Accounting for Nonrefundable Fees and Costs Associated With Originating or Acquiring Loans and Initial Direct Costs of Leases (“ASC 310-20”). The costs deferred consist of employee compensation and benefits for those employees directly involved with performing the development, as well as other direct and incremental costs. All costs incurred in excess of the related revenues are expensed as incurred. During the three months ended September 28, 2008 and September 27, 2009, the Company deferred $377 and $783, respectively, of direct costs incurred. During the nine months ended September 28, 2008 and September 27, 2009, the Company deferred $874 and $3,377, respectively, of direct costs incurred. Direct costs included in long-term deferred service cost in the accompanying condensed consolidated balance sheets were $1,223 and $4,621 at December 28, 2008 and September 27, 2009, respectively.

 

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Property and Equipment
Property and equipment are recorded at cost. The Company provides for depreciation by charges to operations on a straight-line basis in amounts estimated to allocate the cost of the assets over their estimated useful lives. Depreciation expense was $814 and $832 for the three months ended September 28, 2008 and September 27, 2009, respectively, and $2,435 and $2,410 for the nine months ended September 28, 2008 and September 27, 2009, respectively. Expenditures for repairs and maintenance are expensed as incurred. Property and equipment consisted of the following:
                         
            As of  
    Estimated Useful     December 28,     September 27,  
    Life     2008     2009  
Computer equipment and purchased software
  1.5 – 3 years   $ 2,513     $ 2,545  
Test and lab equipment
  3 years     4,510       7,869  
Leasehold improvements
  Shorter of original contractual life of the lease or 5 years     6,546       6,559  
Office furniture and equipment
  3 – 5 years     856       849  
 
                 
 
                       
Total property and equipment
            14,425       17,822  
Less: Accumulated depreciation and amortization
            (9,603 )     (12,039 )
 
                   
 
                       
 
          $ 4,822     $ 5,783  
 
                   
Revenue Recognition
The Company derives revenue from the licensing of software products and software upgrades; the sale of hardware products, maintenance and support services; and the sale of professional services, including training. The Company’s products incorporate software that is more than incidental to the related hardware. Accordingly, the Company recognizes revenue in accordance with ASC 985-605.
Under multiple-element arrangements where several different products or services are sold together, the Company allocates revenue to each element based on vendor specific objective evidence (“VSOE”) of fair value. It uses the residual method when fair value does not exist for one or more of the delivered elements in a multiple-element arrangement. Under the residual method, the fair value of the undelivered elements is deferred and subsequently recognized when earned. For a delivered item to be considered a separate element, the undelivered items must not be essential to the functionality of the delivered item and there must be VSOE of fair value for the undelivered items in the arrangement. Fair value is generally limited to the price charged when the Company sells the same or similar element separately or, when applicable, the stated substantive renewal rate. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized after delivery of those elements occurs or when fair value can be established. For example, in situations where the Company sells a product during a period when it has a commitment for the delivery or sale of a future specified software upgrade, the Company defers revenue recognition until the specified software upgrade is delivered.
Significant judgments in applying accounting rules and regulations to the Company’s business practices principally relate to the timing and amount of revenue recognition given its current concentration of revenues with one customer and its inability to establish VSOE of fair value for specified software upgrades.
The Company sells its products primarily through original equipment manufacturer (“OEM”) arrangements with telecommunications infrastructure vendors such as Nortel Networks. The Company collaborates with its OEM customers on a best efforts basis to develop initial product features and subsequent enhancements for the products that are sold by that particular OEM to its wireless operator customers. For each OEM customer, the Company expects to continue to develop products based on its core technology that are configured for the requirements of the OEM’s base stations and its operator customers.
This business practice is common in the telecommunications equipment industry and is necessitated by the long planning cycles associated with wireless network deployments, coupled with rapid changes in technology. Large and complex wireless networks support tens of millions of subscribers and it is critical that any changes or upgrades be planned well in advance to ensure that there are no service disruptions. The evolution of the Company’s infrastructure technology therefore must be planned, implemented and integrated with the wireless operators’ plans for deploying new applications and services and any equipment or technology provided by other vendors.

 

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Given the nature of the Company’s business, the majority of its sales are generated through multiple-element arrangements comprised of a combination of products, maintenance and support services, specified product upgrades and in some cases, upfront licensing and development fees. The Company has established a business practice of negotiating with OEMs the pricing for future purchases of new product releases and specified software upgrades. For example, for Nortel Networks, the Company expects that it will release one or more optional specified upgrades annually. To determine whether these optional future purchases are elements of current purchase transactions, the Company assesses whether such new products or specified upgrades will be offered to the OEM customer at a price that represents a significant and incremental discount to current purchases. Because the Company sells uniquely configured products through each OEM customer, it does not maintain a list price for its products and specified software upgrades. Additionally, as it does not sell these products and upgrades to more than one customer, the Company is unable to establish VSOE of fair value for these products and upgrades. Consequently, the Company is unable to determine if the license fees it charges for the optional specified upgrades include a significant and incremental discount. As such, the Company defers all revenue related to current product sales, software-only license fees, maintenance and support services and professional services until all specified upgrades committed at the time of shipment have been delivered. For example, the Company recognizes deferred revenue from sales to an OEM customer only after it delivers a specified upgrade to which it had previously committed. However, when it commits to an additional upgrade before it has delivered a previously committed upgrade, the Company defers all revenue from product sales after the date of such commitment until it delivers the additional upgrade. Any revenue that the Company had deferred prior to the additional commitment is recognized after the previously committed upgrade is delivered.
If there are no commitments outstanding for specified upgrades, the Company recognizes revenue when all of the following have occurred: (1) delivery (FOB origin), provided that there are no uncertainties regarding customer acceptance; (2) there is persuasive evidence of an arrangement; (3) the fee is fixed or determinable; and (4) collection of the related receivable is reasonably assured, as long as all other revenue recognition criteria have been met. If there are uncertainties regarding customer acceptance, the Company recognizes revenue and related cost of revenue when those uncertainties are resolved. Any adjustments to software license fees are recognized when reported to the Company by an OEM customer.
For arrangements where the Company receives initial licensing fees or customization fees for new products under development, the Company defers recognition of these fees until the final product has been delivered and accepted, and then recognizes the fees over the expected customer relationship period. Revenue from pre-production units is deferred and recognized once the final product has been delivered and accepted and the other criteria for revenue recognition are met, including but not limited to VSOE of fair value for post-contract customer support (“PCS”). If VSOE of fair value does not exist for undelivered elements, the Company defers all revenues until VSOE of fair value exists or the undelivered element is delivered. If the only remaining undelivered element is PCS, the Company recognizes revenue ratably over the contractual PCS period.
For arrangements that include annual volume commitments and pricing levels, where the associated discounts represent significant and incremental discounts and where the maximum discount to be provided can not be quantified prior to the expiration of the arrangement, the Company recognizes revenue, provided that delivery and acceptance has occurred and no other commitments such as specified upgrades are outstanding, based on the lowest pricing level stated in the arrangement. Any amounts invoiced in excess of the lowest pricing level are deferred and recognized ratably over the remaining discount period, which typically represents the greater of the PCS period or the remaining contractual period.
For its direct sales to end user customers, which have not been material to date, the Company recognizes product revenue upon delivery, provided that all other revenue recognition criteria have been met.
The Company’s support and maintenance services consist of the repair or replacement of defective hardware, around-the-clock help desk support, technical support and the correction of bugs in its software. The Company’s annual support and maintenance fees are based on a percentage of the initial sales or list price of the applicable hardware and software products and may include a fixed amount for help desk services. Included in the price of the product, the Company provides maintenance and support during the product warranty period, which is typically one year. As discussed above, the Company defers all revenue, including revenue related to PCS, until all specified upgrades outstanding at the time of shipment have been delivered. In connection with an amendment to the Company’s OEM arrangement with Nortel Networks dated September 28, 2007, the Company can no longer assert VSOE of fair value for PCS to Nortel Networks. When VSOE of fair value for PCS can not be established, all revenue related to product sales and software-only license fees, including bundled PCS, is deferred until all specified software upgrades outstanding at the time of shipment are delivered. At the time of the delivery of all such upgrades, the Company recognizes a proportionate amount of all such revenue previously deferred based on the portion of the applicable warranty period that has elapsed as of the time of such delivery. The unearned revenue is recognized ratably over the remainder of the applicable warranty period. When VSOE of fair value for PCS can be established, the Company allocates a portion of the initial product revenue and software-only license fees to the bundled PCS based on the fees the Company charges for annual PCS when sold separately. When all specified software upgrades outstanding at the time of shipment are delivered, under the residual method, the Company recognizes the previously deferred product revenue and software-only license fees, as well as the earned PCS revenue, based on the portion of the applicable warranty period that has elapsed. The unearned PCS revenue is recognized ratably over the remainder the applicable warranty period. Notwithstanding the Company’s inability to establish VSOE of fair value of PCS to Nortel Networks for revenue recognition purposes, the Company presents product revenue and service revenue separately on its consolidated statements of income based on historical maintenance and support services renewal rates at the time of sale.

 

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For PCS renewals, the Company recognizes revenue for such services ratably over the service period as services are delivered.
The Company provides professional services for deployment optimization, network engineering and radio frequency deployment planning, and provides training for network planners and engineers. The Company generally recognizes revenue for these services as the services are performed as it has deemed such services not essential to the functionality of its products.
In addition, certain contracts contain other mutually agreed upon specifications or service level requirements. Certain of the Company’s product specifications include an uptime guarantee and guarantees regarding failure rates. Historically, the Company has not incurred substantial costs relating to these guarantees and the Company currently expenses such costs as they are incurred. The Company reviews these costs on a regular basis as actual experience and other information becomes available; and should they become more substantial, the Company would accrue an estimated exposure and consider the potential related effects of the timing of recording revenue on its sales arrangements. The Company has not accrued any costs related to these warranties in the accompanying consolidated financial statements.
In accordance with ASC 605-45, Principal Agent Considerations (“ASC 605-45”), the Company classifies the reimbursement by customers of shipping and handling costs as revenue and the associated cost as cost of revenue. The Company records reimbursable out-of-pocket expenses in both product and services revenues and as a direct cost of product and services. For the first three quarters of fiscal 2008 and 2009, shipping and handling and reimbursable out-of-pocket expenses were not material.
The Company has not issued and does not anticipate issuing any refunds for products sold. As such, no provisions have been recorded against deferred revenue, revenue or any related receivables for potential refunds.
The Company anticipates that the revenue recognition related to the Company’s fixed-mobile convergence products will be complex, given that a number of the Company’s current arrangements for the development and supply of these products contain significant customization services, volume discounts, specified upgrades and multiple elements for new service offerings for which vendor-specific evidence of fair value does not currently exist. To date, there have been no material revenues recognized with respect to these products.
Concentrations of Credit Risk and Significant Customers
Financial instruments that subject the Company to credit risk consist of cash and cash equivalents, short-term and long-term restricted investments, short-term and long-term investments, accounts receivable and forward foreign currency exchange contracts. The Company maintains its cash and cash equivalents and investment accounts with two major financial institutions. The Company’s cash equivalents and investments are invested in securities with high credit ratings.
The Company’s customers are principally located in the United States, Canada, Europe and Japan. The Company performs ongoing credit evaluations of the financial condition of its customers and generally does not require collateral. Although the Company is directly affected by the overall financial condition of the telecommunications industry as well as global economic conditions, management does not believe significant credit risk exists as of September 27, 2009 beyond the risks discussed below related to Nortel Networks’ bankruptcy filing and the anticipated sale of Nortel Networks’ CDMA business to Ericsson. The Company generally has not experienced any material losses related to receivables from individual customers or groups of customers in the telecommunications industry. Except as described below with respect to Nortel Networks, the Company believes that all of its accounts receivable are collectible and, therefore, has not provided any reserve for doubtful accounts as of December 28, 2008 or September 27, 2009.
At December 28, 2008, Nortel Networks accounted for $500 of accounts receivable that was paid in the ordinary course prior to Nortel Networks’ bankruptcy filing. In addition, at December 28, 2008, the Company had $21,818 of outstanding invoices due from Nortel Networks that it has accounted for on the cash basis; see Note 13 for further discussion. At December 28, 2008, the Company had four customers that accounted for 49%, 15%, 11% and 11% of accounts receivable. At September 27, 2009, the Company had one customer, Nortel Networks, that accounted for 81% of accounts receivable. Nortel Networks accounted for 93% and 88% of revenues for the three months ended September 28, 2008 and September 27, 2009, respectively. Nortel Networks accounted for 98% and 86% of revenues for the nine months ended September 28, 2008 and September 27, 2009, respectively.
On January 14, 2009, Nortel Networks Corporation announced that it, Nortel Networks Limited, and certain of its other Canadian subsidiaries filed for creditor protection under the Companies’ Creditors Arrangement Act in Canada. Some of Nortel Networks Corporation’s U.S. subsidiaries, including Nortel Networks, filed Chapter 11 voluntary petitions in the State of Delaware. On June 19, 2009, Nortel Networks Corporation announced the proposed “stalking horse” asset sale of Nortel Networks’ CDMA business. On July 28, United States and Canadian bankruptcy courts approved a bid by Ericsson to purchase Nortel Networks’ CDMA business, subject to satisfaction of regulatory and other conditions. See Note 13 for further discussion.
The Company is subject to credit risk under its forward foreign currency exchange contracts; see Note 6.

 

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Segment and Geographic Information
ASC 280-10, Segment Reporting (“ASC 280-10”), establishes standards for reporting information about operating segments in annual financial statements and requires selected information of these segments be presented in interim financial reports to stockholders. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. The Company’s chief operating decision making group, as defined under ASC 280-10, consists of the Company’s chief executive officer, chief financial officer and executive vice presidents. As of September 27, 2009, the Company views its operations and manages its business as one operating segment. The Company continues to evaluate its current and new products for their impact on reporting segments.
Export sales from the United States to unaffiliated customers are primarily to Canada, and accounted for 93% and 88% of revenues individually for the three months ended September 28, 2008 and September 27, 2009, respectively. Export sales from the United States to unaffiliated customers are primarily to Canada, and accounted for 98% and 86% of revenues individually for the nine months ended September 28, 2008 and September 27, 2009, respectively.
In the first quarter of fiscal 2009, the Company completed the sale of intellectual property and goodwill from its U.K. subsidiary to the U.S. parent. Transfers between the Company and its subsidiaries are generally recorded at amounts similar to the prices paid by unaffiliated foreign dealers. All intercompany profit is eliminated in consolidation.
The Company’s identifiable long-lived assets by geographic region as of December 28, 2008 and September 27, 2009 were as follows:
                 
    December 28,     September 27,  
    2008     2009  
United States
  $ 5,501     $ 52,975  
United Kingdom
    12,178       958  
Other foreign locations
    1,098       861  
 
           
 
               
 
  $ 18,777     $ 54,794  
 
           
Stock-Based Compensation
As of September 27, 2009, the Company had two stock-based employee compensation plans which are more fully described in Note 9.
Comprehensive Income (Loss)
ASC 220-10, Comprehensive Income, establishes standards for reporting and displaying comprehensive income and its components in financial statements. Comprehensive income (loss) is defined as the change in stockholders’ equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income (loss) for all periods presented is equal to the reported net income (loss).
Net Income (Loss) Per Share
The Company calculates net income per share in accordance with ASC 260-10, Earnings Per Share. Basic net income (loss) per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share is computed using the weighted average number of common shares outstanding and, when dilutive, potential common shares from options, warrants and unvested common stock using the treasury stock method. Diluted weighted average shares outstanding do not include options to purchase common stock and unvested restricted shares outstanding totaling 10,024,575 and 12,017,188 for the three months ended September 28, 2008 and September 27, 2009, respectively, as their effect would have been anti-dilutive. Diluted weighted average shares outstanding do not include options to purchase common stock and unvested restricted shares outstanding totaling 10,181,349 and 11,582,556 for the nine months ended September 28, 2008 and September 27, 2009, respectively, as their effect would have been anti-dilutive.

 

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Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10, Income Taxes (“ASC 740-10”), which is the asset and liability method for accounting and reporting income taxes. Under ASC 740-10, deferred tax assets and liabilities are recognized based on temporary differences between the financial reporting and income tax bases of assets and liabilities using statutory rates. In addition, ASC 740-10 requires a valuation allowance against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
ASC 740-10 also provides criteria for the recognition, measurement, presentation and disclosures of uncertain tax positions. A tax benefit from an uncertain tax position may be recognized if it is “more likely than not” that the position is sustainable based solely on its technical merits. As of December 28, 2008 and September 27, 2009, the Company had $5,703 and $6,025, respectively, including interest, of unrecognized tax benefits.
Fair Value of Financial Instruments
Financial instruments consist principally of cash and cash equivalents, short-term and long-term investments, short-term and long-term restricted investments, accounts receivable, forward foreign currency exchange contracts and accounts payable. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values due to their short-term maturities. Forward foreign currency exchange contracts are carried at fair value based on quoted market prices for financial instruments with similar characteristics. The Company’s short-term and long-term investments are classified as held-to-maturity and are reported at amortized cost, which approximates fair market value. Refer to Notes 3 and 5 for further discussion of fair value of investments.
Recently Issued Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (“FASB”) issued ASC 805-10, Business Combinations (“ASC 805-10”). ASC 805-10 applies to all transactions in which an entity obtains control of one or more businesses and establishes principles and requirements for how the acquirer:
a. Recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values;
b. Recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and
c. Determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.
While prior FASB guidance permitted deferred recognition of pre-acquisition contingencies until the contingency was resolved and consideration was issued or issuable, ASC 805-10 requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Acquisition costs, such as legal, accounting and other professional and consulting fees, are to be expensed in the periods in which the costs are incurred and the services are received, except for costs to issue debt or equity securities. ASC 805-10 was effective for the Company for business combinations for which the acquisition date is on or after January 1, 2009. The Company has not had any business combinations after this date.
In September 2006, the FASB issued ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”). ASC 820-10 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820-10 was effective on January 1, 2008. However, in February 2008, the FASB delayed the effective date of ASC 820-10 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of ASC 820-10 for the Company’s financial assets and liabilities did not have a material impact on its consolidated financial statements. The adoption of ASC 820-10 for the Company’s non-financial assets and liabilities did not have a material impact on its financial position or results from operations.
In December 2007, the FASB issued ASC 810-10-65, Noncontrolling Interests in Consolidated Financial Statements (“ASC 810-10-65”). ASC 810-10-65 amends ASC 810-10-10 to establish accounting and reporting standards for the noncontrolling (i.e. minority) interest in a subsidiary and for the deconsolidation of a subsidiary. ASC 810-65 will require, among other things, that a minority interest shall be clearly identified and presented within the equity section of a consolidated balance sheet and that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of a consolidated statement of income. ASC 810-10-65 was effective for fiscal years beginning after December 15, 2008. The adoption of ASC 810-10-65 did not have a material effect on the Company’s consolidated financial statements.

 

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In April 2008, the Financial Accounting Standards Board, (“FASB”) issued ASC 350-30, General Intangibles Other Than Goodwill (“ASC 350-30”), which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under ASC 350-10, Intangibles — Goodwill and Other (“ASC 350-10”). ASC 350-30 requires an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset.
ASC 350-30 also requires the following incremental disclosures for renewable intangible assets:
   
The weighted-average period prior to the next renewal or extension (whether explicit and implicit) for each major intangible asset class;
 
   
The entity’s accounting policy for the treatment of costs incurred to renew or extend the term of a recognized intangible asset; and
 
   
For intangible asset renewed or extended during the period:
   
For entities that capitalize renewal or extension costs, the costs incurred to review or extend the asset, for each major intangible asset class and
 
   
The weighted-average period prior to the next renewal or extension (whether explicit and implicit) for each major intangible asset class.
ASC 350-30 is effective for financial statements for fiscal years beginning after December 15, 2008. The guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Accordingly, ASC 350-30 would not serve as a basis to change the useful life of an intangible asset that was acquired prior to the effective date (January 1, 2009 for a calendar year company). However, the incremental disclosure requirements described above would apply to all intangible assets, including those recognized in periods prior to the effective date of ASC 350-30. The adoption of ASC 350-30 did not have a material impact on the Company’s financial position or results of operations.
During the first quarter of 2009, the Company adopted ASC 815-10, Derivative and Hedging, which requires additional disclosures about the Company’s objectives and strategies for using derivative instruments, how the derivative instruments and related hedged items are accounted for under ASC 815-10, and related interpretations, and how the derivative instruments and related hedged items affect the financial statements. The adoption of ASC 815-10 had no financial impact on the Company’s Condensed Consolidated Financial Statements. Refer to Note 6, “Derivative Instruments and Hedging Activities” for additional information on the Company’s hedging activities.
In April 2009, the FASB issued ASC 825-10, Financial Instruments, (“ASC 825-10”). ASC 825-10 requires disclosures about fair value of financial instruments in interim as well as in annual financial statements. ASC 825-10 also requires fair value disclosures in all interim financial statements. ASC 825-10 was effective for the Company as of the second fiscal quarter of 2009 and did not have a material impact on the Company’s financial position, results of operations or cash flows.
In May 2009, the FASB issued ASC 855-10, Subsequent Events (“ASC 855-10”). ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855-10 is effective for interim or annual financial periods ending after June 15, 2009, the quarter ending June 28, 2009 for the Company. The implementation of this standard did not have a significant impact on the financial statements of the Company. Subsequent events through the filing date of this Form 10-Q have been evaluated for disclosure and recognition.
In June 2009, the FASB issued the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative U.S. GAAP. The Codification supersedes all existing non-SEC accounting and reporting standards. As a result, upon adoption, all references to accounting literature in the Company’s SEC filings will be required to conform to the appropriate reference within the Codification. The Company is required to adopt this standard for its third quarter ending September 27, 2009. The adoption of this standard did not have an impact on its financial position or results of operations.
In September 2009, the FASB ratified the final consensuses reached by the Emerging Issues Task Force regarding revenue arrangements with multiple deliverables and software revenue recognition. The consensus reached on arrangements with multiple deliverables addresses how consideration should be allocated to different units of accounting and removes the previous criterion that entities must use objective and reliable evidence of fair value in separately accounting for deliverables. The consensus reached on software revenue recognition will exclude products containing both software and non-software components that function together to deliver the product’s essential functionality from the scope of current revenue recognition guidance for software products. Although these consensuses are effective for the Company as of January 1, 2011, early adoption is permitted with expanded disclosures and retrospective adjustment to the beginning of the fiscal year of adoption. The Company is currently assessing the timing of adoption.

 

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3. Investments
In accordance with ASC 320-10, Investments — Debt and Equity Securities, the Company has classified its investment securities as held-to-maturity. These securities are reported at amortized cost, which approximates fair market value.
The amortized cost and estimated fair value of the Company’s investment securities was as follows:
                                 
    December 28, 2008     September 27, 2009  
            Fair             Fair  
    Amortized     Market     Amortized     Market  
    Cost     Value     Cost     Value  
Certificate of deposits
  $     $     $ 1,694     $ 1,694  
Corporate debt securities
    86,140       86,674       34,651       34,713  
Debt securities of U.S. government agencies
    111,801       112,709       156,162       156,305  
 
                       
 
                               
 
  $ 197,941     $ 199,383     $ 192,507     $ 192,712  
 
                       
All held-to-maturity investment securities had maturities of less than one year as of December 28, 2008. Held-to-maturity investment securities of $163,484 and $29,023 are expected to mature in less than one year and between one to two years, respectively, as of September 27, 2009.
During the quarter ended March 30, 2008, the Company sold certain credit card asset backed securities which were classified as held-to-maturity due to a deterioration of creditworthiness of the underlying trusts that issued the securities. The Company routinely monitors all of its investments, and for the securities that were sold, certain liquidity and cash flow metrics tracked by the Company had recently deteriorated. The Company believed that it was prudent to liquidate these investments prior to any potential downgrades by credit analysts. The Company sold a total of eight securities having a total amortized cost of $16,630 and realized a gain on sale of these investments of $83.
The Company intends to hold all of the securities it held as of September 27, 2009 to maturity, but will continue to monitor the creditworthiness of all securities.
As of September 27, 2009, the Company held 12 securities in an unrealized loss position totaling $33. The unrealized losses on individual securities was less than 1% of amortized cost and represented less than 1% of total amortized cost of all investments. Given the nominal amount of the unrealized loss and the creditworthiness of the issuers of the securities that were in an unrealized loss position at September 27, 2009, the Company concluded there was no other-than-temporary impairment on any of its investments. The Company noted no material declines in fair value subsequent to September 27, 2009.
As of December 28, 2008 and September 27, 2009, the Company had gross unrealized gains in its securities held of $1,442 and $238, respectively.
4. Goodwill and Intangible Assets
As of December 28, 2008 and September 27, 2009, the Company’s goodwill and acquired intangible assets consisted of the following:
                         
    December 28, 2008  
    Gross     Accumulated     Net  
    Intangible     Amortization     Intangible  
Goodwill
  $ 7,998     $     $ 7,998  
Developed technology
    3,340       1,113       2,227  
Customer relationships
    1,350       563       787  
Non-compete agreements
    190       106       84  
 
                 
 
                       
Total goodwill and intangible assets
  $ 12,878     $ 1,782     $ 11,096  
 
                 

 

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    September 27, 2009  
    Gross     Accumulated     Net  
    Intangible     Amortization     Intangible  
Goodwill
  $ 7,998     $     $ 7,998  
Developed technology
    3,340       1,614       1,726  
Customer relationships
    1,350       816       534  
Non-compete agreements
    190       153       37  
 
                 
 
                       
Total goodwill and intangible assets
  $ 12,878     $ 2,583     $ 10,295  
 
                 
Amortization expense on intangible assets was $267 for the three months ended September 28, 2008 and September 27, 2009. Amortization expense on intangible assets was $801 for the nine months ended September 28, 2008 and September 27, 2009. The Company records amortization expense related to developed technology as a component of cost of product revenue in the accompanying consolidated statements of operations. Expected future amortization of intangible assets for fiscal periods indicated is as follows:
         
Fiscal year:
       
Remainder of 2009
  $ 267  
2010
    1,027  
2011
    780  
2012
    223  
 
     
 
       
 
  $ 2,297  
 
     
In accordance with ASC 360-10-35-21, When to Test a Long-Lived Asset for Recoverability (“ASC 360-10-35-21”), the Company considered whether there were any indicators of impairment for its long-lived and intangible assets as of September 27, 2009 and determined there were none.
As it did in fiscal 2008, the Company will conduct its annual goodwill impairment test in the fourth quarter of fiscal 2009 in accordance with ASC 350-10, Intangibles — Goodwill and Other (“ASC 350-10). In accordance with ASC 350-10, the Company considered whether there were any indicators of impairment as of September 27, 2009 and determined there were none.
5. Fair Value Measurements
Effective January 1, 2008, the Company adopted ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”), which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. ASC 820-10 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
   
Level 1 — Quoted prices in active markets for identical assets or liabilities.
 
   
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
 
   
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The Company’s adoption of ASC 820-10 did not have a material impact on its consolidated financial statements. As of December 28, 2008 and September 27, 2009, the Company had investments of $0 and $1,694, respectively, in certificates of deposit disclosed in Note 3 that were valued using Level 1 inputs (quoted market prices for identical assets). As of December 28, 2008 and September 27, 2009, the Company had investments disclosed in Note 3 that were valued using Level 2 inputs (significant and observable assumptions) as follows:
                 
    December 28,     September 27,  
    2008     2009  
Corporate debt securities
  $ 86,674     $ 34,713  
Government sponsored entities
    112,709       156,305  
 
           
 
               
 
  $ 199,383     $ 191,018  
 
           

 

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As of December 28, 2008, the Company had cash equivalents in corporate debt securities and government sponsored entities that were valued using Level 2 inputs (significant and observable assumptions) and had cash equivalents in money market mutual funds that were valued using Level 1 inputs (quoted market prices for identical assets) as follows:
                         
    Level 1     Level 2        
    Inputs     Inputs     Totals  
Corporate debt securities
  $     $ 3,099     $ 3,099  
Government sponsored entities
          1,500       1,500  
Money market mutual funds
    20,665             20,665  
 
                 
 
                       
 
  $ 20,665     $ 4,599     $ 25,264  
 
                 
As of September 27, 2009, the Company had $6,141 in cash equivalents in money market mutual funds that were valued using Level 1 inputs (quoted market prices for identical assets).
As of December 28, 2008, the Company had $193 of restricted investments which represented certificates of deposit that collateralize outstanding letters of credit related to certain of the Company’s facility leases. As of September 27, 2009, the Company had $403 of restricted investments which represented certificates of deposit that collateralize outstanding letters of credit related to certain of the Company’s facility leases as well as the Company’s foreign currency hedging program. The Company believes that carrying value approximates fair value based on the market rate of interest for a comparable instrument as of December 28, 2008 and September 27, 2009.
The Company recognizes all derivative financial instruments in its consolidated financial statements at fair value in accordance with ASC 815-10, Derivatives and Hedging (“ASC 815-10”). The Company determines the fair value of these instruments using the framework prescribed by ASC 815-10, by considering the estimated amount it would receive to sell or transfer these agreements at the reporting date and by taking into account current interest rates, current currency exchange rates, the creditworthiness of the counterparty for assets, and its creditworthiness for liabilities. In certain instances, the Company may utilize financial models to measure fair value. Generally, the Company uses inputs that include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; other observable inputs for the asset or liability; and inputs derived principally from, or corroborated by, observable market data by correlation or other means. The Company has classified its derivative assets and liabilities within Level 2 of the fair value hierarchy because these observable inputs are available for substantially the full term of its derivative instruments. As of September 27, 2009, the Company had $2,311 in currency exchange contracts valued using Level 2 inputs.
On December 29, 2008, the Company adopted ASC 820-10 for all nonfinancial assets and nonfinancial liabilities not recognized or disclosed at fair value in the financial statements on a recurring basis. The adoption of ASC 820-10 for those assets and liabilities did not have a material impact on the Company’s financial position, results of operations or liquidity. The Company did not have any nonfinancial assets or nonfinancial liabilities that would be recognized or disclosed at fair value on a recurring basis as of September 27, 2009.
6. Derivative Instruments and Hedging Activities
The Company operates internationally and, in the normal course of business, is exposed to fluctuations in foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating the business. During fiscal 2009, the Company began entering into derivative instruments for risk management purposes only. The Company does not enter into derivative instruments for speculative purposes. The Company’s current derivative program does not qualify for hedge accounting treatment under ASC 815-10.
Beginning in fiscal 2009, the Company has used forward foreign currency exchange contracts to hedge its exposure to forecasted foreign currency denominated transactions based in the United Kingdom. These forward contracts are not designated as cash flow, fair value or net investment hedges under ASC 815-10; are marked-to-market with changes in fair value recorded to earnings; and are entered into for periods consistent with currency transaction exposures, generally less than one year. These derivative instruments do not subject its earnings or cash flows to material risk since gains and losses on these derivatives generally offset losses and gains on the expenses and transactions being hedged. However, changes in currency exchange rates related to any unhedged transactions may impact the Company’s earnings and cash flows.
The success of the Company’s hedging program depends, in part, on forecasts of transaction activity in various currencies (primarily British pound sterling and Indian rupee). The Company may experience unanticipated currency exchange gains or losses to the extent that there are differences between forecasted and actual activity during periods of currency volatility.

 

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The following table summarizes the outstanding forward foreign exchange contracts held by the Company at September 27, 2009.
                         
            September 27, 2009  
            Local     Approximate  
            Currency     U.S. Dollar  
    Hedge Type     Amount     Equivalent  
British pound
  Sale     475       757  
British pound
  Sale     475       757  
British pound
  Sale     500       797  
 
                 
 
                       
 
            1,450     $ 2,311  
 
                 
As of September 27, 2009, the Company’s forward foreign exchange contracts are classified as short-term with maturities between one and three months.
Realized and unrealized foreign currency gains (losses), net of hedging are accounted for in other income (expense). The Company had no forward foreign exchange contracts outstanding during the three or nine months ended September 28, 2008. During the three months ended September 27, 2009, the Company recorded a foreign exchange loss of $94 in interest and other income, net. During the nine months ended September 27, 2009, the Company recorded a foreign exchange gain of $721 in interest and other income, net. As of September 27, 2009, $204 of the then fair value of the Company’s outstanding forward foreign exchange contracts was included in prepaid expenses and other current assets, representing the unrealized gains on those contracts in the accompanying condensed consolidated balance sheet. The Company settles forward foreign exchange contracts in cash.
The Company does not have significant concentrations of credit risk arising from its derivative financial instruments, whether from an individual counterparty or group of counterparties. The Company reduces its concentration of counterparty credit risk on its derivative instruments by limiting acceptable counterparties to major financial institutions with investment grade credit ratings, and by actively monitoring credit ratings and outstanding positions on an ongoing basis. Furthermore, none of the Company’s derivative transactions are subject to collateral or other security arrangements or contain provisions that are dependent on its credit ratings from any credit rating agency.
7. Income Taxes
The Company recorded an income tax benefit of $9,019 for the three months ended September 27, 2009, inclusive of discrete items. This tax benefit relates principally to losses incurred from operations in the United States expected to be recovered from both income generated in the United States during the remainder of 2009 and the carryback of any excess loss to offset taxable profits reported in prior years. The Company recorded an income tax benefit of $25,655 for the nine months ended September 27, 2009, inclusive of discrete items. This tax benefit relates principally to losses incurred from operations in the United States expected to be recovered from both income generated in the United States during the remainder of 2009 and the carryback of any excess loss to offset taxable profits reported in prior years and the impact of the reduction of a valuation allowance against the Company’s U.K. net operating loss carryforwards as a result of profit realized on the sale of intellectual property and goodwill to the U.S. parent. The Company has eliminated the impact of this inter-company sale in the financial statements in accordance with the provisions of ASC 810-10, Consolidation . The effect of discrete items for the three months ended September 27, 2009 was a net tax expense of $250 resulting from a reduction of tax credits and interest recorded for unrecognized tax benefits partially offset by benefits from the exercise of stock options. The effect of discrete items for the nine months ended September 27, 2009 was a net tax benefit of $3,015 consisting of the benefit associated with the release of the valuation allowance on U.K. net operating losses as a result of the sale of intellectual property and goodwill noted above partially offset by net discrete tax expense from interest recorded for unrecognized tax benefits, a reduction of tax credits and the exercise of stock options.
The Company recorded an income tax benefit of $5,404 for the three months ended September 28, 2008, inclusive of discrete items. This tax benefit relates principally to losses incurred from operations in the United States, partially offset by losses from foreign operations for which no tax benefit can be recognized. The Company recorded income tax expense of $2,354 for the nine months ended September 28, 2008, inclusive of discrete items. This expense relates to profits from United States operations for this period and the effect of losses from foreign operations for which no tax benefit can be recognized. The effect of discrete items for the three and nine months ended September 28, 2008 was a tax benefit of $238 and $172 respectively. The discrete items result from tax benefits from stock options, interest expense recorded for unrecognized tax benefits and realization of additional tax credits.

 

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The Company reviews all available evidence to evaluate the recovery of deferred tax assets, including the recent history of accumulated losses in all tax jurisdictions over the last three years as well as its ability to generate income in future periods. At September 27, 2009, the Company had $24,597 in gross deferred tax assets against which $7,002 in valuation allowances have been recorded related to state tax credits for which it is more likely than not that these assets will not be realized given the nature of the assets and the likelihood of future realization.
At September 27, 2009, the Company had $5,685 of unrecognized tax benefits, the benefit of which, if recognized, would reduce the Company’s effective tax rate. The Company does not anticipate a material change to the amount of its unrecognized tax benefits over the next twelve months.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. At September 27, 2009, the Company had $340 of interest accrued on its unrecognized tax benefits.
The Company files income tax returns in the U.S. federal tax jurisdiction, various state jurisdictions and various foreign jurisdictions. The statute of limitations for federal and state tax authorities is closed for years prior to the year ended January 1, 2006 although carryforward attributes that were generated prior to 2004 may still be subject to examination if they either have been or will be utilized to offset taxable income in tax years 2004 and forward. During fiscal 2008, The Commonwealth of Massachusetts completed an audit of the Company’s Massachusetts excise tax returns for the tax years ended January 2, 2005, January 1, 2006 and December 31, 2006. There was no change made to the Company’s tax liability, however, certain tax benefit carryovers were adjusted.
During the first quarter of 2009, the Internal Revenue Service (“IRS”) began an examination of the Company’s U.S. federal income tax returns for the tax years ended December 31, 2006 and December 30, 2007. No adjustments have been proposed to date by the IRS.
The statute of limitations in the United Kingdom is closed for tax years prior to December 31, 2003. The statute of limitations in India is closed for years prior to 2005.
The Emergency Economic Stabilization Act of 2008 was enacted into law on October 3, 2008. A provision of this law extended the federal research and experimental credit for expenses incurred from January 1, 2008 through December 31, 2009. The Company recognized a benefit of approximately $560 and $1,321 from the federal research credit for the three and nine months ended September 27, 2009 respectively, compared with no benefit for the three and nine months ended September 28, 2008.
The Company’s subsidiary in India has operated under a tax holiday granted to certain software companies that resulted in tax savings of $1,469 through September 27, 2009. The tax holiday is scheduled to expire in March 2011.
8. Commitments and Contingencies
The Company conducts its operations in leased facilities, and rent expense charged to operations for the three months ended September 28, 2008 and September 27, 2009 was $388 and $385, respectively. Rent expense charged to operations for the nine months ended September 28, 2008 and September 27, 2009 was $1,095 and $1,190, respectively.
In connection with a lease incentive arrangement entered into as part of the Company’s headquarters lease, the Company recorded a lease incentive obligation and is amortizing that obligation as a reduction to rent expense over the term of the lease. As of December 28, 2008 and September 27, 2009, the unamortized amount was $1,696 and $1,305, respectively. During the three months ended September 28, 2008 and September 27, 2009, the Company amortized the lease incentive obligation by approximately $130 and $131, respectively. During the nine months ended September 28, 2008 and September 27, 2009, the Company amortized the lease incentive obligation by approximately $391 and $391, respectively. The remaining lease incentive amounts are classified either as components of accrued expenses and other current liabilities or other liabilities based on the future timing of amortization against rent expense.
In addition, certain of the Company’s facilities operating leases contain escalating rent payments and as a result, the Company has straight-lined the rent expense associated with these leases in accordance with ASC 840-10, Leases.
Future minimum commitments as of September 27, 2009, under all of the Company’s leases, are as follows:
         
Fiscal year:
       
Remainder of 2009
  $ 400  
2010
    1,587  
2011
    1,491  
2012
    492  
2013
    10  
 
     
 
       
 
  $ 3,980  
 
     

 

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The Company has contractual commitments that require the Company to purchase certain minimum quantities of products as of September 27, 2009.
Future minimum commitments as of September 27, 2009 are as follows:
         
Fiscal year:
       
Remainder of 2009
  $ 2,618  
2010
    897  
2011
    213  
 
     
 
       
 
  $ 3,728  
 
     
Indemnification
The Company includes indemnification provisions in software license agreements with its OEM customers. These indemnification provisions include provisions indemnifying the customer against losses, expenses, and liabilities from damages that could be awarded against the customer in the event that the Company’s software is found to infringe upon a patent or copyright of a third party. The scope of remedies available under these indemnification obligations is limited by the OEM agreements. The Company believes that its internal business practices and policies and the ownership of information limits the Company’s risk in paying out any claims under these indemnification provisions. To date, the Company has not been subject to any litigation and has not had to reimburse any customers for any losses associated with these indemnification provisions.
9. Stock Plans
Stock Options
As there was no public market for the Company’s common stock prior to July 19, 2007, the date of the Company’s IPO, the Company determined the volatility percentage used in calculating the fair value of stock options it granted based on an analysis of the historical stock price data for a peer group of companies that issued options with substantially similar terms. The expected volatility percentage used in determining the fair value of stock options granted in the nine months ended September 28, 2008 was 58% and in the nine months ended September 27, 2009 was 51%. The expected life of options has been determined utilizing the “simplified” method as prescribed by the SEC’s Staff Accounting Bulletin No. 107. The expected life of options granted during the nine months ended September 28, 2008 and September 27, 2009 was 6.25 years. For the nine months ended September 28, 2008 and September 27, 2009, the weighted-average risk free interest rate used was 3.22% and 2.41%, respectively. The risk-free interest rate is based on a weighted average of a 7-year treasury instrument whose term is consistent with the expected life of the stock options. Although the Company paid a one-time special cash dividend in April 2007, the expected dividend yield is assumed to be zero as the Company does not currently anticipate paying cash dividends on its shares of common stock in the future. ASC 718-10, Stock Compensation, requires companies to utilize an estimated forfeiture rate when calculating the expense for the period, whereas previous guidance permitted companies to record forfeitures based on actual forfeitures, which was the Company’s historical policy under such previous guidance. As a result, the Company applied an estimated forfeiture rate between 4% and 5% for the nine months ended September 28, 2008 and 6% for the nine months ended September 27, 2009 in determining the expense recorded in its consolidated statement of operations. These rates were derived by review of the Company’s historical forfeitures since 2000.

 

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Stock option activity under the 2007 Plan for the nine months ended September 27, 2009 is summarized as follows:
                                                 
                            Weighted                
                    Weighted     Average                
                    Average     Remaining             Weighted  
            Range of     Exercise     Contractual     Aggregate     Average  
    Number of     Exercise     Price     Term in     Intrinsic     Fair Value  
    Shares     Prices     per Share     Years     Value     per Share  
Outstanding at December 28, 2008
    12,729,531     $ 0.001–7.89     $ 2.94       6.68     $ 37,866          
 
                                     
 
                                               
Granted
    2,963,822     $ 5.22–5.99     $ 5.46                     $ 5.46  
 
                                             
 
                                               
Exercised
    (1,293,863 )     0.11–6.44       1.57             $ 5,454          
 
                                             
 
                                               
Cancelled
    (408,051 )   $ 1.51–7.44       5.36                          
 
                                         
 
                                               
Outstanding at September 27, 2009
    13,991,439     $ 0.001–7.89     $ 3.53       6.79     $ 46,314          
 
                                     
 
                                               
Exercisable at September 27, 2009
    7,609,158     $ 0.001–7.89     $ 2.30       5.37     $ 34,496          
 
                                     
 
                                               
Options vested or expected to vest at September 27, 2009 (1)
    13,572,675     $ 0.001–7.89     $ 3.47       6.72     $ 45,692          
 
                                     
 
                                               
Available for grant at September 27, 2009
    14,358,782                                          
 
                                             
 
     
1.  
This represents the number of vested stock options as of September 27, 2009 plus the unvested outstanding options at September 27, 2009 expected to vest in the future, adjusted for estimated forfeitures.
For the three months ended September 28, 2008 and September 27, 2009, the Company recorded expense of $1,278 and $1,687, respectively, in connection with share-based awards and related tax benefit of approximately $193 and $333 for the three months ended September 28, 2008 and September 27, 2009, respectively. For the nine months ended September 28, 2008 and September 27, 2009, the Company recorded expense of $3,542 and $4,500, respectively, in connection with share-based awards and related tax benefit of approximately $504 and $873 for the nine months ended September 28, 2008 and September 27, 2009, respectively. As of September 27, 2009, future expense for non-vested stock options of $17,004 was expected to be recognized over a weighted-average period of 2.68 years.
The following table summarizes stock-based compensation expense related to employee and director stock options, employee stock purchases, and restricted stock grants for the three and nine months ended September 28, 2008 and September 27, 2009, which were allocated as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 28,     September 27,     September 28,     September 27,  
    2008     2009     2008     2009  
Cost of service revenue
  $ 70     $ 104     $ 181     $ 292  
Research and development
    757       984       2,112       2,620  
Selling and marketing
    266       342       763       875  
General and administrative
    185       257       486       713  
 
                       
 
                               
Total stock-based compensation
  $ 1,278     $ 1,687     $ 3,542     $ 4,500  
 
                       
Common Stock Repurchase Plans
In July 2008, the Company’s board of directors authorized the repurchase of up to $20,000 of the Company’s common stock over the following 12 months. This initial stock repurchase program was scheduled to terminate on July 29, 2009 or earlier if the Company had so elected. The purchases of common stock were executed periodically on the open market, as market conditions warranted, under a Rule 10b5-1 plan, which the Company entered into in August 2008 and which permitted shares to be repurchased when the Company might otherwise have been precluded from doing so under insider trading laws. The Company completed its initial stock repurchase program in April 2009.
In February 2009, the Company’s board of directors authorized a second stock repurchase program authorizing the Company to purchase up to an additional $20,000 of the Company’s common stock following the completion of the initial stock repurchase program.

 

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The following table summarizes the Company’s repurchases under the initial stock repurchase program for the nine months ended September 27, 2009.
                                 
                            Approximate  
                            Dollar Value  
                    Total     of  
                    Number of     Shares That  
                    Shares     May  
                    Purchased     Yet Be  
    Total     Average     as Part of     Purchased  
    Number     Price     Publicly     Under the  
    of Shares     Paid per     Announced     Announced  
Period   Purchased     Share     Program     Program  
Through December 28, 2008
                          $ 6,673  
December 29, 2008 — January 25, 2009
    318,400     $ 5.43       318,400     $ 4,944  
January 26, 2009 — February 22, 2009
    329,400     $ 5.34       329,400     $ 3,185  
February 23, 2009 — March 29, 2009
    299,730     $ 5.65       299,730     $ 1,492  
March 30, 2009 — April 26, 2009
    206,918     $ 5.80       206,918     $ 292  
April 27, 2009 — May 24, 2009
    51,061     $ 5.69       51,061     $  
 
                       
 
                               
Total
    1,205,509     $ 5.54       1,205,509     $  
 
                       
The following table summarizes the Company’s repurchases under the second stock repurchase program for the nine months ended September 27, 2009.
                                 
                            Approximate  
                            Dollar Value  
                    Total     of  
                    Number of     Shares That  
                    Shares     May  
                    Purchased     Yet Be  
    Total     Average     as Part of     Purchased  
    Number     Price     Publicly     Under the  
    of Shares     Paid per     Announced     Announced  
Period   Purchased     Share     Program     Program  
 
                          $ 20,000  
December 29, 2008 — January 25, 2009
        $           $ 20,000  
January 26, 2009 — February 22, 2009
        $           $ 20,000  
February 23, 2009 — March 29, 2009
        $           $ 20,000  
March 30, 2009 — April 26, 2009
        $           $ 20,000  
April 27, 2009 — May 24, 2009
    188,482     $ 5.33       188,482     $ 18,995  
May 25, 2009 — June 28, 2009
    215,266     $ 5.77       215,266     $ 17,753  
June 29, 2009 — July 26, 2009
        $           $ 17,753  
July 27, 2009 — August 23, 2009
    61,276     $ 6.03       61,276     $ 17,384  
August 24, 2009 — September 27, 2009
        $           $ 17,384  
 
                       
 
                               
Total
    465,024     $ 5.63       465,024     $ 17,384  
 
                       
10. Deferred Revenue and Deferred Product and Service Costs
Under the Company’s revenue recognition policy, as described above in Note 2 “Summary of Significant Accounting Policies,” the Company recognizes revenue from sales to an OEM customer only when it delivers a specified upgrade to which it has previously committed. When the Company commits to an additional upgrade before it has delivered a previously committed upgrade, it defers all revenue from product sales after the date of such commitment until it delivers the additional upgrade.

 

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The Company committed to a specified future software upgrade in April 2005, which the Company refers to as its April 2005 specified upgrade. The Company delivered the April 2005 specified upgrade in April 2007. The Company committed to a subsequent specified upgrade in September 2006, which the Company refers to as its September 2006 specified upgrade. The Company delivered the September 2006 specified upgrade in November 2007. The Company committed to a specified upgrade in June 2007, which the Company refers as its June 2007 specified upgrade. The Company delivered the June 2007 specified upgrade in June 2008. The Company committed to an additional subsequent specified upgrade in December 2007, which the Company refers to as its December 2007 specified upgrade. The Company delivered the December 2007 specified upgrade in the fourth quarter of fiscal 2008. The Company has outstanding commitments for additional specified upgrades committed to in July 2008, October 2008 and May 2009, which the Company refers to as its July 2008 specified upgrade, its October 2008 specified upgrade and its May 2009 specified upgrade, respectively. The Company expects to deliver the July 2008 specified upgrade in fiscal 2009 and the October 2008 and May 2009 specified upgrades in the first half of fiscal 2010.
At December 28, 2008 and September 27, 2009, other deferred revenue primarily related to sales and development services for the Company’s new fixed-mobile convergence related products.
Deferred revenue and deferred product and service costs at December 28, 2008 consisted of the following:
                         
    Current     Long-Term     Total  
Deferred revenue related to December 2007 specified upgrade
  $ 7,397     $     $ 7,397  
Deferred revenue related to July 2008 specified upgrade
    37,775             37,775  
Deferred revenue related to October 2008 specified upgrade
    13,663             13,663  
Other deferred revenue
    2,475       5,550       8,025  
 
                 
 
                       
Total deferred revenue
  $ 61,310     $ 5,550     $ 66,860  
 
                 
 
                       
Deferred product cost related to December 2007 specified upgrade
  $ 79     $     $ 79  
Deferred product cost related to July 2008 specified upgrade
    742             742  
Deferred product cost related to October 2008 specified upgrade
    566             566  
Other deferred product and service costs
    526       1,300       1,826  
 
                 
 
                       
Total deferred product and service costs
  $ 1,913     $ 1,300     $ 3,213  
 
                 
Deferred revenue and deferred product and service costs at September 27, 2009 consisted of the following:
                         
    Current     Long-Term     Total  
Deferred revenue related to July 2008 specified upgrade
  $ 37,775     $     $ 37,775  
Deferred revenue related to October 2008 specified upgrade
    47,359             47,359  
Deferred revenue related to May 2009 specified upgrade
    37,987             37,987  
Other deferred revenue
    1,139       14,447       15,586  
 
                 
 
                       
Total deferred revenue
  $ 124,260     $ 14,447     $ 138,707  
 
                 
 
                       
Deferred product cost related to July 2008 specified upgrade
  $ 742     $     $ 742  
Deferred product cost related to October 2008 specified upgrade
    1,248             1,248  
Deferred product cost related to May 2009 specified upgrade
    720             720  
Other deferred product and service costs
    307       4,865       5,172  
 
                 
 
                       
Total deferred product and service costs
  $ 3,017     $ 4,865     $ 7,882  
 
                 
11. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
                 
    December 28,     September 27,  
    2008     2009  
Payroll and payroll-related accruals
  $ 9,497     $ 6,872  
Accrued rent expense
    603       595  
Accrued legal fees
    161       464  
Accrued audit and tax
    722       401  
Accrued royalties
    1,644       1,811  
Other accruals
    1,738       1,931  
 
           
 
               
 
  $ 14,365     $ 12,074  
 
           

 

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12.  
Related Party Transactions
The Company has an agreement with Qualcomm Incorporated (“Qualcomm”) under which it licenses software for use in the development of infrastructure equipment. The Company also has a supply and distribution agreement with Qualcomm relating to the Company’s “ipBTS” products. The Company paid Qualcomm approximately $161 during the three months ended September 28, 2008 and $538 during the three months ended September 27, 2009 in upfront license payments, royalties and component purchases under its license and supply agreements with Qualcomm. The Company paid Qualcomm approximately $1,086 during the nine months ended September 28, 2008 and $1,390 during the nine months ended September 27, 2009 in upfront license payments, royalties and component purchases under its license and supply agreements with Qualcomm. During each of the three months ended September 28, 2008 and September 27, 2009, Qualcomm paid the Company $2,000 for development services. During the nine months ended September 28, 2008 and September 27, 2009, Qualcomm paid the Company $2,406 and $3,030, respectively, for prototype purchases and development services. Amounts due to Qualcomm of $909 and $1,070 were included in accrued expenses and other current liabilities as of December 28, 2008 and September 27, 2009, respectively.
In January 2009, the Company formalized a development agreement with Qualcomm to develop and commercialize certain EV-DO software products. The fees paid by Qualcomm under this agreement are potentially subject to refund as royalties on future sales of this developed product, if and when development and commercialization occur. During fiscal 2008 and the first three quarters of fiscal 2009, total development fees under this arrangement were $6,500 and were classified as long-term deferred revenue as of September 27, 2009. The Company received a letter from Qualcomm dated September 24, 2009 which gave the Company a 30 day written notice of Qualcomm’s intent to terminate the development agreement. The Company intends to renegotiate its contract with Qualcomm. Should the termination become effective in the fourth quarter of fiscal 2009, the Company would recognize $6,500 of revenue.
As of December 28, 2008, Qualcomm owned 9% of the Company’s outstanding common stock. As of September 27, 2009, Qualcomm owned approximately 6% of the Company’s outstanding common stock.
Some of the technology that the Company incorporates into its EV-DO products and sells to Nortel Networks is licensed from Qualcomm. In the fourth quarter of fiscal 2008 and the first quarter of fiscal 2009, Qualcomm undertook an audit of the royalties that were paid in respect of the EV-DO products that the Company sold between 2003 and 2007. Qualcomm determined that the Company does not owe any additional royalties beyond the amounts accrued.
13. Nortel Networks Bankruptcy
On January 14, 2009, Nortel Networks Corporation announced that it, Nortel Networks Limited, and certain of its other Canadian subsidiaries filed for creditor protection under the Companies’ Creditors Arrangement Act in Canada. Also on January 14, 2009, some of Nortel Networks Corporation’s U.S. subsidiaries, including Nortel Networks Inc., filed Chapter 11 voluntary petitions in the State of Delaware (the “bankruptcy filing”).
In connection with the announcement, Nortel Networks informed the Company that it will continue to purchase goods and services from the Company and that the Company is a long term partner and a key supplier to Nortel Networks. Purchases subsequent to the bankruptcy filing have been under the terms of Nortel Networks current agreement with the Company and the Company has been collecting receivables from Nortel Networks in the ordinary course related to products and services purchased since Nortel Networks’ bankruptcy filing.
Substantially all of the Company’s current billings and revenue are derived from Nortel Networks. Pre-bankruptcy filing outstanding invoices to Nortel Networks as of December 28, 2008 and September 27, 2009 totaled $21,818 and $36,442, respectively. Collection of these invoices will be subject to Nortel Networks’ bankruptcy proceedings, and the Company is not able to estimate how much, if any, of these invoices will be collected. As such, the Company has elected to treat these invoices on a cash basis. Invoices outstanding as of the bankruptcy filing date are not reflected in the Company’s Balance Sheets as of December 28, 2008 and September 27, 2009.
The Company has been working with Nortel Networks to have its agreement assumed, as it has been told by Nortel that it is a long term partner and key supplier to Nortel. If Nortel Networks’ agreement with the Company is assumed, Nortel Networks would be required to become current in all of its outstanding obligations to the Company, including obligations outstanding prior to the filing. If the agreement is not assumed, all outstanding obligations will be subject to discharge and the Company likely would not be able to collect these receivables in full, if at all. Transactions after the filing are subject to normal terms as stated in the contract and obligations are required to be paid in due course.
On January 22, 2009, the United States Trustee appointed the Company to the Official Committee of Unsecured Creditors in the Nortel Networks bankruptcy cases. There are four other members of such Committee. The Committee has been and will represent the interests of all unsecured creditors and attempt to maximize recovery for all unsecured creditors in its negotiations with the debtor and other parties in the case.
On June 19, 2009, Nortel Networks Corporation announced the proposed “stalking horse” asset sale of Nortel Networks’ CDMA business to Nokia Siemens Networks B.V. (“Nokia”), a global wireless network infrastructure provider. Two additional entities were qualified by Nortel Networks Corporation to bid with Nokia in an auction to purchase the CDMA business. The auction was held on July 24, 2009. On July 28, 2009, the United States and Canadian bankruptcy courts approved a bid for Nortel Networks’ CDMA business by Ericsson, another global wireless network infrastructure provider, subject to satisfaction of regulatory and other conditions, which the Company now expects to be completed in November 2009.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such forward-looking statements include any expectation of earnings, revenues, billings or other financial items; development of femtocell alliances and shipments; statements related to our relationship with Nortel Networks, Inc., or Nortel Networks, the effect of Nortel Networks’ bankruptcy or the anticipated sale of Nortel Networks’ CDMA business to Ericsson; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements concerning new products or services; statements related to future capital expenditures; statements related to future economic conditions or performance; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “target,” “continue,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this Quarterly Report on Form 10-Q and in our other filings with the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
We are a leading provider of network infrastructure products used by wireless operators to provide mobile broadband services. We specialize in helping operators transform the mobile experience of users worldwide. Our high performance technology and products, from emerging comprehensive femtocell solutions to core mobile network infrastructure, enable operators to deliver broadband services to mobile subscribers, wherever they are.
Most of our current products are based on a wireless communications standard known as CDMA2000 1xEV-DO, or EV-DO. In 2002, we began delivering commercial infrastructure products based on the first generation EV-DO standard known as Rev 0. The second generation EV-DO standard is known as Rev A and supports push-to-talk, Voice-over-IP, or VoIP, and faster Internet services. We delivered our first Rev A software release in April 2007. Prior to 2008, most of our EV-DO sales were driven by operator deployments focused on coverage — with operators extending their broadband services across larger portions of their subscriber geographies. Data traffic and service revenue growth continues to outpace voice growth at many major wireless operators around the world. Our EV-DO sales in 2008 and the first three quarters of 2009 were driven by capacity growth as operators looked to expand their capacity to accommodate increased data traffic fueled by greater consumer use of handheld devices, web browsing and 3G multimedia applications, although operators in some markets continue to deploy our products to expand coverage. Over the longer term, we expect our EV-DO sales to continue to be driven by capacity growth as operators acquire more broadband subscribers that consume more broadband data.
We have developed a special business model to serve mobile operators and our original equipment manufacturer, or OEM customers with embedded software products. Our software is deployed in an OEM’s installed base of wireless networks. These networks are designed to deliver high quality wireless services to millions of consumers and are built and regularly upgraded over long periods of time, often 10 to 15 years. A key element of our strategy is to deliver significant increases in performance and functionality to both our OEM customers and to operators through software upgrades to these networks. In 2007, we delivered two major EV-DO software releases that provide for deployment of high-performance multi-media applications by enabling faster downlink and uplink speeds, supporting push-to-talk services, and adding new proprietary “clustering” features that are designed to dramatically improve network scalability. In 2008 we delivered two additional EV-DO software releases which enable mobile operators to more efficiently increase capacity and accelerate the roll-out of next-generation multimedia services.

 

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We are also investing significantly in fixed mobile convergence, or FMC, products that transform the experience of using mobile devices indoors, providing benefits such as better coverage, better quality and performance of broadband applications, and lower costs for both users and operators. Our FMC products enable operators to take advantage of wireline broadband connections such as cable, DSL and fiber that already exist in most offices and homes to connect mobile devices to an operator’s services. There are two ways to accomplish this. The first is to use Wi-Fi and the second is to place a personal base station, or what the industry refers to as a femtocell access point, in the home or office. To address both of these market opportunities, we have developed our universal access gateway, or UAG, product to manage security and hand-offs when connecting a Wi-Fi phone or a femtocell product to an operator’s network. Currently, there is significant operator interest in our FMC products, especially our femtocells, as they work with existing handsets. Our FMC products include versions to support CDMA and UMTS networks. Our FMC products are an important component of our growth and diversification strategy. Users also utilize our mobile broadband technology and products to create private mobile networks.
We were founded in March 2000 and sold our first product in the second quarter of fiscal 2002. Our growth has been driven primarily by sales through our OEM customers to wireless operators already using our EV-DO products as they increase the capacity and geographic coverage of their networks, and by an increase in the number of wireless operators that decide to deploy our EV-DO products on their networks. We have sold over 60,000 channel card licenses for use by over 70 operators worldwide.
In April 2007, we acquired 3Way Networks, a United Kingdom-based provider of femtocell products and solutions for UMTS networks, for an aggregate purchase price of approximately $11.0 million in cash and 441,845 shares of common stock. The acquisition furthered our strategy to address the UMTS market and to deliver FMC and in-building mobile broadband solutions.
In July 2007, we completed our IPO, in which we sold and issued 8.3 million shares of our common stock at an issue price of $7.00 per share. We raised a total of $58.1 million in gross proceeds from our IPO, or $50.8 million in net proceeds after deducting underwriting discounts and commissions of $4.1 million and other offering costs of approximately $3.2 million.
In August 2007, we entered into an agreement with Nokia Siemens Networks to certify interoperability of our UMTS femtocell product with Nokia Siemens Networks’ femtocell gateway product. We and Nokia Siemens Networks plan to provide a joint solution to operators, and cooperate in joint marketing, sales and support programs. The agreement is non-exclusive and sets forth the terms under which we may use their proprietary interface specifications of their products.
In September 2007, we entered into an agreement with Nortel Networks, amending certain provisions of the Development and Purchase and Sale Agreement for CDMA High Data Rate (1xEV-DO) Products, dated as of October 1, 2001, between us and Nortel Networks, in which we agreed to pricing for our products and services, including pricing for software products and upgrades that were under development at the time and were subsequently delivered in June 2008.
In January 2008, we entered into a global sourcing agreement with Thomson to supply our UMTS femtocell technology. Pursuant to the agreement, Thomson may use our femtocell products in conjunction with its own residential gateway offerings. The agreement is non-exclusive and sets forth the terms and conditions under which Thomson may purchase our femtocell products. The term of the agreement extends through January 2011, with automatic annual renewals. Either party may terminate the agreement with 90 days notice.
In February 2008, we entered into a global OEM agreement with Motorola to provide our CDMA femtocell solution products. The agreement is non-exclusive and sets forth the terms and conditions under which Motorola may purchase our femtocell and UAG products. The initial term of the agreement extends through May 2010, with automatic annual renewals. Following the initial term, Motorola may terminate the agreement with 180 days notice.
In June 2008, we entered into an agreement with Alcatel-Lucent to develop an integrated IP Multimedia Subsystem, or IMS, femtocell solution for CDMA network operators that combines Airvana’s femtocell access point and femtocell network gateway with Alcatel-Lucent’s IMS core network infrastructure. The development agreement was terminated by Alcatel-Lucent in the second quarter of fiscal 2009.
In July 2008, we entered into an agreement with Hitachi to develop a joint CDMA femtocell solution that integrates our femtocell products with Hitachi’s core radio access network infrastructure that Hitachi offers in Japan.
In September 2008, we entered into a supply agreement with Hitachi under which Hitachi will provide marketing, sales and support activities for our femtocell products. The initial term of the supply agreement extends through June 2014 and provides for automatic annual renewals, unless either party gives 180 days notice of its intent not to renew.
In November 2008, we entered into another agreement with Nortel Networks amending certain provisions of the Development and Purchase and Sale Agreement for CDMA High Data Rate (1xEV-DO) Products, dated as of October 1, 2001, between us and Nortel Networks, in which we agreed to pricing for software products and upgrades that were under development at the time.
In December 2008, we entered into a sourcing agreement with Pirelli Broadband Solutions to add wireless broadband connectivity to Pirelli’s portfolio of consumer broadband devices by using our UMTS femtocell technology. The agreement is non-exclusive and sets forth the terms and conditions under which Pirelli may purchase our femtocell products. The initial term of the agreement extends through November 2010, with automatic annual renewals, unless either party gives 90 days notice of its intent not to renew.

 

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In June 2009, we entered into a global reseller agreement with a multinational infrastructure provider to supply and support our femtocell service manager and UAG products. The agreement is non-exclusive and sets forth the terms and conditions under which the customer may purchase our FMC products. The initial term of the agreement extends through May 2012.
In June 2009, we entered into an agreement with a multinational infrastructure provider for the licensing and support of our femtocell service manager. The agreement is non-exclusive and sets forth the terms and conditions under which the customer may purchase our product. The initial term of the agreement extends through June 2014, with automatic annual renewals, unless either party gives 90 days notice of its intent not to renew.
In June 2009, we entered into a master purchase agreement with Sprint/United Management Company, or (Sprint) to supply and support femtocell products. Under the agreement, we will provide our HubBub CDMA femtocell for Sprint’s commercial 3G femtocell service offerings. The agreement is non-exclusive and sets forth the terms and conditions under which Sprint may purchase our femtocell product and services. The term of the agreement extends through December 2014.
In September 2009, we entered into a supply and licensing agreement with a multinational infrastructure provider to to supply our UMTS and CDMA 2000 Femtocell technology for integration into its products such as stand alone femtocell access points or residential gateways, and resale of such products to its customers. The agreement is non-exclusive and sets forth the terms and conditions under which it may purchase our femtocell products and services. The term of the agreement extends through September 2012.
Our Development and Purchase Agreement for CDMA High Data Rate (1xEV-DO) Products with Nortel Networks is subject to rejection and discharge in Nortel Networks’ bankruptcy. United States and Canadian bankruptcy courts recently approved a bid by Telefon AB L.M. Ericsson, or Ericsson, to purchase Nortel Networks’ CDMA business. We intend to work to have our agreement with Nortel Networks assumed by Ericsson, but we may not be successful in having our agreement assumed without concession, or at all.
Our OEM Business Model
We operate in the highly consolidated and competitive market for mobile broadband equipment. To compete in this market, we have developed OEM channels, unique products and a business approach that targets the needs of large equipment vendors and their end customers, wireless operators. Wireless operators invest significantly in building out large-scale wireless networks, which are very costly to replace. Equipment vendors compete aggressively to win market share and they retain their market position by upgrading their installed systems regularly, thereby enabling their wireless operator customers to deliver new services to their subscribers. These vendors develop detailed product roadmaps and look to us to design and deliver software upgrades that are consistent with their roadmaps.
We collaborate with our OEM customers to develop specific features for products that they sell to their wireless operator customers. We expect to continue to develop, for each OEM customer, products based on our core technology that are configured specifically to meet the requirements of each OEM and its customers. We also offer our OEM customers the option to purchase and make available to their wireless operator customers new products and specified upgrades at prices that we set typically several months prior to the new product or specified upgrade release. We expect that we will release one or more specified upgrades per year.
Our OEM customers typically are also potential competitors of ours in the markets that they serve. We face the competitive risk that our OEM customers might develop internally alternative solutions or purchase alternative products from our competitors. Our future success depends on our ability to continue to develop products that offer advantages over alternative solutions that our OEM customers might develop or purchase from others.
Our typical sales arrangements involve multiple elements, including: perpetual licenses for our software products and specified software upgrades; the sale of hardware, maintenance and support services; and the sale of professional services, including training. Software is more than incidental to all of our products and, as a result, we recognize revenue in accordance with Accounting Standards Codification, or ASC 985-605, Software Revenue Recognition, or ASC 985-065.
Impact of ASC 985-605, Software Revenue Recognition
To recognize revenue from current product shipments, we must establish vendor specific objective evidence, or VSOE, of fair value for all undelivered elements of our sales arrangements, including our specified software upgrades. The best objective evidence of fair value would be to sell these specified software upgrades separately to multiple customers for the same price. However, because of our OEM business model, the features and functionality delivered in our software upgrades are defined in collaboration with our OEMs based on each OEM’s particular requirements. As a result, it is highly unlikely that we will ever be able to sell the same standalone software upgrade to a different OEM customer and thus establish VSOE of fair value for such upgrade.

 

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As a result, we defer all revenue from sales to OEMs until all elements without VSOE of fair value have been delivered. This deferral is required because there is no basis to allocate revenue between the delivered and undelivered elements of the arrangement without VSOE of fair value. The revenue deferral is necessary even though (1) our specified software upgrades are not essential to the standalone functionality of any product currently deployed, (2) the purchase of our upgrades are based on separate decisions by our OEM customers and generally require separate payment at the time of delivery and (3) there is no refund liability for payments received on any previously shipped and installed product in the event we are not able to deliver the specified upgrade.
We recognize deferred revenue from sales to an OEM customer only when we deliver a specified upgrade that we have previously committed. When we commit to an additional upgrade before we have delivered a previously committed upgrade, we defer all revenue from product sales after the date of such commitment until we deliver the additional upgrade. Any revenue that we had deferred prior to the additional commitment is recognized when the previously committed upgrade is delivered.
We anticipate that the revenue recognition related to the our fixed-mobile convergence products will be complex given that a number of our current arrangements for the development and supply of these products contain significant customization services, volume discounts, specified upgrades and multiple elements for new service offerings for which VSOE of fair value does not currently exist. To date, there have been no material revenues recognized with respect to these products.
The following diagram presents a hypothetical example of how software product releases and commitments to specified upgrades affect the relationship between product billings, product revenue and deferred product revenue under a business model similar to our current EV-DO OEM business model. The diagram does not reflect the actual timing of any of our software releases, the actual level of our product and service billings, revenue or deferred revenue in any period, the actual timing of recognition of our product and service revenues, or the deferral of product revenue that can result from the inability to establish VSOE of fair value for maintenance and support services.
(DIAGRAM)
  
Software release A is delivered and related product and service billings are recognized as revenue because there are no outstanding commitments for upgrades.
 
Software upgrade B is committed in Period 1 and, therefore, product and service billings for shipments of software release A after that point cannot be recognized as revenue before software upgrade B is delivered.

 

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ƒ  
Before software upgrade B is delivered, software upgrade C is committed in Period 2 and, therefore, product and service billings for shipments of software release A after that point cannot be recognized before software upgrade C is delivered.
 
 
When software upgrade B is delivered in Period 3, all deferred revenue, which consists of deferred revenue from billings of software release A, from the time of the commitment of software upgrade B until the time of the commitment of software upgrade C is recognized, subject to being able to establish VSOE of fair value for maintenance and support services.
 
 
When software upgrade C is delivered in Period 4, all remaining deferred revenue from the time of the commitment of software upgrade C, which consists of deferred revenue from billings of software release A and software upgrade B, is recognized because no commitments are outstanding, subject to being able to establish VSOE of fair value for maintenance and support services.
As illustrated in this example, we begin to recognize our revenue in periods during which we deliver specified upgrades. When we have such revenue recognition events, we begin to recognize revenue from sales invoiced during multiple prior periods. As a result, we believe that our revenue, taken in isolation, provides limited insight into the performance of our business. We evaluate our performance by also assessing: product and service billings, which reflects our sales activity in a period; cost related to product and service billings, which reflects the cost associated with our product and service billings; deferred revenue at the end of the period, which reflects the cumulative billings that we were unable to recognize under our revenue recognition policy; deferred product cost at the end of a period, which reflects the cumulative costs that we were unable to recognize under our revenue recognition policy associated with our deferred product revenue; and cash flow from operating activities. We expect this pattern of commitments and delivery of future specified upgrades and the resulting impact on the timing of revenue recognition to continue with respect to our OEM business. As we introduce new products, the variability of the total revenue recognized in any fiscal period may moderate, provided that we are able to establish VSOE of fair value for these new products or upgrades to these new products, and as sales of these new products represent a larger percentage of our overall business.
Key Elements of Financial Performance
Revenue
Our revenue consists of product revenue and service revenue from sales through our OEM customers and directly to our end customers.
Product Revenue. Our product revenue is principally currently derived from the sale of our EV-DO mobile network products that are used by wireless operators to provide mobile broadband services. These products include four major components: base stations or OEM base station channel cards; radio network controllers; network management systems; and software upgrades to the OEM’s installed base. We have sold OEM base station channel cards both as hardware/software combinations and as software licenses when the OEM customer chooses to have the hardware manufactured for it by a third party. Radio network controllers, or RNCs, and network management systems are usually sold as software licenses as the OEM customer procures off-the-shelf hardware from third party suppliers. Almost all of our revenue and product and service billings to date have been derived from sales of our EV-DO products through our OEM agreement with Nortel Networks. Revenue from our FMC products have not been material to date.
We first derived revenue and product and service billings in fiscal 2002 from the sale of first generation EV-DO mobile network products based on the Rev 0 version of the standard. Prior to the third quarter of fiscal 2006, we sold Rev 0-based base station channel cards, which were manufactured for us by a third party, and licensed Rev 0 software for these OEM base station channel cards, as well as for RNCs and network management systems. In connection with the transition to products based on the Rev A version of the standard, Nortel Networks exercised its right to license our hardware design in order to manufacture the OEM base station channel cards that support Rev A instead of purchasing this hardware from us. As a result, since the third quarter of fiscal 2006, our product sales to Nortel Networks have been derived solely from the license of software, specifically Rev 0 and Rev A software, RNCs and network management systems, as well as Rev A software for OEM base station channel cards and system upgrades.
Under our revenue recognition policy, as described above, we begin to recognize revenue from sales to an OEM customer only after we deliver a specified upgrade that we have previously committed. When we commit to an additional upgrade before we have delivered a previously committed upgrade, we defer all revenue from product sales after the date of such commitment until we deliver the additional upgrade.

 

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Our product revenue in fiscal 2006 consisted primarily of software license fees and hardware shipments to our primary OEM customer from fiscal 2002 through the first quarter of fiscal 2005, which is when we made an additional commitment for a specified future software upgrade. We refer to that software upgrade as our April 2005 specified upgrade or software version 4.0. In the first quarter of fiscal 2007, we delivered software version 4.0. As a result, we recognized product revenue of $141.5 million that consisted primarily of software license fees and hardware shipments to our primary OEM customer from April 2005 through September 2006, which is when we made another commitment for a specified future software upgrade. We refer to that software upgrade as our September 2006 specified upgrade or software version 5.0. In the fourth quarter of fiscal 2007, we delivered software version 5.0. As a result, we recognized product revenue of $137.4 million that consisted primarily of software license fees and hardware shipments to our primary OEM customer from September 2006 through June 2007, which is when we made another commitment for a specified future software upgrade. We refer to that software upgrade as the June 2007 specified upgrade or software version 6.0. In the second quarter of fiscal 2008, we delivered software version 6.0. As a result, we recognized product revenue of $59.0 million that consisted primarily of billings from software license fees to our primary OEM customer from June 2007 through December 2007, when we made another commitment for a specified future software upgrade. We refer to that software upgrade as the December 2007 specified upgrade or software version 7.0. In the fourth quarter of fiscal 2008, we delivered software version 7.0. As a result, we recognized product revenue of $57.1 million that consisted primarily of billings from software license fees to our primary OEM customer from December 2007 through July 2008, when we made another commitment for a specified future software upgrade. We refer to that software upgrade as the July 2008 specified upgrade or software version 8.0. In October 2008, we made another commitment for a specified software upgrade, which we refer to as the October 2008 specified upgrade or software version 8.1. In May 2009, we made another commitment for a specified software upgrade, which we refer to as the May 2009 specified upgrade or software version 8.2. As of September 27, 2009, there were three specified software upgrades that we had not yet delivered, software versions 8.0, 8.1 and 8.2. We expect to deliver software version 8.0 in the fourth quarter of fiscal 2009, subsequent to the sale of Nortel’s CDMA business to Ericsson. We expect to deliver software versions 8.1 and 8.2 in the first half of fiscal 2010.
Service Revenue. Our service revenue is derived from support and maintenance services, which we refer to as post-contract customer support, or PCS, for our EV-DO products and other professional services, including training. Our support and maintenance services consist of the repair or replacement of defective hardware, around-the-clock help desk support, technical support and the correction of bugs in our software. Our annual support and maintenance fees are based on a fixed-dollar amount associated with, or a percentage of the initial sales price for, the applicable hardware and software products. Included in the price for the product, we provide maintenance and support during our product warranty period, which is two years for our base station channel cards and one year for our software products.
As discussed above, we defer all revenue, including revenue related to maintenance and support services, until all specified upgrades outstanding at the time of shipment have been delivered. When VSOE of fair value for PCS does not exist, all revenue related to product sales and software-only license fees, including bundled PCS, is deferred until all specified software upgrades outstanding at the time of shipment are delivered. At the time of the delivery of all such upgrades, we recognize a proportionate amount of all such revenue previously deferred based on the portion of the applicable warranty period that has elapsed at the time of such delivery. The unearned revenue is recognized ratably over the remainder of the applicable warranty period. When VSOE of fair value for PCS exists, we allocate a portion of the initial product revenue and software-only license fees to the bundled PCS based on the fees we charge for annual PCS when sold separately. When all specified software upgrades outstanding at the time of shipment are delivered, under the residual method, we recognize the previously deferred product revenue and software-only license fees, as well as the earned PCS revenue, based on the portion of the applicable warranty period that has elapsed. The unearned PCS revenue is recognized ratably over the remainder the applicable warranty period. Notwithstanding our inability to establish VSOE of fair value of maintenance and support services to Nortel Networks under ASC 985-605 for revenue recognition purposes, we are permitted to present product revenue and service revenue separately on our consolidated statements of operations based on historical maintenance and support services renewal rates at the time of sale.
Our support and maintenance arrangements for our EV-DO products are typically renewable for one-year periods. We invoice our support and maintenance fees in advance of the applicable maintenance period, and we recognize revenue from maintenance and support services ratably over the term of the applicable maintenance and support period as services are delivered.
We also offer professional services such as deployment optimization, network engineering and radio frequency deployment planning, and provide training for network planners and engineers. We generally recognize revenue for these services as the services are performed.
Product and Service Billings
Product and service billings, which is a non-GAAP measure, represents the amount invoiced for products and services that are delivered and services that are to be delivered to our end customers directly or through our OEM channels for which we expect payment will be made in accordance with normal payment terms. Software-only product sales under our OEM agreements are invoiced monthly upon notification of sale by the OEM customer. We present the product and service billings metric because we believe it provides a consistent basis for understanding our sales activity and our OEM channel sales from period to period. We use product and service billings as a measure to assess our business performance and as a key factor in our incentive compensation program.

 

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Wireless operators generally purchase communications equipment in stages — driven first by coverage and later by capacity. The initial stage involves deploying new services in selected parts of their networks, often those geographic regions with the highest concentration of customers. Wireless operators then typically expand coverage throughout their network. Later purchases are driven by a desire to expand capacity as the usage of new services grows. Initial purchases usually occur around the time that we and our OEM customers offer products that substantially improve the performance of the network. Subsequent purchases to expand the geographic coverage and capacity of an operator’s wireless network are difficult to predict because they are typically related to consumer demand for mobile broadband services. As a result, our product and service billings have fluctuated significantly from period to period and we expect them to continue to fluctuate significantly from period to period for the foreseeable future.
On January 14, 2009, Nortel Networks announced that it had filed for bankruptcy protection. At the time of that filing, we had outstanding invoices to Nortel Networks in the amount of $21.8 million and during the first quarter of fiscal 2009 we invoiced an additional $14.6 million to Nortel Networks related to royalties earned and services performed through January 13, 2009. The collection of these amounts is subject to Nortel Networks’ bankruptcy proceedings. As a result, we excluded from billings and accounts receivable pre-bankruptcy filing outstanding invoices to Nortel Networks of $21.8 million from the quarter and year ended December 28, 2008 and $14.6 million for the quarter ended March 29, 2009. Outstanding invoices as of the date of the Nortel Networks filing will be accounted for on a cash basis as collected.
Our product and service billings were $43.0 million in the third quarter of fiscal 2008 and $107.1 million in the first three quarters of fiscal 2008 and $31.2 million in the third quarter of fiscal 2009 and $88.7 million in the first three quarters of fiscal 2009. Product and service billings to Nortel Networks comprised 93% of billings in the third quarter of fiscal 2008, 95% of billings in the first three quarters of fiscal 2008, 87% of billings in the third quarter of fiscal 2009 and 89% of billings in the first three quarters of fiscal 2009.
The following table reconciles revenue to product and service billings:
                                 
    Three Months Ended     Nine Months Ended  
    September 28,     September 27,     September 28,     September 27,  
    2008     2009     2008     2009  
    (dollars in thousands)  
Revenue
  $ 8,247     $ 2,726     $ 74,904     $ 16,869  
Deferred revenue, at end of period
    112,134       138,707       112,134       138,707  
Less: deferred revenue, at beginning of period
    (77,396 )     (110,185 )     (79,978 )     (66,860 )
 
                       
 
                               
Product and service billings
  $ 42,985     $ 31,248     $ 107,060     $ 88,716  
 
                       
Deferred Revenue
Product and service billings for invoiced shipments and software license fees, and related maintenance services, as well as non-recurring engineering and other development services for which revenue is not recognized in the current period are recorded as deferred revenue. Deferred revenue increases each fiscal period by the amount of product and service billings that are deferred in the period and decreases by the amount of revenue recognized in the period. We classify deferred revenue that we expect to recognize during the next twelve months as current deferred revenue on our balance sheet and the remainder as long-term deferred revenue.
Under our revenue recognition policy as described above, we recognize revenue from sales to an OEM customer only when we deliver a specified upgrade to which we had previously committed. When we commit to an additional upgrade before we have delivered a previously committed upgrade, we defer all revenue from product sales after the date of such commitment until we deliver the additional upgrade.
We committed to a specified future software upgrade in April 2005, which we refer to as our April 2005 specified upgrade. We delivered the April 2005 specified upgrade in April 2007. We committed to a subsequent specified upgrade in September 2006, which we refer to as our September 2006 specified upgrade. We delivered the September 2006 specified upgrade in November 2007. We committed to a specified upgrade in June 2007, which we refer to as our June 2007 specified upgrade. We delivered the June 2007 specified upgrade in June 2008. We committed to a subsequent specified upgrade in December 2007, which we refer to as our December 2007 specified upgrade. We delivered the December 2007 specified upgrade in the fourth quarter of fiscal 2008. We have outstanding commitments for additional specified upgrades committed to in July 2008, October 2008 and May 2009, which we refer to as our July 2008 specified upgrade, its October 2008 specified upgrade and our May 2009 specified upgrades. We expect to deliver the July 2008 specified upgrade in the fourth quarter of fiscal 2009, subsequent to the expected closing of Ericsson’s acquisition of Nortel’s CDMA business. We expect to deliver the October 2008 and May 2009 specified upgrades in the first half of fiscal 2010.

 

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Deferred revenue at December 28, 2008 consisted of the following:
                         
    Current     Long-Term     Total  
Deferred revenue related to December 2007 specified upgrade
  $ 7,397     $     $ 7,397  
Deferred revenue related to July 2008 specified upgrade
    37,775             37,775  
Deferred revenue related to October 2008 specified upgrade
    13,663             13,663  
Other deferred revenue
    2,475       5,550       8,025  
 
                 
 
                       
Total deferred revenue
  $ 61,310     $ 5,550     $ 66,860  
 
                 
   
Deferred revenue at September 27, 2009 consisted of the following:
                         
    Current     Long-Term     Total  
Deferred revenue related to July 2008 specified upgrade
  $ 37,775     $     $ 37,775  
Deferred revenue related to October 2008 specified upgrade
    47,359             47,359  
Deferred revenue related to May 2009 specified upgrade
    37,987             37,987  
Other deferred revenue
    1,139       14,447       15,586  
 
                 
 
                       
Total deferred revenue
  $ 124,260     $ 14,447     $ 138,707  
 
                 
We expect Ericsson’s acquisition of Nortel’s CDMA business to close in the fourth quarter of 2009, and we expect to collect our outstanding pre-bankruptcy filing invoices to Nortel of $36.4 million. If we collect this amount, approximately $0.5 million would be immediately recorded to revenue and the remaining amount of $35.9 million would be recorded as deferred revenue related to our October 2008 specified upgrade.
Cost of Revenue
Cost of product revenue consists primarily of:
   
cost for channel card hardware provided by contract manufacturers;
 
   
cost of hardware for our RNCs and network management systems;
 
   
license fees for third-party software and other intellectual property used in our products; and
 
   
other related overhead costs.
Cost of service revenue consists primarily of salaries, benefits and stock-based compensation for employees that provide support services to customers and manage the supply chain.
Some of the technology that we incorporate into our EV-DO products and sell to Nortel Networks is licensed from Qualcomm. In the fourth quarter of fiscal 2008 and the first quarter of fiscal 2009, Qualcomm undertook an audit of the royalties that we paid to Qualcomm in respect of the EV-DO products that we sold between 2003 and 2007. Qualcomm determined that we do not owe them any additional royalties beyond the amounts we had accrued.
Cost Related to Product and Service Billings
Cost related to product and service billings, which is a non-GAAP measure, includes the cost of products delivered and invoiced to our customers, the cost directly attributable to the sale of software-only products by our OEM partners and the cost of services in the current period. Cost related to product billings is recorded as deferred product and service cost until such time as the related deferred revenue is recognized as revenue. At the time of revenue recognition, we expense the related deferred product and service costs in our income statement as cost of revenue.

 

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Deferred Product and Service Costs
Cost related to product billings for invoiced shipments and software-only license fees for which revenue is not recognized in the current period is recorded as deferred product cost. In addition, when we perform development services that are essential to the functionality of the initial delivery of a new product where the associated revenues have been deferred due to the fact that they do not qualify as units of accounting separate from the delivery of the software, we defer direct and incremental development costs. The costs deferred consist of employee compensation and benefits for those employees directly involved with performing the development, as well as other direct and incremental costs. All costs incurred in excess of the related revenues are expensed as incurred. Deferred product and service costs increases each fiscal period by the amount of product and service costs associated with product and service billings that are deferred in the period and decreases by the amount of product and service costs associated with revenue recognized in the period. We classify deferred product cost that we expect to recognize during the next twelve months as current deferred product and service costs on our balance sheet. As of September 27, 2009, $3.0 million of deferred product cost was included in current assets and $4.9 million of deferred service cost was included in long-term assets.
Gross Profit
Our gross profit represents revenue recognized during the period less related cost and is primarily attributable to OEM product shipments and software license fees. Our gross profit varies from period to period according to the mix of our revenue from hardware products, software products and services.
Gross Profit on Billings
Our gross profit on billings, a non-GAAP measure, represents product and service billings during the period less cost related to product and service billings and is primarily attributable to OEM product shipments and software license fees. Our gross profit on billings varies from period to period according to our mix of billings from hardware products, software products and services.
Due to Nortel Networks’ bankruptcy filing on January 14, 2009, we excluded $14.6 million of pre-bankruptcy filing outstanding invoices to Nortel Networks from billings for the nine months ended September 27, 2009. As a result, our gross profit on billings was reduced by the same amount for the nine months ended September 27, 2009.
Operating Expenses
Research and Development. Research and development expense consists primarily of:
   
salaries, benefits and stock-based compensation related to our engineers;
 
   
cost of prototypes and test equipment relating to the development of new products and the enhancement of existing products;
 
   
payments to suppliers for design and consulting services; and
 
   
other related overhead costs.
We expense all research and development cost as it is incurred. Our research and development is performed by our engineering personnel in the United States, India and the United Kingdom. We intend to continue to invest significantly in our research and development efforts, which we believe are essential to maintaining our competitive position and the development of new products for new markets. Accordingly, we expect research and development expense to remain relatively flat through the remainder of fiscal 2009.
Sales and Marketing. Sales and marketing expense consists primarily of:
   
salaries, benefits and stock-based compensation related to our sales, marketing and customer support personnel;
 
   
commissions payable to our sales personnel;
 
   
travel, lodging and other out-of-pocket expenses;
 
   
marketing program expenses; and
 
   
other related overhead costs.
We expense sales commissions at the time they are earned, which typically is when the associated product and service billings are recorded or when a customer agreement is executed. We expect sales and marketing expense to increase in amount and as a percentage of product and service billings for the foreseeable future as we continue to increase the number of sales, marketing and customer service employees to expand our international presence and support our new femtocell products.

 

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General and Administrative. General and administrative expense consists primarily of:
   
salaries, benefits and stock-based compensation related to our executive, finance, legal, human resource and administrative personnel;
 
   
professional services costs; and
 
   
other related overhead costs.
We expect general and administrative expense to decrease slightly in the fourth quarter of 2009.
Stock-Based Compensation Expense
We adopted the requirements of ASC 718-10, Stock Compensation , or ASC 718-10, in the first quarter of fiscal 2006. ASC 718-10 addresses all forms of shared-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. ASC 718-10 requires us to expense share-based payment awards with compensation cost for share-based payment transactions measured at fair value.
Based on current stock option grants, we expect to recognize a future expense for non-vested options of $17.0 million over a weighted-average period of 2.68 years as of September 27, 2009. We expect stock-based compensation expense will increase for the foreseeable future as we expect to continue to grant stock-based incentives to our employees.
Operating Income on Billings
Operating income on billings, which is a non-GAAP measure, varies from period to period according to the amount of gross profit on billings less operating expenses for the period.
Interest Income, Net
Interest income, net, primarily relates to interest earned on our cash, cash equivalents and investments.
Cash Flow from Operating Activities
Customer collections and, consequently, cash flow from operating activities are driven by sales transactions and related product and service billings, rather than recognized revenues. We believe cash flow from operating activities is a useful measure of the performance of our business because, in contrast to income statement profitability metrics that rely principally on revenue, cash flow from operating activities captures the contribution of changes in deferred revenue and deferred charges. We present cash flow from operating activities because it is a metric that management uses to track business performance and, as such, is a key factor in our incentive compensation program. In addition, management believes this metric is frequently used by securities analysts, investors and other interested parties in the evaluation of software companies with significant deferred revenue balances.
Due to the Nortel Networks’ bankruptcy filing on January 14, 2009, we excluded $36.4 million of pre-bankruptcy filing outstanding invoices to Nortel Networks from accounts receivable as of September 27, 2009. The collection of these amounts is subject to Nortel Networks’ bankruptcy proceedings, and as a result, we cannot determine when we may collect these amounts, if at all. These amounts will be treated on a cash basis, if and when collected. Cash flows for the first quarter of 2009 were negatively impacted by $28.2 million, and cash flows for the second quarter of fiscal 2009 were negatively impacted by $8.2 million as a result of Nortel Networks’ bankruptcy filing.
Cash and Investments
We had unrestricted cash and cash equivalents and investments totaling $228.4 million as of December 28, 2008 and $205.3 million as of September 27, 2009. Our existing cash and cash equivalents and investments are invested primarily in money market funds, high grade government sponsored enterprises (AAA/A1+), high-grade commercial paper (A1+/P1), and high grade corporate notes (A1/A+). We do not invest in any types of asset backed securities such as those backed by mortgages or auto loans. None of our investments have incurred defaults or have been downgraded. We do not hold auction rate securities. We hold unrestricted cash and cash equivalents for working capital purposes. We do not enter into investments for trading or speculative purposes. We have an investment policy that guides our investing activities. Among other things, our investment policy limits the concentration of our investments in any one issuer (with the exception of investments in U.S. Treasury and U.S. agency debt obligations and SEC-registered money market funds) to no more than 10% of the book value of our investment portfolio at the time of purchase. The primary objectives of our investment activities are to preserve principal, maintain proper liquidity to meet operating needs, maximize yields and maintain proper fiduciary control over our investments.

 

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We enter into derivative instruments for risk management purposes only and we do not enter into derivative instruments for speculative purposes. Our derivative program does not qualify for hedge accounting treatment. We operate internationally and, in the normal course of business, are exposed to fluctuations in foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating the business. To limit further our exposure to currency exchange rate fluctuations, we also occasionally exchange U.S. Dollars for other currencies in which we incur expenses significantly in advance of our need to make payments in those currencies.
We use forward foreign currency exchange contracts to hedge our exposure to forecasted foreign currency denominated transactions based in the United Kingdom. These forward contracts are not designated as cash flow, fair value or net investment hedges; are marked-to-market with changes in fair value recorded to earnings; and are entered into for periods consistent with currency transaction exposures, generally less than one year. These derivative instruments do not subject our earnings or cash flows to material risk since gains and losses on these derivatives generally offset losses and gains on the expenses and transactions being hedged. In addition, changes in currency exchange rates related to any unhedged transactions may impact our earnings and cash flows. As of September 27, 2009, we had $2.3 million in currency exchange contracts. Gains and losses on the changes in fair value recorded to earnings are classified as other income and amounted to a $94,000 loss for the three months ended September 27, 2009, and a $721,000 gain for the nine months ended September 27, 2009.
Fiscal Year
Our fiscal year ends on the Sunday closest to December 31. Our fiscal quarters end on the Sunday that falls closest to the last day of the third calendar month of the quarter.
Critical Accounting Policies and Estimates
This management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition. Management bases its estimates and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We regard an accounting estimate or assumption underlying our financial statements as a “critical accounting estimate” where (i) the nature of the estimate or assumption is material due to the level of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and (ii) the impact of the estimates and assumptions on financial condition or operating performance is material.
Revenue Recognition
We derive revenue from the licensing of software products and software upgrades; the sale of hardware products, maintenance and support services; and the sale of professional services, including training. Our products incorporate software that is more than incidental to the related hardware. Accordingly, we recognize revenue in accordance with ASC 985-605.
Under multiple-element arrangements where several different products or services are sold together, we allocate revenue to each element based on VSOE of fair value. We use the residual method when fair value does not exist for one or more of the delivered elements in a multiple-element arrangement. Under the residual method, the fair value of the undelivered elements are deferred and subsequently recognized when earned. For a delivered item to be considered a separate element, the undelivered items must not be essential to the functionality of the delivered item and there must be VSOE of fair value for the undelivered items in the arrangement. Fair value is generally limited to the price charged when we sell the same or similar element separately or, when applicable, the stated substantive renewal rate. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established. For example, in situations where we sell a product during a period when we have a commitment for the delivery or sale of a future specified software upgrade, we defer revenue recognition until the specified software upgrade is delivered.
Significant judgments in applying the accounting rules and regulations to our business practices principally relate to the timing and amount of revenue recognition given our current concentration of revenues with one customer and our inability to establish VSOE of fair value for specified software upgrades.
We sell our products primarily through OEM arrangements with telecommunications infrastructure vendors such as Nortel Networks. We have collaborated with our OEM customers on a best efforts basis to develop initial product features and subsequent enhancements for the products that are sold by a particular OEM to its wireless operator customers. For each OEM customer, we expect to continue to develop products based on our core technology that are configured for the requirements of the OEM’s base stations and its operator customers.

 

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This business practice is common in the telecommunications equipment industry and is necessitated by the long planning cycles associated with wireless network deployments coupled with rapid changes in technology. Large and complex wireless networks support tens of millions of subscribers and it is critical that any changes or upgrades be planned well in advance to ensure that there are no service disruptions. The evolution of our infrastructure technology therefore must be planned, implemented and integrated with the wireless operator’s plans for deploying new applications and services and any equipment or technology provided by other vendors.
Given the nature of our business, the majority of our sales are generated through multiple-element arrangements comprised of a combination of products, maintenance and support services and, importantly, specified product upgrades. We have established a business practice of negotiating with OEMs the pricing for future purchases of new product releases and specified software upgrades. We expect that we will release one or more optional specified upgrades annually. To determine whether these optional future purchases are elements of current purchase transactions, we assess whether such new products or specified upgrades will be offered to the OEM customer at a price that represents a significant and incremental discount to current purchases. Because we sell uniquely configured products through each OEM customer, we do not maintain a list price for our products and specified software upgrades. Additionally, as we do not sell these products and upgrades to more than one customer, we are unable to establish VSOE of fair value for these products and upgrades. Consequently, we are unable to determine if the license fees we charge for the optional specified upgrades include a significant and incremental discount. As such, we defer all revenue related to current product sales, software-only license fees, maintenance and support services and professional services until all specified upgrades committed at the time of shipment have been delivered. For example, we recognize deferred revenue from sales to an OEM customer only when we deliver a specified upgrade that we had previously committed. However, when we commit to an additional upgrade before we have delivered a previously committed upgrade, we defer all revenue from product sales after the date of such commitment until we deliver the additional upgrade. Any revenue that we have deferred prior to the additional commitment is recognized after the previously committed upgrade is delivered.
If there are no commitments outstanding for specified upgrades, we recognize revenue when all of the following have occurred: (1) delivery (FOB origin), provided that there are no uncertainties regarding customer acceptance; (2) there is persuasive evidence of an arrangement; (3) the fee is fixed or determinable; and (4) collection of the related receivable is reasonably assured, as long as all other revenue recognition criteria have been met. If there are uncertainties regarding customer acceptance, we recognize revenue and related cost of revenue when those uncertainties are resolved. Any adjustments to software license fees are recognized when reported to us by an OEM customer.
For arrangements where we receive initial licensing fees or customization fees for new products under development, we defer recognition of these fees until the final product has been delivered and accepted, and then we recognize the fees over the expected customer relationship period. Revenue from pre-production units is deferred and recognized once the final product has been delivered and accepted, provided that the other criteria for revenue recognition are met, including but not limited to the establishment of VSOE of fair value for post-contract support. If VSOE of fair value cannot be established for undelivered elements, we defer all revenues until VSOE of fair value can be established or the undelivered element is delivered. If the only remaining undelivered element is post-contract support, we recognize revenue ratably over the contractual post-contract support period.
For arrangements that include annual volume commitments and pricing levels, where such discounts are significant and incremental and where the maximum discount to be provided cannot be quantified prior to the expiration of the arrangement, we recognize revenue, provided that delivery and acceptance has occurred and provided that no other commitments such as specified upgrades are outstanding, based on the lowest pricing level stated in the arrangement. Any amounts invoiced in excess of the lowest pricing level are deferred and recognized ratably over the remaining discount period, which typically represents the greater of the PCS period or the remaining contractual period.
For our direct sales to end user customers, which have not been material to date, we recognize product revenue upon delivery provided that all other revenue recognition criteria have been met.
Our support and maintenance services consist of the repair or replacement of defective hardware, around-the-clock help desk support, technical support and the correction of bugs in our software. Our annual support and maintenance fees are based on a percentage of the initial sales or list price of the applicable hardware and software products and may include a fixed amount for help desk services. Included in the price of the product, we provide maintenance and support during the product warranty period, which is typically one year. As discussed above, we defer all revenue, including revenue related to maintenance and support services (“post-contract customer support” or “PCS”), until all specified upgrades outstanding at the time of shipment have been delivered. In connection with an amendment to our OEM arrangement with Nortel Networks in 2007, we can no longer assert VSOE of fair value for PCS to Nortel Networks. When VSOE of fair value for PCS cannot be established, all revenue related to product sales and software-only license fees, including bundled PCS, is deferred until all specified software upgrades outstanding at the time of shipment are delivered. At the time of the delivery of all such upgrades, we recognize a proportionate amount of all such revenue previously deferred based on the portion of the applicable warranty period that has elapsed as of the time of such delivery. The unearned revenue is recognized ratably over the remainder of the applicable warranty period. When VSOE of fair value for PCS can be established, we allocate a portion of the initial product revenue and software-only license fees to the bundled PCS based on the fees we charge for annual PCS when sold separately. When all specified software upgrades outstanding at the time of shipment are delivered, under the residual method, we recognize the previously deferred product revenue and software-only license fees, as well as the earned PCS revenue, based on the portion of the applicable warranty period that has elapsed. The unearned PCS revenue is recognized ratably over the remainder the applicable warranty period. Notwithstanding our inability to establish VSOE of fair value of maintenance and support services to Nortel Networks for revenue recognition purposes, we present product revenue and service revenue separately on our consolidated statements of income based on historical maintenance and support services renewal rates at the time of sale.

 

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For maintenance and service renewals, we recognize revenue for such services ratably over the service period as services are delivered.
We provide professional services for deployment optimization, network engineering and radio frequency deployment planning, and provides training for network planners and engineers. We generally recognize revenue for these services as the services are performed as we have deemed such services not essential to the functionality of our products. We have not issued any refunds on products sold. As such, no provisions have been recorded against revenue or related receivables for potential refunds.
In addition, certain of our contracts include guarantees regarding failure rates. Historically, we have not incurred substantial costs relating to these guarantees and we currently expense such costs as they are incurred. We review these costs on a regular basis as actual experience and other information becomes available; and should they become more substantial, we would accrue an estimated exposure and consider the potential related effects of the timing of recording revenue on our license arrangements. We have not accrued any costs related to these warranties in the accompanying consolidated financial statements.
In accordance with ASC 605-45, Principal Agent Considerations, or ASC 605-45, we classify the reimbursement by customers of shipping and handling costs as revenue and the associated cost as cost of revenue. We record reimbursable out-of-pocket expenses in both product and services revenues and as a direct cost of product and services. For fiscal 2008 and the first three quarters of fiscal 2009, shipping and handling and reimbursable out-of-pocket expense were not material.
We have neither issued nor do we anticipate issuing any refunds on products sold. As such, no provisions have been recorded against deferred revenues, revenue or any related receivables for potential refunds.
We anticipate that the revenue recognition related to the our fixed-mobile convergence products will be complex given that a number of our current arrangements for the development and supply of these products contain significant customization services, volume discounts, specified upgrades and multiple elements for new service offerings for which vendor-specific evidence of fair value does not currently exist. To date, there have been no material revenues recognized with respect to these products.
During the three months ended June 28, 2009, we recognized $1.2 million of previously deferred revenues as a result of the termination of a customer arrangement and cancellation of all of our remaining obligations under that arrangement.
Investments and Restricted Investments
We determine the appropriate categorization of investments in securities at the time of purchase. As of December 28, 2008 and September 27, 2009, our investments were categorized as held-to-maturity and are presented at their amortized cost. We classify securities on our balance sheet as short-term or long-term based on the date we reasonably expect the securities to mature or liquidate.
As of September 27, 2009, we held 12 securities in an unrealized loss position totaling approximately $33,000. The unrealized losses on these individual securities were less than 1% of amortized cost and represented less than 1% of total amortized cost of all investments. Given the creditworthiness of the issuers of the securities that are in an unrealized loss position at September 27, 2009, we concluded there is no other-than-temporary impairment on any of these investments. We noted no material declines in fair value subsequent to September 27, 2009.
Stock-Based Compensation
Through the year ended January 1, 2006, we accounted for our stock-based awards to employees using the intrinsic value method and elected the disclosure-only requirements. Under the intrinsic value method, compensation expense is measured on the date of the grant as the difference between the deemed fair value of our common stock and the exercise or purchase price multiplied by the number of stock options or restricted stock awards granted. We followed the provisions of ASC 505-50, Equity Based Payments to Non-Employees, to account for grants made to non-employees.

 

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ASC 718-10 requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their estimated fair values. In accordance with ASC 718-10, we recognize the compensation cost of share-based awards on a straight-line basis over the vesting period of the award, which is generally four to five years, and have elected to use the Black-Scholes option pricing model to determine fair value. ASC 718-10 eliminated the alternative of applying the intrinsic value method to stock compensation awards. We adopted the accounting standards of ASC 718-10 on the first day of fiscal 2006 using the prospective-transition method. As such, we will continue to apply the intrinsic value method in future periods to equity awards granted prior to the adoption of ASC 718-10.
As there was no public market for our common stock prior to July 19, 2007, the date of our IPO, we determined the volatility percentage used in calculating the fair value of stock options it granted based on an analysis of the historical stock price data for a peer group of companies that issued options with substantially similar terms. The expected volatility percentage used in determining the fair value of stock options granted in the nine months ended September 28, 2008 was 58% and in the nine months ended September 27, 2009 was 51%. The expected life of options was determined utilizing the “simplified” method as prescribed by the SEC’s Staff Accounting Bulletin No. 107. The expected life of options granted during the nine months ended September 28, 2008 and September 27, 2009 was 6.25 years. For the nine months ended September 28, 2008 the weighted-average risk free interest rates used was 3.22% and for the nine months ended September 27, 2009 the weighted-average risk free interest rates used was 2.41%. The risk-free interest rate is based on a 7-year treasury instrument whose term is consistent with the expected life of the stock options. Although we paid a one-time special cash dividend in April 2007, the expected dividend yield is assumed to be zero as we do not currently anticipate paying cash dividends on our common stock in the future. In addition, ASC 718-10 requires companies to utilize an estimated forfeiture rate when calculating the expense for the period, whereas prior FASB accounting guidance permitted companies to record forfeitures based on actual forfeitures, which was our historical policy. As a result, we applied an estimated forfeiture rate between 4% and 5% for the nine months ended September 28, 2008 and 6% for the nine months ended September 27, 2009 in determining the expense recorded in our consolidated statements of operations. These rates were derived by review of our historical forfeitures since 2000.
For the third quarter of fiscal 2008 we recorded an expense of $1.3 million for share-based awards and a related tax benefit of approximately $193,000. For the third quarter of fiscal 2009 we recorded an expense of $1.7 million for share-based awards and a related tax benefit of approximately $333,000. For the first three quarters of fiscal 2008 we recorded an expense of $3.5 million for share-based awards and a related tax benefit of approximately $504,000. For the first three quarters of fiscal 2009 we recorded an expense of $4.5 million for share-based awards and a related tax benefit of approximately $873,000. As of September 27, 2009, future expense for non-vested stock options of $17.0 million was expected to be recognized over a weighted-average period of 2.68 years.
Income Taxes
We are subject to income taxes in both the United States and foreign jurisdictions, and we use estimates in determining our provision for income taxes. We account for income taxes under the provisions of ASC 740-10, Income Taxes (“ASC 740-10”), which requires the recognition of deferred income tax assets and liabilities for expected future tax consequences of events that have been recognized in our financial statements or tax returns. Under ASC 740-10, we determine the deferred tax assets and liabilities based upon the difference between the financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We must then periodically assess the likelihood that our deferred tax assets will be recovered from our future taxable income, and, to the extent we believe that it is more likely than not our deferred tax assets will not be recovered, we must establish a valuation allowance against our deferred tax assets.
In July 2006, the FASB issued accounting guidance which creates a single model to address uncertainty in tax positions and clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with ASC 740-10 by prescribing the minimum threshold a tax position is required to meet before being recognized in an enterprise’s financial statements. We adopted this guidance on January 1, 2007. We did not recognize any liability for unrecognized tax benefits as a result of adopting this guidance as of January 1, 2007. Our liability, including interest, was $5.7 million at December 28, 2008 and $6.0 million at September 27, 2009. During the nine months ended September 28, 2008, we recognized interest on uncertain tax liabilities of $142,000. During the nine months ended September 27, 2009, we recognized interest on uncertain tax liabilities of $156,000.

 

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Results of Operations
Comparison of Three Months Ended September 28, 2008 and September 27, 2009
Revenue and Product and Service Billings
                         
    Three Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (dollars in thousands)  
Revenue
  $ 8,247     $ 2,726     $ (5,521 )
Deferred revenue, end of period
    112,134       138,707          
Less: deferred revenue, beginning of period
    (77,396 )     (110,185 )        
 
                   
 
                       
Product and service billings
  $ 42,985     $ 31,248     $ (11,737 )
 
                   
Our revenue for the third quarter of fiscal 2009 was derived principally from maintenance and support services performed during the quarter. Our revenue for the third quarter of fiscal 2008 was derived principally from the ratable recognition of software license revenue related to the delivery of our June 2007 specified upgrade to Nortel Networks in the second quarter of fiscal 2008. As we are not able to assert VSOE of fair value on our maintenance services, we recognize Nortel Networks-related software revenue ratably over the warranty period, provided that there are no other outstanding commitments or upgrades. Our revenue for the third quarter of fiscal 2008 was also derived from maintenance and support services performed during the quarter.
The decrease in our product and service billings for the third quarter of fiscal 2009, as compared to the third quarter of fiscal 2008, was due primarily to delays in the delivery and acceptance of our software version 8.0 upgrade due to the timing of the expected purchase by Ericsson of Nortel’s CDMA business. We estimate that approximately $5 million to $7 million of upgrade billings shifted out of the third quarter 2009 due to this delay.
Cost of Revenue and Cost Related to Product and Service Billings
                         
    Three Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (dollars in thousands)  
Cost of revenue
  $ 2,652     $ 2,900     $ 248  
Deferred product and service cost, end of period
    2,397       7,882          
Less: deferred product and service cost, beginning of period
    (1,354 )     (6,492 )        
 
                   
 
                       
Cost related to product and service billings
  $ 3,695     $ 4,290     $ 595  
 
                   
Cost of revenue in the third quarter of fiscal 2009 increased slightly as compared to the third quarter of fiscal 2008 due primarily to an increase in cost of service revenue of $0.3 million associated with an increase in customer service headcount to support a larger installed base of product.
The increase in cost related to product and service billings was due primarily to direct development costs associated with our development arrangements with Hitachi.
Gross Profit and Gross Profit on Billings
                         
    Three Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (In thousands)  
Gross profit
  $ 5,595     $ (174 )   $ (5,769 )
Deferred revenue, at end of period
    112,134       138,707          
Less: Deferred revenue, at beginning of period
    (77,396 )     (110,185 )        
Deferred product and service cost, at beginning of period
    1,354       6,492          
Less: Deferred product and service cost, at end of period
    (2,397 )     (7,882 )        
 
                   
 
                       
Gross profit on Billings
  $ 39,290     $ 26,958     $ (12,332 )
 
                   
The decrease in gross profit in the third quarter of fiscal 2009 as compared to the third quarter of fiscal 2008 was due primarily to a decrease in revenue of $5.5 million to $2.7 million in the third quarter of fiscal 2009. We expect gross profit on our revenue to continue to fluctuate significantly in the future due to the time period between commitments for future software upgrades and the volume of sales in those time intervals.

 

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Gross profit on Billings decreased primarily due to a decrease in product and service billings of $11.7 million to $31.2 million in the third quarter of fiscal 2009, partially offset by an increase in cost related to product and service billings of $0.6 million to $4.3 million in the third quarter of fiscal 2009.
Operating Expenses
                                 
    Three Months Ended     Period-to-Period  
    September 28,     September 27,     Change  
    2008     2009     Amount     Percentage  
    (dollars in thousands)  
Research and development
  $ 18,859     $ 18,443     $ (416 )     (2.2 )%
Sales and marketing
    3,809       4,245       436       11.4 %
General and administrative
    2,281       3,438       1,157       50.7 %
 
                           
 
                               
Total operating expenses
  $ 24,949     $ 26,126     $ 1,177       4.7 %
 
                           
Research and Development. Research and development expense decreased slightly in the third quarter of fiscal 2009 as compared to the third quarter of fiscal 2008. The decrease was primarily related to a decrease in development tools expense of $0.4 million, a decrease in outside service expense of $0.4 million as well as an increase in direct costs recorded to long-term deferred service cost of $0.4 million, partially offset by an increase in salary and benefit expense of $0.8 million associated with an increase in the number of research and development employees. We expect research and development expense to remain relatively flat through the remainder of fiscal 2009.
Sales and Marketing. The increase in sales and marketing expense was primarily due to an increase in salary and benefit expense of $0.5 million associated with an increase in the number of sales, marketing and customer service employees to expand our international presence and support our new FMC products, which we expect to be sold to a larger base of OEMs and operators than our EV-DO products.
General and Administrative. The increase in general and administrative expense in the third quarter of fiscal 2009 as compared to the third quarter of fiscal 2008 was primarily due to an increase in legal expense and outside service expense, some of which is related to the expected sale of Nortel’s CDMA business to Ericsson. We expect general and administrative expense to decrease slightly in the fourth quarter of fiscal 2009.
Operating Loss and Operating Profit on Billings
                         
    Three Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (In thousands)  
Operating loss
  $ (19,354 )   $ (26,300 )   $ (6,946 )
Deferred revenue, at end of period
    112,134       138,707          
Less: Deferred revenue, at beginning of period
    (77,396 )     (110,185 )        
Deferred product and service cost, at beginning of period
    1,354       6,492          
Less: Deferred product and service cost, at end of period
    (2,397 )     (7,882 )        
 
                   
 
                       
Operating profit on billings
  $ 14,341     $ 832     $ (13,509 )
 
                   
The increase in operating loss was due primarily to the decrease in our gross profit, described above, coupled with the increase in our operating expenses, described above.
The decrease in operating profit on Billings was due to the decrease in our gross profit on Billings, described above, as well as the increase in our operating expenses, described above.
Interest Income and Other Income, Net. Interest income and other income, net, primarily consists of interest generated from the investment of our cash balances. The decrease in interest income from $1.5 million in the third quarter of fiscal 2008 to $0.4 million in the third quarter of fiscal 2009 was due primarily to lower interest rates and returns on investments coupled with lower average cash balances, as well as losses of $94,000 relating to our hedging program.
Income Taxes. We recognized a tax benefit of $9.0 million in the third quarter of fiscal 2009 primarily related to losses incurred from operations in the United States expected to be recovered from both income generated in the United States during the remainder of 2009 and the carryback of any excess loss to offset taxable profits reported in prior years. We recorded an income tax benefit of $5.4 million in the third quarter of fiscal 2008 relating principally to losses incurred in the United States taxed at the federal and state statutory rates partially offset by the effect of losses from foreign operations for which no tax benefit could be recognized.
When we begin to ship our FMC products in the United States in significant volumes, our effective state tax rate may increase and we may realize benefits from our state tax credit carryforwards.

 

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Comparison of Nine Months Ended September 28, 2008 and September 27, 2009
Revenue and Product and Service Billings
                         
    Nine Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (dollars in thousands)  
Revenue
  $ 74,904     $ 16,869     $ (58,035 )
Deferred revenue, end of period
    112,134       138,707          
Less: deferred revenue, beginning of period
    (79,978 )     (66,860 )        
 
                   
 
                       
Product and service billings
  $ 107,060     $ 88,716     $ (18,344 )
 
                   
Our revenue for the first three quarters of fiscal 2009 was derived principally from the ratable recognition of software license revenue related to the delivery of our December 2007 specified upgrade to Nortel Networks in the fourth quarter of fiscal 2008. As we are not able to assert VSOE of fair value on our maintenance services, we recognize Nortel Networks-related software revenue ratably over the warranty period, provided that there are no other outstanding commitments or upgrades outstanding at the time of shipment. Our revenue for the first three quarters of fiscal 2009 also consists of maintenance and support services performed during the period as well as recognition of other service revenue associated with the termination of our development agreement with Alcatel-Lucent. Our revenue for the first three quarters of fiscal 2008 was derived principally from the ratable recognition of software license revenue related to the delivery of our June 2007 specified upgrade to Nortel Networks in the second quarter of fiscal 2008. Our revenue for the first three quarters of fiscal 2008 was also derived from maintenance and support services performed during the period.
The decrease in our product and service billings for the first three quarters of fiscal 2009 as compared to the first three quarters of fiscal 2008 was due primarily to the exclusion of $14.6 million of pre-bankruptcy filing outstanding invoices to Nortel Networks that are subject to Nortel Networks’ bankruptcy proceedings, delays of approximately $5 million to $7 million of software upgrades due to the timing of the closing of Nortel’s sale of its CDMA business to Ericsson and the resulting delay of the delivery and acceptance of our software version 8.0 upgrade, offset by higher RNC sales volumes in the first three quarters of fiscal 2009 due to new coverage deployments as well as expansion of existing deployments by operators.
Cost of Revenue and Cost Related to Product and Service Billings
                         
    Nine Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (dollars in thousands)  
Cost of revenue
  $ 7,892     $ 8,849     $ 957  
Deferred product and service cost, end of period
    2,397       7,882          
Less: deferred product and service cost, beginning of period
    (1,050 )     (3,213 )        
 
                   
 
                       
Cost related to product and service billings
  $ 9,239     $ 13,518     $ 4,279  
 
                   
Cost of revenue in the first three quarters of fiscal 2009 increased as compared to the first three quarters of fiscal 2008 due primarily to an increase in cost of service revenue of $1.2 million associated with an increase in customer service headcount to support a larger installed base of product as well as the recognition of direct development costs of $0.5 million associated with the termination of our development agreement with Alcatel-Lucent, partially offset by a decrease in royalty costs of $0.9 million related to the decrease in software license revenue recognized in the first three quarters of fiscal 2009 as compared to the first three quarters of fiscal 2008.
The increase in cost related to product and service billings was due primarily to direct development costs associated with our development arrangements with Hitachi and Alcatel-Lucent.

 

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Gross Profit and Gross Profit on Billings
                         
    Nine Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (In thousands)  
Gross profit
  $ 67,012     $ 8,020     $ (58,992 )
Deferred revenue, at end of period
    112,134       138,707          
Less: Deferred revenue, at beginning of period
    (79,978 )     (66,860 )        
Deferred product and service cost, at beginning of period
    1,050       3,213          
Less: Deferred product and service cost, at end of period
    (2,397 )     (7,882 )        
 
                   
 
                       
Gross profit on Billings
  $ 97,821     $ 75,198     $ (22,623 )
 
                   
The decrease in gross profit was due primarily to a decrease in revenue from $74.9 million to $16.9 million in the first three quarters of fiscal 2009. We expect gross profit on our revenue to continue to fluctuate significantly in the future due to the time period between commitments for future software upgrades and the volume of sales in those time intervals.
Gross profit on Billings decreased primarily due to a decrease in product and service billings of $18.3 million to $88.7 million due primarily to the exclusion of $14.6 million of pre-bankruptcy filing outstanding invoices to Nortel Networks that are subject to Nortel Networks’ bankruptcy proceedings, coupled with an increase in cost related to product and service billings of $4.3 million to $13.5 million in the first three quarters of fiscal 2009.
Operating Expenses
                                 
    Nine Months Ended     Period-to-Period  
    September 28,     September 27,     Change  
    2008     2009     Amount     Percentage  
    (dollars in thousands)  
Research and development
  $ 56,209     $ 54,202     $ (2,007 )     -3.5 %
Sales and marketing
    11,212       12,345       1,133       10.1 %
General and administrative
    6,675       8,311       1,636       24.5 %
 
                         
 
                               
Total operating expenses
  $ 74,096     $ 74,858     $ 762       1.0 %
 
                         
Research and Development. The decrease in research and development expense in the first three quarters of fiscal 2009 as compared to the same period in 2008 was due primarily to deferral of $3.4 million of direct development costs associated with our development arrangements with Hitachi and Alcatel-Lucent and to a lesser extent due to a decrease in prototype expense of $0.7 million associated with lower EV-DO prototypes, partially offset by an increase in consulting expense of $2.1 million to cover short term project needs.
Sales and Marketing. The increase in sales and marketing expense was primarily due to an increase in salary and benefit expense of $1.0 million associated with an increase in the number of sales, marketing and customer service employees to expand our international presence and support our new FMC products, which we expect to be sold to a larger base of OEMs and operators than our EV-DO products.
General and Administrative. The increase in general and administrative expense in the first three quarters of fiscal 2009 as compared to the first three quarters of fiscal 2008 was due to an increase in legal expense of $0.5 million and outside service expense of $0.6 million, an increase in salaries and benefits of $0.3 million as a result of an increase in the number of general and administrative employees to support our growth as well as an increase in stock compensation expense of $0.2 million due to new grants of stock options to employees during the first half of fiscal 2009.
Operating Loss and Operating Profit on Billings
                         
    Nine Months Ended        
    September 28,     September 27,     Period-to-Period  
    2008     2009     Change  
    (In thousands)  
Operating loss
  $ (7,084 )   $ (66,838 )   $ (59,754 )
Deferred revenue, at end of period
    112,134       138,707          
Less: Deferred revenue, at beginning of period
    (79,978 )     (66,860 )        
Deferred product and service cost, at beginning of period
    1,050       3,213          
Less: Deferred product and service cost, at end of period
    (2,397 )     (7,882 )        
 
                   
 
                       
Operating profit on Billings
  $ 23,725     $ 340     $ (23,385 )
 
                   

 

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The decrease in operating loss was due primarily to the decrease in our gross profit, described above, coupled with the small increase in our operating expenses, described above.
The decrease in operating profit on Billings was due to the decrease in our gross profit on Billings, described above, coupled with the small increase in our operating expenses, described above.
Interest Income, Net. Interest income, net, primarily consists of interest generated from the investment of our cash balances. The decrease in interest income from $5.8 million in the first three quarters of fiscal 2008 to $3.1 million in the first three quarters of fiscal 2009 was due primarily to lower interest rates and returns on investments coupled with lower average cash balances, partially offset by $721,000 of foreign exchange gains relating to our hedging program.
Income Taxes. We recognized a tax benefit of $25.7 million for the nine months ended September 27, 2009 primarily related to losses incurred from operations in the United States and the impact of the reduction of valuation allowance against our U.K. net operating loss carryforwards as a result of implementing a sale of intellectual property from our U.K. subsidiary to the U.S. parent company. The benefit from the losses in the United States is expected to be recovered from both income generated in the United States during the remainder of 2009 and the carryback of any excess loss to offset taxable profits reported in prior years. Approximately $3.0 million of the benefit recognized during the nine months ended September 27, 2009 is discrete and relates to implementation of our tax planning strategy. We recorded income tax expense of $2.4 million for the nine months ended September 28, 2008 relating principally to profits in the United States taxed at the federal and state statutory rates and the effect of losses from foreign operations for which no tax benefit could be recognized.
When we begin to ship our FMC products in the United States in significant volumes, our effective state tax rate may increase and we may realize benefits from our state tax credit carryforwards.
Liquidity and Capital Resources
As of September 27, 2009, our principal sources of liquidity were cash, cash equivalents and investments of $205.3 million. Our existing cash and cash equivalents and investments are invested primarily in money market funds, high grade government sponsored enterprises (AAA/A1+), high-grade commercial paper (A1+/P1) and high grade corporate notes (A1/A+). We do not invest in any types of asset backed securities such as those backed by mortgages or auto loans. None of our investments have incurred defaults or have been downgraded. We do not hold auction rate securities. We hold unrestricted cash and cash equivalents for working capital purposes. We do not enter into investments for trading or speculative purposes. We have an investment policy that guides our investing activities. Among other things, our investment policy limits the concentration of our investments in any one issuer (with the exception of investments in U.S. Treasury and U.S. agency debt obligations and SEC-registered money market funds) to no more than 10% of the book value of our investment portfolio at the time of purchase. The primary objectives of our investment activities are to preserve principal, maintain proper liquidity to meet operating needs, maximize yields and maintain proper fiduciary control over our investments.
As of September 27, 2009, we did not have any lines of credit or other similar source of liquidity.
                 
    As of     As of  
    December 30,     September 27,  
    2008     2009  
Cash and cash equivalents
  $ 30,425     $ 12,819  
Investments, short-term
    197,941       163,484  
Investments, long-term
          29,023  
Accounts receivable, net
    3,354       18,436  
Working capital
    156,532       90,289  
                 
    Nine     Nine  
    Months     Months  
    Ended     Ended  
    September 28,     September 27,  
    2008     2009  
Cash flow provided by (used in) operating activities
  $ 13,310     $ (13,519 )
Cash flow (used in) provided by investing activities
    (2,213 )     1,381  
Cash flow provided by (used in) financing activities
    460       (5,468 )

 

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We enter into derivative instruments for risk management purposes only and we do not enter into derivative instruments for speculative purposes. Our derivative program does not qualify for hedge accounting treatment. We operate internationally and, in the normal course of business, are exposed to fluctuations in foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating our business.
We use forward foreign currency exchange contracts to manage our exposure to forecasted foreign currency denominated transactions based in the United Kingdom. These forward contracts are not designated as cash flow, fair value or net investment hedges; are marked-to-market with changes in fair value recorded to earnings; and are entered into for periods consistent with currency transaction exposures, generally less than one year. These derivative instruments do not subject our earnings or cash flows to material risk since gains and losses on these derivatives generally offset losses and gains on the expenses and transactions being hedged. In addition, changes in currency exchange rates related to any unhedged transactions may impact our earnings and cash flows. As of September 27, 2009, we had $2.3 million in currency exchange contracts. During the nine months ended September 27, 2009, we recorded $0.7 million of foreign exchange gains in interest and other income, net to the outstanding forward foreign exchange contracts. As of September 27, 2009, the fair value of our forward foreign currency exchange contracts of $0.2 million is included in prepaid expenses and other current assets in the accompanying condensed consolidated balance sheet.
On January 14, 2009, Nortel Networks announced that it and certain of its affiliates had filed for bankruptcy protection. At the time of that filing, we had outstanding invoices to Nortel Networks in the amount of $21.8 million and during the first quarter of fiscal 2009, we invoiced an additional $14.6 million related to royalties earned and services performed through January 13, 2009. The collection of these amounts is subject to Nortel Networks’ bankruptcy proceedings and it is likely that a portion or all of these amounts will not be collected. Had Nortel Networks not filed for bankruptcy protection, these amounts would likely have been paid in due course in the first quarter of 2009. Cash flows for the first half of fiscal 2009 was negatively impacted by $36.4 million, representing the total amount of invoices due during the first half of fiscal 2009 from Nortel Networks, collection of which is subject to their bankruptcy proceedings. In connection with the announcement, Nortel Networks informed us that it will continue to purchase goods and services from us and that we are a long term partner and a key supplier to Nortel Networks. Purchases subsequent to the bankruptcy filing are under the terms of Nortel Networks’ current agreement with us. We have been collecting receivables from Nortel Networks in the ordinary course related to products and services purchased since Nortel Networks’ bankruptcy filing. We have been working with Nortel Networks to assume its agreement with us. If Nortel Networks assumes its agreement with us, Nortel Networks would be required to become current in all of its outstanding obligations to us, including obligations outstanding prior to the bankruptcy filing date. If the agreement is not assumed, all outstanding obligations will be subject to discharge and we likely will not be able to collect these receivables in full. The current status of Nortel Networks’ bankruptcy is described elsewhere in this Quarterly Report.
During the first three quarters of fiscal 2008 we funded our operations primarily with cash flow from operating activities. During the first three quarters of fiscal 2009, we funded our operations primarily from our cash reserves.
In the first three quarters of fiscal 2008, we generated $13.3 million in cash flow from operating activities despite a net loss of $3.6 million. This was primarily a result of an increase in deferred revenue of $32.2 million associated with billings and a decrease in accounts receivable of $6.1 million associated with collections of billings. These increases in cash flow were partially offset by accrued income tax payments of $24.6 million. Our ability to generate cash flow from operations depends in large part on the volume of our product and service billings, our ability to collect accounts receivable, timing of tax payments, and the growth of our operating expenses.
In the first three quarters of fiscal 2009, cash used in operating activities totaled $13.5 million, primarily due to a net loss of $38.1 million, an increase in accounts receivable of $15.1 million and our inability to collect $36.4 million of invoices due from Nortel Networks that are subject to Nortel Networks’ bankruptcy proceedings, partially offset by an increase in deferred revenue of $71.8 million.
Cash flow from investing activities for the first half of fiscal 2008 and 2009 resulted primarily from the timing of purchases, maturities and sales of investments and purchases of property and equipment.
Cash flow from financing activities in the first three quarters of fiscal 2008 consisted primarily of proceeds from the exercise of stock options as well as the tax benefit associated with the exercise of stock options during the year, substantially offset by repurchases of our common stock under our initial $20 million stock repurchase program. Cash flow from financing activities in the first three quarters of fiscal 2009 consisted primarily of repurchases of our common stock under our stock repurchase programs, partially offset by proceeds from the exercise of stock options.

 

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We believe our existing cash, cash equivalents and investments and our cash flows from operating activities will be sufficient to meet our anticipated cash needs for at least one operating cycle (12 months). Our future working capital requirements will depend on many factors, including the collection of $36.4 million of outstanding invoices to Nortel that are subject to Nortel’s bankruptcy filing, the rate of our product and service billings growth, the introduction and market acceptance of new products, the expansion of our sales and marketing and research and development activities, and the timing of our revenue recognition and related income tax payments. To the extent that our cash, cash equivalents and investments and cash from operating activities are insufficient to fund our future activities, we may be required to raise additional funds through bank credit arrangements or public or private equity or debt financings. We also may need to raise additional funds in the event we determine in the future to effect one or more acquisitions of businesses, technologies or products. In the event we require additional cash resources, we may not be able to obtain bank credit arrangements or effect any equity or debt financing on terms acceptable to us or at all.
During the first three quarters of fiscal 2009, we repurchased a total of 1.7 million shares of our common stock for approximately $9.3 million under our initial $20 million stock repurchase program, which was approved by our Board of Directors in July 2008 and completed in April 2009, and our second $20 million stock repurchase program, which was approved by our Board of Directors in February 2009. As of September 27, 2009, there was $17.4 million remaining under the second stock repurchase program, which terminates on April 30, 2010 or earlier if we so elect.
During the first quarter of 2009, the Internal Revenue Service (“IRS”) began an examination of the our U.S. federal income tax returns for the tax years ended December 31, 2006 and December 30, 2007. No adjustments have been proposed to date by the IRS.
In October of 2004, we entered into a seven-year lease agreement for our headquarters facility. We are obligated to pay monthly rent through 2012.
Future minimum commitments as of September 27, 2009, under all of our operating leases are as follows:
         
Fiscal year:        
Remainder of 2009
  $ 400  
2010
    1,587  
2011
    1,491  
2012
    492  
2013
    10  
 
     
 
 
  $ 3,980  
 
     
Item 3.  
Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Exchange Risk
Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British pound and Indian rupee, the currencies in which our operating obligations in Cambridge, United Kingdom and Bangalore, India, are paid. We use derivative instruments to limit our expense and cash flow exposure to changes in currency exchange rates in the United Kingdom. We had currency derivative instruments outstanding in the contract amount of $2.3 million at September 27, 2009. We recorded $204,000 of other assets to recognize the change in fair value of these derivative instruments at September 27, 2009. Should we discontinue using derivative instruments to manage our earnings in the United Kingdom, fluctuations in currency exchange rates could affect our business in the future. To limit further our exposure to currency exchange rate fluctuations, we also occasionally exchange U.S. Dollars for other currencies in which we incur expenses significantly in advance of our need to make payments in those currencies. In the event of a hypothetical ten percent adverse movement in foreign currency exchange rates, taking into account our hedges described above, our losses of future earnings and assets as well as our loss of cash flows would be immaterial; however, actual effects might differ materially from this hypothetical analysis.

 

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Interest Rate Sensitivity
We had unrestricted cash and cash equivalents and investments totaling $228.4 million at December 28, 2008 and $205.3 million at September 27, 2009. Our existing cash and cash equivalents and investments are invested primarily in money market funds, high grade government sponsored enterprises (AAA/A1+), high-grade commercial paper (A1+/P1) and high grade corporate notes (A1/A+). We do not invest in any types of asset backed securities such as those backed by mortgages or auto loans. None of our investments have incurred defaults or have been downgraded. We do not hold auction rate securities. We hold unrestricted cash and cash equivalents for working capital purposes. We do not enter into investments for trading or speculative purposes. We have an investment policy that guides our investing activities. Among other things, our investment policy limits the concentration of our investments in any one issuer (with the exception of investments in U.S. Treasury and U.S. agency debt obligations and SEC-registered money market funds) to no more than 10% of the book value of our investment portfolio at the time of purchase. The primary objectives of our investment activities are to preserve principal, maintain proper liquidity to meet operating needs, maximize yields and maintain proper fiduciary control over our investments.
Although our investments are subject to credit risk, our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure from any single issue, issuer or type of investments. We do not own derivative financial investment instruments in our investment portfolio. In the event of a hypothetical ten percent adverse movement in interest rates, our losses of future earnings and assets, fair values of risk sensitive financial instruments, as well as our loss of cash flows would be immaterial; however, actual effects might differ materially from this hypothetical analysis.
Item 4.  
Changes in Internal Controls over Financial Reporting and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 27, 2009. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 27, 2009, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting occurred during the fiscal quarter ended September 27, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. Other Information
Item 1A.  
Risk Factors
Our business is subject to numerous risks. We caution you that the following important factors, among others, could cause our actual results to differ materially from those expressed in forward-looking statements made by us or on our behalf in filings with the SEC, press releases, communications with investors and oral statements. Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q and in any other public statements we make may turn out to be wrong. They may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from those anticipated in forward-looking statements. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosure we make in our reports filed with the SEC.
Risks Relating to Our Business
We depend on a single OEM customer that recently filed for bankruptcy protection, Nortel Networks, for almost all of our revenue and billings, and a significant shortfall in sales to Nortel Networks or the successor to its CDMA business would significantly harm our business and operating results; Nortel Networks’ CDMA business may soon be sold.
We derived almost all of our revenue and billings in each of the last several years from sales to a single OEM customer, Nortel Networks. Nortel Networks accounted for 86% of our revenue and 89% of our billings in the first three quarters of fiscal 2009, 99% of our revenue and 93% of our billings in fiscal 2008, 99% of our revenue and 98% of our billings in fiscal 2007 and 95% of our revenue and 94% of our billings in fiscal 2006. On January 14, 2009, Nortel Networks announced that it and certain of its affiliates had filed for bankruptcy protection. At the time of that filing, we had $21.8 million in outstanding invoices to Nortel Networks and we billed an additional $14.6 million during the first quarter of fiscal 2009 related to royalties earned and services provided through January 13, 2009. The collection of these amounts is subject to Nortel Networks’ bankruptcy proceedings and it is likely that a portion or all of these amounts will not be collected. As a result, we have excluded the $36.4 million of pre-bankruptcy filing outstanding invoices to Nortel Networks from accounts receivable and $36.3 million from deferred revenue as of September 27, 2009, $21.8 million from billings for the quarter and year ended December 28, 2008, and $14.6 million from billings for the quarter ended March 29, 2009.

 

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On July 28, 2009, U.S. and Canadian bankruptcy courts approved a bid by Telefon AB L.M. Ericsson, or Ericsson, a global provider of technology and services to telecom operators, to acquire Nortel Networks’ CDMA business, subject to satisfaction of regulatory and other conditions. Since the date of Nortel Networks’ bankruptcy filing, we and Nortel Networks have continued to deliver products and services to Nortel Networks’ CDMA EV-DO wireless operators under the terms of Nortel Networks’ existing agreement with us. We are continuing to incur costs related to the research and development of future software releases for Nortel Networks. Although we intend to work with Nortel Networks and Ericsson to have our agreement assumed, there can be no assurance that our agreement with Nortel Networks will be assumed or that we will recover our costs. Even if our agreement with Nortel Networks is assumed there are no assurances that we will be able to collect all of Nortel Network’s outstanding obligations to us, including obligations outstanding prior to January 14, 2009. If our agreement is not assumed, all outstanding obligations will be subject to discharge and we likely will not be able to collect these receivables in full. Should our agreement with Nortel Networks not be assumed, we would cease to do business with the purchaser of Nortel Networks’ CDMA business unless we could agree on the terms for a new agreement. Any new terms agreed to could be less favorable to us than our current agreement.
In addition, because of Nortel Networks’ bankruptcy filing, operators may continue to slow or discontinue their purchases of infrastructure solutions from Nortel Networks, especially new customers that have not yet established a long-term relationship with Nortel Networks, which would harm our business. In the fourth quarter of fiscal 2008, Nortel Networks announced new EV-DO business with China Telecom. The first phase deployments at China Telecom were completed in the first half of fiscal 2009. We believe any further expansion is unlikely. Furthermore, we anticipate that we will continue incur some costs related to working with Nortel Networks and Ericsson to assume our contract and collect our outstanding invoices. This process could continue to be time consuming and could divert management’s attention and resources away from our business.
Even if our contract is assumed, Ericsson, as successor to Nortel Networks’ CDMA business, could terminate that contract at any time and, in any event, the contract does not contain commitments for future purchases of our products. The rate at which Nortel Networks’ CDMA business purchases products from us depends on its success in selling to operators its own EV-DO infrastructure solutions that include our products. There can be no assurance that Nortel Networks or Ericsson, as successor to Nortel Networks’ CDMA business, will continue to devote and invest significant resources and capital to its wireless infrastructure business or that it will be successful in the future in such business. Nortel Networks or Ericsson, as successor to Nortel Networks’ CDMA business, may experience disruptions in its supply chain as a result of uncertainty related to their bankruptcy filing and proposed sale. In addition, Nortel Networks may seek to develop an alternative solution by utilizing technology that has been developed by LG Electronics, with which Nortel Networks has a joint venture. Should Ericsson successfully complete the acquisition of Nortel Networks’ CDMA business, it could seek to deploy alternative solutions by utilizing technology that has been developed by it or slow its participation in the CDMA infrastructure business, including EV-DO. Should the bankruptcy proceedings and acquisition of Nortel Networks’ CDMA infrastructure business be delayed, our ability to negotiate commercial terms of our planned software releases may be hampered, operators may delay deployment of our releases, and our business and operating results may be harmed. If Nortel Networks is not successful in carrying out its planned sale of its CDMA business to Ericsson, Nortel Networks could have significant liquidity issues and cease to operate. We expect to derive a substantial majority of our revenue, billings and cash flow in fiscal 2009 and fiscal 2010 from Nortel Networks, and therefore any adverse change in our relationship with Nortel Networks, or the successor to its CDMA business, or a significant decline or shortfall in our sales to Nortel Networks, would significantly harm our business and operating results.
Because our OEM business model requires us to defer the recognition of most of our revenue from product and service sales until we deliver specified upgrades, and in some cases to further defer a portion of our revenue until applicable warranty periods expire, our revenue in any period is not likely to be indicative of the level of our sales activity in that period.
We recognize revenue from the sale of products and services under our OEM agreements only after we deliver specified upgrades to those products that were committed at the time of sale. The period of development of these upgrades can range from 12 to 24 months after the date of commitment. As a result, most of our revenue in any quarter typically reflects license fees under our OEM agreements for products and services delivered and invoiced to customers several quarters earlier. For these products and services, we generally record the amount of the invoice as deferred revenue and then begin to recognize such deferred revenue as revenue upon delivery of the committed software upgrades. When we cannot establish vendor specific objective evidence, or VSOE, of fair value for our maintenance and support services, we recognize a portion of the product and services revenue based on the portion of the maintenance period that has elapsed when the revenue first becomes recognizable, and we recognize the remaining portion of that product and services revenue ratably over the remaining maintenance period. As a result, our revenue is not likely to be indicative of the level of our sales activity in any period. Due to our OEM business model, we expect that, for the foreseeable future, any quarter in which we recognize a significant amount of deferred revenue as a result of our delivery of a previously committed upgrade will be followed by one or more quarters of insignificant revenue as we defer revenue while we develop additional upgrades. Investors may encounter difficulties in tracking the performance of our business because our revenue will not reflect the level of our billings in any period, and these difficulties could adversely affect the trading price of our common stock.

 

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Our revenue and billings growth may be constrained by our product concentration and lack of revenue diversification.
Almost all of our revenue and billings to date have been derived from sales of our EV-DO products, and we expect EV-DO revenues to remain a major contributor to revenue for the foreseeable future. Continued market acceptance of these products is critical to our future success. The future demand for our EV-DO products depends, in large part, on the continued expansion of the EV-DO-based wireless networks currently deployed by operators and determinations by additional operators to deploy EV-DO-based wireless networks. Demand for our EV-DO products also depends on our ability to continue to develop and deliver on a timely basis product upgrades to enable operators to enhance the performance of their networks and implement new mobile broadband services. Any decline in demand for EV-DO products, or inability on our part to develop and deliver product upgrades that meet the needs of operators, would adversely affect our business and operating results.
A majority of our current products are based exclusively on the CDMA2000 air interface standard for wireless communications, and therefore any movement by existing or prospective operator customers to a different standard could impair our business and operating results.
There are multiple competing air interface standards for wireless communications networks. A majority of our current products are based exclusively on the CDMA2000 air interface standard, which handles a majority of wireless subscribers in the United States. Other standards, such as GSM/UMTS, are currently the primary standards used by wireless operators in mobile networks worldwide. Our EV-DO products do not operate in networks using the GSM/UMTS standards.
We believe there are a limited number of operators that have not already chosen the air interface standard to deploy in their 3G wireless networks. Our success will therefore depend, to a significant degree, on whether operators that have currently deployed CDMA2000-based networks expand and upgrade their networks and whether additional operators that have not yet deployed 3G networks select CDMA2000 as their standard. Our business will be harmed if operators currently utilizing the CDMA2000 standard transition their networks to a competing standard and we have not at that time developed and begun to offer competitive products that are compatible with that standard. Our business will also be harmed if operators that have currently deployed both CDMA and GSM/UMTS networks determine to focus more of their resources on their GSM/UMTS networks.
The introduction of fourth generation wireless technology could reduce spending on our EV-DO products and therefore harm our operating results.
The standards for mobile broadband solutions are expected to evolve into a fourth generation of wireless standards, known as 4G. Wireless operators have announced plans to build networks based on the 4G standard. For example, Verizon Wireless, Bell Mobility and TELUS have each announced its intent to build 4G networks using the Long Term Evolution, or LTE, standard and Sprint Nextel has announced its intent to build a 4G network using WiMAX technology. In addition, Bell Mobility and TELUS each recently announced that they will overlay their CDMA networks with UMTS technology as they migrate to the LTE standard. The market for our existing EV-DO products is likely to decline if and when operators begin to delay expenditures for EV-DO products in anticipation of the availability of new 4G-based products. Our primary OEM customer, Nortel Networks, has publicly announced that it is developing 4G-based LTE products. We do not have an agreement to supply Nortel Networks, any successor to Nortel Networks’ CDMA business, or any other OEM with any 4G-based products. We believe that it is likely that Nortel Networks, or any successor to Nortel Networks business, will choose to enter into partnerships for 4G-based products with one or more of our competitors or choose to develop these products internally.
Our future success will depend on our ability to develop and market new products compatible with 4G standards and the acceptance of those products by operators. The development and introduction of these products will be time consuming and expensive, and we may not be able to correctly anticipate the market for 4G-compatible products and related business trends. Any inability to develop successfully 4G-based products could harm significantly our future business and operating results.
The variable sales and deployment cycles for our EV-DO products are likely to cause our quarterly billings to fluctuate materially.
The deployment by operators of wireless infrastructure equipment that enables new end-user services typically occurs in stages, and our quarterly billings will vary significantly depending on the rate at which such deployments occur. Operators will typically make significant initial investments for new equipment to assure that new services facilitated by such equipment are available to end-users throughout the operator’s network. Operators typically will defer significant additional purchases of such equipment until end-user usage of the services offered through such equipment creates demand for increased capacity. Our quarterly billings will typically increase significantly when an operator either chooses initially to deploy an EV-DO network or deploys a significant product upgrade introduced by us, and our quarterly billings will decline in other quarters when those deployments have been completed.

 

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It is difficult to anticipate the rate at which operators will deploy our wireless infrastructure products, the rate at which the use of new mobile broadband services will create demand for additional capacity, and the rate at which operators will implement significant product upgrades. For example, our product and service billings in fiscal 2006 reflected an increase in sales of software for OEM base station channel cards that support Rev A as operators ramped up their deployments of EV-DO infrastructure. Our product and service billings for each of the second half of fiscal 2007 and the first half of fiscal 2008 were less than our product and service billings for the first half of fiscal 2007. Our product and service billings for the second half of fiscal 2008 were greater than they were for the first half of fiscal 2008. We believe that several large operators completed their initial deployments of Rev A software in the first half of fiscal 2007 and then moderated their deployments over the remainder of the year. We believe that several large operators began their capacity deployments in the second half of fiscal 2008. The staged deployments of wireless infrastructure equipment by customers of both our existing and new OEMs are likely to continue to cause significant volatility in our quarterly operating results.
If demand for mobile broadband services does not grow as quickly as we anticipate, or develops in a manner that we do not anticipate, our revenue and billings may decline or fail to grow, which would adversely affect our operating results.
We derive, and expect to continue to derive, a substantial portion of our revenue and billings from sales of mobile broadband infrastructure products. We expect demand for mobile broadband services to continue to be the primary driver for growth and expansion of EV-DO networks. The market for mobile broadband services is relatively new and still evolving, and it is uncertain whether these services will achieve and sustain high levels of demand and market acceptance. The level of demand and continued market acceptance for these services may be adversely affected by factors that limit or interrupt the supply of mobile phones designed for EV-DO networks. In addition, the unavailability of EV-DO versions of popular mobile devices, such as the Apple i-Phone that only work on UMTS technology, could hamper the expansion of EV-DO networks. Another expected driver for the growth of EV-DO networks is VoIP. The migration of voice traffic to EV-DO networks will depend on many factors outside of our control. If the demand for VoIP and other mobile broadband services does not grow, or grows more slowly than expected, the need for our EV-DO products would be diminished and our operating results would be significantly harmed.
Deployments of our EV-DO products by two large U.S. wireless operators account for a substantial majority of our revenue and billings, and a decision by these operators to reduce their use of our products would harm our business and operating results.
A substantial portion of our cumulative billings for fiscal 2006, 2007 and 2008 and the first three quarters of fiscal 2009 were attributable to sales of our EV-DO products by Nortel Networks to two large wireless operators in North America. Our sales of EV-DO products currently depend to a significant extent on the rate at which these operators expand and upgrade their CDMA networks. Our business and operating results would be harmed if either of these operators were to select a wireless network solution offered by a competitor or for any other reason were to discontinue or reduce the use of our products or product upgrades in their networks.
If the market for our FMC products does not develop as we expect, or our FMC products do not achieve sufficient market acceptance, our business will suffer.
We are investing significantly in the development of both our EV-DO based and UMTS based FMC products so that operators may offer mobile broadband services using wireline broadband connections and a combination of mobile and Wi-Fi networks. We do not expect to have meaningful sales of our CDMA FMC products until the first half of fiscal 2010, depending on operators’ deployment plans. However, it is possible that the market for our FMC products will not develop as we expect. The market for our UMTS FMC products is developing more slowly than the market for our CDMA products. It is uncertain whether our FMC products will achieve and sustain high levels of demand, market acceptance and profitability. Our ability to sell our FMC products will depend, in part, on factors outside our control, such as the commercial availability and market acceptance of mobile phones designed to support FMC applications and the market acceptance of femtocell access point products. The market for our FMC products may be smaller than we expect, the market may develop more slowly than we expect or our competitors may develop alternative technologies that are more attractive to operators. Our FMC products are an important component of our growth and diversification strategy and, therefore, if we are unable to successfully execute on this strategy, our sales, billings and revenues could decrease and our operating results could be harmed.
Our future sales will depend on our success in generating sales to a limited number of OEM customers, and any failure to do so would have a significant detrimental effect on our business.
There are a limited number of OEMs that offer EV-DO solutions, several of which have developed their own EV-DO technology internally and, therefore, do not require solutions from us. We currently have agreements with two OEM customers, one of whom is in bankruptcy (Nortel Networks’ bankruptcy and its implications for us are discussed elsewhere in this Quarterly Report). We do not expect to commence significant sales to one of these OEM customers in the immediate future because the markets for the products that we are developing for this customer are still developing. The market for our FMC products is still developing. We currently have agreements with four OEM customers to deliver our UMTS femtocell product solutions and agreements with four OEM customers and one operator customer to deliver our CDMA femtocell product solutions, but have not yet had any significant sales to these customers. Our operating results for the foreseeable future will depend to a significant extent on our ability to effect sales to our existing CDMA and UMTS OEM customers and to establish new OEM relationships. Our OEM customers have substantial purchasing power and leverage in negotiating pricing and other contractual terms with us. In addition, further consolidation in the communications equipment market could adversely affect our OEM customer relationships. If we fail to generate significant product and service billings through our existing OEM relationships or if we fail to establish significant new OEM relationships, we will not be able to achieve our anticipated level of sales and our results of operations will suffer.

 

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The unpredictability of our future results may adversely affect the trading price of our common stock.
Our operating results have varied significantly from period to period, and we expect them to continue to vary significantly from period to period for the foreseeable future due to a number of factors in addition to the unpredictable purchasing patterns of operators. The following factors, among others, can contribute to the unpredictability of our operating results:
   
the effect of our OEM business model or changes to this model on our revenue recognition;
 
   
the timing of agreements or commitments with our OEM customers for new products or software upgrades;
 
   
the timing of our delivery of software upgrades;
 
   
the timing of our delivery of maintenance and support sold with products;
 
   
the ability of our customers to pay amounts owed to us as they become due (or in the case of Nortel Networks, when they would have become due, but for their filing for bankruptcy);
 
   
the unpredictable deployment and purchasing patterns of operators;
 
   
fluctuations in demand for products of our OEM customers that are sold together with our products, and the timing and size of orders for such products of our OEM customers;
 
   
new product introductions and enhancements by our competitors and us;
 
   
the timing and acceptance of software upgrades sold by our OEM customers to their installed base of operators;
 
   
changes in our pricing policies or the pricing policies of our competitors;
 
   
our ability to develop, introduce and deploy new products and product upgrades that meet customer requirements in a timely manner;
 
   
adjustments in the reporting of royalties and product sales by our OEM customers resulting from reviews and audits of such reports;
 
   
our and our OEM customers’ ability to obtain sufficient supplies of limited source components or materials;
 
   
our and our OEM customers’ ability to attain and maintain production volumes and quality levels for our products; and
 
   
general economic conditions, as well as those specific to the communications, networking, wireless and related industries.
Our operating expenses are largely based on our anticipated organizational and product and service billings growth, especially as we continue to invest significant resources in the development of future products and expand our international presence. Most of our expenses, such as employee compensation, are relatively fixed in the short term. As a result, any shortfall in product and service billings in relation to our expectations could cause significant changes in our operating results from period to period and could result in negative cash flow from operations.
We believe that comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. It is likely that in some future periods, our revenue, product and service billings, earnings, cash from operations or other operating results will be below the expectations of securities analysts and investors. In that event, the price of our common stock may decrease substantially.

 

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We may not be able to achieve profitability for any period in the future or sustain cash flow from operating activities.
We began to recognize revenue in fiscal 2002, began to have positive cash flow from operating activities in fiscal 2004 and achieved profitability in fiscal 2006. We have only a limited operating history on which you can base your evaluation of our business, including our ability to continue to grow our revenue and billings and to sustain cash flow from operating activities and profitability. The amount and percentage of our operating expenses that are fixed expenses have increased as we have grown our business. As we continue to expand and develop our business, we will need to generate significant billings to maintain positive cash flow from operating activities, and we might not sustain positive cash flow from operating activities for any substantial period of time. We do not expect to achieve profitability for any fiscal year unless we are able to recognize significant revenue from our OEM arrangements in that fiscal year. If we are unable to increase our billings and sustain cash flow from operating activities, the market price of our common stock will likely fall.
On January 14, 2009, Nortel Networks announced that it and certain of its affiliates had filed for bankruptcy protection. As of September 27, 2009, we had $36.4 million of outstanding invoices to Nortel Networks related to royalties earned and services provided through January 13, 2009. The collection of these amounts is subject to Nortel Networks’ bankruptcy proceedings and a portion or all of these amounts may not be collected. Had Nortel Networks not filed for bankruptcy protection, these amounts would likely have been paid in due course in the first and second quarter of fiscal 2009. Our cash flows for the first three quarters of fiscal 2009 were negatively impacted by $36.4 million, representing the total billed amounts due from Nortel Networks at the time of the filing.
Claims by other parties that we infringe their proprietary technology could force us to redesign our products or to incur significant costs.
Many companies in the wireless industry have significant patent portfolios. These companies and other parties may claim that our products infringe their proprietary rights. We may become involved in litigation as a result of allegations that we infringe the intellectual property rights of others. Any party asserting that our products infringe their proprietary rights would force us to defend ourselves, and possibly our customers, against the alleged infringement. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. We also could be forced to do one or more of the following:
   
stop selling, incorporating or using our products that use the challenged intellectual property;
 
   
obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all;
 
   
redesign those products that use any allegedly infringing technology, which may be costly and time-consuming; or
 
   
refund deposits and other amounts received for allegedly infringing technology or products.
For example, in 2006, we received a letter from Wi-LAN Inc. asserting that some of our EV-DO products infringe two issued United States patents and an issued Canadian patent relating to wireless communication technologies. A majority of our revenue to date has been derived from the allegedly infringing EV-DO products. We have evaluated various matters relating to Wi-LAN’s assertion and we do not believe that such products infringe any valid claim of the patents identified by Wi-LAN in that letter. In November 2007, we received an additional letter from Wi-LAN asserting that some of our other products infringe one of the previously identified United States patents and that the products identified in the first letter and some of our other products infringe two other United States patents. We have evaluated Wi-LAN’s claims related to the products and patents identified in its November 2007 letter and we do not believe that our products infringe any valid claim of the patents identified by Wi-LAN in that letter. Under certain circumstances we may seek to obtain a license to use the relevant technology from Wi-LAN. We cannot be certain that Wi-LAN would provide such a license or, if provided, what its economic terms would be. If we were to seek to obtain such a license, and such license were available from Wi-LAN, we could be required to make significant payments with respect to past and/or future sales of our products, and such payments may adversely affect our financial condition and operating results. If Wi-LAN determines to pursue claims against us for patent infringement, we might not be able to successfully defend against such claims.
Intellectual property litigation can be costly. Even if we prevail, the cost of such litigation could deplete our financial resources. Litigation is also time consuming and could divert management’s attention and resources away from our business. Furthermore, during the course of litigation, confidential information may be disclosed in the form of documents or testimony in connection with discovery requests, depositions or trial testimony. Disclosure of our confidential information and our involvement in intellectual property litigation could materially adversely affect our business. Some of our competitors may be able to sustain the costs of complex intellectual property litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could significantly limit our ability to continue our operations.

 

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If we are not successful in obtaining from third parties licenses to intellectual property that are required for CDMA and UMTS femtocell products that we are developing, we may not be able to expand our business as expected and our business may suffer.
The CDMA and UMTS femtocell markets are characterized by the presence of many patents held by third parties. We will need to obtain licenses from third parties for intellectual property associated with our development of CDMA and UMTS femtocell products. Any required license might not be available to us on acceptable terms, or at all. If we succeed in obtaining these licenses, but the payments under these licenses are higher than we anticipate, our costs for these products would increase and our operating results would suffer. If we failed to obtain a required license, our ability to develop CDMA and UMTS femtocell products would be impaired, we may not be able to expand our business as expected and our business may suffer.
If we do not timely deliver new and enhanced products that respond to customer requirements and technological changes, operators may not buy our products and our revenue and product and service billings may decline significantly.
The market for our products is characterized by rapid technological change, frequent new product introductions and evolving industry standards. To achieve market acceptance for our products, we must effectively anticipate operator requirements, and we must offer products that meet changing operator demands in a timely manner. Operators may require product features and capabilities that our current products do not have. If we fail to develop products that satisfy operator requirements, our ability to create or increase demand for our products will be harmed.
In developing our wireless infrastructure products, we seek to identify the long-term trends of wireless operators and their customers. The development cycle for our products and technologies can take multiple years. The ultimate success of our new products depends, in large part, on the accuracy of our assessments of the long-term needs of the industry, and it is difficult to change quickly the design or function of a planned new product if the market need does not develop as we anticipate.
We may experience difficulties with software development, industry standards, hardware design, manufacturing or marketing that could delay or prevent our development, introduction or implementation of new products and enhancements. The introduction of new products by competitors, including some of our OEM customers, the emergence of new industry standards or the development of entirely new technologies that replace existing product offerings could render our existing or future products obsolete. If our products become technologically obsolete, operators may purchase solutions offered by our competitors and our ability to generate revenue and product and service billings may be impaired.
Our revenue and product and service billings growth will be limited if our OEM customers are unable to continue to sell our products to large wireless operators or if we have to discount our products to support the selling efforts of our OEM customers.
Our future success depends in part on the ability of our OEM customers to sell our products to large wireless operators operating complex networks that serve large numbers of subscribers and transport high volumes of traffic. Our OEM customers operate in a highly competitive environment and may need to reduce the prices they charge for our products in order to maintain or expand their market share. We may reduce the prices we charge our OEM customers for our products in order to support their selling efforts. If our OEM customers incur shortfalls in their sales of mobile broadband solutions to their existing customers or fail to expand their customer bases to include additional operators that deploy our products in large-scale networks serving significant numbers of subscribers or if we reduce the prices we charge our OEM customers for our products, our operating results will suffer.
We depend on sole sources for certain components of our products and our business would be harmed if supplies from our sole sources were disrupted.
We depend on sole sources for certain components of our products and also rely on contract manufacturers for the production of our hardware products. We have not entered into long-term agreements with any of our suppliers. We depend on several software vendors for the operating system and other capabilities used in our products. In addition, we and one of our OEM customers purchase from Qualcomm the cell site modem chips used in any base station and base station channel cards. If these cell site modem chips were to become unavailable to us or to our OEM customers, it would take us a significant period of time to develop alternative solutions and it is likely that our operating results would be significantly harmed.
The market for network infrastructure products is highly competitive and continually evolving, and if we are not able to compete effectively, we may not be able to continue to expand our business as expected and our business may suffer.
The market for network infrastructure products is highly competitive and rapidly evolving. The market is subject to changing technology trends, shifting customer needs and expectations and frequent introduction of new products.
We expect competition to persist and intensify in the future as the market for network infrastructure products grows and new and existing competitors devote considerable resources to introducing and enhancing products. For our EV-DO products, we face competition from several of the world’s largest telecommunications equipment providers that provide either a directly competitive product or a product based on alternative technologies, including Alcatel-Lucent, Hitachi, Huawei, LG-Nortel and Samsung. In our sales to OEM customers, we face the competitive risk that OEMs might seek to develop internally alternative solutions to those currently purchased from us. Additionally, our OEM customers might elect to purchase technology from our competitors. For our FMC products, our competition includes several public companies, including Cisco and Ericsson, as well as several private companies such as Huawei.

 

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Our current and potential competitors may have significantly greater financial, technical, marketing and other resources than we do and may be able to devote greater resources to the development, promotion, sale and support of their products. In addition, many of our competitors have more extensive customer relationships than we do, and, therefore, our competitors may be in a stronger position to respond quickly to new technologies and may be able to market or sell their products more effectively. Moreover, further consolidation in the communications equipment market could adversely affect our OEM customer relationships and competitive position. Our products may not continue to compete favorably. We may not be successful in the face of increasing competition from new products and enhancements introduced by existing competitors or new companies entering the markets in which we provide products. As a result, we may experience price reductions for our products, order cancellations and increased expenses. Accordingly, our business may not grow as expected and our business may suffer.
Our agreement with our largest OEM customer, Nortel Networks, provides Nortel Networks with an option to license some of our intellectual property to develop internally products competitive with the products it currently purchases from us.
Under our OEM agreement with Nortel Networks, Nortel Networks has the option to purchase from us the specification for communications among base stations, radio network controllers and network management systems. The specification would enable Nortel Networks to develop EV-DO software to work with the base station channel card software licensed from us and deployed in the networks of its wireless operator customers. If Nortel Networks elects to exercise this option, Nortel Networks will pay us a fixed fee as well as a significant royalty on sales of current and future products that incorporate this specification. The royalty rate varies with annual volume but represents a portion of the license fees we currently receive from our sales to Nortel Networks. If Nortel Networks were to exercise the option, Nortel Networks would receive the current interface specification at the time of option exercise, updated with an upgrade then under development, plus one additional upgrade subject to a development agreement within a limited time after the option exercise for an additional fee. If Nortel Networks were in the future to develop its own EV-DO software, it could, by exercising this option, enable its own software to communicate with the base station channel cards currently installed in its customers’ networks. If our agreement with Nortel Networks is assumed, and Ericsson purchases Nortel Networks’ CDMA business, Ericsson will succeed to the rights of Nortel Networks described above.
Adverse conditions in the global economy and disruption of financial and credit markets could negatively affect our customers’, and therefore our performance.
A prolonged economic downturn in the business or geographic areas in which we sell our products could reduce demand for our products and result in a decline in our revenue and billings. Volatility and disruption of financial and credit markets could limit customers’ ability to obtain adequate financing to maintain operations and invest in network infrastructure and therefore also could reduce demand for our products and result in a decline in our revenues and billings.
In addition, during economic downturns, customers may slow the rate at which they pay their vendors or become unable to pay their debts as they become due. If any of our significant customers do not pay amounts owed to us in a timely manner or becomes unable to pay such amounts to us at a time when we have substantial amounts receivable from such customers, our cash flow and results of operations may suffer. As of September 27, 2009, Nortel Networks had outstanding invoices to us of $36.4 million subject to the bankruptcy process. As a consequence of Nortel Networks’ bankruptcy, we were not be able to collect on these invoices when they otherwise were due, and we may never be able to collect them in full, or at all.
Additionally, disruptions of the credit markets and any limitations on the availability of credit to our customers could impact their ability to invest in network infrastructure and purchase our products.
Because our business depends on the continued strength of the communications industry, our operating results will suffer if that industry experiences an economic downturn.
We derive most of our revenue and billings from purchases of our products by customers in the communications industry. Our future success depends upon the continued demand from wireless operators for communications equipment. The communications industry is cyclical and reactive to general economic conditions. In the recent past, worldwide economic downturns, pricing pressures, mergers and deregulation have led to consolidations and reorganizations. These downturns, pricing pressures and restructurings have caused delays and reductions in capital and operating expenditures by many wireless operators. These delays and reductions, in turn, have reduced demand for communications products such as ours. A continuation or recurrence of these industry patterns, as well as general domestic and foreign economic conditions and other factors that reduce spending by companies in the communications industry, could harm our operating results in the future.

 

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The success of our business could be jeopardized if we are unable to protect our intellectual property adequately.
Our success depends to a degree upon the protection of our software, hardware designs and other proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, and confidentiality provisions in agreements with employees, contract manufacturers, consultants, customers and other third parties to protect our intellectual property rights. Other parties may not comply with the terms of their agreements with us, and we may not be able to enforce our rights adequately against these parties. In addition, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. If competitors are able to use our technology, our ability to compete effectively could be harmed. For example, if a competitor were to gain use of certain of our proprietary technology, it might be able to develop and manufacture similarly designed and equipped mobile broadband solutions at a reduced cost, which could result in a decrease in demand for our products. Furthermore, we have adopted a strategy of seeking limited patent protection both in the United States and in foreign countries with respect to the technologies used in or relating to our products. We do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims, and even if patents are issued, they may be contested, circumvented or invalidated over the course of our business. Moreover, the rights granted under any issued patents may not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop and obtain patents for technologies that are similar to or superior to our technologies. If that happens, we may need to license these technologies and we may not be able to obtain licenses on reasonable terms, if at all, thereby causing great harm to our business. In addition, if we resort to legal proceedings to enforce our intellectual property rights, the proceedings could become burdensome and expensive, even if we were to prevail.
We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders and harm our financial condition and operating results.
We intend to pursue acquisitions of companies or assets in order to enhance our market position or expand our product portfolio. We may not be able to find suitable acquisition candidates and we may not be able to complete acquisitions on favorable terms, if at all. If we do complete acquisitions, we cannot be sure that they will ultimately strengthen our competitive position or that they will not be viewed negatively by customers, securities analysts or investors. In addition, any acquisitions that we make could lead to difficulties in integrating personnel and operations from the acquired businesses and in retaining and motivating key personnel from those businesses. Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities, increase our expenses and harm our operating results or financial condition. Future acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, which could harm our business, financial condition and operating results.
The outcome of an ongoing IRS examination of our tax returns, future interpretations of existing accounting standards or the application of new accounting standards could adversely affect our cash balance and operating results.
During the first quarter of 2009, the IRS began an examination of the our U.S. federal income tax returns for the tax years ended December 31, 2006 and December 30, 2007. No adjustments have been proposed to date by the IRS. However, the IRS has met with us regarding our tax treatment of deferred revenue and is in the process of finalizing its position which may differ from our position. We have elected to defer advance payments, that are also deferred for GAAP financial reporting purposes, for up to one year under IRS Revenue Procedure 2004-34 based on the fact that we have ongoing obligations with respect to those advanced payments. Should the IRS challenge our position and prevail on appeal, there would be no impact on tax expense, however the inclusion of these advance payments in taxable income would be accelerated by one year and we would be required to pay such taxes. We would also be liable for interest on amounts deferred in prior years.
GAAP is subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, or AICPA, the SEC and various other bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and they could affect the reporting of transactions completed before the announcement of a change.
For example, we recognize substantially all of our revenue in accordance with ASC 985-605. The AICPA and its Software Revenue Recognition Task Force continue to issue interpretations and guidance for applying the relevant accounting standards to a wide range of sales contract terms and business arrangements that are prevalent in software licensing arrangements and arrangements for the sale of hardware products that contain more than an insignificant amount of software. We collaborate with our OEM customers to develop and negotiate pricing for specific features for future product releases and specified software upgrades. Because we do not sell the same products and upgrades to more than one customer, we are unable to establish fair value for these products and upgrades. As a result, under ASC 985-605, we are required to defer most of our revenue from sales to our OEM customers until after we ship specified upgrades that were committed to the OEM customer at the time of sale. Future interpretations of existing accounting standards, including ASC 985-605, or changes in our business practices could result in future changes in our revenue recognition accounting policies that have a material adverse effect on our results of operations.
In August 2008, the SEC decided to seek public comments on the potential mandatory adoption of International Financial Reporting Standards, or IFRS, by all U.S. issuers. The proposed roadmap targets potential mandatory adoption of IFRS in the United States beginning in 2014, but lays out several milestones that would need to be achieved prior to the SEC mandating use of IFRS for all U.S. issuers. The proposed rule would allow certain qualifying domestic issuers to use IFRS as early as fiscal years ending on or after December 15, 2009. Should we be required to adopt IFRS, our operating results for past, current, or future periods may be adversely affected. We have not yet assessed the impact of potentially applying IFRS.

 

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In December 2008, the FASB and the International Accounting Standards Board issued a discussion paper which detailed their preliminary views on a single, assets-and liabilities-based revenue recognition model that they believe will improve financial reporting. If and when a new revenue recognition model is finalized, it may change the way in which we recognize and record revenue and could adversely affect our operating results in current or future periods. We have not yet assessed the impact of this preliminary revenue recognition model.
In September 2009, the Emerging Issues Task Force (“EITF”) finalized two revenue recognition standards which reduced the number of transactions accounted for under ASC 985-605 and modified the scope of this standard. We have not yet fully completed our analysis of the new pronouncements, which will be effective for new or materially modified contracts in fiscal years beginning on or after June 15, 2010.
The loss of key personnel or an inability to attract and retain additional personnel may impair our ability to grow our business.
We are highly dependent upon the continued service and performance of our senior management team and key technical and sales personnel, including our President and Chief Executive Officer, Chief Technical Officer, and Vice President, Femto Business and Corporate Development. None of these officers is a party to an employment agreement with us, and any of them therefore may terminate employment with us at any time with no advance notice. The replacement of these officers likely would involve significant time and costs, and the loss of these officers may significantly delay or prevent the achievement of our business objectives.
We face intense competition for qualified individuals from numerous technology, software and manufacturing companies. For example, our competitors may be able to attract and retain a more qualified engineering team by offering more competitive compensation packages. If we are unable to attract new engineers and retain our current engineers, we may not be able to develop and service our products at the same levels as our competitors and we may, therefore, lose potential customers and sales penetration in certain markets. Our failure to attract and retain suitably qualified individuals could have an adverse effect on our ability to implement our business plan and, as a result, our ability to compete effectively in the mobile broadband solutions market could decrease, our operating results could suffer and our revenues could decrease.
We have incurred, and will continue to incur, significant increased costs as a result of operating as a public company as compared with our history as a private company, and our management is required to devote substantial time to public company compliance initiatives. If we are unable to absorb these increased costs or maintain management focus on development and sales of our product offerings and services, we may not be able to achieve our business plan.
As a public company, we have incurred, and will continue to incur, significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and the NASDAQ Stock Market, have imposed a variety of requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel have and will continue to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and have made some activities more time-consuming and costly. For example, we believe these new rules and regulations have made it more difficult and expensive for us to obtain director and officer liability insurance.
We are exposed to potential risks and will continue to incur significant costs as a result of the internal control testing and evaluation process mandated by Section 404 of the Sarbanes-Oxley Act of 2002.
We assessed the effectiveness of our internal control over financial reporting as of December 28, 2008 and assessed all deficiencies on both an individual basis and in combination to determine if, when aggregated, they constitute a material weakness. As a result of this evaluation, no material weaknesses were identified.

 

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We expect to continue to incur significant costs, including increased accounting fees and increased staffing levels, in order to maintain compliance with Section 404 of the Sarbanes-Oxley Act. We continue to monitor our controls for any weaknesses or deficiencies. No evaluation can provide complete assurance that our internal controls will detect or uncover all failures of persons within our company to disclose material information otherwise required to be reported. The effectiveness of our controls and procedures could also be limited by simple errors or faulty judgments. In addition, as we continue to expand globally, the challenges involved in implementing appropriate internal controls will increase and will require that we continue to improve our internal controls over financial reporting.
In the future, if we fail to complete our Sarbanes-Oxley 404 evaluation in a timely manner, or if our independent registered public accounting firm cannot attest in a timely manner to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal controls which could adversely impact the market price of our common stock. We or our independent registered public accounting firm may identify material weaknesses in internal controls over financial reporting which may result in a loss of public confidence in our internal controls and adversely impact the market price of our common stock. In addition, any failure to implement required, new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations.
If we are unable to manage our growth and expand our operations successfully, our business and operating results will be harmed and our reputation may be damaged.
We anticipate that further expansion of our infrastructure and headcount may be required to achieve planned expansion of our product offerings and planned increases in our customer base. Our growth has placed, and is expected to continue to place, a significant strain on our administrative and operational infrastructure. Our ability to manage our operations and growth will require us to continue to refine our operational, financial and management controls, human resource policies, and reporting systems and procedures.
We may not be able to implement improvements to our management information and control systems in an efficient or timely manner and may discover deficiencies in existing systems and controls. If we are unable to manage future expansion, our ability to provide high quality products and services could be harmed, which would damage our reputation and brand and substantially harm our business and results of operations.
We may need additional capital in the future, which may not be available to us, and if it is available, may dilute our existing stockholders’ ownership of our common stock.
We may need to raise additional funds through public or private debt or equity financings in order to:
   
fund ongoing operations;
 
   
take advantage of opportunities, including more rapid expansion of our business or the acquisition of complementary products, technologies or businesses;
 
   
develop new products; or
 
   
respond to competitive pressures.
Any additional capital raised through the sale of equity may dilute our current stockholders’ percentage ownership of our common stock. Capital raised through debt financing would require us to make periodic interest payments and may impose potentially restrictive covenants on the conduct of our business. Furthermore, additional financings may not be available on terms favorable to us, or at all, particularly in the current economic environment. A failure to obtain additional funding could prevent us from making expenditures that may be required to grow or maintain our operations.
Our ability to sell our products depends in part on the quality of our support and services offerings, and our failure to offer high quality support and services would have a material adverse effect on our sales and operating results.
Once our products are deployed within an operator’s network, the operator and our OEM customer depend on our support organization to resolve issues relating to our products. A high level of support is critical for the successful marketing and sale of our products. If we do not effectively assist operators in deploying our products, succeed in helping operators quickly resolve post-deployment issues, and provide effective ongoing support it would adversely affect our ability to sell our products. As a result, our failure to maintain high quality support and services would have a material adverse effect on our business and operating results.
Our products are highly technical and may contain undetected software or hardware errors, which could cause harm to our reputation and adversely affect our business.
Our products are highly technical and complex and are critical to the operation of many networks. Our products have contained and are expected to continue to contain one or more undetected errors, defects or security vulnerabilities. Some errors in our products may only be discovered after a product has been installed and used by an operator. For example, we have encountered errors in our software products that have caused operators using our products to experience a temporary loss of certain network services. Any errors, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business, results of operations and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claims related to changes to our products made by our OEM customers. Our contracts for the sale of our products contain provisions relating to warranty disclaimers and liability limitations, which in certain cases may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our financial condition could be harmed.

 

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Our international operations subject us to additional risks that can adversely affect our operating results.
We have sales personnel in seven countries worldwide, approximately 180 engineers and support staff in Bangalore, India and approximately 50 engineers and support staff in Cambridge, United Kingdom. We expect to continue to add personnel in foreign countries, especially at our Bangalore, India and Cambridge, United Kingdom facilities. Our international operations subject us to a variety of risks, including:
   
the difficulty of managing and staffing foreign offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;
 
   
difficulties in enforcing contracts, collecting accounts receivable and longer payment cycles, especially in emerging markets;
 
   
the need to localize our products and licensing programs for international customers;
 
   
tariffs and trade barriers and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;
 
   
increased exposure to foreign currency exchange rate risk; and
 
   
reduced protection for intellectual property rights in some countries.
As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our foreign operations incur expenses in local currencies. Because we incur a substantial portion of our operating expenses in India and the United Kingdom, we are subject to currency exchange risks between the U.S. Dollar on the one hand, and the Indian rupee and British pound, on the other. We may derive some of our future revenue from customers in foreign countries that pay for our products in the form of their local currency, which also would subject us to currency exchange risks. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, operating results and financial condition.
If wireless devices pose safety risks, we may be subject to new regulations, and demand for our products and those of our licensees and customers may decrease.
Concerns over the effects of radio frequency emissions, even if unfounded, may have the effect of discouraging the use of wireless devices, which would decrease demand for our products and those of our licensees and customers. In recent years, the FCC and foreign regulatory agencies have updated the guidelines and methods they use for evaluating radio frequency emissions from radio equipment, including wireless phones and other wireless devices. In addition, interest groups have requested that the FCC investigate claims that wireless communications technologies pose health concerns and cause interference with airbags, hearing aids and other medical devices. Concerns have also been expressed over the possibility of safety risks due to a lack of attention associated with the use of wireless devices while driving. Any legislation that may be adopted in response to these expressions of concern could reduce demand for our products and those of our licensees and customers in the United States as well as foreign countries.

 

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Risks Relating to Ownership of Our Common Stock
The market price of our common stock may be volatile.
Our common stock has a limited trading history. The trading prices of the securities of technology companies have been highly volatile. Some of the factors that may cause the market price of our common stock to fluctuate include:
   
fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;
 
   
fluctuations in our revenue as a result of our revenue recognition policy, even during periods of significant sales activity;
 
   
changes in estimates of our financial results or recommendations by securities analysts;
 
   
failure of any of our products to achieve or maintain market acceptance;
 
   
any adverse change in our relationship with Nortel Networks, including as a result of Nortel Networks’ bankruptcy filing;
 
   
any adverse resolution of the IRS examination of the our U.S. federal income tax returns for the tax years ended December 31, 2006 and December 30, 2007;
 
   
changes in market valuations of similar companies;
 
   
success of competitive products;
 
   
the progress of the sale of Nortel Networks’ CDMA business, whether to Ericsson or another purchaser;
 
   
changes in our capital structure, such as future issuances of securities or the incurrence of debt;
 
   
announcements by us or our competitors of significant products, contracts, acquisitions or strategic alliances;
 
   
regulatory developments in the United States, foreign countries or both;
 
   
litigation involving our company, our general industry or both;
 
   
additions or departures of key personnel;
 
   
general perception of the future of CDMA technology;
 
   
investors’ general perception of us; and
 
   
changes in general economic, industry and market conditions.
In addition, if the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to class action lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.
If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.
The trading market for our common stock will rely in part on the research and reports that equity research analysts publish about us and our business. We do not control these analysts. The price of our stock could decline if one or more equity analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.
A significant portion of our total outstanding shares may be sold into the public market in the near future, which could cause the market price of our common stock to drop significantly, even if our business is doing well.
If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sell shares of common stock, the market price of our common stock could decline significantly.
The holders of a majority of our common stock have rights, subject to some conditions, to require us to file registration statements under the Securities Act or to include their shares in registration statements that we may file in the future for ourselves or other stockholders. If we register their shares of common stock, they could sell those shares in the public market.

 

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Our directors and management will exercise significant control over our company.
Our directors and executive officers and their affiliates beneficially owned a majority of our outstanding common stock as of September 27, 2009. As a result, these stockholders, if they act together, are able to influence our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control of our company and might affect the market price of our common stock.
Provisions in our certificate of incorporation, our by-laws or Delaware law might discourage, delay or prevent a change in control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Provisions of our certificate of incorporation, our by-laws or Delaware law may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which our stockholders might otherwise receive a premium for their shares of our common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include:
   
limitations on the removal of directors;
 
   
a classified board of directors so that not all members of our board are elected at one time;
 
   
advance notice requirements for stockholder proposals and nominations;
 
   
the inability of stockholders to act by written consent or to call special meetings;
 
   
the ability of our board of directors to make, alter or repeal our by-laws; and
 
   
the ability of our board of directors to designate the terms of and issue new series of preferred stock without stockholder approval, which could be used to institute a rights plan, or a poison pill, that would work to dilute the stock ownership of a potential hostile acquirer, likely preventing acquisitions that have not been approved by our board of directors.
In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly-held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns, or within the last three years has owned, 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner.
The existence of the foregoing provisions and anti-takeover measures could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that stockholders could receive a premium for their common stock in an acquisition.
We do not currently intend to pay dividends on our common stock and, consequently, the ability to achieve a return on an investment in our common stock will depend on appreciation in the price of our common stock.
Although we paid a special cash dividend on our capital stock in April 2007, we do not intend to pay any cash dividends on our common stock for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, stockholders are not likely to receive any dividends on shares of common stock for the foreseeable future.

 

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Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
During the third quarter of fiscal 2009, we repurchased shares of our common stock under our second stock repurchase program as follows:
                                 
                            Approximate  
                            Dollar Value  
                    Total     of  
                    Number of     Shares That  
                    Shares     May  
                    Purchased     Yet Be  
    Total     Average     as Part of     Purchased  
    Number     Price     Publicly     Under the  
    of Shares     Paid per     Announced     Announced  
Period   Purchased     Share     Program     Program  
Through June 28, 2009
                          $ 17,753  
June 29, 2009 — July 26, 2009
        $           $ 17,753  
July 27, 2009 — August 23, 2009
    61,267     $ 6.03       61,267     $ 17,384  
August 24, 2009 — September 27, 2009
        $           $ 17,384  
 
                       
 
                               
Total
    61,267 (1)   $ 6.03       61,267     $ 17,384  
 
                       
     
(1)  
We repurchased 61,267 shares of our common stock in the third quarter of fiscal 2009 pursuant to our second share repurchase program, which we publicly announced in February 2009. Our board of directors approved the repurchase by us of shares of our common stock having a value of up to $20.0 million in the aggregate pursuant to the second stock repurchase program.

 

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Item 6.  
Exhibits
         
  31.1    
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d- 14(a), by Chief Executive Officer.
       
 
  31.2    
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d-14(a), by Chief Financial Officer.
       
 
  32.1    
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer.
       
 
  32.2    
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Financial Officer.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
    AIRVANA, INC.
 
       
 
  By:   /s/ Randall S. Battat
 
       
 
      Randall S. Battat
Date: November 4, 2009
      President and Chief Executive Officer
 
      (Principal Executive Officer)
 
       
 
  By:   /s/ Jeffrey D. Glidden
 
       
 
      Jeffrey D. Glidden
Date: November 4, 2009
      Vice President, Chief Financial Officer
 
      (Principal Financial Officer)

 

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EXHIBIT INDEX
         
Exhibit    
Number   Description
       
 
  31.1    
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d- 14(a), by Chief Executive Officer.
       
 
  31.2    
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d-14(a), by Chief Financial Officer.
       
 
  32.1    
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer.
       
 
  32.2    
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Financial Officer.

 

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