S-1 1 ds1.htm REGISTRATION STATEMENT ON FORM S-1 Registration Statement on Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on December 22, 2006

Registration No. 333-            


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933


BigBand Networks, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware   3663   87-0619936

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

475 Broadway Street

Redwood City, California 94063

650-995-5000

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)


Robert E. Horton

Vice President and General Counsel

BigBand Networks, Inc.

475 Broadway Street

Redwood City, California 94063

650-995-5000

(Name, address, including zip code, and telephone number, including area code, of agent for service)


Copies to:

 

Jeffrey D. Saper

J. Robert Suffoletta

Wilson Sonsini Goodrich & Rosati

Professional Corporation

650 Page Mill Road

Palo Alto, California 94304

650-493-9300

 

Christopher L. Kaufman

Tad J. Freese

Latham & Watkins LLP

140 Scott Drive

Menlo Park, California 94025

650-328-4600


Approximate date of commencement of proposed sale to the public:    As soon as practicable after this Registration Statement becomes effective.


If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨


CALCULATION OF REGISTRATION FEE

 


Title of Each Class of Securities to be Registered   

Proposed Maximum

Aggregate Offering

Price (1)(2)

  

Amount of

Registration

Fee

Common Stock, $0.001 par value

   $140,000,000    $14,980

(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457 under the Securities Act of 1933, as amended.
(2) Includes shares the underwriters have the option to purchase to cover over-allotments, if any.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a) may determine.



Table of Contents

The information in this prospectus is not complete and may be changed. Neither we nor the selling stockholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Issued December 22, 2006

 

                       Shares

 

LOGO

 

COMMON STOCK

 


 

BigBand Networks, Inc. is offering                       shares of its common stock and the selling stockholders are offering                       shares of common stock. This is our initial public offering and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $             and $             per share.

 


 

We have applied to have our common stock approved for quotation on the NASDAQ Global Market under the symbol “BBND.”

 


 

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 7.

 


 

PRICE $             A SHARE

 


 

    

  Price to  

Public

  

Underwriting

Discounts

and

Commissions

  

Proceeds to

BigBand

  

Proceeds to

Selling

Stockholders

Per Share

   $        $        $        $    

Total

   $                $                    $                  $                

 

We have granted the underwriters the right to purchase up to an additional                       shares of common stock to cover over-allotments. We will not receive any proceeds from the sale of shares by the selling stockholders.

 

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the shares to purchasers on                     , 2007.

 

 


 

MORGAN STANLEY   MERRILL LYNCH & CO.
JEFFERIES & COMPANY
COWEN AND COMPANY
THINKEQUITY PARTNERS LLC

 

                    , 2007


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   7

Special Note Regarding Forward Looking Statements and Industry Data

   24

Use of Proceeds

   25

Dividend Policy

   25

Capitalization

   26

Dilution

   28

Selected Consolidated Financial Data

   29

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   31

Business

   52

Management

   67

Certain Relationships and Related Party Transactions

   83

Principal and Selling Stockholders

   85

Description of Capital Stock

   87

Shares Eligible for Future Sale

   91

Material United States Federal Tax Considerations for Non-United States Holders of Common Stock

   93

Underwriters

   97

Legal Matters

   100

Experts

   100

Where You Can Find Additional Information

   101

Index To Financial Statements

   F-1

 


 

You should rely only on the information contained in this prospectus or in any free writing prospectus we may authorize to be delivered or made available to you. Neither we nor the selling stockholders have authorized anyone to provide you with information different from that contained in this prospectus. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of shares of our common stock.

 

Until                     , 2007 (25 days after the commencement of this offering), all dealers that buy, sell or trade shares of our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

For investors outside the United States: Neither we nor any of the selling stockholders nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside of the United States.

 


 

BigBand Networks, BME, BMR, Cuda, FastFlow and RateShaping are trademarks of BigBand Networks in the United States and other countries. This prospectus also includes other trademarks of BigBand and trademarks of other persons.

 

i


Table of Contents

PROSPECTUS SUMMARY

 

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. Before deciding to invest in shares of our common stock, you should read this summary together with the more detailed information, including our consolidated financial statements and the related notes, elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in each case included elsewhere in this prospectus.

 

BIGBAND NETWORKS, INC.

 

We develop, market and sell network-based platforms that enable cable operators and telephone companies, collectively called service providers, to offer video, voice and data services across coaxial, fiber and copper networks. We have significant expertise in rich media processing, communications networking and bandwidth management. We have delivered what we believe to be the only successful commercial deployments of switched broadcast, an application that substantially increases the volume of content that a service provider can offer. In addition, we were the first to implement what we believe has become the industry’s de facto network architecture for digital simulcast, an application that facilitates the insertion of advertising and the transmission of video in a digital format across a network while still providing service to analog subscribers. Our product applications of Digital Simulcast, TelcoTV, Switched Broadcast, and High-Speed Data and Voice-over-IP are a combination of our modular software and programmable video and data hardware platforms.

 

Our software and hardware product applications are used by leading service providers worldwide to offer video, voice and data services to tens of millions of subscribers, 24 hours a day, seven days a week. We have sold our product applications to more than 100 customers globally, including Cablevision, Charter, Comcast, Cox, Time Warner Cable and Verizon, which are six of the ten largest service providers in the United States. Our net revenues increased 59.6% to $113.6 million for the nine month period ended September 30, 2006 from $71.2 million in the same period in 2005. We achieved our first quarter of profitability in the three months ended September 30, 2006.

 

Intelligent, High-Bandwidth Video Networks Are Needed

 

Service providers derive most of their revenue from consumer subscriptions and advertising. Service providers are increasingly bundling disparate video, voice and data services into integrated offerings, also known as “triple-play” services. Video is the most technically demanding, provides the richest user experience and currently offers the greatest revenue per subscriber of the triple-play services. As of December 2006, Yankee Group Research estimates that, on average, consumers spend per month $68 for digital video services compared to $47 for voice and $33 for data services.

 

Competition to deliver video, voice and data services has fueled recurring cycles of network investment as service providers seek to capture increasing revenues by offering additional services. Regulatory, technological and competitive factors are leading service providers to increasingly compete against one another for consumer subscription and advertising revenues. For example, cable operators have added approximately eight million voice-over-IP subscribers, while telephone companies are investing in video, such as Verizon’s announced plan to upgrade its fiber-optic network for video and data services at a cost of $18 billion. In addition to competing among themselves, service providers are facing competition from Internet and media companies, such as ABC.com, Apple Computer, Google and Yahoo, which use the Internet to deliver video content and advertising directly to consumers.

 

To differentiate their video, voice and data services from the competition, service providers are beginning to develop differentiated video offerings that more directly respond to consumer demand for more personalized and richer content, a higher quality experience and greater ease of access to this content. For example, subscribers are

 

1


Table of Contents

demanding more high definition television, or HDTV, and gaining more control over their consumption of video content through video-on-demand, or VOD, technologies. At the same time, advertisers are increasingly demanding that video-based advertising deliver more relevant ads with the interactivity to measure return on ad spending comparable to ads placed on the Internet. The need to respond to consumer demands for richer, more accessible and more relevant content, and advertisers’ demands for increased interactivity, is forcing service providers to improve their networks.

 

Current service provider networks are not well suited to deliver the entire triple-play bundle of services and relevant advertising. In particular, these networks lack sufficient bandwidth necessary to deliver rich video services such as HD programming and lack the interactivity and ability to tailor programming and advertising to subscribers. As a result, a simple expansion of network capacity is not likely to meet these challenges, and there is a need for platforms designed primarily for reliable and cost-effective video delivery, which in turn will enable the entire triple-play offering. The rapidly changing trends in consumer demands and advertiser requirements, coupled with the competitive environment, are forcing service providers to develop more intelligent, extensible networks to provide these advanced services, enable increasingly relevant advertising and make more efficient use of available network capacity.

 

The BigBand Solution

 

The limitations of existing networks pose significant challenges to service providers. The BigBand solution addresses these challenges by enabling service providers to deliver high-quality video, voice and data services and more effective video advertising.

 

    Intelligent Bandwidth Management.    The growing volume and richness of video content being demanded by subscribers, such as HDTV, is straining the capacity of existing fixed-bandwidth networks. Our media processing capabilities significantly increase the capacity of these networks without a costly capital expansion.

 

    High-Quality Video Experience.    Video is less tolerant of the delays and errors that degrade the quality of the viewing experience. Our product applications enhance video quality in the network by correcting errors before subscribers are impacted.

 

    Enhanced Video Personalization.    Networks lack the intelligence to understand and react to subscriber television viewing behavior. Using our product applications, service providers interact with their subscribers down to the individual channel change and, as a result, can more accurately tailor programming packages to the interests of their subscribers.

 

    Ability to Deliver Relevant Video Advertising.    Existing networks provide only limited ability to deliver more relevant ads to audiences. Our products allow service providers to insert advertising tailored to specific geographic zones.

 

    Optimize Return on Existing Infrastructure Investment.    Service providers have spent billions to build and maintain their networks and want to extend the useful life of their infrastructure investments. Our network-based products allow service providers to manage service quality and upgrade their voice, video and data offerings from the network, avoiding costly upgrades and installations of customer premise equipment, or CPE.

 

    Platform Flexibility.    Networks must have the flexibility to rapidly deploy new services, such as HDTV, VOD and voice-over-IP, or VoIP. Our fully programmable hardware and modular software architecture is field-upgradable and designed to meet service provider requirements for network flexibility.

 

2


Table of Contents

Competitive Strengths of BigBand

 

We have core expertise in media processing, communications networking and bandwidth management. We hold 23 U.S. patents, 16 of which relate to our video products and seven of which relate to our data products. Our expertise in emerging technologies, such as switched broadcast, and our customer relationships with large service providers are key strengths that enable us to gain greater insight into the network requirements of our customers. Leveraging this expertise, we combine our fully programmable hardware and modular software architecture to deliver product applications designed to meet service provider needs for intelligent, high-bandwidth networks. Our products are interoperable with a broad range of content and services in various parts of a service provider’s network. Further, we believe our product applications decrease our customers’ total cost of ownership, reduce their time-to-market with new services and improve their ability to achieve more efficient bandwidth utilization.

 

Risk Factors

 

Our business is subject to numerous risks, which are highlighted in the section entitled “Risk Factors” immediately following this prospectus summary. Some of these risks are:

 

    we depend on the adoption of advanced technologies by service providers for substantially all of our net revenues;

 

    our customer base is highly concentrated, and there are a limited number of potential customers for our products;

 

    the timing of a significant portion of our revenue is dependent on complex systems integration;

 

    our operating results are likely to fluctuate significantly for a variety of reasons; and

 

    our operating results in a particular period can be impacted by our lengthy sales cycle.

 

For further discussion of these and other risks you should consider before making an investment in our common stock, see the section entitled “Risk Factors” immediately following this prospectus summary.

 

Corporate Information

 

Our company was founded in December 1998, and through 2001 we were engaged principally in research and development on video-related products. To expand our product offerings, in June 2004, we acquired the high-speed data equipment BAS division of ADC Telecommunications, Inc. Our principal executive offices are located at 475 Broadway Street, Redwood City, California 94063, and our telephone number is 650-995-5000. We operate research and development facilities in Westborough, Massachusetts, Tel Aviv, Israel and Redwood City, California. As of September 30, 2006, we had 507 employees. Except where the context requires otherwise, in this prospectus the “Company,” “BigBand,” “we,” “us” and “our” refer to BigBand Networks, Inc., a Delaware corporation, and, where appropriate, its subsidiaries.

 

3


Table of Contents

THE OFFERING

 

Common stock offered by us

                 shares

 

Common stock offered by the selling stockholders

                 shares

 

Common stock to be outstanding after this offering

                 shares

 

Use of proceeds

We intend to use the net proceeds to us from this offering for the repayment of approximately $14.0 million in indebtedness, for working capital, for capital expenditures and for other general corporate purposes. We may also use a portion of our net proceeds to fund acquisitions of complementary businesses, products or technologies. We will not receive any of the proceeds from the sale of shares by the selling stockholders. See “Use of Proceeds.”

 

Proposed NASDAQ Global Market symbol

BBND

 

The number of shares of common stock that will be outstanding after this offering is based on the number of shares outstanding at September 30, 2006, which excludes:

 

    48,468,333 shares of common stock issuable upon the exercise of options outstanding at September 30, 2006, at a weighted-average exercise price of $0.30 per share;

 

    3,734,658 shares of common stock issuable upon the exercise of warrants outstanding at September 30, 2006, at a weighted-average exercise price of $0.91 per share, of which warrants to purchase 418,612 shares of common stock at a weighted-average exercise price of $0.55 per share will expire at the closing of this offering if they have not been exercised;

 

                     shares of common stock reserved for future issuance under our Employee Stock Purchase Plan; and

 

                     shares of common stock reserved for future issuance under our 2007 Equity Incentive Plan.

 

Unless otherwise indicated, all information in this prospectus assumes:

 

    the automatic conversion of all outstanding shares of our preferred stock into an aggregate of                  shares of common stock effective immediately prior to the closing of this offering;

 

    a 1-for-         reverse stock split to be effective prior to the closing of this offering; and

 

    no exercise by the underwriters of their right to purchase up to                  shares of common stock from us to cover over-allotments.

 

4


Table of Contents

SUMMARY CONSOLIDATED FINANCIAL INFORMATION

 

We present below our summary consolidated financial information. The summary consolidated statements of operations data for the years ended December 31, 2003, 2004 and 2005 have been derived from audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated statements of operations data for the nine months ended September 30, 2005 and 2006, and the summary consolidated balance sheet data as of September 30, 2006 have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited consolidated financial statements include, in the opinion of management, all adjustments, which include only normal recurring adjustments, that management considers necessary for the fair presentation of the financial information set forth in those statements. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited and unaudited consolidated financial statements and related notes, each included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results to be expected in any future period.

 

    Years Ended December 31,    

Nine Months Ended

September 30,

 
    2003     2004     2005     2005     2006  
    (in thousands, except per share data)  

Consolidated Statements of Operations Data(1):

         

Net revenues

         

Products

  $ 20,014     $ 31,536     $ 85,966     $ 62,773     $ 97,313  

Services

    1,566       3,936       12,013       8,475       16,309  
                                       

Total net revenues

    21,580       35,472       97,979       71,248       113,622  

Cost of net revenues(2)

         

Products

    8,597       21,300       55,933       41,816       49,486  

Services

    1,027       2,221       3,900       2,589       6,689  
                                       

Total cost of net revenues

    9,624       23,521       59,833       44,405       56,175  

Gross profit

         

Products

    11,417       10,236       30,033       20,957       47,827  

Services

    539       1,715       8,113       5,886       9,620  
                                       

Total gross profit

    11,956       11,951       38,146       26,843       57,447  
                                       

Operating expense

         

Research and development(2)

    9,519       21,582       30,701       22,804       26,600  

Sales and marketing(2)

    10,376       15,891       22,729       16,188       20,965  

General and administrative(2)

    3,095       5,782       6,984       5,137       8,048  

Amortization of purchased intangible assets

          286       573       429       429  

In-process research and development

          966                    
                                       

Total operating expense

    22,990       44,507       60,987       44,558       56,042  
                                       

Operating income (loss)

    (11,034 )     (32,556 )     (22,841 )     (17,715 )     1,405  

Other income (expense), net

    (673 )     (957 )     (1,696 )     (1,118 )     (1,488 )
                                       

Net loss before provision for income taxes and cumulative effect of change in accounting principle

    (11,707 )     (33,513 )     (24,537 )     (18,833 )     (83 )

Provision (benefit) for income taxes

          250       325       262       (17 )
                                       

Net loss before cumulative effect of change in accounting principle

    (11,707 )     (33,763 )     (24,862 )     (19,095 )     (66 )

Cumulative effect of change in accounting principle

                (633 )     (633 )      
                                       

Net loss

  $ (11,707 )   $ (33,763 )   $ (25,495 )   $ (19,728 )   $ (66 )
                                       

Net loss per common share, basic and diluted

  $ (0.50 )   $ (1.05 )   $ (0.59 )   $ (0.46 )   $ (0.00 )
                                       

Shares used in computing net loss per common share, basic and diluted

    23,325       32,125       43,175       42,887       45,387  
                                       

Pro forma net loss per common share, basic and diluted(3)

      $ (0.13 )     $ (0.00 )
                     

Shares used in computing pro forma net loss per common share, basic and diluted(3)

        194,221         196,433  
                     

 

(Footnotes appear on the next page)

 

5


Table of Contents
    

As of

September 30, 2006

     Actual   

Pro

Forma(4)

  

Pro Forma

As Adjusted(5)

     (in thousands)

Consolidated Balance Sheet Data:

        

Cash, cash equivalents and marketable securities

   $ 40,051    $ 40,051    $     

Working capital

     15,154      18,193   

Total assets

     105,847      105,847   

Current and long-term debt

     14,097      14,097   

Preferred stock warrant liability

     3,039        

Redeemable convertible preferred stock

     117,307        

Common stock and additional paid-in capital

     15,780      136,126   

  (1)   On June 29, 2004, we completed the acquisition of Broadband Access Systems, Inc., which we refer to as BAS, from ADC Telecommunications, Inc. in a transaction accounted for as a business combination using the purchase method. For further information on the BAS acquisition, see Note 4 of the Notes to Consolidated Financial Statements included in this prospectus.
  (2)   Includes stock-based compensation as follows:

 

    

Years Ended

December 31,

  

Nine Months Ended

September 30,

     2003    2004    2005        2005            2006    
     (in thousands)

Cost of net revenues

   $    $ 46    $ 87    $ 66    $ 181

Research and development

     52      299      516      405      512

Sales and marketing

          134      263      193      310

General and administrative

     51      222      237      158      327
                                  

Total stock-based compensation

   $ 103    $ 701    $ 1,103    $ 822    $ 1,330
                                  

 

  (3)   The pro forma weighted average common shares outstanding reflects the conversion of our redeemable convertible preferred stock (using the if-converted method) into common stock as though the conversion had occurred on the original date of issuance.
  (4)   The pro forma column in the summary consolidated balance sheet data table above gives effect to the conversion of all outstanding shares of our redeemable convertible preferred stock and all outstanding shares of non-voting class B common stock into common stock upon the completion of this offering, resulting in the termination of the redeemable convertible preferred stock and class B common stock conversion feature, the termination of the redemption rights associated with the class B common stock and the reclassification of the preferred stock warrant liabilities to additional paid-in capital upon closing of this offering.
  (5)   The pro forma as adjusted column in the summary consolidated balance sheet data table above gives effect to items described in footnote (4) as well as our receipt of the estimated net proceeds from the sale of              shares of common stock offered by us in this offering, based on an assumed initial public offering price of $             per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and our use of proceeds from this offering to repay approximately $14.0 million of outstanding indebtedness.

 

6


Table of Contents

RISK FACTORS

 

You should carefully consider the risks described below before making an investment decision. Our business, prospects, financial condition or operating results could be materially adversely affected by any of these risks, as well as other risks not currently known to us or that we currently consider immaterial. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing the risks described below, you should also refer to the other information contained in this prospectus, including our consolidated financial statements and the related notes, before deciding to purchase any shares of our common stock.

 

Risks Related to our Business

 

We depend on the adoption of advanced technologies by cable operators and telephone companies for substantially all of our net revenues, and any decrease or delay in capital spending for these advanced technologies would harm our operating results, financial condition and cash flows.

 

Substantially all of our sales are dependent upon the adoption of advanced technologies by cable operators and telephone companies, and we expect these sales to continue to constitute a significant majority of our sales for the foreseeable future. Demand for our products will depend on the magnitude and timing of capital spending by service providers on advanced technologies for constructing and upgrading their network infrastructure, and a reduction or delay in this spending could have a material adverse effect on our business.

 

The capital spending patterns of our existing and potential customers are dependent on a variety of factors, including:

 

    available capital and access to financing;

 

    annual budget cycles;

 

    overall consumer demand for video, voice and data services and the acceptance of newly introduced services;

 

    competitive pressures, including pricing pressures;

 

    the impact of industry consolidation;

 

    the strategic focus of our customers and potential customers;

 

    technology adoption cycles and network architectures of service providers, and evolving industry standards that may impact them;

 

    the status of federal, local and foreign government regulation of telecommunications and television broadcasting, and regulatory approvals that our customers need to obtain;

 

    discretionary customer spending patterns;

 

    bankruptcies and financial restructurings within the industry; and

 

    general economic conditions.

 

Any slowdown or delay in the capital spending by service providers as a result of any of the above factors would likely have a significant impact on our quarterly revenue and profitability levels.

 

Our operating results are likely to fluctuate significantly and may fail to meet or exceed the expectations of securities analysts or investors or our guidance, causing our stock price to decline.

 

Our operating results have fluctuated in the past and are likely to continue to fluctuate, on an annual and a quarterly basis, as a result of a number of factors, many of which are outside of our control. These factors include:

 

    the level and timing of capital spending of our customers, both in the United States and in international markets;

 

    the timing, mix and amount of orders, especially from significant customers;

 

7


Table of Contents
    changes in market demand for our products;

 

    our ability to secure significant orders from telephone companies;

 

    our mix of products sold between video products, which generally have higher margins, and our cable modem termination system, or CMTS, data products, which generally have lower margins;

 

    the mix of software and hardware products sold;

 

    our unpredictable and lengthy sales cycles, which typically range from nine to eighteen months;

 

    the timing of revenue recognition on sales arrangements, which may include multiple deliverables;

 

    new product introductions by our competitors;

 

    market acceptance of new or existing products offered by us or our customers;

 

    competitive market conditions, including pricing actions by our competitors;

 

    our ability to complete complex development of our software and hardware on a timely basis;

 

    our ability to design, install and receive customer acceptance of our products;

 

    unexpected changes in our operating expense;

 

    the potential loss of key manufacturer and supplier relationships;

 

    the cost and availability of components used in our products;

 

    changes in domestic and international regulatory environments; and

 

    the impact of new accounting rules.

 

We establish our expenditure levels for product development and other operating expense based on projected sales levels, and our expenses are relatively fixed in the short term. Accordingly, variations in the timing of our sales can cause significant fluctuations in operating results. As a result of all these factors, our operating results in one or more future periods may fail to meet or exceed the expectations of securities analysts or investors or our guidance, which would likely cause the trading price of our common stock to decline substantially.

 

We anticipate that our gross margins will fluctuate with changes in our product mix and expected decreases in the average selling prices of our products, which may adversely impact our operating results.

 

Our industry has historically experienced a decrease in average selling prices. We anticipate that the average selling prices of our products will decrease in the future in response to competitive pricing pressures, increased sales discounts and new product introductions by our competitors. We may experience substantial decreases in future operating results due to the decrease of our average selling prices. To maintain our gross margin levels, we must develop and introduce on a timely basis new products and product enhancements as well as continually reduce our product costs. Our failure to do so would likely cause our revenue and gross margins to decline, which could have a material adverse effect on our operating results and cause the price of our common stock to decline. We also anticipate that our gross margins will fluctuate from period to period as a result of the mix of products we sell in any given period, with our video products generally yielding higher gross margins than our data products. If our sales of these lower margin products significantly expand in future quarterly periods, our overall gross margin levels and operating results would be adversely impacted.

 

Our continued growth will depend significantly on our ability to deliver products that help enable telephone companies to provide video services. If the projected growth in demand for video services from telephone companies does not materialize or if these service providers find alternative methods of delivering video services, future sales of our video products will suffer.

 

Prior to 2006, our sales were principally to cable operators. In 2006, however, we generated significant sales from telephone companies. Our growth is dependent on our ability to sell video products to telephone companies that are increasingly reliant on the delivery of video services to their customers. Although a number of our

 

8


Table of Contents

existing products are being deployed in these networks, we will need to devote considerable resources to obtain orders, qualify our products and hire knowledgeable personnel to address telephone company customers, each of which will require significant time and financial commitment. These efforts may not be successful in the near future, or at all. If technological advancements allow these telephone companies to provide video services without upgrading their current system infrastructure or that allow them a more cost-effective method of delivering video services than our products, projected sales of our video products will suffer. Even if these providers choose our video products, they may not be successful in marketing video services to their customers, in which case additional sales of our products would likely be reduced.

 

Selling successfully to the telephone company market will be a significant challenge for us. Several of our largest competitors, such as Cisco Systems and Motorola Corporation, have mature customer relationships with many of the largest telephone companies, while we have limited recent experience with sales and marketing efforts designed to reach these potential customers. In addition, telephone companies face specific network architecture and legacy technology issues that we have only limited expertise in addressing. If we fail to penetrate the telephone company market successfully, our growth in revenues and operating results would be correspondingly limited.

 

Our customer base is highly concentrated, and there are a limited number of potential customers for our products. The loss of any of our key customers would likely reduce our revenues significantly.

 

Historically, a large portion of our sales have been to a limited number of customers. Sales to our five largest customers accounted for approximately 73% of our net revenues in the nine months ended September 30, 2006, approximately 69% of our net revenues in the year ended December 31, 2005, and approximately 61% of our net revenues in the year ended December 31, 2004. Time Warner Cable accounted for 12% of our net revenues in the nine months ended September 30, 2006, 10% of our net revenues in the year ended December 31, 2005, and 12% of our net revenues in the year ended December 31, 2004. Verizon accounted for 27% of our net revenues in the nine months ended September 30, 2006. Comcast accounted for 14% of our net revenues in the nine months ended September 30, 2006 and 18% of our net revenues in the year ended December 31, 2004. Cox accounted for 13% of our net revenues in the nine months ended September 30, 2006, 20% of our net revenues in the year ended December 31, 2005, and 18% of our net revenues in the year ended December 31, 2004.

 

We anticipate that a large portion of our revenues will continue to depend on sales to a limited number of customers, and we do not have contracts or other agreements that guarantee continued sales to these or any other customers. In addition, as the consolidation of ownership of cable operators and telephone companies continues, we may lose existing customers and have access to a shrinking pool of potential customers. We expect to see continuing industry consolidation and customer concentration due to the significant capital costs of constructing video, voice and data networks and for other reasons. For example, Adelphia, formerly the fifth largest cable company in the United States, which accounted for 7% of our net revenue in the nine months ended September 30, 2006, was sold in 2006 to Comcast and Time Warner Cable, the two largest U.S. cable operators. Further business combinations may occur in our customer base which will result in increased purchasing leverage by these customers over us. This may reduce the selling prices of our products and services and as a result may harm our business and financial results. Many of our customers desire to have two sources for the products we sell to them. As a result, our future revenue opportunities could be limited, and our profitability could be adversely impacted. The loss of, or reduction in orders from, any of our key customers would significantly reduce our revenues and have a material adverse impact on our business, operating results and financial condition.

 

The timing of a significant portion of our net revenues is dependent on complex systems integration.

 

We derive a significant portion of our net revenues from sales that include the network design, installation and integration of equipment, including equipment acquired from third parties to be integrated with our products to the specifications of our customers. We base our revenue forecasts on the estimated timing to complete the network design, installation and integration of our customer projects and customer acceptance of those products. The systems of our customers are both diverse and complex, and our ability to configure, test and integrate our systems with other elements of our customers’ networks is dependent upon technologies provided to our

 

9


Table of Contents

customers by third parties. As a result, the timing of our revenue related to the implementation of our product applications in these complex networks is difficult to predict and could result in lower than expected revenue in any particular quarter. Similarly, our ability to deploy our equipment in a timely fashion can be subject to a number of other risks, including the availability of skilled engineering and technical personnel, the availability of equipment produced by third parties and our customers’ need to obtain regulatory approvals.

 

If revenues forecasted for a particular period are not realized in such period due to the lengthy, complex and unpredictable sales cycles of our products, our operating results for that or subsequent periods will be harmed.

 

The sales cycles of our products are typically lengthy, complex and unpredictable and usually involve:

 

    a significant technical evaluation period;

 

    a significant commitment of capital and other resources by service providers;

 

    substantial time required to engineer the deployment of new technologies or new video, voice and data services;

 

    substantial testing and acceptance of new technologies that affect key operations; and

 

    substantial test marketing of new services with subscribers.

 

For these and other reasons, our sales cycles generally have been between nine and eighteen months, but can last longer. If orders forecasted for a specific customer for a particular quarter do not occur in that quarter, our operating results for that quarter could be substantially lower than anticipated. Our quarterly and annual results may fluctuate significantly due to revenue recognition policies and the timing of the receipt of orders.

 

We only recently became profitable on a quarterly basis, and we may not be able to achieve profitability on an annual basis or sustain profitability on a quarterly basis in future periods.

 

The three-month period ended September 30, 2006 has been the only fiscal quarter in which we have achieved profitability. We reported losses for our 2005, 2004 and 2003 fiscal years. We are continuing to incur increased research and development, sales and marketing, and general and administrative expenses. As a result, we may not be able to sustain profitability in future fiscal quarters or achieve profitability on an annual basis in the future.

 

Our independent registered public accountants have identified and reported to us material weaknesses in our internal controls for the years ended December 31, 2004 and 2005 that, if not properly remediated, could result in material misstatements in our financial statements in future periods and impair our ability to comply with the accounting and reporting requirements applicable to public companies.

 

In connection with the audits of our consolidated financial statements for each of the years ended December 31, 2004 and 2005, our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting under the standards established by the American Institute of Certified Public Accountants. Our independent registered public accounting firm has indicated that the material weaknesses in our revenue recognition process and financial statement closing process resulted from having insufficient procedures in place and an insufficient number of qualified resources in our finance department with the required proficiency to apply our accounting policies in accordance with U.S. generally accepted accounting principles, or GAAP. Our independent registered public accounting firm was not, however, engaged to audit the effectiveness of our internal control over financial reporting. If such an evaluation had been performed or when we are required to perform such an evaluation, additional material weaknesses, significant deficiencies and other control deficiencies may have been or may be identified. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be evaluated frequently, as described further under “—We will incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which could adversely affect our operating results.”

 

10


Table of Contents

Because of these material weaknesses, there is heightened risk that a material misstatement of our annual or quarterly financial statements will not be prevented or detected. Our remediation efforts to address these material weaknesses are still in process. In addition, the remediation steps we have taken, are taking and expect to take may not effectively remediate the material weaknesses, in which case our internal control over financial reporting would continue to be ineffective. Once we become a public company, we will be required to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 as of December 31, 2008 and subsequent fiscal years. In the event that we do not adequately remedy these material weaknesses, and if we fail to maintain proper and effective internal controls in future periods, it could adversely affect our operating results, financial condition and our ability to run our business effectively and could cause investors to lose confidence in our financial reporting.

 

If we do not adequately manage and evolve our financial reporting and managerial systems and processes, our operating results and financial condition may be harmed.

 

Our ability to successfully implement our business plan and comply with regulations applicable to being a public reporting company requires an effective planning and management process. We expect that we will need to continue to improve existing, and implement new, operational and financial systems, procedures and controls to manage our business effectively in the future. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, could harm our ability to accurately forecast sales demand, manage our supply chain and record and report financial and management information on a timely and accurate basis. In addition, the successful enhancement of our operational and financial systems, procedures and controls will result in higher general and administrative costs in future periods, and may adversely impact our operating results and financial condition.

 

In connection with our implementation, in the third quarter of 2006, of more stringent controls related to contracts for providing customer support, we discovered that certain end users in China maintained that they were entitled to company-provided support, while our contracts with these customers did not provide for customer support. In response, the Audit Committee of our Board of Directors conducted an independent investigation of the matter, employing independent counsel and an independent accounting firm. The investigation, which was completed in December 2006, found numerous instances in which resellers of our product applications in China, with the understanding and approval of our China personnel, agreed to provide technical support, extended warranty terms and potentially other undefined terms without proper documentation and without communicating these arrangements to our legal and finance departments. As a result, we have deferred approximately $4.8 million in revenue from customers in China, which will be recognized in future periods if we satisfy all of the elements of our revenue recognition criteria. Our controls previously in place did not prevent these occurrences and we have therefore implemented a number of additional controls and remedial actions to ensure the appropriate accounting of future transactions and control over contracts with end users in China. In the event that we do not adequately implement these additional controls and remedial actions, additional material weaknesses could be identified and could cause investors to lose confidence in our financial reporting.

 

We may not accurately anticipate the timing of the market needs for our products and develop such products at the appropriate times, which could harm our operating results and financial condition.

 

Accurately forecasting and meeting our customers’ requirements is critical to the success of our business. Forecasting to meet customers’ needs is particularly difficult in connection with newer products and products under development. Our ability to meet customer demand depends on our ability to configure our product applications to the complex architecture that our customers have developed, the availability of components and other materials and the ability of our contract manufacturers to scale their production of our products. Our ability to meet customer requirements depends on our ability to obtain sufficient volumes of these components and materials in a timely fashion. If we fail to meet customers’ supply expectations, our net revenues will be adversely affected, and we will likely lose business. In addition, our priorities for future product development are based on our expectations of how the market for video, voice and data services will continue to develop in the United States and in international markets. If the market for such services develops more rapidly than we

 

11


Table of Contents

anticipate, then our product development efforts may be behind, which may result in our being unable to recoup

our capital spent on product development as a result of a missed market opportunity. Conversely, if the market develops more slowly than we anticipate, we may find that we have expended significant capital on product development prior to our being able to generate any revenues for those products. If we are unable to accurately time our product introductions to meet market demand, it could have a material adverse impact on our operating results and financial condition.

 

In addition, if actual orders are materially lower than the indications we receive from our customers, our ability to manage inventory and expenses will also be harmed. If we enter into purchase commitments to acquire components and materials, or expend resources to manufacture products, and those products are not purchased by our customers when expected, our business and operating results could suffer.

 

We need to develop and introduce new and enhanced products in a timely manner to remain competitive, and our product development efforts require substantial research and development expense.

 

The markets in which we compete are characterized by continuing technological advancement, changes in customer requirements and evolving industry standards. To compete successfully, we must design, develop, manufacture and sell new or enhanced products that provide increasingly higher levels of performance and reliability and meet the cost expectations of our customers. Our product development efforts require substantial research and development expense. Research and development expense in the nine months ended September 30, 2006 were $26.6 million, in the year ended December 31, 2005 were $30.7 million and in the year ended December 31, 2004 were $21.6 million. There can be no assurance that we will achieve an acceptable return on our research and development efforts.

 

We are currently developing a modular cable modem termination system, or M-CMTS, that we believe will be important for our future revenue growth and operating results. If we fail to deliver our M-CMTS product to market in a timely and cost-effective manner, or if our M-CMTS product fails to operate with all the functionality our customers expect, our future operating results would be harmed. Likewise, new technologies, standards and formats are being adopted by our customers. While we are in the process of developing products based on many of these new formats in order to remain competitive, we do not have such products at this time and cannot be certain when, if at all, we will have products in support of such new formats.

 

Our future growth depends on market acceptance of several emerging video, voice and data services, on the adoption of new network architectures and technologies and on several other industry trends.

 

Future demand for our products will depend significantly on the growing market acceptance of several emerging video, voice and data services, including high-speed data services; HDTV; addressable advertising; video delivered over telephone company networks; and VoIP.

 

The effective delivery of these services will depend on service providers developing and building new network architectures to deliver them. If the introduction or adoption of these services or the deployment of these networks is not as widespread or as rapid as we or our customers expect, our revenue growth will be limited.

 

Furthermore, we expect the extent and nature of regulatory attitudes towards issues such as competition among service providers, access by third parties to networks of other service providers and new services such as VoIP to impact our customers’ purchasing decisions. If service providers do not pursue the opportunity to offer integrated video, voice and data services as aggressively as we expect, our revenue growth would be limited.

 

The markets in which we operate are intensely competitive, and many of our competitors are larger, more established and better capitalized than we are.

 

The markets for selling network-based hardware and software products to service providers are extremely competitive and have been characterized by rapid technological change. In the CMTS market, we compete principally with Cisco Systems, Motorola and Arris. In the video market, we compete broadly with system suppliers including Harmonic, Motorola, Scientific Atlanta (a division of Cisco Systems), SeaChange

 

12


Table of Contents

International, Tandberg Television, Terayon Communication Systems and a number of smaller companies. We may not be able to compete successfully in the future, which may harm our business.

 

Many of our competitors are substantially larger and have greater financial, technical, marketing and other resources than us. Given their capital resources, many of these large organizations are in a better position to withstand any significant reduction in capital spending by customers in these markets. They often have broader product lines and market focus and are not as susceptible to downturns in a particular market. In addition, many of our competitors have been in operation much longer than we have and therefore have more long-standing and established relationships with domestic and foreign service providers. If any of our competitors’ products or technologies were to become the industry standard, our business would also be seriously harmed. If our competitors are successful in bringing their products to market earlier, or if their products are more technologically capable than ours, then our sales could be materially adversely affected.

 

Recently, we have seen rapid consolidation among our competitors, such as Cisco’s acquisition of Scientific Atlanta and purchases of VOD solutions by each of Cisco, Harmonic and Motorola. In addition, some of our competitors have entered into strategic relationships with one another to offer a more comprehensive solution than would be available individually. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in the evolving industry for video. Many of the companies driving this consolidation trend have significantly greater financial, technical and other resources than we do, and are much better positioned than we are to offer complementary products and technologies. These combined companies may offer more compelling product offerings and be able to offer greater pricing flexibility, making it more difficult for us to compete while sustaining acceptable gross margins. Finally, continued industry consolidation may impact customers’ perceptions of the viability of smaller companies, which may affect their willingness to purchase products from us. These competitive pressures could harm our business, operating results and financial condition.

 

In the event that certain of our competitors integrate products performing functions similar to our products into their existing network infrastructure offerings, our existing and potential customers may decide against using our products in their networks, which would harm our business.

 

Other providers of network-based hardware and software products are offering or announcing functionality aimed at solving similar problems addressed by our products. For example, several vendors have recently announced their intention to develop a switched broadcast product application. The inclusion of, or the announcement of the intent to include, functionality perceived to be similar to our product offerings in our competitors’ products that have been accepted as necessary components of network architecture may have an adverse effect on our ability to market and sell our products. Furthermore, even if the functionality offered by other network infrastructure providers is more limited than our products, a significant number of customers may elect to accept such limited functionality in lieu of adding components from a different vendor. Many of our existing and potential customers have invested substantial personnel and financial resources to design and operate their networks and have mature relationships with other providers of network infrastructure products, which may make them reluctant to add new components to their networks, particularly from new vendors. In addition, our customers’ other vendors with a broader product offering may be able to offer pricing or other concessions that we are not able to match because we currently offer a more modest suite of products and have fewer resources. If our existing or potential customers are reluctant to add network infrastructure from new vendors or otherwise decide to work with their existing vendors, our business, operating results and financial condition will be adversely affected.

 

We need to develop additional distribution channels to market and sell our products.

 

The majority of our sales to date have been direct sales to large cable operators in North America. Our video products have been traditionally sold to large cable operators with recent sales to telephone companies. We have not focused on smaller service providers and have had only limited access to service providers in certain international markets, including Asia and Europe. Although we intend to establish strategic relationships with leading distributors worldwide in an attempt to reach new customers, we may not succeed in establishing these

 

13


Table of Contents

relationships. Even if we do establish these relationships, the distributors may not succeed in marketing our products to their customers. Some of our competitors have established long-standing relationships with cable operators and telephone companies that may limit our and our distributors’ ability to sell our products to those customers. Even if we were to sell our products to those customers, it would likely not be based on long-term commitments, and those customers would be able to terminate their relationships with us at any time without significant penalties.

 

We depend on a limited number of third parties to manufacture, assemble and supply our products.

 

We obtain many components and modules necessary for the manufacture or integration of our products from a sole supplier or a limited group of suppliers, with whom we do not generally maintain long-term agreements. Our reliance on sole or limited suppliers involves several risks, including the inability to obtain an adequate supply of required components or modules and reduced control over pricing, quality and timely delivery of components. For example, we depend exclusively on Broadcom for one of the chipsets in our CMTS product. Our ability to deliver our products on a timely basis to our customers would be materially adversely impacted if we needed to find alternative replacements for the chipsets, central processing units or power supplies that we use in our products. Significant time and effort would be required to locate new vendors for these alternative components, if alternatives are even available to us. In addition, the lead times associated with certain components are lengthy and preclude rapid changes in quantity requirements and delivery schedules.

 

In addition, increased demand by third parties for the components we use in our products may lead to decreased availability and higher prices for those components, since we carry little inventory of our products and product components. As a result, we may not be able to secure sufficient components at reasonable prices or of acceptable quality to build products in a timely manner, which would impact our ability to deliver products to our customers, and our business, operating results and financial condition would be adversely affected.

 

We currently rely on a single contract manufacturer, ACT Corporation, to assemble our products, manage our supply chain and negotiate component costs for our CMTS products. Likewise, we rely exclusively on Flextronics to assemble our products, manage our supply chain and negotiate component costs for our video products. Our reliance on these contract manufacturers reduces our control over the assembly process, exposing us to risks, including reduced control over quality assurance, production costs and product supply. If we fail to manage our relationships with these contract manufacturers effectively, or if these contract manufacturers experience delays, disruptions, capacity constraints or quality control problems in their operations, our ability to ship products to our customers could be impaired and our competitive position and reputation could be harmed. If contract manufacturers are unable to negotiate with their suppliers for reduced component costs, our operating results would be harmed. If we are required to change contract manufacturers, we may lose net revenues, incur increased costs and damage our customer relationships. Qualifying a new contract manufacturer and commencing volume production are expensive and time-consuming.

 

We must manage the expected growth in our business effectively even if our infrastructure, management and resources might be strained.

 

We have experienced rapid growth in our business in recent periods. This growth and any future growth will likely place a significant strain on our resources. For example, we are currently planning to hire additional development, sales, customer support, marketing and administrative personnel. In addition, we may need to expand and otherwise improve our internal systems, including our management information systems, customer relationship and support systems, and operating, administrative and financial systems and controls. This effort may require us to make significant capital expenditures or incur significant expenses, and divert the attention of management, sales, support and finance personnel from our core business operations, which may adversely affect our financial performance in future periods. Moreover, our growth has resulted, and any future growth will result, in increased responsibilities of management personnel. Managing this growth will require substantial resources that we may not have or otherwise be able to obtain.

 

14


Table of Contents

Our products must interoperate with many software applications and hardware found in our customers’ networks. If we are unable to ensure that our products interoperate properly, our business would be harmed.

 

Our products must interoperate with our customers’ existing networks, which often have varied and complex specifications, utilize multiple protocol standards, software applications and products from multiple vendors, and contain multiple generations of products that have been added over time. As a result, we must continually ensure that our products interoperate properly with these existing networks. To meet these requirements, we must undertake development efforts that require substantial capital investment and the devotion of substantial employee resources. We may not accomplish these development efforts quickly or cost-effectively, if at all. For example, our products currently interoperate with set-top boxes marketed by vendors such as Scientific Atlanta and Motorola and with VOD servers marketed by SeaChange and C-COR. If we fail to maintain compatibility with these set-top boxes, VOD servers or other software or equipment found in our customers’ existing networks, we may face substantially reduced demand for our products, which would adversely affect our business, operating results and financial condition.

 

We have entered into interoperability arrangements with a number of equipment and software vendors for the use or integration of their technology with our products. In these cases, the arrangements give us access to and enable interoperability with various products in the digital video market that we do not otherwise offer. If these relationships fail, we will have to devote substantially more resources to the development of alternative products and the support of our products, and our efforts may not be as effective as the combined solutions with our current partners. In many cases, these parties are either companies that we compete with directly in other areas, such as Motorola, or companies that have extensive relationships with our existing and potential customers and may have influence over the purchasing decisions of these customers. A number of our competitors have stronger relationships with some of our existing and potential partners and, as a result, our ability to have successful partnering arrangements with these companies may be harmed. Our failure to establish or maintain key relationships with third party equipment and software vendors may harm our ability to successfully sell and market our products. We are currently investing, and plan to continue to invest, significant resources to develop these relationships. Our operating results could be adversely affected if these efforts do not generate the revenues necessary to offset this investment.

 

In addition, if we find errors in the existing software or defects in the hardware used in our customers’ networks or problematic network configurations or settings, as we have in the past, we may have to modify our software or hardware so that our products will interoperate with our customers’ networks. This could cause longer installation times for our products and could cause order cancellations, either of which would adversely affect our business, operating results and financial condition.

 

Our failure to adequately protect our intellectual property and proprietary rights may adversely affect us.

 

We hold numerous issued U.S. patents and have a number of patent applications pending in the United States and foreign jurisdictions. Although we attempt to protect our intellectual property rights through patents, trademarks, copyrights, licensing arrangements, maintaining certain technology as trade secrets and other measures, we cannot assure you that any patent, trademark, copyright or other intellectual property rights owned by us will not be invalidated, circumvented or challenged, that such intellectual property rights will provide competitive advantages to us or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. Despite our efforts, other competitors may be able to develop technologies that are similar or superior to our technology, duplicate our technology or design around the patents that we own. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in certain foreign countries in which we do business or may do business in the future.

 

The steps that we have taken may not be able to prevent misappropriation of our technology. In addition, we may take legal action to enforce our patents and other intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results and financial condition.

 

15


Table of Contents

In order to successfully develop and market certain of our planned products, we may be required to enter into technology development or licensing agreements with third parties. Although companies may be willing to enter into technology development or licensing agreements, such agreements may not be negotiated on terms acceptable to us, or at all. Our failure to enter into technology development or licensing agreements, when necessary, could limit our ability to develop and market new products and could cause our business to suffer.

 

Our use of open source and third-party software could impose limitations on our ability to commercialize our products.

 

We incorporate open source software into our products, including certain open source code which is governed by the GNU General Public License, Lesser GNU General Public License and Common Development and Distribution License. The terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to seek licenses from third parties in order to continue offering our products, make generally available, in source code form, proprietary code that links to certain open source modules, re-engineer our products, discontinue the sale of our products if re-engineering could not be accomplished on a cost-effective and timely basis, or become subject to other consequences, any of which could adversely affect our business, operating results and financial condition.

 

We may also find that we need to incorporate certain proprietary third-party technologies, including software programs, into our products in the future. However, licenses to relevant third-party technology may not be available to us on commercially reasonable terms, if at all. Therefore, we could face delays in product releases until alternative technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could materially adversely affect our business, operating results and financial condition.

 

We may face intellectual property infringement claims from third parties.

 

Our industry is characterized by the existence of an extensive number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. From time to time, third parties have asserted and may assert patent, copyright, trademark and other intellectual property rights against us or our customers. Our suppliers and customers may have similar claims asserted against them. We have agreed to indemnify some of our suppliers and customers for alleged patent infringement. The scope of this indemnity varies, but, in some instances, includes indemnification for damages and expenses including reasonable attorneys’ fees. Any future litigation, regardless of its outcome, could result in substantial expense and significant diversion of the efforts of our management and technical personnel. An adverse determination in any such proceeding could subject us to significant liabilities, temporary or permanent injunctions or require us to seek licenses from third parties or pay royalties that may be substantial. Furthermore, necessary licenses may not be available on satisfactory terms, or at all.

 

Our business is subject to the risks of warranty returns, product liability and product defects.

 

Products like ours are very complex and can frequently contain undetected errors or failures, especially when first introduced or when new versions are released. Despite testing, errors may occur. Product errors could affect the performance of our products, delay the development or release of new products or new versions of products, adversely affect our reputation and our customers’ willingness to buy products from us and adversely affect market acceptance or perception of our products. Any such errors or delays in releasing new products or new versions of products or allegations of unsatisfactory performance could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in redesigning the products, subject us to liability for damages and divert our resources from other tasks, any one of which could materially adversely affect our business, results of operations and financial condition. Our products must successfully interoperate with products from other vendors. As a result, when problems occur in a network, it may be difficult to identify the sources of these problems. The occurrence of hardware and software errors, whether or not caused by our products, could result in the delay or loss of market acceptance of our products, and therefore delay our ability to

 

16


Table of Contents

recognize revenue from sales, and any necessary revisions may cause us to incur significant expenses. The occurrence of any such problems could harm our business, operating results and financial condition.

 

Although we have limitation of liability provisions in our standard terms and conditions of sale, they may not fully or effectively protect us from claims as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries. The sale and support of our products also entails the risk of product liability claims. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover any claim asserted against us. In addition, even claims that ultimately are unsuccessful could result in our expenditure of funds in litigation and divert management’s time and other resources.

 

Our ability to sell our products is highly dependent 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 results of operations.

 

Once our products are deployed within our customers’ networks, our customers depend on our support organization to resolve any issues relating to our products. If we or our channel partners do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell our products to existing customers would be adversely affected and our reputation with potential customers could be harmed. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. Our failure to maintain high-quality support and services would have a material adverse effect on our business, operating results and financial condition.

 

Competition for qualified personnel, particularly management and research and development personnel, is intense. In order to manage our expected growth, we must be successful in attracting and retaining qualified personnel.

 

Our future success will depend on the ability of our management to operate effectively, both individually and as a group. We are dependent on our ability to retain and motivate high caliber personnel, in addition to attracting new personnel. The loss of any of our senior management or other key product development or sales and marketing personnel could adversely affect our future business, operating results and financial condition. In addition, a large number of our research and product development personnel have broad expertise in video algorithms, radio frequency and digital video standards that is vitally important in our product development efforts. If we were to lose a significant number of these research and development employees, our ability to develop successful new products would be harmed, and our revenues and operating results would likely suffer as a result. Competition for qualified management, technical and other personnel can be intense, and we may not be successful in attracting and retaining such personnel. While our employees are required to sign standard agreements concerning confidentiality and ownership of inventions, we generally do not have employment contracts or non-competition agreements with our personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly senior management and engineers and other technical personnel, could negatively affect our business, operating results and financial condition.

 

Our further expansion into international markets may not succeed.

 

International sales represented 15% of our net revenues for the nine months ended September 30, 2006, 17% of our net revenues for the year ended December 31, 2005, and 20% of our net revenues for the year ended December 31, 2004. We intend to continue expanding into international markets. We are currently expanding our indirect sales channels in Europe and Asia through distributor and reseller arrangements with third parties. However, we may not be able to successfully enter into additional reseller and/or distribution agreements and/or may not be able to successfully manage our product sales channels. In addition, many of our resellers also sell products from other vendors that compete with our products and may choose to focus on products of those vendors. Additionally, our ability to utilize an indirect sales model in these international markets will depend on

 

17


Table of Contents

our ability to qualify and train those resellers to perform product installations and to provide customer support. If we fail to develop and cultivate relationships with significant resellers, or if these resellers are not successful in their sales efforts whether because they are unable to provide support or otherwise, we maybe unable to grow or sustain our revenue in international markets.

 

Our continued growth will require further expansion of our international operations in Europe, Asia Pacific and other markets. We are presently establishing a small research and development presence in China. Managing research and development operations in numerous locations requires substantial management oversight. If we are unable to expand our international operations successfully and in a timely manner, our business, operating results and financial condition may be harmed. Such expansion may be more difficult or take longer than we anticipate, and we may not be able to successfully market, sell, deliver and support our products internationally.

 

Our international operations, the international operations of our contract manufacturers and our outsourced development contractors, and our efforts to increase sales in international markets, are subject to a number of risks, including:

 

    political and economic instability;

 

    unpredictable changes in foreign government regulations and telecommunications standards;

 

    legal and cultural differences in the conduct of business;

 

    import and export license requirements, tariffs, taxes and other trade barriers;

 

    inflation and fluctuations in currency exchange rates;

 

    difficulty in collecting accounts receivable;

 

    potentially adverse tax consequences;

 

    the burden of complying with a wide variety of foreign laws, treaties and technical standards;

 

    difficulty in protecting our intellectual property;

 

    acts of war or terrorism and insurrections;

 

    difficulty in staffing and managing foreign operations; and

 

    changes in economic policies by foreign governments.

 

The effects of any of the risks described above could reduce our future revenues from our international operations.

 

Regional instability in Israel may adversely affect business conditions and may disrupt our operations and negatively affect our operating results.

 

A substantial portion of our research and development operations and our contract manufacturing occurs in Israel. As of September 30, 2006, we had 159 full-time employees located in Israel. In addition, we have additional capabilities at this facility consisting of customer service, marketing and general and administrative employees. Accordingly, we are directly influenced by the political, economic and military conditions affecting Israel, and any major hostilities, such as the recent hostilities in Lebanon, involving Israel or the interruption or curtailment of trade between Israel and its trading partners could significantly harm our business. The September 2001 terrorist attacks, the ongoing U.S. war on terrorism and the terrorist attacks and hostilities within Israel have heightened the risks of conducting business in Israel. In addition, Israel and companies doing business with Israel have, in the past, been the subject of an economic boycott. Israel has also been and is subject to civil unrest and terrorist activity, with varying levels of severity, since September 2000. Security and political conditions may have an adverse impact on our business in the future. Hostilities involving Israel or the interruption or curtailment of trade between Israel and its trading partners could adversely affect our operations and make it more difficult for us to recruit qualified personnel in Israel.

 

In addition, most of our employees in Israel are obligated to perform annual reserve duty in the Israel Defense Forces and several were called for active military duty in connection with the hostilities in Lebanon in

 

18


Table of Contents

mid-2006. Should hostilities in the region escalate again, some of our employees would likely be called to active military duty, possibly resulting in interruptions in our sales and development efforts and other impacts on our business and operations which we cannot currently assess.

 

We may engage in future acquisitions that dilute the ownership interests of our stockholders, cause us to incur debt or assume contingent liabilities.

 

As part of our business strategy, from time to time, we review potential acquisitions of other businesses, and we expect to acquire businesses, products, or technologies in the future. In the event of any future acquisitions, we could:

 

    issue equity securities which would dilute current stockholders’ percentage ownership;

 

    incur substantial debt;

 

    assume contingent liabilities; or

 

    expend significant cash.

 

These actions could harm our business, operating results and financial condition, or the price of our common stock. Moreover, even if we do obtain benefits from acquisitions in the form of increased sales and earnings, there may be a delay between the time when the expenses associated with an acquisition are incurred and the time when we recognize such benefits. This is particularly relevant in cases where it is necessary to integrate new types of technology into our existing portfolio and where new types of products may be targeted for potential customers with which we do not have pre-existing relationships. Acquisitions and investment activities also entail numerous risks, including:

 

    difficulties in the assimilation of acquired operations, technologies and/or products;

 

    unanticipated costs associated with the acquisition transaction;

 

    the diversion of management’s attention from other business;

 

    adverse effects on existing business relationships with suppliers and customers;

 

    risks associated with entering markets in which we have no or limited prior experience;

 

    the potential loss of key employees of acquired businesses;

 

    difficulties in the assimilation of different corporate cultures and practices; and

 

    substantial charges for the amortization of certain purchased intangible assets, deferred stock compensation or similar items.

 

We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and our failure to do so could have a material adverse effect on our business, operating results and financial condition.

 

We are subject to import/export controls that could subject us to liability or impair our ability to compete in international markets.

 

Our products are subject to U.S. export controls and may be exported outside the United States only with the required level of export license or through an export license exception, in most cases because we incorporate encryption technology into our products. In addition, various countries regulate the import of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers internationally.

 

19


Table of Contents

In addition, we may be subject to customs duties and export quotas, which could have a significant impact on our revenue and profitability. While we have not encountered significant difficulties in connection with the sales of our products in international markets, the future imposition of significant increases in the level of customs duties or export quotas could have a material adverse effect on our business.

 

If we fail to comply with environmental regulatory requirements, our future revenues could be adversely affected.

 

We face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of many of our products. The European Union, or EU, has adopted certain directives to facilitate the recycling of electrical and electronic equipment sold in the EU, including the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment directive that restricts the use of lead, mercury and certain other substances in electrical and electronic products placed on the market in the EU after July 1, 2006. In connection with our compliance with these environmental laws and regulations, we have incurred substantial costs, including research and development costs, and costs associated with assuring the supply of compliant components from our suppliers. Similar laws and regulations have been proposed or may be enacted in other regions, including in the United States, China and Japan. Other environmental regulations may require us to reengineer our products to utilize components that are compatible with these regulations, and this reengineering and component substitution may result in additional costs to us or disrupt our operations or logistics.

 

New privacy laws and regulations or changing interpretations of existing laws and regulations could harm our business.

 

Governments in the United States and other countries have adopted laws and regulations regarding privacy and advertising that could impact important aspects of our business. In particular, governments are considering new limitations or requirements with respect to our customers’ collection, use, storage and disclosure of personal information for marketing purposes. Any legislation enacted or regulation issued could dampen the growth and acceptance of addressable advertising which is enabled by our products. If the use of our products to increase advertising revenue is limited or becomes unlawful, our business, results of operations and financial condition would be harmed.

 

Recent accounting regulations related to equity compensation could adversely affect our earnings and our ability to attract and retain key personnel.

 

Since our inception, we have used stock options as a fundamental component of our employee compensation packages. We believe that our stock option plans are an essential tool to link the long-term interests of our stockholders and employees and serve to motivate management to make decisions that will, in the long run, give the best returns to stockholders. The Financial Accounting Standards Board has instituted changes to GAAP that require us to record a charge to earnings for employee stock option grants and employee stock purchase plan rights. In addition, NASDAQ Global Market, or NASDAQ, regulations requiring stockholder approval for all stock option plans could make it more difficult for us to grant options to employees in the future. To the extent that these or other new regulations make it more difficult or expensive to grant options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business, operating results and financial condition.

 

Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.

 

Our corporate headquarters are located in the San Francisco Bay area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, could have a material adverse impact on our

 

20


Table of Contents

business, operating results and financial condition. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, acts of terrorism or war could cause disruptions in our or our customers’ business or the economy as a whole. To the extent that such disruptions result in delays or cancellations of customer orders, or the deployment of our products, our business, operating results and financial condition would be adversely affected.

 

Risks Related to this Offering and Ownership of our Common Stock

 

We will incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which could adversely affect our operating results.

 

As a public company we will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with recently adopted corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the Securities and Exchange Commission, or SEC, and the NASDAQ. In addition, our management team will also have to adapt to the requirements of being a public company. The expenses incurred by public companies for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to substantially increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We are unable to currently estimate these costs with any degree of certainty. We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage than used to be available. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.

 

Our failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in new products could reduce our ability to compete and could harm our business.

 

We expect that our existing cash and cash equivalents and existing amounts available under our revolving credit facility, together with the net proceeds from this offering, will be sufficient to meet our anticipated cash needs for at least the next twelve months. After that, we may need to raise additional funds, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and the per share value of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness and force us to maintain specified liquidity or other ratios, any of which could harm our business, operating results and financial condition. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

 

    develop or enhance our products and services;

 

    continue to expand our product development sales and marketing organizations;

 

    acquire complementary technologies, products or businesses;

 

    expand operations, in the United States or internationally;

 

    hire, train and retain employees; or

 

    respond to competitive pressures or unanticipated working capital requirements.

 

Our failure to do any of these things could seriously harm our business, operating results and financial condition.

 

An active, liquid and orderly trading market for our common stock may not develop, the price of our stock may be volatile, and you could lose all or part of your investment.

 

Prior to this offering, there has been no public market for shares of our common stock. The initial public offering price of our common stock will be determined through negotiation with the underwriters. This price will

 

21


Table of Contents

not necessarily reflect the price at which investors in the market will be willing to buy and sell our shares of common stock following this offering. In addition, the trading price of our common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control, including those factors described above in “—Our operating results are likely to fluctuate significantly and may fail to meet or exceed the expectations of securities analysts or investors or our guidance, causing our stock price to decline.”

 

In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of companies’ stock, including ours, regardless of actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

Concentration of ownership among our existing executive officers, directors and their affiliates may prevent new investors from influencing significant corporate decisions.

 

Upon completion of this offering, our executive officers, directors and their affiliates will beneficially own, in the aggregate, approximately         % of our outstanding common stock. As a result, these stockholders will be able to exercise a significant level of control over all matters requiring stockholder approval, including the election of directors, amendment of our certificate of incorporation and approval of significant corporate transactions. This control could have the effect of delaying or preventing a change of control of our company or changes in management and will make the approval of certain transactions difficult or impossible without the support of these stockholders. See “Principal and Selling Stockholders” for additional detail about the shareholdings of these persons.

 

Future sales of shares by existing stockholders could cause our stock price to decline.

 

If our existing stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline. Based on shares of common stock outstanding as of September 30, 2006, upon completion of this offering, we will have outstanding a total of                      shares of common stock, assuming no exercise of the underwriters’ over-allotment option. Of these shares, only the                      shares of common stock sold in this offering by us and the selling stockholders will be freely tradable, without restriction, in the public market. Our underwriters, however, may, in their sole discretion, permit our officers, directors and other current stockholders who are subject to the contractual lock-up to sell shares prior to the expiration of the lock-up agreements.

 

We expect that the lock-up agreements pertaining to this offering will expire 180 days from the date of this prospectus (subject to extension upon the occurrence of specified events). After the lock-up agreements expire, up to an additional                      shares of common stock will be eligible for sale in the public market,                      of which shares are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act and various vesting agreements. In addition,                      shares of common stock that are either subject to outstanding options or reserved for future issuance under our employee benefit plans will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the lock-up agreements and Rule 144 and Rule 701 under the Securities Act. If these additional shares of common stock are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

 

22


Table of Contents

Anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt.

 

Our certificate of incorporation, bylaws and Delaware law contain provisions which could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents include provisions:

 

    creating a classified board of directors whose members serve staggered three-year terms;

 

    authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;

 

    limiting the liability of, and providing indemnification to, our directors and officers;

 

    limiting the ability of our stockholders to call and bring business before special meetings;

 

    requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;

 

    controlling the procedures for the conduct and scheduling of board and stockholder meetings; and

 

    providing the board of directors with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings.

 

These provisions, alone or together, could delay hostile takeovers and changes in control or changes in our management.

 

As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock.

 

Any provision of our certificate of incorporation or bylaws, or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

 

Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

 

The initial public offering price of our common stock is substantially higher than the net tangible book value per share of our outstanding common stock immediately after this offering. Therefore, if you purchase our common stock in this offering, you will incur an immediate dilution of $             in net tangible book value per share from the price you paid. In addition, following this offering, purchasers in the offering will have contributed             % of the total consideration paid by our stockholders to purchase shares of common stock. The exercise of outstanding options and warrants will result in further dilution. For a further description of the dilution that you will experience immediately after this offering, see “Dilution.”

 

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

 

Our management will have broad discretion to use our net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply our net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds from this offering for the repayment of outstanding indebtedness and for general corporate purposes, including working capital and capital expenditures, which may in the future include investments in, or acquisitions of, complementary businesses, services or technologies. Our management might not be able to yield a significant return, if any, on any investment of these net proceeds. You will not have the opportunity to influence our decisions on how to use our net proceeds from this offering.

 

23


Table of Contents

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS AND INDUSTRY DATA

 

This prospectus includes forward looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward looking statements. We have based these forward looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short term and long term business operations and objectives, and financial needs. These forward looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors.” In light of these risks, uncertainties and assumptions, the forward looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward looking statements.

 

Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Before investing in our common stock, investors should be aware that the occurrence of the risks, uncertainties and events described in the section entitled “Risk Factors” and elsewhere in this prospectus could have a material adverse effect on our business, results of operations and financial condition.

 

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this prospectus to conform these statements to actual results or to changes in our expectations.

 

This prospectus also contains statistical data and estimates, including those relating to market size and growth rates of the markets in which we participate, that we obtained from industry publications and reports generated by American Advertising Federation, In-Stat, IDC, Kagan Research LLC, Yankee Group Research Inc. and ZenithOptimedia Group. These publications typically indicate that they have obtained their information from sources they believe to be reliable, but do not guarantee the accuracy and completeness of their information. Although we have assessed the information in the publications and found it to be reasonable and believe the publications are reliable, we have not independently verified their data.

 

You should read this prospectus and the documents that we reference in this prospectus and have filed with the SEC as exhibits to the registration statement of which this prospectus is a part with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

 

24


Table of Contents

USE OF PROCEEDS

 

We estimate that our net proceeds from the sale of the common stock that we are offering will be approximately $            , assuming an initial public offering price of $             per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses that we must pay. If the underwriters’ option to purchase additional shares in this offering is exercised in full, we estimate that our net proceeds will be approximately $            . We will not receive any proceeds from the sale of shares of common stock by the selling stockholders.

 

We expect to use a portion of our net proceeds to repay the entire outstanding balance under our term loan and revolving credit facility with Silicon Valley Bank, which was approximately $14.0 million as of September 30, 2006. This term loan bears interest at the Federal Reserve’s prime rate plus 0.25%, which was 8.50% as of September 30, 2006, and this revolving credit facility bears interest at the Federal Reserve’s prime rate, which was 8.25% as of September 30, 2006. The term loan has a maturity date of August 18, 2009. The revolving credit facility has a maturity date of August 18, 2008. We have used the proceeds of the term loan and the revolving credit facility for working capital and other general corporate purposes.

 

We intend to use the remaining net proceeds to us from this offering for working capital, capital expenditures and other general corporate purposes. We may also use a portion of our net proceeds to fund acquisitions of complementary businesses, products or technologies. However, we do not have agreements or commitments for any specific repayments or acquisitions at this time.

 

Pending use of the proceeds as described above, we intend to invest the proceeds in short-term, interest-bearing, investment-grade securities.

 

DIVIDEND POLICY

 

We have never declared or paid cash dividends on our common or preferred stock. We currently do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of directors, subject to applicable laws and compliance with certain covenants under our credit facility, which restrict or limit our ability to pay dividends, and will depend on our financial condition, results of operations, capital requirements, general business conditions and other factors that our board of directors may deem relevant.

 

25


Table of Contents

CAPITALIZATION

 

The following table sets forth our capitalization as of September 30, 2006:

 

    on an actual basis;

 

    on a pro forma basis to give effect to the conversion of all outstanding shares of our redeemable convertible preferred stock and all outstanding shares of non-voting class B common stock into common stock upon the completion of this offering, resulting in the termination of the redeemable convertible preferred stock and class B common stock conversion feature, the termination of the redemption rights associated with the class B common stock and the reclassification of the preferred stock warrant liabilities to additional paid-in capital upon closing of this offering; and

 

    on a pro forma as adjusted basis to reflect, in addition, our receipt of the estimated net proceeds from the sale of              shares of common stock offered by us in this offering, based on an assumed initial public offering price of $             per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our use of proceeds from this offering to repay approximately $14.0 million of outstanding indebtedness and the filing of the restated certificate of incorporation upon completion of this offering.

 

You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    As of September 30, 2006
        Actual             Pro Forma        

Pro Forma

    As Adjusted    

    (in thousands, except per share data)

Cash, cash equivalents and marketable securities

  $ 40,051     $ 40,051     $             
                     

Current and long-term debt

    14,097       14,097    

Preferred stock warrant liability

    3,039          

Redeemable convertible preferred stock; $.001 par value: 128,266 shares authorized and 117,755 shares issued and outstanding actual; no shares authorized and no shares issued and outstanding pro forma; 5,000 shares authorized and no shares issued and outstanding pro forma as adjusted

    117,307          

Common stock, $.001 par value; 335,000 shares authorized actual; 335,000 shares authorized pro forma; 250,000 shares authorized pro forma as adjusted

     

Class A voting: 300,000 shares designated and 31,551 shares issued and outstanding actual; 300,000 shares designated and 197,072 shares issued and outstanding pro forma; 250,000 shares designated and              shares issued and outstanding pro forma as adjusted

    32       197    

Class B non-voting: 35,000 shares designated and 14,475 shares issued and outstanding actual; no shares designated and no shares issued and outstanding pro forma; no shares designated and no shares issued and outstanding pro forma as adjusted

    14          

Additional paid-in capital

    15,734       135,929    

Deferred stock compensation

    (1,715 )     (1,715 )  

Accumulated other comprehensive income

    6       6    

Accumulated deficit

    (120,236 )     (120,236 )  
                     

Total stockholders’ equity (deficit)

    (106,165 )     14,181    
                     

Total capitalization

  $ 28,278     $ 28,278     $  
                     

 

26


Table of Contents

This table excludes the following shares:

 

    48,468,333 shares of common stock issuable upon exercise of stock options as of September 30, 2006, at a weighted-average exercise price of $0.30 per share;

 

    3,734,658 shares of common stock issuable upon exercise of warrants outstanding as September 30, 2006, at a weighted-average exercise price of $0.91 per share;

 

                     shares of common stock reserved for future issuance under our Employee Stock Purchase Plan;

 

                     shares of common stock reserved for future issuance under our 2007 Equity Incentive Plan; and

 

                     shares of common stock if the underwriters’ over-allotment option were exercised in full.

 

27


Table of Contents

DILUTION

 

Our pro forma net tangible book value as of September 30, 2006, was $         million, or $         per share of common stock. Net tangible book value per share represents the amount of stockholders’ equity divided by                  shares of common stock outstanding after giving effect of the automatic conversion of all outstanding shares of preferred stock into shares of common stock and all of the outstanding class B common stock into shares of common stock upon completion of this offering.

 

Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after the completion of this offering. After giving effect to our sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share, the mid-point of the range on the cover of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value as of September 30, 2006 would have been, $             million, or $             per share. This represents an immediate increase in net tangible book value of $             per share to existing stockholders and an immediate dilution in net tangible book value of $             per share to investors purchasing common stock in this offering, as illustrated in the following table:

 

Assumed initial public offering price per share

      $             

Pro forma net tangible book value per share as of September 30, 2006, before giving effect to this offering

   $                

Increase in pro forma net tangible book value per share attributed to new investors purchasing shares in this offering

     
         

Pro forma net tangible book value per share after giving effect to this offering

     
         

Dilution per share to new investors in this offering

      $  
         

 

If the underwriters exercise their option to purchase additional shares of our common stock in full, the pro forma net tangible book value per share after giving effect to this offering would be $             per share, the increase in pro forma net tangible book value per share to existing stockholders would be $             per share and the dilution to new investors purchasing shares in this offering would be $             per share.

 

The following table presents on a pro forma basis as of September 30, 2006, after giving effect to the sale of              shares and the automatic conversion of all preferred stock into common stock upon completion of this offering, the differences between the existing stockholders and the purchasers of shares in this offering with respect to the number of shares purchased from us, the total consideration paid and the average price paid per share:

 

     Shares Purchased     Total Consideration    

Average

Price Per
Share

        Number        Percent       Amount      Percent      
     (in thousands, except per share and percent)      

Existing stockholders

                   %   $                              %   $             

New public investors

            
                          

Total

      100.0 %   $      100.0 %  
                          

 

The above discussion and table assume no exercise of stock options or warrants outstanding as of September 30, 2006, including 48,468,333 shares of common stock issuable upon exercise of options with a weighted-average exercise price of $0.30 per share and 3,734,658 shares of common stock issuable upon exercise of warrants with a weighted-average exercise price of $0.91 per share. If all of these options and warrants were exercised, then our existing stockholders, including the holders of these options and warrants, would own     % and our new investors would own     % of the total number of shares of our common stock outstanding upon the closing of this offering.

 

28


Table of Contents

SELECTED CONSOLIDATED FINANCIAL DATA

 

The following selected consolidated financial data should be read in conjunction with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes included in this prospectus. The selected consolidated financial data included in this section is not intended to replace the consolidated financial statements and the related notes included in this prospectus.

 

The consolidated statements of operations data for the years ended December 31, 2003, 2004 and 2005, and consolidated balance sheets data as of December 31, 2004 and 2005, were derived from our audited consolidated financial statements that are included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2001 and 2002, and consolidated balance sheets data as of December 31, 2001, 2002 and 2003, were derived from our audited consolidated financial statements not included in this prospectus. The consolidated statements of operations data for the nine months ended September 30, 2005 and 2006, and consolidated balance sheet data as of September 30, 2006 were derived from our unaudited consolidated financial statements that are included elsewhere in this prospectus. The unaudited consolidated financial statements were prepared on a basis consistent with our audited consolidated financial statements contained in this prospectus and include, in the opinion of management, all adjustments necessary for the fair presentation of the financial information contained in those statements. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods, and the results for the nine months ended September 30, 2006, are not necessarily indicative of results to be expected for the full year or for any other period.

 

    Years Ended December 31,    

Nine Months

Ended

September 30,

 
    2001     2002     2003     2004     2005     2005     2006(4)  
    (in thousands, except per share data)  

Consolidated Statements of Operations Data(1):

             

Net revenues

             

Products

  $ 392     $ 9,203     $ 20,014     $ 31,536     $ 85,966     $ 62,773     $ 97,313  

Services

          371       1,566       3,936       12,013       8,475       16,309  
                                                       

Total net revenues

    392       9,574       21,580       35,472       97,979       71,248       113,622  

Cost of net revenues(2)

             

Products

    204       4,545       8,597       21,300       55,933       41,816       49,486  

Services

          213       1,027       2,221       3,900       2,589       6,689  
                                                       

Total cost of net revenues

    204       4,758       9,624       23,521       59,833       44,405       56,175  

Gross profit

             

Products

    188       4,658       11,417       10,236       30,033       20,957       47,827  

Services

          158       539       1,715       8,113       5,886       9,620  
                                                       

Total gross profit

    188       4,816       11,956       11,951       38,146       26,843       57,447  
                                                       

Operating expenses

             

Research and development(2)

    12,568       7,669       9,519       21,582       30,701       22,804       26,600  

Sales and marketing(2)

    7,034       6,278       10,376       15,891       22,729       16,188       20,965  

General and administrative(2)

    4,163       2,378       3,095       5,782       6,984       5,137       8,048  

Amortization of purchased intangible assets

                      286       573       429       429  

In-process research and development

                      966                    
                                                       

Total operating expenses

    23,765       16,325       22,990       44,507       60,987       44,558       56,042  
                                                       

Operating income (loss)

    (23,577 )     (11,509 )     (11,034 )     (32,556 )     (22,841 )     (17,715 )     1,405  

Other income (expense), net

    (523 )     (36 )     (673 )     (957 )     (1,696 )     (1,118 )     (1,488 )
                                                       

Net loss before provision for income taxes and cumulative effect of change in accounting principle

    (24,100 )     (11,545 )     (11,707 )     (33,513 )     (24,537 )     (18,833 )     (83 )

Provision (benefit) for income taxes

                      250       325       262       (17 )
                                                       

Net loss before cumulative effect of change in accounting principle

    (24,100 )     (11,545 )     (11,707 )     (33,763 )     (24,862 )     (19,095 )     (66 )

Cumulative effect of change in accounting principle

                            (633 )     (633 )      
                                                       

Net loss

  $ (24,100 )   $ (11,545 )   $ (11,707 )   $ (33,763 )   $ (25,495 )   $ (19,728 )   $ (66 )
                                                       

Net loss per common share, basic and diluted

  $ (1.81 )   $ (0.56 )   $ (0.50 )   $ (1.05 )   $ (0.59 )   $ (0.46 )   $ (0.00 )
                                                       

Shares used in computing net loss per common share, basic and diluted

    13,299       20,633       23,325       32,125       43,175       42,887       45,387  
                                                       

Pro forma net loss per common share, basic and diluted(3)

          $ (0.13 )     $ (0.00 )
                         

Shares used in computing pro forma net loss per common share, basic and diluted(3)

            194,221         196,433  
                         

 

(Footnotes appear on the next page)

 

29


Table of Contents

 

     As of December 31,    

As of
September 30,

2006

 
     2001     2002     2003     2004     2005    
     (in thousands)  

Consolidated Balance Sheet Data:

            

Cash, cash equivalents and marketable securities

   $ 4,252     $ 9,638     $ 14,290     $ 23,796     $ 24,287     $ 40,051  

Working capital

     4,734       9,424       16,188       27,606       5,812       15,154  

Total assets

     12,309       21,920       30,862       80,052       76,816       105,847  

Current and long-term debt

                 4,662       12,094       11,418       14,097  

Preferred stock warrant liability(5)

                             1,642       3,039  

Redeemable convertible preferred stock

     44,028       59,846       75,060       118,204       117,307       117,307  

Common stock and additional paid-in capital

     925       1,376       1,535       14,049       14,990       15,780  

Total stockholders’ deficit

     (36,726 )     (47,943 )     (59,388 )     (83,926 )     (107,819 )     (106,165 )

  (1)   On June 29, 2004, we completed the acquisition of Broadband Access Systems, Inc., which we refer to as BAS, from ADC Telecommunications, Inc. in a transaction accounted for as a business combination using the purchase method. For further information on our acquisition of BAS, see Note 4 of the Notes to Consolidated Financial Statements included in this prospectus.

 

  (2)   Includes stock-based compensation as follows:

 

     Years Ended December 31,   

Nine Months
Ended

September 30,

       2001        2002        2003        2004      2005      2005        2006(4)  
     (in thousands)

Cost of net revenues

   $   —    $    $    $ 46    $ 87    $ 66    $ 181

Research and development

          165      52      299      516      405      512

Sales and marketing

          164           134      263      193      310

General and administrative

               51      222      237      158      327
                                                

Total stock-based compensation

   $    $ 329    $ 103    $ 701    $ 1,103    $ 822    $ 1,330
                                                

 

  (3)   The pro forma weighted average common shares outstanding reflects the conversion of our redeemable convertible preferred stock (using the if-converted method) into common stock as though the conversion had occurred on the original date of issuance.
  (4)   We adopted the fair value recognition and measurement provisions of SFAS No. 123(R), Share-Based Payments, effective January 1, 2006, using the prospective transition method. For periods prior to January 1, 2006, we followed the intrinsic value recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. For further information, see Note 2 to the Notes to Consolidated Financial Statements included in this prospectus.
  (5)   We adopted the provisions of Financial Accounting Standards Board Staff Position No. 150-5, Issuer’s Accounting under Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares that Are Redeemable, or FSP 150-5, an interpretation of FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, effective July 1, 2005. Pursuant to FSP 150-5, freestanding warrants for shares that are either puttable or warrants for shares that are redeemable are classified as liabilities on the consolidated balance sheet at fair value. At the end of each reporting period, changes in fair value during the period are recorded as a component of other income (expense), net. Prior to July 1, 2005, we accounted for warrants for the purchase of preferred stock under EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. For further information regarding the cumulative effect of accounting change from the adoption of FSP 150-5, see Note 2 of the Notes to Consolidated Financial Statements included in this prospectus.

 

30


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and related notes that are included elsewhere in this prospectus. This discussion contains forward-looking statements, which are based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or in other parts of this prospectus.

 

Overview

 

Our company was founded in December 1998, and through 2001 we were engaged principally in research and development. We first generated meaningful product revenues in 2002, principally from our initial media processing platform designed for video. Since 2003, we have expanded our customer base to include six of the ten largest service providers in the United States, including Cablevision, Comcast, Charter, Cox, Time Warner Cable and Verizon. To expand the breadth of our products, in June 2004, we acquired the high-speed data equipment BAS division of ADC Telecommunications, Inc. From 2003 through 2005, we experienced significant revenue growth that was derived primarily from cable operators. Beginning in 2005, we commenced sales efforts to telephone companies and began recognizing significant revenues from one of these companies in 2006.

 

We first achieved profitability on a quarterly basis for the three months ended September 30, 2006. As of September 30, 2006, we had an accumulated deficit of $120.2 million.

 

Our net revenues are influenced by a variety of factors, including the level and timing of capital spending of our customers, and the annual budgetary cycles of, and the timing and amount of orders from, significant customers. The selling prices of our products vary based upon the particular customer implementation, which impacts the relative mix of software, hardware and services associated with the sale.

 

Our sales cycle for an initial customer purchase typically ranges from nine to eighteen months, but can be longer. This process generally involves several stages before we can recognize revenues on the sale of our products. As a provider of advanced technologies, we seek to actively participate with our existing and potential customers in the evaluation of their technology needs and network architectures, including the development of initial designs and prototypes. Following these activities, we typically respond to a service provider’s request for proposal, configure our products to work within our customer’s network architecture, and test our products first in laboratory testing and then in field environments to ensure interoperability with existing products in the service provider’s network. Following testing, our revenue recognition depends on satisfying complex customer acceptance criteria specified in our contract with the customer and our customer’s schedule for roll-out of the product. Completion of several of these stages is substantially outside of our control, which causes our revenue patterns from a given customer to vary widely from period to period. After initial deployment of our products, subsequent purchases of our products typically have a more compressed sales cycle.

 

Due to the nature of the cable and telecommunications industries, we sell our products to a limited number of large customers, which have varied over time. For the nine months ended September 30, 2006, and the years ended December 31, 2005 and December 31, 2004, we derived 73%, 69% and 61% of our net revenues from our top five customers, respectively. During these periods, we derived 27%, 0% and 0% of our net revenues from Verizon, 12%, 10% and 12% from Time Warner Cable, 13%, 20% and 18% from Cox, 7%, 37% and 13% from Adelphia and 14%, 2% and 18% from Comcast, respectively. We believe that for the foreseeable future our net revenues will be concentrated in a relatively small number of large customers. The loss of one or more of our large customers, or the cancellation or deferral of purchases by one or more of these customers, would have a material adverse impact on our revenues and operating results.

 

We sell our products and services to customers in the United States through our direct sales force. We sell to customers internationally through a combination of direct sales and resellers. In the nine months ended September 30, 2006, approximately 85% of our sales were to customers in the United States and 15% were to customers outside the United States.

 

31


Table of Contents

Net Revenues.    We derive our net revenues from sales of, and services for, video and data products. Our product revenues are comprised of a combination of software licenses and hardware. Our primary video products include TelcoTV, Digital Simulcast and Switched Broadcast. Our data products include High-Speed Data and Voice-over-IP. Our services include ongoing customer support and maintenance, product installation and training. Our customer support and maintenance is available in a tiered offering at either a standard or enhanced level. The substantial majority of our customers have purchased our enhanced level of customer support and maintenance. The accounting for our net revenues is complex and, as discussed below, we account for revenues in accordance with Statement of Position, or SOP 97-2, Software Revenue Recognition.

 

Cost of Net Revenues.    Our cost of product revenues consists primarily of payments for components and product assembly, costs of product testing, provisions taken for excess and obsolete inventory and for warranty obligations and manufacturing overhead. Cost of services revenues is primarily comprised of personnel costs in providing technical support, costs incurred to support deployment and installation within our customers’ networks and training costs.

 

Gross Margin.    Our gross profit as a percentage of net revenues, or gross margin, has been and will continue to be affected by a variety of factors, including the mix of software and hardware sold, the mix of revenue between our video and data products, the average selling prices of our products, and the mix of revenue between products and services. We achieve a higher gross margin on the software content of our products compared to the hardware content. We also generally earn a higher gross margin on our video products compared to our data products. In general, we expect the average selling prices of our products to decline over time, but we seek to maintain our overall gross margins by introducing new products with higher margins, selling software enhancements to existing products, achieving price reductions for components and improving product design to reduce costs. Our gross margins for products are also influenced by the specific terms of our contracts, which may vary significantly from customer to customer based on the type of products sold, the overall size of the customer’s order, and the architecture of the customer network, which can influence the amount and complexity of design, integration and installation services.

 

Operating Expense.    Our operating expense consists of research and development, sales and marketing, general and administrative, in-process research and development and amortization of intangible assets. Personnel related costs are the most significant component of operating expense. We grew from 156 employees at December 31, 2003, to 507 at September 30, 2006. We expect to continue to hire a significant number of new employees to support the growth we anticipate.

 

Research and development expense is the largest component of our operating expense and consists primarily of personnel costs, independent contractor costs, prototype expenses and other allocated facilities and information technology expense. The majority of our research and development staff is focused on software development. All research and development costs are expensed as incurred. Our development teams are located in Westborough, Massachusetts, Tel Aviv, Israel and Redwood City, California. We expect our research and development expenses to continue to increase in absolute dollars in future periods.

 

Sales and marketing expense relates primarily to compensation and associated costs for marketing and sales personnel, sales commissions, promotional and other marketing expenses, travel, trade-show expenses, depreciation expenses for demonstration equipment used for trade-shows and allocated facilities and information technology expense. Marketing programs are intended to generate net revenues from new and existing customers and are expensed as incurred. We expect sales and marketing expense to increase in absolute dollars as we hire additional personnel, expand our sales and marketing efforts domestically and internationally and seek to increase our brand awareness.

 

General and administrative expense consists primarily of compensation and associated costs for general and administrative personnel, professional fees and allocated facilities and information technology expenses. Professional services consist of outside legal, accounting and information technology and other consulting costs. We expect that general and administrative expense will increase in absolute dollars as we hire additional

 

32


Table of Contents

personnel, incur costs related to the anticipated growth of our business, and make improvements to our information technology infrastructure. In addition, we expect to incur significant additional costs as we transition to being a public company, including the costs of SEC reporting, Sarbanes-Oxley Act compliance and director and officer liability insurance.

 

BAS Acquisition

 

In June 2004, we acquired the BAS division of ADC Telecommunications, Inc. to expand our suite of product offerings with a high-speed data product. The aggregate consideration for this acquisition was valued at approximately $25.1 million and was allocated between net tangible and intangible assets of $19.8 million and $5.3 million, respectively. The net tangible assets included a $4.7 million increase in the basis of acquired inventory, all of which was sold by the end of 2005.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires our management to make estimates, assumptions, and judgments 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 applicable periods. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.

 

The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.

 

Revenue Recognition

 

We derive net revenues from sales of our products and services. Product revenues consists of sales of our hardware and software products. Shipping charges, which have been insignificant to date, are included in product revenues, and the related shipping costs are included in cost of product revenue. Service revenues consists of customer support and maintenance, product installation and training activities.

 

Software is essential to the functionality of our products. We provide software updates that we choose to develop, which we refer to as unspecified software updates, and enhancements related to our products through support service contracts. As a result, we account for revenue in accordance with Statement of Position, or SOP 97-2, Software Revenue Recognition as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, for all transactions involving the sale of software.

 

We recognize product revenue when all of the following have occurred: (1) we have entered into an arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is probable. Pricing is considered fixed or determinable at the execution of a legally binding arrangement, based on specific products and quantities to be delivered at specified prices. We assess the ability to collect from our customers based on a number of factors, including credit-worthiness and any past transaction history of the customer. In the limited circumstances where we may have a customer not deemed creditworthy, we will defer all net revenues from the arrangement until payment is received and all other revenue recognition criteria have been met.

 

Product revenues consist of hardware and a perpetual license to our software. Product revenues are generally recognized upon transfer of title to the customer assuming all other revenue recognition criteria are met, except for customers that require contractually negotiated acceptance of our products, in which case we

 

33


Table of Contents

recognize net revenues at the earlier of receipt of acceptance from the customer or when the rejection period lapses. Substantially all of our contracts, including those with resellers, do not include rights of return. To the extent that our agreements contain such terms, we recognize revenue once the right of return lapses. Returns to date have been insignificant. Our resellers generally do not maintain any inventory and only receive products from us when an end-user customer has committed to the purchase.

 

Most of our products are sold in combination with customer support and maintenance services, which consist of software updates and product support. Software updates provide customers with rights to unspecified software updates that we choose to develop and to maintenance releases and patches released during the term of the support period. Product support services include telephone support, access to on-site technical support personnel and repair or replacement of hardware in the event of damage or failure during the term of the support period. Net revenues for support services are recognized on a straight-line basis over the service contract term, which is generally one year. Installation services and training services, when provided, are also recognized in service revenues when performed.

 

We use the residual method, as allowed by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence, or VSOE, of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and any remaining amount provided for under the contract is recognized. When the undelivered element is customer support and maintenance, that portion of the revenue is recognized ratably over the term of the customer support arrangement, and the remaining revenue associated with the arrangement is recognized when all the other criteria of SOP 97-2 are satisfied. We have established VSOE of the fair value of our customer support and maintenance and other services based upon the normal pricing and discounting practices for those services when sold separately and the prices at which our customers have renewed their customer support and maintenance arrangements. If evidence of the fair value of one or more undelivered elements does not exist, all revenues are 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 which includes a commitment for delivery of a future specified software feature or functionality, we defer revenue recognition for the entire arrangement until the specified software feature or functionality is delivered.

 

Revenue recognition requirements under SOP 97-2 are very complex. In applying our revenue recognition policy, we must determine which portions of our revenue are recognized currently and which portions must be deferred.

 

Valuation of Inventories

 

Inventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out method. We provide for excess and obsolete inventories after evaluation of historical sales and usage, current economic trends, market conditions, product rationalization, forecasted sales, product lifecycle and current inventory levels. Provisions for excess and obsolete inventory are recorded as cost of net product revenues. This evaluation requires us to make estimates regarding future events in an industry where rapid technological changes are prevalent. It is possible that increases in inventory write-downs may be required in the future if there is a decline in market conditions or if changes in expected product lifecycles occur. If market conditions improve or product lifecycles extend, we may have greater success in selling inventory that had previously been written down. In either event, the actual value of our inventory may be higher or lower and recognition of such difference will affect our cost of net revenues in a future period, which could materially affect our operating results and financial position.

 

Warranty Liabilities

 

We warrant our products against defects in materials and workmanship. Generally, we warrant our products for one year. For our largest telephone company customer, we warrant our products for five years. A provision

 

34


Table of Contents

for estimated future costs related to warranty activities is recorded as a component of cost of net product revenues when the product revenues are recognized based upon our historical product failure rates and historical costs incurred in correcting product failures. The recorded amount is adjusted from time to time for specifically identified warranty exposures. Where we have experienced higher product failure rates and costs of correcting product failures change, or our estimates relating to specifically identified warranty exposures changed, we have recorded additional warranty reserves and may be required to do so in future periods. If our estimated reserves differ from our actual warranty costs based on historical experience, we may reverse a portion of or increase such provisions in future periods. In the event we change our warranty reserve estimates, the resulting charge against future cost of sales or reversal of previously recorded charges may materially affect our gross margins and operating results.

 

Stock-Based Compensation

 

Prior to January 1, 2006, we accounted for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB No. 25, and Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25. The intrinsic value represents the difference between the per share market price of the stock on the date of grant and the per share exercise price of the respective stock option. The resulting stock-based compensation is deferred and amortized to expense over the grant’s vesting period, which is generally four years.

 

During the year ended December 31, 2005, we granted options to employees to purchase a total of 7,533,708 shares of common stock at exercise prices ranging from $0.25 to $0.47 per share.

 

We estimated the fair value of our common stock with the assistance of a third-party valuation firm. This firm provided contemporaneous valuation reports dated June 29, 2004, December 31, 2005, June 1, 2006 and September 30, 2006, which valued our common stock at $0.44, $0.55, $0.65 and $1.32, respectively.

 

We determined that the deemed fair value of the options to purchase 7,533,708 shares of common stock granted in 2005 ranged from $0.47 to $0.55 per share.

 

We recorded deferred stock-based compensation relative to these options of $0.4 million during 2005, which is being amortized over the vesting periods of the applicable options on a straight-line basis. During 2005, we amortized $1.1 million of deferred stock based compensation, leaving approximately $2.6 million to be amortized in future periods. The total unamortized deferred stock-based compensation recorded for all outstanding option grants made through December 31, 2005 is expected to be amortized as follows: $0.3 million in the remainder of 2006, $1.0 million in 2007, $0.5 million in 2008 and $31,000 in 2009.

 

On January 1, 2006, we adopted the provisions of the Financial Accounting Standards Board, or FASB, SFAS 123R, Share-Based Payments, or SFAS 123R. Under SFAS 123R, stock-based compensation costs for employees is measured at the grant date, based on the estimated fair value of the award at that date, and is recognized as expense over the employee’s requisite service period, which is generally over the vesting period, on a straight-line basis. We adopted the provisions of SFAS 123R using the prospective transition method. Under this transition method, non-vested option awards outstanding at January 1, 2006, continue to be accounted for under the intrinsic value method under APB No. 25. All awards granted, modified or settled after the date of adoption are accounted for using the measurement, recognition and attribution provisions of SFAS 123R.

 

During the nine months ended September 30, 2006, we granted options to employees to purchase a total of 7,391,175 shares of common stock at exercise prices ranging from $0.47 to $0.65 per share that had a deemed fair value ranging from $0.55 to $1.32 per share.

 

We make a number of estimates and assumptions related to SFAS 123R. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results differ from our estimates, such amounts will

 

35


Table of Contents

be recorded as an adjustment in the period estimates are revised. Actual results may differ substantially from these estimates. In valuing share-based awards under SFAS 123R, significant judgment is required in determining the expected volatility of our common stock and the expected term individuals will hold their share-based awards prior to exercising. Expected volatility of the stock is based on our peer group in the industry in which we do business because we do not have sufficient historical volatility data for our own stock. The expected term of options granted represents the period of time that options granted are expected to be outstanding and was calculated using the simplified method permitted by the SEC Staff Accounting Bulletin No. 107. In the future, as we gain historical data for volatility in our own stock and the actual term employees hold our options, expected volatility and expected term may change which could substantially change the grant-date fair value of future awards of stock options and ultimately the expense we record.

 

For the nine months ended September 30, 2006, the total compensation cost related to stock-based awards granted under SFAS 123R to employees and directors but not yet amortized was approximately $3.1 million, net of estimated forfeitures. These costs will be amortized on a straight-line basis over a weighted average period of approximately 3.2 years. Amortization for the nine months ended September 30, 2006 was approximately $0.5 million.

 

Allowances for Doubtful Accounts

 

We make judgments as to our ability to collect outstanding accounts receivable and provide allowances for the applicable portion of accounts receivable when collection becomes doubtful. We provide allowances based upon a specific review of all significant outstanding invoices, analysis of our historical collection experience and current economic trends. If the historical data we use to calculate the allowance for doubtful accounts does not reflect our future ability to collect outstanding accounts receivable, additional provisions for doubtful accounts may be needed and our future results of operations could be materially affected. Our allowance for doubtful accounts was approximately $23,000, $23,000 and $60,000 at December 31, 2004 and 2005 and at September 30, 2006, respectively.

 

Estimation of Fair Value of Warrants to Purchase Redeemable Convertible Preferred Stock

 

On July 1, 2005, we adopted FSP 150-5. Our outstanding warrants to purchase shares of our redeemable convertible preferred stock are subject to the requirements in FSP 150-5, which require us to classify these warrants as current liabilities and to adjust the value of these warrants to their fair value at the end of each reporting period. At the time of adoption, we recorded $0.6 million for the cumulative effect of this change in accounting principle to reflect the cumulative change in estimated fair value of these warrants as of that date. We recorded $0.1 million and $1.4 million of expense in other expense, net, for the remainder of 2005 and the nine months ended September 30, 2006, respectively, to reflect further increases in the estimated fair value of the warrants. We estimated the fair value of these warrants at the respective balance sheet dates using the Black-Scholes option valuation model, based on the estimated market value of the underlying redeemable convertible preferred stock at the valuation measurement date, the remaining contractual term of the warrant, risk-free interest rates and expected dividends on and expected volatility of the price of the underlying redeemable convertible preferred stock. These estimates, especially the market value of the underlying redeemable convertible preferred stock and the expected volatility, are highly judgmental and could differ materially in the future.

 

Upon the closing of this offering, these warrants will become warrants to purchase shares of our common stock and, as a result, will no longer be subject to FSP 150-5. At that time, the then-current aggregate fair value of these warrants will be reclassified from current liabilities to additional paid-in capital, a component of stockholders’ deficit, and we will cease to record any related periodic fair value adjustments.

 

Impairment of Intangible Assets and Other Long-lived Assets

 

We assess impairment of long-lived assets in accordance with FAS No. 144, Impairment of Long-Lived Assets and test long-lived assets for recoverability when events or changes in circumstances indicate that their

 

36


Table of Contents

carrying amount may not be recoverable. Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; or current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.

 

Recoverability is assessed based on the sum of the undiscounted cash flows expected to result from the use and the eventual disposal of the asset. An impairment loss is recognized in the consolidated statements of operations when the carrying amount is not recoverable and exceeds fair value, which is determined on a discounted cash flow basis.

 

We make estimates and judgments about future undiscounted cash flows and fair value. Although our cash flow forecasts are based on assumptions that are consistent with our plans, there is significant exercise of judgment involved in determining the cash flows attributable to a long-lived asset over its estimated remaining useful life. Our estimates of anticipated future cash flows could be reduced significantly in the future. As a result, the carrying amount of our long-lived assets could be reduced through impairment charges in the future. Changes in estimated future cash flows could also result in a shortening of estimated useful life of long-lived assets including intangibles for depreciation and amortization purposes.

 

Accounting for Income Taxes

 

As part of the process of preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. We estimate actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in our consolidated statements of operations become deductible expenses under applicable income tax laws or loss or credit carry forwards are utilized. Accordingly, realization of our deferred tax assets is dependent on future taxable income against which these deductions, losses and credits can be utilized.

 

We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance.

 

Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We recorded a full valuation allowance as of September 30, 2006, because, based on the available evidence, we believed at that time it was more likely than not that we would not be able to utilize all of our deferred tax assets in the future. We intend to maintain the full valuation allowances until sufficient evidence exists to support the reversal of the valuation allowances. We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans and estimates. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted.

 

Material Weaknesses in Internal Controls

 

The audits of our 2004 and 2005 financial statements were both completed in 2006. In connection with these audits, our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting under the standards established by the American Institute of Certified Public Accountants. Our auditors were not, however, engaged to audit the effectiveness of our internal control over financial reporting. If such an evaluation had been performed or when we are required to perform such an evaluation, additional material weaknesses, significant deficiencies and other control deficiencies may have been or may be identified. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be evaluated frequently.

 

37


Table of Contents

Our auditors noted a number of matters involving our internal control over financial reporting that were considered to be material weaknesses in connection with our financial statements for the year ended December 31, 2005. In this regard,

 

    Our revenue recognition processes and procedures did not support timely and accurate reporting of the net revenues, deferred revenues and related costs of goods sold transactions in our financial results and related accounts. Further, we had an insufficient number of qualified financial personnel with the required proficiency to apply our accounting principles in this area. Our independent registered public accounting firm identified a substantial number of adjustments required to fairly present our consolidated financial statements in accordance with GAAP, relating, among other things, to our analysis and documentation of sales arrangements and assessments of, and accounting for, VSOE in our revenue recognition process.

 

    Our financial closing process and procedures did not support the timely and accurate reporting of our financial results. Our independent registered public accounting firm identified a substantial number of adjustments. These adjustments resulted from various control deficiencies such as: (i) the improper accounting of accruals, such as accruals for operating and compensation expenses and the related reconciliation of accounts payable and accrued liability accounts resulting in the overstatement of expenses; (ii) the lack of proper analysis and tracking of actual warranty costs and warranty experience and the impact thereof on established provisions for product warranties; (iii) the lack of proper analysis and tracking of excess and obsolete inventory and (iv) the improper accounting for transactions denominated in foreign currencies required to fairly present in accordance with GAAP our consolidated financial statements.

 

We have taken several steps to address the material weaknesses identified by our independent registered public accountants, including:

 

    Since June 2005, we have doubled the number of our finance staff and increased and upgraded our senior finance personnel. We have thereby significantly increased our finance personnel with public accounting and public reporting experience including by hiring a worldwide controller, a director of Sarbanes-Oxley compliance, a director of tax and treasury functions and a corporate controller. In particular, we hired a number of finance personnel with experience in revenue recognition, inventory and warranty accounting.

 

    We have implemented additional controls for the quarterly and annual financial close processes, including timely preparation and review of reconciliations, reviews of significant accounts and automation of system-based controls. We also made changes in our forecasting and budgeting processes, which are intended to improve our ability to analyze our operating results.

 

    We have made improvements in our analysis and review of all significant accounting estimates, including inventory valuation, excess and obsolete inventory provisions, warranty and other reserves and accruals.

 

    In July 2005, we commenced a review of internal control over financial reporting and related accounting processes and procedures for purposes of complying with Section 404 of the Sarbanes-Oxley Act and hired a full time director of Sarbanes-Oxley compliance. This review is ongoing. Under Section 404, our management will have to evaluate, and our independent registered public accounting firm will have to opine on the effectiveness of, our internal control over financial reporting beginning with our Annual Report on Form 10-K for the year ending December 31, 2008, due to be filed in March 2009.

 

However, these remediation efforts are still in process and have not yet been completed. Because of these material weaknesses, there is heightened risk that a material misstatement of our annual or quarterly financial statements will not be prevented or detected. In addition, the remediation steps we have taken, are taking, and expect to take may not effectively remediate the material weaknesses, in which case our internal control over financial reporting would continue to be ineffective. We cannot guarantee that we will be able to complete our

 

38


Table of Contents

remedial actions successfully. Even if we are able to complete these actions successfully, these measures may not adequately address our material weaknesses. In addition, it is possible that we will discover additional material weaknesses in our internal control over financial reporting.

 

Revenue Recognition on Sales in China

 

In connection with our implementation, in the third quarter of 2006, of more stringent controls related to contracts for providing customer support, we discovered that certain end users in China maintained that they were entitled to company-provided support while our contracts with these customers did not provide for customer support. In response, the Audit Committee of our Board of Directors conducted an independent investigation of the matter, employing independent counsel and an independent accounting firm. The investigation, which was completed in December 2006, found numerous instances in which resellers of our products in China, with the understanding and approval of our China personnel, agreed to provide technical support, extended warranty terms and potentially other undefined terms without proper documentation and without communicating these arrangements to our legal and finance departments. As a result, we have deferred approximately $4.8 million in revenue from customers in China, which will be recognized in future periods upon the satisfaction of all of the elements of our revenue recognition criteria. Our controls previously in place did not prevent these occurrences and we have therefore implemented a number of additional controls and remedial actions to ensure the appropriate accounting of future transactions and control over contracts with end users in China.

 

39


Table of Contents

Results of Operations

 

The following table shows the percentage relationships of the listed items from our consolidated statements of operations, as a percentage of total net revenues for the periods indicated:

 

    Years Ended
December 31,
    Nine Months Ended
September 30,
 
        2003             2004             2005             2005             2006      
                      (unaudited)  

Consolidated Statements of Operations Data:

         

Net revenues

         

Products

  92.7 %   88.9 %   87.7 %   88.1 %   85.6 %

Services

  7.3     11.1     12.3     11.9     14.4  
                             

Total net revenues

  100.0     100.0     100.0     100.0     100.0  
                             

Cost of net revenues

         

Products

  39.8     60.0     57.1     58.7     43.5  

Services

  4.8     6.3     4.0     3.6     5.9  
                             

Total cost of net revenues

  44.6     66.3     61.1     62.3     49.4  
                             

Gross profit:

         

Products

  52.9     28.9     30.6     29.4     42.1  

Services

  2.5     4.8     8.3     8.3     8.5  
                             

Total gross profit

  55.4     33.7     38.9     37.7     50.6  
                             

Operating expense

         

Research and development

  44.1     60.8     31.3     32.0     23.4  

Sales and marketing

  48.1     44.8     23.2     22.7     18.5  

General and administrative

  14.3     16.4     7.1     7.2     7.0  

Amortization of intangible assets

      0.8     0.6     0.6     0.4  

In-process research and development

      2.7              
                             

Total operating expense

  106.5     125.5     62.2     62.5     49.3  
                             

Operating income (loss)

  (51.1 )   (91.8 )   (23.3 )   (24.8 )   1.3  

Other expense, net

  (3.1 )   (2.7 )   (1.8 )   (1.6 )   (1.4 )
                             

Net loss before provision for income taxes and cumulative effect of change in accounting principle

  (54.2 )   (94.5 )   (25.1 )   (26.4 )   (0.1 )

Provision for income taxes

  0.0     0.7     0.3     0.4     0.0  
                             

Net loss before cumulative effect of change in accounting principle

  (54.2 )   (95.2 )   (25.4 )   (26.8 )   (0.1 )

Cumulative effect of change in accounting principle

          0.7     0.9      
                             

Net loss

  (54.2 )%   (95.2 )%   (26.0 )%   (27.7 )%   (0.1 )%
                             

 

Nine Months Ended September 30, 2006 and 2005

 

Net Revenues.    Net revenues for the nine months ended September 30, 2006 were $113.6 million compared to $71.2 million for the comparable period in the prior year, an increase of $42.4 million, or 59.6%. Revenues from our top five customers comprised 73% and 66% of net revenues for the nine months ended September 30, 2006 and 2005, respectively. During the period ended September 30, 2006, revenues from customers in the United States comprised 85% of net revenues, and revenues from customers outside the United States comprised 15% of net revenues, compared to the same period in 2005, in which customers in the United States comprised 82% of net revenues, and revenues from customers outside the United States comprised 18% of net revenues.

 

Products revenues for the nine months ended September 30, 2006 were $97.3 million compared to $62.8 million for the comparable period in the prior year, an increase of $34.5 million, or 54.9%. This increase was primarily due to a $57.9 million increase in revenues from our video products, partially offset by a $23.3 million decrease in revenues from our data products. Of the $57.9 million increase in video products, $29.3 million was attributable to the first recognition of significant net revenues from our TelcoTV products. The

 

40


Table of Contents

decrease in revenues from data products was primarily due to $18.8 million of revenues recognized in 2005 following satisfaction of customer acceptance criteria for product shipped to a single customer in 2004.

 

Services revenues for the nine months ended September 30, 2006 was $16.3 million compared to $8.5 million for the comparable period in the prior year, an increase of $7.8 million, or 91.8%. This $7.8 million increase was primarily due to an increase in customer support and maintenance revenues earned on a larger installed base of products.

 

Gross Profit/Gross Margin.    Gross profit for the nine months ended September 30, 2006 was $57.4 million compared to $26.8 million for the comparable period of 2005, an increase of $30.6 million, or 114.2%. Gross margin increased to 50.6% during the nine months ended September 30, 2006 compared to 37.7% in the comparable period of 2005.

 

Products gross margin for the nine months ended September 30, 2006 was 49.1% compared to 33.4% for the comparable period of 2005. This increase was due to a shift in product mix in 2006 towards video products, which have relatively higher margins. Gross margin in the nine months ended September 30, 2005 was adversely impacted by the sale of inventory acquired in the BAS transaction. Under purchase accounting, the carrying value of this inventory was increased by $4.7 million to its fair market value at the time of acquisition. The sale of a portion of this inventory reduced products gross margin by $3.5 million, or 5.6% of products revenues, in the nine months ended September 30, 2005. Gross margins in the nine months ended September 30, 2006, were also impacted by a $0.7 million provision for excess and obsolete inventory. In addition, gross margins in the nine months ended September 30, 2005 decreased as a result of a physical inventory write-down of $1.5 million and a specific warranty provision of $0.8 million recorded for the expected cost of repairing a defective subcomponent.

 

Services gross margin for the nine months ended September 30, 2006 was 59.0% compared to 69.5% for the comparable period of 2005. This decrease was due to a planned increase in the number of services personnel in anticipation of future growth in our business.

 

Research and Development.    Research and development expense was $26.6 million for the nine months ended September 30, 2006, or 23.4% of net revenues, compared to $22.8 million in the comparable period of 2005, or 32.0% of net revenues. The $3.8 million increase was primarily due to increased compensation costs of $2.9 million attributable to an increase in employee headcount and $1.2 million attributable to increased contractor expenses. During the nine month periods ended September 30, 2006 and 2005, we received $0.6 million and $0.6 million, respectively, in payments for non-recurring engineering that offset research and development expenses. Research and development expense included stock-based compensation expense of $0.5 million and $0.4 million during the nine month periods ended September 30, 2006 and 2005, respectively.

 

Sales and Marketing.    Sales and marketing expense was $21.0 million, or 18.5% of net revenues, for the nine months ended September 30, 2006 compared to $16.2 million, or 22.7% of net revenues, during the comparable period of 2005. The $4.8 million increase was primarily due to increased compensation costs of $3.4 million resulting from increased commissions and salaries, as well as increased headcount in support of our overall growth. In addition, travel cost increased by $0.8 million. Sales and marketing expense included stock-based compensation expense of $0.3 million and $0.2 million during the nine month periods ended September 30, 2006 and 2005, respectively.

 

General and Administrative.    General and administrative expense was $8.0 million, or 7.0% of net revenues, for the nine months ended September 30, 2006 compared to $5.1 million, or 7.2% of net revenues, during the comparable period of 2005. The $2.9 million increase was primarily due to increased compensation costs of $1.4 million attributable to an increase in employee headcount, including additional accounting and finance personnel, and an increase of $0.8 million in spending related to our preparation for becoming a public company, including consulting costs associated with Sarbanes-Oxley compliance and improvement to our ERP systems. General and administrative expense included stock-based compensation expense of $0.3 million and $0.2 million during the nine month periods ended September 30, 2006 and 2005, respectively.

 

41


Table of Contents

Other Expense, Net.    Other expense, net includes interest income, interest expense and other expense, net was $1.5 million during the nine months ended September 30, 2006, compared to $1.1 million in the comparable period of 2005. Other expense, net consisted primarily of expenses associated with changes in the fair value of our outstanding preferred stock warrants, interest expense and interest income. The change in other expense, net was primarily due to the adoption of FSP 150-5 on July 1, 2005, which resulted in a $1.4 million expense arising from the increase in value of preferred stock warrants during the 2006 period. This compares to a $0.1 million expense from the increase in value of preferred stock warrants during the 2005 period. We also experienced an increase of $0.4 million in interest expense due to relatively higher debt balances. These increases were partially offset by $0.6 million of remaining proceeds received upon satisfaction of an escrow condition on the sale of an investment obtained in conjunction with our BAS acquisition.

 

Provision for Income Taxes.    We incurred U.S. operating losses through June 30, 2006. Because of net operating loss carryforwards in the United States, the provision (benefit) for income taxes of ($17,000) and $0.3 million for the nine month periods ended September 30, 2006 and 2005, respectively, were primarily related to provisions for foreign income taxes. As of December 31, 2005, we had net operating loss carryforwards for federal and state income tax purposes of $134.3 million and $100.3 million, respectively. We also had federal research and development tax credit carryforwards of approximately $1.4 million and state research and development tax credit carryforwards of approximately $1.5 million. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which is uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. If not utilized, the federal and state net operating loss and tax credit carryforwards will expire between 2019 and 2025, and the state net operating loss and tax credit carryforward will expire between 2008 and 2015. Utilization of these net operating losses and credit carryforwards will likely be subject to an annual limitation due to the provisions of Section 382 of the Internal Revenue Code.

 

Cumulative Effect of Change in Accounting Principle.    Upon adoption of FSP 150-5 on July 1, 2005, we reclassified the fair value of warrants from equity to a liability and recorded a cumulative effect of a change in accounting principle of $0.6 million in the nine months ended September 30, 2005.

 

Years Ended December 31, 2005 and 2004

 

Net Revenues.    Net revenues for 2005 were $98.0 million compared to $35.5 million for 2004, an increase of $62.5 million, or 176.1%. During 2005, revenues from our top five customers comprised 69% of net revenues, compared with 61% of net revenues during 2004. During 2005, revenues from customers in the United States comprised 83% of net revenues, and revenues from customers outside the United States comprised 17% of net revenues, compared to 2004 in which customers in the United States comprised 80% of net revenues, and revenues from customers outside the United States comprised 20% of net revenues.

 

Products revenues for 2005 were $86.0 million compared to $31.5 million for 2004, an increase of $54.5 million, or 173.0%. The increase was primarily due to a $44.7 million increase in revenue from our data products based on the inclusion of a full year of results from data products that we acquired in the BAS acquisition in June 2004. This $44.7 million increase also includes revenues of $18.8 million resulting from the timing of revenue recognition in 2005 associated with product previously shipped to a single customer in 2004 that was pending customer acceptance criteria. The increase in products revenues was also due to a $9.7 million increase in revenues of our video products, primarily due to the broader adoption of our Digital Simulcast product and the initial deployment of our Switched Broadcast product application.

 

Services revenues for 2005 were $12.0 million compared to $3.9 million in 2004, an increase of $8.1 million, or 207.7%. This $8.1 million increase was primarily due to a larger installed base of products, including the installed base of products acquired in the BAS transaction.

 

Gross Profit/Gross Margin.    Gross profit for 2005 was $38.1 million compared to $12.0 million for 2004, an increase of $26.1 million, or 217.5%. Gross margin increased to 38.9% in 2005 compared to 33.7% in 2004.

 

42


Table of Contents

Products gross margin for 2005 was 34.9% compared to 32.5% for 2004. Products gross margin in 2005 and 2004 were adversely impacted by the sale of inventory acquired in the BAS transaction. Under purchase accounting, the carrying value of this inventory was increased by $4.7 million in June 2004, the date of acquisition, to the then fair market value. This inventory was sold in 2005 and 2004 reducing gross profit in those periods by $3.5 million and $1.2 million, respectively. This reduced product gross margin by 4.1% in 2005 and 3.8% in 2004. In addition, gross margin in 2005 decreased as a result of a physical inventory write-down of $1.8 million and specific warranty provisions of $1.5 million recorded for the expected cost of repairing defective subcomponents.

 

Services gross margin for 2005 was 67.5% compared to 43.6% for 2004. Services gross margin was adversely impacted in 2004 by a $0.7 million reduction to deferred services revenues arising from the application of purchase accounting for services contracts acquired in the BAS acquisition. The remainder of the increase in services gross margin in 2005 was primarily due to economies of scale arising from a larger installed base of video products and data products, due in part to the installed base of products acquired in connection with the BAS acquisition.

 

Research and Development.    Research and development expense was $30.7 million in 2005, or 31.3% of net revenues, compared to $21.6 million in 2004, or 60.8% of net revenues. The $9.1 million increase was primarily due to increased compensation costs of $6.6 million attributable to an increase in headcount, $1.8 million in increased depreciation of computer and lab equipment, a portion of which was acquired in the BAS acquisition, and $0.5 million attributable to increased contractor expenses. During 2005, we received $0.4 million in payments for non-recurring engineering that offset research and development expenses, compared to zero in 2004. Research and development expense included stock-based compensation expense of $0.5 million and $0.3 million during 2005 and 2004, respectively.

 

Sales and Marketing.    Sales and marketing expense was $22.7 million, or 23.2% of net revenues, in 2005 compared to $15.9 million, or 44.8% of net revenues, in 2004. The $6.8 million increase was primarily due to an increase of $3.8 million in compensation costs arising from increased salaries and commissions, and an increase of $0.9 million in travel expenses. Sales and marketing expense included stock-based compensation expense of $0.3 million and $0.1 million during 2005 and 2004, respectively.

 

General and Administrative.    General and administrative expense increased to $7.0 million, or 7.1% of net revenues, in 2005, from $5.8 million, or 16.4% of net revenues, in 2004. This $1.2 million increase was primarily due to an increase of $1.7 million in compensation costs related to an increase in headcount, partially offset by a $0.3 million decrease in consulting fees. General and administrative expense included stock-based compensation expense of $0.2 million in each of 2005 and 2004, respectively.

 

In-Process Research and Development.    We allocated a portion of the purchase price for the BAS acquisition to in-process research and development, which allocation is determined through established valuation techniques. In-process research and development represents an expense recorded for the portion of the purchase price of an acquisition allocated to research and development when technological feasibility of a research program has not been established and no future alternative uses exist at the time of acquisition. Total in-process research and development expense was $1.0 million for the year ended December 31, 2004, which related primarily to ongoing software development efforts for the data products we acquired in connection with the BAS transaction.

 

Other Expense, Net.    Other expense, net was $1.7 million in 2005 compared to $1.0 million in 2004. The increase was primarily due to an increase of $0.7 million in interest expenses incurred on higher debt balances carried in 2005 compared to 2004, and $0.5 million related primarily to foreign exchange losses. This increase in other expense, net was partially offset by an increase in interest income of $0.5 million earned due to interest earned on relatively higher interest rates and relatively higher invested balances during 2005 compared to 2004.

 

43


Table of Contents

Provision for Income Taxes.    We incurred U.S. operating losses in 2005 and 2004. Because of the net operating loss carryforward in the United States, the provision for income tax for 2005 and 2004 was $0.3 million in both periods reflecting provisions for foreign income taxes.

 

Cumulative Effect of Change in Accounting Principle.    Upon adoption of FSP 150-5 on July 1, 2005, we reclassified the fair value of warrants from equity to a liability and recorded a cumulative effect of a change in accounting principle of $0.6 million for 2005.

 

Years Ended December 31, 2004 and 2003

 

Net Revenues.    Net revenues for 2004 were $35.5 million compared to $21.6 million for 2003, an increase of $13.9 million, or 64.4%. During 2004, net revenues from customers in the United States comprised 80% of net revenues, and net revenues from customers outside the United States comprised 20% of net revenues, compared to 2003 in which customers in the United States comprised 91% of net revenues, and net revenues from customers outside the United States comprised 9% of net revenues.

 

Products revenues for 2004 were $31.5 million compared to $20.0 million for 2003, an increase of $11.5 million, or 57.5%. This $11.5 million increase was primarily due to $7.0 million of data product revenues resulting from the BAS acquisition in June 2004.

 

Services revenues for 2004 were $3.9 million compared to $1.6 million in 2003, an increase of $2.3 million, or 143.8%. This $2.3 million increase was primarily due to services contracts acquired in conjunction with the BAS acquisition, and to a lesser extent, a larger installed base of products requiring customer support and higher net revenues from renewals of customer support contracts.

 

Gross Profit/Gross Margin.    Gross profit for 2004 was $12.0 million compared to $12.0 million for 2003. Gross margin decreased to 33.7% in 2004 compared to 55.4% in 2003.

 

Products gross margin for 2004 was 32.5% compared to 57.0% for 2003. This decrease was primarily due to a shift in product mix towards relatively lower margin data products during 2004. Product gross margin in 2004 was also affected by the sale of inventory acquired in the BAS transaction. Under purchase accounting, the carrying value of this inventory was increased by $4.7 million in 2004 to its then fair market value. The sale of this inventory in 2004 reduced products gross margin in 2004 by $1.2 million or 3.8% of net products revenues. Gross margins in 2004 were also negatively impacted by a physical inventory write-off of $1.2 million.

 

Services gross margin for 2004 was 43.6% compared to 34.4% for 2003. The increase in services gross margin in 2004 was primarily due to economies of scale arising from a larger installed base of video and data products due in part to the acquisition of an installed base of data products in connection with the BAS acquisition.

 

Research and Development.    Research and development expense was $21.6 million in 2004, or 60.8% of net revenues, compared to $9.5 million in 2003, or 44.1% of net revenues. This $12.1 million increase was primarily due to increased compensation related costs of $7.2 million related to an increase in headcount due in large part to research and development staff and facilities and information technology costs resulting from the BAS acquisition in June 2004.

 

Sales and Marketing.    Sales and marketing expense was $15.9 million, or 44.8% of net revenues, in 2004 compared to $10.4 million, or 48.1% of net revenues, in 2003. This $5.5 million increase was primarily due to an increase of $2.4 million in compensation costs related to an increase in headcount, an increase of $0.6 million in travel expenses and an increase of $1.6 million in commission expenses due in large part to the BAS acquisition in June 2004.

 

General and Administrative.    General and administrative expense was $5.8 million, or 16.4% of net revenues, in 2004 compared to $3.1 million, or 14.3% of net revenues, in 2003. This $2.7 million increase was

 

44


Table of Contents

primarily due to an increase of $0.8 million in compensation costs related to an increase in headcount, $0.7 million related to the lease on our Westborough, Massachusetts location that we acquired in connection with the BAS transaction in June 2004 and a $0.7 million increase in contractor expenses.

 

In-Process Research and Development.    We allocated a portion of the purchase price for the BAS acquisition to in-process research and development through established valuation techniques. Total in-process research and development expense was $1.0 million for the year ended December 31, 2004, which related primarily to ongoing software development efforts for our data products we acquired in connection with the BAS transaction.

 

Other Expense, Net.    Other expense, net was $1.0 million in 2004 compared to income of $0.7 million in 2003. The change was primarily related to interest expense incurred on higher debt balances in 2004 compared to 2003.

 

Provision for Income Taxes.    We incurred U.S. operating losses in 2004 and 2003. Because of the net operating loss carryforward in the United States, the provision for income tax for 2004 and 2003 was $0.3 million and zero, respectively, reflecting provisions for foreign income taxes.

 

45


Table of Contents

Quarterly Results of Operations

 

The following tables set forth selected unaudited quarterly consolidated statements of operations data for the last seven fiscal quarters, as well as the percentage that each line item represents of total net revenues. The information for each of these quarters has been prepared on the same basis as the audited consolidated financial statements included elsewhere in this prospectus and, in the opinion of management, includes all adjustments, consisting solely of normal recurring adjustments, necessary for the fair presentation of the results of operations for these periods. This data should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of our operating results for any future period.

 

    Quarters Ended  
    Mar 31,
2005
    Jun 30,
2005
    Sep 30,
2005
    Dec 31,
2005
    Mar 31,
2006
    Jun 30,
2006
    Sep 30,
2006
 
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

             

Net revenues

             

Products

  $ 16,619     $ 25,944     $ 20,210     $ 23,193     $ 27,974     $ 32,245     $ 37,094  

Services

    2,788       3,035       2,652       3,538       4,576       5,763       5,970  
                                                       

Total net revenues

    19,407       28,979       22,862       26,731       32,550       38,008       43,064  
                                                       

Cost of net revenues

             

Products

    9,054       20,287       12,475       14,117       13,884       17,220       18,382  

Services

    774       922       893       1,311       2,016       2,280       2,393  
                                                       

Total cost of net revenues

    9,828       21,209       13,368       15,428       15,900       19,500       20,775  

Gross profit

             

Products

    7,565       5,657       7,735       9,076       14,090       15,025       18,712  

Services

    2,014       2,113       1,759       2,227       2,560       3,483       3,577  
                                                       

Total gross profit

    9,579       7,770       9,494       11,303       16,650       18,508       22,289  
                                                       

Operating expense

             

Research and development

    7,879       7,274       7,651       7,897       8,320       8,964       9,316  

Sales and marketing

    5,213       5,402       5,573       6,541       6,757       7,163       7,045  

General and administrative

    1,497       1,743       1,897       1,847       2,527       2,599       2,922  

Amortization of intangible assets

    143       143       143       144       143       143       143  
                                                       

Total operating expense

    14,732       14,562       15,264       16,429       17,747       18,869       19,426  
                                                       

Operating income (loss)

    (5,153 )     (6,792 )     (5,770 )     (5,126 )     (1,097 )     (361 )     2,863  

Other income (expense), net

    (443 )     (293 )     (382 )     (578 )     (223 )     (361 )     (904 )
                                                       

Net income (loss) before provision for income taxes and cumulative effect of change in accounting principle

    (5,596 )     (7,085 )     (6,152 )     (5,704 )     (1,320 )     (722 )     1,959  

Provision (benefit) for income taxes

    97       104       61       63       (257 )     (141 )     381  
                                                       

Net income (loss) before cumulative effect of change in accounting principle

    (5,693 )     (7,189 )     (6,213 )     (5,767 )     (1,063 )     (581 )     1,578  

Cumulative effect of change in accounting principle

                633                          
                                                       

Net income (loss)

  $ (5,693 )   $ (7,189 )   $ (6,846 )   $ (5,767 )   $ (1,063 )   $ (581 )   $ 1,578  
                                                       

Net income (loss) per common share, basic

  $ (0.14 )   $ (0.17 )   $ (0.16 )   $ (0.13 )   $ (0.02 )   $ (0.01 )   $ 0.03  
                                                       

Net income (loss) per common share, diluted

  $ (0.14 )   $ (0.17 )   $ (0.16 )   $ (0.13 )   $ (0.02 )   $ (0.01 )   $ 0.01  
                                                       

 

46


Table of Contents
    Quarters Ended  
   

Mar 31,

2005

   

Jun 30,

2005

   

Sep 30,

2005

   

Dec 31,

2005

   

Mar 31,

2006

   

Jun 30,

2006

   

Sep 30,

2006

 
    (in percent)  

Consolidated Statements of Operations Data:

             

Net revenues

             

Products

  85.6 %   89.5 %   88.4 %   86.8 %   85.9 %   84.8 %   86.1 %

Services

  14.4     10.5     11.6     13.2     14.1     15.2     13.9  
                                         

Total net revenues

  100.0     100.0     100.0     100.0     100.0     100.0     100.0  
                                         

Cost of net revenues

             

Products

  46.6     70.0     54.6     52.8     42.6     45.3     42.6  

Services

  4.0     3.2     3.9     4.9     6.2     6.0     5.6  
                                         

Total cost of net revenues

  50.6     73.2     58.5     57.7     48.8     51.3     48.2  

Gross profit

             

Products

  39.0     19.5     33.8     34.0     43.3     39.5     43.5  

Services

  10.4     7.3     7.7     8.3     7.9     9.2     8.3  
                                         

Total gross profit

  49.4     26.8     41.5     42.3     51.2     48.7     51.8  
                                         

Operating expense

             

Research and development

  40.6     25.1     33.5     29.5     25.6     23.6     21.6  

Sales and marketing

  26.9     18.6     24.4     24.5     20.8     18.8     16.4  

General and administrative

  7.7     6.1     8.3     7.0     7.7     6.8     6.8  

Amortization of intangible assets

  0.7     0.5     0.6     0.5     0.4     0.4     0.3  
                                         

Total operating expense

  75.9     50.3     66.8     61.5     54.5     49.6     45.1  
                                         

Operating income (loss)

  (26.5 )   (23.5 )   (25.3 )   (19.2 )   (3.3 )   (0.9 )   6.7  

Other income (expense), net

  (2.3 )   (0.9 )   (1.5 )   (2.2 )   (0.8 )   (1.0 )   (2.1 )
                                         

Net income (loss) before provision for income taxes and cumulative effect of change in accounting principle

  (28.8 )   (24.4 )   (26.8 )   (21.4 )   (4.1 )   (1.9 )   4.6  

Provision (benefit) for income taxes

  0.5     0.4     0.3     0.2     (0.8 )   (0.4 )   0.9  
                                         

Net income (loss) before cumulative effect of change in accounting principle

  (29.3 )   (24.8 )   (27.1 )   (21.6 )   (3.3 )   (1.5 )   3.7  

Cumulative effect of change in accounting principle

          2.8                  
                                         

Net income (loss)

  (29.3 )%   (24.8 )%   (29.9 )%   (21.6 )%   (3.3 )%   (1.5 )%   3.7 %
                                         

 

Our net revenues and cost of net revenues have generally increased sequentially during the last seven quarters. However, during the second quarter of 2005, we experienced an unusual increase in product net revenues from data products primarily due to $18.8 million of revenues recognized in 2005 following satisfaction of customer acceptance criteria for product shipped to a single customer in 2004.

 

Gross margins have fluctuated on a quarterly basis primarily due to mix shifts between video and data products and between the hardware and software content of our products. In addition, gross margins have been impacted by the timing of physical inventory write-downs, the timing of specific inventory and warranty provisions and the timing of sales and cost of sales associated with inventory acquired in connection with the BAS acquisition. For example, the first and second quarters of 2005 were impacted by the write-off of inventory resulting from book to physical adjustments of $1.2 million and $0.6 million, respectively. The third quarter of 2006 was negatively impacted by a provision of $0.8 million for excess and obsolete inventory during that quarter. The third and fourth quarters of 2005 were impacted by specific warranty provisions recorded during those periods of $0.8 million and $0.7 million, respectively, for the estimated cost of repairing defective subcomponents. The cost of net revenues and gross margins during the second quarter of 2005 were negatively affected by $3.5 million or 11.9%, respectively, related to the sale of inventory acquired in connection with our BAS acquisition.

 

47


Table of Contents

Operating expense has generally increased sequentially due to the growth of our business. Our research and development expense in the first quarter of 2005 was impacted by increased costs associated with CableLabs certification efforts relating to our data products. Our sales and marketing expense in the fourth quarter of 2005 was impacted by increased sales headcount and higher overall commissions as a result of our growth. Our general and administrative expenses in the first quarter of 2006 were impacted by consulting fees related to information systems and preparation for Sarbanes-Oxley compliance.

 

In the third quarter of 2005, we adopted FSP 150-5, which requires us to classify the warrants on our preferred stock as liabilities and adjust our warrant instruments to fair value at each reporting period. We recorded a $0.6 million cumulative effect charge for adoption as of July 1, 2005, reflecting the fair value of the warrants as of that date, and $50,000, $50,000, $0.1 million, zero, and $1.3 million of additional expense that was recorded in other expense, net in the quarters ended September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, and September 30, 2006, respectively, to reflect the increase in fair value of the warrants.

 

Our quarterly results of operations have varied in the past and are likely to do so again in the future. As such, we believe that period-to-period comparisons of our operating results should not be relied upon as an indication of future performance. In future periods, the market price of our common stock could decline if our revenue and results of operations are below the expectations of analysts or investors.

 

Liquidity and Capital Resources

 

Since inception, we have financed our operations primarily through private sales of equity and from borrowings under credit facilities, and more recently from cash flow from operations. At September 30, 2006, our cash, cash equivalents and marketable securities totaled $40.1 million.

 

Operating Activities

 

Our operating activities generated cash in the amount of $18.7 million in the nine months ended September 30, 2006, primarily due to an increase in deferred revenues of $21.1 million, a decrease in inventory of $9.7 million and an increase in other accrued liabilities of $2.7 million. These changes resulted primarily from the significant growth in our business, the timing of shipments and the satisfaction of revenue recognition criteria under our revenue recognition policy. These changes were partially offset by an increase in trade receivables of $21.2 million due to the growth in our business and a decrease in accounts payable of $1.1 million due to the timing of payment. We also had non-cash charges of $8.1 million, comprised primarily of $4.5 million in depreciation on property and equipment, and $1.4 million related to the increase in fair value of preferred stock warrants during the period.

 

Our operating activities generated cash in the amount of $1.4 million in the year ended December 31, 2005, primarily due to an increase in deferred revenues of $18.7 million and an increase in other accrued liabilities of $2.7 million. These changes resulted primarily from the growth in our business, the timing of shipments and the satisfaction of revenue recognition criteria under our revenue recognition policy. Operating cash flow was also favorably affected by a decrease in trade receivables of $6.0 million due to the timing of collections. These changes were largely offset by a loss of $25.5 million, an increase in inventory of $7.7 million, an increase in prepaid and other assets of $1.3 million and a decrease in accounts payable of $1.1 million due to the timing of payment. We also had non-cash charges of $9.0 million, comprised primarily of $5.9 million in depreciation on property and equipment and $0.7 million related to the increase in value of preferred stock warrants during the period.

 

Our operating activities used cash in the amount of $21.5 million in the year ended December 31, 2004, primarily due to a net loss during the period of $33.8 million and an increase in trade receivables of $15.0 million. The increase in trade receivables was largely due to the timing of a large shipment of data products to a specific customer, which occurred late in 2004. These items were partially offset by a decrease in inventory of $9.4 million due to the increase in shipments to customers late in the year and an increase in deferred revenues of $7.5 million. We also had non-cash charges of $5.4 million, comprised primarily of

 

48


Table of Contents

$3.2 million in depreciation on property and equipment and $1.0 million related to in-process research and development charges.

 

Investing Activities

 

Our investing activities used cash of $9.0 million in the nine months ended September 30, 2006, primarily from net purchases of marketable securities of $3.0 million and the purchase of property and equipment of $6.7 million to support the growth in our business. These capital expenditures consisted primarily of computer and test equipment and software purchases.

 

Our investing activities used cash of $7.7 million in the year ended December 31, 2005, primarily from net purchases of marketable securities of $6.9 million and the purchase of property and equipment of $6.0 million. These capital expenditures consisted primarily of computer and test equipment and software purchases. These uses of funds for investing activities were partially offset by $5.3 million in proceeds from the sale of an investment acquired in connection with the BAS acquisition in 2004.

 

Our investing activities used cash of $2.8 million in the year ended December 31, 2004 primarily due to the purchases of property, plant and equipment of $1.4 million to support growth in our business and net payments of $1.5 million for the BAS acquisition. The capital expenditures consisted primarily of computer and test equipment and software purchases.

 

Financing Activities

 

Our financing activities provided cash of $3.0 million in the nine months ended September 30, 2006, primarily from a net increase in borrowings of $2.8 million and proceeds of $0.4 million received from the exercise of options to purchase our common stock.

 

Our financing activities used cash of $0.2 million in the year ended December 31, 2005, primarily from repayments of loans and payments against capital lease obligations of $0.7 million, offset by proceeds of $0.5 million received from the exercise of options to purchase our common stock.

 

Our financing activities provided cash of $33.7 million in the year ended December 31, 2004, principally due to the sale of our preferred stock of $25.1 million, the exercise of warrants to purchase our common stock of $1.9 million and proceeds from net borrowings of $7.4 million.

 

Our revolving credit facility with Silicon Valley Bank provides up to $10.0 million in the form of a term loan and up to $20.0 million for working capital requirements. As of September 30, 2006, $10.0 million was outstanding under the term loan and $4.0 million was outstanding under the revolving credit facility for working capital. The term loan bears interest at the Federal Reserve’s prime rate plus 0.25%, and the revolving credit facility bears interest at the Federal Reserve’s prime rate. The loan is collateralized by all of our tangible assets. The loan agreement contains financial and non-financial covenants including maintaining a “tangible net worth,” as defined in the credit facility, of at least $6.0 million. Through September 30, 2006, we were in compliance with all covenants. We expect to use approximately $14.0 million of the net proceeds of this offering to repay outstanding debt under our term loan and the revolving credit facility.

 

We believe that our existing cash and cash equivalents and existing amounts available under our revolving credit facility, together with the net proceeds from this offering, will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital requirements will depend on many factors including our rate of revenue growth, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access of adequate manufacturing capacity and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be harmed.

 

49


Table of Contents

Contractual Obligations and Commitments

 

The following summarizes our contractual obligations at December 31, 2005:

 

     Payments Due by Period
     Total   

Less Than

1 Year

   1 – 3 Years    3 – 5 Years    Thereafter
     (in thousands)

Operating lease obligations

   $ 4,323    $ 2,656    $ 1,667    $    $

Capital lease obligations

     218      218               

Notes payable(1)

     11,200      4,200      7,000          

Interest payments on credit facility(2)

     1,290      1,001      289      
                                  

Total

   $ 17,031    $ 8,075    $ 8,956    $    $
                                  

  (1)   This note payable was refinanced on August 18, 2006. We expect to repay this note payable with a portion of the net proceeds from this offering.
  (2)   Represents estimated interest payments on our debt using an interest rate of 9.28% at December 31, 2005.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2006, we have no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K.

 

Effects of Inflation

 

Our monetary assets, consisting primarily of cash, marketable securities and receivables, are not affected by inflation because they are short-term and in the case of cash are immaterial. Our non-monetary assets, consisting primarily of inventory, intangible assets, goodwill and prepaid expenses and other assets, are not affected significantly by inflation. We believe that the impact of inflation on replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. However, the rate of inflation affects our cost of goods sold and expenses, such as those for employee compensation, which may not be readily recoverable in the price of products and services offered by us.

 

Recent Accounting Pronouncements

 

See Note 2 of the Notes to Consolidated Financial Statements included in this prospectus for recent accounting pronouncements that could have an effect on us.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Sensitivity

 

The primary objectives of our investment activity are to preserve principal, provide liquidity and maximize income without significantly increasing risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The risk associated with fluctuating interest rates is limited to our investment portfolio. A 10% decrease in interest rates in 2005 and in the nine months ended September 30, 2006, would result in a decrease in our interest income of $63,000 and $85,000, respectively. As of September 30, 2006, our investments were in commercial paper, corporate notes and bonds, market auction preferred stock and U.S. government securities.

 

Our exposure to interest rates also relates to the increase or decrease in the amount of interest we must pay on our outstanding variable rate debt instruments, primarily certain borrowings under our revolving credit facility.

 

50


Table of Contents

Our revolving credit facility provides financing up to $20.0 million for working capital requirements and $10.0 million under the term facility. As of September 30, 2006, $10.0 million was outstanding under the term loan facility and $4.0 million was outstanding under the revolving credit facility. The loans bear interest at the Federal Reserve’s prime rate for the revolving credit facility and at the Federal Reserve’s prime rate plus 0.25% per annum under the term facility. A 10% increase in the prime rate would result in an increase in interest expense of $0.1 million on an annual basis.

 

Foreign Currency Risk

 

Our sales contracts are primarily denominated in United States dollars and therefore the majority of our net revenues are not subject to foreign currency risk. Our operating expense and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro. To date, we have not entered into any hedging contracts since exchange rate fluctuations have had little impact on our operating results and cash flows.

 

51


Table of Contents

BUSINESS

 

Overview

 

We develop, market and sell network-based platforms that enable cable operators and telephone companies to offer video, voice and data services across coaxial, fiber and copper networks. We have significant expertise in rich media processing, communications networking and bandwidth management. We have delivered what we believe to be the only successful commercial deployments of switched broadcast, an application that substantially increases the volume of content that a service provider can offer. In addition, we believe we were the first to implement what has become the industry’s de facto network architecture for digital simulcast, an application that facilitates the insertion of advertising and the transmission of video in a digital format across a network while still providing service to analog subscribers. Our product applications of Digital Simulcast, TelcoTV, Switched Broadcast, and High-Speed Data and Voice-over-IP are a combination of our modular software and programmable video and data hardware platforms. Leading service providers use our product applications to offer video, voice and data services to tens of millions of subscribers, 24 hours a day, seven days a week. We outsource the manufacturing of our products. We have sold our product applications to more than 100 customers globally. We sell our product applications domestically to customers through a direct sales model, and internationally, through a combination of direct sales to service providers and sales through independent resellers. Our customers include Cablevision, Charter, Comcast, Cox, Time Warner Cable and Verizon, which are six of the ten largest service providers in the United States.

 

Industry Background

 

Cable operators and telephone companies derive most of their revenue from consumer subscriptions for video, voice or data services and from advertising. To attract and retain subscribers, service providers are increasingly bundling video, voice and data services, often called a “triple-play” offering. Video has the most stringent bandwidth requirements, is the most technically demanding and provides the richest user experience. Video consumes up to ten times the bandwidth and is approximately 1,000 times more sensitive to packet error, loss and delay when compared with typical voice and data services. Video also offers the greatest revenue per subscriber of the triple-play services. As of December 2006, Yankee Group Research, an independent industry research group, estimates that, on average, consumers spend $68 per month for digital video services compared to $47 for voice and $35 for data services. As a result, video presents the greatest opportunities and greatest challenges in delivering the triple-play bundle.

 

Competitive Dynamics Changing Video, Voice and Data Networks

 

The competition for video subscriptions has been increasing over time, and this competition has fueled recurring cycles of network investment as service providers seek to capture increasing revenues from subscribers by offering additional services. Satellite broadcasters, starting in 1994, began offering improved digital video services. They started to capture video subscribers from cable operators and, by the end of the third quarter of 2005, had gained an estimated 28% of the total U.S. paid television subscribers according to IDC, an independent industry research firm. In response, cable operators upgraded their coaxial networks to provide comparable digital video services. Kagan Research LLC, an independent research firm, estimates that cable operators have invested over $100 billion building networks that increased their capacity to offer digital video services and were capable of two-way communication.

 

The competition for control over the delivery of triple-play services, particularly video, to the home has dramatically increased with the recent entrance of the telephone companies into the market in 2005. Historically, telephone companies built networks to offer voice services, while cable operators built networks for broadcast television. The two did not directly compete with one another. In recent years, additional regulatory, technological and competitive factors have enabled service providers to compete directly and aggressively in each others’ markets. Initial competition among cable operators and telephone companies began with both offering high-speed data services. Then, cable operators used their two-way broadcast networks to offer VoIP

 

52


Table of Contents

services. As of September 2006, cable operators offering VoIP services had added approximately eight million voice subscribers in North America, according to In-Stat, an independent market research firm. Similarly, telephone companies have started upgrading their networks, which were originally built for voice and later upgraded to enable the delivery of high-bandwidth video services and higher speed data services. For example, Verizon recently announced plans to spend $18 billion by 2010 to significantly expand its fiber-optic network infrastructure and to add an estimated 11 million video and data subscribers. Other telephone companies have announced plans to develop interactive video services that leverage internet protocols to stream particular television shows, movies or other video content as they are demanded by individual subscribers, instead of broadcasting all content to all subscribers, regardless of the actual content being watched. The ability of telephone companies to offer these advanced services that feature video have, in turn, forced cable operators to increase the capacity and performance of their networks to keep pace.

 

In addition to competing with one another, service providers must react to Internet content aggregators and media companies offering competitive video, voice and advertising services directly to consumers through the Internet. For example, in an effort to increase sales of its iPod devices, Apple Computer offers video content that can be downloaded through the Internet through its iTunes store. Likewise, ABC.com is offering individual television programs and other video content directly to consumers over the Internet, and a number of providers are offering low cost voice services over the Internet. At the same time, online media companies like Google and Yahoo are aggregating or facilitating access to content and increasing the relevance, interactivity and measurability of advertising to attract advertising spending. Competitive activities such as these pose a threat to service providers’ paid subscriber and advertising revenues.

 

Changing Consumer Demands

 

Given increasing competition, service providers are attempting to differentiate their offerings by addressing changing consumer behavior and evolving advertiser demands. Consumers are increasingly directing their spending on video, voice and data services to those providers offering services that more closely match their preferences. In particular, consumers are seeking greater personalization of content, a higher quality experience and greater ease and speed of access to their video, voice and data services.

 

    Personalization.    With the proliferation in content, consumers are seeking content that is increasingly customized to their personal interests. This personalized content spans everything from the purchase of downloadable songs to customized video programming, such as VOD and niche channel packages.

 

    Richer Content.    Consumers are demanding a higher quality experience, whether it is online or in their television viewing. As a result, a rapidly growing number of consumers are purchasing HDTVs and high-speed data services to access richer content, such as HD programming, user-generated video clips and interactive online video games.

 

    Ease and Speed of Access.    In an increasingly mobile world, consumers desire faster access to content, whether voice, video or data, from virtually anywhere using a wide range of devices, such as portable media players, televisions, mobile phones, personal digital assistants and personal computers.

 

Consumers have been able to gain greater personalization, richer content and better access to their voice and data services delivered through the Internet using network-based technologies. For video, however, there has been only a limited response to these consumer demands. To offer richer, more personalized content at the speeds consumers expect and to capture the larger video subscription opportunity, service providers are developing networks with the bandwidth to deliver richer services and the intelligence to tailor video services and direct advertising to individual subscribers.

 

Advertisers Demand Greater Intelligence in Video-Based Advertising

 

Traditionally, advertisers attempted to reach consumers through media channels such as broadcast television that distributed the same advertising to wide audiences. The Internet offers advertisers a distribution channel that

 

53


Table of Contents

delivers more relevant ads, while at the same time offering the interactivity required to measure return on ad spending. Advertisers are demanding that video-based advertising networks increase the relevancy, interactivity and measurability of their networks.

 

    Relevancy.    Advertisers are demanding that their ads be addressed to a relevant audience. For example, they desire to target video advertising to particular geographic zones, and ultimately want to tailor advertising to specific subscribers.

 

    Interactivity.    Advertisers want to provide consumers with an easy and immediate way to respond to an advertisement. For example, advertisers would like to provide subscribers with the ability to use a remote control to immediately access additional product information associated with a television advertisement.

 

    Measurability.    Advertisers are seeking ad distribution networks that allow them to measure the effectiveness of their ad spending and are willing to pay more for video advertisements that result in a higher consumer response rate.

 

According to ZenithOptimedia Group, a market research firm, the market for North American television advertising in 2005 was approximately $58 billion. However, a survey of advertising executives conducted by the industry group, American Advertising Federation, indicated that 97% of respondents intend to shift spending away from traditional broadcast and cable TV ads to online video ads, with nearly 43% planning to shift at least 20% of their spending by 2010. To encourage advertisers to direct more spending toward television advertisements, service providers must be able to deliver relevant advertisements and measure the effectiveness of marketing campaigns for advertisers. The current video networks of service providers are limited in their ability to provide the intelligence necessary for the relevancy, interactivity and measurability required to meet the expanding demands of advertisers.

 

Intelligent, High-Bandwidth Video Networks are Needed

 

Current service provider networks, originally built to deliver voice or video services, are not well suited to offer the entire suite of triple-play services and relevant advertising. In particular, these networks are not equipped for increasingly rich and interactive video content. Cable operators originally built their networks for the one-way broadcast of analog video content. In response to competition by satellite providers, they upgraded their networks to digital, but these networks still lack the capacity to deliver the rich content and interactivity increasingly required by consumers and advertisers. Telephone companies originally constructed low-bandwidth networks that were capable of delivering highly interactive voice services, but these networks lack the bandwidth necessary to deliver rich video services. However, with increasing competition for traditional voice services and the revenue opportunities and network requirements of video, these telephone companies need networks with the bandwidth and interactivity that enable advanced video services that meet the demands of consumers and advertisers. Cable operators and telephone companies therefore must develop intelligent, high-bandwidth video networks for their consumer and advertiser customers.

 

Delivering high-quality, personalized video services and relevant video-based advertising has strained service providers’ existing network infrastructures and requires service providers to overcome the following challenges:

 

    Bandwidth Limitations Posed by Video.    Service providers’ fixed-bandwidth networks are not equipped for the volume and richness of content being demanded by subscribers. For example, a typical HDTV video stream requires 19.4 Mbps of continuous bandwidth, which is up to ten times the bandwidth required by a standard definition video stream and substantially greater than the 10 Mbps limit of most copper-based network data connections. To meet the demand for more and richer content such as HDTV, service providers must either undertake a costly capital expansion of their network infrastructures or use their existing infrastructure more efficiently.

 

   

Difficulty of Delivering a High-Quality Video Experience.    Service provider networks are inherently prone to packet loss, error and delay. This problem is exacerbated as the richness and volume of the

 

54


Table of Contents
 

content being delivered across the network increases. Among video, voice and data services, video delivery has the most stringent requirements for packet order, loss and timing, as well as the need for the greatest network capacity and scalability. For example, HDTV is approximately 1,000 times more sensitive to packet loss, error and delay than voice and data services. To ensure a consistently high-quality subscriber viewing experience, service providers must find solutions that maintain the integrity of the video streams as these streams move across their networks.

 

    Lack of Customized Video Programming.    Existing network infrastructures lack the intelligence to allow service providers to understand and react to subscriber television viewing behavior. As a result, service providers lack the ability to deliver video programming packages tailored to the interests of specific subscribers or groups of subscribers. Service providers require network infrastructure that will enable them to understand subscriber viewing behavior and, based on that assessment, allow them to deliver new video channels and programming packages to specific subscribers or groups of subscribers.

 

    Requirement for More Relevant Video Advertising.    Advertisers are demanding that their ads be addressed to a relevant audience. To satisfy this demand, service providers need the capability to deliver video advertising to particular geographic segments and demographic groups, and ultimately, to tailor advertising to specific subscribers. In most broadcast implementations, service providers lack the media processing capabilities to distinguish one subscriber from another and the capacity to insert tailored advertising into a continuous video stream without degrading service quality. Service providers are seeking solutions that will enable the seamless insertion of relevant advertisements into video streams.

 

    High Cost of Infrastructure Investment.    Service providers have invested heavily to establish their existing network infrastructures, including the deployment of a significant amount of CPE, such as cable set-top boxes and cable modems. Service providers must either make significant investments to upgrade or replace their existing infrastructure, or find ways to extend the useful life of their installed equipment. Service providers generally prefer network-based capital investments since these costs can be allocated across many subscribers without costly replacement of existing CPE.

 

    Need to Rapidly Deliver Advanced Services.    Historically, service providers have needed to make very large capital expenditures to purchase replacement network equipment to support next-generation services. With the increasing pace of change, service providers require platforms with the flexibility to rapidly deploy advanced video and data services while minimizing lengthy and capital-intensive network upgrades.

 

Although service providers face a common challenge—how to rapidly and economically offer an increasing amount of video, voice and data content, deliver a more compelling user experience, and deliver more relevant programming and advertising to their subscribers—the technical and bandwidth challenges associated with video are greater than those of data and voice services. As a result, there is a need for platforms designed primarily for reliable and cost-effective video delivery, which in turn enable the entire triple-play offering.

 

The BigBand Solution

 

We develop, market and sell network-based platforms that enable service providers to offer video, voice and data services across coaxial, fiber and copper networks. Our software and hardware product applications are used to offer video, voice and data services commercially to tens of millions of subscribers, 24 hours a day, seven days a week and have been successfully deployed by leading service providers worldwide including six of the ten largest service providers in the United States.

 

We combine rich media processing, modular software and high-speed switching and routing with carrier-class hardware configurations into product applications designed to address specific service provider needs. Our product applications enable service providers to deliver high-quality video, voice and data services and offer more effective video advertising. Our key product applications include Digital Simulcast, TelcoTV, Switched Broadcast, and High-Speed Data and Voice-over-IP.

 

55


Table of Contents

Our solution offers the following key benefits:

 

    Intelligent Bandwidth Management.    Using our product applications, service providers can address their increasing bandwidth needs. For example, we offer what we believe to be the only switched broadcast application commercially deployed today. Our Switched Broadcast product application only transmits channels to subscribers when the subscribers in a service group are in the process of watching those channels, instead of broadcasting all channels to all subscribers all the time. This enables service providers to achieve up to 50% savings in bandwidth usage for digital subscribers, allowing service providers to offer additional services without altering the subscriber viewing experience. One of our customers that had used all of its available bandwidth capacity for existing channel programming was able to use our Switched Broadcast product application to add new, higher revenue HDTV channels without dropping existing channels.

 

    High-Quality Video Experience.    Our product applications allow service providers to minimize the likelihood of video quality errors by detecting potential video quality degradation in real-time and correcting such degradation before the video stream is delivered to subscribers. Our core suite of video processing software modules are designed to enhance the richness of the viewing experience by optimizing the delivery of video streams, while our program level redundancy functionality adds the switching capability to automatically provision an alternative video stream should the quality of the primary stream begin to degrade.

 

    Enhanced Video Personalization.    Using our product applications, service providers interact with their subscribers down to the individual channel change and, as a result, can more accurately tailor programming packages to the interests of their subscribers. For example, our Switched Broadcast product application enables service providers to satisfy consumer demand for increasingly personalized content by expanding the number of channels that can be offered because selected channels are only delivered when the channel is requested by a subscriber in the service group. Using this application, one of our customers was able to offer additional channel packages tailored to demographic groups.

 

    Ability to Deliver Relevant Video Advertising.    Our product applications allow service providers to insert advertising tailored to specific subscriber groups. For example, using our Digital Simulcast application, service providers can simultaneously insert different ads into multiple copies of the same program and forward them to specific geographic zones. This allows service providers to attract advertisers interested in reaching niche markets.

 

    Optimize Return on Existing Infrastructure Investment.    Our network-based product applications allow service providers to manage service quality from the network, rather than deploying costly personnel and equipment at the customer premises. Because our product applications are deployed at the network level, service providers can leverage their infrastructure investment across many subscribers and avoid the hardware and service costs associated with an upgrade of equipment in the homes of subscribers. For example, using our M-CMTS architecture, service providers will be able to quadruple the existing downstream capacity of our High-Speed Data product application without the need to replace CPE. The need for higher speeds is increasingly required for the delivery of video over the Internet.

 

    Platform Flexibility.    Our product applications feature a fully programmable hardware and modular software architecture. Our field-upgradable hardware is designed to meet service provider platform flexibility requirements and to minimize the need to replace existing hardware. For example, one customer initially purchased our equipment for basic media processing functionality and was subsequently able to further enhance this same hardware platform within a matter of hours to deliver our advanced Digital Simulcast product application simply by licensing an additional software application from us.

 

56


Table of Contents

Strategy

 

Our objective is to be the leading provider of network-based products that enable the delivery of high-bandwidth, high-quality video, voice and data services and more effective video advertising. Key elements of our strategy include the following:

 

    Further Technology Leadership Position.    Over the past eight years, we have developed differentiated media processing and video systems design expertise. We used our media processing expertise to deliver what we believe to be the only switched broadcast product commercially deployed today. We are also building upon our IP networking and media processing expertise to develop the first M-CMTS solution. We will continue leveraging our expertise to deliver products that focus on optimizing network infrastructure and enabling delivery of a high-quality user experience.

 

    Leverage Modular Architecture to Accelerate New Product Introduction.    We have created a series of media processing software modules that, when combined with our programmable hardware and switching fabric, serve as the foundation for a range of network-based product applications. The competition between cable operators and telephone companies is accelerating the rate of change in their networks, and we believe our software modules will serve as the foundation for rapidly delivering solutions that address our customers’ bandwidth and service delivery needs.

 

    Expand Footprint Within Existing Customer Base.    We are intensely customer focused. We have customer relationships with a number of service providers both in the United States and internationally, including six of the ten largest service providers in the United States. We believe these customer relationships give us a strong advantage in understanding our customers’ network challenges and delivering timely solutions, as we did with our Switched Broadcast product application. We will continue to work closely with our customers on the designs of their network architectures and emerging services, expand our relationships with these customers to deploy more of our existing applications, and develop and deliver new applications to address their network challenges.

 

    Expand Customer Base Regardless of Access Technology.    Service providers deploy video, voice and data services to subscribers across networks based on coaxial, fiber and copper. We have successfully deployed our product applications across these access technologies. We are currently providing Verizon with a solution that allows both digital and analog transmission of video over fiber-optic lines. Other telephone companies deploying video services over existing DSL lines leverage our media processing expertise to provide such video services. Still others use our product applications to carry services over coaxial cable. We intend to leverage our media processing expertise to penetrate new customers worldwide, regardless of the type of access networks they use.

 

    Broaden Addressable Advertising Capabilities.    We currently enable service providers to insert video advertisements targeted to subscribers in specific geographic zones. We intend to collaborate with our customers to continue developing and deploying next-generation advertising solutions and are currently in field trials with a leading cable operator for the delivery of ads tailored down to the individual subscriber level.

 

    Leverage Video Over IP Expertise.    We believe that service providers will seek to offer live and on-demand video services to an increasing array of IP-capable devices, such as TVs, personal computers, mobile phones and portable devices, as well as attempt to integrate video, VoIP and data into new services. This will create a need for platforms that integrate video processing and IP networking. Since inception, our development efforts have focused on combining networking with real-time processing of video. Our M-CMTS architecture is the first step in our plan to meet the market demand for video over IP by enabling cable operators to more cost effectively offer bandwidth to IP-enabled devices. We intend to further leverage our video expertise to provide a broader array of solutions to cable operators as they scale their video-enhanced triple-play services directed at PCs and other IP-capable devices.

 

57


Table of Contents

Product Applications

 

We deliver product applications that provide rich media processing and high-speed switching and routing, which enable service providers to offer advanced video, voice and data services to subscribers and advertisers. Our product applications are a combination of our video or data hardware platforms and key software modules that run inside our carrier-class hardware platforms and deliver the application-specific functions.

 

Video

 

We combine our carrier-class hardware platforms and modular media processing software to deliver the following product applications:

 

Digital Simulcast.    We were first to implement what we believe has become the industry’s de facto network architecture for digital simulcast. Historically, video content was broadcast only in analog form. Analog video presents a number of limitations to service providers, including deterioration of video quality, higher cost to insert relevant advertising in the video stream, and the cost of converting analog to digital for certain digital devices in the home, such as digital video recorders.

 

Our Digital Simulcast product application enables service providers to create a digital version of analog inputs and deliver both analog and digital video streams to subscribers. This gives service providers a cost-efficient way of migrating subscribers from analog to digital video, which uses lower cost all-digital set-top boxes, while still supporting a large installed base of analog set-top boxes and televisions. In addition, using our Digital Simulcast product application, service providers can overcome the video quality limitations inherent in the transport of analog over long distances and the low-quality conversion from analog to digital in consumer digital devices. They also can reduce their investment in costly equipment used to transport analog signals and achieve operational efficiency by using a converged digital network. Finally, our Digital Simulcast application allows service providers to insert advertisements into the digital video stream and deliver those ads either in digital or analog form to subscribers. This offers our customers incremental revenue opportunities through the ability to insert advertisements into the digital stream targeted to specific geographic zones.

 

We deliver our Digital Simulcast product application by combining our Broadband Multimedia-Service Router hardware platform, which we refer to as our BMR, with our core media processing modules with advanced splicing capability.

 

TelcoTV.    Telephone companies use our BMR to provide a very high-quality viewing experience, while still benefiting from the use of digital video transport throughout their networks. We enable telephone companies to leverage their existing Synchronous Optical Network, or SONET, infrastructure, which was originally designed for voice communications, to transport video content throughout the network. This provides significant cost savings as telephone companies are not required to build a dedicated video transport network. They deploy our video application in network locations called video serving offices, or VSOs, that provide service directly to consumers. This product application leverages the same key technologies that were previously deployed in many of the largest cable operator networks in the world. Our TelcoTV product application integrates our core media processing modules with our BMR with built-in radio frequency, or RF, modulation, analog decoding and local content insertion. Our platforms have been engineered to comply with the Level-3 Network Equipment Building System standard, or NEBS, which is a set of telecommunications industry safety and environmental design guidelines for equipment in central offices.

 

Switched Broadcast.    We believe we were the first company to develop and commercially deploy a switched broadcast application. Traditionally, service providers broadcast all channels to all subscribers at all times. Our Switched Broadcast application enables service providers to transmit video channels to subscribers only when the subscribers in a smaller subset of subscribers within a network, called a service group, are in the process of watching those channels. Depending on the number of subscribers and the amount of duplicate channels within a service group, our Switched Broadcast product application typically allows service providers to achieve up to 50% bandwidth savings in the delivery of digital video content and use the reclaimed bandwidth to offer additional content. This reclaimed bandwidth can be used to deliver niche video packages, more HDTV

 

58


Table of Contents

channels, high-speed data service and/or voice service. Service providers often use our Switched Broadcast product application as a means to free up the bandwidth to implement digital simulcast. The diagram below illustrates how bandwidth can be reclaimed using our Switched Broadcast product application, which broadcasts only those channels that are being watched within a service group.

 

LOGO

 

In addition, our Switched Broadcast product application gives our service providers real-time access to the actual viewing habits of their subscriber groups, information that is increasingly valuable as they and their advertisers seek to tailor advertising or personalized channel services to specific subscriber groups and individual subscribers.

 

We deliver our Switched Broadcast product application by combining our core media processing modules with our BMR, Switched Broadcast Session Server and Broadband Multimedia-Service Edge hardware platform, which we refer to as our BME.

 

Data

 

High-Speed Data and Voice-over-IP.    Our High-Speed Data product application enables cable operators to offer real-time services, such as VoIP and streaming video content over the Internet. Using our High-Speed Data product application, cable operators can offer different levels of data speeds, which can be tiered based on the level of subscriber fees or on real-time bandwidth needs. Our High-Speed Data product application offers redundancy characteristics and a distributed switch fabric with routing and forwarding capabilities across multiple application modules, instead of in a central core where switching latency can be exacerbated. As a result, those cable operators that are deploying voice services can leverage the ability of our High-Speed Data product application to reduce dropped packets and latency to deliver high-quality and reliable voice services.

 

Modular CMTS is the next generation of our High-Speed Data product application, which is currently in multiple customer trials on three continents. Customers using our existing CMTS product will be able to cost-effectively upgrade to our M-CMTS platform. This will allow them to quadruple their downstream delivery capacity without additional CMTS equipment or next-generation cable modems. We accomplish this by combining a software upgrade with an external edge quadrature amplitude modulation, or QAM, modulator for downstream traffic, freeing up processing capacity in our CMTS to process more downstream traffic on the same hardware. We expect to begin commercial deployment of our M-CMTS product in the first half of 2007.

 

Platforms and Technologies

 

Our intelligent, network-based product applications are built on an architecture that combines modular software with extensible video and data hardware platforms. Our modular software architecture enables us to more quickly and cost effectively develop new features and products. Our hardware platforms offer field-upgradeable hardware, high-speed switching and routing with general-purpose processing capabilities in a chassis-based design. This hardware and software approach provides our customers with rich media processing capabilities in a carrier-class hardware configuration that can be extended across multiple network locations and, as needed, to accommodate more services and more subscribers. Our hardware platforms and modular software consist of:

 

Hardware and Management Software Platforms

 

Broadband Multimedia-Service Router (BMR).    Our Broadband Multimedia-Service Router is our hardware platform that is designed for the real-time processing and switching of video. The BMR platform is a

 

59


Table of Contents

protocol-neutral architecture that processes and switches MPEG, IP and Ethernet packets. We accelerate our software media processing functionality through digital signal processors and field programmable gate arrays, which also allow the BMR to be upgraded or reconfigured over time and from remote locations. The BMR has a chassis-based design that provides carrier-class reliability and flexibility to expand functionality and capacity as network requirements evolve by adding new network cards. The BMR supports the transmission of digital and analog signals using radio frequency, or RF, interfaces to the physical cable network through QAM, quadrature phase shift keying and analog RF.

 

Broadband Multimedia-Service Edge (BME).    The Broadband Multimedia-Service Edge is our hardware platform that is optimized to communicate directly with subscriber set-top boxes and cable modems from the edge of the service provider’s network. Our BME provides media processing and switching of video services, such as VOD and Switched Broadcast, and of data services when used with the Cuda CMTS in our modular CMTS architecture. This allows service providers to utilize Gigabit Ethernet transport to the edge of their network, without the need to upgrade CPE. The BME provides high reliability while terminating 24 QAM channels, which gives our customers a space-efficient and cost-effective system that can scale as capacity needs dictate.

 

Cuda Cable Modem Termination System (CMTS).    Our Cuda CMTS is a DOCSIS 2.0-qualified hardware platform dedicated to the delivery of our data applications for cable operators. Instead of locating all routing and forwarding in a central switching core, our Cuda hardware system architecture distributes these capabilities across multiple application modules to offer carrier-class reliability. It has a total switching capacity of 204 Gbps and provides the superior RF performance critical for real-time services, such as VoIP and streaming video, that require very low packet error rates. Our CMTS platform supports QAM RF modulation for both downstream and upstream digital traffic. Because of its high-density design, this platform allows our customers to scale their services with reduced space and power consumption. Moreover, like the BMR and BME, the Cuda is field-upgradeable to support new services and network architectures.

 

BigBand Session and Resource Manager.    Our Session and Resource Manager is an application server platform for real-time control and management of video and data traffic traversing the network. Our Switched Broadcast Session Server, or SBSS, manages customer transactions down to the channel change level to allow service providers to dynamically switch the broadcast content being requested in a service group. With the knowledge of the customer transactions, the SBSS can switch and load-balance broadcast channels across the BMEs in the network.

 

BigBand FastFlow Broadband Provisioning Manager (BPM).    FastFlow is our network-based software suite for provisioning high-speed data and voice services to cable modems. FastFlow configures, activates and monitors the performance of a wide variety of devices, including DOCSIS set-top boxes, cable modems and multimedia terminal adapters. With extensive support for user self-provisioning capabilities, our FastFlow BPM platform often eliminates the need for expensive field personnel to be dispatched to a subscriber’s home to provision new services.

 

Software Modules

 

Video Software Modules.    We have created a set of individual software modules that define the attributes and functionality of our product applications. We design these modules with well-defined software interfaces to facilitate software development and maintenance, enabling faster response to service provider needs and the delivery of new features. Our software architecture also allows these modules to be combined with one another in various configurations. Selected modular software components are described below:

 

   

RateShaping.    Our RateShaping module combines digital signal processing and statistical multiplexing using complex algorithms to enable more video streams to be transported using the same amount of bandwidth. With RateShaping, we conserve bandwidth by intelligently allocating bandwidth to programs that require more, while reducing bandwidth to programs that require less. The diagram below

 

60


Table of Contents
 

depicts how our RateShaping module can take variable-rate video streams and adjust them to conform to a fixed amount of bandwidth capacity.

 

LOGO

 

    RateClamping.    The amount of bandwidth required to deliver a digital video program varies based on the complexity of the picture being transmitted within that program. For applications where a constant bit rate is desired, such as Switched Broadcast, RateClamping converts variable input feeds into constant bit rate streams, with the output bandwidth determined according to the service provider’s priorities. RateClamping is frequently utilized to deliver services such as VOD, Switched Broadcast and network-based digital video recorders. The diagram below depicts how our RateClamping module can convert variable-rate video streams into constant-rate video streams.

 

LOGO

 

    Splicing.    Our Splicing functionality allows an alternate program, usually an advertisement, to be seamlessly inserted into an existing video stream. Using our Splicing functionality, service providers can perform hundreds of concurrent splices of different ads to multiple advertising zones, targeting different neighborhoods, in a single BMR. Our Splicing functionality is integral to our Digital Simulcast solution.

 

    Video over Ethernet.    Using our Video over Ethernet functionality, service providers can process and transmit digital video streams over IP inputs and outputs, which is less expensive than legacy video- specific interfaces, such as Asynchronous Serial Interface, or ASI. Ethernet, however, can cause latency problems in the network, which are particularly problematic in the delivery of video programming. Our Video over Ethernet functionality corrects the inherent timing effects introduced by Ethernet as it arrives in the BMR and encapsulates video into IP packets on video outputs.

 

    Encryption.    Our Encryption module scrambles the video stream and interfaces with a standards-based conditional access system to allow operators to secure their video content and restrict usage to only authorized subscribers.

 

    Program-level Redundancy.    Our Redundancy module inspects a video stream at the individual program level to detect errors and switches to the back-up source program without interrupting other programs on the same transport stream. By contrast, other competitive redundancy solutions do not detect problems with individual programs, which can result in a lower quality viewer experience.

 

    Metadata Processing.    Our applications process metadata such as the name of the program, plot summary and actors. This allows the service provider to actively control the type and amount of metadata that is provided to the subscriber’s television, thus enabling the service provider to populate program guide content and provide enhanced interactive TV functions.

 

Modular Data Software.    Our High-Speed Data and Voice-over-IP product applications use a modular design where various functions run as separate modules such that modifications to one set of functions or protocols will not disrupt the functionality of others. Our High-Speed Data and Voice-over-IP product applications support the DOCSIS 1.0, 1.1 and 2.0, EuroDOCSIS, PacketCable, PacketCable Multimedia, and DOCSIS Set-Top Gateway, or DSG, industry standards and formats.

 

61


Table of Contents

Select features of our data software are as follows:

 

    Security Enhancements.    Our software helps service providers to secure the granting of IP addresses to new subscribers, the ability to filter certain IP addresses and encrypted communication between our data platform and a wide variety of cable modems.

 

    Troubleshooting and Capacity Planning Analysis.    Using our software, service providers can gather detailed statistics about traffic flows through their system, allowing them to troubleshoot customer specific problems and perform trending and capacity planning functions.

 

    Automated Service Interruption Protection.    Our software is designed to allow service providers to deliver uninterrupted service to their subscribers despite problems inherent in hardware, software and in the hybrid-fiber coaxial network infrastructure. Our data software includes spectrum management for monitoring and mitigating RF noise conditions affecting certain channels; redundancy to recover from hardware or software faults on particular components of the system; and routing protocol enhancements to mitigate loss of service due to fiber cuts or equipment failures in a service provider’s network.

 

Customers

 

We sell our products to cable operators and telephone companies worldwide. In the United States, our products are deployed by six of the ten largest service providers. The following is a list of our customers from which we have recognized at least $250,000 in net revenues since January 1, 2005:

 

Adelphia
Bright House Networks
BSI
Cable Net Akita
Cableone
Cablevision
CAIW
Casema
  Charter
Comcast
Cox
Delta
Ehime CATV
Essent
IdeaTel Belgium
Iesy
  ish
Jupiter Telecom KBW
Megacable
Multikabel
Musashino Mitaka CATV
Phoenix CATV
RCN
Rock Hill Telephone
  Service Electric Company
Time Warner Cable
TVC Communications
Verizon
Videotron
Wave Broadband
Wide Open West
Yamaguchi Cablevision
     
     
     
     
     
     
     
     

 

A substantial majority of our sales have been to relatively few customers. However, our large customers have changed over time. Sales to our five largest customers represented 73%, 69% and 61% of our net revenues in the nine months ended September 30, 2006, the year ended December 31, 2005, and the year ended December 31, 2004, respectively. Time Warner Cable accounted for approximately 12% of our net revenues in the nine months ended September 30, 2006, 10% of our net revenues in the year ended December 31, 2005, and 12% of our net revenues in the year ended December 31, 2004. Verizon accounted for approximately 27% of our net revenues in the nine months ended September 30, 2006. Cox accounted for approximately 13% of our net revenues in the nine months ended September 30, 2006, 20% of our net revenues in the year ended December 31, 2005, and 18% of our net revenues in the year ended December 31, 2004. Comcast accounted for approximately 14% of our net revenues in the nine months ended September 30, 2006 and 18% of our net revenues in the year ended December 31, 2004. Although we are attempting to broaden our customer base by penetrating new markets and expanding internationally, we expect continuing customer concentration due to the significant capital costs of constructing service provider networks and industry consolidation. We expect that in future periods a limited number of large customers will continue to comprise a large percentage of our revenues.

 

Sales to customers outside of the United States represented approximately 15% of net revenues for the nine months ended September 30, 2006, 17% of net revenues for the year ended December 31, 2005, and 20% for the year ended December 31, 2004.

 

Backlog

 

We schedule production of our products based upon our backlog, open contracts, informal commitments from customers and sales projections. Our backlog consists of firm purchase orders by customers for delivery

 

62


Table of Contents

within the next six months. As of December 31, 2005, we had backlog of $33.1 million, compared with backlog of $17.4 million as of December 31, 2004. Anticipated orders from customers may fail to materialize and delivery schedules may be deferred or canceled for a number of reasons, including reductions in capital spending by service providers or changes in specific customer requirements. As a result, our backlog is not necessarily indicative of actual sales for any succeeding period.

 

Sales and Marketing

 

We sell our products in the United States primarily through our direct sales force and internationally through a combination of direct sales to service providers and sales through independent resellers. Our direct sales force, distributors and resellers are supported by our highly trained technical staff, which includes application engineers who work closely with service providers to develop technical proposals and design systems to optimize performance and economic benefits to potential customers. Our sales offices outside of the United States are located in the United Kingdom, France, Germany, China, Hong Kong, Korea and Japan. International resellers are generally responsible for importing our products and providing certain installation, technical support and other services to customers in their territory.

 

Our marketing organization develops strategies for product lines and market segments, and, in conjunction with our sales force, identifies the evolving technical and application needs of customers so that our product development resources can be deployed to meet anticipated product requirements. Our marketing organization is also responsible for setting price levels, forecasting demand and generally supporting the sales force, particularly at major accounts. We have many programs in place to heighten industry awareness of our company and our products, including participation in technical conferences, industry initiatives such as CableLabs’ PacketCable Multimedia and DOCSIS 3.0 working groups, publication of articles in industry journals and exhibitions at trade-shows.

 

Customer Service and Technical Support

 

We offer our customers a range of support offerings, including program management, training, installation and post-sales technical support. As a part of our pre-sales effort, our engineers design the implementation of our products in our customers’ environments to meet their performance and interoperability requirements. We also offer training classes to assist them in the management of our product applications.

 

Our technical support organization, with personnel in the United States, Europe and Asia, offers support 24 hours a day, seven days a week. For our direct customers, we offer tiered customer support programs depending upon the service needs of our customers’ deployments. Using our standard support package, our customers receive telephone support and access to online technical information. Under our enhanced support package, in addition to the standard support offerings, our customers are entitled to software product upgrades and maintenance releases, advanced return materials authorization and on-site support, if necessary. Support contracts typically have a one-year term. For end customers purchasing through resellers, primary product support is provided by our resellers, with escalation support provided by us.

 

Research and Development

 

We focus our research and development efforts on developing new products and systems, and adding new features to existing products and systems. Our development strategy is to identify features, products and systems for both software and hardware that are, or are expected to be, needed by our customers. Our success in designing, developing, manufacturing and selling new or enhanced products will depend on a variety of factors, including the identification of market demand for new products, product selection, timely implementation of product design and development, product performance, effective manufacturing and assembly processes and sales and marketing. Because these research and development efforts are complex, we may not be able to successfully develop new products, and any new products developed by us may not achieve market acceptance.

 

Research and development expense in the nine months ended September 30, 2006 was $26.6 million, in the year ended December 31, 2005 was $30.7 million and in the year ended December 31, 2004 was $21.6 million.

 

63


Table of Contents

Intellectual Property

 

As of December 20, 2006, we held 23 issued U.S. patents, 16 of which relate to our video products and seven of which relate to our CMTS products. Additionally, we had 60 U.S. patent applications pending, 41 of which relate to our video products and 19 of which relate to our CMTS products. Although we attempt to protect our intellectual property rights through patents, trademarks, copyrights, licensing arrangements, trade secrets and other measures, there is a risk that any patent, trademark, copyright or other intellectual property rights owned by us may be invalidated, circumvented or challenged; that these intellectual property rights may not provide competitive advantages to us; and that any of our pending or future patent applications may not be issued with the scope of the claims sought by us, if at all. Others may develop technologies that are similar or superior to our technology, duplicate our technology or design around the patents that we own. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in certain foreign countries in which we do business or may do business in the future.

 

We generally enter into confidentiality or license agreements with our employees, consultants, vendors and customers, and generally limit access to and distribution of our proprietary information. Nevertheless, we cannot assure you that the steps taken by us will prevent misappropriation of our technology. In addition, from time to time, legal action by us may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results and financial condition.

 

From time to time, it may be necessary for us to enter into technology development or licensing agreements with third parties. Although many companies are often willing to enter into such technology development or licensing agreements, we may not be able to negotiate these agreements on terms acceptable to us, or at all. Our failure to enter into technology development or licensing agreements, when necessary, could limit our ability to develop and market new products and could cause our business to suffer.

 

Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. In particular, leading companies in the networking industry have extensive patent portfolios. From time to time, third parties, including certain of these leading companies, have asserted and may assert exclusive patent, copyright, trademark and other intellectual property rights against us or our customers. Although these third parties may offer a license to their technology, the terms of any offered license may not be acceptable and the failure to obtain a license or the costs associated with any license could cause our business, operating results or financial position to be materially adversely affected.

 

Manufacturing and Suppliers

 

We outsource the manufacturing of our products. Flextronics Corporation serves as our sole contract manufacturer for our video products, and ACT Corporation serves as our sole contract manufacturer for our CMTS products. Once our products are manufactured, they are sent to our headquarters in Redwood City, California or our facility in Westborough, Massachusetts, where we perform final assembly and quality-control testing. We believe that outsourcing our manufacturing enables us to conserve capital, better adjust manufacturing volumes to meet changes in demand and more quickly deliver products.

 

We submit purchase orders to our contract manufacturers that describe the type and quantities of our products to be manufactured, the delivery date and other delivery terms. Neither Flextronics nor ACT has any written contractual obligation to accept any purchase order that we submit. We do not have a written agreement with ACT.

 

We and our contract manufacturers purchase many of our components from a sole supplier or a limited group of suppliers. For example, we depend on Vecima Networks for decoding video components. We do not

 

64


Table of Contents

have a written agreement with many of these component suppliers, and we do not require our contract manufacturers to have written agreements with these component manufacturers. As a result, we may not be able to obtain an adequate supply of components on a timely basis. Our reliance on sole or limited suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and reduced control over pricing, quality and timely delivery of components. We monitor the supply of the component parts and the availability of alternative sources. If our supply of any key component is disrupted, we may be unable to deliver our products to our customers on a timely basis, which could result in lost or delayed revenues, injury to our reputation, increased manufacturing costs and exposure to claims by our customers. Even if alternate suppliers are available, we may have difficulty identifying them in a timely manner, we may incur significant additional expense in changing suppliers, and we may experience difficulties or delays in the manufacturing of our products.

 

Our manufacturing operations consist primarily of supply chain managers, new product introduction and test engineering personnel. Our manufacturing organization designs, develops and implements complex test processes to help ensure the quality and reliability of our products. The manufacturing of our products is a complex process, and we may experience production problems or manufacturing delays in the future. Any difficulties we experience in managing relationships with our contract manufacturers, or any interruption in our own or our contract manufacturers operations, could impede our ability to meet our customers’ requirements and harm our business, operating results and financial condition.

 

Competition

 

The markets for our products are extremely competitive and are characterized by rapid technological change. The principal competitive factors in our markets include the following:

 

    product performance, features, interoperability and reliability;

 

    technological expertise;

 

    relationships with service providers;

 

    price of products and services and cost of ownership;

 

    sales and distribution capabilities;

 

    customer service and support;

 

    compliance with industry standards and certifications;

 

    size and financial stability of operations;

 

    breadth of product line;

 

    intellectual property portfolio; and

 

    ability to scale manufacturing.

 

We believe we compete principally on the performance, features, interoperability and reliability of our products and our technological expertise. Several companies, including companies that are significantly larger and more established, such as Cisco Systems and Motorola, also compete in these markets. Many of these larger competitors have substantially broader product offerings and bundle their products or incorporate functionality into existing products in a manner that discourages users from purchasing our products or that may require us to add incremental features and functionality to differentiate our products or lower our prices. Furthermore, many of our competitors have greater financial, technical, marketing, distribution, customer support and other resources, as well as better name recognition and access to customers than we do.

 

Conditions in our markets could change rapidly and significantly as a result of technological advancements or continuing market consolidation. The development and market acceptance of alternative technologies could

 

65


Table of Contents

decrease the demand for our products or render them obsolete. Our competitors may introduce products that are less costly, provide superior performance or achieve greater market acceptance than our products. In addition, these larger competitors often have broader product lines and market focus, are in a better position to withstand any significant reduction in capital spending by customers in these markets, and will therefore not be as susceptible to downturns in a particular market. These competitive pressures are likely to continue to adversely impact our business. We may not be able to compete successfully in the future, and competition may harm our business.

 

We believe standards bodies may commoditize the markets in which we compete and would require that we add incremental features and functions to differentiate our products. If the product design or technology of our competitors were to become an industry standard, our business could be seriously harmed.

 

Employees

 

As of September 30, 2006, we employed a total of 507 people, including 173 in sales, service and marketing, 223 in research and development, 42 in manufacturing operations and 69 in a general and administrative capacity. As of such date, we had 318 employees in the United States, 159 in Israel and 30 in other foreign countries. We also engage a number of temporary employees and consultants. None of our employees is represented by a labor union with respect to his or her employment with us. We have not experienced any work stoppages, and we consider our relations with our employees to be good. Our future success will depend upon our ability to attract and retain qualified personnel. Competition for qualified personnel remains strong, and we may not be successful in retaining our key employees or attracting skilled personnel.

 

Facilities

 

Our corporate headquarters are located at 475 Broadway Street, Redwood City, California. These offices consist of approximately 15,736 square feet. The lease for this property expires in December 2008. We also lease additional office space located at 585 Broadway Street, Redwood City, California. These offices consist of approximately 10,000 square feet. The lease for this property expires in February 2008.

 

In addition to our headquarters, we lease approximately 62,505 square feet of office space in Westborough, Massachusetts under a lease that expires in March 2007 and approximately 30,784 square feet of office space in Tel Aviv, Israel that expires in July 2007. We also lease sales and support offices in Slough, England; Dusseldorf and Rosenheim, Germany; Hong Kong, Shanghai and Beijing, China; Seoul, South Korea; Tokyo, Japan; and Merignac, France.

 

We believe that our existing properties are in good condition and are sufficient and suitable for the conduct of our business. As our existing leases expire and as we continue to expand our operations, we believe that suitable space will be available on commercially reasonable terms.

 

Legal Proceedings

 

From time to time, we are involved in various legal proceedings arising from the normal course of business activities. We are not presently a party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, operating results or financial condition.

 

66


Table of Contents

MANAGEMENT

 

Executive Officers and Directors

 

The following table sets forth information about our executive officers and directors as of December 1, 2006:

 

Name

     Age     

Position(s)

Executive Officers:

         

Amir Bassan-Eskenazi

     42      President, Chief Executive Officer and Chairman of the Board

Frederick Ball

     44      Senior Vice President and Chief Financial Officer

John Connelly

     48      Executive Vice President of Marketing & Business Development

Robert Horton

     35      Vice President and General Counsel

Gil Kaufman

     56      Executive Vice President of Worldwide Engineering

Jeffrey Lindholm

     50     

Senior Vice President of Worldwide Field Operations

Ran Oz

     39      Executive Vice President, Chief Technology Officer and Director

Non-Employee Directors:

         

Lloyd Carney(1)(2)

     44      Director

Dean Gilbert

     50      Director

Ken Goldman(1)

     57      Director

Gal Israely(1)

     46      Director

Bruce Sachs(2)(3)

     46      Director

Robert Sachs(3)

     57      Director

Geoffrey Yang(2)(3)

     47      Director

  (1)   Member of our audit committee
  (2)   Member of our compensation committee
  (3)   Member of our nominating and governance committee

 

Amir Bassan-Eskenazi has served as our President, Chief Executive Officer and Chairman of the Board of Directors since he co-founded the company in December 1998. Prior to co-founding BigBand, Mr. Bassan-Eskenazi served in various executive capacities at Optibase Ltd., a provider of digital video solutions from 1991 to 1998, including as Executive Vice President of Marketing and Chief Operating Officer. Mr. Bassan-Eskenazi holds a B.S. in Electrical Engineering from Technion, Israel Institute of Technology.

 

Frederick Ball has served as our Senior Vice President and Chief Financial Officer since August 2004. Prior to joining BigBand, Mr. Ball served as Chief Operating Officer and director of CallTrex Corporation, a provider of customer service solutions, from October 2003 to May 2004. From September 1999 to July 2003, Mr. Ball served as Chief Financial Officer and Executive Vice President of Corporate Development and Mergers and Acquisitions at Borland Software Corporation, a software company. Mr. Ball currently serves as a member of the board of directors of Electro Scientific Industries, a supplier of laser systems. Mr. Ball holds a B.S. in Accounting from Virginia Polytechnic Institute and State University.

 

John Connelly has served as our Executive Vice President of Marketing and Business Development since October 2003. Prior to joining BigBand, Mr. Connelly served as Vice President of Marketing at Network Physics, a maker of network performance management solutions, from October 2000 to May 2002. He holds a B.S. in Electrical Engineering from Rutgers University and an M.S. in Electrical Engineering from Purdue University.

 

Robert Horton has served as our Vice President and General Counsel since February 2005. Prior to joining BigBand, Mr. Horton served as Senior Counsel for Borland Software Corporation, a software company, from November 2002 to January 2005. From January 2002 to November 2002, Mr. Horton served as an associate at the law firm of Covington & Burling LLP. From 1997 to November 2001, Mr. Horton served as an associate at the law firm of Wilson Sonsini Goodrich & Rosati, P.C. Mr. Horton holds a B.A. in History from the University of Notre Dame and a J.D. from Northwestern University.

 

67


Table of Contents

Gil Kaufman has served as our Executive Vice President of Worldwide Engineering since June 2004. Mr. Kaufman previously served as Senior Director of Engineering for the Content Networking Business Unit at Cisco Systems, a provider of networking equipment and network management, from March 2001 to June 2004. Mr. Kaufman holds a B.S. in Electrical Engineering from Lehigh University and an M.S. in Electrical Engineering from Purdue University.

 

Jeffrey Lindholm has served as our Senior Vice President of Worldwide Field Operations since November 2006. Prior to joining BigBand, Mr. Lindholm served in various executive positions at Juniper Networks, a networking equipment company, from February 2002 to November 2006, including as Chief Marketing Officer from January 2006 to November 2006 and as Vice President of Worldwide Sales from February 2002 to January 2006. Mr. Lindholm served as Vice President of Worldwide Sales and Support of Unisphere Networks, a provider of carrier-class IP infrastructure products, from March 1999 until its acquisition by Juniper Networks in February 2002. Mr. Lindholm holds a B.S. degree in Marketing from Boston College School of Management.

 

Ran Oz has served as our Executive Vice President and Chief Technology Officer since he co-founded the company in December 1998, and as a director since May 2005. Mr. Oz holds a B.S. degree in Electrical Engineering from Technion, Israel Institute of Technology, an M.S. in Electrical Engineering from Tel Aviv University and an M.B.A from the University of Phoenix.

 

Lloyd Carney has served as a director since April 2006. Mr. Carney has been the General Manager of Netcool Products for IBM, an information technology company, since February 2006. Prior to joining IBM, Mr. Carney served as Chairman of the Board and Chief Executive Officer of MicroMuse, a provider of service and business assurance software, from July 2003 through its February 2006 acquisition by IBM. From January 2002 to July 2003, Mr. Carney served as Chief Operating Officer and Executive Vice President of Juniper Networks, a networking equipment company. Mr. Carney also previously served in various executive positions at Nortel Networks from June 1997 to September 2001. Mr. Carney currently serves as a member of the board of directors of Cypress Semiconductor. Mr. Carney holds a B.S. in Electrical Engineering Technology from Wentworth Institute and an M.A. in Applied Business Management from Leslie College.

 

Dean Gilbert has served as a director since February 2002. Since September 2006, Mr. Gilbert has been a Vice President of Syndication at Google, an Internet search company. Mr. Gilbert has also been a Managing Partner of Sandalwood Investments, an independent venture investment and consulting firm, since January 2001. Prior to this time, Mr. Gilbert served as Executive Vice President and General Manager of @Home Networks from 1996 to 2000. Mr. Gilbert co-founded Monogram Holdings, a real-estate management company, in June 2003 and was responsible for sales at Monogram Holdings through March 2005. Mr. Gilbert holds a B.A. in Telecommunications and an M.A. in Telecommunications and Business from Michigan State University.

 

Ken Goldman has served as a director since April 2006. Mr. Goldman was Senior Vice President of Finance and Administration and Chief Financial Officer of Siebel Systems, Inc., a supplier of customer software solutions and services that was acquired by Oracle Corporation in January 2006, from August 2000 through March 2006. From December 1999 to December 2003, Mr. Goldman was a member of the Financial Accounting Standards Advisory Council. Mr. Goldman currently serves as a member of the board of directors of Juniper Networks, a networking equipment company, and of Leadis Technology, Inc., a semiconductor design and development company. Mr. Goldman holds a B.S. in Electrical Engineering from Cornell University and an M.B.A. from Harvard Business School.

 

Gal Israely has served as a director since inception in December 1998. Mr. Israely is a managing partner of the Cedar Fund, a venture capital firm he co-founded in 1997. Prior to co-founding Cedar, Mr. Israely was a Managing Director in the high technology investment banking group of Bear, Stearns & Co., Inc. Mr. Israely holds a B.A. in Economics and an M.B.A. in Finance from Tel Aviv University.

 

Bruce Sachs has served as a director since July 2005. Mr. Sachs has been a General Partner at Charles River Ventures, a venture capital firm, since October 1999. Prior to joining Charles River Ventures, Mr. Sachs served

 

68


Table of Contents

as an executive at numerous companies, including Ascend Communications, Stratus Computer, Bay Networks and Xylogics. Mr. Sachs currently serves as a member of the board of directors of Vertex Pharmaceuticals. Mr. Sachs holds a B.S. in Electrical Engineering from Bucknell University and an M.S. in Electrical Engineering from Cornell University, as well as an M.B.A. from Northeastern University.

 

Robert Sachs has served as a director since January 2006. Mr. Sachs is a Principal of the Continental Consulting Group, LLC, a Boston-based cable and telecommunications consulting firm, which Mr. Sachs co-founded in January 1998. After founding Continental Consulting Group, Mr. Sachs served as President and Chief Executive Officer of the National Cable & Telecommunications Association, from August 1999 through February 2005. Prior to January 1998, Mr. Sachs served as an executive of Continental Cablevision and MediaOne for more than 18 years. Mr. Sachs also serves as a member of the board of directors of Global Crossing. Mr. Sachs holds a B.S. in Political Science from the University of Rochester, an M.S. in Journalism from Columbia University and a J.D. from Georgetown University.

 

Geoffrey Yang has served as a director since April 2000. Mr. Yang is a Partner at Redpoint Ventures, a venture capital firm, which he co-founded in 1999. Immediately prior to co-founding Redpoint Ventures, Mr. Yang was a General Partner with Institutional Venture Partners, a venture capital firm. Mr. Yang currently serves as a member of the board of directors of TiVo, as well as numerous private companies. Mr. Yang holds a B.A. in Economics from Princeton University, a B.S.E. in Engineering and Management Systems from Princeton University and an M.B.A. from Stanford University.

 

Our executive officers are appointed by our board of directors and serve until their successors have been duly elected and qualified. There are no family relationships among any of our directors or executive officers.

 

Board of Directors

 

Our board of directors currently consists of nine members. Our bylaws permit our board of directors to establish by resolution the authorized number of directors, and nine directors are currently authorized.

 

As of the closing of this offering, our amended and restated certificate of incorporation and amended and restated bylaws will provide for a classified board of directors consisting of three classes of directors, each serving staggered three-year terms, as follows:

 

    the Class I directors will be Ran Oz, Amir Bassan-Eskenazi and Ken Goldman, and their terms will expire at the annual meeting of stockholders to be held in 2007;

 

    the Class II directors will be Lloyd Carney, Gal Israely and Bruce Sachs, and their terms will expire at the annual meeting of stockholders to be held in 2008; and

 

    the Class III directors will be Geoffrey Yang, Dean Gilbert and Robert Sachs, and their terms will expire at the annual meeting of stockholders to be held in 2009.

 

Upon expiration of the term of a class of directors, directors for that class will be elected for three-year terms at the annual meeting of stockholders in the year in which that term expires. Each director’s term continues until the election and qualification of his successor, or his earlier death, resignation or removal. Any increase or decrease in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the directors. This classification of our board of directors may have the effect of delaying or preventing changes in control of our company.

 

Director Independence

 

In December 2006, our board of directors undertook a review of the independence of each director and considered whether any director has a material relationship with us that could compromise his ability to exercise independent judgment in carrying out his responsibilities. As a result of this review, our board of directors determined that Lloyd Carney, Ken Goldman, Gal Israely, Robert Sachs, Bruce Sachs and Geoffrey Yang,

 

69


Table of Contents

representing six of our nine directors, are “independent directors” as defined under the rules of the NASD, constituting a majority of independent directors of our board of directors as required by the rules of the NASDAQ.

 

Committees of the Board of Directors

 

Our board of directors has established an audit committee, a compensation committee and a nominating and governance committee, each of which will have the composition and responsibilities described below.

 

Audit Committee

 

Our audit committee is comprised of Lloyd Carney, Ken Goldman and Gal Israely, each of whom is a non-employee member of our board of directors. Mr. Goldman is the chairperson of our audit committee. Our board of directors has determined that each member of our audit committee meets the requirements for independence and financial literacy under the requirements of the NASDAQ and SEC rules and regulations. Mr. Goldman is our audit committee financial expert, as that term is defined under the SEC rules implementing Section 407 of the Sarbanes-Oxley Act of 2002 and possesses financial sophistication as required by the NASDAQ rules. Our audit committee is responsible for, among other things:

 

    selecting and hiring our independent auditors, and approving the audit and non-audit services to be performed by our independent auditors;

 

    evaluating the qualifications, performance and independence of our independent auditors;

 

    monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters;

 

    reviewing the adequacy and effectiveness of our internal control policies and procedures;

 

    discussing the scope and results of the audit with the independent auditors and reviewing with management and the independent auditors our interim and year-end operating results; and

 

    preparing the audit committee report that the SEC requires in our annual proxy statement.

 

Compensation Committee

 

Our compensation committee is currently comprised of Lloyd Carney, Geoffrey Yang and Bruce Sachs, each of whom is a non-employee member of our board of directors. Mr. Carney is the chairperson of our compensation committee. Our board of directors has determined that each member of our compensation committee meets the requirements for independence under the current requirements of the NASDAQ. The compensation committee is responsible for, among other things:

 

    reviewing and approving for our executive officers: the annual base salary, the annual incentive bonus, including the specific goals and amount, equity compensation, employment agreements, severance arrangements and change in control arrangements, and any other benefits, compensations or arrangements;

 

    reviewing the succession planning for our executive officers;

 

    reviewing and recommending compensation goals and bonus and stock compensation criteria for the Company’s employees;

 

    preparing the compensation committee report that the SEC requires to be included in our annual proxy statement; and

 

    administrating, reviewing and making recommendations with respect to our equity compensation plans.

 

70


Table of Contents

Nominating and Governance Committee

 

Our nominating and governance committee is comprised of Geoffrey Yang, Bruce Sachs and Robert Sachs, each of whom is a non-employee member of our board of directors. Robert Sachs is the chairperson of our nominating and governance committee. Our board of directors has determined that each member of our nominating and governance committee satisfies the requirements for independence under the NASDAQ rules. The nominating and governance committee is responsible for, among other things:

 

    assisting our board of directors in identifying prospective director nominees and recommending nominees for each annual meeting of stockholders to the board of directors;

 

    reviewing developments in corporate governance practices and developing and recommending governance principles applicable to our board of directors;

 

    overseeing the evaluation of our board of directors and management; and

 

    recommending members for each board committee to our board of directors.

 

Director Compensation

 

We have agreed to provide compensation to our non-employee directors who have joined our board of directors during 2006. Effective upon the closing of this offering, our board of directors has used the compensation terms offered to these individual directors and adopted them as a compensation policy that will be applicable to all of our non-employee directors. This compensation policy provides that each such non-employee director will receive the following compensation for board services:

 

    an annual director retainer of $20,000;

 

    compensation for attending board meetings in-person of $2,000 per meeting;

 

    compensation for attending committee meetings in-person of $1,000 per meeting;

 

    compensation for attending board or committee meetings telephonically of $500 per meeting;

 

    upon first joining the board, an automatic initial grant of a stock option to purchase 200,000 shares of our common stock vesting as to 25% of the shares on the first anniversary of the grant date and an additional 1/48th of the total shares vesting monthly thereafter so that the award is fully vested four years after the grant date;

 

    for each director whose term continues following an annual meeting, an automatic annual grant of a stock option for the purchase of 75,000 shares of our common stock vesting as to 1/12th of the shares per month so that the award is fully vested one year after the grant date; and

 

    for each full year of service, for the chairperson of the audit committee, an automatic additional grant of a stock option to purchase 25,000 shares of our common stock, for the chairperson of the compensation committee, an automatic additional grant of a stock option to purchase 15,000 shares, and for the chairperson of the nominating and governance committee, an automatic additional grant of a stock option to purchase 5,000 shares, in each case vesting as to 1/12th of the shares per month so that the award is fully vested one year after the grant date.

 

If, following a change of control, a director is terminated, all options granted to the director pursuant to the compensation policy shall fully vest and become immediately exercisable.

 

Prior to the above policy being effective, certain of our non-employee directors have received options to purchase shares of our common stock under our stock option plans in connection with their service to the company. In January 2006, we granted options to purchase 200,000 shares of our common stock at an exercise price of $0.47 per share to Robert Sachs. In April 2006, we granted options to purchase 200,000 shares of our common stock to Mr. Carney at an exercise price of $0.55 per share and options to purchase 205,000 shares of our common stock to Mr. Goldman at an exercise price of $0.55 per share, of which options to purchase 5,000 shares were granted to Mr. Goldman in connection with his service as the chairperson of our audit committee. These options vest over four years at a rate of 25% after one year and 1/48th per month thereafter, so long as the

 

71


Table of Contents

holder continues to serve as a director, except that options to purchase 5,000 shares of Mr. Goldman’s options are fully vested on the first anniversary of the date of the grant. In November 2006, we granted Mr. Goldman options to purchase an additional 20,000 shares of our common stock at an exercise price of $1.32 per share. These options vest at a rate of 25% after one year and 1/48th per month thereafter, so long as the holder continues to serve as a director.

 

In February 2002, we granted Mr. Gilbert options to purchase 390,029 shares at an exercise price of $0.20 per share and in December 2003, we granted Mr. Gilbert options to purchase 150,000 shares at an exercise price of $0.19 per share. These options vest over four years at a rate of 25% after one year and 1/48th per month thereafter, so long as the holder continues to serve as a director. Pursuant to Mr. Gilbert’s option agreements, in the event of an acquisition any remaining unvested shares subject to Mr. Gilbert’s options would accelerate and become vested and exercisable immediately prior to the closing of the acquisition. Our board of directors may require our stockholders’ approval for the grant of this acceleration right to Mr. Gilbert. An acquisition is defined in the 2001 Plan and 2003 Plan to mean any merger or consolidation after which the voting securities of our company outstanding immediately prior thereto represent less than a majority of the combined voting power of the voting securities of our company or other acquiring or such surviving or acquiring entity outstanding immediately after the event, any sale of all or substantially all of the assets or capital stock of our company or any other acquisition of the business of our company as determined by our board of directors. In December 2006, we granted Mr. Gilbert an option to purchase 200,000 shares at an exercise price of $1.34 per share. This option vests over four years at a rate of 25% after one year and 1/48th per month thereafter, so long as the holder continues to serve as a director.

 

Compensation Committee Interlocks and Insider Participation

 

None of the members of our compensation committee is an officer or employee of our company. None of our executive officers currently serves, or in the past year has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors or compensation committee.

 

Executive Compensation

 

The following table provides information regarding the compensation of our chief executive officer and each of our other four most highly compensated executive officers during 2005. We refer to these executive officers as our named executive officers.

 

Summary Compensation Table

 

     Annual Compensation   

Long Term

Compensation
Awards

      

Name and Principal Position

   Salary    Bonus    Securities
Underlying
Options
   All Other
Compensation ($)
 

Amir Bassan-Eskenazi, President and Chief Executive Officer

   $ 250,000    $ 104,018          

Frederick Ball, Senior Vice President and Chief Financial Officer

     206,416      70,000          

Gil Kaufman, Executive Vice President of Worldwide Engineering

     170,000      57,750          

Ran Oz, Chief Technology Officer & Executive Vice President

     155,000      50,000       $ 22,176 (1)

John Connelly, Executive Vice President of Marketing & Business Development

     200,000               

  (1)   Consists of payment for car leasing expenses in the amount of $9,385, taxes related to a car expense benefit in the amount of $4,908 and other benefits in the amount of $7,883.

 

72


Table of Contents

Stock Option Grants in Last Fiscal Year

 

The following table summarizes the stock options granted to each named executive officer during 2005, including the potential realizable value over the 10-year term of the options, which is based on assumed rates of stock appreciation of 5% and 10%, compounded annually, and subtracting from that result the aggregate option exercise price. These assumed rates of appreciation comply with the rules of the SEC and do not represent our estimate of our future stock price. Actual gains, if any, on stock option exercises will depend on the future performance of our common stock. The percentage of the total options granted to employees is based upon options to purchase an aggregate of 7,533,708 shares of common stock we granted to employees in 2005.

 

     Individual Grants    Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Appreciation for
Option Terms

Name

   Number of
Securities
Underlying
Options
Granted
   Percent of
Total Options
Granted to
Employees
   Exercise
Price Per
Share
  

Fair Market
Value

Per Share(1)

   Expiration
Date
   5%    10%

Amir Bassan-Eskenazi

                    

Frederick Ball

                    

Gil Kaufman

                    

Ran Oz

                    

John Connelly

                    

  (1)   Represents the fair market value, as determined by our board of directors, of our common stock on the date of grant of the options.

 

Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

 

The following table provides information regarding the exercise of stock options during 2005 by our named executive officers, and the value of unexercised stock options held by our named executive officers at December 31, 2005. The value realized and the value of unexercised in-the-money options at December 31, 2005 have been calculated based on an assumed initial public offering price of $            , less the applicable exercise price, in accordance with SEC rules.

 

    

Shares
Acquired
on

Exercise

  

Value
Received

  

Number of Securities
Underlying Unexercised
Options at

Fiscal Year-End

  

Value of Unexercised
In-the-Money Options

at Fiscal Year-End

Name

         Exercisable    Unexercisable    Exercisable    Unexercisable

Amir Bassan-Eskenazi

         4,857,590    1,261,528    $                 $             

Frederick Ball

         700,000    1,400,000      

Gil Kaufman

         825,000    1,375,000      

Ran Oz

         1,490,896    1,261,528      

John Connelly

         704,166    595,834      

 

Employment Agreements and Change in Control Arrangements

 

Amir Bassan-Eskenazi.    We have entered into an employment agreement, dated January 1, 2000, with Mr. Bassan-Eskenazi, our President and Chief Executive Officer. Mr. Bassan-Eskenazi’s current annual salary is $290,000. Pursuant to his employment agreement, Mr. Bassan-Eskenazi may receive a bonus of up to 30% of his base salary. The level of Mr. Bassan-Eskenazi’s bonus is determined at our discretion and is based on Mr. Bassan-Eskenazi’s performance and our performance, among other factors. Mr. Bassan-Eskenazi’s employment agreement provides that, if Mr. Bassan-Eskenazi’s employment is terminated without cause and not due to death or disability, Mr. Bassan-Eskenazi would be entitled to a severance payment in an amount equal to twelve months of his then-current base salary and our company’s contribution to his health insurance premiums.

 

73


Table of Contents

This payment is conditioned on Mr. Bassan-Eskenazi’s execution of a comprehensive release of claims. Pursuant to Mr. Bassan-Eskenazi’s agreement, termination within one year following a sale of all or substantially all of our assets, technology or stock, a merger, consolidation or any other change in share ownership resulting in a change of control of BigBand is deemed to be termination without cause if one of the following has occurred (i) a reduction in salary or a material reduction in the level of benefits in effect immediately prior to the change in control, (ii) a diminution in the nature or scope of authority, duties or responsibility in effect immediately prior to the change in control or (iii) a required change in location of more than 50 miles of the principal office to which Mr. Bassan-Eskenazi would report. Pursuant to his employment agreement, Mr. Bassan-Eskenazi may terminate the agreement at any time with at least six months’ written notice. Mr. Bassan-Eskenazi’s employment agreement further provides that upon the termination of Mr. Bassan-Eskenazi’s employment with us, we will reimburse Mr. Bassan-Eskenazi for moving and relocation expenses to Israel for Mr. Bassan-Eskenazi and his family. If such relocation reimbursements are considered compensation includible in gross income, we have agreed under Mr. Bassan-Eskenazi’s employment agreement to make a gross up payment in order to put him in the same financial position after the payment of taxes with respect to such includible amounts as he would have been if none of the reimbursement amounts had been includible in gross income.

 

We also entered into stock option agreements with Mr. Bassan-Eskenazi, pursuant to which, Mr. Bassan-Eskenazi may be eligible for vesting acceleration of the stock options in certain events as follows:

 

    in the event of a sale of all or substantially all of our assets, technology or stock, a merger, consolidation or any other change in share ownership resulting in a change of control of our company, 50% of the shares subject to the options that at such time remain unvested would accelerate and immediately become vested and exercisable;

 

    in the event that Mr. Bassan-Eskenazi is terminated, without cause, within one year following any change in control as described in the preceding paragraph, all remaining unvested shares subject to the options would accelerate and become immediately vested and exercisable;

 

    a termination that would trigger this option vesting acceleration event includes each of the following occurring within one year after a change in control as described above: a material reduction in salary or level of benefits in effect immediately prior to the change in control, a material diminution in the nature or scope of authority, duties or responsibility in effect immediately prior to a change in control or a required change in location of more than 50 miles of the principal office to which Mr. Bassan-Eskenazi would report.

 

    in the event that Mr. Bassan-Eskenazi is terminated at any time without cause, any remaining unvested shares subject to the options would accelerate and become vested and exercisable;

 

    in the event that Mr. Bassan-Eskenazi dies while employed by our company or ceases to be employed by our company by reason of his disability, the options granted to Mr. Bassan-Eskenazi that would have vested in the 180-day period following the date of death or disability, as applicable, would accelerate and become vested and exercisable immediately upon his death or disability, as applicable; and

 

    in the event that Mr. Bassan-Eskenazi voluntarily terminates his employment with our company, other than in connection with an event pursuant to which we would have the right to terminate Mr. Bassan-Eskenazi for cause, the options granted to Mr. Bassan-Eskenazi that would have vested in the 180-day period following the date of termination would accelerate and become vested and exercisable immediately upon termination.

 

The term “cause” is defined in the option agreements to mean a refusal to render services to us pursuant to any employment agreement to which Mr. Bassan-Eskenazi has entered with us; a repeated refusal to follow our company rules or policies; the commission of any act of disloyalty, gross negligence, dishonesty or breach of fiduciary duty toward our company or our customers; a material breach of any employment agreement, non-disclosure or non-competition agreement that he has entered with us; a commission of a felony or an act of fraud or embezzlement or the misappropriation of money or other assets of the company; or unfairly competing with the company.

 

74


Table of Contents

Frederick Ball.    We entered into an offer letter agreement dated August 5, 2004, as amended, with Mr. Ball, our Senior Vice President and Chief Financial Officer. Mr. Ball’s current annual salary is $225,000. Mr. Ball’s offer letter provides that if we terminate Mr. Ball without cause, he will receive a severance payment equal to six months of his then-current annual salary. The offer letter agreement defines “cause” to mean a serious violation of any company policy or engaging in criminal conduct. In addition, the offer letter provides that if Mr. Ball is terminated or constructively terminated within six months following a change of control, the greater of the equivalent of twelve months accelerated vesting or 50% of the remaining unvested shares subject to Mr. Ball’s outstanding stock options, would become immediately vested and exercisable. If any payments or benefits to Mr. Ball would be subject to an excise tax under Section 4999 or Section 280G of the Internal Revenue Code or any similar successor provision, we are required to make gross-up payments to Mr. Ball to compensate him for any tax losses pursuant to the letter agreement.

 

In the related option agreements we entered into with Mr. Ball, a “change in control” is defined to mean a sale of all or substantially all of our assets, technology or stock, a merger, consolidation or any other change in share ownership resulting in a change of control of our company. A termination that would trigger the option vesting acceleration event includes constructive termination by the new controlling party and Mr. Ball not holding a comparable position within six months of the change of control. The related option agreements further define a “termination event” to mean an involuntary termination without cause within six months of a change in control, or each of the following occurring within six months after a change in control: a material reduction in salary or level of benefits in effect immediately prior to the change in control or a material diminution in the nature or scope of authority, duties or responsibility in effect immediately prior to the change in control.

 

Gil Kaufman.    We entered into an offer letter agreement dated May 16, 2004 with Mr. Kaufman, our Executive Vice President of Worldwide Engineering. Mr. Kaufman’s current annual salary is $200,000. The offer letter provides that if we terminate Mr. Kaufman without cause, he will receive a severance payment equal to three months of his then-current salary.

 

Ran Oz.    Our wholly-owned Israeli subsidiary, BigBand Networks, Ltd., entered into an employment agreement dated January 2, 2000 with Mr. Oz, our Executive Vice President and Chief Technology Officer. Mr. Oz’s current annual base salary is $200,000. Mr. Oz’s employment agreement provides for a bonus of up to 30% of his salary for the relevant period, the level of which is determined by the achievement of certain tasks, as agreed by Mr. Oz and our company. In addition, the agreement provides for payment for a car for Mr. Oz and for social benefits, including contributions to a pension or insurance fund in an amount equal to 13.3% of Mr. Oz’s base salary, contributions to a professional advancement fund in an amount equal to 7.5% of Mr. Oz’s base salary, subject to Mr. Oz’s self-participation in the fund, and a disability insurance premium equal to 2.5% of Mr. Oz’s base salary.

 

The agreement further provides that, if the employment of Mr. Oz is terminated without good cause and not due to death or disability, Mr. Oz would be entitled to a 12-month prior notice or the payment of an amount equal to twelve months of his then-current salary and benefits. Pursuant to this agreement, termination within one year following a sale of all or substantially all of our assets, technology or stock, a merger, consolidation or any other change in share ownership resulting in a change of control of our company is deemed to be a termination without good cause. A reduction in salary or a material reduction in the level of benefits in effect immediately prior to the change in control, a diminution in the nature or scope of authority, duties or responsibility in effect immediately prior to the change in control or a required change in location of more than 50 miles of the principal office to which Mr. Oz would report, each within one year following a change in control, are deemed “termination” in the agreement. In addition, any material adverse change by the company to Mr. Oz’s scope of responsibility, position or job description may be deemed, at Mr. Oz’s option, as a termination without cause. The agreement also provides that Mr. Oz is entitled to terminate his employment with our company following a six-month prior notice and receive an amount equal to six months of his then-current salary and benefits, regardless of whether our company continues his employment following such notice.

 

75


Table of Contents

We also entered into an option agreement with Mr. Oz, pursuant to which Mr. Oz may be eligible for vesting acceleration of his stock options in certain events as follows:

 

    in the event of a sale of all or substantially all of our assets, technology or stock, a merger, consolidation or any other change in share ownership resulting in a change of control of our company, 50% of the shares subject to the options that at such time remain unvested would accelerate and immediately become vested and exercisable;

 

    in the event that Mr. Oz is terminated, without cause, within one year following any change in control as described in the preceding paragraph, all remaining unvested shares subject to his option would accelerate and become immediately vested and exercisable;

 

    a termination that would trigger this option vesting acceleration event includes each of the following occurring within one year after a change in control as described above: a material reduction in salary or level of benefits in effect immediately prior to the change in control, a material diminution in the nature or scope of authority, duties or responsibility in effect immediately prior to a change in control or a required change in location of more than 50 miles of the principal office to which Mr. Oz would report.

 

    in the event that Mr. Oz is terminated at any time without cause, any remaining unvested shares subject to the options would accelerate and become vested and exercisable;

 

    in the event that Mr. Oz dies while employed by our company or ceases to be employed by our company by reason of his disability, the options granted to Mr. Oz that would have vested in the 180-day period following the date of death or disability, as applicable, would accelerate and become vested and exercisable immediately upon his death or disability, as applicable; and

 

    in the event that Mr. Oz voluntarily terminates his employment with our company, other than in connection with an event pursuant to which we would have the right to terminate Mr. Oz for cause, the options granted to Mr. Oz that would have vested in the 180-day period following the date of termination would accelerate and become vested and exercisable immediately upon termination.

 

The term “cause” is defined in Mr. Oz’s the option agreement to mean a refusal to render services to us pursuant to any employment agreement to which Mr. Oz has entered with us; a repeated refusal to follow our company rules or policies; the commission of any act of disloyalty, gross negligence, dishonesty or breach of fiduciary duty towards our company or our customers; a material breach of any employment agreement, non-disclosure or non-competition agreement that he has entered with us; a commission of a felony or an act of fraud or embezzlement or the misappropriation of money or other assets of our company; or unfairly competing with our company.

 

John Connelly.    We entered into an offer letter agreement dated October 11, 2003 with Mr. Connelly, our Executive Vice President of Marketing and Business Development. Mr. Connelly’s current annual salary is $200,000. The offer letter provides that if we terminate Mr. Connelly without cause, he will receive a severance payment equal to three months of his then-current salary, provided that he signs a comprehensive release of claims.

 

The offer letter agreement refers to an option plan for the definition of cause. In the 2003 Plan, under which Mr. Connelly was granted options, “cause” is defined to mean disloyalty, dishonesty, fraud or any termination for reasons of negligence in the discharge of duties, breach of fiduciary duty, willful cause of damage or loss to our company or any of its affiliate in any fashion or similar cause, or any other breach of an employment or other agreement with our company which results in direct or indirect loss, damages or injury to our company or any affiliate, or the unauthorized disclosure of any trade secrets or confidential information of our company or any of its affiliates.

 

Jeffrey Lindholm.    We entered into an offer letter agreement dated October 30, 2006, with Mr. Lindholm, our Senior Vice President of Worldwide Field Operations, which provides for an annual base salary of $250,000,

 

76


Table of Contents

with an annual additional variable compensation of up to $150,000. The level of Mr. Lindholm’s additional variable compensation is determined based on a combination of sales compensation in accordance with our sales

compensation plan and participation in our performance bonus program on the same basis as other members of our senior management. In addition, the offer letter provides for a sign-up bonus in an aggregate amount of $50,000, paid in equal installments on January 1, 2007, March 1, 2007 and May 1, 2007 if Mr. Lindholm remains actively employed on each of these dates. The offer letter provides that if Mr. Lindholm is terminated or constructively terminated, without his misconduct, within six months following a change in control, the greater

of the equivalent of twelve months accelerated vesting or 50% of the remaining unvested shares subject to Mr. Lindholm’s outstanding stock options would become immediately vested and exercisable. In addition, upon the above-described termination and subject to execution of a general release, Mr. Lindholm will receive a severance payment equal to six months of his then-current base salary.

 

The offer letter agreement refers to the option agreement, to be entered into, for the definition of a change in control. In the offer letter agreement, “misconduct” is defined to mean the commission of any act of fraud, embezzlement or dishonesty, any unauthorized use or disclosure of confidential information of our company or its subsidiaries or any other intentional misconduct adversely affecting the business or affairs of our company or its subsidiaries in a material manner. A “constructive termination” is defined in the offer letter agreement to mean a required change in location of more than 50 miles of the principal office to which Mr. Lindholm would report, a failure to pay, or a material reduction of, salary or level of benefits unless reductions comparable in amount and duration are concurrently made for all other employees at a comparable level, a significant reduction of duties, position or responsibilities unless the reduction is solely by virtue of the company being acquired and made part of a larger entity or our determination that Mr. Lindholm’s services are no longer needed, all to which Mr. Lindholm has not expressly consented in writing.

 

Employee Benefit Plans

 

2007 Equity Incentive Plan

 

We expect our board of directors to adopt, and our stockholders to approve, our 2007 Equity Incentive Plan, or 2007 Plan, prior to the completion of this offering. Our 2007 Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, to our employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, stock appreciation rights, restricted stock, restricted stock units, performance units and performance shares to our employees, directors and consultants and our parent and subsidiary corporations’ employees and consultants.

 

We have reserved a total of              shares of our common stock for issuance under the 2007 Plan, plus (a) any shares which have been reserved but not issued under our 1999 Plan, 2001 Plan and 2003 Plan as of this offering and (b) any shares subject to stock options or similar awards granted under our 1999 Plan, 2001 Plan and 2003 Plan that expire or otherwise terminate without having been exercised in full and shares issued pursuant to awards granted under such plans that are forfeited to or repurchased by us. The maximum number of shares that may be added to the 2007 Plan from the 1999 Plan, 2001 Plan and 2003 Plan is              shares. In addition, our 2007 Plan provides for annual increases in the number of shares available for issuance thereunder on the first day of each fiscal year, beginning with our 2008 fiscal year, equal to the lesser of:

 

        % of the outstanding shares of our common stock on the last day of the immediately preceding fiscal year;

 

                 shares; or

 

    such other amount as our board of directors may determine.

 

In the case of options intended to qualify as “performance-based compensation” within the meaning of Section 162(m) of the Internal Revenue Code, the committee will consist of two or more “outside directors” within the meaning of Section 162(m) of the Internal Revenue Code. The administrator has the power to determine the terms of the awards, including the exercise price, the number of shares subject to each such award, the exercisability of the awards and the form of consideration payable upon exercise. The administrator also has

 

77


Table of Contents

the authority to institute an exchange program whereby the exercise prices of outstanding awards may be reduced, outstanding awards may be surrendered in exchange for awards with a lower exercise price or outstanding awards may be transferred to a third party.

 

The exercise price of options granted under our 2007 Plan must at least be equal to the fair market value of our common stock on the date of grant. The term of an incentive stock option may not exceed ten years, except that with respect to any participant who owns 10% or more of the voting power of all classes of our outstanding stock as of the grant date, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the grant date. The administrator determines the term of all other options.

 

After termination of an employee, director or consultant, he or she may exercise the vested portion of his or her option for the period of time stated in the option agreement. Generally, if termination is due to death or disability, the option will remain exercisable for 12 months. In all other cases, the option will generally remain exercisable for three months. However, an option generally may not be exercised later than the expiration of its term.

 

Stock appreciation rights may be granted under our 2007 Plan, which allow the recipient to receive the appreciation in the fair market value of our common stock between the exercise date and the date of grant. The administrator determines the terms of stock appreciation rights, including when such rights become exercisable and whether to pay the increased appreciation in cash or with shares of our common stock, or a combination thereof. Stock appreciation rights expire under the same rules that apply to stock options.

 

Restricted stock may be granted under our 2007 Plan, which are awards of our shares of common stock that vest in accordance with terms and conditions established by the administrator. The administrator will determine the number of shares of restricted stock granted to any participant. The administrator may impose whatever conditions to vesting it determines to be appropriate. For example, the administrator may set restrictions based on the achievement of specific performance goals. Shares of restricted stock that do not vest are subject to our right of repurchase or forfeiture.

 

Restricted stock units may be granted under our 2007 Plan, which are awards that are paid out in installments or on a deferred basis. The administrator determines the terms and conditions of restricted stock units including the vesting criteria and the form and timing of payment.

 

Performance units and performance shares may be granted under our 2007 Plan. Performance units and performance shares are awards that will result in a payment to a participant only if performance goals established by the administrator are achieved or the awards otherwise vest. The administrator will establish organizational or individual performance goals in its discretion, which, depending on the extent to which they are met, will determine the number and/or the value of performance units and performance shares to be paid out to participants. Performance units shall have an initial dollar value established by the administrator prior to the grant date. Performance shares shall have an initial value equal to the fair market value of our common stock on the grant date. Payment for performance units and performance shares may be made in cash or in shares of our common stock with equivalent value, or in some combination, as determined by the administrator.

 

Unless the administrator provides otherwise, our 2007 Plan does not allow for the transfer of awards and only the recipient of an award may exercise an award during his or her lifetime.

 

Our 2007 Plan provides that in the event of our change in control, as defined in the 2007 Plan, each outstanding award will be treated as the administrator determines, including that the successor corporation or its parent or subsidiary will assume or substitute an equivalent award for each outstanding award. The administrator is not required to treat all awards similarly. If there is no assumption or substitution of outstanding awards, the awards will fully vest, all restrictions will lapse and the awards will become fully exercisable. The administrator will provide notice to the recipient that he or she has the right to exercise the option and stock appreciation right as to all of the shares subject to the award, all restrictions on restricted stock will lapse and all performance goals or other vesting requirements for performance shares and units will be deemed achieved, and all other terms and conditions met. The option or stock appreciation right will terminate upon the expiration of the period of time the

 

78


Table of Contents

administrator provides in the notice. In the event the service of an outside director is terminated on or following a change in control, other than pursuant to a voluntary resignation, his or her options and stock appreciation rights will fully vest and become immediately exercisable, all restrictions on restricted stock will lapse and all performance goals or other vesting requirements for performance shares and units will be deemed achieved, and all other terms and conditions met.

 

Our 2007 Plan will automatically terminate in 2017, unless we terminate it sooner. In addition, our board of directors has the authority to amend, suspend or terminate the 2007 Plan, provided such action does not impair the rights of any participant.

 

2003 Share Option and Incentive Plan

 

Our board of directors adopted our 2003 Share Option and Incentive Plan in September 2003, and our stockholders approved it in August 2004. Our board of directors has determined not to grant any additional awards under the 2003 Plan after the completion of this offering. However, the 2003 Plan will continue to govern the terms and conditions of the outstanding awards granted under it. As of September 30, 2006, options to purchase a total of 38,270,484 shares of our common stock were issued and outstanding, and a total of 2,309,083 shares of our common stock had been issued upon the exercise of options and restricted stock awards granted under the 2003 Plan that had not been repurchased by us.

 

Our 2003 Plan provides for the grant of options and restricted stock awards to our service providers. Nonqualified options and restricted stock awards may be granted to our employees, directors and consultants, and incentive stock options, within the meaning of Section 422 of the Internal Revenue Code, may be granted only to our employees. Our board of directors or a committee of our board of directors administers our 2003 Plan. The administrator has the authority to determine the terms and conditions of the awards granted under our 2003 Plan.

 

Our 2003 Plan provides that in the event of our acquisition, we or our successor will make provisions for the continuation of awards outstanding at such time or the assumption of such awards by our successor. In addition to or in lieu of the foregoing, with respect to options outstanding at the time of the acquisition, we can provide notice to participants that either they (i) must exercise their options within a period we specify in the notice and that the options will terminate upon the expiration of such period or (ii) will receive a cash payment equal to the difference between the fair market value of the shares subject to such options over the exercise price of such options and that the options will terminate upon consummation of the acquisition; provided, however, that before terminating any portion of an unvested and exercisable option (other than in exchange for a cash payment), we must first accelerate in full the exercisability of the option that is to be terminated.

 

2001 Share Option and Incentive Plan

 

Our board of directors adopted our 2001 Share Option and Incentive Plan in October 2001, and our stockholders approved it in November 2001. Our board of directors has determined not to grant any additional awards under the 2001 Plan after the completion of this offering. However, the 2001 Plan will continue to govern the terms and conditions of the outstanding awards granted under it. As of September 30, 2006, options to purchase a total of 7,210,473 shares of our common stock were issued and outstanding, and a total of 1,486,552 shares of our common stock had been issued upon the exercise of options and restricted stock awards granted under the 2001 Plan that had not been repurchased by us.

 

Our 2001 Plan provides for the grant of options and restricted stock awards to our service providers. Our 2001 Plan provides for the grant of stock options that qualify either as incentive stock options within the meaning of Section 422 of the Internal Revenue Code, or as options granted pursuant to the provisions of Sections 102 or 3(i) of the Israeli Tax Ordinance (New Version) of 1961, or the Israeli Tax Ordinance. Nonqualified options and restricted stock awards may be granted to our employees, directors and consultants, and incentive stock options and options granted pursuant to Section 102 of the Ordinance may be granted only to our employees. Our board of directors or a committee of our board of directors administers our 2001 Plan. The administrator has the authority to determine the terms and conditions of the awards granted under our 2001 Plan.

 

79


Table of Contents

Our 2001 Plan provides that in the event of our acquisition, we or our successor will make provisions for the continuation of awards outstanding at such time or the assumption of such awards by our successor. In addition to or in lieu of the foregoing, with respect to options outstanding at the time of the acquisition, we can provide notice to participants that either they must exercise their options within the period we specify in the notice and that the options will terminate upon the expiration of such period, or will receive a cash payment equal to the difference between the fair market value of the shares subject to such options over the exercise price of such options and that the options will terminate upon consummation of the acquisition.

 

1999 Share Option and Incentive Plan

 

Our board of directors adopted our 1999 Share Option and Incentive Plan in November 1999, and our stockholders approved it in December 1999. Our board of directors has determined not to grant any additional awards under the 1999 Plan after the completion of this offering. However, the 1999 Plan will continue to govern the terms and conditions of the outstanding awards granted under the 1999 Plan. As of September 30, 2006, options to purchase a total of 2,987,376 shares of our common stock were issued and outstanding, and a total of 2,232,741 shares of our common stock had been issued upon the exercise of options and restricted stock awards granted under the 1999 Plan that had not been repurchased by us.

 

Our 1999 Plan provides for the grant of options and restricted stock awards to our service providers. Our 1999 Plan provides for the grant of stock options that qualify either as incentive stock options within the meaning of Section 422 of the Internal Revenue Code, or as options granted pursuant to the provisions of Sections 102 or 3(i) of the Israeli Tax Ordinance. Nonqualified options and restricted stock awards may be granted to our employees, directors and consultants, and incentive stock options and options granted pursuant to Section 102 of the Ordinance may be granted only to our employees. Our board of directors or a committee of our board of directors administers our 1999 Plan. The administrator has the authority to determine the terms and conditions of the awards granted under our 1999 Plan.

 

Our 1999 Plan provides that in the event of our acquisition, we or our successor will make provisions for the continuation of awards outstanding at such time or the assumption of such awards by our successor. In addition to or in lieu of the foregoing, with respect to options outstanding at the time of the acquisition, we can provide notice to participants that either they must exercise their options within the period we specify in the notice and that the options will terminate upon the expiration of such period, or will receive a cash payment equal to the difference between the fair market value of the shares subject to such options over the exercise price of such options and that the options will terminate upon consummation of the acquisition.

 

Employee Stock Purchase Plan

 

Concurrently with this offering, we intend to establish our Employee Stock Purchase Plan, or ESPP. We expect our board of directors to adopt and our stockholders to approve the ESPP prior to the completion of this offering.

 

A total of              shares of our common stock will be made available for sale under our ESPP. In addition, our ESPP provides for annual increases in the number of shares available for issuance under the plan on the first day of each fiscal year, beginning with our 2008 fiscal year, equal to the lesser of:

 

    3.5% of the outstanding shares of our common stock on the first day of the fiscal year;

 

                 shares; or

 

    such other amount as may be determined by our board of directors.

 

Our board of directors or its committee has full and exclusive authority to interpret the terms of the ESPP and determine eligibility.

 

80


Table of Contents

All of our employees are eligible to participate if they are customarily employed by us or any participating subsidiary for at least 20 hours per week and more than five months in any calendar year. However, an employee may not be granted rights to purchase stock if:

 

    such employee immediately after the grant would own stock possessing 5% or more of the total combined voting power or value of all classes of our capital stock; or

 

    such employee’s rights to purchase stock under all of our employee stock purchase plans would accrue at a rate that exceeds $25,000 worth of our stock for each calendar year in which such rights are outstanding.

 

Our ESPP is intended to qualify under Section 423 of the Internal Revenue Code, and provides for consecutive, non-overlapping six-month offering periods. The offering periods generally start on the first trading day on or after November 15 and May 15 of each year, except for the first such offering period which will commence on the first trading day on or after the effective date of this offering and will end on the first trading day on or after November 15, 2007.

 

Our ESPP permits participants to purchase common stock through payroll deductions of up to     % of their eligible compensation which includes a participant’s straight time gross earnings, commissions, overtime and shift premium, exclusive of payments for incentive compensation, bonuses and other compensation. A participant may purchase a maximum of              shares of common stock during a six-month offering period.

 

Amounts deducted and accumulated by the participant are used to purchase shares of our common stock at the end of each six-month offering period. The purchase price is 85% of the fair market value of our common stock at the exercise date. Participants may end their participation at any time during an offering period, and will be paid their payroll deductions to date. Participation ends automatically upon termination of employment with us.

 

A participant may not transfer rights granted under the ESPP other than by will, the laws of descent and distribution or as otherwise provided under the ESPP.

 

In the event of our merger or change in control, as defined under the ESPP, a successor corporation may assume or substitute each outstanding purchase right. If the successor corporation refuses to assume or substitute for the outstanding purchase rights, the offering period then in progress will be shortened, and a new exercise date will be set.

 

Our ESPP will automatically terminate in 2026, unless we terminate it sooner. In addition, our board of directors has the authority to amend, suspend or terminate our ESPP, except that, subject to certain exceptions described in the ESPP, no such action may adversely affect any outstanding rights to purchase stock under our ESPP.

 

Limitation on Liability and Indemnification Matters

 

Our amended and restated certificate of incorporation, which will be in effect upon the completion of this offering, contains provisions that limit the liability of our directors for monetary damages to the fullest extent permitted by Delaware law. Consequently, our directors will not be personally liable to us or our stockholders for monetary damages for any breach of fiduciary duties as directors, except liability for:

 

    any breach of the director’s duty of loyalty to us or our stockholders;

 

    any act or omission not in good faith or that involves intentional misconduct or a knowing violation of law;

 

    unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law; or

 

    any transaction from which the director derived an improper personal benefit.

 

Our amended and restated certificate of incorporation and amended and restated bylaws to be in effect upon the completion of this offering provide that we are required to indemnify our directors and officers, in each case

 

81


Table of Contents

to the fullest extent permitted by Delaware law. Our amended and restated bylaws also provide that we are obligated to advance expenses incurred by a director or officer in advance of the final disposition of any action or proceeding, and permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in that capacity regardless of whether we would otherwise be permitted to indemnify him or her under the provisions of Delaware law. We have entered and expect to continue to enter into agreements to indemnify our directors, executive officers and other employees as determined by our board of directors. With specified exceptions, these agreements provide for indemnification for related expenses including, among other things, attorneys’ fees, judgments, fines and settlement amounts incurred by any of these individuals in any action or proceeding. We believe that these bylaw provisions and indemnification agreements are necessary to attract and retain qualified persons as directors and officers. We also maintain directors’ and officers’ liability insurance.

 

The limitation of liability and indemnification provisions in our amended and restated certificate of incorporation and amended and restated bylaws may discourage stockholders from bringing a lawsuit against our directors and officers for breach of their fiduciary duty. They may also reduce the likelihood of derivative litigation against our directors and officers, even though an action, if successful, might benefit us and other stockholders. Further, a stockholder’s investment may be adversely affected to the extent that we pay the costs of settlement and damage awards against directors and officers as required by these indemnification provisions. At present, there is no pending litigation or proceeding involving any of our directors, officers or employees for which indemnification is sought, and we are not aware of any threatened litigation that may result in claims for indemnification.

 

82


Table of Contents

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

 

Since January 1, 2003, we were or will be a party to the transactions described below in which:

 

    the amounts involved exceeded or will exceed $60,000; and

 

    a director, executive officer, holder of more than 5% of any class of our voting securities or any member of their immediate family had or will have a direct or indirect material interest.

 

Sales of Preferred Stock

 

We have issued and sold an aggregate of 60,503,650 shares of preferred stock to investors in the following rounds of financing (excluding shares of preferred stock issued upon exercise of preferred stock warrants):

 

    in May 2003 through August 2003, we sold an aggregate of 21,520,803 shares of Series D preferred stock at a price of approximately $0.697 per share;

 

    in May 2004 and June 2004, we sold an aggregate of 22,949,866 shares of Series E-1 preferred stock at a price of approximately $1.0915 per share; and

 

    in June 2004, we sold an aggregate of 16,032,982 shares of Series E-2 preferred stock in connection with the acquisition of the high-speed data BAS equipment division of ADC Telecommunications, Inc.

 

Upon completion of this offering, all of our outstanding shares of preferred stock will automatically convert into shares of common stock.

 

The following table summarizes the issuances of our preferred stock and Class B common stock since January 1, 2003 by our directors, executive officers, entities affiliated with such persons and holders of more than 5% of our outstanding common stock: