UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

Form 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007 OR

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

For the transition period from                    to                    

CAVIUM NETWORKS, INC.

DELAWARE		77-0558625
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

805 E. Middlefield Road Mountain View, California		94043
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (650) 623-7000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes     þ No     o

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

Large accelerated filer o                    Accelerated filer o                    Non-accelerated filer þ

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

The number of shares of the Registrant’s Common Stock, $.001 par value, outstanding at November 1, 2007 was: 39,720,223

 

 

CAVIUM NETWORKS, INC.

QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007

TABLE OF CONTENTS

				Page
		PART I. FINANCIAL INFORMATION
Item 1.		Condensed Consolidated Financial Statements		3
		Condensed Consolidated Balance Sheets at September 30, 2007 and December 31, 2006 (unaudited)		3
		Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited)		4
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (unaudited)		5
		Notes to Condensed Consolidated Financial Statements (unaudited)		6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		28
Item 4T.		Controls and Procedures		28
		PART II. OTHER INFORMATION
Item 1.		Legal Proceedings		29
Item 1A.		Risk Factors		29
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		41
Item 3.		Defaults upon Senior Securities		42
Item 4.		Submission of Matters to a Vote of Security Holders		42
Item 5.		Other Information		42
Item 6.		Exhibits		42
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

CAVIUM NETWORKS, INC.

		September 30,				December 31,
		2007				2006
Assets
Current assets:
Cash and cash equivalents		$	101,504			$	10,154
Accounts receivable, net of allowances of $108 and $102, respectively			7,762				7,248
Inventories			6,799				5,006
Prepaid expenses and other current assets			971				405
Total current assets			117,036				22,813
Property and equipment, net			5,890				5,040
Intangible assets, net			3,911				1,902
Other assets			156				207
Total assets		$	126,993			$	29,962
Liabilities, Mandatorily Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable		$	4,003			$	2,904
Accrued expenses and other current liabilities			2,330				2,853
Deferred revenue			2,585				628
Capital lease and technology license obligations, current portion			3,884				2,564
Preferred stock warrant liability			—				701
Notes payable, current portion			—				1,474
Total current liabilities			12,802				11,124
Notes payable, net of current portion			—				2,526
Capital lease and technology license obligations, net of current portion			800				1,016
Other non-current liabilities			—				39
Total liabilities			13,602				14,705
Commitments and contingencies (Note 12)
Mandatorily redeemable convertible preferred stock, par value $0.001:
22,935,158 and 22,935,158 shares authorized; none and 22,364,197 shares issued and outstanding; none and $69,623 aggregate liquidation preference			—				72,437
Stockholders’ equity (deficit)
Common stock, par value $0.001:
40,965,057 and 40,965,057 shares authorized; 39,661,706 and 9,365,600 shares issued and outstanding			40				9
Additional paid-in capital			174,050				3,731
Accumulated deficit			(60,699	)			(60,920	)
Total stockholders’ equity (deficit)			113,391				(57,180	)
Total liabilities, mandatorily redeemable convertible preferred stock and stockholders’ equity (deficit)		$	126,993			$	29,962

          The accompanying notes are an integral part of these condensed consolidated financial statements (unaudited).

CAVIUM NETWORKS, INC.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Revenue		$	14,165			$	9,187			$	37,972			$	24,335
Cost of revenue			5,207				3,878				14,087				9,635
Gross profit			8,958				5,309				23,885				14,700
Operating expenses:
Research and development			4,796				4,224				13,843				14,283
Sales, general and administrative			3,976				2,594				10,667				7,547
Total operating expenses			8,772				6,818				24,510				21,830
Income (loss) from operations			186				(1,509	)			(625	)			(7,130	)
Other income (expense), net:
Interest expense			(73	)			(271	)			(572	)			(555	)
Warrant revaluation expense			—				(13	)			(574	)			(316	)
Interest income and other			1,307				117				2,193				234
Total other income (expense), net			1,234				(167	)			1,047				(637	)
Income (loss) before income tax expense			1,420				(1,676	)			422				(7,767	)
Income tax expense			(110	)			—				(201	)			(2	)
Net income (loss)		$	1,310			$	(1,676	)		$	221			$	(7,769	)
Net income (loss) per common share, basic		$	0.03			$	(0.21	)		$	0.01			$	(0.97	)
Shares used in computing basic net income (loss) per common share			39,046				8,156				25,498				7,972
Net income (loss) per common share, diluted		$	0.03			$	(0.21	)		$	0.01			$	(0.97	)
Shares used in computing diluted net income (loss) per common share			42,737				8,156				28,786				7,972

          The accompanying notes are an integral part of these condensed consolidated financial statements (unaudited).

CAVIUM NETWORKS, INC.

		Nine Months Ended
		September 30,
		2007				2006
Cash flows from operating activities
Net income (loss)		$	221			$	(7,769	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Stock-based compensation expense			1,302				494
Amortization of warrant costs to interest expense			149				124
Revaluation of warrants to fair value			574				316
Depreciation and amortization			4,285				3,603
Other			—				10
Changes in assets and liabilities
Accounts receivable, net			(513	)			(919	)
Inventories			(1,790	)			(2,399	)
Prepaid expenses and other current assets			(170	)			(142	)
Other assets			(176	)			(31	)
Accounts payable			935				872
Accrued expenses and other current and non-current liabilities			(520	)			(64	)
Deferred revenue			1,957				615
Net cash provided by (used in) operating activities			6,254				(5,290	)
Cash flows used in investing activities
Purchases of property and equipment			(2,713	)			(1,267	)
Purchases of IP licenses and intangible assets			(369	)			—
Net cash used in investing activities			(3,082	)			(1,267	)
Cash flows provided by financing activities
Proceeds from term loan financing			—				4,000
Repayment of term loan financing			(4,000	)			—
Proceeds from issuance of convertible preferred stock, net of issuance cost			—				8,658
Proceeds from initial public offering, net of costs			97,458				—
Payments of initial public offering costs			(2,740	)			—
Proceeds from issuance of common stock upon exercise of options			177				1,124
Principal payment of capital lease and technology license obligations			(2,707	)			(2,299	)
Repurchases of shares of unvested common stock			(10	)			(18	)
Proceeds from issuance of convertible preferred stock in connection with warrant exercise			—				775
Net cash provided by financing activities			88,178				12,240
Net increase in cash and cash equivalents			91,350				5,683
Cash and cash equivalents, beginning of period			10,154				7,879
Cash and cash equivalents, end of period		$	101,504			$	13,562
Supplemental disclosure of cash flow information
Cash paid for interest		$	422			$	431
Income tax paid		$	469			$	2
Supplemental disclosure of non-cash activities
Capital lease and technology license obligations		$	3,342			$	2,908
Vesting of early exercised options		$	88			$	108
Additions to property and equipment included in accounts payable and accrued expenses		$	389			$	758
Net exercise of common stock warrant		$	249				—
Conversion of mandatorily redeemable convertible preferred stock to common stock		$	72,437				—

          The accompanying notes are an integral part of these condensed consolidated financial statements (unaudited).

CAVIUM NETWORKS, INC.

1. Organization and Significant Accounting Policies

Organization

     Cavium Networks, Inc. (the “Company”) was incorporated in the State of California on November 21, 2000 and was reincorporated in the State of Delaware effective February 6, 2007. The Company designs, develops and markets semiconductor processors for intelligent and secure networks.

Initial Public Offering

     In May 2007, the Company completed its initial public offering (“IPO”) of common stock in which it sold and issued 7,762,500 shares of common stock, including 1,012,500 shares of underwriters’ over-allotment, at an issue price of $13.50 per share. A total of $104.8 million in gross proceeds was raised from the IPO, or approximately $94.8 million in net proceeds after deducting underwriting discounts and commissions of $7.3 million and other offering costs of $2.7 million. Upon the closing of the IPO, all shares of convertible preferred stock outstanding automatically converted into 22,364,378 shares of common stock, and 102,619 warrants to purchase mandatorily redeemable convertible preferred stock were converted into warrants to purchase common stock.

Summary of Significant Accounting Policies

Basis of Presentation

     The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 10 of SEC Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, these financial statements should be read in conjunction with the Company’s Registration Statement on Form S-1 (File No.333-140660) on file with the SEC for the years ended December 31, 2005 and 2006.

     The unaudited condensed consolidated financial statements contain all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly the Company’s consolidated financial position at September 30, 2007, and the consolidated results of its operations for the three and nine months ended September 30, 2007 and 2006, and the consolidated cash flows for the nine months ended September 30, 2007 and 2006. The results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the full year.

Use of Estimates

     The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in its consolidated financial statements and accompanying notes. Management bases its estimates on historical experiences and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of the assets and liabilities. Actual results could differ from those estimates.

Cash & Cash Equivalents

     The Company considers all highly liquid investments with an original or remaining maturity of 90 days or less at the date of purchase to be cash equivalents. Cash equivalents consist primarily of money market instruments.

Allowance for Doubtful Accounts

     The Company reviews its allowance for doubtful accounts quarterly by assessing individual accounts receivable over a specific age and amount, and all other balances on a pooled basis based on historical collection experience and economic risk assessment. The Company’s allowance for doubtful accounts was $43,000 and $68,000 as of September 30, 2007 and December 31, 2006 respectively.

Inventories

     Inventories consist of work-in-process and finished goods. Inventories are stated at the lower of cost (determined using the first-in, first-out method), or market value (estimated net realizable value). The Company writes down inventory by establishing inventory reserves based on historical usage and forecasted demand. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand and such differences may have a material effect on recorded inventory values. Inventory reserves, once established, are not released until the related inventories have been sold, scrapped or otherwise disposed of.

Property and Equipment

     Property and equipment are stated at cost and depreciated over their estimated useful lives, generally three to five years, using the straight-line method. Leasehold improvements are amortized over the shorter of estimated useful lives or unexpired lease term. Additions and improvements that increase the value or extend the life of an asset are capitalized. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to income. Repairs and maintenance costs are expensed as incurred.

		Estimated
		Useful Lives
Software and computer equipment		1 to 5 years
Test equipment		1 to 3 years
Furniture, office equipment and leasehold improvements		1 to 5 years

     The Company capitalizes the cost of fabrication masks that are reasonably expected to be used during production manufacturing. Such amounts are included within property and equipment and depreciated to cost of revenue over a period of twelve months. If the Company does not reasonably expect to use the fabrication mask during production manufacturing, the related mask costs are expensed to research and development in the period in which the costs are incurred. The Company has capitalized $106,000 and $539,000 for the three months ended September 30, 2007 and 2006, respectively, and $1,837,000 and $539,000 mask costs in property and equipment for the nine months ended September 30, 2007 and 2006, respectively.

Impairment of Long-Lived Assets

     The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount.

Fair Value of Financial Instruments

     The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses and liabilities, approximate their fair values due to their short-term nature.

Concentration of Risk

     The Company’s products are currently manufactured, assembled and tested by third-party contractors in Asia. There are no long-term agreements with any of these contractors. A significant disruption in the operations of one or more of these contractors would impact the production of the Company’s products for a substantial period of time, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

     Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents and accounts receivable. The Company deposits cash and cash equivalents with credit worthy financial institutions. The Company has not experienced any losses on its deposits of cash and cash equivalents. Management believes that the financial institutions are reputable and, accordingly, minimal credit risk exists.

     The Company’s accounts receivable are derived from revenue earned from customers primarily headquartered in the United States. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers. The Company provides an allowance for doubtful accounts receivable based upon the expected collectibility of accounts receivable. Summarized below are individual customers whose accounts receivable balances or revenues were 10% or higher of respective total consolidated amounts.

		For the three months								For the nine months
		ended September 30,								ended September 30,
		2007				2006				2007				2006
Percentage of total revenue
Customer A			24	%			18	%			24	%			16	%
Customer B			18	%			19	%			19	%			21	%
All other customers			58	%			63	%			57	%			63	%
Total			100	%			100	%			100	%			100	%

		As of September 30, 2007				As of December 31, 2006
Percentage of gross accounts receivable
Customer E			12	%			23	%
All other customers			88	%			77	%
Total			100	%			100	%

Intangible Assets

     Prepaid technology licenses and acquired technologies, which include technologies acquired from other companies either as a result of acquisitions or licensing, are capitalized and amortized on the straight-line method over the estimated useful life of the technologies, which generally do not exceed three years. Technology license obligations payable in installments are capitalized using the present value of the payments.

Revenue Recognition

     The Company derives its revenue primarily from sales of semiconductor products. The Company recognizes revenue from product sales when persuasive evidence of a binding arrangement exists, delivery has occurred, the fee is deemed fixed or determinable and free of contingencies and significant uncertainties, and collection is probable. The fee is considered fixed or determinable at the execution of an agreement, based on specific products and quantities to be delivered at specified prices, which is often memorialized with a customer purchase order. Agreements with non-distributor customers do not include rights of return or acceptance provisions. The Company assesses the ability to collect from the Company’s customers based on a number of factors, including credit worthiness and any past transaction history of the customer. If the customer is not deemed credit worthy, or the fee is not considered fixed or determinable, the Company will defer all revenue from the arrangement until payment is received and all other revenue recognition criteria is met.

     Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue. The Company generally recognizes revenue at the time of shipment to the Company’s customers. Revenue consists primarily of sales of the Company’s products to networking original equipment manufacturers (“OEM”), their contract manufacturers or distributors. Initial sales of the Company’s products for a new design are usually made directly to networking OEMs as they design and develop their product. Once their design enters production, they often outsource their manufacturing to contract manufacturers that purchase the Company’s products directly from the Company or from the Company’s distributors.

     Revenue is recognized upon shipment for sales to distributors with limited rights of returns and price protection if the Company concludes it can reasonably estimate the credits for returns and price adjustments issuable. The Company records an estimated allowance, at the time of shipment, based on the Company’s historical patterns of returns and pricing credits of sales recognized upon shipment. The credits issued to distributors or other customers were not material for the three or nine months ended September 30, 2007 and 2006.

     Revenue and costs relating to sales to distributors are deferred if the Company grants more than limited rights of returns and price credits or if it cannot reasonably estimate the level of returns and credits issuable. During the quarter ended June 30, 2007, the Company signed a distribution agreement with Avnet, Inc.(“Avnet”) to distribute the Company’s products primarily in the United States. Given the terms of the distribution agreement, for sales to Avnet revenue and costs will be deferred until products are sold by Avnet to their end customers. For the third quarter ended September 30, 2007, less than 1% of the Company’s net revenues were from products sold by Avnet. Revenue recognition depends on notification from the distributor that product has been sold to Avnet’s end customers. Avnet reports to the Company, on at least a monthly basis, the product resale price, quantity and end customer shipment information,

as well as inventory on hand. Reported distributor inventory on hand is reconciled monthly to deferred revenue balances. The Company maintains system controls to validate distributor data and verify that the reported information is accurate. Deferred income on shipments to Avnet is included in deferred revenue and reflects the effects of any distributor price adjustments and the amount of gross margin expected to be realized when Avnet sells those products to their customers. Accounts receivable from Avnet is recognized and inventory is relieved when title to inventories transfers, which typically takes place at the time of shipment, which is the point in time at which the Company has a legal enforceable right to collection under normal payment terms.

     The Company also derives revenue in the form of license and maintenance fees through licensing its software products. Revenue from such arrangements is recorded by applying the provisions of Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Modification of SOP No. 97-2, Software Revenue Recognition with Respect to Certain Transactions. Revenue from such arrangements totaled $197,000 and $168,000 for the three months ended September 30, 2007 and 2006, and $780,000 and $542,000 for the nine months ended September 30, 2007 and 2006, respectively. The value of any support services is recognized as services revenue on a straight-line basis over the term of the related support period, which is typically one year.

     The Company also enters into development agreements with some of its customers. Development revenue is recognized under the proportional performance method, with the associated costs included in cost of revenue. The Company estimates the proportional performance of the development contracts based on an analysis of progress toward completion. The Company periodically evaluates the actual status of each project to ensure that the estimates to complete each contract remain accurate. A provision for estimated losses on contracts is made in the period in which the loss becomes probable and can be reasonably estimated. To date, the Company has not recorded any such losses. If the amount billed exceeds the amount of revenue recognized, the excess amount is recorded as deferred revenue. Revenue recognized in any period is dependent on progress toward completion of projects in progress. To the extent the Company is unable to estimate the proportional performance then the revenue is recognized on a completed contract basis.

     Total deferred revenue was $2,585,000 and $628,000 as of September 30, 2007 and December 31, 2006, respectively, which includes deferred revenue associated with license and maintenance fees and development revenue.

Warranty Accrual

     The Company’s products are subject to a one-year warranty period. The Company provides for the estimated future costs of replacement upon shipment of the product as cost of revenue. The warranty accrual is estimated based on historical claims compared to historical revenue and assumes that products have to be replaced subject to a claim. The following table presents a reconciliation of the Company’s product warranty liability, which is included within accrued expenses and other current liabilities in the consolidated balance sheets:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Beginning balance		$	183			$	135			$	161			$	106
Accruals for warranties issued			113				26				211				91
Settlements made			(32	)			(22	)			(108	)			(58	)
Ending balance		$	264			$	139			$	264			$	139

Indemnities

     In the ordinary course of business the Company enters into agreements with customers that include indemnity provisions. Based on historical experience and other available information the Company believes its exposure related to the above indemnity provisions were immaterial for each of the periods presented.

Research and Development

     Research and development costs are expensed as incurred and primarily include personnel costs, prototype expenses, which include the cost of fabrication mask costs not reasonably expected to be used in production manufacturing, and allocated facilities costs as well as depreciation of equipment used in research and development.

Advertising

     The Company expenses advertising costs as incurred. Advertising costs were $53,000 and $39,000 for the three months ended September 30, 2007 and 2006, respectively, and $296,000 and $189,000 for the nine months ended September 30, 2007 and 2006, respectively.

Operating Leases

     The Company recognizes rent expense on a straight-line basis over the term of the lease. The difference between rent expense and rent paid is recorded as accrued rent in accrued expenses and other current and non-current liabilities components of the consolidated balance sheets.

Income Taxes

     The Company provides for deferred income taxes under the asset and liability method. Under this method, deferred tax assets, including those related to tax loss carryforwards and credits, and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is recorded to reduce deferred tax assets when it is more likely than not that the net deferred tax asset will not be recovered.

Accounting for Stock-Based Compensation

     Prior to January 1, 2006, the Company 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 25, and Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25, and had adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS 123, and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. In accordance with APB 25, the Company recognized no stock-based compensation expense for options granted to employees with an exercise price equal to or greater than the fair value of the underlying common stock on the date of grant.

     Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R) using the prospective transition method, which requires it to apply the provisions of SFAS 123(R) only to awards granted, modified, repurchased or cancelled after the adoption date. Under this transition method, the Company’s stock-based compensation expense recognized during the year-ended December 31, 2006 is based on the grant date fair value of stock option awards the Company grants or modifies on or after January 1, 2006. The Company recognizes this expense on a straight-line basis over the options’ vesting periods. The Company estimates the grant date fair value of stock option awards under the provisions of SFAS 123(R) using the Black-Scholes option valuation model, which requires, among other inputs, an estimate of the Company’s fair value of the underlying common stock on the date of grant.

     For the three months ended September 30, 2007 and 2006, the Company recorded stock-based compensation expense of $525,000 and $226,000, respectively. For the nine months ended September 30, 2007 and 2006, the Company recorded stock-based compensation expense of $1,302,000 and $494,000, respectively. In future periods, stock-based compensation expense may increase as the Company issues additional stock-based awards to continue to attract and retain key employees. SFAS 123(R) also requires that the Company recognize stock-based compensation expense only for the portion of stock options that are expected to vest, based on the Company’s estimated forfeiture rate. If the actual number of future forfeitures differs from that estimated by management, the Company may be required to record adjustments to stock-based compensation expense in future periods.

     The Company accounts for stock-based compensation arrangements with non-employees in accordance with SFAS 123 and Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, using a fair value approach. The fair value of the stock options granted to non-employees was estimated using the Black-Scholes option valuation model. This model utilizes the estimated fair value of the Company’s common stock, the contractual term of the option, the expected volatility of the price of the Company’s common stock, risk-free interest rates and the expected dividend yields of the Company’s common stock. Stock-based compensation expense related to non-employees was $19,000 and $11,000 for the three months ended September 30, 2007 and 2006, respectively. Stock-based compensation expense related to non-employees was $101,000 and $65,000 for the nine months ended September 30, 2007 and 2006, respectively.

     The following are the stock-based compensation expense included in the consolidated statement of operations for each of the periods presented:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
						(in thousands)
Cost of revenue		$	16			$	3			$	36			$	6
Research and development			222				122				537				263
Sales, general and administrative			287				101				729				225
		$	525			$	226			$	1,302			$	494

Other Comprehensive Income (Loss)

     Comprehensive income (loss) includes all changes in equity that are not the result of transactions with stockholders. For the three months and nine months ended September 30, 2007 and 2006, there are no components of comprehensive income (loss) which are excluded from the net income (loss) and, therefore, no separate statement of comprehensive income (loss) has been presented.

Recent Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). The purpose of SFAS No. 157 is to define fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The Company is required to adopt the provision of SFAS No. 157 beginning with its the first quarter of 2008. The Company is currently evaluating what impact, if any, SFAS No. 157 will have on its consolidated financial position, results of operations and cash flow.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure eligible financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is required to adopt the provisions of SFAS No. 159 beginning with its first quarter of 2008. The Company is currently evaluating what impact, if any, SFAS No. 159 will have on its consolidated financial position, results of operations and cash flows.

2. Net Income (Loss) Per Common Share

     We calculate net income (loss) per share in accordance with SFAS No. 128 (“SFAS 128”), Earnings Per Share. Under SFAS 128, basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period (excluding shares subject to repurchase). Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common and common equivalent shares outstanding during the period. Potentially dilutive securities, composed of incremental common shares issuable upon the exercise of stock options and common stock subject to repurchase, are included in diluted net income per share for the three and nine months ended September 30, 2007.

     The following table sets forth the computation of income (loss) per share:

		Three Months Ended								Nine Months Ended
(in thousands, except per share data)	September 30,									September 30,
		2007				2006				2007				2006
Net income (loss)		$	1,310			$	(1,676	)		$	221			$	(7,769	)
Weighted average common shares outstanding — basic			39,046				8,156				25,498				7,972
Dilutive effect of employee stock plans			3,691				—				3,288				—
Weighted average common shares outstanding — diluted			42,737				8,156				28,786				7,972
Basic net income (loss) per share		$	0.03			$	(0.21	)		$	0.01			$	(0.97	)
Diluted net income (loss) per share		$	0.03			$	(0.21	)		$	0.01			$	(0.97	)

     The following weighted average outstanding options, common stock subject to repurchase and convertible preferred stock were excluded from the computation of diluted net income (loss) per common share for the periods presented because including them would have had an antidilutive effect:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands)		2007				2006				2007				2006
Options to purchase common stock and common stock subject to repurchase			605				3,466				724				2,929
Convertible preferred stock (as converted basis)			—				21,714				—				21,305
Convertible stock warrants (as converted basis)			—				313				—				313
Common stock warrants			65				—				65				—

3. Inventories

     Inventories are stated at the lower of cost (determined using the first-in, first-out method), or market value (estimated net realizable value) and are comprised of the following:

		As of				As of
		September 30, 2007				December 31, 2006
		(in thousands)
Work-in-process		$	5,967			$	2,069
Finished goods			832				2,937
		$	6,799			$	5,006

4. Property and Equipment, net

     Property and equipment, net, consisted of the following:

		As of				As of
		September 30, 2007				December 31, 2006
		(in thousands)
Test equipment		$	3,575			$	1,418
Software and computer equipment			8,966				7,178
Furniture, office equipment and leasehold improvements			57				40
			12,598				8,636
Less: accumulated depreciation and amortization			(6,708	)			(3,596	)
		$	5,890			$	5,040

     Depreciation and amortization expense were $1,278,000 and $635,000 for the three months ended September 30, 2007 and 2006, respectively, and $3,112,000 and $1,505,000 for the nine months ended September 30, 2007 and 2006, respectively.

     Assets recorded under capital leases included in property and equipment were $4,482,000 and $3,623,000 at September 30, 2007 and December 31, 2006, respectively. Amortization expense related to assets recorded under capital lease was $396,000 and $315,000 for three months ended September 30, 2007 and 2006, respectively, and $1,026,000 and $718,000 for the nine months ended September 30, 2007 and 2006, respectively.

5. Intangible Assets, net

     Intangible assets, net, consisted of the following:

		As of				As of
		September 30, 2007				December 31, 2006
		(in thousands)
Developed technology		$	3,343			$	3,343
Technology license			8,726				5,544
			12,069				8,887
Less: accumulated depreciation & amortization			(8,158	)			(6,985	)
		$	3,911			$	1,902

     Amortization expense was $364,000 and $699,000 for the three months ended September 30, 2007 and 2006, respectively, and $1,173,000 and $2,097,000 for the nine months ended September 30, 2007 and 2006, respectively. Amortization expense decreased in the first three and nine months in 2007 compared to 2006 due to the completion of amortization of one of the capitalized licenses in 2006.

6. Accrued Expenses and Other Current Liabilities

		As of				As of
		September 30, 2007				December 31, 2006
		(in thousands)
Accrued compensation and related benefit		$	913			$	851
Accrued warranty			264				161
Refundable deposits related to unvested employee stock option exercises			92				173
Professional fees			427				583
Income tax payable			291				558
Other			343				527
		$	2,330			$	2,853

7. Notes Payable

     In October 2005, the Company entered into a loan and security agreement with Silicon Valley Bank to provide a revolving line of credit for $6.0 million collateralized by eligible receivables and all of the Company’s other assets except intellectual property. Borrowings under the revolving line of credit bear interest at the bank’s prime rate plus an applicable margin based on certain financial ratios of the Company at the borrowing date. The applicable rate of interest under the revolving line of credit was 10.5% as of December 31, 2006. On January 25, 2007, the Company entered into a loan modification agreement that extended the term of the existing revolving line of credit through July 4, 2008.

     In October 2005, the Company also entered into a term loan and security agreement (the “October 6, 2005 Term Loan and Security Agreement”) with Silicon Valley Bank and Gold Hill Venture Lending that provided a $4.0 million term loan line of credit. The credit line was secured by all of the Company’s other assets except intellectual property. Upon entering into the October 6, 2005 Term Loan and Security Agreement, the Company issued warrants to purchase a total of 27,500 shares of Series D convertible preferred stock at a price of $6.58 per share.

     In June 2006, the Company borrowed $4.0 million against the October 6, 2005 Term Loan and Security Agreement line of credit. Concurrently, the Company issued additional warrants to purchase 27,500 shares of Series D convertible preferred stock at a price of $6.58 per share. On October 24, 2006 the Company entered into the First Amendment to October 6, 2005 Term Loan and Security Agreement. The term loan carried a fixed interest rate of 10.5% as of December 31, 2006 and $4.0 million was outstanding under this term loan. The Company repaid the term loan on May 3, 2007 subsequent to the IPO.

     All warrants to purchase Series D convertible preferred stock were converted to warrants to purchase common stock as detailed in the Warrant section below.

8. Mandatorily Redeemable Convertible Preferred Stock and Stockholders’ Deficit

     Mandatorily Redeemable Convertible Preferred Stock

     At the closing of the IPO in May 2007, all outstanding mandatorily redeemable convertible preferred stock converted to common stock. The following table sets forth the information about the mandatorily redeemable convertible preferred stock:

		As of September 30,				As of December 31,
		2007				2006
		(in thousands, except share data)
Mandatorily redeemable convertible preferred stock, par value $0.001
Series A: 4,349,995 shares authorized; 4,349,989 shares issued and outstanding at December 31, 2006 and none was issued and outstanding at September 30, 2007; none and $7,830 liquidation preference		$	—			$	7,773
Series B: 7,612,431 shares authorized; 7,564,448 shares issued and outstanding at December 31, 2006 and none was issued and outstanding at September 30, 2007; none and $15,885 liquidation preference			—				16,534
Series C: 6,206,897 shares authorized; 6,206,892 shares issued and outstanding at December 31, 2006 and none was issued and outstanding at September 30, 2007; none and $18,000 liquidation preference			—				17,973
Series D: 4,765,835 shares authorized at December 31, 2006; 4,242,866 shares issued and outstanding at December 31, 2006 and none was issued and outstanding as of September 30, 2007; none and $27,908 liquidation preference			—				30,157
Total mandatorily redeemable convertible preferred stock		$	—			$	72,437

     Warrants

     Pursuant to the amendment with Silicon Valley Bank and Gold Hill Venture Lending, and upon closing of the company’s IPO in May 2007, all of the outstanding warrants to purchase mandatorily redeemable convertible preferred stock converted to warrants to purchase common stock. The following table sets forth the warrant liability that was reclassified to additional paid-in-capital.

Number

Estimated Fair

Series of

of Shares

Value Reclassified to

Convertible

Subject to

Exercise

Additional Paid-in-capital

Expiration

Preferred Stock

Warrants

Issue Date

Price

Upon IPO

Date

B

47,619

November 1, 2002

$

2.10

$

568,000

October 31, 2012

D

27,500

October 6, 2005

6.58

352,000

October 5, 2015

D

27,500

June 19, 2006

6.58

352,000

October 5, 2015

102,619

$

1,272,000

     On May 1, 2007, the Company signed an amendment with Silicon Valley Bank who held warrants to purchase 47,619 shares of Series B preferred stock and 17,187 shares of Series D preferred stock to convert the warrants to common stock warrant. As a result, the fair value of the warrants at the time of the conversion was $745,000. The remaining warrants to purchase Series D preferred stock were automatically converted to common stock warrants at the closing of the IPO on May 7, 2007. The fair value of the warrants at the conversion was $527,000.

     On July 12, 2007, the Company issued an aggregate of 28,239 shares of common stock to Gold Hill Venture Lending pursuant to the net exercise provisions of common stock warrant to purchase 37,813 shares of common stock at an exercise price of $6.58 per share. No cash was paid to the Company for such issuance of the common stock.

Common Stock

     In May 2007, the Company completed its IPO in which the Company sold and issued 7,762,500 shares of common stock, including 1,012,500 shares of the underwriters’ over-allotment, at an issue price of $13.50 per share. The Company received gross proceeds of $104.8 million from the IPO, or approximately $94.8 million in net proceeds after deducting underwriting discounts and commissions of $7.3 million and other offering costs of $2.7 million. Upon the closing of the IPO, all shares of mandatorily redeemable convertible preferred stock outstanding automatically converted into 22,364,378 shares of common stock. As of September 30, 2007 the Company had the following common stock outstanding:

Common stock outstanding at December 31, 2006			9,365,600
Common stock issued in IPO			7,762,500
Conversion of mandatorily redeemable convertible preferred stock to common stock			22,364,378
Common stock issued in connection with exercises of stock options			155,574
Common stock issued in connection with the common stock warrant exercises			28,239
Repurchases of shares of unvested common stock			(14,585	)
Common stock outstanding at September 30, 2007			39,661,706

Stock Options and Unvested Common Stock

     Upon completion of its IPO in May 2007, the Company adopted the 2007 Stock Incentive Plan (the “Plan”), which reserved 5,000,000 shares of the Company’s common stock. The Plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, performance stock awards, and other forms of equity compensation (collectively, “stock awards”), and performance cash awards, all of which may be granted to employees (including officers), directors, and consultants or affiliates. As of September 30, 2007, 114,700 shares have been granted under the Plan.

     Under the Company’s 2001 Stock Incentive Plan (“2001 plan”), certain employees and directors have the right to early-exercise unvested stock options, subject to rights held by the Company to repurchase unvested shares in the event of voluntary or involuntary termination. For options granted prior to March 2005, the Company has the right to repurchase any such shares at the shares’ original purchase price. For options granted after March 2005, the Company has the right to repurchase such shares at the lower of market value or the original purchase price.

     For those options granted prior to March 2005, in accordance with EITF 00-23, Working Group Work Plan Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25, Accounting for Stock Issued to Employees, and FASB Interpretation No. 44 Accounting for Certain Transactions involving Stock Compensation, the Company accounts for cash received in consideration for the early-exercise of unvested stock options as a current liability, included as a component of accrued liabilities in the Company’s consolidated balance sheets. For those shares issued in connection with options granted prior to March 2005, there were 169,595 and 377,030 unvested shares outstanding as of September 30, 2007 and December 31, 2006, respectively, and $92,000 and $173,000 related liabilities, respectively.

     Detail related to activity of unvested shares of common stock is as follows:

						Weighted-
						Average
		Number of				Exercise/
		Unvested Shares				Purchase
		Outstanding				Price
Balance as of December 31, 2006			872,210			$	1.63
Issued			68,180				5.50
Vested			(149,885	)			1.23
Forfeited			(14,585	)			0.71
Balance as of March 31, 2007			775,920				2.06
Issued			12,217				6.45
Vested			(133,769	)			1.11
Forfeited			—				—
Balance as of June 30, 2007			654,368				2.34
Issued			—				—
Vested			(118,288	)			2.38
Forfeited			—				—
Balance as of September 30, 2007			536,080				2.33

     Detail related to stock option activity is as follows:

		Number of				Weighted Average
		Shares				Exercise Price per
		Outstanding				Share
Balance at December 31, 2006			4,221,404			$	2.05
Options granted			361,375				8.52
Options exercised			(92,578	)			4.58
Options forfeited			(75,504	)			4.62
Balance as of March 31, 2007			4,414,697				2.48
Options granted			—				—
Options exercised			(62,865	)			1.92
Options cancelled			(17,195	)			1.51
Balance as of June 30, 2007			4,334,637				2.49
Options granted			114,700				27.53
Options exercised			(131	)			3.04
Options cancelled			(556	)			24.59
Balance as of September 30, 2007			4,448,650				3.13

     The total intrinsic value for options exercised for the three months ended September 30, 2007 and 2006 was $3,000 and $70,000, respectively, and for the nine months ended September 30, 2007 and 2006 was $1,157,000 and $525,000, respectively, representing the difference between the estimated fair value of the Company’s common stock at the date of exercise and the exercise price paid.

     The following table summarizes information about stock options outstanding:

		Number
		Outstanding As of				Weighted Average				Weighted
		September 30,				Remaining				Average
Exercise Prices		2007				Contractual Term				Exercise Price
$0.19 to 0.20			208,122				5.24			$	0.20
0.30			587,555				6.84				0.30
0.80			11,000				7.21				0.80
1.02			1,149,575				7.84				1.02
1.50			65,750				8.21				1.50
3.04			1,696,434				8.47				3.04
3.74			93,500				8.70				3.74
5.42			150,000				9.16				5.42
5.52			65,500				8.91				5.52
8.52			307,014				9.49				8.52
27.00			85,200				9.79				27.00
28.46			14,750				9.96				28.46
29.74			14,250				9.89				29.74
$0.19-29.74			4,448,650				8.07				3.13
Exercisable			2,021,457								1.17
Vested and expected to vest			4,134,227								3.07

The fair value of each employee option grant for the three and nine months ended September 30, 2007 and 2006 under SFAS 123(R) was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions.

		For the Three Months				For the Nine Months
		Ended September 30,				Ended September 30,
		2007		2006		2007		2006
Risk-free interest rate		4.13%		5.12%		4.13-4.72%		4.36%--5.12%
Expected life		4 years		4 years		4 years		4 to 5 years
Dividend yield		None		None		None		None
Volatility		45%		50%		45-55%		50--60%

     The Company determined that it was not practical to calculate the volatility of its share price since the Company’s securities were not publicly traded prior to May 2, 2007 and therefore, there was no readily determinable market value for its stock; it had limited information on its own past volatility; and the Company is a high-growth technology company whose future operating results are not comparable to its prior operating results. Therefore, the Company estimated its expected volatility based on reported market value data for a group of publicly traded companies, which it selected from certain market indices, that the Company believed was relatively comparable to the Company after consideration of the market data group companies’ size, stage of life cycle, profitability, growth, and risk and return on investment. The Company used the average expected volatility rates reported by the comparable group for an expected term that approximated the expected term estimated by the Company, or a lesser period equal to the full history of the comparable company if less than the expected life.

     The estimated weighted-average grant date fair value of options granted for the three months ended September 30, 2007 and 2006 was $11.04 and $2.36, respectively, and the weighted-average grant date fair value of options granted for the nine months ended September 30, 2007 and 2006 was $7.16 and $2.00, respectively.

9. Current and Deferred Income Taxes

     For the three and nine months ended September 30, 2007 and 2006, the provision for income taxes was based on the estimated annual effective tax rate in compliance with SFAS 109 and other related guidance. The Company updates its estimate of its annual effective tax rate at the end of each quarterly period. The estimate takes into account estimations of annual pre-tax income, the geographic mix of pre-tax income and interpretations of tax laws and the possible outcomes of current and future audits.

     The following table presents the provision and benefit for income taxes and the effective tax rates for the three and nine months ended September 30, 2007 and 2006:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		(in thousands)								(in thousands)
		2007				2006				2007				2006
Income (loss) before income tax expense		$	1,420			$	(1,676	)		$	422			$	(7,767	)
Income tax expense			110				—				201				2
Effective tax rate			7.7	%			0	%			47.6	%			0	%

     The provision for income taxes for the three and nine months ended September 30, 2007 of $110,000 and $201,000, respectively, were related principally to the federal alternative minimum tax, international taxes and state income taxes. The difference between the provision for income that would be derived by applying the statutory rate to income before tax for the three months and nine months ended September 30, 2007 and the provision actually recorded was due to the impact of non-deductible SFAS 123R stock option compensation expenses and warrant expenses offset by the benefit from net operating loss carryforwards.

     The Company is in the process of expanding its international operations and staff to better support its expansion into international markets. This expansion includes the implementation of an international structure that includes, among other things, a research and development cost-sharing arrangement, certain licenses and other contractual arrangements between the Company and its wholly-owned domestic and foreign subsidiaries. The Company’s foreign subsidiaries have acquired certain rights to sell the existing intellectual property and intellectual property that will be developed or licensed in the future. The existing rights were transferred for an initial payment. As a result of these changes and an expanding customer base in Asia, the Company expects that an increasing percentage of its consolidated pre-tax income will be derived from, and reinvested in, its Asian operations. The Company anticipates that this pre-tax income will be subject to foreign tax at relatively lower tax rates when compared to the U.S. federal statutory tax rate and as a consequence, the Company’s effective income tax rate is expected to be lower than the U.S. federal statutory rate.

     The Company adopted FIN 48 on January 1, 2007. As a result of the adoption of FIN 48, the Company did not recognize any adjustment to the liability for uncertain tax positions and therefore did not record any adjustment to the beginning balance of retained earnings on the consolidated balance sheet. As of the date of adoption, the Company recorded a $3.1 million reduction to deferred tax assets for unrecognized tax benefits, all of which is currently offset by a full valuation allowance and therefore did not record any adjustment to the beginning balance of retained earnings on the balance sheet. As of January 1, 2007 and September 30, 2007, the Company had $3.0 million and $3.2 million, respectively of unrecognized tax benefits, which is netted against deferred tax assets and is fully offset by a valuation allowance. The unrecognized tax benefit increased by approximately $133,000.

     The Company files income tax returns in the U.S. federal jurisdiction, California and various state and foreign tax jurisdictions in which it has a subsidiary or branch operation. The United States federal corporation income tax returns beginning with the 2000 tax year remain subject to examination by the Internal Revenue Service (“IRS”). The California corporation income tax returns beginning with the 2000 tax year remain subject to examination by the California Franchise Tax Board. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, it did not have any accrued interest or penalties associated with any unrecognized tax benefits. Although timing of the resolution and/or closure on audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

10. Retirement Plan

     The Company has established a defined contribution savings plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. Company contributions to the plan may be made at the discretion of the board of directors. Through September 30, 2007, the Company has not made any contributions to the plan.

11. Segment Information

     SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company is organized as, and operates in, one reportable segment: the development and sale of semiconductor processor solutions for next-generation intelligent networking equipment. The chief operating decision-maker is the Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by information about revenue by customer and geographic region, for purposes of evaluating financial performance and allocating resources. The Company and its Chief Executive Officer evaluate performance based primarily on revenue to the customers and in the geographic locations in which the Company operates. Revenue is attributed by geographic location based on the bill-to location of customer. The Company’s assets are primarily located in the United States of America and not allocated to any specific region. Therefore, geographic information is presented only for total revenue. Substantially all of the Company’s long-lived assets are located in the United States of America.

     The following table is based on the geographic location of the OEMs or the distributors who purchased its products. For sales to the distributors, their geographic location may be different from the geographic locations of the ultimate end users. Sales by geography for the periods indicated were as follows:

		For the three months								For the nine months
		ended September 30,								ended September 30,
		2007				2006				2007				2006
						(In thousands)
United States		$	8,435			$	5,260			$	23,163			$	14,110
Taiwan			2,567				2,019				7,162				5,114
China			1,128				699				2,296				1,490
Japan			516				746				2,030				2,073
Other countries			1,519				463				3,321				1,548
Total		$	14,165			$	9,187			$	37,972			$	24,335

12. Commitments and Contingencies

     The Company leases its facilities under non-cancelable operating leases, which contain renewal options and escalation clauses, and expire May 2012. The Company also acquires certain assets under capital leases.

     Minimum commitments under non-cancelable capital and operating lease agreements as of September 30, 2007 were as follows:

		Capital lease and
		technology license				Purchase				Operating
		obligations				commitment				leases				Total
		(in thousands)
as of end of Q3 2007		$	1,740			$	695			$	271			$	2,706
2008			2,959				7,114				691				10,764
2009			231								93				324
2010											44				44
2011											44				44
Thereafter											24				24
			4,930			$	7,809			$	1,167			$	13,906
Less: Interest component			(246	)
Present value of minimum lease payment			4,684
Less: current portion			(3,884	)
Long-term portion of obligations		$	800

     Rent expense incurred under operating leases was $257,000 and $200,000 for the three months ended September 30, 2007 and 2006, respectively, and $721,000 and $576,000 for the nine months ended September 30, 2007 and 2006, respectively.

     The technology license obligations include future cash payments payable primarily for two license agreements with outside vendors. One of the license agreements is for electronic design automation software which is used in the design of the Company’s products. The second license agreement includes a non-exclusive, non-transferable right to develop multiple licensed MIPS cores that implement the MIPS architecture. This second license agreement requires the Company to pay $1.9 million after the completion of its IPO for an automatic two-year extension of the license. As of September 30, 2007, $400,000 was paid, and the balance is accrued within capital lease and technology license obligations on consolidated balance sheets.

     The Company has a purchase agreement with Synopsys to purchase certain intellectual property (“IP”) which is to be used for the Company’s future products. The Company has an agreement to pay $1.15 million over the two-year period for various IP, for which $336,000 has already been paid to purchase certain IP as of September 30, 2007.

     The Company is not currently a party to any legal proceedings that management believes would have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.

     Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Overview

     We are a provider of highly integrated semiconductor products that enable intelligent processing for networking, communications and security applications. We market and sell our products to providers of networking equipment that sell their products into the enterprise network, data center, broadband and consumer, and access and service provider markets. Our products are used in a broad array of networking equipment, including routers, switches, content-aware switches, unified threat management, or UTM and other security appliances, application-aware gateways, voice/video/data, or triple-play, gateways, wireless local area network, or WLAN and third-generation, or 3G access and aggregation devices, storage networking equipment, servers and intelligent network interface cards. We focus our resources on the design, sales and marketing of our products, and outsource the manufacturing of our products.

     From our incorporation in 2000 through 2003, we were primarily engaged in the design and development of our first processor family, NITROX, which we began shipping commercially in 2003. In 2004, we introduced and commenced commercial shipments of NITROX Soho. In 2006, we commenced our first commercial shipments of our OCTEON family of multi-core MIPS64 processors. We introduced a number of new products within all three of these product families in 2006. In 2007 we introduced our new line of OCTEON based Storage Services Processors designed to address the specific needs in the storage market, as well as other new products in the OCTEON and NITROX families. Since inception, we have invested heavily in new product development and achieved our first quarter of profitability during the quarter ended September 30, 2007. Our revenue has grown from approximately $7.4 million in 2004 to approximately $34.2 million in 2006 and approximately $38.0 million in the first nine months of 2007, driven primarily by demand in the enterprise network and data center markets. We expect sales of our products for use in the enterprise network and data center markets to continue to represent a substantial portion of our revenue in the foreseeable future. However, we expect sales into those market to decline as a percentage of overall sales as sales in the broadband and consumer and the access and service provider markets are expected to increase at a rate faster than the expected increase in sales into the enterprise network and data center markets.

     We primarily sell our products to OEMs, either directly or through their contract manufacturers. Contract manufacturers purchase our products only when an OEM incorporates our product into the OEM’s product, not as commercial off-the-shelf products. Our customers’ products are complex and require significant time to define, design and ramp to volume production. Accordingly, our sales cycle is long. This cycle begins with our technical marketing, sales and field application engineers engaging with our customers’ system designers and management, which is typically a multi-month process. If we are successful, a customer will decide to incorporate our product in its product, which we refer to as a design win. Because the sales cycles for our products are long, we incur expenses to develop and sell our products, regardless of whether we achieve the design win and well in advance of generating revenue, if any, from those expenditures. We do not have long-term purchase commitments from any of our customers, as sales of our products are generally made under individual purchase orders. However, once one of our products is incorporated into a customer’s design, it is likely to remain designed in for the life cycle of its product. We believe this to be the case because a redesign would generally be time consuming and expensive. We have experienced revenue growth due to an increase in the number of our products, an expansion of our customer base, an increase in the number of average design wins within any one customer and an increase in the average revenue per design win.

Key Business Metrics

     Design Wins. We closely monitor design wins by customer and end market on a periodic basis. We consider design wins to be a key ingredient in our future success, although the revenue generated by each design can vary significantly. Our long-term sales expectations are based on internal forecasts from specific customer design wins based upon the expected time to market for end customer products deploying our products and associated revenue potential.

     Pricing and Margins. Pricing and margins depend on the features of the products we provide to our customers. In general, products with more complex configurations and higher performance tend to be priced higher and have higher gross margins. These configurations tend to be used in high performance applications that are focused on the enterprise network, data center, and access and service provider markets. We tend to experience price decreases over the life cycle of our products, which can vary by market and application. In general, we experience less pricing volatility with customers that sell to the enterprise and data center markets.

     Sales Volume. A typical design win can generate a wide range of sales volumes for our products, depending on the end market demand for our customers’ products. This can depend on several factors, including the reputation, market penetration, the size of the end market that the product addresses, and the marketing and sales effectiveness of our customers. In general, our customers with greater market penetration and better branding tend to develop products that generate larger volumes over the product life cycle. In addition, some markets generate large volumes if the end market product is adopted by the mass market.

     Customer Product Life Cycle. We typically commence commercial shipments from nine months to three years following the design win. Once our product is in production, revenue from a particular customer may continue for several years. We estimate our customers’ product life cycles based on the customer, type of product and end market. In general, products that go into the enterprise network and data center take longer to reach volume production but tend to have longer lives. Products for other markets, such as broadband and consumer, tend to ramp relatively quickly, but generally have shorter life cycles. We estimate these life cycles based on our management’s experience with providers of networking equipment and the semiconductor market as a whole.

Results of Operations

Three and Nine Months Ended September 30, 2007 and 2006

     Revenue. Our revenue consists primarily of sales of our semiconductor products to providers of networking equipment and their contract manufacturers and through distributors. Initial sales of our products for a new design are usually made directly to providers of networking equipment as they design and develop their product. Once their design enters production, they often outsource their manufacturing to contract manufacturers that purchase our products directly from us or from our distributors. We price our products based on market and competitive conditions and periodically reduce the price of our products, as market and competitive conditions change, and as manufacturing costs are reduced. We do not experience different margins on direct sales to providers of networking equipment and indirect sales through contract manufacturers because in all cases we negotiate product pricing directly with the providers of networking equipment. To date, all of our revenue has been denominated in U.S. dollars.

     We also derive revenue in the form of license and maintenance fees through licensing our software products which help our customers build products around our systems-on-a-chip, or SoCs in a more time and cost efficient manner. Revenue from such arrangements totaled $197,000 and $168,000 for the three months ended September 30, 2007 and 2006, respectively, and $780,000 and $542,000 for the nine months ended September 30, 2007 and 2006, respectively.

     Our customers representing greater than 10% of revenue for each of the periods were:

		For the three months								For the nine months
		ended September 30,								ended September 30,
		2007				2006				2007				2006
Percentage of total revenue
Cisco			24	%			18	%			24	%			16	%
F5 Networks			18	%			19	%			19	%			21	%
All other customers			58	%			63	%			57	%			63	%
Total			100	%			100	%			100	%			100	%

The increase in percentage of revenue from Cisco is due to the increased sales for existing design wins that went into production during the respective periods.

     Our distributors are used primarily to support international sale logistics in Asia, including importation and credit management. Total revenue through distributors with limited rights of returns and price protection was $3.0 million and $3.0 million for the three months ended September 30, 2007 and 2006, respectively, which accounted for 21.2% and 32.3% of revenue, respectively, and $8.7 million and $7.9 million for the nine months ended September 30, 2007 and 2006, respectively, which accounted for 22.9% and 32.2% of revenue, respectively. While we have purchase agreements with our distributors, the distributors do not have long-term contracts with any of the equipment providers. Our distributor agreements limit the distributor’s ability to return product up to a portion of purchases in the preceding quarter. Given our experience, along with our distributors’ limited contractual return rights, we believe we can reasonably estimate expected returns from our distributors. Accordingly, we recognize sales to distributors at the time of shipment, reduced by our estimate of expected returns.

     Revenue and costs relating to sales to distributors are deferred if we grant more than limited rights of returns and price credits or if we cannot reasonably estimate the level of returns and credits issuable. During the quarter ended June 30, 2007, we signed a distribution agreement with Avnet, Inc.(“Avnet”) to distribute our products primarily in the United States. Given the terms of the distribution agreement, for sales to Avnet, revenue and costs will be deferred until products are sold by Avnet to their end customers. For the third quarter of fiscal 2007, less than 1% of our net revenues were from products sold by Avnet. Revenue recognition depends on notification from Avnet that product has been sold to Avnet’s end customers.

     The following table is based on the geographic location of the original equipment manufacturers or the distributors who purchased our products. For sales to our distributors, their geographic location may be different from the geographic locations of the ultimate end customers. Revenue by geography for the periods indicated were:

		For the three months								For the nine months
		ended September 30,								ended September 30,
		2007				2006				2007				2006
		(In thousands)
United States		$	8,435			$	5,260			$	23,163			$	14,110
Taiwan			2,567				2,019				7,162				5,114
China			1,128				699				2,296				1,490
Japan			516				746				2,030				2,073
Other countries			1,519				463				3,321				1,548
Total		$	14,165			$	9,187			$	37,972			$	24,335

     Cost of Revenue and Gross Margin. We outsource wafer fabrication, assembly and test functions of our products. A significant portion of our cost of revenue consists of payments for the purchase of wafers and for assembly and test services. To a lesser extent, cost of revenue includes expenses relating to our internal operations that manage our contractors, the cost of shipping and logistics, royalties, inventory valuation charges taken for excess and obsolete inventories, warranty costs and changes in product cost due to changes in sort, assembly and test yields. In general, our cost of revenue associated with a particular product declines over time as a result of yield improvements, primarily associated with design and test enhancements.

     We use third-party foundries and assembly and test contractors, which are primarily located in Asia, to manufacture, assemble and test our semiconductor products. We purchase processed wafers on a per wafer basis from our fabrication suppliers, which are currently TSMC and UMC. We also outsource the sort, assembly, final testing and other processing of our product to third-party contractors, primarily ASE and ISE. We negotiate wafer fabrication on a purchase order basis and do not have long-term agreements with any of our third-party contractors. A significant disruption in the operations of one or more of these contractors would impact the production of our products which could have a material adverse effect on our business, financial condition and results of operations.

     Cost of revenue also includes amortized costs related to certain acquired technology assets in 2004 and 2005. In August 2004, we acquired certain assets of Brecis Communications Corporation, which included the purchase of its secure communication processor product line. We capitalized a total of $2.3 million of developed technology and are amortizing that amount on a straight-line basis over the expected useful life of three years. In April 2005, we acquired Menlo Logic, LLC, which included the purchase of technology used for secure communication. We capitalized a total of $1.1 million of developed technology and are amortizing that amount on a straight-line basis over the expected useful life of three years. The total estimated purchase price was allocated to tangible and identifiable intangible assets and liabilities assumed based on their estimated fair value. The total intangible assets amortization expense included in cost of revenue was $215,000 and $279,000 for the three months ended September 30, 2007 and 2006, and $772,000 and $836,000 for the nine months ended September 30, 2007 and 2006.

     In addition, we incur costs for the fabrication of masks used by our contract manufacturers to manufacture wafers that incorporate our products. The cost of fabrication mask sets increased due to our transition from a 130-nanometer to a 90-nanometer process in our next-generation products which began in 2007. During the three months ended September 30, 2007 and 2006, we capitalized $106,000

and $539,000 of mask costs, respectively. During the nine months ended September 30, 2007 and 2006, we capitalized $1,837,000 and $539,000 of mask costs, respectively. As our product processes continue to mature and as we develop more history and experience, we expect that, in the future, a greater percentage of mask costs will be used directly for production manufacturing and will be capitalized. We amortized the cost of fabrication masks that we reasonably expect to use for production manufacturing. We amortized those costs over a 12-month period and included them in cost of revenue. The balance of capitalized mask costs at September 30, 2007 was $1,065,000. As our products mature and there is increasing assurance that any particular product design will likely go into production, we anticipate that a larger percentage of our total mask costs will be capitalized and amortized to cost of revenue.

     Our revenue, cost of revenue, gross profit and gross margin for the three months and nine months ended September 30, 2007 and 2006 were:

		For the three months ended																For the nine months ended
		September 30,																September 30,
		2007				2006				change				% change				2007				2006				change				% change
		(In thousands)																				(In thousands)
Revenue		$	14,165			$	9,187			$	4,978				54.2	%		$	37,972			$	24,335			$	13,637				56.0	%
Cost of revenue			5,207				3,878				1,329				34.3	%			14,087				9,635				4,452				46.2	%
Gross Profit		$	8,958			$	5,309			$	3,649				68.7	%		$	23,885			$	14,700			$	9,185				62.5	%
Gross Margin			63.2	%			57.8	%			5.4	%							62.9	%			60.4	%			2.5	%

     Our gross margin has been and will continue to be affected by a variety of factors, including average sales prices of our products, the product mix, the timing of cost reductions for fabricated wafers and assembly and test service costs, inventory valuation charges and the timing and changes in sort, assembly and test yields. Overall product margin is impacted by the mix between higher performance, higher margin products and lower performance, lower margin products. In addition, we typically experience lower yields and higher associated costs on new products, which improve as production volumes increase.

     Three Months and Nine Months Ended September 30, 2007 Compared to the Three Months and Nine Months Ended September 30, 2006: Revenue. Our revenue was $14.2 million and $38.0 million in the three months and nine months ended September 30, 2007, respectively, as compared to $9.1 million and $24.3 million in the three months and nine month ended September 30, 2006, an increase of 54.2% and 56.0%, respectively. The majority of the increase is related to an increase in sales of $4.5 million and $12.2 million, respectively, in the three months and nine months ended September 30, 2007, to existing customers, which were primarily a result of design wins reaching commercial production. In the three months and nine months ended September 30, 2007 and 2006, a substantial majority of our sales were to customers that sell into the enterprise network and data center markets. In the three months and nine months ended September 30, 2007 we derived 21.2% and 22.7% of our revenue from indirect channels compared to 32.2% in both three months and nine months ended September 30, 2006.

     Three Months and Nine Months Ended September 30, 2007 Compared to the Three Months and Nine Months Ended September 30, 2006: Gross Margin. Gross margin increased 5.4 percentage points and 2.5 percentage points to 63.2 % and 62.9% in the three months and nine months ended September 30, 2007 from 57.8% and 60.4% in the three months and nine months ended September 30, 2006. The increase in gross margin in the three months and nine months ended September 30, 2007 compared to the three months and nine months ended September 30, 2006 were primarily due to a slight shift in product mix to more complex, higher performance products, and manufacturing cost improvements made during 2006 due to lower unit wafer costs, and assembly and test costs.

     Research and Development Expenses

     Research and development expenses primarily include personnel costs, the cost of fabrication masks for prototype products, MIPS architecture license fees, engineering design development software and hardware tools, allocated facilities expenses and depreciation of equipment used in research and development and, stock-based compensation under SFAS 123(R).

     The cost of masks used for development purposes are expensed to research and development. We expensed total development fabrication mask costs of $0 for both the three months ended September 30, 2007 and 2006, respectively, and $0 and $1,236,000 for the nine months ended September 30, 2007 and 2006, respectively. As our product processes continue to mature and as we develop more history and experience, we expect that, in the future, a lesser percentage of mask costs will be expensed to research and development and more will be used directly for production manufacturing and as a result expensed to cost of revenue.

     We expect research and development expenses to continue to increase in total dollars although we expect these expenses to generally decrease as a percentage of revenue. Additionally, as a percentage of revenue, these costs fluctuate from one period to another. Total research and development expenses for the three months and nine months ended September 30, 2007 and 2006 were:

		For the three months ended																For the nine months ended
		September 30,																September 30,
		2007				2006				change				% change				2007				2006				change				% change
		(In thousands)																				(In thousands)
Research and development expenses		$	4,796			$	4,224			$	572				13.5	%		$	13,843			$	14,283			$	(440	)			-3.1	%
Percent of total revenue			33.9	%			46.0	%			-12.1	%							36.5	%			58.7	%			-22.2	%

     Three Months and Nine Months Ended September 30, 2007 Compared to the Three Months and Nine Months Ended September 30, 2006: Research and Development Expenses. Research and development expenses increased by $0.6 million, or 13.5% in the first three months ended September 30, 2007 from $4.2 million in the three months ended September 30, 2006, and decreased by $0.4 million, or 3.1% in the nine months ended September 30, 2007 from $14.3 million in the nine months ended September 30, 2006. Of the $0.6 million increase in the three months ended September 2007 compared to 2006, salaries and benefits accounted for $0.6 million, stock-based compensation expense accounted for $0.1 million, professional services and other miscellaneous expenses accounted for $0.3 million, offset by tools and masks cost of $0.4 million. Of the $0.4 million decrease in the nine months ended September 30, 2007 compared to 2006, salaries and benefits increased by $1.4 million, stock-based compensation expense increased by $0.3 million, professional services and other miscellaneous expenses increased by $0.7 million, offset by decrease in tools and masks cost of $2.8 million. We capitalized the costs of fabrication masks that are reasonably expected to be used during production manufacturing. Research and development headcount increased to 122 at the end of September 2007 from 100 at the end of September 2006.

     Sales, General and Administrative Expenses

     Sales, general and administrative expenses primarily include personnel costs, accounting and legal fees, information systems, sales commissions, trade shows, marketing programs, depreciation, allocated facilities expenses and stock-based compensation under SFAS 123(R). We plan to continue to increase hiring of our sales and marketing organization to enable us to expand into existing and new markets. We also plan to continue to invest in expanding our domestic and international sales and marketing activities and building brand awareness. We incurred significant additional, accounting and legal compliance costs as well as additional insurance, and investor relations and other costs associated with being a public company. We expect sales, general and administrative expenses to increase significantly in absolute dollars and to generally decrease as a percentage of revenue in the future due to our expected growth and economies of scale. Total sales, general and administrative costs for the three months and nine months ended September 30, 2007 and 2006 were:

		For the three months ended																For the nine months ended
		September 30,								change				% change				September 30,								change				% change
		2007				2006												2007				2006
						(In thousands)																(In thousands)
Sales, general and administrative		$	3,976			$	2,594			$	1,382				53.3	%		$	10,667			$	7,547			$	3,120				41.3	%
Percent of total revenue			28.1	%			28.2	%			-0.2	%							28.1	%			31.0	%			-2.9	%

     Three Months and Nine Months Ended September 30, 2007 Compared to the Three Months and Nine Months Ended September 30, 2006: Sales, General and Administrative Expenses. Sales, general and administrative expenses increased $1.4 million and $3.1 million, or 53.3% and 41.3% to $4.0 million and $10.7 million in the three months and nine months ended September 30, 2007 from $2.6 million and $7.5 million in the three months and nine months ended September 30, 2006. Of the $1.4 million increase in the three months ended September 30, 2007 compared to 2006, salaries, benefits and commissions accounted for $0.6 million, travel and other miscellaneous expenses accounted for $0.3 million, stock-based compensation expense accounted for $0.2 million, and marketing programs, accounting, legal fees and other services accounted for $0.3 million. Of the $3.1 million increase in the nine months ended September 30, 2007 compared to 2006, salaries, benefits and commissions account for $1.5 million, travel and other miscellaneous expenses accounted for $0.3 million, stock-based compensation expense accounted for $0.5 million, and marketing programs, accounting, legal fees and other services accounted for $0.8 million, which were due to the implementation of internal systems and other costs associated with being a public company. Sales, general and administrative headcount increased to 57 at the end of September 2007 from 43 at the end of September 2006.

     Other Income (Expense), Net. Other income (expense), net primarily includes interest income on cash and cash equivalents and interest expense on notes payable. It also includes adjustments we made to record our preferred stock warrants at fair value in accordance with FSP 150-5. These warrants have converted into warrants to purchase shares of our common stock in May 2007 and therefore there are no warrant revaluation expenses in the quarter ended September 30, 2007.

		For the three months ended																For the nine months ended
		September 30,								change				% change				September 30,								change				% change
		2007				2006												2007				2006
						(In thousands)																(In thousands)
Interest income and other		$	1,307			$	117			$	1,190				1017.1	%		$	2,193			$	234			$	1,959				837.2	%
Interest expense			(73	)			(271	)			198				-73.1	%			(572	)			(555	)			(17	)			3.1	%
Warrant revaluation expense			—				(13	)			13				-100.0	%			(574	)			(316	)			(258	)			81.6	%
Total other income (expense), net			1,234				(167	)			1,401				838.9	%			1,047				(637	)			1,684				264.4	%

     Three Months and Nine Months Ended September 30, 2007 Compared to the Three Months and Nine Months Ended September 30, 2006: Other Income (Expense), Net. Other income (expense), net increased in the three months and nine months ended September 30, 2007 due primarily to the increase in interest income as a result of higher cash balances, offset by warrant revaluation expenses recognized to record our preferred stock warrants at fair value and interest expense attributable to the $4.0 million drawn against our Term Loan line of credit. This Term Loan line of credit was paid off on May 3, 2007.

     Income Tax Expense. For the three and nine months ended September 30, 2007 and 2006, the provision for income taxes was based on our estimated annual effective tax rate in compliance with SFAS 109 and other related guidance. We update our estimate of our annual effective tax rate at the end of each quarterly period. Our estimate takes into account estimations of annual pre-tax income, the geographic mix of pre-tax income and our interpretations of tax laws and the possible outcomes of current and future audits.

     The following table presents the provision and benefit for income taxes and the effective tax rates for the three and nine months ended September 30, 2007 and 2006:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		(in thousands)								(in thousands)
		2007				2006				2007				2006
Income (loss) before income taxes expense		$	1,420			$	(1,676	)		$	(422	)		$	(7,767	)
Income tax expense			110				—				201				2
Effective tax rate			7.7	%			0	%			47.6	%			0	%

     Three Months and Nine Months Ended September 30,2 007 Compared to the Three Months and Nine Months Ended September 30, 2006: Income Tax Expense. The provision for income taxes for the three and nine months ended September 30, 2007 of $110,000 and $201,000, respectively, relates principally to the federal alternative minimum tax, international taxes and state income taxes. The difference between the provision for income that would be derived by applying the statutory rate to our income before tax for the three months and nine months ended September 30, 2007 and the provision actually recorded was due to the impact of non-deductible SFAS 123R stock option compensation expenses and warrant expenses offset by the benefit from net operating loss carryforwards.

     We are in the process of expanding our international operations and staff to better support our expansion into international markets. This expansion includes the implementation of an international structure that includes, among other things, a research and development cost-sharing arrangement, certain licenses and other contractual arrangements between us and our wholly-owned domestic and foreign subsidiaries. Our foreign subsidiaries have acquired certain rights to use our existing intellectual property and intellectual property that we develop or license in the future. The existing rights were transferred for an initial payment. As a result of these changes and an expanding customer base in Asia, we expect that an increasing percentage of our consolidated pre-tax income will be derived from, and reinvested in, our international operations. We anticipate that this pre-tax income will be subject to foreign tax at relatively lower tax rates when compared to the U.S. federal statutory tax rate and as a consequence, our effective income tax rate is expected to be lower than the U.S. federal statutory rate.

     As a result of the adoption of FIN 48, we did not recognize any adjustment to the liability for uncertain tax positions and therefore did not record any adjustment to the beginning balance of retained earnings on the consolidated balance sheet. As of the date of adoption, we recorded a $3.1 million reduction to deferred tax assets for unrecognized tax benefits, all of which is currently offset by a full valuation allowance and therefore did not record any adjustment to the beginning balance of retained earnings on the balance sheet. As of January 1, 2007 and September 30, 2007, we had $3.0 million and $3.2 million, respectively of unrecognized tax benefits, which is netted against deferred tax assets and is fully offset by a valuation allowance. The unrecognized tax benefit increased by approximately $133,000.

     We file income tax returns in the U.S. federal jurisdiction, California and various state and foreign tax jurisdictions in which we have a subsidiary or branch operation. Our United States federal corporation income tax returns beginning with the 2000 tax year remain subject to examination by the IRS. Our California corporation income tax returns beginning with the 2000 tax year remain subject to examination by the California Franchise Tax Board. Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, we did not have any accrued interest or penalties associated with any unrecognized tax benefits. Although timing of the resolution and/or closure on audits is highly uncertain, we do not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, we did not have any accrued interest or penalties associated with any unrecognized tax benefits. Although timing of the resolution and/or closure on audits is highly uncertain, we do not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

Liquidity and Capital Resources

     In May 2007, we received net proceeds of approximately $94.8 million (after underwriters’ discounts of $7.3 million and additional offering related costs of approximately $2.7 million). Our primary sources of cash historically have been proceeds from issuances of convertible preferred stock, cash collections from customers, a working capital line of credit and term loan and cash received from the exercise of employee stock options. As of September 30, 2007, we had cash and cash equivalents of $101.5 million and net accounts receivable of $7.8 million.

     In October 2005, we entered into a Loan and Security Agreement with Silicon Valley Bank to provide a revolving line of credit for $6.0 million collateralized by eligible receivables and all of our other assets except intellectual property. Borrowings under the revolving line of credit bore interest at the bank’s prime rate plus an applicable margin based on certain financial ratios of the company at the borrowing date. On January 25, 2007, we entered into a loan modification agreement that extended the term of this credit facility through July 4, 2008. Upon our IPO in May 2007, we have cancelled the line of credit.

     In October 2005, we also entered into a Term Loan and Security Agreement with Silicon Valley Bank and Gold Hill Venture Lending (“Gold Hill”) that provided a $4.0 million term loan line of credit (“Term Loan”). The credit line was secured by all of our other assets except intellectual property.

     In September 2006, we borrowed $4.0 million against this Term Loan line of credit. On October 24, 2006, we entered into the First Amendment to the Term Loan and Security Agreement. The amendment reduced the interest rate on the Term Loan to a fixed rate of 10.5%, effective November 1, 2006. In addition, it eliminated the Gold Hill prepayment fee and final payment fee. This Term Loan was paid off as of as of May 3, 2007 subsequent to the IPO.

     Following is a summary of our working capital and cash and cash equivalents as of September 30, 2007 and December 31, 2006:

		As of
		September 30,				December 31,
		2007				2006
		(in thousands)
Working capital		$	104,234			$	11,689
Cash and cash equivalents			101,504				10,154