Summary of BIGBAND NETWORKS, INC.

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 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "project", "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from the future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled "Risk Factors" and those included elsewhere in this Form 10-Q. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
BigBand Networks develops, markets and sells network-based solutions that enable cable operators and telecommunications companies to offer video services across coaxial, fiber and copper networks. Our customer base includes seven of the ten largest service providers in the U.S. Our revenues from our product applications are influenced by a variety of factors, including the level and timing of capital spending by our customers and the annual budgetary cycles of, and the timing and amount of orders from, significant customers. The selling prices of our products vary based upon the particular customer implementation, which impacts the relative mix of software, hardware and services associated with the sale.
Our sales cycle typically ranges from six to 18 months, but can be longer if the sale relates to new product introductions. Our sales process generally involves several stages before we can recognize revenues on the sale of our products. As a provider of advanced technologies, we seek to actively participate with our existing and potential customers in the evaluation of their technology needs and network architectures, including the development of initial designs and prototypes. Following these activities, we typically respond to a service provider's request for proposal, configure our products to work within our customer's network architecture, and test our products first in laboratory testing and then in field environments to ensure interoperability with existing products in the service provider's network. Following testing, our revenue recognition generally depends on satisfying the acceptance criteria specified in our contract with the customer and our customer's schedule for roll-out of the product. Completion of several of these stages is substantially outside of our control, which causes our revenue patterns from a given customer to vary widely from period to period. After initial deployment of our products, subsequent purchases of our products typically have a more compressed sales cycle.
Due to the nature of the cable and telecommunications industries, we sell our products to a limited number of large customers. For the three months ended September 30, 2009 and 2008, we derived 83% and 90%, respectively, of our net revenues from our top five customers. For the nine months ended September 30, 2009 and 2008, we derived 76% and 81%, respectively, of our net revenues from our top five customers. We believe that for the foreseeable future our net revenues will continue to be highly concentrated in a limited number of large customers. The loss of one or more of our large customers, or the cancellation or deferral of purchases by one or more of these customers, would have a material adverse impact on our revenues and operating results.
We sell our products and services to customers in the U.S. and Canada through our direct sales force. We sell to customers internationally through a combination of direct sales and resellers. In conjunction with recently-introduced products, we expect our proportion of international revenues to gradually increase in 2010.
Net Revenues. We derive our net revenues principally from sales of, and services for video solutions, with a minimal remaining contribution from our data products, which we retired in October 2007. Our product revenues are comprised of a combination of software licenses and hardware. Our products primarily include Broadcast Video, TelcoTV and Switched Digital Video.
Our service revenues include ongoing customer support and maintenance, product installation and training. Our customer support and maintenance is available in a tiered offering at either a standard or enhanced level. The majority of our customers have purchased our enhanced level of customer support and maintenance. The accounting for revenues is complex and we account for revenues in accordance with applicable U.S. generally accepted accounting principles (GAAP).
Our order visibility remains limited, but we expect an increase in net revenues for the three months ending December 31, 2009 compared to the three months ended September 30, 2009. We continue to experience lengthened sales cycles in the evaluation and the deployment of our products as customers continue to deal with the challenging macro-economic environment.
Cost of Net Revenues. Our cost of product revenues consists primarily of payments for components and product assembly, costs of product testing, provisions recorded for excess and obsolete inventory, provisions recorded for warranty obligations, manufacturing overhead and allocated facilities and information technology expense. Cost of service revenues is primarily comprised of personnel costs in providing technical support, costs incurred to support deployment and installation within our customers' networks, training costs and allocated facilities and information technology expense. We decreased headcount in these functions to 88 employees as of September 30, 2009 from 96 employees as of September 30, 2008. We expect services and manufacturing operations headcount to remain relatively flat in the near term.

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Gross Margin. Our gross profit as a percentage of net revenues, or gross margin, has been and will continue to be affected by a variety of factors, including the mix of software and hardware sold, the mix of revenue between our products, the average selling prices of our products, and the mix of revenue between products and services. We achieve a higher gross margin on the software content of our products compared to the hardware content. In general, we continue to experience competitive pricing pressures on our products and we expect the average selling prices of our products to decline compared to the three months ended September 30, 2009. Our gross margins for products are also influenced by the specific terms of our contracts, which may vary significantly from customer to customer based on the type of products sold, the overall size of the customer's order, and the architecture of the customer network, which can influence the amount and complexity of design, integration and installation services.
Operating Expenses. Our operating expenses consist of research and development, sales and marketing, general and administrative, restructuring and other charges. Personnel related costs are the most significant component of our total operating expenses. Our headcount in operating functions, particularly in research and development, has increased to 385 employees as of September 30, 2009 from 376 employees as of September 30, 2008. We have re-invested a portion of our realized expense savings from our February 2009 restructuring plan to fund new product initiatives in strategic areas. Accordingly, we expect expenses to increase in the near term compared to the three months ended September 30, 2009, primarily due to a projected increase in headcount and independent contractors within research and development.
Research and development expense is the largest functional component of our operating expenses and consists primarily of personnel costs, independent contractor costs, prototype expenses, and other allocated facilities and information technology expense. The majority of our research and development staff is focused on software development. All research and development costs are expensed as incurred. Our development teams are located in Tel Aviv, Israel; Shenzhen, Peoples' Republic of China; Westborough, Massachusetts and Redwood City, California. Due to the long-term opportunities that we see for our business, we are accelerating certain technology projects. Accordingly, we expect our research and development expense to increase in absolute dollars for the three months ending December 31, 2009 compared to the three months ended September 30, 2009, due to new product initiatives in key strategic areas for both new and existing products.
Sales and marketing expense relates primarily to compensation and associated costs for marketing and sales personnel, sales commissions, promotional and other marketing expenses, travel, trade-show expenses and allocated facilities and information technology expense. Marketing programs are intended to generate revenues from new and existing customers and are expensed as incurred. We expect sales and marketing expense to remain relatively flat in absolute dollars for the three months ending December 31, 2009 compared to the three months ended September 30, 2009.
General and administrative expense consists primarily of compensation and associated costs for general and administrative personnel, professional services and allocated facilities and information technology expenses. Professional services consist of outside legal, accounting and other consulting costs. We expect that general and administrative expense will increase modestly in absolute dollars for the three months ending December 31, 2009 compared to the three months ended September 30, 2009, primarily due to modest projected increases in our legal fees related to a lawsuit filed by us against Imagine Communications, Inc. alleging patent infringement and other overhead expenses.
Class action litigation charges are settlement fees and expenses, related to a series of purported shareholder class action lawsuits against officers, directors and underwriters of our initial public offering. In accordance with the provisions of Financial Accounting Standards Board Accounting Standards Codification 450 Contingencies, we recorded an expense of $1.5 million in our consolidated results of operations for the year ended December 31, 2008, and an additional expense of $0.5 million for the nine months ended September 30, 2009 (all of which was recorded in the three months ended June 30, 2009). These lawsuits had been settled or dismissed as of the date of this filing, and hence the Company has no further significant obligations. Critical Accounting Policies and Estimates Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP, and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of our condensed consolidated financial statements requires our management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the applicable periods. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our condensed consolidated financial statements, which, in turn, could change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.

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Critical accounting policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements include accounting for revenue recognition, the valuation of inventories, warranty liabilities, stock- based compensation, the allowance for doubtful accounts, the impairment of long-lived assets, and income taxes, the policies of which are discussed under the caption "Critical Accounting Policies and Estimates" in our 2008 Form 10-K filed with the SEC on March 10, 2009. For additional information on the recent accounting pronouncements impacting our business, see Note 2 of the Notes to Condensed Consolidated Financial Statements.
Results of Operations
The percentage relationships of the listed items from our condensed consolidated statements of operations as a percentage of total net revenues were as follows:

                                                     Three Months Ended                  Nine Months Ended
                                                       September 30,                       September 30,
                                                   2009              2008              2009             2008
Total net revenues                                  100.0 %          100.0 %           100.0 %          100.0 %
Total cost of net revenues                           50.0             40.8              41.3             40.3

Total gross profit                                   50.0             59.2              58.7             59.7


Operating expenses:
Research and development                             52.7             27.4              32.6             30.8
Sales and marketing                                  27.1             14.6              17.4             16.7
General and administrative                           20.7             11.3              13.4             11.9
Restructuring charges                                   -              1.5               1.3              1.7
Amortization of intangible assets                       -              0.2                 -              0.3
Class action litigation charges                         -                -               0.5                -

Total operating expenses                            100.5             55.0              65.2             61.4


Operating (loss) income                             (50.5 )            4.2              (6.5 )           (1.7 )
Interest income                                       2.5              2.5               2.0              3.1
Other income (expense), net                           0.1             (0.3 )               -              1.0

(Loss) income before provision for
(benefit from) income taxes                         (47.9 )            6.4              (4.5 )            2.4
Provision for (benefit from) income taxes             1.0             (0.1 )             0.7              0.5

Net (loss) income                                  (48.9) %            6.5 %           (5.2) %            1.9 %

Net Revenues
Total net revenues decreased 54.0% to $22.2 million for the three months ended September 30, 2009 from $48.3 million for the three months ended September 30, 2008. The $26.1 million decrease in total net revenues was primarily attributable to lower bookings being closed during the three months ended June 30, 2009, which decreased our deferred revenues coming into the three months ended September 30, 2009. While our deferred revenues increased by $2.0 million as of September 30, 2009 compared to June 30, 2009, our visibility remains limited during these challenging economic times, and pricing pressure from our competitors continues to delay sales cycles.
Total net revenues decreased 19.9% to $105.1 million for the nine months ended September 30, 2009 from $131.2 million for the nine months ended September 30, 2008. The $26.1 million decrease was primarily due to a $34.8 million decrease in Video product revenues and a $0.6 million decrease in Data product revenues, partially offset by a $9.3 million increase in service revenues. More than 50% of the reduction in our Video product revenues was attributable to a slow down in the deployment schedule of our largest Telco customer. Additionally, Broadcast Video revenues declined as a result of our cable customers reducing their broadcast media router expansion plans, due to a reduction in advertising spending during these challenging economic times.
Revenues from our top five customers comprised 83% and 90% of net revenues for the three months ended September 30, 2009 and 2008, respectively. Revenues from our top five customers comprised approximately 76% and 81% of net revenues for the nine months ended September 30, 2009 and 2008, respectively. Brighthouse, Comcast, Time Warner Cable and Verizon each represented 10% or more of our net revenues for the three months ended September 30, 2009. Time Warner Cable and Verizon each represented 10% or more of our net revenues for the nine months ended September 30, 2009. Bright House Networks, Comcast, Time Warner Cable and Verizon each represented 10% or more of our net revenues for the three months ended September 30, 2008. Cox

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Communications, Time Warner Cable and Verizon each represented 10% or more of our net revenues for the nine months ended September 30, 2008.
For both the three and nine months ended September 30, 2009, Time Warner Cable represented more than 30% of our net revenues compared to less than 20% for both the three and nine months ended September 30, 2008. Revenues varied from period to period based upon Time Warner Cable's deployment schedule of large Switched Digital Video projects.
For the three months ended September 30, 2009, Verizon represented less than 20% of our net revenues compared to more than 40% for the three months ended September 30, 2008. For the nine months ended September 30, 2009, Verizon represented approximately 20% of our net revenues compared to approximately 30% for the nine months ended September 30, 2008. The decreases were due to a decline in order volume associated with a slower deployment schedule in Verizon's video network.
Net revenues are allocated to the geographical region based on the shipping destination of customer orders. Net revenues by geographical region as a percentage of total net revenues were as follows:

                                           Three Months Ended         Nine Months Ended
                                             September 30,              September 30,
                                            2009         2008         2009         2008
     United States                           91.4 %       94.8 %        86.5 %      90.8 %
     Asia                                     5.2          1.5           8.4         3.3
     Europe                                   2.4          2.6           3.6         3.2
     Americas excluding United States         1.0          1.1           1.5         2.7

     Total net revenues                     100.0 %      100.0 %       100.0 %     100.0 %

Product Revenues. Product revenues decreased 67.0% to $12.6 million for the three months ended September 30, 2009 from $38.3 million for the three months ended September 30, 2008. Video product revenues decreased $25.1 million for the three months ended September 30, 2009 from the comparable prior period, due to a $17.0 million decrease in TelcoTV revenues, a $7.2 million decrease in Broadcast Video revenues and a $0.9 million decrease in Switched Digital Video revenues. Data revenues decreased $0.6 million related to the retirement of our cable modem termination system (CMTS) platform products in October 2007.
Product revenues decreased 34.0% to $68.8 million for the nine months ended September 30, 2009 from $104.2 million for the nine months ended September 30, 2008. Video product revenues decreased $34.8 million for the nine months ended September 30, 2009 from the comparable prior period, due to a $28.9 million decrease in TelcoTV revenues and a $14.5 million decrease in Broadcast Video revenues, which was partially offset by an $8.6 million increase in Switched Digital Video revenues. Data revenues decreased $0.6 million related to the retirement of our CMTS platform products in October 2007.
Service Revenues. Service revenues for the three months ended September 30, 2009 were $9.6 million compared to $9.9 million for the three months ended September 30, 2008, a decrease of $391,000 or 3.9%. The decrease was primarily due to a $1.0 million decrease in Data service revenues. This was partially offset by a $0.6 million increase in Video service revenues related to Video customer support and maintenance revenues.
Service revenues for the nine months ended September 30, 2009 were $36.3 million compared to $27.0 million for the nine months ended September 30, 2008, an increase of $9.3 million or 34.5%. The increase was primarily due to a $5.6 million recognition of service revenues from decommissioned analog technology as described below, a $5.3 million increase in Video customer support and maintenance revenues from our new and installed base of customers and a $2.1 million increase in Video installation and training revenues. These increases were partially offset by a $3.7 million decrease in customer support and maintenance revenues from our retired CMTS platform products.
In an effort to switch to all-digital broadcasting, the U.S. federal government set June 12, 2009 as the final date for full power television stations that broadcasted in analog to convert to digital only. Previously, we sold analog products to a large telecommunication customer that allowed analog transmission of video over fiber-optic lines. As part of its compliance with the move to all-digital, this customer has completed the decommissioning of the analog technology products from its network and migrated to an all-digital format. We recognized $5.6 million of the remaining deferred service revenues and a $0.5 million benefit from the reversal of warranty reserves related to these decommissioned analog technology products for the three months ended June 30, 2009.
Gross Profit and Gross Margin
Gross profit for the three months ended September 30, 2009 was $11.1 million compared to $28.6 million for the three months ended September 30, 2008, a decrease of $17.5 million or 61.1%. Gross margin decreased to 50.0% for the three months ended September 30, 2009 compared to 59.2% for the three months ended September 30, 2008.

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Gross profit for the nine months ended September 30, 2009 was $61.8 million compared to $78.3 million for the nine months ended September 30, 2008, a decrease of $16.5 million or 21.1%. Gross margin decreased to 58.7% for the nine months ended September 30, 2009 compared to 59.7% for the nine months ended September 30, 2008.
Product Gross Margin. Product gross margin for the three months ended September 30, 2009 was 35.1% compared to 56.2% for the three months ended September 30, 2008. Product gross margin decreased primarily due to lower absorption of fixed manufacturing costs, a higher concentration of revenues being generated from lower margin hardware products and continued downward pricing pressure. These factors were partially offset by a modest decrease in manufacturing overhead expenses due to our reduction in headcount as well as operational efficiencies gained by centralizing our manufacturing operations in Massachusetts and a modest decrease in warranty expense. Product gross margin for the three months ended September 30, 2009 and 2008 included stock-based compensation expense of $0.3 million and $0.2 million respectively.
Product gross margin for the nine months ended September 30, 2009 decreased to 50.3% from 58.3% for the nine months ended September 30, 2008, due to a higher concentration of revenues being generated from lower margin hardware products, and continued downward pricing pressure. Additionally, product gross margin in 2008 was positively impacted by an unusually high concentration of higher margin software revenues in the first quarter. These factors were partially offset by a $1.8 million decrease in manufacturing overhead expenses due to our reduction in headcount as well as operational efficiencies gained by centralizing our manufacturing operations in Massachusetts. Warranty expense decreased $0.8 million, primarily related to a $0.5 million benefit from the reversal of warranty reserves related to decommissioned analog products. Product gross margin for the nine months ended September 30, 2009 and 2008 included stock-based compensation expense of $0.9 million and $0.8 million respectively.
Services Gross Margin. Services gross margin for the three months ended September 30, 2009 was 69.8% compared to 70.4% for the three months ended September 30, 2008. The decrease was due to a $0.4 million decrease in service revenues and a $0.1 million increase in cost of services, which was primarily related to an increase in independent contractor costs. Services gross margin for both the three months ended September 30, 2009 and 2008 included stock-based compensation expense of $0.2 million.
Services gross margin for the nine months ended September 30, 2009 was 74.8% compared to 65.1% for the nine months ended September 30, 2008. The increase was due to a $9.3 million increase in service revenues, primarily attributable to $5.6 million recognition of deferred service revenues from decommissioned analog products with no related cost of service. Additionally, cost of services decreased $0.3 million primarily from lower compensation expense and travel due to a lower average headcount. Services gross margin for the nine months ended September 30, 2009 and 2008 included stock-based compensation expense of $0.6 million and $0.5 million respectively. Operating Expenses
Research and Development. Research and development expense was $11.7 million for the three months ended September 30, 2009, or 52.7% of net revenues, compared to $13.2 million for the three months ended September 30, 2008, or 27.4% of net revenues. While our headcount increased 8.2%, expense decreased $1.5 million primarily due to a $1.1 million decrease in salary and related benefits as a result of a shift of headcount to a more cost effective location in Shenzhen, China. Additionally, bonus expense decreased by $0.8 million for the three months ended September 30, 2009 compared to the same period in 2008 as a result of a decline in our financial performance. These factors were partially offset by an increase in stock-based compensation, which was $1.3 million for the three months ended September 30, 2009 compared to $1.0 million for the three months ended September 30, 2008.
Research and development expense was $34.3 million for the nine months ended September 30, 2009, or 32.6% of net revenues, compared to $40.4 million for the nine months ended September 30, 2008, or 30.8% of net revenues. The decrease of $6.1 million was due to a $3.3 million decrease in salary and related benefits as a result of a shift of headcount to a more cost effective location in Shenzhen, China, a decrease of $1.9 million in bonus expense, and a $0.9 million reduction in independent contractor costs. In addition, travel, facility costs and other overhead expenses decreased $0.7 million due to cost containment efforts. These factors were partially offset by a $0.7 million increase in stock-based compensation, which was $3.6 million for the nine months ended September 30, 2009 compared to $2.9 million for the nine months ended September 30, 2008.
Sales and Marketing. Sales and marketing expense was $6.0 million for the . . .