BUSINESS

Overview

We are a leading provider of Carrier Ethernet solutions that enable telecommunication service providers to deliver cost-effective business broadband services over fiber- and copper-based metro access networks. Our family of products, which we refer to as EtherTone platforms, enable telecommunication carriers, or carriers, and other service providers overcome bandwidth and functionality limitations of legacy technology in their metro access networks and enables carriers and other service providers to meet enterprise demand for mission-critical bandwidth-intensive applications and value-added managed services. Our EtherTone platforms also enable mobile broadband services by facilitating the cost-effective transmission of network traffic from wireless base stations back to the wireless operators’ core network, in a process known as backhauling. For both metro access and wireless backhaul networks, our EtherTone platforms efficiently manage growing integrated traffic, improve bandwidth capacity and utilization, reduce network complexity and offer carriers the reliability and scalability they seek when transitioning from legacy access technologies.

Our products address the high-growth Carrier Ethernet-based metro access equipment and wireless backhaul equipment markets. Infonetics, a market research firm, estimates the Ethernet-based metro access equipment market will grow from $340 million in 2007 to $922 million by 2010 and the Ethernet-based wireless backhaul equipment market will grow from $242 million in 2007 to $2.5 billion by 2010. We therefore estimate our combined business and mobile broadband addressable market to grow from $582 million in 2007 to $3.4 billion by 2010, which represents CAGR of 80%.

We are headquartered in Sunnyvale, CA, with a majority of our research and development operations in Wuhan, China and manufacturing operations in Shenzhen, China. We have operated a Silicon Valley/China hybrid business model since 2000, pairing the benefits of our United States-based platform design, sales and management expertise with highly productive, low cost, China-based engineering and manufacturing support. Our successful operation of the hybrid business model combined with third party contract manufacturing provides us with accelerated development cycles and an efficient cost structure. Approximately two-thirds of our 123 employees are based in China.

We were incorporated in January 1998 to provide network access equipment and in 2002 we began developing our EtherTone platforms and underlying Ethernet access technology. We began shipping our EtherTone platforms in 2004 and currently target tier 1 carriers, who are large global carriers, and other service providers. As of September 30, 2007, we have deployed our EtherTone solutions to 21 carriers and other service providers, including Bell Canada, Level 3 Communications, MTS Allstream, Rogers Communications, Verizon and XO Communications. We believe our customers have deployed approximately 8,500 platform units to serve global enterprises in industries including communications, finance and insurance, Internet and media, travel and hospitality, electronics and energy. We primarily sell our EtherTone platforms through a combination of our direct sales force, a global OEM agreement with Ciena and a global reseller agreement with Nortel. Our platforms are supported by our customer support and services team in conjunction with a global support and services agreement with Alcatel- Lucent.

Industry

Importance of Business Broadband Services for Carriers

While carriers typically provide broadband services to both residential and business customers, the financial return of providing broadband services to these customers differs significantly. Residential broadband service providers face intense competition from carrier, cable and wireless operators, experience high customer churn due to relatively low switching costs and are subject to extensive regulations by government agencies. In addition, network upgrades by carriers to extend broadband

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services to residential customers require substantial upfront capital expenditures and face uncertain consumer adoption rates. According to Infonetics, carriers take between two to three years to achieve positive return on invested capital for residential broadband deployments. These factors make it difficult for carriers to profitably deliver broadband services to residential markets.

In contrast, business broadband services have historically provided greater returns to carriers than residential services. When providing business broadband services for mission-critical applications, carriers must provide measurable SLAs that define stringent terms and QoS levels to be delivered and specify remuneration for the failure to meet these requirements. Due to the higher barriers of entry resulting from stringent QoS levels and SLA requirements, the complexity of deploying services to global enterprises and the high costs and risks associated with switching service providers, the market for business broadband services has fewer competitors and lower customer churn rates than residential services. Additionally, because capital expenditures to provide business broadband services are made in direct response to purchase commitments from enterprise customers, carriers can generate a positive return in a relatively short period of time. For example, a tier 1 carrier customer generated a positive return on invested capital within four months of deployment. These factors, combined with less government regulation, have historically enabled carriers to achieve higher margins on their business service offerings.

Although revenues from enterprise customers have historically generated high gross profit for carriers, these margins are under pressure as the price for high-speed access to carrier networks has been falling over the last few years. According to tariffs publicly-disclosed by telecommunication carriers, the recurring monthly price of bandwidth T1 service has fallen from approximately $400 to $500 for a megabyte per second, or Mbps, to $100 to $200 per Mbps over the last two years. In an effort to maintain high gross profit, we believe carriers are leveraging the availability of low-cost bandwidth to support the delivery of bandwidth-intensive applications and value-added managed services to the enterprise.

Enterprise Demand for Bandwidth-Intensive Applications and Value-Added Managed Services

When Internet and data network services were first widely adopted by enterprises, they were primarily used for email, file transfers and Internet web browsing. In an effort to improve efficiency and better utilize available resources, enterprises now require business broadband services to manage an increasing number of bandwidth-intensive applications. These applications and services include:

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In addition to bandwidth-intensive applications, enterprises also demand value-added managed services from carriers, including managed virtual private network, or VPN, hosted VoIP, remote audio and video teleconferencing and performance monitoring and management services. These bandwidth-intensive applications and value-added managed services result in increased and unpredictable bandwidth consumption and require a high-degree of network management for the prioritization of data traffic flow.

Increasing Demand for Backhaul Capacity for Mobile Broadband

Carriers and other service providers are experiencing growing demand for bandwidth capacity from wireless operators that frequently rely on carrier networks to backhaul voice, data and video traffic from the wireless operators’ base stations to their networks. Wireless operator demand for more backhaul capacity is partly driven by the increased number of subscribers, which Infonetics expects will grow from 2.5 billion subscribers in 2006 to 3.6 billion subscribers in 2010, and an increase in minutes of use per subscriber. Demand for increased backhaul capacity is also driven by the delivery of bandwidth-intensive data and video services over mobile networks, such as SMS messaging, texting, ring tones, mobile music, video games, mobile Internet access and other mobile entertainment content. We believe wireless operators’ planned roll out of next-generation bandwidth-intensive mobile networks, such as 3G/4G cellular LTE, Wi-Fi and WiMAX, will increase the demand for bandwidth-intensive mobile data and video services. According to Strategy Analytics, an independent research firm, these services are expected to increase globally at a 13% CAGR from 2007 to 2011 to surpass $150 billion by 2011. In addition to the large increase of data volume, the variety and mix of file and traffic types and the difficultly in predicting traffic patterns is driving the need for bandwidth capacity.

In response to growing demand for mobile broadband, wireless operators are increasing the capacity of existing base stations and are also adding more base stations around the world. Infonetics expects the number of cell site connections worldwide will increase from 2.6 million in 2006 to 3.6 million by 2010. We believe the increase in cell site connections will further increase demand for backhaul capacity.

Providing Business Broadband Services: The Metro Access Network Bottleneck

Carrier networks to provide business broadband services consist of long-haul, metro core and metro access networks. Long-haul networks connect multiple cities over long distances, linking to metro core networks that connect carrier central offices and major traffic points of presence, or PoPs, within a city. The carrier’s metro access network connects the carrier’s central office and PoPs to enterprise LANs.

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Growing enterprise demand for bandwidth-intensive applications and value-added managed services places significant strain on legacy carrier networks in providing business broadband services, particularly in the metro access portion of the network. Limitations of carriers’ legacy metro access network technologies, such as TDM based T1/E1 copper telephone lines or packet-based Frame Relay and Asynchronous Transfer Mode, or ATM, lines, create a bottleneck at the metro access network, which constrains the carriers’ ability to effectively provide business broadband services. These limitations include:

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These limitations of legacy metro access networks create a bottleneck for carriers and other service providers seeking to transition their business model to support the delivery of bandwidth-intensive applications and value-added managed services to the enterprise. We believe carriers and other service providers are seeking a reliable and robust metro access network for business broadband that:

Emergence of Carrier Ethernet as a Metro Access and Wireless Backhaul Networking Technology

Ethernet is a networking technology originally developed for deployment in the enterprise LAN. Its compelling benefits including “plug and play” functionality, low deployment costs, economies of scale and ease of management, have driven the adoption of Ethernet technology as the standard for enterprise LANs. These benefits have also led to the deployment of Ethernet in recent years in carrier metro core and long-haul networks, where the priority is to rapidly transfer large amounts of data.

Ethernet technology has historically not been deployed in the metro access network due to its inability to match the required QoS levels and enforce SLAs that have evolved over the past two decades in TDM networks. However, TDM is expensive to deploy and manage and has many technical limitations. Significant recent advances in standards for reliability, network resilience, as well as the development of a centralized management system, are contributing to the proliferation of Ethernet in the metro access network to enable carriers to deliver business broadband services. Through continued standardization and innovation, Ethernet-based networks are now able to offer QoS levels and SLA enforcement policies that are superior to TDM-based networks. These enhancements enable carriers to deliver bandwidth-intensive applications and managed services over metro access and wireless backhaul networks in a service known as Carrier Ethernet. With the adoption of Carrier Ethernet, carriers and other service providers can maintain and potentially increase their margins from business and mobile broadband services. According to a survey conducted by Heavy Reading, an independent communications equipment industry publication, more than 93% of respondent carriers said that their company offers or plans to offer some kind of Ethernet connectivity service by the end of 2009.

Wireless backhaul for mobile broadband has generally been transported over T1/E1 lines. As the need for wireless backhaul capacity increases, wireless operators require additional bandwidth capacity. With traditional technology, carriers must lease bandwidth in T1/E1 increments resulting in linearly increasing costs. Utilizing Carrier Ethernet technology enables carriers to benefit from Ethernet’s lower initial costs for bandwidth, while enabling carriers to benefit from declining marginal costs due to Ethernet’s scalability. In addition, as more wireless backhaul networks are based on IP technology, carriers benefit from Ethernet’s ability to efficiently transport IP-based data.

Our Solution

We developed our EtherTone platforms for business broadband to enable carriers and other service providers to efficiently and cost-effectively deliver bandwidth-intensive applications and value-added managed services. Additionally, our EtherTone platforms enable carriers to cost-effectively provide

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Carrier Ethernet-based wireless backhaul services to their wireless operator customers for mobile broadband. EtherTone helps carriers overcome the challenges they face in the metro access network by:

In addition to enabling carriers and other service providers to efficiently and cost-effectively deliver bandwidth-intensive applications and value-added managed services, our EtherTone platforms provide our customers with ongoing operating expense savings and expenditure reductions that contribute to a rapid return on investment. For example, in the case of our largest tier 1 carrier deployment, EtherTone delivered a positive return on the carrier’s invested capital within the first four months of deployment. Recurring expense and expenditure reductions for carriers include:

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Our EtherTone platforms enable carriers and other service providers to deliver business broadband and mobile broadband services, and reliably support QoS levels and enforce SLAs while reducing recurring operating expense and capital expenditures.

Our Silicon Valley/China Hybrid Business Model

Our Silicon Valley/China hybrid business model fully integrates our operations in Sunnyvale, Wuhan, Shenzhen and a new operations center in Hong Kong and is core to our business strategy. Functions performed from our corporate headquarters in Sunnyvale include platform design, sales and corporate management. Functions performed in Wuhan include engineering, marketing documentation and maintaining our management information systems. We manage our contract manufacturers from our Shenzhen location and are in the process of moving the final assembly and testing portion of our manufacturing process from Sunnyvale to Hong Kong.

We began moving the majority of our engineering execution operations to Wuhan, China in 2000 through our acquisition of a small privately-held company. Since this acquisition we have significantly increased the size of our Wuhan operations. Our system architects located in Sunnyvale, California serve as the primary interface between our engineering team and our customer base. System architects are responsible for creating high-level designs for new platforms and feature enhancements based on customer feedback, and our engineering execution team in Wuhan is responsible for developing our platforms and feature enhancements based on the designs. Both locations have essential platform and feature enhancement development responsibilities. The United States-based system architects and Wuhan-based engineering execution personnel have worked together since 2000 and communicate frequently to develop all of our platforms and feature enhancements.

Our team in Shenzhen, China manages our relationships with our contract manufacturing vendors, which are also based in Shenzhen. This team is in regular contact with our contract manufacturers and our Wuhan engineers to manage production and delivery of our platforms and feature enhancements.

Our United States and China employees both contribute to building our unified corporate culture. In order for the hybrid business model to work effectively, it is important to have experienced management teams and a high degree of senior-level continuity within each of our locations. Since 2000, we have retained all our senior-level engineering staff and have experienced minimal turnover of our mid- to low-level engineering staff. Chinese nationals manage our China operations, which we believe contributes to a cohesive culture and increases employee loyalty. We believe it would be difficult for a competitor to replicate our hybrid business model without the long-term working relationships and integrated platform development experience that we have established over the last seven years.

We believe our Silicon Valley/China hybrid business model provides us with many benefits, including:

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Our Strategy

Our goal is to extend our position as a leading provider of cost-effective Carrier Ethernet-based platforms that enable metro access networks to deliver business broadband and expand our presence in providing wireless backhaul for mobile broadband. Key elements of our strategy include:

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Technology

Recent Development of Carrier Ethernet

The development of Carrier Ethernet as a technology for providing business and mobile broadband has required significant advances in standards for reliability, network resilience and centralized management. Established in 2001, the Metro Ethernet Forum, or MEF, of which we are a member, has worked on the development of carrier-class standards for Ethernet which encompass standardization of services, scalability, reliability, QoS and service management. Since 2004, the MEF has released and certified standards for the architecture, protocol, service and management of Carrier Ethernet-based metro access network solutions. We have designed our EtherTone platforms to meet the latest MEF standards and EtherEdge and EtherReach have successfully completed MEF 9 and MEF 14 certifications, enabling carriers and other service providers to offer a number of Carrier Ethernet services to be built around our platforms.

Field-Programmable Gate Array, or FPGA, Semiconductor Devices

We utilize a combination of FPGAs and standard chipsets as the processing backbone for our EtherTone platforms. To leverage available technology, we utilize standard chipsets for commoditized functionality, such as Ethernet switching, and use FPGAs to enable advanced functionality. Unlike standard application-specific integrated circuit, or ASIC, chipsets, custom chipsets, or network processors that are pre-loaded with embedded features and functionalities, FPGAs contain programmable logic components and interconnects, which enable a high degree of flexibility and performance. Our engineering team’s significant knowledge and experience with FPGAs enables us to develop proprietary algorithms to optimally program FPGAs with customized features and functionalities. Key benefits from designing our platforms around FPGAs include:

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Technology Alliances

We have established, and intend to establish additional, technology alliances to enhance our platforms and address our customer needs. We have established a technology partnership and teaming agreement with Axerra Networks Inc., or Axerra, that provides us access to their pseudo-wire based circuit emulation technology. Through the alliance with Axerra, we are able to provide an integrated Carrier Ethernet-based wireless backhaul solution for mobile broadband.

We intend to establish additional technology alliances with other third parties to provide additional capabilities and features that could enhance our performance monitoring and network element management solutions.

Platforms

The EtherTone Platforms

Our EtherTone platforms deliver scalable, cost-effective Carrier Ethernet-based services for business and mobile broadband. Our EtherTone family of platforms includes EtherEdge, EtherReach and EtherSLAM. EtherEdge is typically the first ANDA platform deployed in a carrier network with subsequent deployments of our EtherReach and EtherSLAM platforms as we expand our presence within a carrier network.

Our EtherTone platforms include:

Our EtherView is a complementary element management system that supports our EtherTone platforms. EtherView is a graphical user interface, or GUI, application that provides traditional fault, configuration, accounting, performance and security functions that can be integrated into a wide variety

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of operations support system applications. EtherView can scale to support and manage up to 10,000 network elements to provide a Carrier Ethernet element management solution. We also offer a secure web-based GUI management interface as well as a traditional carrier command-line interface that comes standard with all of our platforms.

EtherCare Customer Service and Support

To support our EtherTone platform deployments, we offer our customers the option to purchase a complementary offering called EtherCare, which provides global service and support. EtherCare provides our customers with a broad range of plans including training, on-site and telephonic technical support and repair and replacement services. We believe providing high-quality, ongoing service and support is instrumental in developing and maintaining a successful, long-term relationship with our customers.

Over 90% of our deployed platforms are covered under EtherCare plans. EtherCare provides us with recurring revenue and increased ongoing contacts with our customers. We expect EtherCare revenue to increase as the number of EtherTone platforms deployed increases.

We employ a two-pronged approach in providing customer service and support. First, for technical issues requiring dedicated engineering or technical support, we rapidly respond to our customers’ needs utilizing our support and engineering personnel in both our Sunnyvale and Wuhan facilities. Second, through our partnership with Alcatel-Lucent’s services organization, we offer service and support in over 130 countries with approximately 18,000 network experts located around the world. Our non-exclusive service agreement with Alcatel-Lucent was signed in 2006 and runs through 2009. Through this relationship we have signed global, multi-year EtherCare agreements. We believe this partnership provides us a competitive advantage, extending the reach and credibility of our service and support capabilities globally.

Customers

We sell our EtherTone platforms and EtherCare support services to a global customer base including telecommunications carriers and wireless service providers. We have sold our EtherTone solutions to 20 carriers and 1 wireless service provider. From the beginning of 2006 through September 30, 2007, the following customers accounted for five percent or greater of our revenue over this period:

Level 3 Communications

MTS Allstream

Verizon

XO Communications

Our business depends significantly on a limited number of key customers. Verizon is our largest customer and accounted for approximately 41% of our revenues for the year ended December 31, 2006 and 71% of our revenues for the nine months ended September 30, 2007. MTS Allstream, Level 3 Communications, XO Communications and Rogers Communications comprised our three next largest customers in the year ended December 31, 2006, accounting for approximately 16%, 10%, 10% and 8% of revenues, respectively. Approximately 99% of revenues during the nine months ended September 30, 2007 were from existing customers, and approximately 87% of our revenues during this period were from Verizon, XO Communications and MTS Allstream alone.

Contracts with our customers establish general terms and conditions of the relationship. Once a contract is established, we continue to work to ensure our platforms meet the needs and requirements of our customers in order to secure purchase orders and deepen our relationship with the customer. For example, our initial deployment with Verizon in 2004 (then, MCI WorldCom) included just over 100

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platform units deployed throughout a portion of their United States network. Since then, we have expanded our presence to deploy over 1,725 platform units covering Verizon’s global network in 23 countries in North America, South America, Europe, Asia, the Middle East and Australia.

We believe that our customers have deployed our EtherTone platforms to support end user solutions across several industry verticals, including communications, finance and insurance, Internet and media, travel and hospitality, electronics and energy.

Sales and Marketing

We sell our EtherTone platforms and related services through a combination of our direct sales force and our value-added partners.

The typical process when securing a new carrier customer or a new design win with an existing customer begins with our direct sales force’s, or value-added partner’s, prior knowledge and influence over an anticipated request for proposal, or RFP. In some cases, we may be able to secure design wins and preempt the issuance of a RFP. Once we receive a formal RFP, our sales engineers conduct pre-sales consultations with the carrier to analyze their existing network infrastructure and identify how our EtherTone platforms can be customized and implemented to meet the carrier’s needs. We will then develop and submit a full sales proposal. If selected, the carrier will then test our platforms in labs and, on a trial basis, in a limited portion of its network. Upon successful completion of the test and trial processes, the carrier initiates its purchase order and deploys our platforms on their network. The sales cycle for deployments with new carrier customers or new design wins, from initial contact to revenue recognition is long, and may, in some cases, take up to two years.

We generally derive repeat business for add-on platform sales from our existing customers as they expand the deployment of our EtherTone platforms throughout their network. Of our 21 EtherTone customers, 14 have ordered multiple products. The sales cycle for additional platform deployments, from purchase order to revenue recognition, typically takes two to three months.

Direct Sales Force

Our direct sales team has significant experience with the carrier equipment procurement process, and is focused on securing new customer and design wins. We typically locate our sales personnel in or around cities with existing or potential customers. As of September 30, 2007, we had sales personnel located in Atlanta, Georgia; Newark, New Jersey; Richardson, Texas; Washington DC; Vancouver, Canada; and London, United Kingdom. We expect to add sales offices and sales personnel in strategic locations globally as we continue to grow our business.

Value-Added Partners

An important part of our distribution strategy includes establishing value-added partnerships with resellers and OEMs that offer complementary products. As a result of our successful direct sales wins, we have attracted value-added partners that enable us to strategically extend the reach of our sales efforts globally. We have established a global OEM relationship with Ciena and reseller relationship with Nortel, both of which have already generated design wins for us. We have also established selected reseller relationships for local sales and systems integration in China and Mexico and we intend to expand our roster of value-added partners.

Ciena integrates our EtherTone platforms with their OnCenter product to create a Carrier Ethernet-based metro access solution for business broadband that will be marketed by Ciena as the CN3000 Ethernet Access Series, or CN3000.

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Nortel currently resells our EtherReach platforms as a bundled offering with its flagship Optical Multiservice Edge, or OME, 6500 series to offer a complete end-to-end Carrier Ethernet solution. Nortel currently has over 4,000 OME systems deployed worldwide. We believe our arrangement with Nortel represents a significant opportunity to market our platforms to a large, installed customer base.

For sales completed through our value-added partners, we intend to maintain direct contact and dialogue with the end customer to facilitate testing, acceptance and service support as well as to generate follow-on sales opportunities.

Marketing and Business Development

Our marketing and business development team is responsible for communicating EtherTone’s value proposition to our existing and potential customer base, while increasing our brand awareness through direct customer interactions, public relations, tradeshows, industry events and Internet marketing. Our team also works to secure additional value-added partners, forge technology and industry alliances, promote the adoption of MEF standards and formulate strategic approaches to securing tier 1 carrier contracts. Our multi-lingual marketing and business development team is another example of our hybrid business model, as most of our marketing documentation is created in our Wuhan office.

Manufacturing

We outsource manufacturing for all our platforms to three ISO 9000 certified contract manufacturing facilities located in Shenzhen, China. Sanmina-SCI is currently our primary contract manufacturer, with Shenzhen GongJin and Elite our secondary contract manufacturers.

Our Shenzhen office oversees our contract manufacturers to help ensure on-time delivery of high quality platforms, respond to issues that arise during the manufacturing process and monitor inventory levels of component parts. Once manufactured, platforms are sent to our Sunnyvale facility where we perform final assembly and testing before the platforms are shipped to our customers. We are currently in the process of moving our final assembly and testing process to our new facility in Hong Kong to eliminate the logistics of shipping platforms between China and the United States during the manufacturing process. Outsourcing our manufacturing process enables us to reduce inventory levels, working capital requirements and fixed costs while maintaining a flexible and scalable production capacity.

We do not believe any of our significant components are only available from a single source. We provide forecasts to our contract manufacturers so they can accurately source components in advance of their anticipated use. Additionally, we regularly monitor the supply of components in the market place and component inventory levels maintained by our contract manufacturers to ensure that there is an adequate supply for our manufacturing needs.

Research and Development

We believe maintaining our technology leadership through a strong commitment to research and development is critical to our business. We believe our Silicon Valley/China hybrid business model provides us with more value from our research and development investments than we would receive by investing in an entirely United States-based research and development model.

We cultivate strong collaborative relationships with our tier 1 customer base and work closely with them to understand their product development efforts and align our roadmap with their evolving requirements. We believe this approach to research and development provides us with a focused platform development pipeline and early insight to future feature enhancements desired by our

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customers. These working arrangements have enabled us to deepen our customer relationships and secure recurring business while offering platforms to our other customers that address their needs. Once we have developed these platforms for our tier 1 customers, we re-introduce these improvements as feature enhancements more broadly across our customer base.

As of September 30, 2007, we employed 70 research and development personnel, of which 7 were located in Sunnyvale and 63 were located in Wuhan. Our research and development expenses were approximately $2.7 million in fiscal year 2005, $3.5 million in fiscal year 2006 and $3.7 million in the nine months ended September 30, 2007. Our research and development personnel have extensive experience in developing Carrier Ethernet-based metro access network platforms and provide us with the core competencies to deliver platforms required by our customer base for business and mobile broadband.