10-Q
1
a10-12629_110q.htm
10-Q
Table of
Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark
One)
x
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
OR
o
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
COMMISSION FILE NUMBER 000-29661
UTSTARCOM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
52-1782500
(State of Incorporation)
(I.R.S. Employer Identification No.)
1275 HARBOR BAY PARKWAY
ALAMEDA, CALIFORNIA
94502
(Address of principal executive offices)
(zip code)
Registrants telephone
number, including area code: (510) 864-8800
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 x No o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was required
to submit and post such files). Yes o No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
(Do not check if a smaller reporting company)
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes o No x
As
of July 30, 2010 there were 131,905,838 shares of the registrants common
stock outstanding, par value $0.00125.
Table of Contents
TABLE OF
CONTENTS
PART IFINANCIAL INFORMATION
3
ITEM 1CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3
ITEM 2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
23
ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
38
ITEM
4CONTROLS AND PROCEDURES
39
PART IIOTHER
INFORMATION
41
ITEM
1LEGAL PROCEEDINGS
41
ITEM 1ARISK FACTORS
41
ITEM 2UNREGISTERED SALES OF EQUITY SECURITIES AND USE
OF PROCEEDS
41
ITEM 3DEFAULTS UPON SENIOR SECURITIES
42
ITEM
4REMOVED AND RESERVED
42
ITEM
5OTHER INFORMATION
42
ITEM 6EXHIBITS
42
SIGNATURES
44
2
Table of
Contents
PART IFINANCIAL
INFORMATION
ITEM 1CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UTSTARCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30,
December 31,
2010
2009
(In thousands, except par value)
ASSETS
Current
assets:
Cash
and cash equivalents
$
306,841
$
265,843
Short-term
investments
1,155
1,038
Accounts
receivable, net of allowances for doubtful accounts of $30,135 and $26,065,
respectively
44,274
42,346
Notes
receivable
930
1,427
Inventories
59,090
72,300
Deferred
costs
102,231
130,453
Prepaids
and other current assets
56,970
47,906
Short-term
restricted cash
22,162
26,448
Total
current assets
593,653
587,761
Property,
plant and equipment, net
5,186
130,612
Long-term
investments
9,062
8,402
Long-term
deferred costs
180,777
184,978
Long-term
deferred tax assets
5,601
4,822
Other
long-term assets
19,016
12,536
Total
assets
$
813,295
$
929,111
LIABILITIES AND EQUITY
Current
liabilities:
Accounts
payable
$
30,159
$
54,115
Income
taxes payable
1,130
Customer
advances
147,398
120,364
Deferred
revenue
162,443
170,777
Deferred
tax liabilities
3,890
3,890
Other
current liabilities
97,207
142,894
Total
current liabilities
441,097
493,170
Long-term
deferred revenue
108,232
160,932
Other
long-term liabilities
26,927
18,858
Total
liabilities
576,256
672,960
Commitments
and contingencies (Note 10)
Equity:
UTStarcom, Inc.
stockholders equity:
Common
stock: $0.00125 par value; 750,000 authorized shares; 131,905 and 130,095
shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively
154
153
Additional
paid-in capital
1,256,049
1,251,532
Accumulated
deficit
(1,092,102
)
(1,067,174
)
Accumulated
other comprehensive income
72,156
70,848
Total
UTStarcom, Inc. stockholders equity
236,257
255,359
Noncontrolling
interests
782
792
Total
equity
237,039
256,151
Total
liabilities and equity
$
813,295
$
929,111
See accompanying notes to the condensed consolidated financial
statements.
3
Table of
Contents
UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands, except per share data)
Net
sales
Products
$
62,615
$
65,735
$
131,795
$
171,247
Services
10,550
14,428
22,217
28,256
73,165
80,163
154,012
199,503
Cost
of net sales
Products
43,507
87,265
89,789
174,302
Services
6,786
8,736
14,142
19,387
Gross
profit (loss)
22,872
(15,838
)
50,081
5,814
See Note 16 for net sales to related party and associated
cost of net sales
Operating
expenses:
Selling,
general and administrative
21,162
26,971
51,352
81,151
Research
and development
9,078
16,229
19,101
37,737
Restructuring
(216
)
27,757
7,291
32,576
Net
gain on divestitures
(2,056
)
(1,357
)
(3,808
)
(1,357
)
Total
net operating expenses
27,968
69,600
73,936
150,107
Operating
loss
(5,096
)
(85,438
)
(23,855
)
(144,293
)
Interest
income
450
599
798
1,348
Interest
expense
(68
)
(230
)
(138
)
(520
)
Other
income (expense), net
(4,767
)
5,429
100
(1,785
)
Loss
before income taxes
(9,481
)
(79,640
)
(23,095
)
(145,250
)
Income
tax benefit (expense)
510
(4,659
)
(1,843
)
(6,483
)
Net
loss
(8,971
)
(84,299
)
(24,938
)
(151,733
)
Net
loss attributable to noncontrolling interests
6
16
10
17
Net
loss attributable to UTStarcom, Inc.
$
(8,965
)
$
(84,283
)
$
(24,928
)
$
(151,716
)
Net
loss per share attributable to UTStarcom, Inc.- Basic and Diluted
$
(0.07
)
$
(0.66
)
$
(0.19
)
$
(1.20
)
Weighted
average shares used in per-share calculation - Basic and Diluted
130,311
127,160
129,866
126,450
See accompanying notes to the condensed consolidated financial
statements.
4
Table of
Contents
UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six months ended June 30,
2010
2009
(In thousands)
CASH
FLOWS FROM OPERATING ACTIVITIES:
Net
loss
$
(24,938
)
$
(151,733
)
Adjustments
to reconcile net loss to net cash used in operating activities:
Depreciation
and amortization
3,410
6,918
Amortization
of deferred gain on sale-leaseback
(107
)
Provision
for (recovery of) doubtful accounts
4,161
(2,129
)
Deferred
income taxes
(712
)
1,752
Stock-based
compensation expense
4,547
6,427
Other-than-temporary
impairment of equity investment
3,798
Net
gain on divestitures
(3,808
)
(1,357
)
Gain
on settlement of an investment interest
(481
)
Other
42
(503
)
Changes
in operating assets and liabilities, net of dispositions:
Accounts
receivable
(9,928
)
96,273
Inventories
and deferred costs
44,111
30,024
Other
assets
(9,468
)
61,086
Accounts
payable
(25,341
)
(119,405
)
Income
taxes payable
207
2,182
Customer
advances
27,313
33,606
Deferred
revenue
(53,489
)
(21,133
)
Other
liabilities
(40,483
)
17,058
Net
cash used in operating activities
(84,964
)
(37,136
)
CASH
FLOWS FROM INVESTING ACTIVITIES:
Additions
to property, plant and equipment
(1,826
)
(1,337
)
Proceeds
from divestiture
1,500
Proceeds
from sale of building (net of tax payments)
123,955
Change
in restricted cash
2,998
1,404
Proceeds
from settlement of an investment interest
481
Purchase
of an investment interest
(550
)
Purchase
of short-term investments
(9,252
)
(5,613
)
Proceeds
from sale of short-term investments
5,415
6,421
Other
971
392
Net
cash provided by investing activities
123,692
1,267
CASH
FLOWS FROM FINANCING ACTIVITIES:
Repurchase
of common stock
(30
)
Other
(389
)
Net
cash used in financing activities
(30
)
(389
)
Effect
of exchange rate changes on cash and cash equivalents
2,300
(749
)
Net
increase (decrease) in cash and cash equivalents
40,998
(37,007
)
Cash
and cash equivalents at beginning of period
265,843
309,603
Cash
and cash equivalents at end of period
$
306,841
$
272,596
See accompanying notes to the condensed consolidated financial
statements.
5
Table of Contents
UTSTARCOM, INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION AND LIQUIDITY
The
accompanying unaudited condensed consolidated financial statements include the
accounts of UTStarcom, Inc. (Company) and its wholly and majority owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in the preparation of the condensed consolidated financial
statements. The noncontrolling interests in consolidated subsidiaries are shown
separately in the condensed consolidated financial statements.
The
accompanying unaudited condensed consolidated financial statements have been
prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles in the United States (GAAP)
have been condensed or omitted pursuant to such rules and regulations. The
December 31, 2009 condensed consolidated balance sheet was derived from
audited financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States. However, the
Company believes that the disclosures are adequate to make the information
presented not misleading. These condensed consolidated financial statements
should be read in conjunction with the Companys December 31, 2009
financial statements, including the notes thereto, and the other information
set forth in the Companys Annual Report on Form 10-K for the year ended
December 31, 2009. The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying
notes. Actual results may be different. See the Companys 2009 Annual Report
for discussion of the Companys critical accounting policies and estimates.
In
the opinion of management, the accompanying unaudited condensed consolidated
financial statements reflect all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair statement of the Companys
financial condition, the results of its operations and its cash flows for the
periods indicated. The results of operations for the three and six months ended
June 30, 2010 are not necessarily indicative of the operating results for
the full year.
In
December 2009, the Company entered into a Sales Leaseback Agreement for
the sale of its manufacturing, research and development, and administrative
offices facility in Hangzhou, China to a third party for approximately
$138.8 million with leaseback of approximately one-third of the facility.
On May 31, 2010, the Company and the buyer agreed that all conditions
precedent to the closing had been met, the sale was consummated and the
leaseback commenced on June 1, 2010. As of May 31, 2010, the Company
had received all of the sales proceeds. See Note 7 for additional information
on sale-leaseback transaction.
On
February 1, 2010, the Company entered into agreements for a strategic
relationship with Beijing E-town International Investment and
Development Co., Ltd (BEIID) which includes an investment of
$48.5 million in the Companys common stock by BEIID, and two unrelated
investment funds, Elite Noble Limited and Shah Capital Opportunity
Fund LP. These investments are expected to close in the third quarter of
2010.
Management
believes that both the Companys China and non-China operations have sufficient
liquidity to finance working capital and capital expenditure needs during the
next 12 months. There can be no assurance that additional financing, if
required, will be available on terms satisfactory to the Company or at all, and
if funds are raised in the future through issuance of preferred stock or debt,
these securities could have rights, privileges or preference senior to those of
the Companys common stock and newly issued debt could contain debt covenants
that impose restrictions on the Companys operations. Further, any sale of
newly issued debt or equity securities could result in additional dilution to
the Companys current shareholders.
NOTE 2 - ACCOUNTING POLICIES AND RECENT ACCOUNTING
PRONOUNCEMENTS
Earnings Per Share
Basic earnings per share (EPS)
is computed by dividing net income (loss) available to common stockholders by
the weighted average number of shares of the Companys common stock outstanding
during the period, which excludes nonvested restricted stock. Diluted EPS
presents the amount of net income (loss) available to each share of common
stock outstanding during the period plus each share of common stock that would
have been outstanding assuming the Company had issued shares of common stock
for all dilutive potential common shares outstanding during the period. The
Companys potentially dilutive common shares include
6
Table of Contents
outstanding stock options,
nonvested restricted stock, restricted stock units and Employee Stock Purchase
Plan (ESPP) shares prior to termination of the ESPP effective May 15,
2009, which are reflected in diluted net income per share by application of the
treasury stock method. Under the treasury stock method, the amount that the
employee must pay for exercising stock options, the amount of stock-based
compensation cost for future services that the Company has not yet recognized,
and the amount of tax benefit that would be recorded in additional paid-in
capital upon exercise are assumed to be used to repurchase shares. For the
three and six months ended June 30, 2010 and 2009, no potential common
shares were dilutive because of the net loss in the periods. Potential shares
of common stock of approximately 8.5 million and 13.6 million were excluded
from the diluted per share calculation for the three months ended June 30,
2010 and 2009, respectively, while 8.9 million and 14.4 million were excluded
from the diluted per share calculation for the six months ended June 30,
2010 and 2009, respectively, because to include them would have been
anti-dilutive for the periods.
Fair Value
Pursuant
to the accounting guidance for fair value measurements and its subsequent
updates, fair value is defined as the price that would be received from selling
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. As such, fair value is a
market-based measurement that should be determined based on assumptions that
market participants would use in pricing an asset or liability. The
accounting guidance also establishes a three-tier fair value hierarchy which
requires the Company to use observable market data, when available, and to
minimize the use of unobservable inputs when determining fair value. The fair
value hierarchy prioritizes the inputs into three levels that may be used in
measuring fair value as follows:
Level
1 - observable inputs such as quoted prices in active markets for identical
assets or liabilities.
Level
2 - inputs other than the quoted prices in active markets for identical assets
or liabilities that are observable either directly or indirectly.
Level
3 - unobservable inputs based on the Companys assumptions.
In
January 2010, the Financial Accounting Standards Board (FASB) issued
amended standards that require additional fair value disclosures. These
disclosure requirements are effective in two phases. In the first quarter of
2010, the Company adopted the requirements for disclosures about inputs and
valuation techniques used to measure fair value as well as disclosures about
significant transfers between hierarchy levels. Beginning in the first quarter
of 2011, these amended standards will require presentation of disaggregated
activity within the reconciliation for fair value measurements using
significant unobservable inputs (Level 3). These amended standards do not
significantly impact the Companys consolidated financial statements.
At
June 30, 2010, the Company had no assets and liabilities measured at fair
value on a recurring basis. The Companys money market funds, which are included
in cash and cash equivalents, are recorded at cost which approximates fair
value, classified within Level 1 of the fair value hierarchy. The fair
value of certain of the Companys financial instruments that are not measured
at fair value, including accounts receivable, accounts payable, and other
current liabilities, approximates the carrying amount because of their short
maturities.
During
the six months ended June 30, 2010, the Company had no assets and
liabilities measured at fair value on a non-recurring basis. At
December 31, 2009, the Company determined as a result of the sale
leaseback transaction entered into in December 2009 (see Note 7) that the
net book value of its Hangzhou facility was in excess of its fair value. Due to
the apparent decline in value, the Company conducted a recoverability test for
this entity-wide asset and determined the carrying value of the net assets of
the Company exceeded the undiscounted cash flows expected to result from the
use and eventual disposition of the asset group. In the Companys assessment of
fair value, management placed primary reliance on the market approach (the
third party offer). The result of this analysis reduced the Companys overall
assessment of fair value of the property by $33.3 million. Accordingly,
the Company recorded a non-cash impairment charge of $33.3 million during
the fourth quarter of 2009. The Companys overall assessment of fair value of
the property at December 31, 2009 was based on Level 2 inputs.
Variable Interest Entities
In
June 2009, the FASB issued authoritative guidance requiring an enterprise
to perform an analysis to determine whether the enterprises variable interest
or interests give it a controlling financial interest in a variable interest
entity. This analysis identifies the primary beneficiary of a variable interest
entity as one with the power to direct the activities of a variable interest
entity that most significantly impact the entitys economic performance and the
obligation to absorb losses of the entity that could potentially be significant
to the variable interest. The Company adopted this new standard in the first
quarter of fiscal year 2010. See Note 17 for the impact of the adoption of the
guidance on the Companys consolidated financial statements.
7
Table of Contents
Recent Accounting Pronouncements Not Yet
Adopted
In
September 2009, the FASB issued new standards for revenue recognition with
multiple deliverables. These new standards impact the determination of when the
individual deliverables included in a multiple-element arrangement may be
treated as separate units of accounting. Additionally, these new standards
modify the manner in which the transaction consideration is allocated across
the separately identified deliverables by no longer permitting the residual
method of allocating arrangement consideration. These new standards are
effective for the Company beginning in the first quarter of fiscal year 2011,
however early adoption is permitted. The Company is currently assessing the
potential impact, if any, of the guidance on its consolidated financial
statements.
In
September 2009, the FASB issued new standards for the accounting for
certain revenue arrangements that include software elements. These new
standards amend the scope of pre-existing software revenue guidance by removing
from the guidance non-software components of tangible products and certain
software components of tangible products. These new standards are effective for
the Company beginning in the first quarter of fiscal year 2011, however early
adoption is permitted. The Company is currently assessing the potential impact,
if any, of the guidance on its consolidated financial statements.
NOTE 3DIVESTITURES
IP
Messaging and US PDSN Assets
In
June 2010, the Company completed a sale of its non-core IP Messaging and
US PDSN Assets as part of its strategy to focus on core IP-based product
offerings. The divested assets were located in North America, Caribbean, and
Latin America regions and were part of the Multimedia Communications segment.
Consideration for the approximately $1.7 million of net liabilities transferred
included approximately $0.4 million cash proceeds plus potential additional
contingent consideration of up to $1.6 million. A gain of $2.1 million, net of
taxes, was recognized in June 2010 as a reduction to operating expenses.
The Company determined that the sale of these non-core product lines did not
meet the criteria for presentation as a discontinued operation as these
non-core product lines did not meet the definition of a component of an entity.
Sale of Remote Access Server product line
In
January 2010, the Company completed a sale of certain assets and
liabilities related to its Remote Access Server (RAS) product line and
received total consideration of approximately $1.5 million. The primary
RAS product was the Total Control 1000 Transaction Gateway, which offers the
market a proven processing platform for carrier-class transaction network
service providers and enterprises for dial-up connectivity. In the first
quarter of 2010, the Company transferred net liabilities of approximately $0.3
million in connection with this transaction and recorded a net gain of
$1.8 million as a reduction of operating expenses. The Company determined
that the divestiture of the RAS product line did not meet the criteria for
presentation as a discontinued operation as the RAS product line did not meet
the definition of component of an entity.
UTStarcom Personal Communications LLC (PCD)
On July 1, 2008, the Company completed the sale of UTStarcom
Personal Communications LLC, a wholly-owned subsidiary of the Company (PCD),
to Personal Communications Devices, LLC (PCD LLC). Concurrent with
the closing of the divestiture transaction, the Company entered into a
three-year supply agreement with PCD LLC whereby the Company indicated its
intent to supply handset products to PCD LLC. In connection with the wind
down of our Korea operations, in December 2008, we furnished PCD LLC with
180-days notice of termination of the supply agreement.
On
June 30, 2009, the Company entered into a Settlement Agreement and Release
(the Settlement Agreement) with PCD LLC. Under the Settlement Agreement, the
Company waived its right to any earnout payments and granted a call option to
PCD LLC for the Companys $1.6 million investment in the equity securities of
PCD LLC. The Company also agreed to pay
PCD LLC a total of $11.1 million which included warranty costs of approximately
$8.4 million (see Note 8) and a reduction of revenue of approximately $2.7
million. In addition to the $11.1 million claim settlement, the Company
recorded an additional $17.6 million of costs for inventory write-downs to net
realizable value, write-downs of excess inventory and warranty reserves related
to transactions with PCD LLC. The Company recorded these transactions in the
second quarter of 2009, resulting in a decrease in revenue of approximately $2.7
million and an increase in cost of net sales of $26.0 million.
Korea operations
On
July 31, 2009, the Company completed a sale of its Korea operations to an
entity founded by a former employee and received total consideration of
approximately $2.0 million. In connection with this transaction, the
Company recorded a net loss of $1.3 million during 2009. Included in this
amount was $2.2 million of foreign currency losses previously carried in
accumulated other
8
Table of Contents
comprehensive
income that were realized upon completion of sale and liquidation of the
subsidiary. The Company determined that the divestiture of Korea operations did
not meet the criteria for presentation as a discontinued operation as the Korea
operations did not meet the definition of component of an entity.
Sale of Assets to Marvell Technology Group Ltd
In
February 2006, the Company sold substantially all of the assets and
selected liabilities of its semiconductor design business division to Marvell
Technology Group Ltd. (Marvell). In connection with the sale of assets,
the Company entered into a supply agreement with Marvell to purchase chipsets
for the Companys handset products over the next five years. The value
allocated to the supply agreement of $20.2 million has been amortized in
proportion to the quantities of chipsets purchased under the supply agreement.
During the first quarter of 2009, the Company revised its estimates of customer
demand for certain handset products and determined that future chipset
purchases from Marvell would be negligible. As a result, the Company fully
amortized against cost of goods sold the remaining value of the supply
agreement of $8.5 million in the three months ended March 31, 2009.
NOTE 4 - COMPREHENSIVE LOSS
Total
comprehensive loss for the three and six months ended June 30, 2010 and
2009 consisted of the following:
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands)
Net
loss
$
(8,971
)
$
(84,299
)
$
(24,938
)
$
(151,733
)
Other
Comprehensive income
Reclassification
for realization of previously unrealized (gains) losses, net of tax
4,011
3,313
Foreign
currency translation
3,609
(2,657
)
1,308
(2,084
)
Comprehensive
loss
(5,362
)
(82,945
)
(23,630
)
(150,504
)
Comprehensive
loss attributable to noncontrolling interests (1)
(6
)
(16
)
(10
)
(17
)
Comprehensive
loss attributable to UTStarcom, Inc.
$
(5,356
)
$
(82,929
)
$
(23,620
)
$
(150,487
)
(1) Comprehensive loss
attributable to noncontrolling interests consisted solely of net loss.
The
changes in noncontrolling interests during the six months ended June 30,
2010 and 2009 were as follows:
Six months ended June 30,
2010
2009
(in thousands)
Balance at beginning of period
$
792
$
808
Comprehensive loss attributable to noncontrolling
interests
(10
)
(17
)
Balance at end of period
$
782
$
791
9
Table of
Contents
NOTE 5 BALANCE SHEET DETAILS
The following tables provide details of selected
balance sheet items:
June 30,
December 31,
2010
2009
(in thousands)
Inventories:
Raw
materials
$
8,861
$
18,863
Work
in process
21,715
12,881
Finished
goods (1)
28,514
40,556
Total
$
59,090
$
72,300
(1) Includes finished goods at
customer sites of approximately $21.8 million and $33.8 million at
June 30, 2010 and December 31, 2009, respectively, for which the
customer has taken possession, but based on specific contractual terms, title
has not yet passed to the customer.
Inventories
of approximately $2.9 million held by the Companys manufacturing outsource
partner are recorded in prepaids and other current assets in the condensed
consolidated balance sheet at June 30, 2010.
June 30,
December 31,
2010
2009
(in thousands)
Property, plant and equipment, net:
Buildings
$
234
$
184,436
Leasehold
improvements
14,272
15,422
Automobiles
4,126
4,243
Software
36,936
37,240
Equipment
and Furniture
145,914
172,214
Others
2,716
1,690
Total
204,198
415,245
Less:
accumulated depreciation and impairment
(199,012
)
(284,633
)
Total
(see Note 7)
$
5,186
$
130,612
June 30,
December 31,
2010
2009
(in thousands)
Other current liabilities:
Accrued
contract costs
$
18,843
$
27,657
Accrued
payroll and compensation
26,634
35,871
Warranty
costs
9,592
16,150
Accrued
other taxes
15,298
15,863
Restructuring
costs
9,903
21,707
Deposit
received for sale of building
7,323
Others
16,937
18,323
Total
$
97,207
$
142,894
10
Table of Contents
NOTE 6 - CASH, CASH EQUIVALENTS, INVESTMENTS AND FAIR
VALUE MEASUREMENTS
Cash
and cash equivalents, consisting primarily of bank deposits and money market
funds, are recorded at cost which approximates fair value because of the
short-term nature of these instruments. At June 30, 2010 and
December 31, 2009, there were no available-for-sale securities investments
subject to fair value accounting included in cash and cash equivalents or
long-term investments.
Short-term
investments, consisting of bank notes, were $1.2 million and $1.0 million
at June 30, 2010 and December 31, 2009, respectively. The Company
accepts bank notes receivable with maturity dates of between three and six
months from its customers in China in the normal course of business. The
Company may discount these bank notes with banking institutions in China.
During the six months ended June 30, 2010, no bank notes were sold. During
the three months ended June 30, 2009, there were no bank notes sold.
During the six months ended June 30, 2009, the Company sold $9.9 million
of bank notes and recorded immaterial costs as a result of discounting the
notes. All long-term investments are in privately-held companies and are
accounted for under the cost method. The Company recognizes an impairment
charge when a decline in the fair value of its investments below the cost basis
is judged to be other-than-temporary. In making this determination, the Company
reviews several factors to determine whether the losses are
other-than-temporary, including but not limited to: (i) the length of time
the investment was in an unrealized loss position, (ii) the extent to
which fair value was less than cost, (iii) the financial condition and
near term prospects of the issuer and (iv) the Companys intent and
ability to hold the investment for a period of time sufficient to allow for any
anticipated recovery in fair value.
The
following table shows the break-down of the Companys equity securities
classified as long-term investments at June 30, 2010 and December 31,
2009:
June 30,
December 31,
2010
2009
(in thousands)
Cortina
$
3,348
$
3,348
GCT SemiConductor, Inc.
3,000
3,000
Xalted Networks
1,583
1,583
SBI
1,131
471
Total equity securities
$
9,062
$
8,402
SBI NEO
Technology A Investment LPS (SBI)
In
2008, the Company invested $0.5 million into SBI in exchange for
approximately 2% of the Partnership interest. The Partnerships investment
objective is to invest in unlisted or listed companies in Japan and overseas
that are engaged in high growth businesses, including businesses focused on
information technology and the environment. In the first quarter of 2010, the
Company contributed an additional $0.6 million into SBI, and at June 30,
2010 maintains an approximately 2% Partnership interest. The Company has
concluded that it does not have a controlling interest in SBI as it does not
have the power to direct the activities of SBI that most significantly impact
the entitys economic performance. Affiliates of a related party have a
controlling interest in SBI, see Note 16. The Company accounts for the
investment in SBI using the cost method.
NOTE 7 SALE-LEASEBACK TRANSACTION
In
December 2009, the Company entered into a Property Transfer and Leaseback
Agreement (the Sale Leaseback Agreement) for the sale of its manufacturing,
research and development and administrative office facility in Hangzhou, China
(the Hangzhou facility) to a third party for proceeds of approximately
$138.8 million and the leaseback of approximately one-third of the
property through 2016. As of May 31, 2010, the Company had received all of
the sales proceeds and met all criteria for consummation of sale of the Hangzhou
facility. On May 31, 2010, the Company and the buyer agreed that all
conditions precedent to the closing had been met and the leaseback commenced on
June 1, 2010.
Management
determined that the transaction qualified for sale-leaseback accounting as all
of the risks and rewards of ownership were transferred to the buyer upon
closing of the transaction and the leaseback arrangement did not include any
form of continuing involvement, other than a normal leaseback. In the second
quarter of 2010, the Company recorded the sale of the Hangzhou facility and
recorded a deferred gain of $7.7 million at the time of sale. The deferred gain
was represented by the gross sales proceeds of $138.8 million, less $7.5
million of transaction related taxes and other fees, and less the net book
value of the Hangzhou facility of $123.6 million. The gain on sale was deferred
in accordance with the accounting guidance for sale-leaseback transactions, as
the Company has retained more than a minor portion of the use of the property
through the six-year leaseback. The deferred gain on the sale-leaseback is
being amortized in proportion to the related gross rental charged to expense
over the leaseback term. At June 30, 2010, $1.2 million of deferred gain
is included in other current liabilities and $6.5 million of deferred gain is
included in other long-term liabilities in the condensed consolidated balance
sheet.
11
Table of
Contents
In
connection with the Sale Leaseback Agreement, on February 1, 2010, the
Company entered into a Lease Contract (the Lease) with respect to the
leaseback of a portion of the Hangzhou facility. Under the terms of the Lease,
the Company will lease back 71,027 sqm gross floor area (GFA) aboveground and
12,000 sqm GFA underground of the building for a period of 6 years at a
rate of approximately $0.37, $0.44 and $0.47, respectively, per sqm per day for
years 1-2, 3-4 and 5-6, respectively, of the lease period for the aboveground
space; and approximately $3.66 per sqm per month for the underground space for
the full lease period. The Company was also required to pay a security deposit
in the amount of approximately $1.8 million and prepay part of the rent
and fees for the last six months of the lease term in the amount of
approximately $3.4 million upon lease inception on June 1, 2010. The
Company may terminate all or part of the Lease by giving six months advance
notice; however, the Company would be required to pay penalties and additional
compensation in the event of early termination. The Company has determined that
the Lease qualifies as an operating lease. See Note 10 for future minimum lease payments under all
noncancelable operating leases.
NOTE 8 - WARRANTY OBLIGATIONS AND OTHER GUARANTEES
The Company provides a warranty on its equipment and handset sales for
a period generally ranging from one to two years from the time of final
acceptance. At times, the Company has entered into arrangements to provide
limited warranty services for periods longer than two years. The Company
provides for the expected cost of product warranties at the time that revenue
is recognized based on an assessment of past warranty experience and when
specific circumstances dictate. The Company assesses the adequacy of its
recorded warranty liability every quarter and makes adjustments to the
liabilities if necessary. Specific warranty accruals are reversed upon the
expiration of the warranty period and are recorded as a reduction of cost of
net sales. From time to time, the Company may be subject to additional costs
related to non-standard warranty claims from its customers. If and when this
occurs, the Company estimates additional accruals based on historical
experience, communication with its customers and various assumptions that the
Company believes to be reasonable under the circumstances. Such additional
warranty accruals are recorded in the period in which the additional costs are
identified.
Expirations
recorded as a reduction of cost of net sales approximated $1.2 million and $1.8
million for the three months ended June 30, 2010 and 2009, respectively,
and $2.6 million and $2.3 million for the six months ended June 30, 2010
and 2009, respectively and are included in the table below as benefit from
expirations. The following table summarizes the activity related to warranty
obligations during the three and six months ended June 30, 2010 and 2009:
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands)
Balance
at beginning of period
$
12,011
$
29,814
$
16,150
$
29,840
Accruals
for warranties issued during the period (benefit from expirations), net
(1,324
)
7,251
(3,084
)
10,833
Settlements
made during the period
(1,095
)
(3,241
)
(3,474
)
(6,849
)
Balance
at end of period
$
9,592
$
33,824
$
9,592
$
33,824
During the second quarter of 2009, the Company recorded a special
warranty charge related to certain handsets sold to PCD LLC. Under the Settlement Agreement with PCD LLC
(see Note 3), the Company agreed to pay PCD LLC $8.4 million to settle certain
PCD LLC customers warranty claims arising from the handsets sold to PCD
LLC. The $8.4 million claim settlement
is included in the accruals for warranties issued during the three and six
months ended June 30, 2009 in the table above.
Certain
of the Companys sales contracts include provisions under which customers would
be indemnified by the Company in the event of, among other things, a
third-party claim against the customer for intellectual property rights
infringement related to the Companys products.
There are no limitations on the maximum potential future payments under
these guarantees. The Company has not
accrued any amount in relation to these provisions as no such claims have
developed into assertable claims and the Company believes it has defensible
rights to the intellectual property embedded in its products.
NOTE 9 - RESTRUCTURING COSTS
Restructuring Costs
During the three months ended June 30, 2010,
the Company recorded approximately $0.2 million net reversal of restructuring
charges recorded in previous periods. During the six months ended June 30,
2010, the Company recorded approximately $7.3 million in restructuring charges.
For the three and six months ended June 30, 2009, the Company recorded
restructuring charges of $27.8 million and $32.6 million, respectively. The
following describes the Companys restructuring initiatives.
12
Table
of Contents
2009 Restructuring Plan
On
June 9, 2009, the Board of Directors of the Company approved a
restructuring plan (the 2009 Restructuring Plan) designed to reduce the
Companys operating costs. The 2009 Restructuring Plan includes a worldwide
reduction in force of approximately 50% of the Companys headcount, or
approximately 2,300 employees located primarily in China and the United States
and, to a lesser degree, other international locations. During the three months
ended June 30, 2010, the Company recorded $1.4 million reversal of
restructuring charges recorded in prior periods resulting from change in
estimate. This change in estimate resulted from voluntary resignation of
employees originally included in the restructuring plan as well as retention of
employees originally identified in the plan to replace employees who voluntarily
resigned. Partially offsetting this reversal was approximately $0.9 million
additional charges related to employees located in the United States and other
international locations as the Company continues to phase-out non-core
international operations. During the three months ended June 30, 2010, the
Company also recorded an additional $0.3 million of lease costs on exited facilities.
During the six months ended June 30, 2010, the Company recorded
restructuring costs of approximately $6.9 million related to the 2009
Restructuring Plan, net of approximately $1.7 million of reversal of charges
recorded in prior periods. The restructuring costs for the six months ended June 30,
2010 consist primarily of severance and benefits related to additional
employees included in the Restructuring Plan in the first quarter of 2010,
adjusted for change in estimate in the second quarter of 2010. During the
second quarter of 2009, the Company recorded restructuring charges of
approximately $25.9 million related to the 2009 Restructuring Plan, including
$24.7 million for severance and benefits and $1.2 million related to the
estimated loss on a lease obligation that expires in 2013. Total restructuring
costs recorded through June 30, 2010 related to the 2009 Restructuring Plan approximated $46.8 million.
2008 Restructuring Plan
During fiscal 2008, the Company implemented a restructuring plan (the 2008
Restructuring Plan) primarily related to a global reduction in force across
all functions and employee terminations at certain non-core operations which
the Company was in the process of winding down. The total number of employees
affected totaled approximately 750, including 350 in China, 200 in Korea and
200 in other locations including the United States. During the three and six
months ended June 30, 2010, the Company recorded additional restructuring
costs related to the 2008 Restructuring Plan of approximately $0.1 million
and $0.4 million, respectively, for severance and benefit costs being
recognized over the remaining service period for employees included in the 2008
Restructuring Plan. During the three and six months ended June 30, 2009,
the Company recorded $1.8 million and $6.4 million, respectively, in
restructuring charges related to the 2008 Restructuring Plan. Total
restructuring costs recorded through June 30, 2010 related to the 2008 Restructuring Plan approximated $19.8 million.
2007 Restructuring Plan
At June 30, 2010, the 2007 Restructuring Plan was complete.
The activity in the accrued restructuring balances related to the plans
described above was as follows for the six months ended June 30, 2010 and
2009:
Balance at
December 31,
2009
Restructuring
Charges
Cash Payments
Non-cash
Settlement
Balance at
June 30,
2010
(in thousands)
2009
Restructuring Plan
Workforce
Reduction
$
16,939
$
6,480
$
(14,710
)
$
(1,613
)
$
7,096
Lease
Costs
1,516
375
(267
)
1,624
Other
Costs
6
6
Total
2009 Restructuring Plan
18,461
6,855
(14,977
)
(1,613
)
8,726
2008
Restructuring Plan
Workforce
Reduction
2,526
466
(1,815
)
1,177
Lease
Costs
385
(385
)
Other
Costs
30
(30
)
Total
2008 Restructuring Plan
2,941
436
(2,200
)
1,177
2007
Restructuring Plan - Lease Costs
305
(305
)
Total
$
21,707
$
7,291
$
(17,482
)
$
(1,613
)
$
9,903
13
Table of
Contents
Balance at
December 31,
2008
Restructuring
Charges
Cash Payments
Non-cash
Settlement
Balance at
June 30,
2009
(in thousands)
2009
Restructuring Plan
Workforce
Reduction
$
$
24,715
$
(1,070
)
$
(417
)
$
23,228
Lease
Costs
1,223
1,223
Other
Costs
7
(7
)
Total
2009 Restructuring Plan
25,945
(1,077
)
(417
)
24,451
2008
Restructuring Plan
Workforce
Reduction
7,976
5,377
(7,569
)
(380
)
5,404
Lease
Costs
249
1,114
(467
)
896
Other
Costs
498
(64
)
(247
)
187
Total
2008 Restructuring Plan
8,723
6,427
(8,283
)
(380
)
6,487
2007
Restructuring Plan - Lease Costs
788
204
(321
)
671
Total
$
9,511
$
32,576
$
(9,681
)
$
(797
)
$
31,609
The
majority of the remaining cash expenditures related to the 2009 and 2008
Restructuring Plans are expected to be paid in 2010. The remaining liabilities
related to lease obligations are expected to be settled over the remaining
lease term. The Company expects to incur additional restructuring charges in
2010 as it continues to execute the 2009 and 2008 Restructuring Plans.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases certain facilities under
noncancelable operating leases that expire at various dates through 2016. In connection with the Sale Leaseback
Agreement, the Company entered into a lease with respect to the leaseback of a
portion of the Hangzhou facility, see Note 7.
The leaseback commenced on June 1, 2010 and the contractual
obligations related to the Hangzhou facility lease are included in the table
below. Future minimum lease payments under all noncancelable operating leases
with an initial term in excess of one year as of June 30, 2010 are as
follows:
Twelve
months ending June 30:
Amount
(in
thousands)
2011
$
16,666
2012
14,246
2013
14,669
2014
13,861
2015
14,273
Thereafter
7,262
Total
$
80,977
Litigation
Securities Class Action Litigation
Beginning
in October 2004, several shareholder class action lawsuits alleging
federal securities violations were filed against the Company and various
officers and directors of the Company. The actions have been consolidated in
United States District Court for the Northern District of California under the
caption In re UTStarcom, Inc.
Securities Litigation , Master File No. C-04-4908-JW (PVT). The
lead plaintiffs in the case filed a First Amended Consolidated Complaint on
July 26, 2005. The First Amended Complaint
14
Table of Contents
alleged
violations of the Securities Exchange Act of 1934, and was brought on behalf of
a putative class of shareholders who purchased the Companys stock after
April 16, 2003 and before September 20, 2004. On April 13, 2006,
the lead plaintiffs filed a Second Amended Complaint adding new allegations and
extending the end of the class period to October 6, 2005. In addition to
the Company defendants, the plaintiffs are also suing Softbank. Plaintiffs
complaint seeks recovery of damages in an unspecified amount.
On
June 2, 2006, the Company and the individual defendants filed a motion to
dismiss the Second Amended Complaint. On March 21, 2007, the Court granted
defendants motion and dismissed plaintiffs Second Amended Complaint. The
Court granted plaintiffs leave to file a Third Amended Complaint, which
plaintiffs filed on May 25, 2007. On July 13, 2007, the Company and
the individual defendants filed a motion to dismiss and a motion to strike the
Third Amended Complaint. On March 14, 2008, the Court granted defendants
motion and dismissed plaintiffs Third Amended Complaint. The Court granted
plaintiffs leave to file a Fourth Amended Complaint, which plaintiffs
filed on May 14, 2008. On June 13, 2008, consistent with the Courts
March 14, 2008 dismissal order, the Company and the individual defendants
filed objections to the form and content of the Fourth Amended Complaint. On
July 24, 2008, the Court overruled the objections. On September 8,
2008, the Company and the individual defendants filed a motion to dismiss and a
motion to strike certain allegations from the Fourth Amended Complaint. On
March 27, 2009, the Court denied defendants motion to dismiss and granted
defendants motion to strike.
Plaintiffs,
the Company and the individual defendants have signed and filed a stipulation
of settlement providing for the settlement of the case. Defendant Softbank is
not a party to the settlement. The settlement is contingent on approval by the
court. Under the terms of the settlement, the Companys and individual
defendants insurers would pay the full amount of the settlement. On May 13,
2010, the Court granted preliminary approval of the settlement and scheduled a
final approval hearing for August 30, 2010. There is no assurance that the settlement
will receive final approval. Moreover, because Defendant Softbank is not a
party to this settlement, discovery and motion practice are continuing. No trial date has been set. We have continued to incur costs with regard
to discovery in connection with the ongoing litigation between the non-settling
parties. Accordingly, the Company is
unable at this time to estimate the effects of this lawsuit on the Companys
financial position, results of operations, or cash flows.
Shareholder Derivative Litigation
On
November 17, 2006, a shareholder derivative complaint captioned Ernesto Espinoza v. Ying Wu et al. , Case
No. RG06298775, was filed against certain of the Companys current and
former officers and directors in the Superior Court of the County of Alameda,
California. The complaint alleges that the individual defendants, among other
things, breached their duties, were unjustly enriched, and violated the
California Corporations Code in connection with the timing of stock option
grants. The complaint names the Company as a nominal defendant and seeks
unspecified monetary damages against the individual defendants and various
forms of injunctive relief. On February 2, 2007, the Company and the
individual defendants filed demurrers against the complaint. On April 11,
2007, the Court sustained the individual defendants demurrer, overruled the
Companys demurrer, ordered the plaintiff to file an amended complaint, and
ordered the Company to answer the original complaint. The plaintiff filed an
amended complaint and the Company has filed an answer to the amended complaint.
On August 21, 2007, the individual defendants filed demurrers against the
amended complaint. The Court sustained the individual defendants demurrers and
ordered the plaintiff to file a second amended complaint. On
September 26, 2008, plaintiff filed his second amended complaint. On November 21,
2008, the Company and the individual defendants filed demurrers against the
second amended complaint. On February 27, 2009, the Court sustained the
Companys demurrer and ordered the plaintiff to file a third amended
complaint. On March 20, 2009, plaintiff filed his third amended complaint.
On May 5, 2009, the Company and the individual defendants filed demurrers
against the third amended complaint. On August 11, 2009, the Court
sustained the Companys demurrer without leave to amend. On October 13,
2009, plaintiffs filed a notice of appeal.
The
parties have signed a binding Memorandum of Understanding providing for the
settlement of the case. The settlement requires completion of final settlement
documentation. The settlement is contingent on approval by the court. Under the
terms of the settlement, the individual defendants insurer would pay the full
amount of the monetary portion of the settlement. On April 15, 2010,
plaintiff filed a Request for Dismissal without prejudice with the Court of Appeals.
Pursuant to the Request, the appeal may be reinstated if the Superior Court
does not grant preliminary or final approval of the settlement. There is no
assurance that the settlement will receive court approval. Accordingly, the
Company is unable at this time to estimate the effects of this lawsuit on the
Companys financial position, results of operations, or cash flows.
IPO Allocation
On October 31, 2001, a
complaint was filed in United States District Court for the Southern District
of New York against the Company, some of the Companys directors and officers
and various underwriters for the Companys initial public offering.
Substantially similar actions were filed concerning the initial public
offerings for more than 300 different issuers, and the cases were coordinated
as In re Initial Public Offerings Securities
Litigation , Civil Action No. 01-CV-9604. Plaintiffs allege
violations of the Securities Act of 1933 and the Securities Exchange Act of
1934 through undisclosed improper underwriting practices concerning the
15
Table of Contents
allocation of IPO shares in
exchange for excessive brokerage commissions, agreements to purchase shares at
higher prices in the aftermarket and misleading analyst reports. Plaintiffs
seek unspecified damages on behalf of a purported class of purchasers of the
Companys common stock between March 2, 2000 and December 6, 2000.
The Companys directors and officers have been dismissed without prejudice
pursuant to a stipulation. On February 19, 2003, the Court granted in part
and denied in part a motion to dismiss the claims brought by defendants,
including the Company. The order dismissed all claims against the Company
except for a claim brought under Section 11 of the Securities Act of 1933,
which alleges that the registration statement filed in accordance with the IPO
was misleading.
The parties have reached a
global settlement of the litigation. Under the settlement the insurers will pay
the full amount of the settlement share allocated to the Company, and the
Company will bear no financial liability. The Company, as well as the officer
and director defendants who were previously dismissed from the action pursuant
to tolling agreements, will receive complete dismissals from the case. On
October 5, 2009, the Court entered an Opinion and Order granting final
approval of the settlement. Certain objectors have filed appeals. If for any
reason the settlement does not become effective, the Company believes it has
meritorious defenses to the claims and intends to defend the action vigorously.
Other Litigation
The
Company is a party to other litigation matters and claims that are normal in
the course of operations, and while the results of such litigation matters and
claims cannot be predicted with certainty, management of the Company believes
that the final outcome of such matters will not have a material adverse impact
on the Companys financial position, results of operations or cash flows.
Letters of credit
The
Company issues standby letters of credit primarily to support international
sales activities outside of China and in support of purchase commitments. When
the Company submits a bid for a sale, often the potential customer will require
that the Company issue a bid bond or a standby letter of credit to demonstrate
its commitment through the bid process. In addition, the Company may be
required to issue standby letters of credit as guarantees for advance customer
payments upon contract signing or performance guarantees. The standby letters
of credit usually expire without being drawn by the beneficiary thereof.
Finally, the Company may issue commercial letters of credit in support of
purchase commitments. At June 30, 2010, the Company had short-term
restricted cash of $22.2 million, and had long-term restricted cash of $12.1
million included in other long-term assets. The restricted cash amounts
primarily collateralize the Companys outstanding letters of credit
approximating $25.4 million at June 30, 2010.
NOTE 11 STOCK INCENTIVE PLAN
During
the six months ended June 30, 2010, the Company granted equity awards
primarily consisting of restricted stock and restricted stock units (RSUs),
and to a much lesser extent, option awards. Such awards generally vest over a
period of one to four years from the date of grant. Restricted stock has the
voting rights of common stock and the shares underlying restricted stock are
issued and outstanding. There were no option awards during the three months
ended June 30, 2010.
In
February 2008, the Compensation Committee granted 1,073,333
performance-based awards to certain senior executive officers. During the third
quarter of 2008, 233,333 of these contingently issuable shares were forfeited
as a result of employee terminations. On October 6, 2008, the performance
requirements with respect to 60,000 of these contingently issuable shares were
eliminated, these restricted stock units have a fair value of $2.69 per share,
which equals the closing price of the Companys common stock on the NASDAQ
Stock Market on the measurement date of October 6, 2008. On
February 18, 2009, the Committee determined, based on the Companys and
each executive officers level of performance during the Companys 2008 fiscal
year, that an additional 367,500 shares underlying the previously granted
performance-based restricted stock units had been earned, each of these
performance-based restricted stock units has a fair value of $1.27 per share,
which equals the closing price of the Companys common stock on the NASDAQ
Stock Market on the measurement date of February 18, 2009. These
restricted stock units vested 50% on February 27, 2009 and 50% vested on
February 26, 2010.
In
February 2009, the Compensation Committee also granted to senior executive
officers 313,293 restricted stock units with a four-year vesting and an
additional 626,586 performance-based awards, subject to the attainment of goals
determined by the Compensation Committee. The Company may be subject to
variable levels of expense related primarily to the varying levels of
performance, as well as for fluctuations in the Companys stock price as these
awards are marked to market periodically until the earlier of i) the date of
the Compensation Committees determination on performance or ii) the date they
were deemed fully vested as a result of involuntary termination. Of the 626,586
performance-based awards granted in February 2009, 401,859 awards were
deemed fully vested during fiscal 2009 as a result of involuntary terminations,
prior to the annual Compensation Committees evaluation of performance. At its
meeting on February 18, 2010, the Compensation Committee evaluated the
performance against established objectives of the remaining 224,727
performance-based awards and determined 148,769 RSUs were earned.
16
Table
of Contents
In
February 2010, the Compensation Committee decided no annual grants of
stock-based awards would be made to existing senior executives for the 2010
year in light of the Companys previously announced planned changes in
management.
To
reduce the Companys long term cost structure and manage shareholder dilution,
the Company has elected to terminate the ESPP program effective May 15,
2009. The cancellation has been accounted for as a settlement of shares for no
consideration. This resulted in an immediate expense recognition in the first
quarter of 2009 of $1.2 million associated with the unrecognized compensation
for canceled purchase periods of the 24-month offering.
During
the quarter ended June 30, 2009, an adjustment was made to increase the
estimated forfeiture rate for equity awards of employees that are being
included in the 2009 Restructuring Plan as the awards are not expected to
ultimately vest. The resulting net
effect of the forfeiture rate adjustment was a decrease to the Companys
stock-based compensation expense for the three months ended June 30, 2009
by approximately $0.4 million.
The
total stock-based compensation expense, including the ESPP expense described
above, recognized in the condensed consolidated statement of operations for the
three months and six months ended June 30, 2010 and 2009 was as follows:
Three months ended
June 30,
Six months ended
June 30,
2010
2009
2010
2009
(in thousands)
Cost of net sales
$
36
$
60
$
93
$
491
Selling, general and administrative
1,079
1,617
2,480
4,056
Research and development
153
186
361
1,083
Restructuring
419
417
1,613
797
Total
$
1,687
$
2,280
$
4,547
$
6,427
Option
activity as of June 30, 2010 and changes during the six months ended
June 30, 2010 were as follows:
Number of
shares
outstanding
Weighted
average
exercise
price
(in thousands)
Options outstanding, December 31, 2009
5,750
$
8.98
Options granted
100
$
2.18
Options exercised
(2
)
$
2.82
Options forfeited or expired
(699
)
$
11.05
Options outstanding, June 30, 2010
5,149
$
8.57
Nonvested
restricted stock and restricted stock units as of June 30, 2010, and
changes during the six months ended June 30, 2010, were as follows:
Shares
Weighted
average grant
date fair value
(in thousands)
Nonvested at December 31, 2009
4,030
$
2.38
Granted
1,230
$
2.28
Vested
(1,593
)
$
2.35
Forfeited
(430
)
$
2.16
Total nonvested at June 30, 2010
3,237
$
2.39
At
June 30, 2010, there was approximately $5.8 million of total unrecognized
compensation cost not including forfeitures, related to non-vested stock
options, restricted stock and restricted stock units, as measured, which the
Company expects to recognize over a weighted-average period of 2.4 years. For
additional information regarding the Companys stock-based compensation plans,
see the Companys Annual Report on Form 10-K for the year ended
December 31, 2009.
17
Table of
Contents
NOTE 12 - INCOME TAXES
As
of December 31, 2009, the Company had gross unrecognized tax benefits of
approximately $90.6 million and had certain deferred tax assets and the
federal tax benefit of state income tax items totaling $77.8 million. If
recognized, the portion of gross unrecognized tax benefits that would decrease
the provision for income taxes and decrease the Companys net loss is
approximately $12.8 million.
As
of June 30, 2010, the Company had gross unrecognized tax benefits of
approximately $92.4 million and had certain deferred tax assets and the
federal tax benefit of state income tax items totaling $78.4 million. If
recognized, the portion of gross unrecognized tax benefits that would decrease
the provision for income taxes and decrease the Companys net loss is
approximately $14.0 million.
The
Company recognizes interest expense and penalties related to the above
unrecognized tax benefits within income tax expense. The Company had accrued
interest and penalties of approximately $3.1 million as of December 31,
2009 and approximately $3.3 million as of June 30, 2010.
The
Company is subject to taxation in the U.S. federal jurisdiction and
various U.S. state and foreign jurisdictions. The Company is under audit
by the taxing authorities in China on a recurring basis. The material
jurisdictions that the Company is subject to examination are in the
United States and China. The Companys tax years for 1999 through 2009 are
still open for examination in China. The Companys tax years for 2006 through
2009 are still open for examination in the United States. The Company
believes that it is reasonably possible that the amount of gross unrecognized
tax benefits related to the resolution of income tax matters could be reduced
by approximately $1.0 million during the next 12 months as income tax audits
are settled and statute of limitations expire. The portion of the $1.0 million
of gross unrecognized tax benefits that would decrease the provision for income
taxes and increase the Companys net income is approximately $0.7 million.
FASB
ASC 740-10 establishes criteria for recognizing or continuing to recognize only
more-likely-than-not tax positions, which may result in income tax expense
volatility in future periods. While the Company believes that it has adequately
provided for all tax positions, amounts asserted by taxing authorities could be
greater than the Companys accrued position. Accordingly, additional provisions
on income tax related matters could be recorded in the future as revised
estimates are made or the underlying matters are settled or otherwise resolved.
In
establishing its deferred income tax assets and liabilities, the Company makes
judgments and interpretations based on the enacted tax laws and published tax
guidance applicable to its operations. The Company records deferred tax assets
and liabilities and evaluates the need for valuation allowances to reduce the
deferred tax assets to realizable amounts. The likelihood of a material change
in the Companys expected realization of these assets is dependent on future
taxable income and its ability to use foreign tax credit carryforwards
and carrybacks.
Income
tax benefit was $0.5 million for the three months ended June 30, 2010
compared to income tax expense of $4.7 million for the three months ended June 30,
2009. In the second quarter of 2010, a
one-time tax benefit of $0.9 million was recorded mainly related to the release
of previously established valuation allowance on deferred tax assets in Taiwan
which was offset by foreign tax expenses. Income tax expense was
$1.8 million for the six months ended June 30, 2010 compared to $6.5
million for the six months ended June 30, 2009. The decrease in income tax
expense in the six month ended June 30, 2010 compared with six month ended
June 30, 2009 was primarily due to the decreased ordinary income in
jurisdictions where the Company has been profitable and a one-time tax expense
of $1.4 million in the three month ended June 30, 2009 related to establishing
of valuation allowance on net deferred tax assets in Korea.
For
2010 and 2009, the Company has not provided any tax benefit on any forecasted
losses incurred and tax credits generated in the United States and other
countries, because management believes that it is more likely than not that the
tax benefit associated with these losses will not be realized. Also, for 2010
and 2009, the Company continues to accrue tax expense in jurisdictions where
the Company has been historically profitable. Estimates of the annual effective
tax rate at the end of the interim periods are based on evaluations of possible
future events and transactions and may be subject to subsequent refinement or
revision.
18
Table
of Contents
NOTE 13 - OTHER INCOME (EXPENSE), NET
Other
income (expense), net for the three and six months ended June 30, 2010 and
2009, respectively were comprised of the following:
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands)
Other-than-temporary
impairment of equity investment
$
$
(3,798
)
$
$
(3,798
)
Foreign
exchange gains (losses)
(4,938
)
9,003
(851
)
1,745
Settlement
with MRV Communications (1)
58
481
Other
113
224
470
268
Total
$
(4,767
)
$
5,429
$
100
$
(1,785
)
(1) Previously, the Company held an 8% ownership
interest in Fiberxon, which was acquired by MRV Communications (MRV) in 2007.
In connection with the acquisition, Fiberxon shareholders received cash and
stock as well as the right to potential deferred consideration. In December 2009,
MRV entered into a settlement agreement for dismissal of legal proceedings between
MRV and the former shareholders of Fiberxon regarding the amount of contingent
consideration owed related to its acquisition. Proceeds received in the first
quarter of 2010 represented the Companys proportionate share of the settlement
amounts.
NOTE 14 - SEGMENT REPORTING
In
the fourth quarter of 2009, the Company substantially completed the wind-down
of its handset business. Except for sales relating to inventory clearing, the
Company does not expect any significant handset revenue in 2010. Beginning on
January 1, 2010, the Company integrated its Services Segment into its
Multimedia Communications and Broadband Infrastructure segments based on
products for which services are performed. Effective January 1, 2010, the
new reporting segments are as follows:
· Multimedia
CommunicationsFocused on development and market opportunities in IPTV
solutions and Wireless infrastructure technologies, including related services
revenue.
· Broadband
InfrastructureFocused on our world class portfolio of broadband products,
including related services revenue.
· HandsetsFocused
on mobile phone business including PAS and CDMA handset market, as well as data
cards markets. Handset sales to PCD LLC, which commenced after the
July 1, 2008 sale of PCD, are included in this segment.
The
Companys chief operating decision makers make financial decisions based on
information it receives from its internal management system and currently
evaluates the operating performance of and allocates resources to the reporting
segments based on segment revenue and gross profit. Cost of sales and direct
expenses in relation to production are assigned to the reporting segments. The
accounting policies used in measuring segment assets and operating performance
are the same as those used at the consolidated level.
19
Table
of Contents
Summarized
below are the Companys segment net sales, gross (loss) profit and segment
margin for the three and six months ended June 30, 2010 and 2009 based on
the current reporting segment structure. The Company has reclassified its
previously reported segment information for the three and six months ended June 30,
2009 to conform to the current segment presentation.
Three
months ended June 30,
Six
months ended June 30,
2010
% of
net
sales
2009
% of
net
sales
2010
% of
net
sales
2009
% of
net
sales
(in
thousands, except percentages)
Net Sales by Segment
Multimedia
Communications
$
46,986
64
%
$
47,993
60
%
$
89,311
58
%
$
90,476
45
%
Broadband Infrastructure
24,681
34
%
18,986
24
%
59,235
38
%
39,782
20
%
Handsets
1,498
2
%
13,184
16
%
5,466
4
%
69,245
35
%
$
73,165
100
%
$
80,163
100
%
$
154,012
100
%
$
199,503
100
%
Three
months ended June 30,
Six
months ended June 30,
Gross
Gross
Gross
Gross
2010
Profit
%
2009
Profit
%
2010
Profit
%
2009
Profit
%
(in
thousands, except percentages)
Gross (loss) profit by Segment
Multimedia
Communications
$
12,551
27
%
$
15,835
33
%
$
28,571
32
%
$
28,703
32
%
Broadband Infrastructure
8,222
33
%
2,548
13
%
17,845
30
%
5,030
13
%
Handsets
2,099
140
%
(34,221
)
(260
)%
3,665
67
%
(27,919
)
(40
)%
$
22,872
31
%
$
(15,838
)
(20
)%
$
50,081
33
%
$
5,814
3
%
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands)
Segment Margin and Operating Loss
Multimedia
Communications
$
6,052
$
5,430
$
14,253
$
6,063
Broadband
Infrastructure
4,964
(1,652
)
11,508
(4,017
)
Handsets
1,808
(38,702
)
2,999
(38,466
)
Total
segment margin
12,824
(34,924
)
28,760
(36,420
)
General
and Corporate
(17,920
)
(50,514
)
(52,615
)
(107,873
)
Operating
Loss
$
(5,096
)
$
(85,438
)
$
(23,855
)
$
(144,293
)
Sales
are attributed to a geographical area based upon the location of the customer.
Sales data by geographical area are as follows:
Three months ended June 30,
Six months ended June 30,
% of net
% of net
% of net
% of net
2010
sales
2009
sales
2010
sales
2009
sales
(in
thousands, except percentages)
Net Sales by region
United
States
$
2,450
3
%
$
1,731
2
%
$
5,903
4
%
$
42,990
22
%
China
43,211
59
%
52,531
66
%
83,186
54
%
103,749
52
%
Japan
11,137
15
%
6,505
8
%
22,233
14
%
13,042
7
%
India
6,555
9
%
9,536
12
%
12,353
8
%
19,120
10
%
Philippines
2,990
4
%
2,091
3
%
15,674
10
%
2,896
1
%
Other
6,822
10
%
7,769
9
%
14,663
10
%
17,706
8
%
Total
net sales
$
73,165
100
%
$
80,163
100
%
$
154,012
100
%
$
199,503
100
%
Long-lived
assets, consisting of property, plant and equipment, by geographical area are
as follows:
June 30,
December 31,
2010
2009
(in thousands)
United
States
$
123
$
170
China
4,434
129,746
Other
629
696
Total
long-lived assets
$
5,186
$
130,612
20
Table
of Contents
NOTE 15 - CREDIT RISK AND CONCENTRATION
At
June 30, 2010, the Companys accounts receivable balance included amounts
due from Philippine Long Distance Telephone Company representing approximately
21%, of the Companys total accounts receivable, net of allowances for doubtful
accounts. At December 31, 2009, the Companys accounts receivable balance
included amounts due from China Telecom, JiangSu Branch representing
approximately 11% of the Companys total accounts receivable, net of allowances
for doubtful accounts.
The
following customers accounted for 10% or more of the Companys net sales:
For the three
For the six
months ended
months ended
June 30,
June 30,
(% of
net sales)
2010
Softbank
and affiliates
10
%
12
%
Philippines
Long Distance Telephone Company
4
%
10
%
2009
PCD
LLC
17
%
Approximately
55% and 37% of the Companys net sales during the three months ended June 30,
2010 and 2009, respectively, and approximately 49% and 29% of the Companys net
sales during the six months ended June 30, 2010 and 2009, respectively,
were to entities affiliated with the government of China. Accounts receivable
balances from these China government affiliated entities or state owned
enterprises were $40.4 million and $45.7 million as of June 30, 2010 and
December 31, 2009, respectively. The Company extends credit to its
customers in China generally without requiring collateral. With respect to
global sales outside of China, the Company may require letters of credit from
its customers. The Company monitors its exposure for credit losses and
maintains allowances for doubtful accounts.
Approximately
59% and 66% of the Companys sales for the three months ended June 30,
2010 and 2009, respectively, and approximately 54% and 52% of the Companys net
sales during the six months ended June 30, 2010 and 2009, respectively
were made in China. Accordingly, the political, economic and legal environment,
as well as the general state of Chinas economy may influence the Companys
business, financial condition and results of operations. The Companys
operations in China are subject to special considerations and significant risks
not typically associated with companies in the United States. These include
risks associated with, among others, the political, economic and legal
environments and foreign currency exchange. The Companys results may be
adversely affected by, among other things, changes in the political, economic
and social conditions in China, and by changes in governmental policies with
respect to laws and regulations, changes in Chinas telecommunications industry
and regulatory rules and policies, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation.
NOTE 16 - RELATED PARTY TRANSACTIONS
Softbank and affiliates
The
Company recognizes revenue with respect to sales of telecommunications
equipment to affiliates of Softbank, a significant stockholder of the Company.
Softbank offers ADSL coverage throughout Japan, which is marketed under the
name YAHOO! BB. The Company supports Softbanks fiber-to-the-home service
through sales of its carrier class GEPON product as well as its NetRing Ô product. In
addition, the Company supports Softbanks new internet protocol television (IPTV),
through sales of its RollingStream Ô product. During the three
and six months ended June 30, 2010 and 2009, the Company recognized
revenue and related cost of net sales for sales of telecommunications equipment
and services to affiliates of Softbank as follows:
Three Months Ended June 30,
Six Months Ended June 30,
2010
2009
2010
2009
(in
thousands)
Net
sales
$
10,838
$
5,033
$
21,512
$
11,198
Cost
of net sales
3,874
2,841
8,968
6,758
Gross
profit
$
6,964
$
2,192
$
12,544
$
4,440
21
Table of
Contents
Gross
profit as a percentage of net sales fluctuations are expected and generally
result from changes in product mix. In the three and six months ended June 30,
2010, gross profit as a percentage of net sales also benefited approximately $2.4
million from the release of previously deferred revenue carve-out for potential
penalty and cancellation penalties. Included in accounts receivable at June 30,
2010 and December 31, 2009 were $7.6 million and $5.5 million,
respectively, related to these transactions.
Sales
to Softbank include a three year service period and a penalty clause if product
failure rates exceed a certain level over a seven year period. As of June 30,
2010 and December 31, 2009, the Companys customer advance balance related
to Softbank agreements was $0.2 million and $0.2 million, respectively. The
current deferred revenue balance related to Softbank was $1.2 million and $1.4
million as of June 30, 2010 and December 31, 2009, respectively. As
of June 30, 2010, the Companys noncurrent deferred revenue balance
related to Softbank was $7.8 million compared to $8.8 million as of
December 31, 2009.
As
discussed in Note 6, the Company has a $1.1 million investment in SBI.
Affiliates of Softbank have a controlling interest in SBI.
As
of June 30, 2010, Softbank beneficially owned approximately 11% of the
Companys outstanding stock.
NOTE 17VARIABLE INTEREST ENTITIES
In
October 2008, the Company made an investment in Turnstone Environment
Technologies LLC (TET), a Delaware limited liability company formed for
the purpose of licensing and developing energy efficient renewable cooling
solutions for cell towers in the telecommunications industry. In exchange for
5,180,788 Series A Preferred units representing approximately 22% of
voting interest in TET and 500,000 Series A Preferred warrants at an
exercise price of $0.9265 per unit and with an expiration term of 5 years,
the Company contributed $4.8 million in cash. The Company currently does
not have any representation on TETs board of directors nor the ability to
control the management and operation decisions of TET. The operations of TET
are in the development stage and the entity is actively seeking additional
investors. The Company does not intend to and has no obligation to fund future
losses or make additional contributions other than its initial investment. As
of December 31, 2009 and 2008, TET was in effect entirely funded by the
Companys initial investment as the capital contributions of the other current
investors were not substantive. The Company determined that the venture was a
variable interest entity and the Company was the primary beneficiary because it
was exposed to the majority of the variable interest entitys expected losses.
Therefore, the Company was required to consolidate TETs financial statements
under ASC 810-10-15, Variable Interest Entities Subsections.
Beginning January 1, 2009, the assets, liabilities and operating results
of TET were consolidated into the Companys balance sheet and statement of
operations. TET had no revenues and $3.9 million in expenses for the year ended
December 31, 2009, of which $3.1 million relates to amortization of an
acquired exclusive license to utilize solar cooling technology. The Company
initially determined the appropriate amortization period for the exclusive
license was to match the estimated revenue generation period from sale of
products utilizing the licensed technology. In the third quarter of 2009, as a
result of the delay in revenue generation, the Company changed its estimate to
a systematic and rational allocation of straight-line amortization expense
based on the term of the technology license. TETs operations are not
considered to be integral to the Companys major operating activities. As such,
all income and expenses from TETs operations, which are includable in the
Companys income statement as a result of the application of ASC 810-10-15,
Variable Interest Entities Subsections,
have been classified within operating expense.
In the fourth quarter of
2009, the Company evaluated several fourth quarter events, including the
continued unsuccessful efforts of TET to secure additional funding; the
continued unsuccessful efforts of TET to locate a suitable local manufacturing
partner, TETs continued need to amend and extend payment due dates of the
acquired exclusive license to utilize solar cooling technology and the
departure of a key employee of TET. The Company determined that the combined
effect of these events, as well as others, was a triggering event for an
impairment analysis of TETs long-lived assets. The Company furthered
determined that the estimated cash flows from TET were not sufficient to
recover the carrying value of TETs net assets. As a result, the Company
recorded a $0.9 million impairment charge, included within operating expense,
equal to its initial cost of investment of $4.8 million less the cumulative
absorbed losses to date. As of December 31, 2009, the effect of
consolidating TET resulted in an immaterial impact on the consolidated balance
sheet.
22
Table of Contents
In June 2009, the FASB
issued authoritative guidance which revised the approach to identifying primary
beneficiaries from a quantitative-based risks-and rewards calculation to a
qualitative approach when assessing whether an entity has a controlling
financial interest in a variable interest entity. This analysis identifies the
primary beneficiary of a variable interest entity as one with the power to
direct the activities of a variable interest entity that most significantly
impact the entitys economic performance and the obligation to absorb losses of
the entity that could potentially be significant to the variable interest. The
Company adopted this new guidance in the first quarter of fiscal year 2010.
Under the new guidance, the Company concluded that it does not have the power
to direct the activities of TET that most significantly impact the entitys
economic performance, and therefore, is not TETs primary beneficiary which
would require consolidation. The Company further concluded that under the new
guidance it would have accounted for its initial investment under the cost
method. The new guidance also requires an enterprise upon initial adoption to
determine the carrying amount of an investment in an entity that is no longer
consolidated, as if it always had applied the provisions of the new guidance.
Because under either the consolidation model or the cost method, the
balance(s) of the assets/liabilities (investment) would be zero in the
financial statements of the Company at December 31, 2009 or
January 1, 2010, respectively, the adoption of the new guidance in the
first quarter of 2010 has no financial statement impact to the Company.
ITEM 2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This
Quarterly Report on Form 10-Q contains forward-looking statements
regarding future events and our future results that are subject to the safe
harbors created under the Securities Act of 1933 and the Securities Exchange
Act of 1934. Forward-looking statements are based on current expectations,
estimates, forecasts and projections about us, our future performance and the
industries in which we operate as well as on our managements assumptions and
beliefs. Statements that contain words like expects, anticipates, may, will,
targets, projects, intends, plans, believes, seeks, estimates, or
variations of such words and similar expressions are forward-looking
statements. In addition, any statements that refer to trends in our businesses,
future financial results, and our liquidity and business plans are
forward-looking statements. Readers are cautioned that these forward-looking
statements are only predictions and are subject to risks and uncertainties,
including those discussed in Part II, Item 1A-Risk Factors of this
Form 10-Q. Therefore, actual
results may differ materially and adversely from those expressed in any
forward-looking statements. We do not guarantee future results, and actual
results, developments and business decisions may differ from those contemplated
by those forward-looking statements. We
undertake no obligation to update these forward-looking statements to reflect
events or circumstances occurring after the date of this Form 10-Q.
EXECUTIVE SUMMARY
We
are one of the leading global providers of Internet Protocol (IP)-based
network solutions including the integration and support services sold to
telecommunications operators in both emerging and established markets around
the world. Our focus is to design and sell IP-based telecommunications
infrastructure products including our primary product suite of Internet
Protocol TV (IPTV), and broadband solutions along with the ongoing services
relating to the installation, operation and maintenance of these products.
Collectively our range of solutions is designed to expand and modernize
telecommunications networks through smooth network system integration, lower
operating costs and increased broadband access. We also provide the carriers
with increased revenue opportunities by enhancing their subscribers user
experience. The majority of our business is based in China, India and
other Asia markets. We also continue to maintain a presence in selective
markets in Latin America and Europe.
We
differentiate ourselves with products designed to reduce network complexity,
integrate high performance capabilities and allow a simple transition to next
generation networks. We design our products to facilitate cost-effective and
efficient deployment, maintenance and upgrades.
Because
our products are IP-based, our customers can more easily integrate our products
with other industry standard hardware and software. Additionally, we believe we
can introduce new features and enhancements that can be cost-effectively added
to our customers existing networks. IP-based devices can be changed or
upgraded in modules, saving our customers the expense of replacing their entire
system installation.
Overview of Our Second Quarter 2010
· In the second
quarter of 2010, we completed the sale of our manufacturing, research and
development and administrative office facility in Hangzhou, China (the Hangzhou
facility) to a third party for proceeds of approximately $138.8 million
and the leaseback of approximately one-third of the property through 2016. We
derecognized the building from our balance sheet and recorded a deferred gain
of $7.7 million at the time of sale. The deferred gain was represented by the
gross sales
23
Table of Contents
proceeds
of $138.8 million, less $7.5 million of transaction related taxes and other
fees, and less the net book value of the Hangzhou facility of $123.6 million.
The deferred gain on the sale-leaseback is being amortized in proportion to the
related gross rental charged to expense over the leaseback term.
· In June 2010,
we completed a sale of our non-core IP Messaging and US PDSN Assets as part of
our strategy to focus on core IP-based product offerings. The divested assets
were located in North America, Caribbean, and Latin America regions and were
part of the Multimedia Communications segment. Consideration for the
approximately $1.7 million of net liabilities transferred included
approximately $0.4 million cash proceeds plus potential additional contingent
consideration of up to $1.6 million. A gain of $2.1 million, net of taxes, was
recognized in June 2010 as a reduction to operating expenses. The disposal of these product lines is not
expected to have a material impact on future operating results of the
Multimedia Communications segment.
· Net sales decreased by $ 7.0 million to $73.2 million during the three months ended
June 30, 2010 compared to the same period in 2009. The decrease was
primarily due to the wind-down of our handset business which resulted in a
decrease of $11.7 million in revenue. This decrease was partially offset by the
$5.7 million increase in sales of Broadband Infrastructure segment. Accelerated amortization of $23.1 million of
PAS deferred product revenue offset the decrease in revenue of all other major
product lines of the Multimedia Communications segment.
· Gross profit was $22.9 million, or 31% of net
sales in the second quarter of 2010 compared to negative $15.8 million, or
negative 20% of net sales in the corresponding period of 2009. The overall gross profit increase both in
absolute dollars and percentage of net sales was primarily due to additional
inventory reserves and claim settlement recorded in
the second quarter of 2009 related to
certain handsets sold to PCD LLC for the Handsets segment.
· Selling, general and
administrative and research and development operating expenses decreased $13.0
million primarily as a result of lower costs as a result of restructuring and
other cost reduction initiatives, partially offset by a $0.3 million provision
for doubtful accounts during the three months ended June 30, 2010 compared
to $10.5 million recovery of doubtful accounts in the same period of 2009.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Managements
Discussion and Analysis of Financial Condition and Results of Operations is
based upon our Consolidated Condensed Financial Statements, which we have
prepared in accordance with U.S. generally accepted accounting principles. The
preparation of these financial statements requires management to make estimates
and assumptions that affect the amounts reported in our consolidated financial
statements and accompanying notes. Estimates are based on historical
experience, knowledge of economic and market factors and various other
assumptions that management believes to be reasonable under the circumstances.
Actual results may differ from those estimates.
On
a regular basis we evaluate our estimates, assumptions and judgments and make
changes accordingly. An accounting policy is deemed to be critical if it
requires an accounting estimate to be made based on assumptions about matters
that are highly uncertain at the time the estimate is made, if different
estimates reasonably could have been used, or if changes in the estimate that
are reasonably likely to occur could materially impact the financial
statements. We believe that the estimates, assumptions and judgments involved
in revenue recognition, receivables and allowances for doubtful accounts,
accruals including third party commissions payable, restructuring liabilities,
litigation and other contingencies, stock-based compensation, product warranty,
variable interest entities, inventories, deferred costs, research and
development and capitalized software development costs, income taxes,
impairment of intangible assets and long-lived assets, and valuation and impairment
of investments have the greatest potential impact on our condensed consolidated
financial statements, so we consider these to be our critical accounting
policies. Management believes that there have been no significant changes
during the six months ended June 30, 2010 to the items that we disclosed
as our critical accounting policies and estimates in Managements Discussion
and Analysis of Financial Condition and Results of Operations in our Annual
Report on Form 10-K for the year ended December 31, 2009.
RECENT ACCOUNTING PRONOUNCEMENTS
For
a description of the new accounting standards that affect us, see Note 2
of Notes to our Condensed Consolidated Financial Statements included under
Part I, Item 1 of this Quarterly Report on Form 10-Q.
RESULTS OF OPERATIONS
In
the fourth quarter of 2009, we substantially completed the wind-down of our
handset business. Except for sales relating to inventory clearing, we do not
expect any significant revenue from our handset segment in the remainder of
2010. In addition, in order to optimize our resources and improve efficiency,
beginning on January 1, 2010 we integrated our Services Segment into our
24
Table of Contents
Multimedia
Communications and Broadband Infrastructure segments based on products for
which services are performed. Effective January 1, 2010, the new reporting
segments are as follows:
· Multimedia
CommunicationsFocused on development and market opportunities in IPTV
solutions and Wireless infrastructure technologies, including related services
revenue.
· Broadband
InfrastructureFocused on our world class portfolio of broadband products,
including related services revenue.
· HandsetsFocused
on mobile phone business including PAS and CDMA handset market, as well as data
cards markets. Handset sales to PCD LLC, which commenced after the
July 1, 2008 sale of PCD, are included in this segment.
We
have reclassified our previously reported segment information for the three and
six months ended June 30, 2009 to conform to the current segment
presentation.
NET
SALES
Three
months ended June 30,
Six
months ended June 30,
2010
%
of net
sales
2009
%
of net
sales
2010
%
of
net
sales
2009
%
of
net sales
(in thousands, except percentages)
Net Sales by Segment
Multimedia
Communications
$
46,986
64
%
$
47,993
60
%
$
89,311
58
%
$
90,476
45
%
Broadband
Infrastructure
24,681
34
%
18,986
24
%
59,235
38
%
39,782
20
%
Handsets
1,498
2
%
13,184
16
%
5,466
4
%
69,245
35
%
$
73,165
100
%
$
80,163
100
%
$
154,012
100
%
$
199,503
100
%
Three months ended June 30,
Six months ended June 30,
% of net
% of net
% of
net
% of
net
2010
sales
2009
sales
2010
sales
2009
sales
(in thousands, except percentages)
Net Sales by region
United
States
$
2,450
3
%
$
1,731
2
%
$
5,903
4
%
$
42,990
22
%
China
43,211
59
%
52,531
66
%
83,186
54
%
103,749
52
%
Japan
11,137
15
%
6,505
8
%
22,233
14
%
13,042
7
%
India
6,555
9
%
9,536
12
%
12,353
8
%
19,120
10
%
Philippines
2,990
4
%
2,091
3
%
15,674
10
%
2,896
1
%
Other
6,822
10
%
7,769
9
%
14,663
10
%
17,706
8
%
Total
net sales
$
73,165
100
%
$
80,163
100
%
$
154,012
100
%
$
199,503
100
%
Three months ended June 30, 2010 and 2009
Net
sales decreased by 9% to $73.2 million during the three months ended June 30,
2010 compared to the same period in 2009.
The decrease was primarily due to the wind-down of our handset business
which resulted in a decrease of $11.7 million in revenue. This decrease was
partially offset by the $5.7 million increase in sales of Broadband
Infrastructure segment. Multimedia
Communications net sales was at $47.0 million for the three months ended June 30,
2010 as compared to $48.0 million for the same period of 2009 mainly due to the
accelerated amortization of PAS deferred product revenue offsetting the
decrease in revenue of all other major product lines of the segment.
25
Table of Contents
Six months ended June 30, 2010 and 2009
Net
sales decreased by 23% to $154.0 million during the six months ended June 30,
2010 compared to the same period in 2009.
The decrease was primarily due to the wind-down of our handset business
which resulted in a decrease of $63.8 million in revenue. This decrease was
partially offset by the $19.5 million increase in sales of Broadband
Infrastructure segment mainly due to $11.9 million MSAN product revenue
recognized from an international customer in the first quarter of 2010.
Multimedia Communications net sales was at $89.3 million for the six months
ended June 30, 2010 as compared to $90.5 million for the same period of
2009, mainly due to the accelerated amortization of PAS deferred product
revenue offsetting the decrease in revenue of all other major product lines of
the segment.
For
additional discussion, see the Segment Reporting section of this Item 2.
In
2010 and beyond, we do not expect significant new contracts for our PAS
handsets and infrastructure equipment. As of June 30, 2010, we have
approximately $141.7 million of deferred revenue associated with PAS
infrastructure sales to be recognized ratably over the expected period of
support. We review assumptions regarding the estimated post contract support
periods on a regular basis. Due to the China telecommunication industry
restructuring and launching of 3G services in China, the Ministry of Industry
and Information Technology of China announced that PAS services in China will
be phased out by January 1, 2012. In the fourth quarter of 2009, we
determined the remaining expected period of support as 2 years and hence
deferred revenue associated with PAS infrastructure is being recognized ratably
beginning in the fourth quarter of 2009 through the fourth quarter of 2011. As
a result of this change, net sales and gross profit in the first 2 quarters of
2010 were increased by approximately $25.3 million and $8.9 million,
respectively compared to the same periods in 2009. In both fiscal 2010 and
2011, total net sales and gross profit associated with the amortization of all
PAS-related deferred revenue will approximate $93 million and $33 million,
respectively.
The
economic uncertainty that we are operating in today could adversely impact our
business. However, the majority of our business is based in China and Indiatwo
countries that are still projected to have economic growth in 2010. We
currently offer and have initial market acceptance of our IPTV products in
China, India, Taiwan and other geographic regions. We believe that the
IPTV market presents a meaningful growth opportunity in these regions as well
as other regions where we have targeted to expand our IPTV offerings. Our
growth in India, however, may be adversely impacted by recent changes in India
requiring all manufacturers to satisfy certain security and supply chain
standards to the satisfaction of Indian authorities. We are pursuing
alternative long-term solutions and working with the carriers who use our
products to make sure we can satisfy these new requirements.
GROSS (LOSS) PROFIT
Three months ended June 30,
Six months ended June 30,
Gross
Gross
Gross
Gross
2010
Profit %
2009
Profit %
2010
Profit %
2009
Profit %
(in thousands, except percentages)
Gross (loss) profit by Segment
Multimedia
Communications
$
12,551
27
%
$
15,835
33
%
$
28,571
32
%
$
28,703
32
%
Broadband
Infrastructure
8,222
33
%
2,548
13
%
17,845
30
%
5,030
13
%
Handsets
2,099
140
%
(34,221
)
(260
)%
3,665
67
%
(27,919
)
(40
)%
$
22,872
31
%
$
(15,838
)
(20
)%
$
50,081
33
%
$
5,814
3
%
Cost
of sales consists primarily of material and labor costs, including stock-based
compensation, associated with manufacturing, assembly and testing of products,
costs associated with installation and customer training, warranty costs, fees
to agents, inventory write-downs and overhead. Cost of sales also includes
import taxes and tariffs on components and assemblies. Some components and
materials used in our products are purchased from a single supplier or a limited
group of suppliers and, in some cases, are subject to obtaining Chinese import
permits and approvals. Our global program to outsource our manufacturing
operations is still in progress.
Our
gross profit has been affected by average selling prices, material costs,
product mix, the impact of warranty charges and contract loss provisions as
well as inventory reserves and release of deferred revenues and related cost
pertaining to prior years. Our gross profit, as a percentage of net sales,
varies among our product families. We expect that our overall gross profit, as
a percentage of net sales, will fluctuate in the future as a result of shifts
in product mix, stage of product life cycle, anticipated decreases in average
selling prices and our ability to reduce cost of sales.
26
Table
of Contents
Three months ended June 30, 2010 and 2009
Gross
profit was $22.9 million, or 31% of net sales, in the three months ended June 30,
2010 compared to negative $15.8 million, or negative 20% of net sales, in
the corresponding period of 2009. The overall gross profit increase both in
absolute dollars and percentage of net sales was primarily due to additional
inventory reserves and claim settlement recorded in
the second quarter of 2009 related to
certain handsets sold to PCD LLC for the Handsets segment.
The increased sales of Broadband product with high margin contributed $5.7
million gross margin in the second quarter of 2010, compared to the same period
in 2009. In addition, the decrease in sales of higher margin Multimedia
Communications products was partially offset by the acceleration of PAS
deferred product revenue amortization.
Six months ended June 30, 2010 and 2009
Gross
profit was $50.1 million, or 33% of net sales, in the six months ended June 30,
2010 compared to $5.8 million, or 3% of net sales, in the corresponding
period of 2009. The overall gross profit increase both in absolute dollars and
percentage of net sales was primarily due to the acceleration
of PAS deferred product revenue amortization of Multimedia
Communications segment, increased sales of higher margin TN products in the
Broadband Infrastructure segment and less reserve in Handset segment, which was
partially offset by the loss in sales of other Multimedia Communications
products. Compared to the six months ended June 30, 2009, Broadband
Infrastructure segment contributed $12.8 million increase in gross profit in
the same period of 2010. There was $31.6 million gross profit increase in
Handset segment for the six months ended June 30, 2010 compared to the
same period in 2009 primarily due to additional inventory reserves and claim
settlement recorded in the second quarter of 2009 related
to certain handsets sold to PCD LLC, as well as
additional inventory reserves in the first quarter of 2009, partially offset by an $8.5 million decrease
to cost of sales in the Handsets segment resulting from the amortization of the
Marvell supply agreement during the first quarter of 2009 (See Note 3 of notes
to our condensed consolidated financial statements included under Part I, Item
1 of this Quarterly Report on Form 10-Q.)
For
additional discussion, see the Segment Reporting section of this Item 2.
OPERATING EXPENSES
The
following table summarizes our operating expenses:
Three months ended June 30,
Six months ended June 30,
2010
% of
net
sales
2009
% of
net
sales
2010
% of
net
sales
2009
% of
net
sales
(in thousands, except percentages)
Selling,
general and administrative
$
21,162
29
%
$
26,971
34
%
$
51,352
33
%
$
81,151
41
%
Research
and development
9,078
12
%
16,229
20
%
19,101
12
%
37,737
19
%
Restructuring
(216
)
0
%
27,757
35
%
7,291
5
%
32,576
16
%
Net
gain on divestitures
(2,056
)
(3
)%
(1,357
)
(2
)%
(3,808
)
(2
)%
(1,357
)
(1
)%
Total
net operating expenses
$
27,968
38
%
$
69,600
87
%
$
73,936
48
%
$
150,107
75
%
Selling,
general and administrative expenses (SG&A) include compensation and
benefits, professional fees, sales commissions, provision for doubtful accounts
receivable and travel and entertainment costs. Research and development (R&D)
expenses consist primarily of compensation and benefits of employees engaged in
research, design and development activities, costs of parts for prototypes,
equipment depreciation and third party development expenses. We believe that
continued and prudent investment in research and development is critical to our
long-term success, and we will aggressively evaluate appropriate investment
levels. A portion of our costs are fixed
and are difficult to quickly reduce in periods of lower sales.
SELLING, GENERAL AND ADMINISTRATIVE
Three
months ended June 30, 2010 and 2009
SG&A
expenses were $ 21.2 million for
the three months ended June 30, 2010, a decrease of $ 5.8 million as compared to $ 27.0 million for
the same period in 2009. The decrease in SG&A expense was primarily due to
a $9.4 million decrease in personnel related expenses as a result of our
restructuring plans and recent cost reduction measures, a $2.6 million
reduction in legal and accounting fees as a result of reduced activity in
investigations and litigation, a $0.8 million reduction in advertising and
marketing, sales promotions, as well as shows and exhibits expenses due to
reduced sales activities, and a $0.4 million decrease in travel related
expenses due to reduced travel activity and cost containment efforts, and a
$1.0 million decrease in facility related expenses, a $0.7
27
Table of Contents
million
reduction in other taxes, fees, licenses, and a $0.3 million reduction in
insurance as a result of the reduced cost structure. These cost savings were
partially offset by a $0.3 million provision for doubtful accounts during the
three months ended June 30, 2010 compared to $10.5 million recovery of
doubtful accounts in the same period of 2009.
Six months
ended June 30, 2010 and 2009
SG&A
expenses were $ 51.4 million for the
six months ended June 30, 2010, a decrease of $ 29.8
million as compared to $ 81.2 million for
the same period in 2009. The decrease in SG&A expense was primarily due to
a $21.1 million decrease in personnel related expenses as a result of our
restructuring plans and recent cost reduction measures, a $5.5 million
reduction in legal and accounting fees as a result of reduced activity in
investigations and litigation, a $2.1 million reduction in advertising and
marketing, sales promotions, as well as shows and exhibits expenses due to
reduced sales activities, a $0.8 million savings from reduction in the use of
outside services, and a $1.2 million decrease in travel related expenses due to
reduced travel activity and cost containment efforts and a $2.6 million
decrease in facility related expenses, a $0.8 million reduction in other taxes,
fees, licenses and a $0.7 million reduction in insurance as a result of the
reduced cost structure. These cost savings were partially offset by a $4.3
million provision for doubtful accounts compared to $2.1 million recovery of
doubtful accounts in the same period of 2009.
RESEARCH AND DEVELOPMENT
Three months ended June 30, 2010 and 2009
R&D expenses decreased by $ 7.2
million during the three months ended June 30, 2010 compared to
the same period in 2009. The decrease
was mainly due to a $ 5.6 million
decrease as a result of our restructuring plans, $ 0.2
million savings from reduction in use of outside services, and a total
of $ 1.5 million decrease in
depreciation, software license, parts and facilities related expenses as we
continued to streamline our operations and wind down our handset business unit.
Six months ended June 30, 2010 and 2009
R&D expenses decreased by $ 18.6 million
during the six months ended June 30, 2010 compared to the same period in
2009. The decrease was mainly due to a $ 13.4 million decrease as a result of our restructuring
plans, $ 1.7 million savings from
reduction in use of outside services, and a total of $ 3.4 million decrease in depreciation, software license, parts and
facilities related expenses as we continued to streamline our operations and
wind down our handset business unit.
28
Table of Contents
RESTRUCTURING
Three and six months ended June 30, 2010
During the three months ended June 30, 2010, we
recorded approximately $0.2 million net reversal of restructuring charges
recorded in previous periods. During the six months ended June 30, 2010,
we recorded approximately $7.3 million in restructuring charges.
On
June 9, 2009, our Board of Directors approved a restructuring plan (the 2009
Restructuring Plan) designed to reduce our operating costs. The 2009
Restructuring Plan includes a worldwide reduction in force of approximately 50%
of our headcount, or approximately 2,300 employees located primarily in China
and the United States and, to a lesser degree, other international locations.
During the three months ended June 30, 2010, we recorded $1.4 million
reversal of restructuring charges recorded in prior periods resulting from
change in estimate. This change in estimate resulted from voluntary resignation
of employees originally included in the restructuring plan as well as retention
of employees originally identified in the plan and to replace employees who
voluntarily resigned. Partially offsetting this reversal was approximately $0.9
million additional charges related to employees located in the United States
and other international locations as we continue to phase-out non-core
international operations. During the three months ended June 30, 2010, we
also recorded an additional $0.3 million of lease costs on exited facilities.
During the six months ended June 30, 2010, we recorded restructuring costs
of approximately $6.9 million related to the 2009 Restructuring Plan, net of
approximately $1.7 million of reversal of charges recorded in prior periods.
The restructuring costs for the six months ended June 30, 2010 consist
primarily of severance and benefits related to additional employees included in
the Restructuring Plan in the first quarter of 2010, adjusted for change in
estimate in the second quarter of 2010. Total restructuring costs recorded
through June 30, 2010 related to the 2009 Restructuring Plan
approximated $46.8 million.
During
fiscal 2008, we implemented a restructuring plan (the 2008 Restructuring Plan)
primarily related to a global reduction in force across all functions and
employee terminations at certain non-core operations which we were in the
process of winding down. The number of employees affected totaled approximately
750, including 350 in China, 200 in Korea and 200 in other locations including
the United States. During the three and six months ended June 30, 2010, we
recorded additional restructuring costs related to the 2008 Restructuring Plan
of approximately $0.1 million and $0.4 million, respectively, for
severance and benefit costs being recognized over the remaining service period
for employees included in the 2008 Restructuring Plan. Total restructuring
costs recorded through June 30, 2010 related to the 2008 Restructuring Plan approximated $19.8 million.
Three and six months ended June 30, 2009
During
the three and six months ended June 30, 2009, we recorded approximately
$27.8 million and $32.6 million, respectively, in restructuring charges. During
the second quarter of 2009, we recorded restructuring charges of approximately
$25.9 million related to the 2009 Restructuring Plan, including $24.7 million
for severance and benefits and $1.2 million related to the estimated loss on a
lease obligation that expires in 2013. During the three and six months ended June 30,
2009, the Company also recorded $1.8 million and $6.4 million, respectively, in
restructuring charges related to the 2008 Restructuring Plan. The $6.4 million restructuring charge for
the six months ended June 30, 2009 related to the 2008 Restructuring Plan
included $5.3 million for severance and benefits primarily related to the
transition of key functions to China and $1.1 million for lease termination
costs. Approximately 60 employees are affected by the transition of these key
functions to China.
The
majority of the remaining cash expenditures related to the 2009 and 2008
Restructuring Plans are expected to be paid in 2010. The remaining liabilities
related to lease obligations are expected to be settled over the remaining
lease term. We expect to incur additional restructuring charges in 2010 as we
continue to execute the 2009 and 2008 Restructuring Plans.
GAIN ON
DIVESTITURES
Three
and six months ended June 30, 2010
Gain
on divestiture for the three months ended June 30, 2010 of $2.1 million
was related to the sale of our non-core IP Messaging and US PDSN Assets in June 2010.
The divested assets were located in North America, Caribbean, and Latin America
regions and were part of the Multimedia Communications segment. Consideration
for the approximately $1.7 million of net liabilities transferred included
approximately $0.4 million cash proceeds plus potential additional contingent
consideration of up to $1.6 million. Due to the uncertainty surrounding receipt
of the contingent consideration, we have not included this amount in the gain
calculation. If and when additional
consideration is received, it will be recognized as additional gain on
divestiture. Gain on divestitures for the six months ended June 30, 2010
of approximately $3.8 million was comprised of the $2.1 million gain on sale of
IP Messaging and US PDSN Assets and $1.8 million gain on sale of the RAS
product line in the first quarter of 2010.
29
Table of Contents
Three
and six months ended June 30, 2009
Gain
on divestiture for the three and six months ended June 30, 2009 was
comprised of an additional $1.4 million gain on sale of PCD assets resulting from
and adjustment to reflect actual transaction-related costs.
STOCK-BASED COMPENSATION EXPENSE
At
June 30, 2010, there was approximately $5.8 million of total
unrecognized compensation cost not including forfeitures, as measured, related
to non-vested stock options and restricted stock and restricted stock units,
which is expected to be recognized over a weighted-average period of 2.4 years.
The following table summarizes the stock-based compensation expense in our
consolidated statement of operations:
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands)
Cost
of net Sales
$
36
$
60
$
93
$
491
Selling,
general and administrative
1,079
1,617
2,480
4,056
Research
and development
153
186
361
1,083
Restructuring
419
417
1,613
797
Total
$
1,687
$
2,280
$
4,547
$
6,427
OTHER
INCOME (EXPENSE)
INTEREST INCOME
Three and six months ended June 30, 2010 and 2009
Interest
income was $0.5 million and $0.6 million for the three months ended
June 30, 2010 and 2009, respectively. Interest income was
$0.8 million and $1.3 million for the six months ended June 30, 2010
and 2009, respectively. Interest income decreased for the six months ended
June 30, 2010 compared to the same period in 2009, primarily due to a
decline in the average interest rate.
INTEREST EXPENSE
Three and six months ended June 30, 2010 and 2009
Interest
expense was $0.1 million and $0.2 million for the three months ended
June 30, 2010 and 2009, respectively. Interest expense was
$0.1 million and $0.5 million for the six months ended June 30, 2010
and 2009, respectively. The decrease in interest expense for the three and six
months ended June 30, 2010 compared to the same period in 2009 was primarily
attributable to the decreased use of credit facilities in 2010.
OTHER INCOME (EXPENSE), NET
Three months ended June 30, 2010 and 2009
Other
expense, net was $4.8 million for the three months ended June 30,
2010 as compared to other income, net of $5.4 million for the three months
ended June 30, 2009. Other expense, net of $4.8 million for the three
months ended June 30, 2010 consisted primarily of $4.9 million of foreign
currency losses. Other income, net of $5.4
million for the three months ended June 30, 2009 consisted primarily of
foreign currency gains of $9.0 million, offset partially by a $3.8 million
other-than-temporary impairment of an equity investment.
30
Table of
Contents
S ix months ended June 30, 2010 and 2009
Other
income, net for the six months ended June 30, 2010 was $0.1 million as
compared to expense of $1.8 million for the six months ended June 30,
2009. Other income, net for the six months ended June 30, 2010 consisted
primarily of $0.9 million of foreign currency losses, offset partially by $0.4
million settlement proceeds with MRV Communications (MRV) related to our investment
in MRV which was sold in 2009, and $0.4 million of other immaterial items.
Other expense, net for the six months ended June 30, 2009 consisted
primarily of a $3.8 million other-than-temporary impairment of an equity
investment, offset partially by foreign currency gains of $1.7 million.
INCOME TAX EXPENSE
Income
tax expense is based upon a blended effective tax rate based upon our
expectation of the amount of income to be earned in each tax jurisdiction and
is accounted under the liability method. Deferred income taxes are recognized
for the differences between the tax bases of assets and liabilities and their
financial statement amounts based on enacted tax rates. Valuation allowances
are established when necessary to reduce deferred tax assets to the amount
expected to be realized. We expect to maintain a full valuation allowance on
our remaining net deferred tax assets until an appropriate level of
profitability that generates taxable income is sustained or until we are able
to develop tax strategies that would enable us to conclude that it is more
likely than not that a portion of our deferred tax assets will be realizable.
Any reversal of valuation allowances will favorably impact our results of
operations in the period of the reversal.
FASB
ASC 740-10 establishes criteria for recognizing or continuing to recognize only
more-likely-than-not tax positions, which may result in income tax expense
volatility in future periods. While we believe that we have adequately provided
for all tax positions, amounts asserted by taxing authorities could be greater
than our accrued position. Accordingly, additional provisions on income tax
related matters could be recorded in the future as revised estimates are made
or the underlying matters are settled or otherwise resolved.
Three months ended June 30, 2010 and 2009
Income
tax benefit was $0.5 million for the three months ended June 30, 2010
compared to income tax expense of $4.7 million for the three months ended June 30,
2009. In the second quarter of 2010, a
one-time tax benefit of $0.9 million was recorded mainly related to the release
of previously established valuation allowance on deferred tax assets in Taiwan
which was offset by foreign tax expenses. The decrease in income tax expense in
the three month ended June 30, 2010 compared with three month ended June 30,
2009 was primarily due to the decreased ordinary income in jurisdictions where
the Company has been profitable and a one-time tax expense of $1.4 million in
the three month ended June 30, 2009 related to establishing of valuation
allowance on net deferred tax assets in Korea.
Six
months ended June 30, 2010 and 2009
Income
tax expense was $1.8 million for the six months ended June 30, 2010
compared to $6.5 million for the six months ended June 30, 2009. The decrease in income tax expense in the six
month ended June 30, 2010 compared with six month ended June 30, 2009
was primarily due to the decreased ordinary income in jurisdictions where the
Company has been profitable and a one-time tax expense of $1.4 million in the
three month ended June 30, 2009 related to establishing of valuation
allowance on net deferred tax assets in Korea.
SEGMENT REPORTING
Summarized
below are our segment net sales and gross profit for the three and six months
ended June 30, 2010 and 2009, respectively.
Multimedia Communications
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands, except percentages)
Net sales
$
46,986
$
47,993
$
89,311
$
90,476
Gross profit
$
12,551
$
15,835
$
28,571
$
28,703
Gross profit as a percentage of net sales
27
%
33
%
32
%
32
%
31
Table of
Contents
During
the three months ended June 30, 2010, Multimedia Communications segments
sales were $47.0 million as compared to $48.0 million for the same period in
2009 as the accelerated PAS deferred product revenue amortization offset the
decrease in revenue of all other major product lines. Amortization of PAS
deferred product revenue accounted for $23.2 million or 49% of Multimedia Communication
sales for the three months ended June 30, 2010, compared to $10.5 million
or 22% for the same period in 2009. Revenue from Set Top Box (STB) product
accounted for 20% and 9% of Multimedia Communications segments in the second
quarter of 2010 and 2009, respectively.
During
the six months ended June 30, 2010, sales of Multimedia Communications
segment were $89.3 million as compared to $90.5 million for the same period in
2009 as accelerated PAS deferred product revenue amortization offset the decrease
in revenue of all other major product lines. Amortization of PAS deferred
product revenue accounted for $46.3 million or 52% of Multimedia Communications
sales for the six months ended June 30, 2010, compared to $21.0 million or
23% for the same period in 2009.
The
gross profit as a percentage of net sales decreased to 27% for the three months
ended June 30, 2010 from 33% for the corresponding period in 2009. The
decrease in gross profit percentage was mainly due to loss order provision and
inventory provision for STB and NGN products in the second quarter of 2010 as
well as an approximately $1.0 million benefit to gross profit in the second
quarter of 2009 from sales of product inventory which was previously fully
reserved. The gross profit as a percentage of net sales remained stable at 32%
for the six months ended June 30, 2010 and 2009.
In
2010 and beyond, we do not expect significant new contracts for our PAS
handsets and infrastructure equipment. We plan to aggressively pursue opportunities for
our IPTV product portfolios in multiple markets. We believe that the IPTV
market presents a meaningful growth opportunity. We currently offer and have
initial market acceptance of our IPTV products in China, India, Taiwan and
other geographic regions.
Broadband
Infrastructure
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands, except percentages)
Net sales
$
24,681
$
18,986
$
59,235
$
39,782
Gross profit
$
8,222
$
2,548
$
17,845
$
5,030
Gross profit as a percentage of net sales
33
%
13
%
30
%
13
%
Broadband
Infrastructure sales increased by 30% and 49%, respectively, during the three
and six months ended June 30, 2010 as compared to the same periods in
2009. The increase in sales for the
three months ended June 30, 2010 was due to the increase in sales of all
major product lines. The increase in sales for the six months ended June 30,
2010 was mainly due to the increase in sales of MSAN products, including $11.9
million revenue from an international customer. Also contributing to the
increase in sales for the six months ended June 30, 2010 was the increase
in sales of most major product lines, offset partially by a decrease of MSTP
sales. TN product revenue comprised approximately 9% and
1% of Broadband Infrastructure sales for the six months ended June 30,
2010 and 2009, respectively. Softbank in Japan, one of our largest
infrastructure customers, represented approximately 44% and 27% of total
Broadband sales during the three months ended June 30, 2010 and 2009,
respectively, and 36% and 28% during the six months ended June 30, 2010
and 2009, respectively.
During
the fourth quarter of 2009, we began recognizing revenue ratably on a
significant customer contract over the seven year warranty period; for the
three and six months ended June 30, 2010, we recognized revenue of $3.2
million and $6.1 million, respectively, and immaterial gross profit on this
contract.
Gross
profit percentage increase d to 33% for the three months ended June 30, 2010 from 13%
for the corresponding period of 2009. The increase in gross profit percentage was primarily due to the increase in high
margin product sales to Softbank , including approximately $2.4
million from the release of previously deferred revenue carve-out for potential
penalty and cancellation penalties, and also due to lower provision for inventory and loss order in
2010 compared to 2009. Gross profit
percentage increase d to 30% for the six months ended June 30, 2010 from 13% for
the corresponding period of 2009. The increase in gross profit percentage was primarily due to the increase in high margin
product sales to Softbank , including approximately $2.4 million from
the release of previously deferred revenue carve-out for potential penalty and
cancellation penalties, and also due to lower provision for inventory in 2010 compared to
2009, as well as the increase in sales of TN product with higher gross margin.
We
may incur additional warranty expense and inventory reserves as we introduce
new products and may be required to accrue additional contract losses for
certain fixed price contracts as these contracts progress. These factors will
result in negative impacts on our future gross margins, results of operations
and financial position.
32
Table of Contents
Handsets
Three months ended June 30,
Six months ended June 30,
2010
2009
2010
2009
(in thousands, except percentages)
Net sales
$
1,498
$
13,184
$
5,466
$
69,245
Gross profit
$
2,099
$
(34,221
)
$
3,665
$
(27,919
)
Gross profit as a percentage of net sales
140
%
(260
)%
67
%
(40
)%
Net
sales de creased by 89 % and 92% for the three and six months ended June 30, 2010,
respectively, compared to the same period in 2009. The de crease was
primarily due to the substantial wind-down of our worldwide handset business.
Except for sales related to inventory clearing, we do not expect any significant
handset revenue in 2010.
Gross
profit as a percentage of net sales increased from negative 260% for the three
months ended June 30, 2009 to 140% for the corresponding period in 2010.
The increase was due to approximately $1.5 million inventory clearing sales of
PAS and CDMA handset which was previously fully reserved and also due to
approximately $0.5 million royalty reversal. In addition, gross loss in the
second quarter of 2009 included approximately $28.7 million as a result of
transactions with PCD LLC consisting of a claim settlement of $11.1
million for product-related liability disputes and product returns and $17.6
million of costs for inventory write-downs to net realizable value, write-downs
of excess inventory and warranty reserves.
Gross
profit as a percentage of net sales increased from negative 40% for the six
months ended June 30, 2009 to 67% for the corresponding period in 2010.
The increase was mainly due to inventory clearing sales of PAS and CDMA handset
which was previously fully reserved. We incurred additional warranty reserve
recorded during the first quarter of 2009 due to additional repairs for one of
our handset products, and additional inventory reserve for our PAS handsets as
we anticipated decrease in demand after China launched its 3G networks. The
additional PAS handset inventory reserve was partially offset by a decrease to
cost of sales from the amortization of the Marvell supply agreement. In
addition, gross profit for the six months ended June 30, 2009 was also
reduced by approximately $30.0 million as a result of transactions with PCD LLC
consisting of a claim settlement of $11.1 million for product-related
liability disputes and product returns and $18.9 million of costs for inventory
write-downs to net realizable value, write-downs of excess inventory and
warranty reserves.
RELATED PARTY TRANSACTIONS
Softbank and affiliates
We
recognize revenue with respect to sales of telecommunications equipment to
affiliates of Softbank, a significant stockholder of the Company. Softbank
offers ADSL coverage throughout Japan, which is marketed under the name YAHOO!
BB. We support Softbanks fiber-to-the-home service through sales of its
carrier class GEPON product as well as its NetRing Ô product. In addition, we
support Softbanks new internet protocol television (IPTV), through sales of
its RollingStream Ô product.
During the three and six months ended June 30, 2010 and 2009, we
recognized revenue and related cost of net sales for sales of telecommunications
equipment and services to affiliates of Softbank as follows.
Three Months Ended June 30,
Six Months Ended June 30,
2010
2009
2010
2009
(in thousands)
Net
sales
$
10,838
$
5,033
$
21,512
$
11,198
Cost
of net sales
3,874
2,841
8,968
6,758
Gross
profit
$
6,964
$
2,192
$
12,544
$
4,440
Gross
profit as a percentage of net sales fluctuations are expected and generally
result from changes in product mix. In the three and six months ended June 30,
2010, gross profit as a percentage of net sales also benefited approximately $2.4
million from the release of previously deferred revenue carve-out for potential
penalty and cancellation penalties. Included in accounts receivable at June 30,
2010 and December 31, 2009 were $7.6 million and $5.5 million,
respectively, related to these transactions.
33
Table
of Contents
Sales
to Softbank include a three year service period and a penalty clause if product
failure rates exceed a certain level over a seven year period. As of June 30,
2010 and December 31, 2009, our customer advance balance related to
Softbank agreements was $0.2 million and $0.2 million, respectively. The
current deferred revenue balance related to Softbank was $1.2 million and $1.4
million as of June 30, 2010 and December 31, 2009, respectively. As
of June 30, 2010, our noncurrent deferred revenue balance related to
Softbank was $7.8 million compared to $8.8 million as of December 31,
2009.
As
discussed in Note 6 to our condensed consolidated financial statements included
under Part 1, Item 1 of this Quarterly Report on Form 10-Q, we
have a $1.1 million investment in SBI. Affiliates of Softbank have a
controlling interest in SBI.
As
of June 30, 2010, Softbank beneficially owned approximately 11% of our
outstanding stock.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and Capital Resources
The following sections discuss the effects of
changes in our balance sheet and cash flows, contractual obligations and other
commitments on our liquidity and capital resources.
Balance Sheet and Cash Flows
Cash and Cash Equivalents and Short-term
Investments
June 30,
December 31,
2010
2009
Change
(in thousands)
Cash and cash equivalents
$
306,841
$
265,843
$
40,998
Short-term investments - Bank notes
1,155
1,038
117
Total
$
307,996
$
266,881
$
41,115
Six months ended June 30,
2010
2009
Change
(in thousands)
Cash used in operating activities
$
(84,964
)
$
(37,136
)
$
(47,828
)
Cash provided by investing activities
123,692
1,267
122,425
Cash used in financing activities
(30
)
(389
)
359
Effect of exchange rate changes on cash and cash
equivalents
2,300
(749
)
3,049
Net increase (decrease) in cash and cash
equivalents
$
40,998
$
(37,007
)
$
78,005
Cash and cash equivalents, consisting
primarily of bank deposits and money market funds, are recorded at cost which
approximates fair value because of the short-term nature of these
instruments. At June 30,
2010, cash and cash equivalents approximating $213 million was held by our
subsidiaries in China.
Cash used in operating activities during the six
months ended June 30, 2010 of $85.0 million resulted primarily from the
net loss of $24.9 million, adjusted for $3.8 million gains from investing
activities, and by changes in net operating assets and liabilities using net
cash of $67.1 million, partially offset by non-cash charges including $3.4
million of depreciation and amortization, $4.5 million stock-based compensation
and $4.2 million provision for doubtful accounts. Changes in net operating
assets and liabilities using net cash during the six months ended June 30,
2010 included $25.3 million for settlement of accounts payable and $40.5
million for settlement of other liabilities as the Company continues to
streamline operations. Changes in deferred revenue of $53.5 million during the
six months ended June 30, 2010 resulted primarily from amortization of PAS
deferred product revenue. Cash used in operating activities during the six
months ended June 30, 2009 of $37.1 million resulted primarily from the net loss of $151.7 million offset
by non-cash charges including $6.9 million of depreciation and amortization,
$6.4 million stock-based compensation and also offset by changes in operating
assets and liabilities providing net cash of $99.7 million.
The decrease in sales activity in the first six months of 2009
was the primary driver of the changes in operating assets and liabilities.
34
Table of
Contents
Cash provided by investing activities during the
six months ended June 30, 2010 of $123.7 million included net proceeds
from divestiture of $1.5 million, proceeds from sale of building of $124.0
million, and changes in restricted cash of $3.0 million, offset partially by
cash outflows including $3.8 million for net purchases of short-term
investments, $1.8 million for purchases of property, plant and equipment and
$0.6 million for purchase of an investment interest. Cash outflows of
approximately $3.8 million for net purchases of short-term investments related
primarily to a non-qualified deferred compensation plan established in fiscal
2010 which allows a six-month deferral of compensation for certain employees. Cash provided by investing activities during
the six months ended June 30, 2009 was $1.3 million. No significant
investing activities occurred in the six months ended June 30, 2009.
Cash
used in financing was immaterial during the six months ended June 30, 2010
and 2009.
Accounts Receivable, Net
Accounts
receivable increased $2.0 million from $42.3 million at December 31, 2009
to $44.3 million at June 30, 2010. At June 30, 2010, our allowance
for doubtful accounts was $30.1 million on gross receivables of $74.4 million.
We recorded provision for doubtful accounts of $0.3 million and $4.3 million
for the three and six months ended June 30, 2010, respectively. We
recorded net recoveries of doubtful accounts of approximately $10.5 million and
$2.1 million for the three and six months ended June 30, 2009,
respectively, primarily due to significant collection of long-aged receivables
during the second quarter of 2009, partially offset by provision for doubtful
accounts. We assess collectability of receivables based on a number of factors
including analysis of creditworthiness, our customers historical payment
history and current economic conditions, our ability to collect payment and on
the length of time an individual receivable balance is outstanding. We have
certain accounts receivable in China that have been outstanding for a
significant period of time. We provide allowances for these receivables based
on the criteria discussed above. While we believe we have sufficient experience
and knowledge of the China market and customer payment patterns to reasonably
estimate such allowances, actual payment patterns and customer behavior could
differ from our expectations.
Inventories
and Deferred Costs
The
following table summarizes our inventories and deferred costs:
June 30
December 31,
Increase
2010
2009
(Decrease)
(in thousands)
Inventories:
Raw materials
$
8,861
$
18,863
$
(10,002
)
Work in-process
21,715
12,881
8,834
Finished goods
28,514
40,556
(12,042
)
Total inventories
$
59,090
$
72,300
$
(13,210
)
Short-term deferred costs
$
102,231
$
130,453
$
(28,222
)
Long-term deferred costs
$
180,777
$
184,978
$
(4,201
)
Inventories
consist of product held at our manufacturing facility and warehouses, as well
as finished goods at customer sites for which the customer has taken
possession, but based on specific contractual terms, title has not yet passed
to the customer. Finished goods at customer sites were approximately $21.8
million and $33.8 million at June 30, 2010 and December 31, 2009,
respectively.
Inventories
of approximately $2.9 million held by the Companys manufacturing outsource
partner are recorded in prepaids and other current assets in the condensed
consolidated balance sheet at June 30, 2010.
Liquidity
We
have incurred net losses of $225.7 million, $150.3 million and $195.6 million
during the years ended December 31, 2009, 2008 and 2007, respectively.
During the six months ended June 30, 2010, we incurred a net loss of $24.9
million. We have recorded operating losses in 21 of the 22 consecutive
quarters in the period ended June 30, 2010. At June 30, 2010, we have
an accumulated deficit of $1,092.1million. We incurred net cash outflows from
operations of $67.4 million, $55.2 million and $225.1 million in
2009, 2008 and 2007 respectively. Cash used in operations was $85.0 million
during the six months ended June 30, 2010. While operating results are
expected to improve in 2010 compared with prior years, we expect to continue to
incur losses for fiscal 2010.
35
Table of Contents
At
June 30, 2010, we had cash and cash equivalents of $306.8 million, of
which $213 million was held by our subsidiaries in China. The amount of
cash available for transfer from the China subsidiaries will be limited both by
the liquidity needs of the subsidiaries in China and the restriction on
currency exchange by Chinese-government mandated requirements including
currency exchange controls on certain transfers of funds outside of China.
At
June 30, 2010, we had approximately $28.6 million of available credit
facilities. In the second quarter of 2010, we entered
into two credit facilities totaling $29.4 million. Both credit facilities
can be used for the issuance of certain letters of credit and guarantees
and both facilities expire in the second quarter of 2011.
Global
economies have experienced a significant downturn driven by a financial and
credit crisis that will continue to challenge such economies for some period of
time. Under the current macroeconomic environment there are significant risks
and uncertainties inherent in managements ability to forecast future results.
The operating environment confronting us, both internally and externally,
raises significant uncertainties.
In
the past two years, we took a number of actions to improve our liquidity. In
March 2008, we paid $289.5 million to retire our convertible
subordinated notes and related accrued interest. On July 1, 2008, we
completed the sale of PCD. In addition, we divested our Mobile Solutions
Business Unit in July 2008. In the fourth quarter of 2008, management
initiated actions to disband our Custom Solutions Business Unit, to wind down
our Korea based handset operations, and announced initiatives including efforts
to eliminate functional duplications by consolidation of a number of functions
into our China operations. In June 2009, management expanded the
initiatives to include a worldwide reduction in workforce, outsourcing of
manufacturing operations and optimizing research and development spending with
a focus on selected products. Our year-to-year quarterly selling, general and
administrative and research and development operating expenses decreased
significantly in 2009 compared with 2008 and management believes the continuing
efforts to stream-line operations will enable our fixed cost base to be better
aligned with operations, market demand and projected sales levels. If projected
sales do not materialize, we will need to take further actions to reduce costs
and expenses or explore other cost reduction options.
In
December 2009, we entered into a Sales Leaseback Agreement for the sale of
our manufacturing, research and development, and administrative offices
facility in Hangzhou, China to another third party for approximately
$138.8 million with leaseback of a portion of the facility. On May 31,
2010, the buyer and we agreed that all conditions precedent to the closing had
been met and the leaseback commenced on June 1, 2010. As of May 31, 2010, we
had received all of the sales proceeds and met all criteria for consummation of
sale of the Hangzhou facility.
On
February 1, 2010, we entered into agreements for a strategic relationship
with Beijing E-town International Investment and Development Co., Ltd
(BEIID) which includes an investment of $48.5 million in our common
stock by BEIID, and two unrelated investment funds, Elite Noble Limited and
Shah Capital Opportunity Fund LP. These investments are expected to close
in the third quarter of 2010 and will provide additional cash for working
capital and general purposes.
Management
believes that both our China and non-China operations have sufficient liquidity
to finance working capital and capital expenditure needs during the next
12 months. There can be no assurance that additional financing, if
required, will be available on terms satisfactory to us or at all, and if funds
are raised in the future through issuance of preferred stock or debt, these
securities could have rights, privileges or preference senior to those of our
common stock and newly issued debt could contain debt covenants that impose
restrictions on our operations. Further, any sale of newly issued debt or
equity securities could result in additional dilution to our current
shareholders.
Income taxes
The
China Corporate Income Tax Law (CIT Law) became effective on January 1,
2008. Under the CIT Law, Chinas dual tax system for domestic enterprises and
foreign investment enterprises (FIEs) was effectively replaced by a unified
system. The new law establishes a tax rate of 25% for most enterprises and a
reduced tax rate of 15% for certain qualified high technology enterprises.
Prior
to this change in tax law, certain subsidiaries and joint ventures located in
China enjoyed tax benefits in China which were generally available to FIEs. The
tax holidays/incentives for FIEs were applicable or potentially applicable to
UTStarcom ChongQing Telecom Co. Ltd. (CUTS), UTStarcom
Telecom Co., Ltd. (HUTS) and UTStarcom China Co., Ltd. (UTSC),
our active subsidiaries in China, as those entities may qualify as accredited
technologically advanced enterprises.
The
CIT Law targets certain industries for the reduced 15% tax rate for certain
qualified high technology enterprises. For FIEs established before the
promulgation of the new law who had previously enjoyed lower tax rates, any
increase in their tax rates would be gradually phased in over five years.
During the fourth quarter of 2008, two of our China subsidiaries, HUTS and
UTSC, were approved for the reduced 15% tax rate. The approval lasts for three
years and is retroactive to January 1, 2008.
36
Table of Contents
The
Chinese central government may review and audit tax benefits granted by local
or provincial authorities and could determine to disallow such benefits.
Certain of our subsidiaries and joint ventures located in China enjoy tax
benefits in China that are generally available to foreign investment
enterprises. If these tax benefits are reduced, disallowed or repealed due to
changes in tax laws or determination by the Chinese government, our business
could suffer.
Off-balance sheet arrangements
At
June 30, 2010, we do not have any off-balance sheet arrangements.
Contractual obligations and other commitments
Our
obligations under contractual obligations and commercial commitments at
June 30, 2010 were as follows:
Payments Due by Period
Total
Less than
1 year
1-3
years
3-5
years
More than
5 years
(in thousands)
Operating leases
$
80,977
$
16,666
$
28,915
$
28,134
$
7,262
Letters of credit
25,419
13,745
9,114
58
2,502
Purchase commitments
33,861
33,433
428
Total
$
140,257
$
63,844
$
38,457
$
28,192
$
9,764
Operating leases
We
lease certain facilities under non-cancelable operating leases that expire at
various dates through 2013 to 2016. In connection with the Sale Leaseback
Agreement, on February 1, 2010, we entered into a Lease Contract (the Lease)
with respect to the leaseback of a portion of the Hangzhou facility. The Lease
became effective on June 1, 2010 and the contractual obligations related to the
Hangzhou facility Lease are included in the table above.
Letters of credit
We
issue standby letters of credit primarily to support international sales
activities outside of China and in support of purchase commitments. When we
submit a bid for a sale, often the potential customer will require that we
issue a bid bond or a standby letter of credit to demonstrate our commitment
through the bid process. In addition, we may be required to issue standby
letters of credit as guarantees for advance customer payments upon contract
signing or performance guarantees. The standby letters of credit usually expire
six to twelve months from date of issuance without being drawn by the beneficiary
thereof.
Purchase commitments
We
are obligated to purchase raw materials and work-in-process inventory under
various orders from various suppliers, all of which should be fulfilled without
adverse consequences material to our operations or financial condition.
Purchase commitments in the table above include agreements that are cancelable
without penalty.
Intellectual property
Certain
sales contracts include provisions under which customers would be indemnified
by us in the event of, among other things, a third-party claim against the
customer for intellectual property rights infringement related to our products.
There are no limitations on the maximum potential future payments under these
guarantees. We have not accrued any amounts in relation to these provisions as
no such claims have been made and we believe we have valid enforceable rights
to the intellectual property embedded in our products.
Uncertain tax positions
As
of June 30, 2010, we had $92.4 million of gross unrecognized tax benefits. If
recognized, the portion of gross unrecognized tax benefits that would decrease
the provision for income taxes and decrease our net loss is $14.0 million.
The impact on net loss reflects the gross unrecognized tax benefits net of
certain deferred tax assets and the federal tax benefit of state income tax
items totaling $78.4 million. We have not included these amounts in the table
of contractual obligations and commercial commitments because of the difficulty
in making reasonably reliable estimates of the timing of cash settlements with
the respective taxing authorities.
37
Table of Contents
Third Party Commissions
The
Company records accruals for commissions payable to third parties in the normal
course of business. Such commissions are recorded based on the terms of the
contracts between the Company and the third parties and paid pursuant to such
contracts. Consistent with our accounting policies, these commissions are
recorded as operating expense in the period in which the liability is incurred.
As of June 30, 2010, approximately $6.2 million of such accrued commissions had
not been claimed by the third parties for more than three years. Management has
performed, and continues to perform, follow-up procedures with respect to these
accrued commissions. Upon completion of such follow-up procedures, if the
accrued commissions have not been claimed and the statute of limitations, if any,
has expired or a reasonable period of time has elapsed, the Company will
reverse such accruals. Such reversals will be recorded in the Statement
of Operations during the period management determines that such accruals
are no longer necessary. During the six months ended June 30, 2010
approximately $0.2 million was released to cost of net sales as a result of
expiration of statute of limitations. During the six months ended June 30,
2009, no accruals were released to cost of net sales as a result of expiration
of statute of limitations.
ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We
are exposed to the impact of interest rate changes, changes in foreign currency
exchange rates and changes in the stock market.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. The fair value of our investment
portfolio would not be significantly affected by either a 10% increase or
decrease in interest rates due mainly to the short term nature of most of our
investment portfolio. However, our interest income can be sensitive to changes
in the general level of U.S and China interest rates since the majority of our
funds are invested in instruments with maturities of less than one year. In a
declining interest rate environment, as short term investments mature,
reinvestment occurs at less favorable market rates. Given the short term nature
of certain investments, anticipated declining interest rates will negatively
impact our investment income.
We maintain an investment portfolio of various holdings, types and
maturities. We do not use derivative financial instruments. We place our cash
investments in instruments that meet high credit quality standards, as
specified in our investment policy guidelines. Our policy is to limit the risk
of principal loss and to ensure the safety of invested funds by generally
attempting to limit market risk. Funds in excess of current operating
requirements are mostly invested in money market funds which are rated AAA. Our
cash and cash equivalents are not subject to significant interest rate risk due
to the short maturities of these instruments. As of June 30, 2010 the
carrying value of our cash and cash equivalents approximated fair value.
The
table below represents carrying amounts and related weighted-average interest
rates of our investment portfolio at June 30, 2010:
(in thousands, except
interest rates)
Cash and cash equivalents
$
306,841
Average interest rate
0.84
%
Restricted cash - short-term
$
22,162
Average interest rate
0.09
%
Short-term investments
$
1,155
Average interest rate
0.00
%
Restricted cash - long-term
$
12,090
Average interest rate
0.01
%
Total investment securities
$
342,248
Average interest rate
0.76
%
38
Table of Contents
Investment Risk
We
have invested in several privately held companies as well as investment funds
which invest primarily in privately held companies, many of which can still be
considered in the start-up or development stages. These investments are
inherently risky, as the market for the technologies or products they have
under development are typically in the early stages and may never materialize.
Foreign Exchange Rate Risk
As
a multinational company, we conduct our business in a wide variety of
currencies and are therefore subject to market risk for changes in foreign
exchange rates. We expect to continue to
expand our business globally and, as such, expect that an increasing proportion
of our business may be denominated in currencies other than U.S. Dollars. As a result, fluctuations in foreign
currencies may have a material impact on our business, results of operations
and financial condition.
Historically,
the majority of our foreign-currency denominated sales have been made in China,
denominated in Renminbi. Additionally, since 2006, we made significant sales in
Japanese Yen, Euros, Indian Rupees and Canadian Dollars. Due to Chinas
currency exchange control regulations, we are limited in our ability to convert
and repatriate Renminbi, as well as in our ability to engage in foreign
currency hedging activities in China. The balance of our cash held in China was
$213 million at June 30, 2010.
Since China un-pegged the Renminbi from the U.S. Dollar in July, 2005,
through June 30, 2010, the Renminbi has strengthened by more than 15% versus
the U.S. Dollar. However, it is
uncertain what further adjustments may be made in the future.
We
may manage foreign currency exposures using forward and option contracts to
hedge and thus minimize exposure to the risk of the eventual net cash inflows
and outflows resulting from foreign currency denominated transactions with
customers, suppliers, and non-U.S. subsidiaries, however, we are not currently
hedging any such transactions. As our
foreign currency balances are not currently hedged, any significant revaluation
of our foreign currency exposures may materially and adversely affect our
business, results of operation and financial condition. We do not enter into foreign exchange forward
or option contracts for trading purposes.
Given
our exposure to international markets, we regularly monitor all of our material
foreign currency exposures. We use
sensitivity analysis to measure our foreign currency risk by computing the
potential decrease in cash flows that may result from adverse or beneficial
changes in foreign exchange rates, relative to the functional currency with all
other variables held constant. The
analysis covers all of our underlying exposures for foreign currency
denominated financial instruments. The
foreign currency exchange rates used were based on market rates in effect at
June 30, 2010. The sensitivity
analysis indicated that a hypothetical 10% adverse or beneficial movement in
exchange rates would have resulted in a loss or gain in the fair values of our
foreign currency denominated financial instruments of $14.2 million at June 30,
2010.
ITEM 4CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
UTStarcom, Inc.
(UTStarcom or the Company) maintains disclosure controls and procedures
that are designed to ensure that information required to be disclosed in the
reports the Company files or submits pursuant to the Securities Exchange Act of
1934, as amended (Exchange Act), is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commissions (SEC) rules and forms, and that such information is
accumulated and communicated to the Companys management, including its chief
executive officer (CEO) and chief financial officer (CFO), as appropriate,
to allow timely decisions regarding required financial disclosure.
In
connection with the preparation of this Quarterly Report on Form 10-Q (Form 10-Q),
the Company carried out an evaluation as of June 30, 2010 under the supervision
and with the participation of the Companys management, including the CEO and
CFO, of the effectiveness of the design and operation of the Companys
disclosure controls and procedures, as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon
this evaluation, management concluded that as of June 30, 2010 the Companys
disclosure controls and procedures were not effective because of the material
weaknesses described in Managements Annual Report on Internal Control over
Financial Reporting, included in Part II, Item 9A - Controls and Procedures
(Item 9A) in the Companys Annual Report on Form 10-K for the fiscal
year ended December 31, 2009 (the 2009 Annual Report), which have not
yet been remediated. Investors are directed to Item 9A in the 2009 Annual
Report for the description of these weaknesses.
A
material weakness is a deficiency, or a combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Companys annual or interim
financial statements will not be prevented or detected on a timely basis. To
address the material weaknesses in internal control over financial reporting
noted above, the Company performed additional analyses and other procedures (as
further described below under Managements Planned Remediation Initiatives and
Interim Measures) to ensure that the Companys consolidated financial
statements were prepared in accordance with generally accepted accounting
principles in the United States (GAAP). Accordingly, the Companys management
believes that the consolidated financial statements included in this
Form 10-Q fairly present in all material respects the Companys
39
Table of Contents
financial
condition, results of operations and cash flows for the periods presented and
that this Form 10-Q does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not
misleading with respect to the periods covered by this report.
Managements Planned Remediation Initiatives and Interim
Measures
The
Company plans to make necessary changes and improvements to the overall design
of its control environment to address the material weaknesses in internal
control over financial reporting noted above. In particular, the Company
implemented during 2009 and the first and second quarters of 2010, and plans to
continue to implement during the remainder of 2010, the specific measures
described below. In addition, in connection with the June 30, 2010 quarter-end
reporting process, the Company has undertaken additional measures described
under the subheading Interim Measures below to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the
Companys consolidated financial statements included in this Form 10-Q and
to ensure that material information relating to the Company and its
consolidated subsidiaries was made known to management in connection with the
preparation of this Form 10-Q.
Remediation Initiatives
1. To remediate the material weakness described in Item 9A in the 2009
Annual Report over The recording of
reserves for losses on customer contracts, the Company transitioned
the responsibility for calculating the loss contract reserves to its local
project office in India in the third and further quarters of 2008, which
facilitated enhanced coordination between the local business units, operations,
sales and the finance teams resulting in more timely and complete information
available for the finance team to analyze. During the third quarter of 2009,
the Company finalized its assessment of additional implemented modules of its
ERP system in the operation in India, which enhanced the overall monitoring and
analysis of the various accounts and balances in India. Although we believe
that these enhanced procedures improved the accuracy of the loss reserve
calculation, they did not operate for an adequate period of time to ensure
effective remediation as of June 30, 2010. In the remainder of 2010, the
Company will continue performing the current procedures and make further
enhancements, if needed, to confirm full and effective remediation.
2. To remediate the material weakness described in Item 9A in the 2009
Annual Report over Period-end financial
reporting process the Company added technical resources to the
finance team in China in the third and fourth quarters of 2009 as well as the
first and second quarters of 2010. In the remainder of 2010, the Company will
continue its effort to consolidate and streamline its global close process in
China, to standardize the processes for such financial reviews and to ensure
the reviewers analyze and monitor financial information in a consistent and
thorough manner. Additional technical resources will enable the Company to
broaden the scope and quality of the independent reviews of underlying
information related to the Companys period-end financial reporting process.
3. To remediate the material weakness described in Item 9A in the 2009
Annual Report over internal control over
financial reporting related to revenue recognition, the Company
will continue to enhance its contracts review process in order to ensure that
appropriate members of management have reviewed and confirmed critical
information necessary to assess the proper revenue recognition accounting. The
Company will continue to assess and enhance its technical resources to broaden
the scope and quality of the independent reviews of underlying information
related to the revenue contracts.
Interim Measures
Management has not yet implemented all of the measures described above
under the heading Remediation
Initiatives and/or tested them. Nevertheless, management believes the
measures identified above to the extent they have been implemented, together
with other measures undertaken by the Company in connection with the
preparation of the condensed consolidated financial statements included in this
Form 10-Q and described below, address the material weaknesses in internal
control over financial reporting described above. These other measures include
the following:
1. Extensive reviews of the reserves for losses on customer contracts
including, in India, reviews of the inventory cost against the current cost
backlog report and reconciliation between the local cost records to the cost
records at the Companys headquarters.
2. A variety of manual review procedures, such as an extensive review
of journal entry postings into the ERP system, a thorough review of account
reconciliations, including revenue and deferred revenue accounts, and a
detailed review at its headquarters of trial balances including those issued
from decentralized locations, to ensure the completeness and accuracy of the
underlying financial information used to generate the consolidated financial
statements.
3. Various reviews of the revenue contracts and associated accounting
memos as well as the consolidated revenue schedules and fulfillment status
reports to ensure that revenue is accurately and completely recorded.
40
Table of Contents
Managements Conclusion
Management
believes the remediation measures described under Managements Planned
Remediation Initiatives and Interim Measures above will strengthen the Companys
internal control over financial reporting and remediate the material weaknesses
identified above. However, management has not yet implemented all of these
measures and/or tested them. Management believes that the interim measures
described under Managements Planned Remediation Initiatives and Interim
Measures above ensure the reliability of financial reporting and the
preparation of the Companys financial statements included in this
Form 10-Q and has discussed this with the Companys Audit Committee.
The
Company is committed to continue improving its internal control processes and
will continue to diligently and vigorously review its disclosure controls and
procedures and its internal control over financial reporting in order to ensure
compliance with the requirements of Section 404 of the Sarbanes-Oxley Act
of 2002. However, any control system, regardless of how well designed, operated
and evaluated, can provide only reasonable, not absolute, assurance that its
objectives will be met. As management continues to evaluate and work to improve
the Companys internal control over financial reporting, it may determine to
take additional or alternate measures to address control deficiencies, and it
may determine not to complete certain of the measures described under Managements
Planned Remediation Initiatives and Interim Measures above.
Changes in Internal Control over Financial Reporting
No
changes other than those described above occurred during the three months ended
June 30, 2010 in our internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
PART IIOTHER
INFORMATION
ITEM 1LEGAL PROCEEDINGS
For
a description of litigation and governmental investigations, see Note 10 to our
Condensed Consolidated Financial Statements included under Part 1, Item 1
of this Quarterly Report on Form 10-Q.
ITEM 1ARISK FACTORS
For a description of risk factors that could
materially affect our business, financial condition and future operating results,
please consider the risk factors set forth in Part I, Item 1A Risk
Factors of our Annual Report on Form 10-K for the fiscal year
ended December 31, 2009. Additional risks and uncertainties not currently
known to us or that we currently deem to be immaterial also may materially and
adversely affect our business, financial condition or future operating results.
ITEM 2UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
There
were no unregistered sales of equity securities during the period covered by
this report.
Issuer Purchases of Equity Securities
The following table summarizes the Companys stock repurchase activity
for the three months ended June 30, 2010:
Total
number of shares
Approximate
dollar value
purchased
as
of
shares that
Total
number of shares
Average
price
part
of publicly announced
may
yet be purchased under
Period
Purchased
(1)
paid
per share
plans
or programs
the
plans or programs
April 2010
$
$
May 2010
5,038
$
2.11
$
June 2010
$
$
Total
5,038
$
(1) During the second quarter of 2010, the Company
acquired 5,038 shares of common stock that employees presented to the Company
to satisfy withholding taxes in connection with the vesting of restricted stock
awards.
41
Table of Contents
ITEM 3DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4 REMOVED AND RESERVED
ITEM 5OTHER INFORMATION
None
ITEM 6EXHIBITS
Exhibit
Number
Description
Form
Incorporated
by Reference
From Exhibit
Number
Date Filed
3.1
Thirteenth
Amended and Restated Certificate of Incorporation of UTStarcom, Inc., as
amended.
8-K
3.1
12/12/2003
3.2
Second
Amended and Restated Bylaws of UTStarcom, Inc., as effective
June 28, 2008.
8-K
3.1
4/14/2008
4.1
See
exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation
and Bylaws defining the rights of holders of Common Stock.
4.2
Specimen
Common Stock Certificate.
S-1/A
4.1
2/7/2000
4.3
Third
Amended and Restated Registration Rights Agreement dated December 14,
1999.
S-1
4.2
12/20/1999
4.4
Stockholder
Rights Agreement, made as of February 1, 2010, by and between
UTStarcom, Inc. and Beijing E-town International Investment and
Development Co., Ltd.
8-K
4.1
2/4/2010
4.5
Stockholder
Rights Agreement, made as of February 1, 2010, by and among
UTStarcom, Inc., Elite Noble Limited and Shah Capital Opportunity
Fund LP.
8-K
4.2
2/4/2010
10.1
Amendment
to Common Stock Purchase Agreement dated February 1, 2010 by and between the
Company and Beijing E-town International Investment and Development Co., Ltd.
8-K
10.1
5/4/2010
10.2
Amendment
to Common Stock Purchase Agreement dated February 1, 2010 by and among the
Company, Elite Noble Limited and Shah Capital Opportunity Fund LP.
8-K
10.2
5/4/2010
10.3
*
Offer
Letter to Edmond Cheng dated April 26, 2010.
8-K
10.1
5/4/2010
10.4
*
Agreement
between Kenneth Luk and UTStarcom, Inc. dated May 3, 2010.
8-K
10.2
5/4/2010
42
Table of Contents
Exhibit
Number
Description
Form
Incorporated
by Reference
From Exhibit
Number
Date Filed
10.5
Supplementary
Agreement on Payment (translation from Chinese).
10-Q
10.11
5/10/2010
10.6
Second
Amendment to Common Stock Purchase Agreement dated February 1, 2010, as
amended on April 30, 2010, by and between the Company and Beijing E-town
International. Investment and Development Co., Ltd.
8-K
10.1
6/10/2010
10.7
Second
Amendment to Common Stock Purchase Agreement dated February 1, 2010, as
amended on April 30, 2010, by and among the Company, Elite Noble Limited and
Shah Capital Opportunity Fund LP.
8-K
10.2
6/10/2010
10.8
Third
Amendment to Common Stock Purchase Agreement dated February 1, 2010, as
amended on April 30, 2010 and June 4, 2010, by and between the Company and
Beijing E-town International Investment and Development Co., Ltd.
8-K
10.1
7/13/2010
10.9
Third
Amendment to Common Stock Purchase Agreement dated February 1, 2010, as
amended on April 30, 2010 and June 4, 2010, by and among the Company, Elite
Noble Limited and Shah Capital Opportunity Fund LP.
8-K
10.2
7/13/2010
31.1
Certification
of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
Filed herewith
31.2
Certification
of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
Filed herewith
32.1
Certifications
Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To
Section 906 of the Sarbanes-Oxley Act of 2002.
Filed herewith
* Management contract, plan or
arrangement
43
Table
of Contents
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
UTSTARCOM, INC.
Date:
August 6, 2010
By:
/s/
EDMOND CHENG
Edmond
Cheng
Senior Vice President and Chief Financial Officer
(Principal
Financial Officer)
44
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.