UTSTARCOM HOLDINGS CORP. - Quarter Report: 2010 March (Form 10-Q)

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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 March 31, 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)

 

 

Registrant’s 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):

 

 

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 April 29, 2010 there were 131,512,481 shares of the registrant’s common stock outstanding, par value $0.00125.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I—FINANCIAL INFORMATION	3
ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	3
ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	21
ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	34
ITEM 4—CONTROLS AND PROCEDURES	36
PART II—OTHER INFORMATION	38
ITEM 1—LEGAL PROCEEDINGS	38
ITEM 1A—RISK FACTORS	38
ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	38
ITEM 3—DEFAULTS UPON SENIOR SECURITIES	38
ITEM 4—REMOVED AND RESERVED	38
ITEM 5—OTHER INFORMATION	38
ITEM 6—EXHIBITS	39
SIGNATURES	41

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

UTSTARCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

		March 31,			December 31,
		2010			2009
		(In thousands, except par value)
ASSETS
Current assets:
Cash and cash equivalents		$	234,441		$	265,843
Short-term investments		279			1,038
Accounts receivable, net of allowances for doubtful accounts of $30,052 and $26,065, respectively		44,745			42,346
Notes receivable		473			1,427
Inventories		71,565			72,300
Deferred costs		127,909			130,453
Prepaids and other current assets		53,004			47,906
Short-term restricted cash		20,941			26,448
Total current assets		553,357			587,761
Property, plant and equipment, net		129,168			130,612
Long-term investments		9,001			8,402
Long-term deferred costs		173,673			184,978
Long-term deferred tax assets		4,833			4,822
Other long-term assets		12,957			12,536
Total assets		$	882,989		$	929,111
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable		$	42,333		$	54,115
Income taxes payable		—			1,130
Customer advances		131,734			120,364
Deferred revenue		170,487			170,777
Deferred tax liabilities		3,890			3,890
Other current liabilities		133,873			142,894
Total current liabilities		482,317			493,170
Long-term deferred revenue		140,316			160,932
Other long-term liabilities		19,639			18,858
Total liabilities		642,272			672,960
Commitments and contingencies (Note 10)
Equity:
UTStarcom, Inc. stockholders’ equity:
Common stock: $0.00125 par value; 750,000 authorized shares; 131,510 and 130,095 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively		153			153
Additional paid-in capital		1,254,367			1,251,532
Accumulated deficit		(1,083,137		)	(1,067,174		)
Accumulated other comprehensive income		68,546			70,848
Total UTStarcom, Inc. stockholders’ equity		239,929			255,359
Noncontrolling interests		788			792
Total equity		240,717			256,151
Total liabilities and equity		$	882,989		$	929,111

 

See accompanying notes to the condensed consolidated financial statements.

 

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UTSTARCOM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

		Three months ended March 31,
		2010			2009
		(In thousands, except per share data)
Net sales
Products		$	69,180		$	105,512
Services		11,667			13,828
		80,847			119,340
Cost of net sales
Products		46,282			87,036
Services		7,356			10,652
Gross profit		27,209			21,652
See Note 16 for net sales to related party and associated cost of net sales
Operating expenses:
Selling, general and administrative		30,190			54,180
Research and development		10,023			21,508
Restructuring		7,507			4,819
Net gain on divestiture		(1,752		)	—
Total net operating expenses		45,968			80,507
Operating loss		(18,759		)	(58,855		)
Interest income		348			749
Interest expense		(70		)	(290		)
Other income (expense), net		4,867			(7,214		)
Loss before income taxes		(13,614		)	(65,610		)
Income tax expense		(2,353		)	(1,824		)
Net loss		(15,967		)	(67,434		)
Net loss attributable to noncontrolling interests		4			1
Net loss attributable to UTStarcom, Inc.		$	(15,963	)	$	(67,433	)
Net loss per share attributable to UTStarcom, Inc. - Basic and Diluted		$	(0.12	)	$	(0.54	)
Weighted average shares used in per-share calculation - Basic and Diluted		129,415			125,731

 

See accompanying notes to the condensed consolidated financial statements.

 

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UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

		Three months ended March 31,
		2010			2009
		(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(15,967	)	$	(67,434	)
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on divestiture		(1,752		)	—
Gain on settlement of an investment interest		(422		)	—
Depreciation and amortization		1,978			3,512
Stock-based compensation expense		2,860			4,146
Provision for doubtful accounts		4,046			8,347
Other		(30		)	(158		)
Changes in operating assets and liabilities, net of dispositions:
Accounts receivable		(8,461		)	54,938
Inventories and deferred costs		19,214			8,167
Other assets		(598		)	38,006
Accounts payable		(16,860		)	(66,151		)
Income taxes payable		(539		)	3,441
Customer advances		8,979			18,525
Deferred revenue		(19,878		)	(6,191		)
Other liabilities		(16,685		)	(11,155		)
Net cash used in operating activities		(44,115		)	(12,007		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment		(470		)	(1,055		)
Proceeds from divestiture		1,500			—
Deposit received on pending sale of building		6,583			—
Change in restricted cash		4,995			2,068
Proceeds from settlement of an investment interest		422			—
Purchase of an investment interest		(563		)	—
Purchase of short-term investments		(5,102		)	(2,055		)
Proceeds from sale of short-term investments		3,264			5,341
Other		814			301
Net cash provided by investing activities		11,443			4,600
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of common stock		(25		)	—
Other		—			(163		)
Net cash used in financing activities		(25		)	(163		)
Effect of exchange rate changes on cash and cash equivalents		1,295			(2,463		)
Net decrease in cash and cash equivalents		(31,402		)	(10,033		)
Cash and cash equivalents at beginning of period		265,843			309,603
Cash and cash equivalents at end of period		$	234,441		$	299,570

 

See accompanying notes to the condensed consolidated financial statements.

 

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UTSTARCOM, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1 - BASIS OF PRESENTATION

 

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 Company’s December 31, 2009 financial statements, including the notes thereto, and the other information set forth in the Company’s 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 of assets, liabilities, revenue, costs, expenses and gains and losses not affecting retained earnings that are reported in the consolidated financial statements and accompanying disclosures. Actual results may be different. See the Company’s 2009 Annual Report for discussion of the Company’s 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 Company’s financial condition, the results of its operations and its cash flows for the periods indicated. The results of operations for the three months ended March 31, 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 $140 million with leaseback of a portion of the facility. To date, the Company has received proceeds of approximately $13.9 million on the transaction. On March 8, 2010, the Company obtained an irrevocable bank guarantee letter from the buyer for the remaining amount of the cash proceeds from the Sale Leaseback Agreement. In April 2010, an additional $55.9 million of sales proceeds were placed in escrow by the buyer. The agreement is expected to close in the second quarter of 2010.

 

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 Company’s common stock by BEIID, and two unrelated investment funds, Elite Noble Limited and Shah Capital Opportunity Fund LP. These agreements are expected to close in the second quarter of 2010.

 

Management believes that both the Company’s China and non-China operations will have sufficient liquidity to finance working capital and capital expenditure needs during the next 12 months. If the Company is not able to execute its plan successfully, the Company may need to obtain funds from equity or debt financings. 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 Company’s common stock and newly issued debt could contain debt covenants that impose restrictions on the Company’s operations. Further, any sale of newly issued debt or equity securities could result in additional dilution to the Company’s current shareholders.

 

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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 Company’s 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 Company’s potentially dilutive common shares include 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 months ended March 31, 2010 and 2009, no potential common shares were dilutive because of the net loss in the periods. Potential shares of common stock of approximately 9.2 million and 15.1 million were excluded from the diluted per share calculation for the three months ended March 31, 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 Company’s 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 Company’s consolidated financial statements.

 

At March 31, 2010, the Company had no assets and liabilities measured at fair value on a recurring basis. The Company’s money market funds are recorded at cost which approximates fair value, classified within Level 1 of the fair value hierarchy. The fair value of certain of the Company’s 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 quarter ended March 31, 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 Company’s assessment of fair value, management placed primary reliance on the market approach (the third party offer). The result of this analysis reduced the Company’s 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 Company’s overall assessment of fair value of the property at December 31, 2009 was based on Level 2 inputs.

 

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Variable Interest Entities

 

In June 2009, the FASB issued authoritative guidance requiring an enterprise to perform an analysis to determine whether the enterprise’s 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 entity’s 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 Company’s consolidated financial statements.

 

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 3—DIVESTITURES

 

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.

 

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 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 Company’s 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

 

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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 months ended March 31, 2010 and 2009 consisted of the following:

 

		Three months ended March 31,
		2010			2009
		(in thousands)
Net loss		$	(15,967	)	$	(67,434	)
Unrealized loss on investments, net of tax		—			(698		)
Foreign currency translation		(2,302		)	573
Comprehensive loss		(18,269		)	(67,559		)
Comprehensive loss attributable to noncontrolling interests (1)		(4		)	(1		)
Comprehensive loss attributable to UTStarcom, Inc.		$	(18,265	)	$	(67,558	)

 

(1)   Comprehensive loss attributable to noncontrolling interests consisted solely of net loss.

 

The changes in noncontrolling interests during the three months ended March 31, 2010 and 2009 were as follows:

 

		Three months ended March 31,
		2010			2009
		(in thousands)
Balance at beginning of period		$	792		$	808
Comprehensive loss attributable to noncontrolling interests		(4		)	(1		)
Balance at end of period		$	788		$	807

 

NOTE 5 — BALANCE SHEET DETAILS

 

As of March 31, 2010 and December 31, 2009, total inventories consisted of the following:

 

		March 31,			December 31,
		2010			2009
		(in thousands)
Inventories:
Raw materials		$	16,874		$	18,863
Work in process		15,712			12,881
Finished goods (1)		38,979			40,556
Total inventories		$	71,565		$	72,300

 

(1)   Includes finished goods at customer sites of approximately $29.1 million and $33.8 million at March 31, 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 $3.8 million held by the Company’s manufacturing outsource partner are recorded in prepaids and other current assets in the condensed consolidated balance sheet at March 31, 2010.

 

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NOTE 6 - CASH, CASH EQUIVALENTS, INVESTMENTS

 

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 March 31, 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 $0.3 million and $1.0 million at March 31, 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. No bank notes were sold during the three months ended March 31, 2010. During the three months ended March 31, 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 Company’s 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 Company’s investments in equity securities classified as long-term investments at March 31, 2010 and December 31, 2009:

 

		March 31,			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		1,070			471
Total equity securities		$	9,001		$	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 Partnership’s 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 March 31, 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 entity’s 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 — LONG-LIVED ASSETS

 

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 to a third party for approximately $140 million and the leaseback of a portion of the property through 2016. The transaction is expected to close in the second quarter of 2010, subject to customary closing conditions, including completion of required regulatory approvals.

 

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 is also required to pay a security deposit in the amount of approximately

 

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$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 on the same day when the first rent payment is due. 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.

 

At March 31, 2010 and December 31, 2009, the long-lived asset to be sold was classified as held for use as the Company expects to retain more than a minor portion of the use of the property through a six-year leaseback. The Company expects the transaction to qualify for sale-leaseback accounting upon closing. Any gain realized on the sale leaseback will be deferred and amortized over the leaseback term.

 

To date, the Company has received proceeds of approximately $13.9 million on the transaction. On March 8, 2010, the Company obtained an irrevocable bank guarantee letter from the buyer for the remaining amount of the cash proceeds from the Sale Leaseback Agreement. In April 2010, an additional $55.9 million of sales proceeds were placed in escrow by the buyer.

 

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.

 

The following table summarizes the activity related to warranty obligations during the three months ended March 31, 2010 and 2009:

 

		Three months ended March 31,
		2010			2009
		(in thousands)
Balance at beginning of period		$	16,150		$	29,840
Accruals (reversals) for warranties issued during the period, net of expirations		(1,760		)	3,582
Settlements made during the period		(2,379		)	(3,608		)
Balance at end of period		$	12,011		$	29,814

 

Certain of the Company’s 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 Company’s 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 first quarter of 2010, the Company recorded approximately $7.5 million in restructuring charges of which $7.1 million related to the 2009 Restructuring Plan and $0.4 million related to the 2008 Restructuring Plan. During the first quarter of 2009, the Company recorded approximately $4.8 million in restructuring charges of which $4.6 million related to the 2008 Restructuring Plan and $0.2 million related to the 2007 Restructuring Plan.

 

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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 Company’s operating costs. The 2009 Restructuring Plan includes a worldwide reduction in force of approximately 50% of the Company’s 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 March 31, 2010, the Company recorded restructuring costs of approximately $7.1 million related to the 2009 Restructuring Plan, net of approximately $0.3 million of reversal of charges recorded in fiscal year 2009. The restructuring costs for the three months ended March 31, 2010 consist primarily of severance and benefits related to additional employees included in the Restructuring Plan. Total restructuring costs recorded through March 31, 2010 related to the 2009 Restructuring Plan approximated $47.1 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 months ended March 31, 2010, the Company recorded additional restructuring costs related to the 2008 Restructuring Plan of approximately $0.4 million for severance and benefit costs being recognized over the remaining service period for employees included in the 2008 Restructuring Plan. During the three months ended March 31, 2009, the Company recorded $4.6 million in restructuring charges related to the 2008 Restructuring Plan including $3.4 million for severance and benefits related to the transition of key functions to China and $1.1 million for lease termination costs. Total restructuring costs recorded through March 31, 2010 related to the 2008 Restructuring Plan approximated $19.7 million.

 

2007 Restructuring Plan

 

At March 31, 2010 the restructuring accrual for the 2007 Plan included within other liabilities of approximately $0.1 million was related to a lease obligation which expires in fiscal year 2010.

 

The activity in the accrued restructuring balances related to the plans described above was as follows for the three months ended March 31, 2010:

 

		Balance at			Restructuring			Cash			Non-cash			Balance at
		December 31, 2009			Charges			Payments			Settlement			March 31, 2010
		(in thousands)
2009 Restructuring Plan
Workforce Reduction		$	16,939		$	7,042		$	(8,218	)	$	(1,194	)	$	14,569
Lease Costs		1,516			98			(132		)	—			1,482
Other Costs		6			—			—			—			6
Total 2009 Restructuring Plan		18,461			7,140			(8,350		)	(1,194		)	16,057
2008 Restructuring Plan
Workforce Reduction		$	2,526		$	397		$	(1,033	)	$	—		$	1,890
Lease Costs		385			—			(236		)	—			149
Other Costs		30			(30		)	—			—			—
Total 2008 Restructuring Plan		2,941			367			(1,269		)	—			2,039
2007 Restructuring Plan - Lease Costs		$	305		$	—		$	(183	)	$	—		$	122
Total		$	21,707		$	7,507		$	(9,802	)	$	(1,194	)	$	18,218

 

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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

 

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 alleged violations of the Securities Exchange Act of 1934, and was brought on behalf of a putative class of shareholders who purchased the Company’s 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 Court’s 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. Discovery and motion practice are ongoing in this litigation. No trial date has been set.

 

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 Company’s and individual defendants’ insurers would pay the full amount of the settlement. The Court has scheduled a preliminary approval hearing for May 10, 2010. 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 Company’s 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 Company’s 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 Company’s 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 Company’s demurrer and ordered the plaintiff to file a third amended complaint. On March 20, 2009, plaintiff filed his third amended

 

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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 Company’s 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 Company’s 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 Company’s directors and officers and various underwriters for the Company’s 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 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 Company’s common stock between March 2, 2000 and December 6, 2000. The Company’s 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.

 

In 2007, a settlement that had been pending with the Court since 2004 was terminated by stipulation of the parties to the settlement, after a ruling by the Second Circuit Court of Appeals in six test cases in the coordinated proceeding (the action involving the Company is not one of the test cases) made it unlikely that the settlement would receive final Court approval. Plaintiffs filed amended master allegations and amended complaints in the six test cases, which the defendants in those cases moved to dismiss. In 2008, the Court largely denied the defendants’ motion to dismiss the amended complaints.

 

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 Company’s 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 March 31, 2010, the Company had short-term restricted cash of $20.9 million, and had long-term restricted cash of $11.1

 

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million included in other long-term assets. The restricted cash amounts primarily collateralize the Company’s outstanding letters of credit approximating $25.7 million at March 31, 2010.

 

NOTE 11 — STOCK INCENTIVE PLANS

 

During the quarter ended March 31, 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.

 

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 Company’s 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 Company’s and each executive officer’s level of performance during the Company’s 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 Company’s 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 Company’s stock price as these awards are “marked to market” periodically until the earlier of i) the date of the Compensation Committee’s 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 Committee’s 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.

 

In February 2010, the Compensation Committee decided no new stock-based awards would be granted to senior executives for the 2010 year in light of the Company’s previously announced planned changes in management.

 

To reduce the Company’s 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.

 

The total stock-based compensation expense, including the ESPP expense described above, recognized in the condensed consolidated statement of operations for the three months ended March 31, 2010 and 2009 was as follows:

 

		Three months ended March 31,
		2010			2009
		(in thousands)
Cost of net sales		$	57		$	430
Selling, general and administrative		1,401			2,439
Research and development		208			897
Restructuring		1,194			380
Total		$	2,860		$	4,146

 

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Option activity as of March 31, 2010 and changes during the three months ended March 31, 2010 was as follows:

 

		Shares		Weighted average exercise price
		(in thousands)
Options outstanding at December 31, 2009		5,750		$	8.98
Options Granted		100		$	2.18
Options Exercised		—		$	—
Options Forfeited or expired		(473	)	$	10.36
Options outstanding at March 31, 2010		5,377		$	8.73

 

Nonvested restricted stock and restricted stock units as of March 31, 2010, and changes during the three months ended March 31, 2010, were as follows:

 

		Shares		Weighted average grant date fair value
		(in thousands)
Nonvested at December 31, 2009		4,030		$	2.38
Granted		730		$	2.43
Vested		(1,250	)	$	2.44
Forfeited		(128	)	$	1.81
Total nonvested at March 31, 2010		3,382		$	2.39

 

At March 31, 2010, there was approximately $7.4 million of total unrecognized compensation cost, 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 1.9 years. For additional information regarding the Company’s stock-based compensation plans, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

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 Company’s net loss is approximately $12.8 million. The Company reduced its total unrecognized tax benefits by approximately $26.5 million during the first quarter of 2009 due to statute of limitations expirations and settlements of income tax audits. The portion of this $26.5 million reduction of gross unrecognized tax benefits that decreased the provision for income taxes and decreased the Company’s net loss during the quarter was approximately $1.4 million.

 

As of March 31, 2010, the Company had gross unrecognized tax benefits of approximately $91.5 million and had certain deferred tax assets and the federal tax benefit of state income tax items totaling $78.1 million. If recognized, the portion of gross unrecognized tax benefits that would decrease the provision for income taxes and decrease the Company’s net loss is approximately $13.4 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 $3.2 million as of March 31, 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 Company’s tax years for 1999 through 2009 are still open for examination in China. The Company’s tax years for 2006 through 2009 are still open for examination in the

 

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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 Company’s 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 Company’s 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 Company’s expected realization of these assets is dependent on future taxable income and its ability to use foreign tax credit carryforwards and carrybacks.

 

Income tax expense was $2.4 million for the three months ended March 31, 2010 compared to $1.8 million for the three months ended March 31, 2009. Income tax expense for the three months ended March 31, 2009 included a one-time tax benefit of $2.8 million related to the recognition of previously unrecognized tax benefits and the reversal of interest and penalties due to statute of limitations expirations and income tax audit settlements. The decrease in income tax expense in the first quarter of 2010 compared with the first quarter of 2009, excluding the one-time tax benefit of $2.8 million, was primarily due to the decreased ordinary income in jurisdictions where the Company has been profitable.

 

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.

 

NOTE 13 - OTHER INCOME (EXPENSE), NET

 

Other income (expense), net for the three months ended March 31, 2010 and 2009, respectively were comprised of the following:

 

		Three months ended March 31,
		2010			2009
		(in thousands)
Foreign exchange gains (losses)		$	4,087		$	(7,258	)
Settlement with MRV Communications (1)		422			—
Other		358			44
Total		$	4,867		$	(7,214	)

 

(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. During the current period, 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 represented the Company’s 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

 

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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 Communications—Focused on development and market opportunities in IPTV solutions and Wireless infrastructure technologies, including related services revenue.

 

·                  Broadband Infrastructure—Focused on our world class portfolio of broadband products, including related services revenue.

 

·                  Handsets—Focused 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 Company’s 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.

 

Summarized below are the Company’s segment net sales, gross profit and segment margin for the three months ended March 31, 2010 and 2009 based on the current reporting segment structure. The Company has reclassified its previously reported segment information for the three months ended March 31, 2009 to conform to the current segment presentation.

 

		Three months ended March 31,
					% of net					% of net
		2010			sales		2009			sales
		(in thousands)
Net Sales by segment
Multimedia Communications		$	42,324		52	%	$	42,484		36	%
Broadband Infrastructure		34,554			43	%	20,795			17	%
Handsets		3,969			5	%	56,061			47	%
Total		$	80,847		100	%	$	119,340		100	%

 

		Three months ended March 31,
					Gross					Gross
		2010			Profit%		2009			Profit%
		(in thousands)
Gross profit by segment
Multimedia Communications		$	16,020		38	%	$	12,867		30	%
Broadband Infrastructure		9,623			28	%	2,483			12	%
Handsets		1,566			39	%	6,302			11	%
Total		$	27,209		34	%	$	21,652		18	%

 

		Three months ended March 31,
		2010			2009
		(in thousands)
Segment Margin and Operating Loss
Multimedia Communications		$	8,201		$	633
Broadband Infrastructure		6,544			(2,365		)
Handsets		1,191			236
Total segment margin		15,936			(1,496		)
General and Corporate		(34,695		)	(57,359		)
Operating Loss		$	(18,759	)	$	(58,855	)

 

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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 March 31,
					% of net					% of net
		2010			sales		2009			sales
		(in thousands)
Net Sales by region
China		$	39,975		49	%	$	51,219		43	%
United States		3,453			4	%	41,259			35	%
Japan		11,096			14	%	6,537			5	%
Philippines		12,684			16	%	805			1	%
Other		13,639			17	%	19,520			16	%
Net sales		$	80,847		100	%	$	119,340		100	%

 

Long-lived assets, consisting of property, plant and equipment, by geographical area are as follows:

 

		March 31,			December 31,
		2010			2009
		(in thousands)
United States		$	110		$	170
China		128,391			129,746
Other		667			696
Total long-lived assets		$	129,168		$	130,612

 

NOTE 15 - CREDIT RISK AND CONCENTRATION

 

At March 31, 2010, the Company’s accounts receivable balance included amounts due from Philippine Long Distance Telephone Company and Softbank Telecom representing approximately 14% and 11% of the total accounts receivable of the Company, respectively. At December 31, 2009, the Company’s accounts receivable balance included amounts due from China Telecom, JiangSu Branch representing approximately 11% of the total accounts receivable of the Company.

 

The following customers accounted for 10% or more of the Company’s net sales:

 

For the three months ended March 31,		% of net sales
2010
Philippine Long Distance Telephone Company		16	%
Softbank and affiliates		13	%
2009
PCD LLC		32	%

 

Approximately 15% and 22% of the Company’s net sales during the three months ended March 31, 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 $39.8 million and $45.7 million as of March 31, 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.

 

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Approximately 49% and 43% of the Company’s sales for the three months ended March 31, 2010 and 2009, respectively, were made in China. Accordingly, the political, economic and legal environment, as well as the general state of China’s economy may influence the Company’s business, financial condition and results of operations. The Company’s 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 Company’s 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 China’s 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 Softbank’s fiber-to-the-home service through sales of its carrier class GEPON product as well as its NetRingÔ product. In addition, the Company supports Softbank’s new internet protocol television (“IPTV”), through sales of its RollingStreamÔ product. During the three months ended March 31, 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 March 31,
		2010			2009
		(in thousands)
Net sales		$	10,674		$	6,165
Cost of net sales		5,094			3,917
Gross profit		$	5,580		$	2,248

 

Gross profit as a percentage of net sales fluctuations are expected and primarily result from changes in product mix. Included in accounts receivable at March 31, 2010 and December 31, 2009 were $10.7 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 March 31, 2010 and December 31, 2009, the Company’s 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 $1.1 million and $1.4 million as of March 31, 2010 and December 31, 2009, respectively. As of March 31, 2010, the Company’s noncurrent deferred revenue balance related to Softbank was $9.1 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 March 31, 2010, Softbank beneficially owned approximately 11% of the Company’s outstanding stock.

 

NOTE 17—VARIABLE 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 TET’s 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

 

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investment. As of December 31, 2009 and 2008, TET was in effect entirely funded by the Company’s 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 entity’s expected losses. Therefore, the Company was required to consolidate TET’s 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 Company’s 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. TET’s operations are not considered to be integral to the Company’s major operating activities. As such, all income and expenses from TET’s operations, which are includable in the Company’s 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, TET’s 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 TET’s long-lived assets. The Company furthered determined that the estimated cash flows from TET were not sufficient to recover the carrying value of TET’s 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.

 

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 entity’s 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 entity’s economic performance, and therefore, is not TET’s 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 2—MANAGEMENT’S 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 management’s 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.

 

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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 and India. We also sell to service providers in selective markets in Asia, 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 First Quarter 2010

 

·                  Net sales decreased $38.5 million to $80.8 million during the first quarter of 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 $52.1 million in revenue, partially offset by a $13.8 million increase in sales of the Broadband Infrastructure segment.

 

·                  Gross profit was $27.2 million, or 34% of net sales, in the first quarter of 2010, compared to $21.7 million, or 18% of net sales, in the corresponding period of 2009. The overall gross profit increase both in absolute dollars and percentage of net sales were primarily due to the acceleration of PAS deferred revenue amortization of Multimedia Communications segment and increased sales of higher margin TN products in the Broadband Infrastructure segment.

 

·                  Selling, general and administrative and research and development operating expenses decreased $35.5 million primarily as a result of restructuring and other cost reduction initiatives.

 

·                  During the first quarter of 2010, we recorded restructuring costs of approximately $7.5 million as we continued to execute our 2009 Restructuring Plan and prior year restructuring plans. We expect to incur additional restructuring charges in 2010 as we continue to execute the 2009 and 2008 Restructuring Plans.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Management’s 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 reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. 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.

 

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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 three months ended March 31, 2010 to the items that we disclosed as our critical accounting policies and estimates in Management’s 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 2010. In addition, in order to optimize our resources and improve efficiency, beginning on January 1, 2010 we integrated our Services Segment into our 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 Communications—Focused on development and market opportunities in IPTV solutions and Wireless infrastructure technologies, including related services revenue.

 

·                  Broadband Infrastructure—Focused on our world class portfolio of broadband products, including related services revenue.

 

·                  Handsets—Focused 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 months ended March 31, 2009 to conform to the current segment presentation.

 

NET SALES

 

		Three months ended March 31,
					% of net					% of net
		2010			sales		2009			sales
		(in thousands)
Net Sales by segment
Multimedia Communications		$	42,324		52	%	$	42,484		36	%
Broadband Infrastructure		34,554			43	%	20,795			17	%
Handsets		3,969			5	%	56,061			47	%
Net sales		$	80,847		100	%	$	119,340		100	%

 

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		Three months ended March 31,
					% of net					% of net
		2010			sales		2009			sales
		(in thousands)
Net Sales by region
China		$	39,975		49	%	$	51,219		43	%
United States		3,453			4	%	41,259			35	%
Japan		11,096			14	%	6,537			5	%
Philippines		12,684			16	%	805			1	%
Other		13,639			17	%	19,520			16	%
Net sales		$	80,847		100	%	$	119,340		100	%

 

Three months ended March 31, 2010 and 2009

 

Net sales decreased by 32% to $80.8 million during the three months ended March 31, 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 $52.1 million in revenue. This decrease was partially offset by the $13.8 million increase in sales of Broadband Infrastructure segment as we recognized $11.9 million on MSAN product revenue from an international customer. Multimedia Communications net sales remained stable at $42.3 million for the three months ended March 31, 2010, mainly due to accelerated amortization of PAS deferred product revenue.

 

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 March 31, 2010, we have approximately $165 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 launch 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 quarter of 2010 were increased by approximately $12.7 million and $4.5 million, respectively. 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 India—two 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 working with the carriers who use our product to make sure we can satisfy these new requirements.

 

GROSS PROFIT

 

		Three months ended March 31,
					Gross					Gross
		2010			Profit%		2009			Profit%
		(in thousands)
Gross profit by segment
Multimedia Communications		$	16,020		38	%	$	12,867		30	%
Broadband Infrastructure		9,623			28	%	2,483			12	%
Handsets		1,566			39	%	6,302			11	%
Total		$	27,209		34	%	$	21,652		18	%

 

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