SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2010
For the transition period from to
Commission file number: 001-33355
BigBand Networks, Inc.
(Exact name of registrant as specified in its charter)
475 Broadway Street
Redwood City, California 94063
(Address of principal executive offices and zip code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant 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 (§232.405 of this chapter) 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of August 1, 2010, 68,713,570 shares of the registrants common stock, par value $0.001 per share, were outstanding.
BigBand Networks, Inc.
FOR THE QUARTER ENDED
June 30, 2010
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
BigBand Networks, Inc.
Condensed Consolidated Balance Sheets
(Unaudited in thousands, except per share data)
See accompanying notes.
BigBand Networks, Inc.
Condensed Consolidated Statements of Operations
(Unaudited in thousands, except per share amounts)
See accompanying notes.
BigBand Networks, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited in thousands)
See accompanying notes.
BigBand Networks, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
BigBand Networks, Inc. (BigBand or the Company), headquartered in Redwood City, California, was incorporated on December 3, 1998, under the laws of the state of Delaware and commenced operations in January 1999. BigBand develops, markets and sells network-based platforms that enable cable multiple system operators and telecommunications companies to offer video services across coaxial, fiber and copper networks.
2. Summary of Significant Accounting Policies
Basis of Presentation
The condensed consolidated financial statements include accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. The accompanying condensed consolidated balance sheet as of June 30, 2010, and the condensed consolidated statements of operations for the three and six months ended June 30, 2010 and 2009, and the condensed consolidated statements of cash flows for the six months ended June 30, 2010 and 2009 are unaudited. The condensed consolidated balance sheet as of December 31, 2009 was derived from the audited consolidated financial statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2009 filed with the U.S. Securities and Exchange Commission (SEC) on March 5, 2010 (Form 10-K). The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Companys Form 10-K.
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and pursuant to the rules and regulations of the SEC as permitted by such rules. Not all of the financial information and footnotes required for complete financial statements have been presented. Management believes the unaudited condensed consolidated financial statements have been prepared on a basis consistent with the audited consolidated financial statements and include all adjustments necessary of a normal and recurring nature for a fair presentation of the Companys condensed consolidated balance sheet as of June 30, 2010, the condensed consolidated statements of operations for the three and six months ended June 30, 2010 and 2009, and the condensed consolidated statements of cash flows for the six months ended June 30, 2010 and 2009. The results for the three and six months ended June 30, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010 or for any other interim period or for any future period.
There have been no significant changes in the Companys accounting policies during the six months ended June 30, 2010 compared to the significant accounting policies described in the Companys Form 10-K.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Management uses estimates and judgments in determining recognition of revenues, valuation of inventories, valuation of stock-based awards, provision for warranty claims, the allowance for doubtful accounts, restructuring costs, valuation of goodwill and long-lived assets, and income tax amounts. Management bases its estimates and assumptions on methodologies it believes to be reasonable. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods.
The Companys software and hardware product applications are sold as solutions and its software is a significant component of these solutions. The Company provides unspecified software updates and enhancements related to products through support contracts. As a result, the Company accounts for revenues in accordance with Accounting Standards Codification (ASC) 985 Software, for each transaction, all of which involve the sale of products with a significant software component. Revenue is recognized when all of the following have occurred: (1) the Company has entered into an arrangement with a customer; (2) delivery has occurred; (3) customer payment is fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is probable.
Product revenues consist of sales of the Companys software and hardware products. Software product sales include a perpetual license to the Companys software. The Company recognizes product revenues upon shipment to its customers, including channel partners, on non-cancellable contracts and purchase orders when all revenue recognition criteria are met, or, if specified in an agreement, upon receipt of final acceptance of the product, provided all other criteria are met. End users and channel partners generally have no rights of return, stock rotation rights, or price protection. Shipping charges billed to customers are included in product revenues and the related shipping costs are included in cost of product revenues.
Substantially all of the Companys product sales have been made in combination with support services, which consist of software updates and customer support. The Companys customer service agreements allow customers to select from plans offering various levels of technical support, unspecified software upgrades and enhancements on an if-and-when-available basis. Revenues for support services are recognized on a straight-line basis over the service contract term, which is typically one year but can extend to five years for the Companys telecommunications customers. Revenues from other services, such as installation, program management and training, are recognized when the services are performed.
The Company uses the residual method to recognize revenues when a customer agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence (VSOE) of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenues. If evidence of the fair value of one or more undelivered elements does not exist, all revenues are deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element is customer support and there is no evidence of fair value for this support, revenue for the entire arrangement is bundled and revenue is recognized ratably over the service period. VSOE of fair value for elements of an arrangement is based on the normal pricing and discounting practices for those services when sold separately.
Fees are typically considered to be fixed or determinable at the inception of an arrangement based on specific products and quantities to be delivered. In the event payment terms are greater than 180 days, the fees are deemed not to be fixed or determinable and revenues are recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.
Deferred revenues consist primarily of deferred service fees (including customer support and professional services such as installation, program management and training) and product revenues, net of the associated costs. Deferred product revenue generally relates to acceptance provisions that have not been met or partial shipment or when the Company does not have VSOE of fair value on the undelivered items. When deferred revenues are recognized as revenues, the associated deferred costs are also recognized as cost of net revenues.
The Company assesses the ability to collect from its customers based on a number of factors, including the credit worthiness of the customer and the past transaction history of the customer. If the customer is not deemed credit worthy, all revenues are deferred from the arrangement until payment is received and all other revenue recognition criteria have been met.
Cash, Cash Equivalents and Marketable Securities
The Company holds its cash and cash equivalents in checking, money market and investment accounts with high credit quality financial institutions. The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.
Marketable securities consist principally of corporate debt securities, commercial paper, securities of U.S. agencies and certificates of deposit, with remaining time to maturity of two years or less. If applicable, the Company considers marketable securities with remaining time to maturity greater than one year and that have been in a consistent loss position for at least nine months to be classified as long-term, as it expects to hold them to maturity. As of June 30, 2010, the Company did not have any such securities. The Company considers all other marketable securities with remaining time to maturity of less than two years to be short-term marketable securities. The short-term marketable securities are classified as current assets because they can be readily converted into securities with a shorter remaining time to maturity or into cash. The Company determines the appropriate classification of its marketable securities at the time of purchase and re-evaluates such designations as of each balance sheet date. All marketable securities and cash equivalents in the portfolio are classified as available-for-sale and are stated at fair value, with all the associated unrealized gains and losses reported as a component of accumulated other comprehensive income (loss). Fair value is based on quoted market rates or direct and indirect observable markets for these investments. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest income. The cost of securities sold and any gains and losses on sales are based on the specific identification method.
The Company reviews its investment portfolio periodically to assess for other-than-temporary impairment in order to determine the classification of the impairment as temporary or other-than-temporary, which involves considerable judgment regarding factors such as the length of the time and the extent to which the market value has been less than amortized cost, the nature of underlying assets, and the financial condition, credit rating, market liquidity conditions and near-term prospects of the issuer. In April 2009, the Financial Accounting Standards Board (FASB) issued new guidance which was incorporated into FASB Accounting Standards Codification 320 Investments Debt and Equity Securities, which established a new method of recognizing and reporting other-than-temporary impairments of debt securities. If the fair value of a debt security is less than its amortized cost basis at the balance sheet date, an assessment would have to be made as to whether the impairment is other-than-temporary. If the Company considers it more likely than not that it will sell the security before it will recover its amortized cost basis, an other-than-temporary impairment will be considered to have occurred. An other-than temporary impairment will also be considered to have occurred if the Company does not expect to recover the entire amortized cost basis of the security, even if it does not intend to sell the security. The Company has recognized no other-than-temporary impairments for its marketable securities.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, restricted cash, accounts receivable, marketable securities, derivatives used in the Companys hedging program, accounts payable and other accrued liabilities approximate their fair value. The carrying values of the Companys other long-term liabilities and the Israeli severance pay fund assets approximate their fair value.
Credit Risk and Concentrations of Significant Customers
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash equivalents, marketable securities, accounts receivable and restricted cash. Cash equivalents, restricted cash and marketable securities are invested through major banks and financial institutions in the U.S. and Israel. Such deposits in the U.S. may be in excess of insured limits and are not insured in Israel. Management believes that the financial institutions that hold the Companys investments are financially sound and, accordingly, minimal credit risk exists with respect to these investments.
The Companys customers are impacted by several factors, including an industry downturn and tightening of access to capital. The market that the Company serves is characterized by a limited number of large customers creating a concentration of risk. To date, the Company has not incurred any significant charges related to uncollectible accounts related to large customers. The Company had three customers which individually had an accounts receivable balance of greater than 10% of the Companys total accounts receivable balance as of both June 30, 2010 and December 31, 2009.
The Company recognized revenues from two and three customers that were 10% or greater of the Companys total net revenues for the three months ended June 30, 2010 and 2009, respectively. The Company recognized revenues from two and three customers that were 10% or greater of the Companys total net revenues for the six months ended June 30, 2010 and 2009, respectively.
Inventories, net consist primarily of finished goods and are stated at the lower of standard cost or market. Standard cost approximates actual cost on the first-in, first-out method. The Company regularly monitors inventory quantities on-hand and records write-downs for excess and obsolete inventories based on the Companys estimate of demand for its products, potential obsolescence of technology, product life cycles and whether pricing trends or forecasts indicate that the carrying value of inventory exceeds its estimated selling price. These factors are impacted by market and economic conditions, technology changes, and new product introductions and require estimates that may include factors that are uncertain. If inventory is written down, a new cost basis is established that cannot be increased in future periods.
Impairment of Long-Lived Assets
The Company periodically evaluates whether changes have occurred that require revision of the remaining useful life of long-lived assets or would render them not recoverable. If such circumstances arise, the Company compares the carrying amount of the long-lived assets to the estimated future undiscounted cash flows expected to be generated by the long-lived assets. If the estimated aggregate undiscounted cash flows are less than the carrying amount of the long-lived assets, an impairment charge, calculated as the amount by which the carrying amount of the assets exceeds the fair value of the assets, is recorded. Through June 30, 2010, no impairment losses have been recognized.
The Company provides a warranty for its software and hardware products. In most cases, the Company warrants that its hardware will be free of defects in workmanship for one year, and that its software media will be free of defects for 90 days. In master purchase agreements with large customers, however, the Company often warrants that its products (hardware and software) will function in material conformance to specifications for a period ranging from one to five years from the date of shipment. In general, the Company accrues for warranty claims based on the Companys historical claims experience. In addition, the Company accrues for warranty claims based on specific events and other factors when the Company believes an exposure is probable and can be reasonably estimated. The adequacy of the accrual is reviewed on a periodic basis and adjusted, if necessary, based on additional information as it becomes available.
The Company follows ASC 740 Income Taxes, which requires the use of the liability method of accounting for income taxes. The liability method computes income taxes based on a projected effective tax rate for the full calendar year. For example, the effective tax rate for the six months ended June 30, 2010 will be based on the projected effective tax rate for the year ending December 31, 2010. The liability method includes the effects of deferred tax assets or liabilities. Deferred tax assets or liabilities are recognized for the expected tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities using the enacted tax rates that will be in effect when these differences reverse. The Company provides a valuation allowance to reduce deferred tax assets to the amount that is expected, based on whether such assets are more likely than not to be realized.
Foreign Currency Derivatives
The Company has revenues, expenses, assets and liabilities denominated in currencies other than the U.S. dollar that are subject to foreign currency risks, primarily related to expenses and liabilities denominated in the Israeli New Shekel. A foreign currency risk management program was established by the Company to help protect against the impact of foreign currency exchange rate movements on the Companys operating results. The Company does not enter into derivatives for speculative or trading purposes. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the consolidated balance sheet at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
The Company selectively hedges future expenses denominated in Israeli New Shekels by purchasing foreign currency forward contracts or combinations of purchased and sold foreign currency option contracts. When the U.S. dollar strengthens against the Israeli New Shekel, the decrease in the value of future foreign currency expenses is offset by losses in the fair value of the contracts designated as hedges. Conversely, when the U.S. dollar weakens significantly against the Israeli New Shekel, the increase in the value of future foreign currency expenses is offset by gains in the fair value of the contracts designated as hedges. The exposures are hedged using derivatives designated as cash flow hedges under ASC 815 Derivatives and Hedging. The effective portion of the derivatives gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and, on occurrence of the forecasted transaction, is subsequently reclassified to the consolidated statement of operations, primarily in research and development expenses. The ineffective portion of the gain or loss is recognized immediately in other income (expense), net. For the three and six months ended June 30, 2010 and 2009, this amount was not material. These derivative instruments generally have maturities of 180 days or less, and hence all unrealized amounts as of June 30, 2010 will have settled as of December 31, 2010.
Prior to June 30, 2010, the Company entered into foreign currency forward contracts to reduce the impact of foreign currency fluctuations on assets and liabilities denominated in currencies other than its functional currency, which is the U.S. dollar. The Company did not have any such transactions outstanding as of June 30, 2010. The Company recognized these derivative instruments as either assets or liabilities on the consolidated balance sheet at fair value. These forward exchange contracts were not accounted for as hedges; therefore, changes in the fair value of these instruments were recorded as other income (expense), net in the consolidated statement of operations. These derivative instruments generally had maturities of 90 days. Gains and losses on these contracts were intended to offset the impact of foreign exchange rate changes on the underlying foreign currency denominated assets and liabilities, primarily liabilities denominated in Israeli New Shekels, and therefore, did not subject the Company to material balance sheet risk.
All of the derivative instruments are with high quality financial institutions and the Company monitors the creditworthiness of these parties. Amounts relating to these derivative instruments were as follows (in thousands):
The change in accumulated other comprehensive income (loss) from cash flow hedges included on the Companys condensed consolidated balance sheets was as follows (in thousands):
The Company applies the fair value recognition and measurement provisions of ASC 718 Compensation Stock Compensation (ASC 718). Stock-based compensation is recorded at fair value as of the grant date and recognized as an expense over the employees requisite service period (generally the vesting period), which the Company has elected to amortize on a straight-line basis.
Recently Issued Accounting Standards
In October 2009, the FASB issued ASU 2009-13 Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements a consensus of the FASB Emerging Issues Task Force (ASU 2009-13) and ASU 2009-14 Software (Topic 985): Certain Revenue Arrangements That Include Software Elements a consensus of the FASB Emerging Issues Task Force (ASU 2009-14). ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. ASU 2009-13 and ASU 2009-14 are effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company is currently evaluating the potential impact of the adoption of ASU 2009-13 and ASU 2009-14 on its consolidated financial position, results of operations or cash flows.
3. Basic and Diluted Net (Loss) Income per Common Share
The computation of basic and diluted net (loss) income per common share was as follows (in thousands, except per share data):
As of June 30, 2010 and 2009, the Company had securities outstanding that could potentially dilute basic net income (loss) per common share in the future, but were excluded from the computation of net (loss) income per common share for the periods presented as their effect would have been anti-dilutive as follows (shares in thousands):
4. Fair Value
The fair value of the Companys cash equivalents and marketable securities is determined in accordance with ASC 820 Fair Value Measurements and Disclosures (ASC 820). ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. 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. As a basis for considering such assumptions, ASC 820 establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (Level 1), inputs other than the quoted prices in active markets that are observable either directly or indirectly (Level 2) and unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions (Level 3). This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. For the Companys Level 2 investments, fair value was derived from non-binding market consensus prices that were corroborated by observable market data, quoted market prices for similar instruments, or pricing models, such as discounted cash flow techniques, with all significant inputs derived from or corroborated by observable market data. The Companys discounted cash flow techniques use observable market inputs, such as LIBOR-based yield curves.
The Companys fair value measurements of its financial assets (cash, cash equivalents and marketable securities) as of June 30, 2010 were as follows (in thousands):
The Companys fair value measurements of its financial assets (cash, cash equivalents and marketable securities) as of December 31, 2009 were as follows (in thousands):
In addition to the amounts disclosed in the above table, the fair value of the Companys Israeli severance pay assets, which were almost fully comprised of Level 2 assets, was $4.1 million and $3.6 million as of June 30, 2010 and December 31, 2009, respectively.
5. Balance Sheet Data
Marketable securities included available-for-sale securities as follows (in thousands):
The fair value of investments showing unrealized loss (none of which had been in a continuous loss position for more than nine months) was $46.7 million and $54.0 million as of June 30, 2010 and December 31, 2009, respectively. The contractual maturity date of the available-for-sale securities was as follows (in thousands):
Inventories, net were comprised entirely of finished goods as of June 30, 2010 and December 31, 2009.
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets were comprised as follows (in thousands):
Property and Equipment, Net
Property and equipment, net is stated at cost, less accumulated depreciation. Depreciation is calculated using the straight-line method and recorded over the assets estimated useful lives of 18 months to seven years. Property and equipment, net was comprised as follows (in thousands):
Goodwill is carried at cost and is not amortized. The carrying value of goodwill was approximately $1.7 million as of June 30, 2010 and December 31, 2009. Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired. The Company considered several factors including management structure and the nature of operations and concluded that it has only one reporting unit. Consistent with this determination, it reviewed the carrying amount of this unit compared to its fair value based on quoted market prices of the Companys common stock. Following this approach, through June 30, 2010, no impairment losses have been recognized.
Other Non-current Assets
Other non-current assets were comprised as follows (in thousands):
Deferred Revenues, Net
Deferred revenues, net were as follows (in thousands):
Other liabilities were comprised as follows (in thousands):
Activity related to product warranty was as follows (in thousands):
6. Restructuring Charges
On May 4, 2010, the Audit Committee under designation of the Board of Directors authorized a restructuring plan pursuant to which 31 employees and 11 contractors were terminated. On February 9, 2009, the Audit Committee under designation of the Board of Directors authorized a restructuring plan pursuant to which employees were terminated. These plans were made in response to market and economic conditions. On October 29, 2007, the Audit Committee under designation of the Board of Directors authorized a restructuring plan in connection with the retirement of the Companys CMTS product line pursuant to which employees were terminated and facilities were vacated. The Company incurred additional charges related to this October 29, 2007 plan for the six months ended June, 30, 2010 and 2009 to adjust its restructuring liability for changes in estimated sublease rentals associated with the facility. All of the restructuring plans were essentially complete as of June 30, 2010. Charges incurred with these restructuring plans were as follows (in thousands):
Restructuring activity for the six months ended June 30, 2010 was as follows (in thousands):
7. Legal Proceedings
BigBand Networks, Inc. v. Imagine Communications, Inc., Case No. 07-351
On June 5, 2007, the Company filed suit against Imagine Communications, Inc. in the U.S. District Court, District of Delaware, alleging infringement of certain U.S. Patents covering advanced video processing and bandwidth management techniques. The lawsuit seeks injunctive relief, along with monetary damages for willful infringement. The Company is subject to certain counterclaims by which Imagine Communications, Inc. has challenged the validity and enforceability of the Companys asserted patents. The Company intends to defend itself vigorously against such counterclaims. No trial date has been set. At this stage of the proceeding, it is not possible for the Company to quantify the extent of potential liabilities, if any, resulting from the alleged counterclaims.
In connection with the settlement of the Companys federal securities litigation (In re BigBand Networks, Inc. Securities Litigation, Case No. C07-5101-SBA) as ordered by the U.S. District Court for the Northern District of California on September 22, 2009, the related shareholder derivative lawsuit (Ifrah v. Bassan-Eskenazi, et. al., Case No. 468401) was dismissed by the Superior Court for the County of San Mateo, California on September 23, 2009, and the state securities litigation (Wiltjer v. Bassan-Eskenazi, et. al., Case No. CGC-07-469661) was dismissed by the Superior Court for the City and County of San Francisco on October 27, 2009. As of June 30, 2010 and December 31, 2009, the Company had no further significant obligations under these lawsuits.
8. Stockholders Equity
The Company allocated stock-based compensation expense as follows (in thousands):
Equity Incentive Plans
Since March 15, 2007, the Company has granted all options and restricted stock units (RSUs) under its 2007 Equity Incentive Plan (2007 Plan). The 2007 Plan allows the Company to award incentive and non-qualified stock options, restricted stock, RSUs and stock appreciation rights to employees, officers, directors and consultants of the Company. Options under the 2007 Plan are granted at an exercise price that equals the closing value of the Companys common stock on the date of grant, generally are exercisable in installments vesting over a four-year period and generally have a maximum term of ten years from the date of grant. The Company creates newly issued shares for all share transactions with employees.
The Company has options outstanding under its 1999, 2001 and 2003 share option and incentive plans (collectively the Prior Plans). Cancelled or forfeited stock option grants under the Prior Plans are added to the total amount of shares available for grant under the 2007 Plan.
The 2007 Plan contains an evergreen provision, pursuant to which the number of shares available for issuance under the 2007 Plan shall be increased on the first day of the fiscal year, in an amount equal to the least of (a) 6,000,000 shares, (b) 5% of the outstanding Shares on the last day of the immediately preceding fiscal year or (c) such number of shares determined by the Board of Directors. Shares available for future issuance under the 2007 Plan were as follows (in thousands):
Data pertaining to stock option activity under all the plans was as follows (in thousands, except per share and period data):
The intrinsic value of an outstanding option is calculated based on the difference between its exercise price and the closing price of the Companys common stock on the last trading date in the year, or in the case of an exercised option, it is based on the difference between its exercise price and the actual fair market value of the Companys common stock on the date of exercise. Stock options with exercise prices greater than the closing price of the Companys common stock on the last trading day of the year have an intrinsic value of zero. The aggregate intrinsic values for options outstanding in the preceding table are based on the Companys closing stock prices of $3.02 and $3.44 per share as of June 30, 2010 and December 31, 2009, respectively. As of June 30, 2010, total unrecognized stock compensation expense relating to unvested stock options, adjusted for estimated forfeitures, was $15.8 million. This amount is expected to be recognized over a weighted-average period of 2.9 years.
Restricted Stock Units
RSU grants under the 2007 Plan generally vest in increments over two to four years from the date of grant. The RSUs are classified as equity awards because the RSUs are paid only in shares upon vesting. RSU awards are measured at the fair value at the date of grant, which corresponds to the closing stock price of the Companys common stock on the date of grant. The Companys RSU activity was as follows (in thousands, except per share data):
As of June 30, 2010, total unrecognized stock compensation expense relating to unvested RSUs, adjusted for estimated forfeitures, was $12.2 million. This amount is expected to be recognized over a weighted-average period of 2.5 years.
On June 11, 2010, the Company granted 388,000 RSUs to certain employees, some or all of which may vest based on achievement of 2010 incentive compensation plan targets, or be cancelled and returned to shares available for future issuance. The Company also granted 91,000 RSUs which vest in five years; however, vesting will accelerate if certain stock performance criteria are attained. The stock compensation expense for these RSUs will be expensed over their estimated vesting period and was immaterial for the three months ended June 30, 2010.
Employee Stock Purchase Plan
Under the Companys 2007 Employee Stock Purchase Plan (ESPP), employees may purchase shares of common stock at a price per share that is 85% of the fair market value of the Companys common stock as of the beginning or the end of each six month offering period, whichever is lower. The ESPP contains an evergreen provision, pursuant to which an annual increase may be added on the first day of each fiscal year, equal to the least of (i) 3,000,000 shares of the Companys common stock, (ii) 2% of the outstanding shares of the Companys common stock on the first day of the fiscal year or (iii) an amount determined by the Board of Directors. The ESPP is compensatory in nature, and therefore results in compensation expense. The Company recorded stock-based compensation expense associated with its ESPP of $74,000 and $0.2 million for the three and six months ended June 30, 2010, respectively. The Company recorded stock-based compensation expense associated with its ESPP of $0.2 million and $0.4 million for the three and six months ended June 30, 2009, respectively. Shares available for future issuance under the ESPP were as follows (in thousands):
Stock-Based Compensation Assumptions
The Company uses the Black-Scholes option-pricing model to determine the fair value of stock-based awards, including ESPP awards, under ASC 718. This model incorporates various subjective assumptions including expected volatility, expected term and interest rates. The fair value of each new option awarded was estimated on the grant date using the assumptions noted as follows:
The computation of expected volatility is derived primarily from the weighted historical volatilities of several comparable companies within the cable and telecommunications equipment industry and to a lesser extent, the Companys weighted historical volatility following its IPO in March 2007. The risk-free interest factor is based on the U.S. Treasury yield curve in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to each grants expected term. For all periods presented, the Company has elected to use the simplified method of determining the expected term as permitted by SEC Staff Accounting Bulletin (SAB) 107 as revised by SAB 110. The Company estimates its forfeiture rate based on an analysis of its actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior, and other factors. Estimates, including achievement of incentive compensation plan targets, are evaluated each reporting period and adjusted, if necessary, by recognizing the cumulative effect of the change in estimate on compensation costs recognized in prior year periods.
9. Segment Reporting
The Company has a single reporting segment. Enterprise-wide disclosures related to revenues and long-lived assets are described below. Net revenues by geographical region were allocated based on the shipping destination of customer orders, and were as follows (in thousands):
Long-lived assets, net of depreciation were as follows (in thousands):
10. Income Taxes
As part of the process of preparing its unaudited condensed consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating the current tax liability under the most recent tax laws and assessing temporary differences resulting from the differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included on the unaudited condensed consolidated balance sheets.
Income tax benefit was $0.3 million and $0.2 million for the three and six months ended June 30, 2010, respectively. Income tax expense was $0.3 million and $0.5 million for the three and six months ended June 30, 2009, respectively. The benefit for the three months ended June 30, 2010 was primarily related to the release of reserves pertaining to the Israeli tax provisions upon finalization of the tax audit for fiscal years from 2004 through 2007. The effective tax rates for these periods differed from the U.S. federal statutory rate primarily due to the differential in foreign tax rates on cost-plus foreign jurisdictions, non deductible stock compensation expense, other currently non-deductible items, movement in the Companys valuation allowance and various discrete items.
11. Comprehensive (Loss) Income
The components of comprehensive (loss) income were as follows (in thousands):
Other comprehensive (loss) income was as follows (in thousands):
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as may, will, expect, believe, anticipate, project, intend, could, estimate, or continue, and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from the future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled Risk Factors and those included elsewhere in this Form 10-Q. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
We develop, market and sell network-based platforms that enable cable multiple system operators (MSOs) and telecommunications companies (collectively, service providers) to offer video services across coaxial, fiber and copper networks. We were incorporated in Delaware in December 1998. Since that time, we have developed significant expertise in rich media processing, communications networking and bandwidth management. Our customers are using our platforms to expand high-definition television (HDTV) services, and enable high-quality video advertising programming to subscribers. Our Broadcast Video, TelcoTV, Switched Digital Video and IPTV (Personalized Video) solutions are comprised of a combination of software and programmable hardware platforms. We have sold our solutions to more than 200 customers globally. We sell our products and services to customers in the U.S. and Canada through our direct sales force. Domestically, our customers include Bright House, Cablevision, Charter, Comcast, Cox, Time Warner Cable and Verizon, which are seven of the ten largest service providers in the U.S. We sell to customers internationally through a combination of direct sales and resellers. Our largest international resellers include Beijing Bupt-Guoan, Ssangyong, and Sugys, who sell to end users such as Jiangsu Cable and LG Telecom.
Net Revenues. We derive our net revenues principally from our video products, which are comprised of a combination of software licenses and programmable hardware platforms, and our service offerings. Our sales cycle typically ranges from six to eighteen months, but can be longer if the sale relates to new product introductions. Our sales process generally involves several stages before we can recognize revenues on the sale of our products. As a provider of advanced technologies, we seek to actively participate with our existing and potential customers in the evaluation of their technology needs and network architectures, including the development of initial designs and prototypes. Following these activities, we typically respond to a service providers request for proposal, configure our products to work within our customers network architecture, and test our products first in laboratory testing and then in field environments to ensure interoperability with existing products in the service providers network. Following testing, our revenue recognition generally depends on satisfying the acceptance criteria specified in our contract with the customer and our customers schedule for roll-out of the product. Completion of several of these stages is substantially outside of our control, which causes our revenue patterns from a given customer to vary widely from period to period. After initial deployment of our products, subsequent purchases of our products typically have a more compressed sales cycle.
Due to the concentrated nature of the cable and telecommunications industries, we sell our products to a limited number of large customers. Within a given quarter, our revenues from our large customers can vary significantly based upon their budgetary cycles and implementation schedules. For the three months ended June 30, 2010 and 2009, we derived approximately 79% and 78%, respectively, of our net revenues from our top five customers. For the six months ended June 30, 2010 and 2009, we derived approximately 73% and 78%, respectively, of our net revenues from our top five customers. We believe that for the foreseeable future our net revenues will continue to be highly concentrated in a limited number of large customers. The loss of one or more of our large customers, or the cancellation or deferral of purchases by one or more of these customers, would have a material adverse impact on our revenues and operating results. We often recognize a substantial portion of our revenues in the last month of a quarter, which limits our visibility to estimated future revenues, product mix and gross margins.
Our service revenues include ongoing customer support and maintenance, product installation and training. Our customer support and maintenance is available in a tiered offering at either a standard or an enhanced level. The majority of our customers have purchased our enhanced level of customer support and maintenance. Our accounting for revenues is complex, and we account for revenues in accordance with applicable U.S. generally accepted accounting principles (GAAP).
Cost of Net Revenues. Our cost of product revenues consists primarily of payments for components and product assembly, costs of product testing, provisions recorded for excess and obsolete inventory, provisions recorded for warranty obligations, manufacturing overhead and allocated facilities and information technology expense. Cost of service revenues is primarily comprised of personnel
costs in providing technical support, costs incurred to support deployment and installation within our customers networks, training costs and allocated facilities and information technology expense.
Gross Margin. Our gross profit as a percentage of net revenues, or gross margin, has been and will continue to be affected by a variety of factors, including the mix of software, hardware and services sold, and the average selling prices of our products. We achieve a higher gross margin on the software content of our products compared to the hardware content. In general, we expect the average selling prices of our products to decline over time due to competitive pricing pressures, but we seek to minimize the impact to our gross margins by introducing new products with higher margins, selling software enhancements to existing products, achieving price reductions for components and improving product design to reduce costs. Our gross margins for products are also influenced by the specific terms of our contracts, which may vary significantly from customer to customer based on the type of products sold, the overall size of the customers order, and the architecture of the customers network, which can influence the amount and complexity of design, integration and installation services.
Operating Expenses. Our operating expenses consist of research and development, sales and marketing, general and administrative, restructuring and other charges. Personnel-related costs are the most significant component of our operating expenses. We currently expect our headcount to remain relatively flat in the near term. We expect our operating expenses to decline in absolute dollars for the three months ending September 30, 2010 compared to the three months ended June 30, 2010 as we remain cautious about our spending in the near term.
Research and development expense is the largest functional component of our operating expenses and consists primarily of personnel costs, independent contractor costs, prototype expenses, and other allocated facilities and information technology expense. All research and development costs are expensed as incurred. Our development teams are located in Tel Aviv, Israel; Shenzhen, China; Westborough, Massachusetts and Redwood City, California. We expect our research and development expense to decrease in absolute dollars for the three months ending September 30, 2010 compared to the three months ended June 30, 2010, primarily due to a reduction in both personnel and independent contractor costs following our May 2010 restructuring plan.
Sales and marketing expense relates primarily to compensation and associated costs for marketing and sales personnel, sales commissions, promotional and other marketing expenses, travel, trade-show expenses and allocated facilities and information technology expense. Marketing programs are intended to generate revenues from new and existing customers and are expensed as incurred. We expect sales and marketing expense to decrease modestly in absolute dollars for the three months ending September 30, 2010 compared to the three months ended June 30, 2010.
General and administrative expense consists primarily of compensation and associated costs for general and administrative personnel, professional services and allocated facilities and information technology expenses. Professional services consist of outside legal, accounting and other consulting costs. We expect general and administrative expense to increase modestly in absolute dollars for the three months ending September 30, 2010 compared to the three months ended June 30, 2010, primarily due to legal fees related to a lawsuit filed by us against Imagine Communications, Inc. alleging patent infringement, and other overhead expenses.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP, and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of our condensed consolidated financial statements requires our management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the applicable periods. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our condensed consolidated financial statements, which, in turn, could change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.
Critical accounting policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements include accounting for revenue recognition, the valuation of inventories, warranty liabilities, stock- based compensation, the allowance for doubtful accounts, the impairment of long-lived assets, and income taxes, the policies of which are discussed under the caption Critical Accounting Policies and Estimates in our 2009 Form 10-K filed with the SEC on March 5, 2010. For additional information on the recent accounting pronouncements impacting our business, see Note 2 of the Notes to Condensed Consolidated Financial Statements.
Results of Operations
The percentage relationships of the listed items from our condensed consolidated statements of operations as a percentage of total net revenues were as follows:
Total net revenues decreased 32.4% to $26.4 million for the three months ended June 30, 2010 from $39.0 million for the three months ended June 30, 2009. The $12.6 million decrease was due to a $7.0 million decrease in service revenues and a $5.6 million decrease in product revenues.
Total net revenues decreased 29.3% to $58.6 million for the six months ended June 30, 2010 from $82.9 million for the six months ended June 30, 2009. The $24.3 million decrease was due to a $14.7 million decrease in product revenues and a $9.6 million decrease in service revenues.
Revenues from our top five customers comprised approximately 79% and 78% of net revenues for the three months ended June 30, 2010 and 2009, respectively. Revenues from our top five customers comprised approximately 73% and 78% of net revenues for the six months ended June 30, 2010 and 2009, respectively. Time Warner Cable and Verizon each represented 10% or more of our net revenues for the three and six months ended June 30, 2010. Charter Communications, Time Warner Cable and Verizon each represented 10% or more of our net revenues for both the three and six months ended June 30, 2009.
Time Warner Cable represented slightly more than 35% of our net revenues for the three months ended June 30, 2010 compared to less than 20% of our net revenues for the three months ended June 30, 2009. The increase as a percentage of total revenues and in absolute dollars was attributable to a multi-site roll out of both our Broadcast Video and Switched Digital Video solutions during the three months ended June 30, 2010. For the six months ended June 30, 2010, Time Warner Cable represented approximately 40% of our net revenues compared to slightly less than 30% for the six months ended June 30, 2009. While net revenues from Time Warner Cable remained relatively flat in absolute dollars, it increased as a percentage of total net revenues due to the relative decrease in net revenues from our other customers.
Verizon represented slightly more than 20% of our net revenues for the three months ended June 30, 2010 compared to more than 30% of our net revenues for the three months ended June 30, 2009. For the six months ended June 30, 2010, Verizon represented slightly more than 15% of our net revenues compared to slightly more than 20% for the six months ended June 30, 2009. The decrease was due to a decline in order volume as Verizon slowed the rollout of its FiOS system which we expect to continue for the remainder of 2010.
Net revenues by geographical region based on the shipping destination of customer orders as a percentage of total net revenues were as follows:
Product Revenues. Product revenues decreased 25.3% to $16.6 million for the three months ended June 30, 2010 from $22.2 million for the three months ended June 30, 2009. The $5.6 million decrease was primarily due to a $3.2 million decrease in Switched Digital Video revenues attributable to delays in closing orders for both new customer deployments as well as expansion projects from our existing customers. Additionally, TelcoTV revenues decreased by $1.7 million primarily due to a slowdown in the rollout of the FiOS system by Verizon. We expect both of these trends to continue for the three months ending September 30, 2010.
Product revenues decreased 26.1% to $41.5 million for the six months ended June 30, 2010 from $56.1 million for the six months ended June 30, 2009. The decrease was primarily due to a $12.5 million decrease in Switched Digital Video revenues and a $1.3 million decrease in TelcoTV revenues. This was partially offset by a $0.8 million increase in Broadcast Video revenues. Data revenues decreased $1.6 million related the retirement of our CMTS platform products in October 2007.
Service Revenues. Service revenues decreased 41.8% to $9.8 million for the three months ended June 30, 2010 from $16.8 million for the three months ended June 30, 2009. The $7.0 million decrease was primarily due to the recognition of $5.6 million of previously deferred service revenues from a large TelcoTV customer related to analog technology that was transitioned to digital technology during the three months ended June 30, 2009, which did not occur in the comparable 2010 period. Additionally, video installation and training revenues decreased $1.2 million as a result of a decline in new customer orders.
Service revenues decreased 36.0% to $17.1 million for the six months ended June 30, 2010 from $26.8 million for the six months ended June 30, 2009. The decrease was primarily due to the previously described $5.6 million recognition of service revenues from decommissioned analog technology, a $2.1 million decrease in Broadcast Video customer support and maintenance revenues due to a decline in pricing from our installed base of customers and a $1.4 million decrease in video installation and training revenues.
Gross Profit and Gross Margin
Gross Profit. Gross profit decreased 44.2% to $14.0 million for the three months ended June 30, 2010 from $25.0 million for the three months ended June 30, 2009. Gross margin decreased to 52.9% for the three months ended June 30, 2010 compared to 64.0% for the three months ended June 30, 2009.
Gross profit decreased 42.8% to $29.0 million for the six months ended June 30, 2010 from $50.6 million for the six months ended June 30, 2009. Gross margin decreased to 49.5% for the six months ended June 30, 2010 compared to 61.1% for the six months ended June 30, 2009.
Product Gross Margin. Product gross margin for the three months ended June 30, 2010 was 43.4% compared to 50.9% for the three months ended June 30, 2009. This decrease was primarily due to lower absorption of fixed manufacturing costs, a higher concentration of revenues being generated from lower margin hardware products, continued downward pricing pressure and higher warranty expense. Warranty expense increased $0.6 million, primarily related to a $0.5 million benefit from the reversal of warranty reserves from analog technology that was transitioned to digital technology during the three months ended June 30, 2009, which did not occur in the comparable 2010 period. Product gross margin for the three months ended June 30, 2010 and 2009 included stock-based compensation expense of $0.4 million and $0.3 million, respectively.
Product gross margin for the six months ended June 30, 2010 was 43.8% compared to 53.7% for the six months ended June 30, 2009. This decrease was primarily due to a higher concentration of revenues being generated from lower margin hardware products and continued downward pricing pressure. Warranty expense increased $0.3 million, primarily related to a $0.5 million benefit from the reversal of warranty reserves related to analog products during the three months ended June 30, 2009. Product gross margin for the six months ended June 30, 2010 and 2009 included stock-based compensation expense of $0.7 million and $0.6 million, respectively.
Services Gross Margin. Services gross margin for the three months ended June 30, 2010 was 69.0% compared to 81.5% for the three months ended June 30, 2009. The decrease was primarily due to a $7.0 million decrease in service revenues, primarily attributable to a $5.6 million recognition of deferred service revenues from analog technology that was transitioned to digital technology with no related cost of service during the three months ended June 30, 2009, which did not occur in the comparable 2010 period. Services gross margin for the three months ended June 30, 2010 and 2009 included stock-based compensation expense of $0.3 million and $0.2 million, respectively.
Services gross margin for the six months ended June 30, 2010 was 63.2% compared to 76.5% for the six months ended June 30, 2009. The decrease was primarily due to a $9.6 million decrease in service revenues, primarily attributable to a $5.6 million
recognition of deferred service revenues from analog technology that was transitioned to digital technology with no related cost of service during the six months ended June 30, 2009, which did not occur in the comparable 2010 period. Services gross margin for the three months ended June 30, 2010 and 2009 included stock-based compensation expense of $0.5 million and $0.4 million, respectively.
Research and Development. Research and development expense was $13.1 million for the three months ended June 30, 2010, or 49.7% of net revenues, compared to $11.1 million for the three months ended June 30, 2009, or 28.5% of net revenues. The increase in absolute dollars was primarily due to a $0.8 million increase in independent contractor costs in Tel Aviv, Israel to accelerate certain new products to market. Salary and related benefits increased by $0.6 million due to an 18.7% increase in headcount, primarily in Shenzhen, China. Research and development expense for the three months ended June 30, 2010 and 2009 included stock-based compensation expense of $1.4 million and $1.2 million, respectively.
Research and development expense was $26.6 million for the six months ended June 30, 2010, or 45.4% of net revenues, compared to $22.6 million for the six months ended June 30, 2009, or 27.3% of net revenues. The increase in absolute dollars was primarily due to a $1.9 million increase in independent contractor costs, a $1.0 million increase in compensation expense related to an increase in headcount, and a $0.5 million increase in stock-based compensation expense. Research and development expense for the six months ended June 30, 2010 and 2009 included stock-based compensation expense of $2.7 million and $2.2 million, respectively.
Sales and Marketing. Sales and marketing expense was $6.0 million for the three months ended June 30, 2010, or 22.7% of net revenues, compared to $5.9 million for the three months ended June 30, 2009, or 15.0% of net revenues. Sales and marketing expense for both the three months ended June 30, 2010 and 2009 included stock-based compensation expense of $0.6 million.
Sales and marketing expense was $12.0 million for the six months ended June 30, 2010, or 20.5% of net revenues, compared to $12.3 million for the three months ended June 30, 2009, or 14.8% of net revenues. The decrease in absolute dollars was primarily due to $0.4 million decrease in compensation expense, which was attributable to a reduction in headcount, partially offset by an increase of $0.2 million in stock-based compensation expense. Sales and marketing expense for the six months ended June 30, 2010 and 2009 included stock-based compensation expense of $1.3 million and $1.1 million, respectively.
General and Administrative. General and administrative expense was $4.0 million for the three months ended June 30, 2010, or 15.2% of net revenues, compared to $5.0 million for the three months ended June 30, 2009, or 12.8% of net revenues. The decrease was primarily due to a $0.4 million decrease in salary and related benefits and a $0.3 million decrease in litigation-related activities. General and administrative expense for the three months ended June 30, 2010 and 2009 included stock-based compensation expense of $1.0 million and $1.2 million, respectively.
General and administrative expense was $8.5 million for the six months ended June 30, 2010, or 14.6% of net revenues, compared to $9.5 million for the six months ended June 30, 2009, or 11.5% of net revenues. The decrease was primarily due to a $0.5 million decrease in bonus expense as a result of a decline in our financial performance, and a $0.5 million decrease in litigation-related activities. General and administrative expense for the six months ended June 30, 2010 and 2009 included stock-based compensation expense of $2.2 million and $2.3 million, respectively.
Restructuring Charges. Restructuring charges were $1.0 million for the three and six months ended June 30, 2010 and zero and $1.4 million for the three and six months ended June 30, 2009, respectively. The 2010 charges included $0.7 million related to a restructuring plan pursuant to which employees and subcontractors were terminated, and $0.3 million to fully reserve for a facility vacated in October 2007, which we no longer believe we can sublease. The 2009 restructuring charges included $0.7 million related to a restructuring plan pursuant to which employees were terminated and $0.7 million related to lower projected sublease income for a facility vacated in October 2007.
Interest income was $0.3 million for the three months ended June 30, 2010 compared to $0.7 million for the three months ended June 30, 2009. Interest income was $0.9 million for the six months ended June 30, 2010 compared to $1.6 million for the six months ended June 30, 2009. The decreases in interest income were primarily attributable to lower interest rates. Our cash, cash equivalents and marketable securities decreased $10.2 million to $163.1 million as of June 30, 2010 from $173.3 million as of June 30, 2009.
Other (expense) income, net
Other (expense) income, net, which consists primarily of foreign exchange gains (losses), was an expense of $95,000 for the three months ended June 30, 2010 compared to income of $130,000 for the three months ended June 30, 2009. Other (expense) income, net, was an expense of $0.2 million for the six months ended June 30, 2010 compared to an expense of $93,000 for the six months ended June 30, 2009.
(Benefit from) provision for income taxes
Income tax benefit for the three months ended June 30, 2010 was $0.3 million, or 3.2%, on a pre-tax loss of $10.0 million, compared to tax expense of $0.3 million, or 9.4%, on pre-tax income of $3.4 million for the three months ended June 30, 2009. The benefit for the three months ended June 30, 2010 was primarily related to the release of reserves pertaining to the Israeli tax provisions upon finalization of the tax audit for fiscal years from 2004 through 2007. Income tax benefit for the six months ended June 30, 2010 was $0.2 million, or 0.8%, on a pre-tax loss of $18.6 million, compared to tax expense of $0.5 million, or 9.3%, on pre-tax income of $5.9 million for the six months ended June 30, 2009. The difference between our effective tax rates and the federal statutory rate of 35% is primarily attributable to the differential in foreign tax rates on cost-plus foreign jurisdictions, non deductible stock compensation expense, other currently non-deductible items, movement in our valuation allowance and various discrete items.
We maintained a valuation allowance as of June 30, 2010 against certain of our deferred tax assets because, based on the available evidence, we believe it is more likely than not that we would not be able to utilize these deferred tax assets in the future. We intend to maintain this valuation allowance until sufficient evidence exists to support its reduction. We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans and estimates. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted.
We had gross unrecognized tax benefits of approximately $2.7 million and $3.4 million as of June 30, 2010 and December 31, 2009, respectively. We expect the unrecognized tax benefits to remain unchanged for the next 12 months.
Our policy to include interest and penalties related to unrecognized tax benefits within our provision for income taxes did not change since December 31, 2010. Our major tax jurisdictions are the U.S. and Israel. The tax years 2000 through 2009 remain open and subject to examination by the appropriate governmental agencies in the U.S. and the tax years 2007 through 2009 remain open and subject to examination by the appropriate governmental agencies in Israel.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through private and public sales of equity securities and from cash provided by operations. As of June 30, 2010, we had no long-term debt outstanding.
Cash, cash equivalents and marketable securities. We had approximately $163.1 million of cash, cash equivalents, and marketable securities as of June 30, 2010 compared to $171.9 million as of December 31, 2009. The decrease was primarily due to net cash used in operating activities in the six months ended June 30, 2010, as we continued to invest in our development efforts in support of new solutions, which have not generated significant cash to date. Marketable securities consist principally of corporate debt securities, commercial paper and securities of U.S. agencies with remaining time to maturity of two years or less.
The key line items affecting cash from operating activities were as follows (in thousands):
Our operating activities used cash of $7.6 million for the six months ended June 30, 2010. This was primarily due to our $6.8 million net loss before non-cash charges and a $7.5 million decrease in accounts payable and accrued and other liabilities primarily due to lower purchasing and timing of payments in 2010, partially offset by a decrease in accounts receivable of $11.9 million following strong customer collections. Our operating activities used cash of $1.2 million for the six months ended June 30, 2009. This was primarily due to a decrease in deferred revenues of $20.7 million as a result of customer acceptance activity for a number of roll outs during the six months ended June 30, 2009. This decrease was offset by income before non-cash charges of $16.5 million and a decrease in accounts receivable of $13.2 million mainly as a result of customer collections.
Our investing activities provided cash of $14.4 million for the six months ended June 30, 2010, primarily from maturities and sales, net of purchases, of marketable securities of $16.7 million, partially offset by the purchase of property and equipment, primarily computer and engineering equipment of $2.4 million. Our investing activities used cash of $16.7 million for the six months ended June 30, 2009, primarily from purchases, net of maturities and sales, of marketable securities, of $13.5 million, the purchase of property and equipment, primarily computer and engineering equipment of $2.1 million, and the purchase of a software license of $1.2 million.
Our financing activities provided cash of $1.3 million and $3.2 million for the six months ended June 30, 2010 and 2009, respectively, through the exercise of stock options under our equity incentive plans and sale of stock under our employee stock purchase plan.
Liquidity and Capital Resource Requirements
We believe that our existing sources of liquidity combined with cash generated from operations will be sufficient to meet our currently anticipated cash requirements for at least the next 12 months. However, the networking industry is capital intensive. In order to remain competitive, we must constantly evaluate the need to make significant investments in products and in research and development. We may seek additional equity or debt financing from time to time to maintain or expand our product lines or research and development efforts, or for other strategic purposes such as acquisitions. The timing and amount of any such financing requirements will depend on a number of factors, including demand for our products, changes in industry conditions, product mix, competitive factors and the timing of any strategic acquisitions. There can be no assurance that such financing will be available on acceptable terms, and any additional equity financing would result in incremental ownership dilution to our existing stockholders.
Contractual Obligations and Commitments
Our contractual obligations as of June 30, 2010 were as follows (in thousands):
Off-Balance Sheet Arrangements
As of June 30, 2010, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.
Effects of Inflation
Our monetary assets, consisting primarily of cash, marketable securities and receivables, are not materially affected by inflation because they are short-term in duration. Our non-monetary assets, consisting primarily of inventory, intangible assets, goodwill and prepaid expenses and other assets, are not affected significantly by inflation. We believe that the impact of inflation on the replacement costs of our equipment, furniture and leasehold improvements will not materially affect our operations. However, the rate of inflation affects our cost of goods sold and operating expenses, such as those for employee compensation, which may not be readily recoverable in the price of the products and services offered by us.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without exposing us to significant risk of loss. The securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of our investment to fluctuate. We maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The risk associated with fluctuating interest rates is not limited to our investment portfolio. As of June 30, 2010, our investments were primarily in commercial paper, corporate notes and bonds, money market funds and U.S.
government and agency securities. If overall interest rates fell 10% for the three months ended June 30, 2010, our interest income would have decreased by an immaterial amount, assuming consistent investment levels.
Foreign Currency Risk
Our sales contracts are primarily denominated in U.S. dollars, and therefore the majority of our revenues are not subject to foreign currency risk. However, if we extend credit to international customers and the U.S. dollar appreciates against our customers local currency, there is an increased collection risk as it will require more local currency to settle our U.S. dollar invoice.
Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Israeli New Shekel, and to a lesser extent the Chinese Yuan and Euro. To help protect against significant fluctuations in value and the volatility of future cash flows caused by changes in currency exchange rates, we have foreign currency risk management programs to hedge both balance sheet items and future forecasted expenses denominated in Israeli New Shekels. An adverse change in exchange rates of 10% for the Israeli New Shekel, Chinese Yuan and Euro, without any hedging of the Israeli New Shekel, would have resulted in an increase in our loss before taxes of approximately $0.8 million for the three months ended June 30, 2010.
We continue to hedge our projected exposure to exchange rate fluctuations between the U.S. dollar and the Israeli New Shekel, and accordingly, we do not anticipate that these fluctuations will have a material impact on our financial results for the three months ending June 30, 2010. Currency forward contracts and currency options are generally utilized in these hedging programs. Our hedging programs are intended to reduce, but not eliminate, the impact of currency exchange rate movements. As our hedging program is relatively short-term in nature, a long-term material change in the value of the U.S. dollar versus the Israeli New Shekel could adversely impact our operating expenses in the future.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Securities Exchange Act of 1934, as amended, we evaluated under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Managements assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance because a control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control systems objectives will be met.
Changes in Internal Control over Financial Reporting
During the three months ended June 30, 2010, there was no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
A discussion of our current litigation is disclosed in the notes to our condensed consolidated financial statements. See Notes to Condensed Consolidated Financial Statements, Note 7 Legal Proceedings in Part I, Item 1 of this quarterly report on Form 10-Q.
Item 1A. RISK FACTORS
An investment in our equity securities involves significant risks. Any of these risks, as well as other risks not currently known to us or that we currently consider immaterial, could have a material adverse effect on our business, prospects, financial condition or operating results. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing the risks described below, you should also refer to the other information contained in this Form 10-Q, including our consolidated financial statements and the related notes, before deciding to purchase any shares of our common stock.
We depend on cable multiple system operators (MSOs) and telecommunications companies adopting advanced technologies for substantially all of our net revenues, and any decrease or delay in capital spending for these advanced technologies would harm our operating results, financial condition and cash flows.
Almost all of our sales depend on cable MSOs and telecommunications companies adopting advanced technologies, and we expect these sales to continue to constitute a significant majority of our revenues for the foreseeable future. Demand for our products will depend on the magnitude and timing of capital spending by service providers on advanced technologies for constructing and upgrading their network infrastructure, and a reduction or delay in this spending could have a material adverse effect on our business.
The capital spending patterns of our existing and potential customers are dependent on a variety of factors, including:
Since 2009, we have seen reduced capital spending by our customers for our key products. Any continued slowdown or delay in the capital spending by service providers for our products as a result of any of the above factors would likely have a significant adverse impact on our quarterly revenue and net losses.
Our operating results are likely to fluctuate significantly and may fail to meet or exceed the expectations of securities analysts or investors or our guidance, causing our stock price to decline.
Our operating results have fluctuated in the past and are likely to continue to fluctuate, on an annual and a quarterly basis, as a result of a number of factors, many of which are outside our control. These factors include:
We establish our expenditure levels for product development and other operating expenses based on projected sales levels, and our expenses are relatively fixed in the short term. Accordingly, variations in the timing of our sales can cause significant fluctuations in our operating results. As a result of all these factors, our operating results in one or more future periods may fail to meet or exceed the expectations of securities analysts or investors or our guidance, which would likely cause the trading price of our common stock to decline substantially.
Our customer base is highly concentrated, and there are a limited number of potential customers for our products. The loss of any of our key customers would likely reduce our revenues significantly.
Historically, a large portion of our sales have been to a limited number of large customers. Our five largest customers accounted for approximately 73% of our net revenues for the six months ended June 30, 2010, compared to 78% of our net revenues for the six months ended June 30, 2009. Time Warner Cable and Verizon each represented 10% or more of our net revenues for the six months ended June 30, 2010. Charter Communications, Time Warner Cable and Verizon each represented 10% or more of our net revenues for the six months ended June 30, 2009. We believe that for the foreseeable future our net revenues will be concentrated in a limited number of large customers.
We anticipate that a large portion of our revenues will continue to depend on sales to a limited number of customers, and we do not have contracts or other agreements that guarantee continued sales to these or any other customers. Consequently, reduced capital expenditures by any one of our larger customers (whether caused by adverse financial conditions, more cautious spending patterns due to the ongoing economic uncertainty or other factors) is likely to have a material negative impact on our operating results. For example, Verizon slowed the rollout of its FiOS system in 2009, which will continue to negatively impact our revenues. In addition, as the consolidation of ownership of cable MSOs and telecommunications companies continues, we may lose existing customers and have access to a shrinking pool of potential customers. We expect to see continuing industry consolidation due to the significant capital costs of constructing video, voice and data networks and for other reasons. Further business combinations may occur in our customer base, which will likely result in our customers gaining increased purchasing leverage over us. This may reduce the selling prices of our products and services and as a result may harm our business and financial results. Many of our customers desire to have two sources for the products we sell to them. As a result, our future revenue opportunities could be limited, and our profitability could be adversely impacted. The loss of, or reduction in orders from, any of our key customers would significantly reduce our revenues and have a material adverse impact on our business, operating results and financial condition.
If revenues forecasted for a particular period are not realized in such period due to the lengthy, complex and unpredictable sales cycles of our products, our operating results for that or subsequent periods will be harmed.
The sales cycles of our products are typically lengthy, complex and unpredictable and usually involve:
For these and other reasons, our sales cycles are generally between six and eighteen months, but can last longer. If orders forecasted for a specific customer for a particular quarter do not occur in that quarter, our operating results for that quarter or subsequent quarters could be substantially lower than anticipated. Our quarterly and annual results may fluctuate significantly due to revenue recognition rules and the timing of the receipt of customer orders.
Additionally, we derive a large portion of our net revenues from sales that include the network design, installation and integration of equipment, including equipment acquired from third parties to be integrated with our products to the specifications of our customers. We base our revenue forecasts on the estimated timing to complete the network design, installation and integration of our customer projects and customer acceptance of those products. The systems of our customers are both diverse and complex, and our ability to configure, test and integrate our systems with other elements of our customers networks depends on technologies provided to our customers by third parties. As a result, the timing of our revenue related to the implementation of our solutions in these complex networks is difficult to predict and could result in lower than expected revenue in any particular quarter. Similarly, our ability to deploy our equipment in a timely fashion can be subject to a number of other risks, including the availability of skilled engineering and technical personnel, the availability of equipment produced by third parties and our customers need to obtain regulatory approvals.
The markets in which we operate are intensely competitive, many of our competitors are larger, more established and better capitalized than we are, and some of our competitors have integrated products performing functions similar to our products into their existing network infrastructure offerings, and consequently our existing and potential customers may decide against using our products in their networks, which would harm our business.
The markets for selling network-based hardware and software products to service providers are extremely competitive and have been characterized by rapid technological change. We compete broadly with system suppliers including ARRIS Group, Cisco Systems, Harmonic, Motorola, SeaChange International and a number of smaller companies. Many of our competitors are substantially larger and have greater financial, technical, marketing and other resources than we have. Given their capital resources, long-standing relationships with service providers worldwide, and broader product lines, many of these large organizations are in a better position to withstand any significant reduction in capital spending by customers in these markets. If we are unable to overcome these resource advantages, our competitive position would suffer.
In addition, other providers of network-based hardware and software products offer functionality aimed at solving similar problems addressed by our products. For example, several vendors have announced products designed to compete with our Switched Digital Video solution. The inclusion of functionality perceived to be similar to our product offerings in our competitors products that already have been accepted as necessary components of network architecture may have an adverse effect on our ability to market and sell our products. In addition, our customers other vendors that can provide a broader product offering may be able to offer pricing or other concessions that we are not able to match because we currently offer a more modest suite of products and have fewer resources. If our existing or potential customers are reluctant to add network infrastructure from new vendors or otherwise decide to work with their other existing vendors, our business, operating results and financial condition will be adversely affected.
In recent years, we have seen consolidation among our competitors, such as Ciscos acquisition of Scientific Atlanta, Motorolas acquisition of Terayon, and purchases of Video on Demand, or VOD, solutions by each of ARRIS Group, Cisco, Harmonic and Motorola. In addition, some of our competitors have entered into strategic relationships with one another to offer a more comprehensive solution than would be available individually. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in the evolving industry for video by increasing the amount of commercial and technical integration of their video products. Due to our comparatively small size and comparatively narrow product offerings, our ability to compete will depend on our ability to partner with companies to offer a more complete overall solution. If we fail to do so, our competitive position will be harmed and our sales will likely suffer. These combined companies may offer more compelling product offerings and may be able to offer greater pricing flexibility, making it more difficult for us to compete while sustaining acceptable gross margins. Finally, continued industry consolidation may impact customers perceptions of the viability of smaller companies, which may affect their willingness to purchase products from us. These competitive pressures could harm our business, operating results and financial condition.
Lower deferred revenue balances will make future period results less predictable.
Historically, we have had relatively high deferred revenue balances at quarter end, which has provided us with some measure of predictability for future periods. However, our deferred revenue balance as of June 30, 2010 was lower than December 31, 2009. This lower deferred revenue balance makes our quarterly revenue more dependent on orders both received and shipped within the same quarter, and therefore less predictable. This lack of deferred revenues could cause additional revenue volatility and harm our stock price.
We have been unable to achieve sustained profitability, which could harm the price of our stock.
Historically, we have experienced significant operating losses and we were not profitable in the six months ended June 30, 2010. If we fail to achieve or sustain profitability in the future, it will harm our long-term business and we may not meet the expectations of the investment community, which would have a material adverse impact on our stock price.
We may not accurately anticipate the timing of the market needs for our products and develop such products at the appropriate times at significant research and development expense, or we may not gain market acceptance of our several emerging video services and/or adoption of new network architectures and technologies, any of which could harm our operating results and financial condition.
Accurately forecasting and meeting our customers requirements is critical to the success of our business. Forecasting to meet customers needs is particularly difficult for newer products and products under development. Our ability to meet customer demand depends on our ability to configure our solutions to the complex architectures that our customers have developed, the availability of components and other materials and the ability of our contract manufacturers to scale their production of our products. Our ability to meet customer requirements depends on our ability to obtain sufficient volumes of required components and materials in a timely fashion. If we fail to meet customers supply expectations, our net revenues will be adversely affected, and we will likely lose business. In addition, our priorities for future product development are based on how we expect the market for video services to develop in the U.S. and in international markets.
Future demand for our products will depend significantly on the growing market acceptance of several emerging video services including HDTV, addressable advertising, video delivered over telecommunications company networks and video delivered over Internet Protocol by cable MSOs. The effective delivery of these services will depend on service providers developing and building new network architectures to deliver them. If the introduction or adoption of these services or the deployment of these networks is not as widespread or as rapid as we or our customers expect, our revenue opportunities will be limited.
Our product development efforts require substantial research and development expense, as we develop new technology, including the BigBand MSP2000 and technology primarily related to the delivery of video over IP networks. In addition, as many of our products are new solutions, there is a risk of delays in delivery of these solutions. Our research and development expense was $13.1 million for the three months ended June 30, 2010, and there can be no assurance that we will achieve an acceptable return on our research and development efforts, and no assurance that we will be able to deliver our solutions in time to achieve market acceptance.
Additionally, our customers are adopting new technologies, standards and formats. In particular, service providers are transitioning from delivering video via radio frequency, which products have historically represented a large majority of our revenues, to delivering video over IP. While we are in the process of developing products based on this and other new formats in order to remain competitive, we do not have such products at this time and cannot be certain when, if at all, we will have products in support of such new formats.
Our ability to grow will depend significantly on our delivery of products that help enable telecommunications companies to provide video services. If the demand for video services from telecommunications companies does not materialize or if these service providers find alternative methods of delivering video services, future sales of our video products will suffer.
We have generated significant revenues from a single telecommunications company. Our ability to grow will depend on our selling video products to additional telecommunications companies. Although a number of our existing products are being deployed in telecom networks, we will need to devote considerable resources to obtain orders, qualify our products and hire knowledgeable personnel to address telecommunications company customers, each of which will require significant time and financial commitment. These efforts may not be successful in the near future, or at all. If technological advancements allow telecommunications companies to provide video services without upgrading their current system infrastructure or provide them a more cost-effective method of delivering video services than our products, projected sales of our video products will suffer. Even if these providers choose our video solutions, they may not be successful in marketing video services to their customers, in which case additional sales of our products would likely be limited.
Selling successfully to additional telecommunication companies will be a significant challenge for us. Several of our largest competitors have mature customer relationships with many of the largest telecommunications companies, while we have limited experience with sales and marketing efforts designed to reach these potential customers. In addition, telecommunications companies face specific network architecture and legacy technology issues that we have only limited expertise in addressing. If we fail to penetrate the telecommunications market successfully, our growth in revenues and our operating results would likely be adversely impacted.
We anticipate that our gross margins will fluctuate with changes in our product mix and we expect decreases in the average selling prices of our hardware and software products, which will adversely impact our operating results.
Our product gross margins declined for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. Our industry has historically experienced a decrease in average selling prices. We anticipate that the average selling prices of our products will continue to decrease in the future in response to competitive pricing pressures, increased sales discounts and new product introductions by our competitors. We may experience substantial decreases in future operating results due to a decrease of our average selling prices. For example, our master agreement with Verizon provides for contractually-negotiated annual price reductions. Additionally, our failure to develop and introduce new products on a timely basis would likely contribute to a decline in our gross margins, which could have a material adverse effect on our operating results and cause the price of our common stock to decline. We
also anticipate that our gross margins will fluctuate from period to period as a result of the mix of products we sell in any given period. If our sales of lower margin products significantly expand in future quarterly periods, our overall gross margin levels and operating results would be adversely impacted.
Continued uncertain general economic conditions may adversely affect our financial condition and results of operations and make our future business more difficult to forecast and manage.
Our business is sensitive to changes in general economic conditions, both in the U.S. and globally. Due to the continued tight credit markets and concerns regarding the availability of credit, our current or potential customers may delay or reduce purchases of our products, which would adversely affect our revenues and therefore harm our business and results of operations.
More generally, we are unable to predict how long the current economic uncertainty will last. There can be no assurances that government responses to the recession will restore confidence in the U.S. and global economies. We expect our business to be adversely impacted by any significant or prolonged uncertainty in the U.S. or global economies as our customers capital spending is expected to be reduced during an economic downturn. The uncertainty regarding the U.S. and global economies also has made it more difficult for us to forecast and manage our business.
We must manage our business effectively even if our infrastructure, management and resources might be strained due to our expense reduction efforts and recent officer departures.
In the past several years, including this year, we have undertaken several reductions in force, experienced a number of changes in our executive management (including the recent departures of our chief operating officer, chief financial officer and the senior vice president of worldwide sales) and implemented other cost reduction measures. Effectively managing our business with reduced headcount and expenses in some areas will likely place increased strain on our existing resources. In particular, the departure of our chief operating officer and the senior vice president of worldwide sales in March 2010 (neither of which we replaced) has placed place additional strain on our existing team and there can be no assurance that the departure of these officers will not disrupt our business operations, customer relationships or other matters. In addition, we may need to expand and otherwise improve our internal systems, including our management information systems, customer relationship and support systems, and operating, administrative and financial systems and controls. These efforts may require us to make significant capital expenditures or incur significant expenses, and divert the attention of management, sales, support and finance personnel from our core business operations, which may adversely affect our financial performance in future periods. Moreover, to the extent we grow in the future, such growth will result in increased responsibilities for our management personnel. Managing any future growth will require substantial resources that we may not have or otherwise be able to obtain.
Our efforts to develop additional channels to market and sell our products internationally may not succeed.
Our video solutions traditionally have been sold directly to large cable MSOs with recent sales directly to telecommunications companies. To date, we have not focused on smaller service providers and have had only limited access to service providers in certain international markets, including Asia and Europe. Although we intend to establish strategic relationships with leading distributors worldwide in an attempt to reach new customers, we may not succeed in establishing these relationships. Even if we do establish these relationships, the distributors may not succeed in marketing our products to their customers. Some of our competitors have established long-standing relationships with cable MSOs and telecommunications companies that may limit our and our distributors ability to sell our products to those customers. Even if we were to sell our products to those customers, it would likely not be based on long-term commitments, and those customers would be able to terminate their relationships with us at any time without significant penalties.
International sales represented 10.8% of our net revenues for the six months ended June 30, 2010 compared to 14.7% for six months ended June 30, 2009. Our international sales depend on our development of indirect sales channels in Europe and Asia through distributor and reseller arrangements with third parties. However, we may not be able to successfully enter into additional reseller and/or distribution agreements and/or may not be able to successfully manage our product sales channels. In addition, many of our resellers also sell products from other vendors that compete with our products and may choose to focus on products of those vendors. Additionally, our ability to utilize an indirect sales model in these international markets will depend on our ability to qualify and train those resellers to perform product installations and to provide customer support. If we fail to develop and cultivate relationships with significant resellers, or if these resellers do not succeed in their sales efforts (whether because they are unable to provide support or otherwise), we may be unable to grow or sustain our revenue in international markets.
We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial results and cash flows.
Because a substantial portion of our employee base is located in Israel, we are exposed to fluctuations in currency exchange rates between the U.S. dollar and the Israeli New Shekel. These fluctuations could have a material adverse impact on our financial results and cash flows. A decrease in the value of the U.S. dollar relative to foreign currencies could increase our operating expenses and the cost of raw materials to the extent that we must purchase components or pay employees in foreign currencies.
Currently, we hedge a portion of our anticipated future expenses and certain assets and liabilities denominated in the Israeli New Shekel. The hedging activities we undertake are intended to partially offset the impact of currency fluctuations. As our hedging
program is relatively short-term in nature, a material long-term change in the value of the U.S. dollar versus the Israeli New Shekel could increase our operating expenses in the future.
Our products must interoperate with many software applications and hardware found in our customers networks. If we are unable to ensure that our products interoperate properly, our business would be harmed.
Our products must interoperate with our customers existing networks, which often have varied and complex specifications, utilize multiple protocol standards, software applications and products from multiple vendors, and contain multiple generations of products that have been added over time. As a result, we must continually ensure that our products interoperate properly with these existing networks. To meet these requirements, we must undertake development efforts that require substantial capital investment and employee resources. We may not accomplish these development efforts quickly or cost-effectively, if at all. For example, our products currently interoperate with set-top boxes marketed by vendors such as Cisco Systems and Motorola and with VOD servers marketed by ARRIS Group and SeaChange. If we fail to maintain compatibility with these set-top boxes, VOD servers or other software or equipment found in our customers existing networks, we may face substantially reduced demand for our products, which would adversely affect our business, operating results and financial condition.
We have entered into interoperability arrangements with a number of equipment and software vendors for the use or integration of their technology with our products. In these cases, the arrangements give us access to and enable interoperability with various products in the digital video market that we do not otherwise offer. If these relationships fail, we will have to devote substantially more resources to the development of alternative products and the support of our products, and our efforts may not be as effective as the combined solutions with our current partners. In many cases, these parties are either companies with which we compete directly in other areas, such as Motorola, or companies that have extensive relationships with our existing and potential customers and may have influence over the purchasing decisions of these customers. A number of our competitors have stronger relationships with some of our existing and potential partners and, as a result, our ability to successfully partner with these companies may be harmed. Our failure to establish or maintain key relationships with third party equipment and software vendors may harm our ability to successfully sell and market our products. We are currently investing significant resources to develop these relationships. Our operating results could be adversely affected if these efforts do not generate the revenues necessary to offset this investment.
In addition, if we find errors in the existing software or defects in the hardware used in our customers networks or problematic network configurations or settings, as we have in the past, we may have to modify our software or hardware so that our products will interoperate with our customers networks. This could cause longer installation times for our products and could cause order cancellations, either of which would adversely affect our business, operating results and financial condition.
Our ability to sell our products is highly dependent on the quality of our support and services offerings, and our failure to offer high-quality support and services would have a material adverse effect on our sales and results of operations.
Once our products are deployed within our customers networks, our customers depend on our support organization to resolve any issues relating to our products. If we or our channel partners do not effectively assist our customers in deploying our products, or succeed in helping our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell our products to existing customers would be adversely affected and our reputation with potential customers could be harmed. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. Our failure to maintain high-quality support and services would have a material adverse effect on our business, operating results and financial condition.
If we fail to comply with new laws and regulations, or changing interpretations of existing laws or regulations, our future revenues could be adversely affected.
Our products are subject to various legal and regulatory requirements and changes. For example, effective June 12, 2009, federal law required that television broadcast stations stop broadcasting in analog format and broadcast only in digital format. This change may have accelerated the timing of sales of our digital products, and consequently the revenue associated with our broadcast solutions may not continue at recent levels, which could disappoint our investors causing our stock price to fall. These and other similar implementations of laws and interpretations of existing regulations could cause our customers to forgo or change the timing of spending on new technology rollouts, such as switched digital video, which could make our results more difficult to predict, or harm our revenues.
Additionally, governments in the U.S. and other countries have adopted laws and regulations regarding privacy and advertising that could impact important aspects of our business. In particular, governments are considering new limits or requirements with respect to our customers collection, use, storage and disclosure of personal information for marketing purposes. Any legislation enacted or regulation issued could dampen the growth and acceptance of addressable advertising which is enabled by our products. If the use of our products to increase advertising revenue is limited or becomes unlawful, our business, results of operations and financial condition would be harmed.
Our expansion of international operations or reliance on operations of contract manufacturers or developers may not succeed.
As of June 30, 2010, approximately 82% of our research and development headcount was located outside the U.S., primarily in Israel and increasingly in China. Managing research and development operations in numerous locations requires substantial management oversight. If we are unable to expand our international operations successfully and in a timely manner, our business, operating results and financial condition may be harmed. Such expansion may be more difficult or could take longer than we anticipate, and we may not be able to successfully market, sell, deliver and support our products internationally.
Our international operations, and the international operations of our contract manufacturers and our outsourced development contractors, are subject to a number of risks, including:
The effects of any of the risks described above could reduce our future revenues or increase our costs from our international operations.
Our business is subject to the risks of warranty returns, product liability and product defects.
Products like ours are very complex and can frequently contain undetected errors or failures, especially when first introduced or when new versions are released. Despite testing, errors may occur. Product errors could affect the performance of our products, delay the development or release of new products or new versions of products, adversely affect our reputation and our customers willingness to buy products from us and adversely affect market acceptance or perception of our products. Any such errors or delays in releasing new products or new versions of products or allegations of unsatisfactory performance could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in redesigning the products, subject us to liability for damages and divert our resources from other tasks, any one of which could materially adversely affect our business, results of operations and financial condition. Our products must successfully interoperate with products from other vendors. As a result, when problems occur in a network, it may be difficult to identify the sources of these problems. The occurrence of hardware and software errors, whether or not caused by our products, could result in the delay or loss of market acceptance of our products, and therefore delay our ability to recognize revenue from sales, and any necessary revisions may cause us to incur significant expenses. The occurrence of any such problems could harm our business, operating results and financial condition.
Although we have limitation of liability provisions in our standard terms and conditions of sale, they may not fully or effectively protect us from claims as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the U.S. or other countries. The sale and support of our products also entails the risk of product liability claims. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover any claim asserted against us. In addition, even claims that ultimately are unsuccessful could result in our expenditure of funds in litigation and divert managements time and other resources.
Regional instability in Israel may adversely affect business conditions and may disrupt our operations and negatively affect our operating results.
A substantial portion of our research and development operations and our contract manufacturing occurs in Israel. As of June 30, 2010, we had 166 full-time employees located in Israel. We also have customer service, marketing and general and administrative employees at this facility. Accordingly, we are directly influenced by the political, economic and military conditions affecting Israel, and any major hostilities involving Israel or the interruption or curtailment of trade between Israel and its trading partners could significantly harm our business. In addition, in the past, Israel and companies doing business with Israel have been the subject of an economic boycott. Israel has also been and is subject to civil unrest and terrorist activity, with varying levels of severity, for the last decade. Security and political conditions may have an adverse impact on our business in the future. Hostilities involving Israel or the
interruption or curtailment of trade between Israel and its trading partners could adversely affect our operations and make it more difficult for us to retain or recruit qualified personnel in Israel.
In addition, most of our employees in Israel are obligated to perform annual reserve duty in the Israeli Defense Forces and several have been called for active military duty in connection with intermittent hostilities over the years. Should hostilities in the region escalate again, some of our employees would likely be called to active military duty, possibly resulting in interruptions in our sales and development efforts and other impacts on our business and operations, which we cannot currently assess.
We depend on a limited number of third parties to provide key components of, and to provide manufacturing and assembly services with respect to, our products.
We and our contract manufacturers obtain many components necessary for the manufacture or integration of our products from a sole supplier or a limited group of suppliers. We or our contract manufacturers do not always have long-term agreements in place with such suppliers. As an example, we do not have a long-term purchase agreement in place with PowerOne, the sole supplier of power supplies for our products. Our direct and indirect reliance on sole or limited suppliers involves several risks, including the inability to obtain an adequate supply of required components, and reduced control over pricing, quality and timely delivery of components. Our ability to deliver our products on a timely basis to our customers would be materially adversely impacted if we or our contract manufacturers needed to find alternative replacements for (as examples) the chassis, chipsets, central processing units or power supplies that we use in our products. Significant time and effort would be required to locate new vendors for these alternative components, if alternatives are even available. Moreover, the lead times required by the suppliers of some components are lengthy and preclude rapid changes in quantity requirements and delivery schedules. Even as we increase our use of standardized components, we may experience supply chain issues, particularly as a result of market volatility. Such volatility could lead suppliers to decrease inventory, which in turn would lead to increased manufacturing lead time for us. In addition, increased demand by third parties for the components we use in our products (for example, Field Programmable Gate Arrays or other semiconductor technology) may lead to decreased availability and higher prices for those components from our suppliers, since we carry little inventory of our products and product components. As a result, we may not be able to secure enough components at reasonable prices or of acceptable quality to build products in a timely manner, which would impact our ability to deliver products to our customers, and our business, operating results and financial condition would be adversely affected.
For manufacturing and assembly, we currently rely exclusively on a number of suppliers including Flextronics or Benchmark, depending on the product, to assemble our products, manage our supply chain and negotiate component costs for our solutions. Our reliance on these contract manufacturers reduces our control over the assembly process, exposing us to risks, including reduced control over quality assurance, production costs and product supply. If we fail to manage our relationships with these contract manufacturers effectively, or if these contract manufacturers experience delays (including delays in their ability to purchase components, as noted above), disruptions, capacity constraints or quality control problems in their operations, our ability to ship products to our customers could be impaired and our competitive position and reputation could be harmed. If these contract manufacturers are unable to negotiate with their suppliers for reduced component costs, our operating results would be harmed. Qualifying a new contract manufacturer and commencing volume production is expensive and time-consuming. If we are required to change contract manufacturers, we may lose net revenues, incur increased costs and damage our customer relationships.
Our failure to adequately protect our intellectual property and proprietary rights, or to secure such rights on reasonable terms, may adversely affect us.
We hold numerous issued U.S. patents and have a number of patent applications pending in the U.S. and foreign jurisdictions. Although we attempt to protect our intellectual property rights through patents, copyrights, trademarks, licensing arrangements, maintaining certain technology as trade secrets and other measures, we cannot be sure that any patent, trademark, copyright or other intellectual property rights owned by us will not be invalidated, circumvented or challenged, that such intellectual property rights will provide competitive advantages to us or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. Despite our efforts, other competitors may be able to develop technologies that are similar or superior to our technology, duplicate our technology to the extent it is not protected, or design around the patents that we own. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries in which we do business or may do business in the future.
The steps that we have taken may not prevent misappropriation of our technology. In addition, to prevent misappropriation we may need to take legal action to enforce our patents and other intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. For example, on June 5, 2007, we filed a lawsuit in federal court against Imagine Communications, Inc., alleging patent infringement. This and other potential intellectual property litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results and financial condition.
In order to successfully develop and market certain of our planned products, we may be required to enter into technology development or licensing agreements with third parties whether to avoid infringement or because we believe a specific functionality is necessary for a successful product launch. These third parties may be willing to enter into technology development or licensing
agreements only on a costly royalty basis or on terms unacceptable to us, or not at all. Our failure to enter into technology development or licensing agreements on reasonable terms, when necessary, could limit our ability to develop and market new products and could cause our business to suffer. For example, we could face delays in product releases until alternative technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could adversely affect our business, operating results and financial condition.
We may face intellectual property infringement claims from third parties.
Our industry is characterized by the existence of an extensive number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. From time to time, third parties have asserted and may assert patent, copyright, trademark and other intellectual property rights against us or our customers. Our suppliers and customers may have similar claims asserted against them. We have agreed to indemnify some of our suppliers and customers for alleged patent infringement. The scope of this indemnity varies, but, in some instances, includes indemnification for damages and expenses including reasonable attorneys fees. Any future litigation, regardless of its outcome, could result in substantial expense and significant diversion of the efforts of our management and technical personnel. An adverse determination in any such proceeding could subject us to significant liabilities, temporary or permanent injunctions or require us to seek licenses from third parties or pay royalties that may be substantial. Furthermore, necessary licenses may not be available on satisfactory terms, or at all.
Our use of open source and third-party software could impose limitations on our ability to commercialize our products.
We incorporate open source software into our products, including certain open source code which is governed by the GNU General Public License, Lesser GNU General Public License and Common Development and Distribution License. The terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to seek licenses from third parties in order to continue offering our products, make generally available, in source code form, proprietary code that links to certain open source modules, re-engineer our products, discontinue the sale of our products if re-engineering could not be accomplished on a cost-effective and timely basis, or become subject to other consequences, any of which could adversely affect our business, operating results and financial condition.
We may engage in future acquisitions that dilute the ownership interests of our stockholders, cause us to use a significant portion of our cash, incur debt or assume contingent liabilities.
As part of our business strategy, from time to time, we review potential acquisitions of other businesses, and we may acquire businesses, products, or technologies in the future. In the event of any future acquisitions, we could:
These actions could harm our business, operating results and financial condition, or the price of our common stock. Moreover, even if we do obtain benefits from acquisitions in the form of increased sales and earnings, there may be a delay between the time when the expenses associated with an acquisition are incurred and the time when we recognize such benefits. This is particularly relevant in cases where it is necessary to integrate new types of technology into our existing portfolio and where new types of products may be targeted for potential customers with which we do not have pre-existing relationships. Acquisitions and investment activities also entail numerous risks, including:
We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and our failure to do so could have a material adverse effect on our business, operating results and financial condition.
Negative conditions in the global credit markets may impair the value or reduce the liquidity of a portion of our investment portfolio.
As of June 30, 2010, we had $33.1 million in cash and cash equivalents and $130.0 million in investments in marketable debt securities. Historically, we have invested these amounts primarily in government agency debt securities, corporate debt securities, commercial paper, auction rate securities, money market funds and taxable municipal debt securities meeting certain criteria. We currently hold no mortgaged-backed or auction rate securities. However, our investments are subject to general credit, liquidity, market and interest rate risks, which may be exacerbated by the ongoing uncertainty in the U.S. and global credit markets that have affected various sectors of the financial markets and caused global credit and liquidity issues. In the future, these market risks associated with our investment portfolio may harm the results of our operations, liquidity and financial condition.
Although we believe we have chosen a more cautious portfolio designed to preserve our existing cash position, it may not adequately protect the value of our investments. Furthermore, this more cautious portfolio is unlikely to provide us with any significant interest income in the near term.
If we do not adequately manage and evolve our financial reporting and managerial systems and processes, our operating results and financial condition may be harmed.
Our ability to successfully implement our business plan and comply with regulations applicable to being a public reporting company requires an effective planning and management process. We expect that we will need to continue to improve existing, and implement new, operational and financial systems, procedures and controls to manage our business effectively in the future. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, could harm our ability to accurately forecast sales demand, manage our supply chain and record and report financial and management information on a timely and accurate basis. In addition, the successful enhancement of our operational and financial systems, procedures and controls will result in higher general and administrative costs in future periods, and may adversely impact our operating results and financial condition.
While we believe that we currently have proper and effective internal control over financial reporting, we must continue to comply with laws requiring us to evaluate those internal controls.
We are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002. The provisions of the act require, among other things, that we evaluate the effectiveness of our internal control over financial reporting and disclosure controls and procedures. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help produce accurate financial statements on a timely basis is a costly and time-consuming effort. For example, our accounting for income taxes requires considerable, specific knowledge of various tax acts, both foreign and domestic, and also involves several subjective judgments that could lead to fluctuations in our results of operations should some or all events not occur as anticipated. We incur significant costs and demands upon management as a result of complying with these laws and regulations affecting us as a public company. If we fail to maintain proper and effective internal controls in future periods, it could adversely affect our ability to run our business effectively and could cause investors to lose confidence in our financial reporting.
We are subject to import/export controls that could subject us to liability or impair our ability to compete in international markets.
Our products are subject to U.S. export controls and may be exported outside the U.S. only with the required level of export license or through an export license exception, in most cases because we incorporate encryption technology into our products. In addition, various countries regulate the import of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers internationally.
In addition, we may be subject to customs duties and export quotas, which could have a significant impact on our revenue and profitability. While we have not yet encountered significant regulatory difficulties in connection with the sales of our products in international markets, the future imposition of significant customs duties or export quotas could have a material adverse effect on our business.
Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.
Our corporate headquarters is located in the San Francisco Bay area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, could have a material adverse impact on our business, operating results and financial condition. In addition, our computer servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, acts of terrorism or war or public health outbreaks could cause disruptions in our or our customers business or the economy as a whole. To the extent that such disruptions result in delays or cancellations of customer orders, or the deployment of our products, our business, operating results and financial condition would be adversely affected.
Item 6. EXHIBITS
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.
Date: August 9, 2010