UTStarcom Holdings Corp. — FY2012 Form 20-F
Reporting period: Fiscal year ended December 31, 2012. This is an annual report, not a standalone fourth-quarter filing. The company prepared its audited consolidated financial statements under U.S. GAAP; the report was signed April 26, 2013.
Business context
UTStarcom sells telecommunications and broadband equipment and related services, while shifting its strategy toward next-generation media operational support services. In August 2012, it divested its IPTV equipment business; it continued to have involvement in certain contracts and invested in the former business. Japan became its largest regional market, and SoftBank—an investor and related party—was its largest customer.
Financial performance and liquidity
| Metric | FY2012 | FY2011 |
|---|---|---|
| Net sales | $186.7 million | $320.6 million |
| Gross profit / gross margin | $68.2 million / 36.5% | $114.3 million / 35.7% |
| Operating income (loss) | $(32.6) million | $20.8 million |
| Net income (loss) attributable to UTStarcom | $(34.4) million | $13.4 million |
| Basic and diluted earnings (loss) per share | $(0.71) | $0.26 |
| Cash used in operating activities | $25.6 million | $41.7 million |
| Cash and cash equivalents at year-end | $179.6 million | $301.6 million |
| Working capital at year-end | $196.4 million | $280.0 million |
| Bank debt | None outstanding | None outstanding |
Sales fell 41.8%. Management attributed the decline principally to the absence of $95.2 million in 2011 PAS infrastructure deferred-revenue amortization, lower IPTV-related sales following the divestiture, and weaker PTN sales in Japan. Gross margin increased slightly, but gross profit fell with revenue. SG&A declined 17.9% and R&D spending declined to $28.1 million from $30.1 million.
Investing activities used $82.7 million, including $56.0 million associated with the IPTV transaction and $15.6 million for investments. Financing activities used $8.8 million, primarily for share repurchases. Total cash and cash equivalents declined $122.0 million during the year. Year-end cash included $49.3 million held in China, where foreign-exchange controls restrict some transfers; the China subsidiaries had no accumulated profits available for dividends under PRC accounting rules. Restricted cash was a further $19.6 million.
Material changes and unusual items
- The IPTV divestiture generated a $17.5 million loss, including employee severance, prepaid VAT write-off and transaction costs. The company also paid approximately $30 million relating to liabilities transferred and invested $20 million in a convertible bond issued by the former business.
- The bond bears 6.5% interest and matures in 2017; it may be converted into an ownership interest or repaid in cash, subject to its terms. Its reported year-end fair value was approximately $20 million.
- Because customer contracts had not all been legally assigned, UTStarcom remained the primary obligor on certain contracts. Related liabilities and deferred costs totaled $47.3 million at year-end; the company said future recognition of related revenue and costs would have no gross-margin impact.
- Investment impairment charges totaled $3.0 million, including $2.2 million for GCT Semiconductor and $0.8 million for Xalted Networks. The GCT impairment was increased after the company received lower financing valuation information in 2013.
- Foreign-exchange losses were $4.7 million, compared with $8.9 million in 2011. A $1.5 million release of a Korean tax-liability reserve partly offset other expense.
- The company repurchased approximately $15.1 million of shares under its repurchase program during 2011–2012. A separate $30 million tender offer for 8.3 million shares was completed in January 2013. A one-for-three reverse share split became effective in March 2013; share and per-share amounts in the filing are adjusted retroactively.
Outlook, risks and contingencies
Management said it expected available liquidity to fund operations, capital expenditure and planned investments for more than 12 months, while acknowledging that performance, cash collections and other assumptions might not be achieved. It expected further expense controls and improved receivables turnover to remain important. The company provided no specific consolidated revenue or earnings guidance. Its strategic targets included launching TV-over-IP services in multiple countries in 2013 and making those services a majority revenue contributor by 2015, with gross margins above 50%; these are forward-looking targets, not reported results.
- Customer and geographic concentration: SoftBank represented approximately 49.3% of FY2012 sales and about 80% of year-end net accounts receivable. Japan generated 53% of sales. A deterioration in the relationship, payment delays, or disruptions in Japan could materially affect results and liquidity.
- Losses and liquidity: The company had an accumulated deficit of $1.153 billion, continued operating losses and negative operating cash flow. Cash availability is affected by China transfer restrictions, collection timing and supplier payment terms.
- Internal controls: Management and the auditor concluded internal control over financial reporting was ineffective at December 31, 2012 because the company lacked sufficient staff with appropriate U.S. GAAP expertise for complex, non-routine transactions. Management described remediation steps, including external review, training and recruiting.
- Commitments and contingencies: Contractual obligations totaled $62.2 million, including $39.3 million of purchase commitments, $11.4 million of operating leases and $11.5 million of letters of credit. Gross unrecognized tax benefits were $54.0 million. Indian telecom security agreements contain potentially significant penalties; the company could not estimate the likelihood or financial impact of a breach and had deferred revenue and costs of $9.8 million and $6.1 million, respectively, on affected contracts.
- Other risks: Risks include competitive pricing, long acceptance and collection cycles, foreign-exchange volatility (the company did not hedge; a hypothetical 10% exchange-rate movement implied a $12.85 million change in fair value of foreign-currency financial instruments), PRC regulatory and tax uncertainty, and dependence on successful execution of a substantially changed business strategy.
- Related-party and subsequent developments: The IPTV buyer was associated with the former CEO. In March 2013, a director and Shah Capital made a preliminary, non-binding $3.20-per-share proposal to take the company private; the board formed an independent special committee. The filing also reports completed March–April 2013 dispositions of NGN and DOCSIS-EOC assets.
The auditor issued an unqualified opinion on the financial statements but an adverse opinion on internal control over financial reporting. The filing also notes that the China-based audit firm was not subject to PCAOB inspection and was among firms named in SEC proceedings concerning audit work papers; UTStarcom itself was not identified as the subject of those proceedings.
Most important facts for investors to verify
- Whether operating cash use, customer collections and available unrestricted cash support management’s liquidity assessment, particularly given China cash-transfer limits.
- SoftBank’s continuing orders, payment performance and related-party commercial terms, including the concentration of receivables.
- Completion of customer-contract assignments from the IPTV divestiture and the nature and recoverability of the associated $47.3 million in liabilities and deferred costs.
- Progress on remediation of the material weakness in financial reporting controls and the status of the auditor-related SEC proceedings and PCAOB inspection limitations.
- Execution and funding of the TV-over-IP strategy, including the assumptions underlying the 2015 revenue and margin targets and the value of the convertible-bond and private-company investments.
- Resolution of the go-private proposal and the effects of the tender offer, reverse split and subsequent asset disposals on share count, cash and the continuing business.