Item 1. Business
The following description of our business should be read in conjunction with the information included elsewhere in this document. The description contains certain forward-looking statements that involve risks and uncertainties. When used in this document, the words “intend,” “anticipate,” “believe,” “estimate,” “plan,” “expect” and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from the results discussed in the forward-looking statements as a result of risk factors set forth elsewhere in this document. See also, “Item 1A.
Item 1A. Risk Factors
From time to time, information provided by us, statements made by our employees or information included in our filings with the Securities and Exchange Commission (including this Form 10-K) may contain statements that are not historical facts, so-called “forward-looking statements,” which involve risks and uncertainties. Such forward-looking statements are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “could,” “will,” “expect,” “intend,” “plans,” “predict,” “anticipate,” “estimate,” “continue,” “believe” or the negative of these terms or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or state other forward-looking information. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Form 10-K.
Our actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. Each of these factors, and others, are discussed from time to time in our filings with the Securities and Exchange Commission.
Our strategic direction has changed. The company has gone from primarily providing VLSI infrastructure products to more customer premise licensing IP cores and VoIP based products. As a result, we are suffering through a period of larger losses, including from operations as well as from write-downs of goodwill and other intangibles assets. Our total revenue has decreased 49.6% from $56.1 million in 2009 to $28.3 million in 2011. Product revenue has decreased 61.1% from $50.7 million in 2009 to $19.7 million in 2011.
As our business model changes there can be no assurances that the move to these new product lines will produce acceptable results. Moreover, any other future changes to our business may not prove successful in the short or long term due to a variety of factors, including competition, customer acceptance, demand for our products and other factors. This may cause a material negative impact on our financial results.
We are using our available cash and cash equivalents each quarter to fund our operations, investments and financing activities. We have incurred significant losses in prior periods. Our revenues and operating results have fluctuated in the past and may fluctuate in the future and we may incur losses and negative cash flows in future periods. These fluctuations are due to a number of factors, many of which are beyond our control. These factors include, among others:
• the effects of competitive pricing pressures, including decreases in average selling prices of our products;
• market acceptance of our products and our customers’ products;
• our customers’ product-to-market launch schedules;
• our ability to develop, introduce, market and support new products and technologies on a timely basis;
• availability and cost of products from our suppliers;
• intellectual property disputes;
• the timing of receipt, reduction or cancellation of significant orders by customers;
• the effects of our competitors’ new product and technology introductions;
• fluctuations in the levels of component inventories held by our customers and distributors and changes in our customers’ and distributors’ inventory management practices;
• shifts in our product mix and the effect of maturing products;
• the timing and extent of product development costs;
• new product and technology introductions by us or our competitors;
• fluctuations in manufacturing yields; and
• significant warranty claims, including those not covered by our suppliers.
The foregoing factors are difficult to forecast, and these, as well as other factors, could materially and adversely affect our quarterly or annual operating results.
Our operating results may fluctuate because of a number of factors, many of which are beyond our control. If our operating results are below the expectations of public market analysts or investors, then the market price of our common stock could decline.
Our net revenues may decrease. Due to current economic conditions and slowdowns in purchases of VLSI semiconductor devices, it has become increasingly difficult for us to predict the purchasing activities of our telecom customers and we expect that our net revenues may decrease further.
Our business is characterized by short-term orders and shipment schedules, and customer orders typically can be cancelled or rescheduled without significant penalty to our customers. Because we do not have substantial non-cancelable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Future fluctuations to our operating results may also be caused by a number of factors, many of which are beyond our control.
In response to anticipated long lead times to obtain inventory and materials from our foundries, we may order inventory and materials in advance of anticipated customer demand, which might result in excess inventory levels if the expected orders fail to materialize. As a result, we cannot predict the timing and amount of shipments to our customers, and any significant downturn in customer demand for our products would reduce our quarterly and annual operating results.
If we seek to secure additional financing we may not be able to do so. If we are able to secure additional financing our stockholders may experience dilution of their ownership interest or we may be subject to limitations on our operations. If we are unable to generate sufficient cash flows from operations to meet our anticipated needs for working capital and capital expenditures, we may need to raise additional funds. However, events in the future may require us to seek additional capital and, if so required, that capital may not be available on terms favorable or acceptable to us, if at all. If we raise additional funds through the issuance of equity securities, our stockholders may experience dilution of their ownership interest, and the newly issued securities may have rights superior to those of our common stock. On October 21, 2009, we filed a shelf registration statement on Form S-3 (File No. 333-162609) (the “Shelf Registration Statement”) which was declared effective by the Securities and Exchange Commission on October 28, 2009, to sell up to $40,000,000 of our securities. During 2010 and 2011, we issued shares for proceeds to the Company in an amount of $19,197,000 worth of common stock under the Shelf Registration Statement. Accordingly, we have a value of $20,803,000 of shares of our common stock, which could still be issued under this arrangement. On February 10, 2012, we entered into an At Market Issuance Sales Agreement with MLV & Co. LLC (“MLV”), pursuant to which we may issue and sell shares of our common stock having an aggregate offering price of up to $10,000,000 from time to time through MLV.
Our stock price is volatile. The market for securities for communication semiconductor companies, including our Company, has been highly volatile. The daily closing price of our common stock has fluctuated between a low of $1.52 and a high of $15.36 (share price is reflective of the November 23, 2009 1 for 8 reverse stock split) during the period from January 1, 2007 to December 31, 2011. It is likely that the price of our common stock will continue to fluctuate widely in the future. Factors affecting the trading price of our common stock include:
• responses to quarter-to-quarter variations in operating results;
• announcements of technological innovations or new products by us or our competitors;
• current market conditions in our served markets; and
• changes in earnings estimates by analysts.
We may have to further restructure our business. We may have to make further restructuring changes if we do not sustain the current level of quarterly revenues. Our restructurings could result in management distractions, operational disruptions, and other difficulties. Over the past several years, we have initiated several restructuring activities in an effort to reduce operating costs. Our most recent restructuring was announced on October 4, 2011. Employees whose positions were eliminated in connection with these restructuring activities may seek employment with our customers or competitors. Although each of our employees is required to sign a confidentiality agreement with us at the time of hire, we cannot guarantee that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, we cannot guarantee that we will not undertake additional restructuring activities and that our restructuring efforts will be successful, or that we will be able to realize the cost savings and other anticipated benefits from our previous restructuring plans. Also, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to new growth opportunities.
We anticipate that shipments of our products to relatively few customers will continue to account for a significant portion of our total net revenues. Historically, a relatively small number of customers have accounted for a significant portion of our total net revenues in any particular period. For the years ended December 31, 2011 and 2010, shipments to our top five customers, including sales through distributors, accounted for approximately 39% and 57% of our total net revenues, respectively. We expect that a limited number of customers may account for a substantial portion of our total net revenues for the foreseeable future.
Some of the following may reduce our total net revenues or adversely affect our business:
• reduction, delay or cancellation of orders from one or more of our significant customers;
• development by one or more of our significant customers of other sources of supply for current or future products;
• loss of one or more of our current customers or a disruption in our sales and distribution channels; and
• failure of one or more of our significant customers to make timely payment of our invoices.
We cannot be certain that our current customers will continue to place orders with us, that orders by existing customers will return to the levels of previous periods or that we will be able to obtain orders from new customers. We have no long-term volume purchase commitments from any of our significant customers.
The cyclical nature of the communication semiconductor industry affects our business. Communication service providers, internet service providers, regional operating companies and inter-exchange carriers continue to closely monitor their capital expenditures. Spending on voice-only equipment remains slow while spending on equipment providing the efficient transport of data services on existing infrastructure appears to be slowly recovering. Demand for new, high-bandwidth applications such as
video conferencing, broadband audio and telephone is placing an increased burden on existing public network infrastructure. We cannot be certain that the market for our products will not decline in the future.
Because of our lack of diversity in geographic sources of revenues, economic factors specific to certain countries may adversely affect our business and operating results. During 2011, a substantial amount of our revenue was from China, Japan, Korea, Taiwan, Italy, Israel and other foreign countries. We expect revenues in 2012 will be substantially concentrated in foreign markets. All of our sales have been historically denominated in U.S. dollars and major fluctuations in currency exchange rates could materially affect our customers’ demand, thereby causing them to reduce their orders, which could adversely affect our operating results. While part of our strategy is to diversify the geographic sources of our revenues, failure to further penetrate other markets could harm our business and results of operations and subject us to increased currency risk.
If foreign exchange rates fluctuate significantly, our profitability may decline. We are exposed to foreign currency rate fluctuations because we incur a significant portion of our operating expenses in currencies other than U.S. dollars (mainly Indian rupees, Israeli shekels and Euros). The U.S. dollar has fluctuated significantly in the past couple of years and this trend may continue.
Our international business operations expose us to a variety of business risks. Foreign markets are a significant part of our net product revenues. For the years ended December 31, 2011 and 2010, foreign shipments accounted for approximately 77% and 75%, respectively of our total net product and services revenues. We expect foreign markets to continue to account for a significant percentage of our total net revenues. A significant portion of our total net revenues will, therefore, be subject to risks associated with foreign markets, including the following:
• unexpected changes in legal and regulatory requirements and policy changes affecting the telecommunications and data communications markets;
• changes in tariffs;
• exchange rates, currency controls and other barriers;
• political and economic instability;
• risk of terrorism or war;
• difficulties in accounts receivable collection;
• difficulties in managing distributors and representatives;
• difficulties in staffing and managing foreign operations;
• difficulties in protecting our intellectual property overseas;
• natural disasters;
• seasonality of customer buying patterns; and
• potentially adverse tax consequences.
Although substantially all of our total net revenues to date have been denominated in U.S. dollars, the value of the U.S. dollar in relation to foreign currencies also may reduce our total net revenues from foreign customers. A substantial amount of our costs are denominated in Israeli shekels and the Indian rupees. To the extent that we further expand our international operations or change our pricing practices to denominate prices in foreign currencies, we will expose our margins to increased risks of currency fluctuations.
Our net product revenues depend on the success of our customers’ products, and our design wins do not necessarily generate revenues in a timely fashion. Our customers generally incorporate our new products into their products or systems at the design stage. However, customer decisions to use our products (design wins), which can often require significant
expenditures by us without any assurance of success, often precede the generation of production revenues, if any, by a year or more. Some customer projects are canceled, and thus will not generate revenues for our products. In addition, even after we achieve a design win, a customer may require further design changes. Implementing these design changes can require significant expenditures of time and expense by us in the development and pre-production process. Moreover, the value of any design win will largely depend upon the commercial success of the customer’s product and on the extent to which the design of the customer’s systems accommodates components manufactured by our competitors. We cannot ensure that we will continue to achieve design wins in customer products that achieve market acceptance. Further, most revenue-generating design wins take several years to translate into meaningful revenues.
We must successfully transition to new process technologies to remain competitive. Our future success depends upon our ability to develop products that utilize new process technologies.
Semiconductor design and process methodologies are subject to rapid technological change and require large expenditures for research and development. We currently manufacture our products using 65, 130 and 180 nanometer complementary metal oxide semiconductor (CMOS) processes. We continuously evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies. Other companies in the industry have experienced difficulty in transitioning to new manufacturing processes and, consequently, have suffered increased costs, reduced yields or delays in product deliveries. We believe that transitioning our products to smaller geometry process technologies will be important for us to remain competitive. We cannot be certain that we can make such a transition successfully, if at all, without delay or inefficiencies.
Our success depends on the timely development of new products, and we face risks of product development delays. Our success depends upon our ability to develop new devices and software for existing and new markets. The development of these new devices and software is highly complex, and from time to time we have experienced delays in completing the development of new products. Successful product development and introduction depends on a number of factors, including the following:
• accurate new product definition;
• timely completion and introduction of new product designs;
• availability of foundry capacity;
• achievement of manufacturing yields; and
• market acceptance of our products and our customers’ products.
Our success also depends upon our ability to do the following:
• build products to applicable standards or customer specifications;
• develop products that meet customer requirements;
• adjust to changing market conditions as quickly and cost-effectively as necessary to compete successfully;
• introduce new products that achieve market acceptance; and
• develop reliable software to meet our customers’ application needs in a timely fashion.
In addition, we cannot ensure that the systems manufactured by our customers will be introduced in a timely manner or that such systems will achieve market acceptance.
We sell a range of products that each has a different gross profit. Our total gross profits will be adversely affected if most of our shipments are of products with low gross profits. We currently sell more than 35 product families. Some of our products have a high gross profit while others do not. If our customers decide to buy more of our products with low gross profits and fewer of our
products with high gross profits, our total gross profits could be adversely affected. We plan our mix of products based on our internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially.
The price of our products tends to decrease over the lives of our products. Historically, average selling prices in the communication semiconductor industry have decreased over the life of a product, and, as a result, the average selling prices of our products may decrease in the future. Decreases in the price of our products would adversely affect our operating results. As global competition increases, our customers are increasingly more focused on price. We may have to decrease our prices to remain competitive in some situations, which may negatively impact our gross margins.
Our success depends on the rate of growth of the global communications infrastructure. We currently derive most of our net revenues from products for telecommunications, data and video communications applications. These markets are characterized by the following:
• susceptibility to seasonality of customer buying patterns;
• subject to general business cycles;
• intense competition;
• rapid technological change; and
• short product life cycles.
We anticipate that these markets will continue to experience significant volatility and reduced demand in the near future.
Our products must successfully include industry standards to remain competitive. Products for telecommunications and data communications applications are based on industry standards, which are continually evolving. Our future success will depend, in part, upon our ability to successfully develop and introduce new products based on emerging industry standards, which could render our existing products unmarketable or obsolete. If the telecommunications or data communications markets evolve to new standards, we cannot be certain that we will be able to successfully design and manufacture new products that address the needs of our customers and include the new standards or that such new products will meet with substantial market acceptance.
Our business has been and may continue to be significantly impacted by the deterioration in worldwide economic conditions, and the current uncertainty in the outlook for the global economy makes it more likely that our actual results will differ materially from expectations. Global credit and financial markets continue to experience disruptions, including diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and continued uncertainty about economic stability. Despite signs of improvement, there can be no assurance that there will not be renewed deterioration in credit and financial markets and confidence in economic conditions. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The continued or further tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to cancel, decrease or delay their existing and future orders with us. In addition, financial difficulties experienced by our suppliers or distributors could result in product delays, increased accounts receivable defaults and inventory challenges. The volatility in the credit markets has severely diminished liquidity and capital availability.
The licensing component of our business strategy increases business risk and volatility. Part of our business strategy is to license IP through agreements with companies whereby companies incorporate our IP into their respective technologies that address certain markets. There can be no assurance that additional companies will be interested in licensing our technology on commercially favorable terms or at
all. We also cannot ensure that companies who license our technology will introduce and sell products incorporating our technology, will accurately report royalties owed to us, will pay agreed upon royalties, will honor agreed upon market restrictions, will not infringe upon or misappropriate our intellectual property and will maintain the confidentiality of our proprietary information. The IP agreements are complex and depend upon many factors including completion of milestones, allocation of values to delivered items and customer acceptances. Many of these factors require significant judgments. Licensing revenue could fluctuate significantly from period to period because it is heavily dependent on a few key deals being completed in a particular period, the timing of which is difficult to predict and may not match our expectations. Because of its high margin content, the licensing mix of our revenue can have a disproportionate impact on gross profit and profitability. Also, generating revenue from these arrangements is a lengthy and complex process that may last beyond the period in which efforts begin and once an agreement is in place, the timing of revenue recognition may be dependent on customer acceptance of deliverables, achievement of milestones, our ability to track and report progress on contracts, customer commercialization of the licensed technology and other factors. Licensing that occurs in connection with actual or contemplated litigation is subject to risk that the adversarial nature of the transaction will induce non-compliance or non-payment. The accounting rules associated with recognizing revenue from these transactions are increasingly complex and subject to interpretation. Due to these factors, the amount of license revenue recognized in any period may differ significantly from our expectations.
Our intellectual property indemnification practices may adversely impact our business. We have historically agreed to indemnify our customers for certain costs and damages of intellectual property rights in circumstances where one of our products is the factor creating the customer’s infringement exposure. This practice may subject us to significant indemnification claims by our customers. In some instances, our products are designed for use in devices manufactured by our customers that comply with international standards. These international standards are often covered by patent rights held by third parties, which may include our competitors. The costs of obtaining licenses from holders of patent rights essential to such international standards could be high. The cost of not obtaining such licenses could also be high if a holder of such patent rights brings a claim for patent infringement. We are not aware of any claimed violations on our part. However, we cannot assure you that claims for indemnification will not be made or that if made, such claims would not have a material adverse effect on our business, results of operations or financial condition.
We continue to expense our new product process development costs when incurred. In the past, we have incurred significant new product and process development costs because our policy is to expense these costs, including tooling, fabrication and pre-production expenses, at the time that they are incurred. We may continue to incur these types of expenses in the future. These additional expenses will have a material and adverse effect on our operating results in future periods.
We face intense competition in the semiconductor market. The communication semiconductor industry is intensely competitive and is characterized by the following:
• rapid technological change;
• subject to general business cycles;
• price erosion;
• limited access to fabrication capacity;
• unforeseen manufacturing yield problems; and
• heightened international competition in many markets.
These factors are likely to result in pricing pressures on our products, thus potentially affecting our operating results.
Our ability to compete successfully in the rapidly evolving area of high-performance integrated circuit technology depends on factors both within and outside our control, including:
• success in designing and subcontracting the manufacture of new products that implement new technologies;
• protection of our products by effective use of intellectual property laws;
• product quality;
• reliability;
• price;
• efficiency of production;
• failure to find alternative manufacturing sources to produce our products with acceptable manufacturing yields;
• the pace at which customers incorporate our products into their products;
• success of competitors’ products; and
• general economic conditions.
The markets that we serve are intensely competitive. A number of our customers have internal semiconductor design or manufacturing capability with which we also compete in addition to our other competitors. Any failure by us to compete successfully in these target markets, would have a material adverse effect on our business, financial condition and results of operations.
We rely on outside fabrication facilities, and our business could be hurt if our relationships with our foundry suppliers are damaged. We do not own or operate a VLSI circuit fabrication facility. A few foundries currently supply us with all of our semiconductor device requirements. While we have had good relations with these foundries, we cannot be certain that we will be able to renew or maintain contracts with them or negotiate new contracts to replace those that expire. In addition, we cannot be certain that renewed or new contracts will contain terms as favorable as our current terms. There are other significant risks associated with our reliance on outside foundries, including the following:
• the lack of assured semiconductor wafer supply and control over delivery schedules;
• the unavailability of, or delays in obtaining access to, key process technologies; and
• limited control over quality assurance, manufacturing yields and production costs.
Reliance on third-party fabrication facilities limits our ability to control the manufacturing process. Manufacturing integrated circuits is a highly-complex and technology-intensive process. We work closely with our foundries to minimize the likelihood of reduced manufacturing yields; however, our foundries occasionally experience lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new process technologies. Such reduced manufacturing yields have at times reduced our operating results. A manufacturing disruption at one or more of our outside foundries, including, without limitation, those that may result from natural disasters, accidents, acts of terrorism or political instability or other natural occurrences, could impact production for an extended period of time.
Our dependence on a small number of fabrication facilities exposes us to risks of interruptions in deliveries of semiconductor devices. We purchase semiconductor devices from outside foundries pursuant to purchase orders, and we do not have a guaranteed level of production capacity at any of our foundries. We provide the foundries with forecasts of our production requirements. However, the ability of each foundry to provide wafers to us is
limited by the foundry’s available capacity and the availability of raw materials. Therefore, our foundry suppliers could choose to prioritize capacity and raw materials for other customers or reduce or eliminate deliveries to us on short notice. Accordingly, we cannot be certain that our foundries will allocate sufficient capacity to satisfy our requirements.
We have been, and expect in the future to be, particularly dependent upon a limited number of foundries for our VLSI device requirements. In 2011, one outside wafer foundry supplied a substantial amount of our total semiconductor wafer requirements. The time required to qualify alternative manufacturing sources for existing or new products could be substantial and we might not be able to find alternative manufacturing sources able to produce our VLSI devices with acceptable manufacturing yields. As a result, we expect that we could experience substantial delays or interruptions in the shipment of our products if there was a sudden increase in demand or if our foundry suppliers were to cease operations or limit our capacity.
We are subject to risks arising from our use of subcontractors to assemble our products. Contract assembly houses in Asia assemble all of our semiconductor products. Raw material shortages, natural disasters, political and social instability, service disruptions, labor disputes, rising wages, currency fluctuations, or other circumstances in the region could force us to seek additional or alternative sources of supply or assembly. This could lead to supply constraints or product delivery delays.
Our failure to protect our proprietary rights, or the costs of protecting these rights, may harm our ability to compete. Our success depends in part on our ability to obtain patents and licenses and to preserve other intellectual property rights covering our products and development and testing tools. To that end, we have obtained certain domestic and foreign patents and intend to continue to seek patents on our inventions when appropriate. The process of seeking patent protection can be time consuming and expensive. We cannot ensure the following:
• that patents will be issued from currently pending or future applications;
• that our existing patents or any new patents will be sufficient in scope or strength to provide meaningful protection or any commercial advantage to us;
• that foreign intellectual property laws will protect our foreign intellectual property rights; and
• that others will not independently develop similar products, duplicate our products or design around any patents issued to us.
Intellectual property rights are uncertain and adjudication of such rights involves complex legal and factual questions. We may be unknowingly infringing on the proprietary rights of others and may be liable for that infringement, which could result in significant liability for us. We occasionally receive correspondence from third parties alleging infringement of their intellectual property rights. If we are found to infringe the proprietary rights of others, we could be forced to either seek a license to the intellectual property rights of others or alter our products so that they no longer infringe the proprietary rights of others. A license could be very expensive to obtain or may not be available at all. Similarly, changing our products or processes to avoid infringing the rights of others may be costly or impractical.
We are responsible for any patent litigation costs. If we were to become involved in a dispute regarding intellectual property, whether ours or that of another company, we may have to participate in legal proceedings in the United States Patent and Trademark Office or in the United States or foreign courts to determine any or all of the following issues: patent validity, patent infringement, patent ownership or inventorship. These types of proceedings may be costly and time consuming for us, even if we eventually prevail. If we do not prevail, we might be forced to pay significant damages, obtain a license, if available, or stop making a certain product. From time to time, we may prosecute patent litigation against others and as part of such litigation, other parties may allege that our patents are not infringed, are invalid and are unenforceable.
We also rely on trade secrets, proprietary know-how and confidentiality provisions in agreements with employees and consultants to protect our intellectual property. Such parties may not comply with the terms of their agreements with us, and we may not be able to adequately enforce our rights against these parties.
We may not be able to pay our debt and other obligations. If our cash, cash equivalents and operating cash flows are inadequate to meet our obligations, we could face substantial liquidity problems. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments on the Amended and Restated Business Financing Agreement between us and Bridge Bank, N.A. or our other obligations, we would be in default under their respective terms. Any such default or cross default would have a material adverse effect on our business, prospects, financial condition and operating results.
The loss of key management could affect our ability to run our business. Our success depends largely upon the continued service of our executive officers and technical personnel and on our ability to continue to attract, retain and motivate other qualified personnel. As the source of our technological and product innovations, our key technical personnel represent a significant asset. The competition for such personnel can be intense in the semiconductor industry. We may also have a particularly hard time attracting and retaining key personnel during periods of poor performance and during this period following our most recent restructuring.
We may engage in acquisitions that may harm our operating results, dilute our stockholders and cause us to incur debt or assume contingent liabilities. We may pursue acquisitions from time to time that could provide new technologies, skills, products or service offerings. Future acquisitions by us may involve the following:
• use of significant amounts of cash and cash equivalents;
• potentially dilutive issuances of equity securities; and
• incurrence of debt or amortization expenses related to intangible assets with definitive lives.
In addition, acquisitions involve numerous other risks, including:
• diversion of management’s attention from other business concerns;
• risks of entering markets in which we have no or limited prior experience; and
• unanticipated expenses and operational disruptions while acquiring and integrating new acquisitions.
From time to time, we have engaged in discussions with third parties concerning potential acquisitions of product lines, technologies and businesses. We currently have no commitments or agreements with respect to any such acquisition. If such an acquisition does occur, we cannot be certain that our business, operating results and financial condition will not be materially adversely affected or that we will realize the anticipated benefits of the acquisition.
Our business could be harmed if we fail to integrate future acquisitions adequately. During the past five years, we have acquired three companies, one based in the United States and two in Israel.
Our management must devote time and resources to the integration of the operations of any future acquisitions. The process of integrating research and development initiatives, computer and accounting systems and other aspects of the operations of any future acquisitions presents a significant challenge to our management. This is compounded by the challenge of simultaneously managing a larger and more geographically dispersed entity.
Future acquisitions could present a number of additional difficulties of integration, including:
• difficulties in integrating personnel with disparate business backgrounds and cultures;
• difficulties in defining and executing a comprehensive product strategy; and
• difficulties in minimizing the loss of key employees of the acquired company.
If we delay integrating or fail to integrate operations or experience other unforeseen difficulties, the integration process may require a disproportionate amount of our management’s attention and financial and other resources. Our failure to address these difficulties adequately could harm our business or financial results, and we could fail to realize the anticipated benefits of the transaction.
We have, in the past, as a result of industry conditions, discontinued or abandoned certain product lines acquired through acquisitions.
We could be subject to class action litigation due to stock price volatility, which if it occurs, will distract our management and could result in substantial costs or large judgments against us. In the past, securities and class action litigation has often been brought against companies following periods of volatility in the market prices of their securities. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert our management’s attention and resources, which could cause serious harm to our business, operating results and financial condition or dilution to our stockholders.
Provisions of our certificate of incorporation, by-laws, rights agreement and Delaware law may discourage takeover offers and may limit the price investors would be willing to pay for our common stock. Delaware corporate law contains, and our certificate of incorporation and by-laws and rights agreement contain, certain provisions that could have the effect of delaying, deferring or preventing a change in control of our Company even if a change of control would be beneficial to our stockholders. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. Certain of these provisions:
• authorize the issuance of “blank check” preferred stock (preferred stock which our Board of Directors can create and issue without prior stockholder approval) with rights senior to those of common stock;
• prohibit stockholder action by written consent;
• establish advance notice requirements for submitting nominations for election to the Board of Directors and for proposing matters that can be acted upon by stockholders at a meeting; and
• dilute stockholders who acquire more than 15% of our common stock.
Natural disasters or acts of terrorism affecting our locations, or those of our suppliers, in the United States or internationally may negatively impact our business. We operate our businesses in the United States and internationally, including the operation of a design center in India, and sales, design and engineering operations in Israel. Some of the countries in which we operate or in which our customers are located have in the past been subject to terrorist acts and could continue to be subject to acts of terrorism. In addition, some of these areas may be subject to natural disasters, such as earthquakes or floods. If our facilities, or those of our suppliers or customers, are affected by a natural disaster or terrorist act, our employees could be injured and those facilities damaged, which could lead to loss of skill sets and affect the development or fabrication of our products, which could lead to lower short and long-term revenues. In addition, natural disasters or terrorist acts in the areas in which we operate or in which our customers or suppliers operate could lead to delays or loss of business opportunities, as well as changes in security and operations at those locations, which could increase our operating costs.
Our ability to sublease excess office space may adversely affect our future cash outflows. We have outstanding operating lease commitments of approximately $17.1 million, payable over the next six years. Some of these commitments are for space that is not being utilized and, for which, we recorded restructuring charges in prior periods. We currently have subleases for the majority of our excess space but our sublease income generated will not offset the entire future commitment. As of December 31, 2011, we have sublease agreements totaling approximately $11.7 million to rent portions of our excess facilities over the next six years. We currently believe that we can fund these lease commitments in the future; however, there can be no assurances that we will not be required to seek additional capital or provide additional guarantees or collateral on these obligations.
Of the office space being leased in our Shelton, Connecticut location, as of December 31, 2011, approximately 111,993 square feet is considered excess, the majority of which we have taken restructuring charges for in prior years. Substantially all of this space is currently being sublet, but not for the full amount of our lease obligation. If we are unable to collect our sub-lease rents, our future cash outflows would be adversely affected.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
Our headquarters is located in a suburban office park in Shelton, Connecticut. We have additional sales offices and design centers located throughout the world. The following is a summary of our material offices and locations for which we have lease commitments:
* 108,093 square feet of excess space is currently subject to subleases and 3,900 square feet is available for lease.
Internationally, we also lease space in Japan, China, Taiwan, France and South Korea for sales offices. Our current facilities are adequate for our needs.
Refer to Note 16 - Commitments and Contingencies of our Consolidated Financial Statements for additional disclosures regarding our commitments under lease obligations. Also, refer to Note 15 - Restructuring Charges of our Consolidated Financial Statements regarding our restructuring charges during fiscal years 2009 through 2011 as we have recorded charges for future rent payments relating to excess office space.
Item 3.
Item 3. Legal Proceedings
We are not party to any material litigation proceedings.
From time to time, we may be subject to legal proceedings and claims in the ordinary course of business. We are not currently aware of any such proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on the business, financial condition or results of our operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded under the symbol “TXCC” on The Nasdaq Capital Market. The following table sets forth, for the periods indicated, the range of high and low closing prices for our common stock. The closing prices indicated reflect the 1 for 8 reverse stock split that was effected on November 23, 2009.
As of March 1, 2012, there were approximately 144 holders of record and approximately 16,180 beneficial shareholders of our common stock.
We have never paid cash dividends on our common stock. We currently do not anticipate paying any cash dividend in the foreseeable future. Any future declaration and payment of dividends will be subject to the discretion of our Board of Directors, will be subject to applicable law and will depend upon our results of operations, earnings, financial condition, contractual limitations, cash requirements, future prospects and any other factors deemed relevant by our Board of Directors.
We also have securities authorized for issuance under equity compensation plans. The following table provides information as of December 31, 2011 with respect to shares of our common stock that may be issued under our existing equity compensation plans, including our 1995 Third Amended and Restated Stock Plan (the “1995 Plan”), 2000 Stock Option Plan (the “2000 Plan”), 2008 Equity Incentive Plan (the “2008 Plan”), and 2005 Employee Stock Purchase Plan (the “Purchase Plan”). No shares are available for future grants under the 1995 Plan or 2000 Plan.
(1) Consists of the 1995 Plan, the 2008 Plan, and the Purchase Plan.
(2) Consists of the 2000 Plan.
(3) Excludes purchase rights accruing under the Purchase Plan which has a stockholder-approved reserve of 250,000 shares. Under the Purchase Plan, each eligible employee is able to purchase up to 2,000 shares of our common stock at semi-annual intervals each year at a purchase price per share equal to 85% of the lower of the fair market value of our common stock on the first or last trading day of a purchase period.
(4) Includes restricted stock units of 1,629,952. These awards have no strike price and are issued from our 2008 Plan.
Equity Compensation Plans Not Approved by Stockholders 2000 Stock Option Plan. The purpose of the 2000 Plan adopted by our Board of Directors on July 14, 2000 and amended on December 21, 2001, was to promote our long-term success, by providing financial incentives to employees and consultants of the Company who are in positions to make significant contributions toward such success, except that no member of our Board of Directors or officer of the Company appointed by the Board of Directors was eligible for grants of options under the 2000 Plan. The 2000 Plan was designed to attract individuals of outstanding ability to become or to continue as employees or consultants, to enable such individuals to acquire or increase their proprietary interest in the Company through the ownership of shares of our Common Stock, and to incentivize such individuals to render superior performance during their associations with us, by providing opportunities to participate in the ownership of our future growth through the granting of NQSOs. The 2000 Plan was administered by our Board of Directors or, at its option, a committee appointed by our Board of Directors. A total of 1,250,000 shares of common stock were reserved for issuance under the 2000 Plan. In April 2008, our Board of Directors determined that no further awards would be made under this plan and that all remaining 303,379 shares available for issuance under the 2000 Plan that were not subject to outstanding stock option awards would be eligible for issuance under the 2008 Equity Incentive Plan.
Issuer Purchases of Equity Securities On February 13, 2008, we announced that our Board of Directors authorized a stock repurchase program under which we could repurchase up to $10 million of our outstanding common stock. The share repurchase program authorized the repurchase of shares through February 2010, from time to time, through transactions in the open market or in privately negotiated transactions.
During the years ended December 31, 2010 and 2011, we did not repurchase any shares.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Conditions and Results of Operations (MD&A) is provided to supplement the accompanying consolidated financial statements and notes in Item 8 to help provide an understanding of our financial condition, changes in our financial condition and results of operations. MD&A is organized as follows:
Caution concerning forward-looking statements. This section discusses how certain forward-looking statements made by us throughout the MD&A are based on management’s present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances.
Overview. This section provides a general description of our business.
Critical accounting policies and use of estimates. This section discusses those accounting policies that are both considered important to our financial condition and operating results and require significant judgment and estimates on the part of management in their application.
Results of operations. This section provides an analysis of our results of operations for the years ended December 31, 2011, 2010 and 2009. In addition, a brief description is provided of transactions and events that impact the comparability of the results.
Liquidity and capital resources. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements. In this section, we also summarize related party transactions and recent accounting pronouncements not yet adopted by us.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements that involve risks and uncertainties. When used in this report, the words, “intend,” “anticipate,” “believe,” “estimate,” “plan,” “expect” and similar expressions as they relate to us are included to identify forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of factors, including those set forth under “Item 1A. Risk Factors” and elsewhere in this report. You should read this discussion in conjunction with the consolidated financial statements and the notes thereto included in this report.
OVERVIEW TranSwitch designs, develops and supplies innovative integrated circuit (IC) and intellectual property (IP) solutions that provide core functionality for voice, data and video communications equipment for network, enterprise and customer premises applications. We provide integrated multi-core network processor System-on-a-Chip (SoC) solutions and software solutions for Fixed, 3G and 4G Mobile, VoIP and Multimedia Infrastructures. For the customer-premises market, we offer a family of communications processors that provide best-in-class performance for a range of applications and also provide interoperable connectivity solutions that provide a bridge between HDMI and DisplayPort and enable the distribution and presentation of high-definition (HD) content for consumer electronic, and personal computer markets. Overall, we have over 100 active customers, including the leading global telecom equipment providers, semiconductor and consumer product companies.
TranSwitch Corporation is a Delaware corporation incorporated on April 26, 1988. Our principal executive offices are located at 3 Enterprise Drive, Shelton CT 06484, and our telephone number at that location is (203) 929-8810. Our Internet address is www.transwitch.com. Our common stock trades on the Nasdaq Capital Market under the symbol “TXCC.”
Our telecom products are sold to original equipment manufacturers (OEMs) for use in a variety of communications network equipment, including:
1. Network Infrastructure Processing - Multi-media processing engines to address multiple carrier segments such as wireline and wireless gateways, session border controllers (SBC), media resource functions (MRF), multi-service access nodes (MSAN), passive optical network multi-dwelling units (PON MDUs) and translation gateways. Enterprise applications include VoIP private branch exchanges.
2. Communication Network Premises Equipment - IP Multimedia Subsystem (IMS) and Voice over LTE (VoLTE) capable 4G/LTE fixed wireless gateways, Residential gateway routers, Small office - home office (SOHO) routers and secure VoIP private branch exchanges (PBXs).
Our interoperable connectivity solutions are sold to OEMs for use in consumer electronics and personal computers.
Our revenues were $28.3 million in 2011, $49.8 million in 2010 and $56.1 million in 2009. As a result of decreased revenues over the past couple of years, we have taken strict cost control measures including the implementation of restructuring plans during 2010 and 2011. Also, during 2011, we paid in full our 5.45% Convertible Notes due September 30, 2011 (“2011 Notes”) and as such there was no outstanding balance as of December 31, 2011 as compared to notes payable of $3.8 million as of December 31, 2010.
During the year ended December 31, 2011, we raised approximately $16.1 million in net proceeds from the sale of 6,210,000 shares of our common stock (see Note 14 of the Notes to the Consolidated Financial Statements).
We also entered into an Amended and Restated Business Financing Agreement (the “Amended Financing Agreement”) with Bridge Bank N.A. (“Bridge Bank”) on April 4, 2011 which amended and restated our existing credit facility. The Amended Financing Agreement provides us a credit facility of up to $5.0 million which bears interest at the higher of (i) the prime rate plus 2.0% or (ii) 5.25% percent, plus the payment of certain fees and expenses (the “Facility”). The Facility is secured by substantially all of our personal property, including our accounts receivable and intellectual property. Subject to the terms of the Amended Financing Agreement, availability under the Facility is based on a formula pursuant to which Bridge Bank would advance an amount equal to the lower of $5.0 million or 80% of our eligible accounts receivable, with account eligibility and advance rates determined by Bridge Bank in its sole discretion. The term of the Facility is two years and at the expiration of such term, all loan advances under the Facility will become immediately due and payable. At December 31, 2011, we had no outstanding borrowings under this facility.
On February 10, 2012, we entered into an At Market Issuance Sales Agreement with MLV & Co. LLC (“MLV”), pursuant to which we may issue and sell shares of our common stock, $0.001 par value per share, having an aggregate offering price of up to $10,000,000 from time to time through MLV (the “Offering”). Also on February 10, 2012, we filed a prospectus supplement with the Securities and Exchange Commission in connection with the Offering.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES Our consolidated financial statements and related disclosures, which are prepared to conform with accounting principles generally accepted in the United States of America (U.S. GAAP), require us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the period reported. We are also required to disclose amounts of contingent assets and liabilities at the date of the consolidated financial statements. Our actual results in future periods could differ from those estimates and assumptions. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
We consider the most critical accounting policies and uses of estimates in our consolidated financial statements to be those relating to:
(1) recognizing net revenues, cost of revenues and gross profit;
(2) estimating allowances for doubtful accounts;
(3) estimating assumptions used in the calculation of stock-based compensation;
(4) estimating values for intangibles and long-lived assets;
(5) estimating values used for the goodwill impairment analysis;
(6) estimating excess inventories;
(7) estimating restructuring liabilities; and
(8) estimating values of investments in non-publicly traded companies.
These accounting policies, the bases for these estimates and their potential impact to our consolidated financial statements, should any of these estimates change, are further described as follows:
Net Revenues, Cost of Revenues and Gross Profit. Net revenues are primarily comprised of product shipments, principally to domestic and international telecommunications and data communications OEMs and to distributors. Net revenues from product sales to OEMs are recognized at the time of product shipment when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) title and risk of loss transfers to the customer; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured. Revenues from our distributors can be recognized when: (1) the prices are fixed at the date of shipment from our facilities; (2) payment is not contractually or otherwise excused until the product is resold; (3) we do not have any obligations for future performance relating to the resale of the product; and (4) the amount of future returns, allowances, refunds and costs to be incurred can be reasonably estimated and are accrued at the time of shipment. Agreements with certain distributors provide price protection and return and allowance rights. Service revenues are recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) we have performed a service in accordance with our contractual obligations; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.
At the time of shipment, we record a reduction to revenue (with a related liability) to accrue for future price protection. This liability is established based on historical experience, contractually agreed-to provisions and future shipment forecasts. Such accruals have been insignificant for the last three years.
We also accrue, at the time of shipment, a reduction to revenue (with a related liability) and an inventory asset against product cost of revenues in order to establish a provision for the gross margin related to future returns under our distributor stock rotation program. Such accruals related to reductions of revenue were $0.4 million, $0.8 million and $0.6 million at December 31, 2011, 2010 and 2009, respectively. The accruals related to inventory assets are insignificant to our financial position and results of operations for all periods presented. Should our actual experience differ from our estimated liabilities, there could be adjustments (either favorable or unfavorable) to our net revenues, cost of revenues and gross profits.
We warranty our products for up to one year from the date of shipment. Warranty expense is insignificant to all periods presented.
We license connectivity solutions, including HDMI, DisplayPort and Ethernet IP Cores. Revenues from licensing arrangements generally consist of multiple elements such as license, implementation and maintenance services. The items (deliverables) included in the arrangements are evaluated to determine whether they represent separate units of accounting. We perform this evaluation at the inception of an arrangement and as we deliver each item in the arrangement.
Generally, we account for a deliverable (or a group of deliverables) separately if (1) the delivered item(s) has standalone value to the customer, (2) there is objective and reliable evidence of the fair value of the undelivered items included in the arrangement, and (3) if we have given the customer a general right of return relative to the delivered items, delivery or performance of the undelivered items or services are probable and substantially in our control.
We also recognize revenue from royalties upon notification of sale by our licensees. The terms of the royalty agreements generally require licensees to give us notification and to pay royalties within 45 days of the end of the quarter during which the sales by the licensees take place.
Estimated Allowances for Doubtful Accounts. We record allowances for doubtful accounts for estimated losses based upon specifically identified amounts that we believe to be uncollectible along with our assessment of the general financial condition of our customer base. If our actual collections experience changes, revisions to our allowances may be required. We have a limited number of customers with individually large amounts due at any given balance sheet date. Any unanticipated change in the creditworthiness of such a customer or other matters affecting the collectability of amounts due from such customers could have a material effect on our results of operations in the period in which such changes or events occur.
Stock-based Compensation. Determining the amount of stock-based compensation for awards granted includes selecting an appropriate model to calculate fair value at the grant date. We have used the Black-Scholes option valuation model to value employee stock option awards. Certain inputs to this valuation model require considerable judgment. These inputs include estimating the volatility of our stock, the expected life of the option awarded and the forfeiture rate. We have estimated volatility, the expected life and the forfeiture rate based on historical data. Volatility is estimated over a term that approximates the expected life of the option awarded.
Intangibles and Long-Lived Assets (including Goodwill). We review long-lived and intangible assets (including goodwill) for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. When factors indicate that a long-lived asset should be evaluated for possible impairment, an estimate of the related asset’s undiscounted future cash flows over the remaining life of the asset is made to measure whether the carrying value is recoverable. Any impairment is measured based upon the excess of the carrying value of the asset over its estimated fair value which is generally based on an estimate of future discounted cash flows. A significant amount of management judgment is used in estimating future discounted cash flows. During the fourth quarter of 2011, impairment testing for certain purchased customer relationships and developed technology was performed by us and indicated that the undiscounted future cash flows of these intangible assets were less than its corresponding carrying amount. As a result of the analyses performed, we measured and recorded an impairment of these intangible assets of $5.4 million in 2011. The 2011 impaired purchased customer relationships and developed technology related to a business acquisition in 2008. We did not record any impairment changes on any other intangibles or long-lived assets in 2010.
Our impairment review of goodwill was performed using a fair-value method and discounted cash flow models with estimated cash flows based on internal forecasts which included terminal values based on current market valuation metrics. The fair value represents the amount at which a reporting unit could be bought or sold in a current transaction between willing parties on an arms-length basis. In estimating fair value, we used our common stock’s market price to determine fair value and other valuation metrics. In addition, we performed discounted cash flow analysis on the reporting units to determine fair value. During the fourth quarter of 2011, impairment testing performed by us indicated that the estimated fair value of the reporting unit tested was less than its corresponding carrying amount. As a result of the analyses performed, we recorded goodwill impairment charges of $8.9 million in 2011. The 2011 impaired goodwill related to a business acquisition in 2008. We did not record any goodwill impairment charges in 2010. During the fourth quarter of 2009, impairment testing we performed indicated that the estimated fair values of two reporting units tested were less than their corresponding carrying amounts. As a result of the analyses performed, we recorded a goodwill impairment charge of $10.1 million in 2009. The impaired goodwill related to business acquisitions in 2007 and 2006.
A considerable amount of management judgment and assumptions are required in performing impairment tests. While we believe that our judgments and assumptions were reasonable, different assumptions could change the estimated fair values and, therefore, additional impairment charges could be required.
Estimated Excess Inventories. We periodically review our inventory levels to determine if inventory is stated at the lower of cost or net realizable value. The telecommunications and data communications industries have experienced a significant downturn during the past few years and, as a result, we have had to evaluate our inventory position based on known backlog of orders, projected sales and marketing forecasts, shipment
activity and inventory held at our significant distributors. We recorded charges for excess and obsolete inventories totaling approximately $0.2 million in 2011, $0.8 million in 2010 and $0.7 million in 2009.
During 2011, 2010 and 2009, we recorded net product revenues of approximately $0.4 million, $1.2 million and $3.0 million, respectively, on shipments of excess and obsolete inventory that had previously been written down to their estimated net realizable value of zero. This resulted in almost 100% gross margin on these product revenues. Had these products been sold at our historical average cost basis, gross margin on these revenues would have been 51%, 58% and 51% in 2011, 2010 and 2009 respectively. We currently do not anticipate that a significant amount of the excess and obsolete inventories subject to the write-downs described above will be used in the future based upon our current demand forecast. Should our actual future demand exceed the estimates that we used in writing down our excess and obsolete inventories, we will recognize a favorable impact to cost of revenues and gross profits. Should demand fall below our current expectations, we may record additional inventory write-downs which will result in a negative impact to cost of revenues and gross profits.
Estimated Restructuring Liabilities. During 2011, we recorded a net restructuring benefit of $5.6 million. On December 28, 2011, we entered into an amendment (the “Amendment”) to a sublease agreement (the “Sublease”) with an unaffiliated party to sublease 92,880 square feet of our office space in Shelton, Connecticut. As a result of the Sublease, we reversed approximately $7.0 million of previously accrued restructuring liabilities. This amendment extends the sublease through May 2017. This benefit was partially offset by approximately $1.4 million of charges for workforce reductions implemented during 2011. In the third quarter of 2011, we implemented a restructuring plan that included a workforce reduction of approximately 39 positions primarily in our Shelton, Connecticut, Fremont, California, New Delhi, India and Bangalore, India locations. We also implemented a restructuring plan in the first quarter of 2011 that included a workforce reduction of approximately 26 positions primarily in our Fremont, California, New Delhi, India and Bangalore, India locations. The restructuring charges are primarily for employee termination benefits. During 2010, we recorded a net restructuring charge of approximately $0.4 million. We implemented a restructuring plan in the first quarter of 2010 that included a workforce reduction of approximately 17 positions in our Shelton, Connecticut, Fremont, California, New Delhi, India and Bangalore, India locations. The restructuring charges were primarily for employee termination benefits. All of the related cash expenditures were paid during 2010. During 2009, we recorded a net restructuring benefit of $6.3 million related to new sublease agreements we entered into during 2009 for unused space in our Shelton, Connecticut location which were partially offset by charges related to workforce reductions and other restructuring adjustments. At December 31, 2011 and 2010, the restructuring liabilities were $4.5 million and $11.2 million, respectively, on our consolidated balance sheets. Restructuring liabilities at December 31, 2011 include approximately $3.7 million of liabilities for facility lease costs and approximately $0.8 million for employee termination benefits (Refer to Note 15 - Restructuring Charges of the Notes to Consolidated Financial Statements). These facility operating leases expire in 2017. The future cash outlays for all of our operating lease commitments are discussed in Note 16 of the Notes to Consolidated Financial Statements. Certain assumptions are used by us to derive this estimate, including future maintenance costs, price escalation and sublease income derived from these facilities. Should we negotiate additional sublease rental income agreements or reach a settlement with our lessors to be released from our existing obligations, we could realize a favorable benefit to our results of future operations. Should future lease, maintenance or other costs related to these facilities exceed our estimates, we could incur additional expenses in future periods.
Valuation of Investments in Non-Publicly Traded Companies. We have been making strategic equity investments in non-publicly traded companies that develop technologies that are complementary to our product road map. Depending on our level of ownership and whether or not we have the ability to exercise significant influence, we account for these investments on either the cost or equity method, and review such investments periodically for impairment. The appropriate reductions in carrying values are recorded when, and if, necessary. The process of assessing whether a particular investment’s net realizable value is less than its carrying cost requires a significant amount of judgment. In making this judgment, we carefully consider the investee’s cash position, projected cash flows (both short and long-term), financing needs, most recent valuation data, the current investing environment, management/ownership changes, and competition. This evaluation process is based on information that we request from these privately held companies. This
information is not subject to the same disclosure and audit requirements as the reports required of United States public companies, and as such, the reliability and accuracy of the data may vary. Based on our evaluations, we recorded impairment charges related to our investments in non-publicly traded companies of zero, zero, and less than $0.1 million during 2011, 2010 and 2009, respectively. Also, during the first quarter of 2010, we sold our investment in Opulan Technologies Corp. (“Opulan”) for $2.7 million. The carrying value of this investment in Opulan was also $2.7 million and accordingly no gain or loss was recorded on this transaction. The total investment in non-public companies was $0.3 million and $3.0 million as of December 31, 2011 and 2010, respectively. (For further discussion, please refer to Note 4 Investments in Non-Publicly Traded Companies and Venture Capital Funds in our Consolidated Financial Statements). We used the modified equity method of accounting to determine the impairment loss for certain investments, as it was determined that no better current evidence of the value of our cost method investments existed and we believe that this gives us the best basis for our estimate given the historic negative cash flows of these companies. The modified equity method of accounting results in recording an impairment loss on a cost method investment equal to the investor’s proportionate share of the investee’s losses as its contributed capital is consumed to fund operating losses of the investee from the inception of the investor’s investment.
RESULTS OF OPERATIONS The results of operations that follow should be read in conjunction with our critical accounting policies and estimates summarized above as well as our consolidated financial statements and notes thereto contained in Item 8 of this report. The following table sets forth certain consolidated statements of operations data as a percentage of net revenues for the periods indicated.
Comparison of Fiscal Years 2011 and 2010 Net Revenues. We have two product line categories: Network Infrastructure and Customer Premises Equipment (CPE). Our Network Infrastructure product lines include our Optical Transport, Carrier Ethernet and Media Gateway/VoIP and Broadband Access product lines. The Optical Transport products are incorporated into OEM systems that improve the efficiency of fiber optic networks for packetized data traffic, thereby increasing the overall network capacity. Our Media Gateway/VoIP products provide Voice-over-IP and other packet processing functionality in a variety of equipment types deployed in wireless and wire-line carrier networks as well as in enterprise networks. These equipment types include large capacity media gateways in
the core of the network, small-medium capacity access gateways in the ‘last-mile’ section of the network and customer premise equipment for business and residential subscribers. The Broadband Access product line is incorporated into equipment that provides high speed connections to subscribers using fiber (FTTx) or DSL technology, enabling telecommunications service providers to support next generation voice, data and video services. The Carrier Ethernet product line facilitates the transition of existing networks-based legacy voice oriented technologies to Ethernet technology which is more suitable and efficient for supporting next generation converged video, data and voice services. Our CPE product line category includes our high-speed interface product line (HDMI, DisplayPort and Ethernet IP Cores) which has been incorporated into a number of consumer electronics and PC appliances and Multi-Service Communications Processors used in broadband modems or to be added as part of a small office, home office, or SOHO, network. Our Network Infrastructure and Multi-Service Communications Processor product lines continue to show a decline year over year, which may affect our impairment analysis of goodwill in the future.
The following table summarizes our net revenue mix by product line category:
Total net revenues in 2011 were $28.3 million as compared to $49.8 million in 2010, a decrease of $21.5 million or 43%. Our Network Infrastructure revenues decrease of approximately 40% was a result of lower sales of Optical Transport and VoIP products due to reduced telecom infrastructure capital expenditures and reduced sales of our ASIC products. Our CPE revenues decrease of approximately 50% was attributable to the ramping down of our Mustang (gigabit Ethernet passive optical) product line towards the end of 2010 and reduced sales of our Communications Processor products. This reduction was partially offset by increased service revenues which include IP licensing of our high speed interface technology.
For 2011 and 2010, international net revenues were approximately 77% and 75%, respectively, of net revenues.
As of December 31, 2011, our backlog was $4.3 million, as compared to $7.5 million as of December 31, 2010. Backlog represents firm orders anticipated to be shipped, and service revenue expected to be billed under existing contracts, during the next 12 months. Our business and, to a large extent, that of the entire communication semiconductor industry, is characterized by short-term order and shipment schedules. Since orders constituting our current backlog are subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty, backlog is not necessarily indicative of future revenues.
Gross Profit. Gross profit was $17.9 million and $27.8 million for the years ended December 31, 2011 and 2010, respectively, a decrease of approximately $9.9 million for 2011 as compared to 2010. The decrease in gross profit was primarily the result of a decrease in net product revenues which was partially offset by higher gross margins on product revenues in 2011. The product gross profit was 65% as a percentage of product revenue in 2011 as compared to 55% in 2010. The total gross profit as a percentage of total revenue was 63% and 56% for 2011 and 2010, respectively. The changes in gross margin percentage are mostly attributable to changes in product mix, especially a larger portion of royalties and higher margin IP licensing revenues.
During the years ended December 31, 2011 and 2010, gross profit was affected favorably in the amount of $0.2 million and $0.5 million, respectively, from the sales of products that had previously been written down to a cost basis of zero. Also during the years ended December 31, 2011 and 2010, we recorded provisions for excess and obsolete inventories in the amount of $0.2 million and $0.8 million, respectively. These charges had a negative impact on our gross profit.
We anticipate that gross profit will continue to be impacted by fluctuations in the volume and mix of our product shipments as well as material costs, yield and the fixed cost absorption of our production operations.
Research and Development. Research and development expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to electronic design automation tools, subcontracting and fabrication costs, depreciation and amortization and facilities expenses. Research and development expenses for 2011 were $18.9 million which increased $2.9 million, or 18% as compared to the prior year. This was a result of increased spending in labor, subcontracting and fabrication costs for our high-speed interface product line.
Marketing and Sales. Marketing and sales expenses consist primarily of personnel-related expenses, trade shows, travel expenses and facilities expenses. Marketing and sales expenses for 2011 were $7.3 million which decreased $0.4 million, or 6% as compared to the prior year. This decrease was a result of lower salaries and employee related expenses due to cost cutting measures that were implemented in 2011. These decreases were partially offset by increased sales costs related to our high-speed interface product line
General and Administrative. General and administrative (G&A) expenses consist primarily of personnel-related expenses, professional and legal fees, and facilities expenses. G&A expenses remained flat at $7.5 million in 2011 as compared to $7.5 million in 2010.
Restructuring (Credits) Charges, net. During the years ended December 31, 2011 and 2010, we recorded net restructuring credits of $5.6 million and net restructuring charges of $0.4 million, respectively. Information on restructuring credits and charges for each of the last two years is located in Note 15 of the Notes to Consolidated Financial Statements.
Impairment of Goodwill and Other Intangibles. For 2011 and 2010, we recorded goodwill and other intangible impairment charges of $14.3 million and zero, respectively. Information on the impairment of goodwill and other intangibles recorded during 2011 is located in Note 1 and Note 7 of the Notes to Consolidated Financial Statements.
Interest Expense net. Interest expense, net was approximately $0.1 million in 2011, a decrease of $0.5 million as compared to 2010.
Interest expense decreased from $0.7 million in 2010 to $0.2 million in 2011 due to lower debt balances resulting from the principal payments made on our 2011 Notes. The interest payments on our debt balances were $0.1 million and $0.4 million for the years ended December 31, 2011 and 2010, respectively. Our 2011 Notes were paid in full as of September 30, 2011 and as such there will be no interest payments on this debt after that date.
Interest income was $0.1 million in both years ended December 31, 2011 and 2010. Interest income may fluctuate in the future as a result of changes in market yields due to interest rate fluctuations and changes in our cash and investment balances. At December 31, 2011 and 2010, the effective interest rates on our interest-bearing securities were approximately 2.54% and 1.36%, respectively.
Other Income (Expense). For the years ended December 31, 2011 and 2010, we had other income of approximately $0.1 million and $0.4 million, respectively. The other income for 2010 was primarily due to both realized and unrealized exchange rate gains and losses which are recorded for the translation of our intercompany loan balances with our wholly owned subsidiaries. In 2011, we determined that our intercompany loan balances with our foreign subsidiaries are classified as long-term. As such, we recorded exchange gains and losses in the translation of these balances as other comprehensive income or loss for the year ended December 31, 2011.
Income Tax Expense. Our income tax expense of $0.6 million in 2011 and $1.0 million in 2010 is applicable to the operating results of certain of our foreign subsidiaries, principally India. We have incurred significant taxable losses for United States federal and state purposes. We have not recognized any income tax benefits on those losses because their realization is uncertain.
Comparison of Fiscal Years 2010 and 2009 Net Revenues. We have two product line categories: Network Infrastructure and Customer Premises Equipment (CPE). Our Network Infrastructure product lines include our Optical Transport, Carrier Ethernet and Media Gateway using VoIP Technology and Broadband Access product lines. The Optical Transport products are incorporated into OEM systems that improve the efficiency of fiber optic networks for packetized data traffic, thereby increasing the overall network capacity. Our Media Gateway/VoIP products provide Voice-over-IP and other packet processing functionality in a variety of equipment types deployed in wireless and wire-line carrier networks as well as in enterprise networks. These equipment types include large capacity media gateways in the core of the network, small-medium capacity access gateways in the ‘last-mile’ section of the network and customer premise equipment for business and residential subscribers. The Broadband Access product line is incorporated into equipment that provides high speed connections to subscribers using fiber (FTTx) or DSL technology, enabling telecommunications service providers to support next generation voice, data and video services. The Carrier Ethernet product line facilitates the transition of existing networks-based legacy voice oriented technologies to Ethernet technology which is more suitable and efficient for supporting next generation converged video, data and voice services. Our CPE product line category includes our high-speed interface product line (HDMI, DisplayPort and Ethernet IP Cores) which has been incorporated into a number of consumer electronics and PC appliances and Multi-Service Communications Processors used in broadband modems or to be added as part of a small office, home office, or SOHO, network. Our Network Infrastructure and Multi-Service communications Processor product lines continue to show a decline year over year.
The following table summarizes our net revenue mix by product line category:
Total net revenues in 2010 were $49.8 million as compared to $56.1 million in 2009, a decrease of $6.3 million or 11%. Our Network Infrastructure revenues decrease of approximately 8% was a result of lower sales of our L3M, CUBIT-3D, TEMx28, ASPEN Express and Entropia products due to reduced telecom infrastructure capital expenditures in the second half of 2010. This was partially offset by increased sales of our EtherMap (Carrier Ethernet products), ENVOY CE4 and our ASIC families of products. Our CPE revenues decrease of approximately 16% was attributable to decreased sales of our Atlanta products (VOIP communication processors) and the ramping down of our Mustang (gigabit Ethernet passive optical) product line. This reduction was partially offset by increased sales from our HDMI products along with increased service revenues which include IP licensing of our high speed interface technology.
For 2010 and 2009, international net revenues were approximately 75% and 70%, respectively, of net revenues.
As of December 31, 2010, our backlog was $7.5 million, as compared to $11.3 million as of December 31, 2009. Backlog represents firm orders anticipated to be shipped, and service revenue expected to be billed under existing contracts, during the next 12 months. Our business and, to a large extent, that of the entire communication semiconductor industry, is characterized by short-term order and shipment schedules. Since orders constituting our current backlog are subject to changes in delivery schedules or to cancellation at the option of the purchaser without significant penalty, backlog is not necessarily indicative of future revenues.
Gross Profit. Gross profit was $27.8 million and $31.5 million for the years ended December 31, 2010 and 2009, respectively. Gross profit decreased by approximately $3.7 million for 2010 as compared to 2009 while the gross profit as a percentage of revenue was the same 56% in 2010 as it was in 2009. The decrease in gross profit is the result of decreased product sales partially offset by increased service revenues.
During the years ended December 31, 2010 and 2009, gross profit was affected favorably in the amount of $0.5 million and $1.3 million, respectively, from the sales of products that had previously been written down to a cost basis of zero. Also during the years ended December 31, 2010 and 2009, we recorded provisions for excess and obsolete inventories in the amount of $0.8 million and $0.7 million, respectively. These charges had a negative impact on our gross profit.
We anticipate that gross profit will continue to be impacted by fluctuations in the volume and mix of our product shipments as well as material costs, yield and the fixed cost absorption of our production operations.
Research and Development. Research and development expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to electronic design automation tools, subcontracting and fabrication costs, depreciation and amortization and facilities expenses. Research and development expenses for 2010 were $16.0 million which decreased $3.1 million, or 16% as compared to the prior year. This decrease was a result of decreased fabrication costs, decreased depreciation, decreased software tool costs and decreases in salaries and employee related costs as a result of workforce reductions, salary reductions and other cost cutting measures that were implemented in 2009 and the first quarter of 2010. During 2010, expenses were also reduced by approximately $0.4 million for the reversal of a sales tax accrual for a long outstanding tax issue which was recently adjudicated in our favor. The matter related to a manufacturing exemption from sales tax which we claimed. All of these expense reductions were partially offset by increased subcontracting costs as a result of our investment in our high-speed interface product line.
Marketing and Sales. Marketing and sales expenses consist primarily of personnel-related expenses, trade shows, travel expenses and facilities expenses. Marketing and sales expenses for 2010 were $7.8 million which decreased $2.6 million, or 25% as compared to the prior year. This decrease was a result of lower salaries and employee related expenses associated with the cost cutting measures that were implemented in 2009 and the first quarter of 2010 and lower commissions due to a decrease in revenues.
General and Administrative. General and administrative (G&A) expenses consist primarily of personnel-related expenses, professional and legal fees, and facilities expenses. G&A expenses were $7.5 million in 2010, a decrease of approximately $0.5 million or 7% compared to the prior year. This decrease was a result of lower employee related expenses, salary reductions and decreased professional fees associated with the cost cutting measures that were implemented in 2009 and the first quarter of 2010 partially offset by increased stock compensation expenses.
Restructuring Charges (Credits), net. During the years ended December 31, 2010 and 2009, we recorded net restructuring charges of approximately $0.4 million and net restructuring credits of $6.3 million, respectively. Information on restructuring charges and credits for 2010 and 2009 is located in Note 15 of the Notes to Consolidated Financial Statements.
Impairment of Goodwill. For 2010 and 2009, we recorded goodwill impairment charges of zero and $10.1 million, respectively. Information on the impairment of goodwill recorded during 2009 is located in Note 1 and Note 7 of the Notes to Consolidated Financial Statements.
Interest Expense net. Interest expense, net was approximately $0.6 million in 2010, a decrease of $0.1 million as compared to 2009.
Interest expense decreased from $0.8 million in 2009 to $0.7 million in 2010 due to lower debt balances resulting from the principal payments made on our 2011 Notes. The interest payments on our debt balances were $0.4 million and $0.5 million for the years ended December 31, 2010 and 2009, respectively.
Interest income was $0.1 million in both years ended December 31, 2010 and 2009. Interest income may fluctuate in the future as a result of changes in market yields due to interest rate fluctuations and changes in our cash and investment balances. At December 31, 2010 and 2009, the effective interest rates on our interest-bearing securities were approximately 1.36% and 0.43%, respectively.
Other Income (Expense). For the years ended December 31, 2010 and 2009, we had other income of $0.4 million and other expense of $0.8 million, respectively. The other income and expense was primarily due to both realized and unrealized exchange rate gains and losses which are recorded for the translation of our intercompany loan balances with our wholly owned subsidiaries.
Income Tax Expense. Our income tax expense of $1.0 million in 2010 and $0.4 million in 2009 is applicable to the operating results of certain of our foreign subsidiaries, principally India. We have incurred significant taxable losses for United States federal and state purposes. We have not recognized any income tax benefits on those losses because their realization is uncertain.
LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2011, we had cash, cash equivalents, restricted cash and short-term investments of approximately $7.6 million compared to $7.8 million as of December 31, 2010. Further, our working capital was $4.9 million as of December 31, 2011 compared to a negative $1.6 million as of December 31, 2010. Our primary source of liquidity is cash, cash equivalents, restricted cash, short term investments, a credit facility agreement and sales of our common stock. We have used cash in our operating activities in each of the last three years, including $11.6 million in 2011, $0.5 million in 2010 and $9.1 million in 2009. During 2011, we reduced our notes payable from $3.8 million as of December 31, 2010 to zero as of December 31, 2011. Our 2011 Notes were paid in full as of September 30, 2011.
During the year ended December 31, 2011, we completed an offering of shares of common stock that resulted in the sale of 6,210,000 shares, with net proceeds to us of approximately $16.1 million (see Note 14 of the Notes to the Consolidated Financial Statements).
We also entered into an Amended and Restated Business Financing Agreement (the “Amended Financing Agreement”) with Bridge Bank N.A. (“Bridge Bank”) on April 4, 2011 which amended and restated our existing credit facility. The Amended Financing Agreement provides us a credit facility of up to $5.0 million which bears interest at the higher of (i) the prime rate plus 2.0% or (ii) 5.25% percent, plus the payment of certain fees and expenses (the “Facility”). The Facility is secured by substantially all of our personal property, including our accounts receivable and intellectual property. Subject to the terms of the Amended Financing Agreement, availability under the Facility is based on a formula pursuant to which Bridge Bank would advance an amount equal to the lower of $5.0 million or 80% of our eligible accounts receivable, with account eligibility and advance rates determined by Bridge Bank in its sole discretion. The term of the Facility is two years and at the expiration of such term, all loan advances under the Facility will become immediately due and payable. At December 31, 2011, we had no outstanding borrowings under this facility.
On February 10, 2012, we entered into an At Market Issuance Sales Agreement with MLV & Co. LLC (“MLV”), pursuant to which we may issue and sell shares of our common stock, $0.001 par value per share, having an aggregate offering price of up to $10,000,000 from time to time through MLV (the “Offering”). Also on February 10, 2012, we filed a prospectus supplement with the Securities and Exchange Commission in connection with the Offering.
We have taken cost cutting measures through restructuring plans we implemented during 2010 and 2011. We currently believe that with our anticipated gross profit margins and operating expenses we can break-even on an operating income basis, excluding stock compensation costs and amortization of purchased intangibles, at the rate of sales of $10.0 million per quarter. Also, we intend to continue to assess our cost structure in relationship to our revenue levels and to make appropriate adjustments to expense levels as required. Nonetheless, we believe that our existing cash and cash equivalents, investments, Amended Financing Agreement and At Market Issuance Sales Agreement will be sufficient to fund operating activities and capital expenditures, and provide adequate working capital at least through the next twelve months.
If our existing resources, including our Amended Financing Agreement, and cash generated from operations are insufficient to satisfy liquidity requirements, we may seek to raise additional funds through public or private debt or equity financings. The sale of equity or debt securities could result in additional dilution to our stockholders, could require us to pledge our intellectual property or other assets to secure the financing, or could impose restrictive covenants on us. We cannot be certain that additional financing will be available in amounts or on terms acceptable to us, or at all. If we are unable to obtain this additional
financing, we may be required to reduce the scope of our planned product development and sales and marketing efforts, which could harm our business, financial condition and operating results, and/or cause us to sell assets or otherwise restructure our business to remain viable.
Commitments and Significant Contractual Obligations We have outstanding operating lease commitments of $17.1 million, payable over the next six years. Some of these commitments are for space that is not being utilized and, for which we recorded restructuring charges in prior years for excess facilities. We currently have subleases for the majority of our excess space but our sublease income generated will not offset the entire future commitment. As of December 31, 2011, we have approximately $11.7 million in anticipated sub-lease income over the next six years relating to portions of our excess facilities. We currently believe that we can fund these lease commitments in the future. However, there can be no assurances that we will not be required to seek additional capital or provide additional guarantees or collateral on these obligations.
A summary of our significant future contractual obligations and their payments follows (in thousands):
We also have pledged approximately $0.1 million as collateral for stand-by letters of credit that guarantee certain long-term property lease obligations and to support customer credit requirements. This $0.1 million is in our bank accounts and is included in our restricted cash as of December 31, 2011.
Off-Balance Sheet Arrangements As of December 31, 2011, we had no material off-balance sheet financing arrangements.
Recent Accounting Pronouncements Newly issued accounting pronouncements that potentially impact our financial statements are disclosed in the Notes to Consolidated Financial Statements of this Form 10-K.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk. We have investments in money market accounts that earn interest income that is a function of the market rates. As a result, we have exposure to changes in interest rates. For example, if interest rates were to decrease by one half percentage point from their current levels, our potential interest income for 2011, assuming a constant cash balance, would decrease by less than $0.1 million.
Foreign Currency Exchange Risk. As substantially all of our net revenues are currently made or denominated in U.S. dollars, a strengthening of the dollar could make our products less competitive in foreign markets. Although we recognize our revenues in U.S. dollars, we incur expenses in currencies other than U.S. dollars. In 2011, operating expenses incurred in foreign currencies, excluding impairment of goodwill and other intangibles, were approximately 62% of our total operating expenses. Although we have not experienced significant foreign exchange rate losses to date, we may in the future, especially to the extent that we do not engage in hedging. We do not enter into derivative financial instruments for trading or speculative purposes. The economic impact of currency exchange rate movements on our operating results is complex because such changes are often linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, may cause us to adjust our financing and operating strategies. Consequently, isolating the effect of changes in currency does not incorporate these other important economic factors.
Fair Market Value of Financial Instruments. Our 2011 Notes were paid in full as of September 30, 2011 and as such we have no exposure relating to these notes as of December 31, 2011.
Item 8.
Item 8. Financial Statements and Supplementary Data
TRANSWITCH CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
REPORT OF MARCUM LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Audit Committee of the
Board of Directors and Shareholders
of TranSwitch Corporation
We have audited the accompanying consolidated balance sheets of TranSwitch Corporation (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss and cash flows for each of the two years in the period ended December 31, 2011. Our audits also included the financial statement schedule as of December 31, 2011 and 2010, and for each of the two years in the period ended December 31, 2011 listed in the index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of TranSwitch Corporation, as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule for 2011 and 2010, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated, March 12, 2012, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ Marcum llp
Hartford, Connecticut
March 12, 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING To the Audit Committee of the
Board of Directors and Shareholders
of TranSwitch Corporation
We have audited TranSwitch Corporation's (the “Company”) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management Annual Report on Internal Control over Financial Reporting” under Item 9A. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that degree of compliance with the policies or procedures may deteriorate.
In our opinion, TranSwitch Corporation maintained, in all material aspects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2011 and 2010 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the two-years in period ended December 31, 2011 and the related financial statement schedule as of December 31, 2011 and 2010 and for each of the two years in the period ended December 31, 2011 of the Company and our report dated March 12, 2012 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ Marcum llp
Hartford, Connecticut
March 12, 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors of
TranSwitch Corporation
We have audited the accompanying consolidated statements of operations, stockholders’ equity and comprehensive loss and cash flows of TranSwitch Corporation and subsidiaries (the “Company”) for the year ended December 31, 2009. Our audit also included the financial statement schedule listed in the Index at Item 15(a)(1). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of the Company’s operations and their cash flows for the year ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ UHY LLP
New Haven, Connecticut
March 16, 2010
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
(In Thousands, Except Share Data)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands, Except Share Data)
See accompanying notes to consolidated financial statements.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies Description of Business TranSwitch Corporation was incorporated in Delaware on April 26, 1988 and is headquartered in Shelton, Connecticut. TranSwitch Corporation and its subsidiaries (collectively, “TranSwitch” or the “Company”) designs, develops and supplies innovative semiconductor and intellectual property (IP) solutions that provide core functionality for voice, data and video communications equipment for network, enterprise and customer premises applications. The Company provides integrated multi-core network processor System-on-a-Chip (SoC) solutions and software solutions for Fixed, 3G and 4G Mobile, VoIP and Multimedia Infrastructures. For the customer premises market, the Company offers interoperable connectivity solutions that enable the reliable distribution and presentation of high-definition (HD) content for consumer electronics, and personal computer markets and also provides a family of communications processors that provide best-in-class performance for a range of applications. The Company’s intellectual property (IP) products are compliant with global industry standards such as HDMI and DisplayPort and also feature our proprietary HDPTM and AnyCableTM technologies. Overall, the Company has over 100 active customers, including the leading global telecom equipment providers, semiconductor and consumer product companies.
Principles of Consolidation The consolidated financial statements include the accounts of TranSwitch Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates. Estimates relate to uncollectable accounts receivable, excess or slow-moving or obsolete inventories, impairment of assets, product warranty allowances, depreciation and amortization, income taxes, sales returns and allowances, stock rotation allowances and contingencies. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
Liquidity The Company has incurred significant operating losses and used cash in its operating activities for the past several years. Operating losses have resulted from inadequate sales levels for the cost structure. The Company’s total revenue has decreased 49.6% from $56.1 million in 2009 to $28.2 million in 2011. Product revenue has decreased 61.1% from $50.7 million in 2009 to $19.7 million in 2011. The Company believes that with the current anticipated gross profit margins and operating expenses, the Company can break-even on an operating income basis, excluding stock compensation costs and amortization of purchased intangibles, at the rate of sales of $10.0 million per quarter. Also, the Company intends to continue to assess its cost structure in relationship to its revenue levels and to make appropriate adjustments to expense levels as required. Nonetheless, the Company believes that its existing cash and cash equivalents, investments, Amended Financing Agreement and At Market Issuance Sales Agreement will be sufficient to fund operating activities and capital expenditures, and provide adequate working capital through at least the next twelve months. There can be no assurance that the anticipated sales level will be achieved.
Cash, Cash Equivalents and Investments All highly liquid investments with an original maturity of three months or less when purchased are considered cash equivalents. Cash equivalents consist of money market funds as of December 31, 2011 and 2010. The majority of the Company’s cash and cash equivalents balances are maintained with a limited number of major financial institutions. Cash and cash equivalents balances at institutions may, at times, be above the Federal Deposit Insurance Corporation insured limit of $0.25 million per account.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies - (continued) Short-term investments as of December 31, 2011 and 2010 consist of government bonds and corporate debt securities which are all due within one year. Such investments are classified as held-to-maturity. Held-to-maturity securities are those securities which the Company has both the ability and intent to hold to maturity. Held-to-maturity securities are stated at amortized cost. Amortized cost and accrued interest as of December 31, 2011 and 2010, approximate market value.
Fair Value of Financial Instruments The carrying amounts for cash and cash equivalents, short-term investments, accounts receivable, and accounts payable approximate fair value. On September 30, 2011, the Company paid in full its 5.45% Convertible Notes due September 30, 2011 (“2011 Notes”) and as such there was no outstanding balance as of December 31, 2011. Based on market conditions, the fair value of the outstanding 2011 Notes was estimated at approximately $3.8 million as of December 31, 2010. The fair value of investments in non-publicly traded companies is not readily determinable.
Accounts Receivables and Allowance for Doubtful Accounts The Company records allowances for doubtful accounts for estimated losses based upon specifically identified amounts that it believes to be uncollectible along with the Company’s assessment of the general financial condition of its customer base. If the Company’s actual collections experience changes, revisions to its allowances may be required. The Company has a limited number of customers with individually large amounts due at any given balance sheet date. Any unanticipated change in the creditworthiness of such customers or other matters affecting the collectability of amounts due from such customers could have a material effect on the Company’s results of operations in the period in which such changes or events occur.
Inventories Inventories are carried at the lower of cost (determined on a weighted-average cost basis) or estimated net realizable value. The Company provides inventory allowances on obsolete inventories and inventories in excess of expected demand for each specific part. The valuation of inventories requires the use of estimates as to the amounts of current inventories that will be sold. These estimates are dependent on the Company’s assessment of current and expected orders from its customers, and orders generally are subject to cancellation with limited advance notice prior to shipment.
Property and Equipment Property and equipment are carried at cost less accumulated depreciation and amortization. Any gain or loss resulting from sale or retirement is included in the consolidated statement of operations. Repairs and maintenance are expensed as incurred while renewals and betterments are capitalized.
Goodwill Goodwill represents the excess of the purchase price over the fair value of identifiable net assets of the business acquired. The Company reviews goodwill for potential impairment at least annually.
Other Intangible Assets Other intangible assets consist of purchased customer relationships and developed technology and are stated at cost, less accumulated amortization. Customer relationships and developed technology are being amortized by the straight line method over their estimated economic useful lives ranging from five to ten years.
Deferred Financing Costs Deferred financing costs are being amortized using the interest method over the term of the related debt. Unamortized deferred financing fees were less than $0.1 million and $0.1 million as of December 31, 2011 and 2010, respectively. Amortization, included in the consolidated statement of operations as a component of interest expense, was $0.1 million, $0.2 million, and $0.2 million for 2011, 2010 and 2009, respectively.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies - (continued) Impairment of Intangibles and Long-Lived Assets The Company reviews long-lived and intangible assets (including goodwill) for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. When factors indicate that a long-lived asset should be evaluated for possible impairment, an estimate of the related asset’s undiscounted future cash flows over the remaining life of the asset is made to measure whether the carrying value is recoverable. Any impairment is measured based upon the excess of the carrying value of the asset over its estimated fair value which is generally based on an estimate of future discounted cash flows. A significant amount of management judgment is used in estimating future discounted cash flows. During the fourth quarter of 2011, impairment testing for certain purchased customer relationships and developed technology was performed by the Company and indicated that the undiscounted future cash flows of the mentioned intangible assets were less than its corresponding carrying amount. As a result of the analyses performed, the Company measured and recorded an impairment of these intangible assets of $5.4 million in 2011. The 2011 impaired purchased customer relationships and developed technology related to a business acquisition in 2008.
The Company’s impairment review of goodwill was performed using a fair-value method and discounted cash flow models with estimated cash flows based on internal forecasts which included terminal values based on current market valuation metrics. The fair value represents the amount at which a reporting unit could be bought or sold in a current transaction between willing parties on an arms-length basis. In estimating fair value, the Company used its common stock’s market price to determine fair value and other valuation metrics. In addition, the Company performed discounted cash flow analysis on the reporting units to determine fair value. During the fourth quarter of 2011, impairment testing performed by the Company indicated that the estimated fair value of the reporting unit tested was less than its corresponding carrying amount. As a result of the analyses performed, the Company recorded goodwill impairment charges of $8.9 million in 2011. The 2011 impaired goodwill related to a business acquisition in 2008. There were no impairment charges in 2010. During the fourth quarter of 2009, impairment testing performed by the Company indicated that the estimated fair values of two reporting units tested were less than their corresponding carrying amounts. As a result of the analyses performed, the Company recorded a goodwill impairment charge of $10.1 million in 2009. The impaired goodwill related to business acquisitions in 2007 and 2006.
Investments in Non-Publicly Traded Companies The Company has minority investments in certain non-publicly traded companies. Depending on the Company’s level of ownership and whether or not the Company has the ability to exercise significant influence, these investments are accounted for by either the cost or equity method. All such investments as of December 31, 2011 and 2010 are accounted for by the cost method. These investments are reviewed periodically for impairment.
Revenue Recognition Net revenues from product sales are recognized at the time of product shipment when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) ownership and risk of loss transfers to the customer; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured.
Revenues from distributors can be recognized when: (1) the prices are fixed at the date of shipment from the Company’s facilities; (2) payment is not contractually or otherwise excused until the product is resold; (3) the Company does not have any obligations for future performance relating to the resale of the product; and (4) the amount of future returns, allowances, refunds and costs to be incurred can be reasonably estimated and are accrued at the time of shipment. Agreements with certain distributors provide price protection and return and allowance rights.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies - (continued) At the time of shipment, the Company records a reduction to revenue (with a related liability) to accrue for future price protection. This liability is established based on historical experience, contractually agreed-to provisions and future shipment forecasts. Such accruals have been insignificant for the last three years.
The Company also accrues, at the time of shipment, a reduction to revenue (with a related liability) and an inventory asset against product cost of revenues in order to establish a provision for the gross margin related to future returns under the Company’s distributor stock rotation program. Such accruals related to reductions of revenue were $0.4 million, $0.8 million and $0.6 million at December 31, 2011, 2010 and 2009, respectively. The accruals related to inventory assets are insignificant to the Company’s financial position and results of operations for all periods presented. Should actual experience differ from estimated liabilities, there could be adjustments (either favorable or unfavorable) to the Company’s net revenues, cost of revenues and gross profits.
Service revenues are recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) services have been performed in accordance with the contractual obligations; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.
The Company licenses connectivity solutions, including HDMI, DisplayPort and Ethernet IP Cores. Revenues from licensing arrangements generally consist of multiple elements such as license, implementation and maintenance services. The items (deliverables) included in the arrangement are evaluated to determine whether they represent separate units of accounting. The Company performs this evaluation at the inception of an arrangement and as the Company delivers each item in the arrangement.
Generally, the Company accounts for a deliverable (or a group of deliverables) separately if (1) the delivered item(s) has standalone value to the customer, (2) there is objective and reliable evidence of the fair value of the undelivered items included in the arrangement, and (3) if the Company has given the customer a general right of return relative to the delivered items, delivery or performance of the undelivered items or services are probable and substantially in the Company’s control.
The Company recognizes revenue from royalties upon notification of sale by its licensees. The terms of the royalty agreements generally require licensees to give notification to the Company and to pay royalties within 45 days of the end of the quarter during which the sales by its licensees take place.
Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, and accounts receivable.
Cash and cash equivalents are held by high-quality financial institutions, thereby reducing credit risk concentrations. In addition, the Company limits the amount of credit exposure to any one financial institution.
At December 31, 2011 and 2010, approximately 59% and 53% of accounts receivable were due from five customers. The majority of the Company’s sales are to customers in the telecommunications and data communications industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies - (continued) Customers that accounted for more than 10% of total accounts receivable at each period end are as follows:
* Accounts receivable due were less than 10% of the Company’s total accounts receivable.
Supplier Concentrations The Company relies on a limited number of suppliers for wafer fabrication capacity. In 2011, one outside wafer foundry supplied a substantial amount of our total semiconductor wafer requirements. Although the Company would likely be able to find alternative manufacturing sources, the Company would experience substantial delays or interruptions in the shipment of products if this supplier were to cease operations.
Operating Leases The Company recognizes rent expense on a straight-line basis over the term of the lease. The difference between rent expense and rent paid is recorded as deferred rent and is included in accrued expenses in our consolidated balance sheets.
Product Warranties The Company provides warranties on its products for up to one year from the date of shipment. A liability is recorded for estimated costs to be incurred under product warranties, which is based on various inputs including historical experience. Estimated warranty expense is recorded as cost of revenues as products are shipped. Product warranty costs are nominal for all periods presented.
Research and Development Costs Research and development costs are expensed as incurred.
Income Taxes Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for operating loss and tax credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided to the extent that it is more likely than not that the Company will not be able to utilize deferred income tax assets in the future.
The Company is required to make a determination of any of its tax positions (federal and state) for which the sustainability of the position, based upon the technical merits, is uncertain. The Company regularly evaluates all tax positions taken and the likelihood of those positions being sustained. If management is highly confident that the position will be allowed and there is a greater than 50% likelihood that the full amount of the tax position will be ultimately realized, the company recognizes the full benefit associated with the tax position. Additionally, interest and penalties related to uncertain tax positions are included as a component of income tax expense.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies - (continued) Stock-Based Compensation The Company recognizes share-based compensation expense for the fair value of the awards on the date granted on a straight-line basis over their vesting term.
Compensation expense is recognized only for share-based payments expected to vest. The Company estimates forfeitures at the date of grant based on the Company’s historical experience and future expectations.
As of December 31, 2011, the unrecognized stock-based compensation cost related to non-vested option awards was $0.08 million and such amount will be recognized in operations over a weighted average period of 1.81 years. As of December 31, 2011, the unrecognized stock-based compensation cost related to non-vested stock awards was $2.7 million and such amount will be recognized in operations over a weighted average period of 2.58 years.
Stock compensation charged to operations was 2.5 million in 2011, $2.4 million in 2010, and $1.3 million in 2009.
Loss Per Common Share The basic and diluted loss per common share amount is based upon the weighted average common shares outstanding during the periods presented. All “in-the-money” stock options and shares issuable upon the conversion of the 5.45% Convertible Notes due 2010 and the 5.45% Convertible Notes due 2011 were anti-dilutive.
Foreign Currency Translation
Substantially all foreign subsidiaries use their local currency as their functional currency. Therefore, assets and liabilities of foreign subsidiaries are translated at exchange rates in effect at the balance sheet date and revenue and expense accounts are translated at average exchange rates during the year. The resulting translation adjustments are recorded in accumulated other comprehensive (loss) income. Translation gains and losses related to monetary assets and liabilities denominated in a currency different from a subsidiary’s functional currency are included in the consolidated statements of operations.
Derivatives and Hedging Activities Fluctuating foreign exchange rates may significantly impact the Company’s operating results and cash flows. The Company periodically hedges forecasted foreign currency transactions related to certain operating expenses. All derivatives are recorded in the balance sheet at fair value. For a derivative designated as a fair value hedge, the effective portion of changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in operations. For a derivative designated as a cash flow hedge, the effective portions of changes in the fair value of cash flow hedges are recorded in other comprehensive income. If the derivative used in an economic hedging activity is not designated in an accounting hedging relationship or if it becomes ineffective, changes in the fair value of the derivative are recognized in operations.
Subsequent Events
Subsequent events have been evaluated through the date the accompanying consolidated financial statements were issued.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Business and Summary of Significant Accounting Policies - (continued) Recent Accounting Pronouncements The Company continually assesses any new accounting pronouncements to determine their applicability to the Company. In the case where it is determined that a new accounting pronouncement affects the Company’s financial reporting, the Company undertakes a study to determine the consequence of the change to its financial reporting, and assures that there are proper controls in place to ascertain that the Company’s financials properly reflect the change. New pronouncements assessed by the Company are discussed below:
In September 2011, FASB issued ASU No. 2011-08, Testing Goodwill for Impairment, which amends the guidance in ASC 350 and allows entities to use a qualitative approach to test goodwill for impairment to determine whether a quantitative assessment is necessary. This guidance is effective for goodwill impairment tests performed in interim and annual periods for fiscal years beginning after December 15, 2011. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.
In June 2011, FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) which provides guidance regarding the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new standard also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. The updated guidance is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will require the Company to change the presentation of comprehensive income to an acceptable method described in this standard. The Company will no longer be allowed to present comprehensive income within the statement of stockholders’ equity. Since this ASU will only change the format of financial statements, it is expected that the adoption of this ASU will not have a material effect on the Company’s consolidated financial position and results of operations.
The Company has considered all other recently issued accounting pronouncements and does not believe the adoption of such pronouncements will have a material impact on its consolidated financial statements.
Note 2. Fair Value Measurements The Company applies fair value standards for recurring financial assets and liabilities only. The accounting framework for determining fair value includes a hierarchy for ranking the quality and reliability of the information used to measure fair value, which enables the reader of the financial statements to assess the inputs used to develop those measurements. The fair value hierarchy consists of three tiers as follows:
Level 1 - Quoted prices in active markets are available for identical assets and liabilities.
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
As of December 31, 2011, the Company’s financial assets included short term investments and investments in non-publicly traded companies. The Company considers net realizable value for its investments in non-publicly traded companies for purposes of determining asset impairment losses. For the year ended December 31, 2011, the Company had no impairment losses on investments in non-publicly traded companies.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2. Fair Value Measurements - (continued) The carrying amounts for cash equivalents, accounts receivable and accounts payable approximate fair value due to their immediate or short-term nature of the maturity. There was no outstanding balance of the 2011 Notes as of December 31, 2011. The fair value of the outstanding 2011 Notes was approximately $3.8 million as of December 31, 2010. The 2011 Notes approximate fair value based on market rates available to the Company for financing with similar terms. The carrying value of such notes was approximately $3.8 million as of December 31, 2010. The fair value of short term investments was $2.0 million and $1.0 million as of December 31, 2011 and 2010, respectively. The short-term investment values are based on a Level 2 valuation technique.
Note 3. Restricted Cash At December 31, 2011 and 2010, the Company’s liquidity was affected by restricted cash balances of approximately $0.1 million and $0.6 million, respectively, which are included in current assets and are not available for general corporate use. The Company has pledged these amounts as collateral for stand-by letters of credit that guarantee certain long-term property lease obligations and to support customer credit requirements.
Note 4. Investments in Non-Publicly Traded Companies and Venture Capital Funds During the first quarter of 2010, the Company sold its investment in Opulan Technologies Corp. (“Opulan”) for $2.7 million. The carrying value of this investment in Opulan was also $2.7 million and accordingly no gain or loss was recorded on this transaction.
The Company owns a 3% limited partnership interest in Neurone II, a venture capital fund organized as a limited partnership and a 0.42% limited partnership interest in Munich Venture Partners Fund (“MVP”). The Company accounts for these investments at cost. The financial condition of these companies is subject to significant changes resulting from their operating performance and their ability to obtain financing. The Company continually evaluates its investments in these companies for impairment. In making this judgment, the Company considers the investee’s cash position, projected cash flows (both short and long-term), financing needs, most recent valuation data, the current investing environment, management/ownership changes, and competition. This evaluation process is based on information that the Company requests from these privately held companies. This information is not subject to the same disclosure and audit requirements as the reports required of United States public companies, and as such, the reliability and accuracy of the data may vary.
During 2009, the Company made additional investments of less than $0.1 million and recognized an impairment of less than $0.1 million on its investment in Neurone II.
During 2010, the Company had sales of investments of $2.7 million in Opulan and less than $0.1 million in Neurone II. Also during 2010, the Company made additional investments of less than $0.1 million in both Neurone II and MVP.
During 2011, the Company made additional investments of less than $0.1 million in MVP.
The Company’s cost method investments were approximately $0.3 million and $0.3 million as of December 31, 2011 and 2010, respectively.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5. Inventories The components of inventories follow:
Note 6. Property and Equipment, Net The components of property and equipment follow:
* Estimated useful life of improvement if shorter.
Depreciation expense was $0.6 million in 2011, $0.6 million in 2010 and $1.1 million in 2009.
Note 7. Goodwill and Other Intangible Assets Changes in the carrying amounts of goodwill and information about intangible assets follow:
(1) During the fourth quarter of 2011, impairment testing performed by the Company indicated that the estimated fair value of the reporting unit tested was less than its corresponding carrying amount. As a result, the Company recorded a goodwill impairment charge of $8.9 million.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 7. Goodwill and Other Intangible Assets - (continued)
(1) During the fourth quarter of 2011, impairment testing for certain purchased customer relationships and developed technology was performed by the Company and indicated that the undiscounted future cash flows of the mentioned intangible assets were less than their corresponding carrying amounts. As a result, the Company recorded an impairment charge of $5.4 million.
Amortization expense related to “Other intangible assets” was $1.4 million in 2011, $1.6 million in 2010 and $1.6 million in 2009. Future estimated aggregate amortization expense for such assets for each of the five years succeeding December 31, 2011 are as follows: 2012 - $0.3 million; 2013 - $0.3 million; 2014 - $0.2 million; 2015 - $0.2 million and 2016 - $0.2 million.
Note 8. Accrued Expenses and Other Current Liabilities The components of accrued expenses and other current liabilities follow:
The Company periodically evaluates any contingent liabilities in connection with any payments to be made for any potential intellectual property infringements, asserted or unasserted. The Company’s accrued royalties as of December 31, 2011 and 2010, represent the contingent payments for asserted or unasserted claims that are probable as of the respective balance sheet dates based on the applicable patent law.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9. Segment and Major Customer Information The Company has one business segment: communication solutions. Its semiconductor and IP solutions provide core functionality for the transmission of voice, video and data. The integration of various technologies and standards in these devices result in a homogeneous product line for management and measurement purposes.
Enterprise-wide Information Enterprise-wide information provided on geographic net revenues is based on billing locations. Long-lived asset information is based on the physical location of the assets. The following tables present net revenues and long-lived assets information for geographic areas:
Information about Major Customers The Company ships its products to distributors and directly to end customers. The following table sets forth the percentage of net revenues attributable to the Company’s significant end customers:
* Revenues were less than 10% of the Company’s net revenues in these years.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Income Taxes Changes in unrecognized income tax benefits follow:
Included in the balance of unrecognized tax benefits at December 31, 2011 are potential benefits of $0.4 million that, if recognized, would impact the Company’s effective tax rate. The Company does not reasonably expect any significant changes in the amount of unrecognized tax benefits to occur within the next twelve months.
Historically, the Company has not accrued or paid significant interest and penalties for underpayments of income taxes due to its net operating loss position. Interest and penalties related to underpayment of income taxes is classified as a component of income tax expense in the consolidated statement of operations. For the year ended December 31, 2011, less than $0.1 million of interest and penalties were recognized in the consolidated statement of operations compared with $0.1 million for the year ended December 31, 2010.
The Company files income tax returns in the United States and several foreign countries and has not extended the statute of limitations to assess additional taxes for any of these jurisdictions. The Company has effectively settled United States Federal tax positions taken through 2002. However, the Company is subject to adjustment in each of these periods, to the extent of its net operating loss carry forwards. The open tax years for foreign jurisdictions are 2003 through 2011 and for United States state and local jurisdictions are 1997 through 2011.
The components of the loss before income taxes follow:
The provision for income taxes consists exclusively of current foreign income taxes.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Income Taxes - (continued) A reconciliation of the United States federal statutory rate to the effective income tax rate follows:
The tax effects of temporary differences that give rise to deferred income taxes follow:
The Company continually evaluates its deferred income tax assets to determine whether it is more likely than not that such assets will be realized. In assessing the realizability, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies. Based on this assessment, management believes that significant uncertainty exists concerning the recoverability of the deferred income tax assets. As such, a valuation allowance has been provided for deferred income tax assets as of December 31, 2011 and 2010. Of the $226.3 million valuation allowance at December 31, 2011, subsequently recognized income tax benefits, if any, in the amount of $4.7 million will be applied directly to additional paid-in capital.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Income Taxes - (continued) At December 31, 2011, the Company had available, for federal income tax purposes, net operating loss (“NOL”) carry-forwards of approximately $502.6 million and research and development tax credit carry-forwards of approximately $21.0 million expiring in varying amounts from 2011 through 2031. For state income tax purposes, the Company had available NOL carry-forwards of approximately $192.9 million and state tax credit carry-forwards of $7.8 million expiring in varying amounts from 2011 to 2031. Additionally, the Company has generated $27.5 million of NOL’s in foreign jurisdictions which can be carried forward indefinitely.
Certain transactions involving the Company’s beneficial ownership have occurred in prior years, which resulted in a stock ownership change for purposes of Section 382 of the Internal Revenue Code of 1986, as amended. Consequently, approximately $192.3 million of the NOL carry-forwards and $11.2 million of research and development tax credit carry-forwards are subject to these limitations. The Company has not yet determined if any of the NOL and credits generated through 2011 will be subject to limitation under Section 382.
Note 11. Stockholder Rights Plan On September 30, 2011, the Board of Directors enacted a stockholder rights plan and declared a dividend of one preferred share purchase right for each outstanding share of the Company’s common stock outstanding at the close of business on October 3, 2011 to the stockholders of record on that date. Each preferred share purchase right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series B Junior Participating Preferred Stock, par value $0.001 per share, of the Company (the “Preferred Shares”), at a price of $20.00 per one one-thousandth of a Preferred Share, subject to adjustment, upon the occurrence of certain triggering events, including, without limitation, the acquisition of 15% or more of the Company’s outstanding common stock by a third party. Until a triggering event occurs, the common stockholders have no right to purchase shares under the stockholder rights plan. If the right to purchase the preferred stock is triggered, the common stockholders will have the ability to purchase sufficient stock to significantly dilute the 15% or greater holder. The Rights will expire on the earlier of (i) May 15, 2015 and (ii) the first anniversary of the adoption of the Rights Agreement if shareholder approval of the Rights Agreement has not been received by or on such date, unless that date is extended or unless the Rights are earlier redeemed by the Company. Each stockholder of record as of October 3, 2011 received a summary of the rights and any new stock certificates issued after the record date contain a legend describing the rights.
A copy of the stockholder rights plan has been filed with the Securities and Exchange Commission as an exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on October 3, 2011.
Note 12. Employee Benefit Plans Employee Stock Purchase Plans Under the Company’s employee stock purchase plans, eligible employees may purchase a limited number of shares of common stock at 85% of the fair market value at either the date of enrollment or the date of purchase, whichever is less. The 1995 Employee Stock Purchase Plan was closed effective December 31, 2004. On May 19, 2005, the Company’s shareholders approved the 2005 Employee Stock Purchase Plan (the “2005 ESPP”). Under the 2005 ESPP, the Company is authorized to issue 250,000 shares of common stock. Shares issued under the 2005 ESPP in 2011, 2010, and 2009 were 58,230, 30,249 and 10,172, respectively.
Stock Option and Award Plans As of December 31, 2011, the Company has one stock option plan which is the 2008 Equity Incentive Plan (the “2008 Plan”). Also, the 1995 Stock Plan, as amended (the “1995 Plan”), expired on March 15, 2010 and the 2000 Stock Option Plan as amended (the “2000 Plan”), expired on July 14, 2010.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12. Employee Benefit Plans - (continued) Under the 1995 Plan, 3,925,000 shares of the Company’s common stock were available to grant to employees in the form of incentive stock options. The 1995 Plan, as amended, expired on March 15, 2010 and as such shares are no longer available for grant. The terms of the options granted are subject to the provisions of the 1995 Plan, as determined by the Compensation Committee of the Board of Directors. The exercise price of options under the 1995 Plan is equal to the fair market value of the common stock on the date of grant. Options granted under the 1995 Plan are generally nontransferable. As of December 31, 2011, 255,902 options were outstanding.
The 2000 Plan provided for the granting of non-qualified options to employees and consultants to purchase up to an aggregate of 1,250,000 shares of common stock and was terminated on July 14, 2010. No member of the Board of Directors or executive officers appointed by the Board of Directors was eligible for grants of options under the 2000 Plan. The terms of the options granted are subject to the provisions of the 2000 Plan, as determined by the Compensation Committee of the Board of Directors. Each non-qualified stock option shall either be fully exercisable on the date of grant or shall become exercisable thereafter in such installments as the Board of Directors may specify. No option granted under the 2000 Plan may be exercised after the expiration of seven years from the date of grant. The exercise price of options under the 2000 Plan is equal to the fair market value of the common stock on the date of grant. Options granted under the 2000 Plan are generally nontransferable. In connection with the adoption of the 2008 Plan on May 22, 2008, shares are no longer available for grant under the 2000 Plan.
The 2008 Plan was approved by shareholders at the shareholder meeting held on May 22, 2008. The purpose of this plan is to provide stock options, stock issuances, and other equity interests in the Company to employees, officers, directors, consultants, and advisors to the Company and its subsidiaries or any future parent corporation. The 2008 Plan is administered by the Board of Directors of the Company who will have sole discretion and authority to interpret and correct the provisions of the Plan and any Award. The Board will also have sole authority to determine the terms and provisions of the respective Stock Option Agreements and Awards, which need not be identical. The aggregate number of shares of Common Stock of the Company that may be issued pursuant to the 2008 Plan is 5,196,250. As of December 31, 2011, there were 770,695 shares available for grant under the 2008 Plan.
Information regarding stock options follows:
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12. Employee Benefit Plans - (continued) Information regarding restricted stock awards follows:
The Company has, in connection with the acquisitions of various companies, assumed the stock option plans of each acquired company. The related options are included in the preceding table.
Options outstanding and exercisable at December 31, 2011 follow:
Stock options generally expire five, seven or ten years from the date of grant and generally vest ratably over periods ranging from immediately to four years.
Stock compensation charged to operations was $2.5 million in 2011, $2.4 million in 2010, and $1.3 million in 2009. Further, no compensation cost was capitalized as part of inventory, and no income tax benefit was recognized in those years. Lastly, no equity awards were settled in cash.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12. Employee Benefit Plans - (continued) Stock-Based Compensation Fair Value Disclosures The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
The weighted average fair value of stock options granted, calculated using the Black-Scholes option-pricing model is $0.00 for 2011, $1.41 for 2010, $1.89 for 2009. In 2011 the company granted stock options to a consultant. The fair value of these options was calculated using the stock price on the date of grant. The cost of this grant was $0.02 million. The weighted average fair value of restricted stock units granted is $3.09 for 2011, $2.37 for 2010 and $3.01 for 2009. The total intrinsic value of the options exercised was $0.08 million for 2011, $0.01 million for 2010, and $0.06 million for 2009. Restricted stock units released had an intrinsic value of $2.2 million in 2011, $0.9 million in 2010, and $0.1 million in 2009.
The Company recognized compensation expense related to stock options granted to non-employees of $.02 million in 2011, zero in 2010, and $0.01 million in 2009.
Employee 401(k) Plan The TranSwitch Corporation 401(k) Retirement Plan (the “Plan”) provides tax-deferred salary deductions for eligible employees. Employees may contribute an annual maximum amount as set periodically by the Internal Revenue Service. The Company had provided matching contributions equal to 50% of the employees’ contributions, up to a maximum of 6% of the employee’s annual compensation. On July 1, 2009, the Company indefinitely suspended its matching contributions. Company contributions begin vesting after two years and are fully vested after three years. Contribution expense related to the Plan was zero in 2011 and 2010, and $0.1 million in 2009.
Note 13. Credit Facility and Convertible Notes Credit Facility: On April 4, 2011, the Company entered into an Amended and Restated Business Financing Agreement (the “Amended Financing Agreement”) with Bridge Bank N.A. (“Bridge Bank”) which amended and restated its existing credit facility. The Amended Financing Agreement provides a credit facility to the Company of up to $5.0 million which bears interest at the higher of (i) the prime rate plus 2.0% or (ii) 5.25% percent, plus the payment of certain fees and expenses (the “Facility”). The Facility is secured by substantially all the personal property of the Company, including its accounts receivable and intellectual property. Subject to the terms of the Amended Financing Agreement, availability under the Facility is based on a formula pursuant to which Bridge Bank would advance an amount equal to the lower of $5.0 million or 80% of the Company’s eligible accounts receivable, with account eligibility and advance rates determined by Bridge Bank in its sole discretion. The term of the Facility is two years and at the expiration of such term, all loan advances under the Facility will become immediately due and payable. At December 31, 2011 and 2010, the Company had no outstanding borrowings under this facility.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Credit Facility and Convertible Notes - (continued) Convertible Notes: On October 26, 2009, the Company exchanged approximately $10.0 million aggregate principal amount of its unsecured Convertible Notes due September 30, 2010 for an equal principal amount of 5.45% Unsecured Convertible Notes due September 30, 2011 (“2011 Notes”). The 2011 Notes were convertible at the option of the holder, at any time on or prior to maturity at an initial conversion ratio of 138.8888 shares per $1,000 principal amount. As of September 30, 2011, the principal amount of these notes would be equal to the value of the common stock into which the 2011 Notes could be converted if the Company’s stock price were $7.20. If a holder of the 2011 Notes converted their notes in connection with a corporate transaction that constituted a change in control, as defined therein, at any time prior to July 6, 2011, then in addition to the conversion shares, as defined therein, such holder was also entitled to receive upon such conversion a make-whole payment premium in cash. Commencing on October 30, 2009, the 2011 Notes were payable in monthly principal payments of $417,000 plus interest. On September 30, 2011, the Company paid in full its 2011 Notes and as such there was no outstanding balance as of December 31, 2011. As of December 31, 2010, $3.8 million of the 2011 Notes remained outstanding, which amount was classified as short-term.
Note 14. Issuance of Common Stock Sale of Stock On May 20, 2011, the Company completed an offering of 6,210,000 shares of common stock that resulted in proceeds to the Company of $16.1 million after deducting the underwriting discounts and commissions and estimated expenses payable by the Company of $1.3 million. The shares were offered pursuant to a prospectus supplement dated May 17, 2011 and an accompanying prospectus dated October 21, 2009, pursuant to the Company's existing effective shelf registration statement on Form S-3 (File No. 333-162609), which was declared effective by the Securities and Exchange Commission on October 28, 2009.
On December 31, 2009, the Company, entered into a Common Stock Purchase Agreement (the “Common Stock Purchase Agreement”) with Seaside 88, LP, a Florida limited partnership (“Seaside”), relating to the offering and sale of up to 1,950,000 shares (the “Shares”) of the Company's common stock. The Common Stock Purchase Agreement required the Company to issue and sell, and Seaside to purchase, up to 75,000 shares of Common Stock once every two (2) weeks, subject to the satisfaction of customary closing conditions, beginning on January 4, 2010 and ending on or about the date that is fifty (50) weeks subsequent to closing. The offering price of the Company’s common stock at each closing was an amount equal to the lower of (i) the daily volume weighted average of actual trading prices of the common stock on the trading market (the “VWAP”) for the ten consecutive trading days immediately prior to a closing date multiplied by 0.875 and (ii) the VWAP for the trading day immediately prior to a closing date multiplied by 0.90.
On June 14, 2010, the Company exercised its option to terminate the Common Stock Purchase Agreement with Seaside. During the year ended December 31, 2010, the Company had twelve closings at purchase prices ranging from $1.40 to $2.69 per share and sold 900,000 shares of stock to Seaside for gross proceeds of approximately $1.8 million and incurred costs of approximately $0.1 million. The proceeds have been used for general corporate purposes, which includes working capital, capital expenditures, repayment of debt, development costs, and strategic investments.
Rights Offering The Company filed a Registration Statement on Form S-1 on April 13, 2010 and as amended on April 20, 2010 and declared effective by the Securities and Exchange Commission on May 3, 2010 (File No. 333-166022), pursuant to which the Company conducted a rights offering by issuing a dividend of subscription rights (the “Rights”) to all of the Company’s stockholders as of April 29, 2010 (the “Record Date”), to exercise the Rights at a price of $2.40 per share, for shares of the Company’s common stock, par value $0.001 per share (the “Rights Offering”).
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 14. Issuance of Common Stock - (continued) Pursuant to the terms of the Rights Offering, the Company distributed to its stockholders transferable rights to subscribe for and purchase up to an aggregate of 4,153,883 shares of its common stock. Each stockholder of record as of the Record Date received one transferable right for every one share of common stock owned on the Record Date. Each right entitled the holder thereof to purchase 0.20 shares of common stock at a price of $2.40 per share (fractional shares were rounded up to the nearest whole share).
On June 3, 2010, as a result of the rights offering, the Company issued 2,117,236 shares of its common stock, par value $0.001 per share, to the holders who exercised their rights pursuant to the basic and over-subscription privileges and pursuant to the terms of the rights offering as described in the prospectus included in the Registration Statement. Such shares of common stock were issued at a subscription price of $2.40 per share. The gross proceeds to the Company were approximately $5.1 million. In addition, the Company incurred $0.5 million in costs associated with this offering.
Note 15. Restructuring Charges During 2011, the Company recorded a net restructuring benefit of $5.6 million. On December 28, 2011, the Company entered into an amendment (the “Amendment”) to a sublease agreement (the “Sublease”) with an unaffiliated party to sublease 92,880 square feet of the Company’s office space in Shelton, Connecticut. As a result of the Sublease, the Company reversed approximately $7.0 million of previously accrued restructuring liabilities. This amendment extends the sublease through May 2017. This benefit was partially offset by approximately $1.4 million of charges for workforce reductions implemented during 2011. In the third quarter of 2011, the Company implemented a restructuring plan that included a workforce reduction of approximately 39 positions primarily in the Company’s Shelton, Connecticut, Fremont, California, and New Delhi and Bangalore, India locations. The Company also implemented a restructuring plan in the first quarter of 2011 that included a workforce reduction of approximately 26 positions primarily in the Company’s Fremont, California, New Delhi, India and Bangalore, India locations. The restructuring charges are primarily for employee termination benefits.
During 2010, the Company recorded a net restructuring charge of approximately $0.4 million. The Company implemented a restructuring plan in the first quarter of 2010 that included a workforce reduction of approximately 17 positions primarily in the Company’s Shelton, Connecticut, Fremont, California, and New Delhi and Bangalore, India locations. The restructuring charges are primarily for employee termination benefits. All of the related cash expenditures were paid during 2010.
During 2009, the Company recorded a net restructuring benefit of approximately $6.3 million, primarily resulting from a new sublease. On March 3, 2009, the Company entered into a sublease with a major corporation to sublease 92,880 square feet of office space located in Shelton, Connecticut to the year 2014. As a result of this sublease, the Company reversed approximately $6.7 million of accrued restructuring expense that it initially recorded in 2001. The Company also reversed approximately $0.9 million of accrued restructuring expense as a result of certain other sub-lease agreements relating to the Company’s excess facilities in Shelton, Connecticut. These benefits were partially offset by approximately $1.3 million of charges for workforce reductions and other restructuring adjustments.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15. Restructuring Charges - (continued) A summary of the restructuring liabilities and activity follows:
Note 16. Commitments and Contingencies Lease Agreements The Company leases buildings and equipment at its headquarters in Shelton, Connecticut as well as at its subsidiaries’ locations worldwide. Rental expense under all operating lease agreements was $1.1 million in 2011, $1.4 million in 2010 and $1.5 million in 2009.
The following table summarizes as of December 31, 2011 future minimum operating lease commitments, including contractually obligated building operating commitments that have remaining, non-cancelable lease terms in excess of one year and future anticipated sublease income:
Patent Indemnity Under the terms of substantially all of its sales agreements, the Company has agreed to indemnify its customers for costs and damages arising from claims against such customer based on, among other things, allegations that the Company’s products infringed upon the intellectual property rights of a third party. In the event of an infringement claim, the Company retains the right to (i) procure for the customer the right to continue using the product; (ii) replace the product with a non-infringing item which shall give equally good service; (iii) modify the product so that it becomes non-infringing; or (iv) remove the product and, on return of the product to the Company, the Company shall refund the buyer’s purchase price. Due to the nature of these indemnification agreements, the maximum potential future payments the Company could be required to make under these guarantees, when and if such claims may arise, cannot be reliably determined. No amounts
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16. Commitments and Contingencies - (continued) have been accrued for any estimated losses with respect to these guarantees for customer indemnifications since it is not probable that a loss will be incurred. No claims have been made under these indemnity provisions.
Purchase Commitments In the normal course of business, the Company makes various commitments to purchase goods or services from specific suppliers, including those related to capital expenditures. As of December 31, 2011, the Company had purchase commitments totaling $4.4 million.
Contingencies In the normal course of business, we may be confronted with issues or events that may result in a contingent liability. These generally relate to lawsuits, claims, environmental actions or the action of various regulatory agencies. If necessary, management consults with counsel and other appropriate experts to assess any matters that arise. If, in management’s opinion, we have incurred a probable loss as set forth by accounting principles generally accepted in the United States, an estimate is made of the loss and the appropriate accounting entries are reflected in our financial statements. Except as discussed below, there are no currently pending, threatened lawsuits or claims against the Company that could have a material adverse effect on our financial position, results of operations or cash flows. On July 29, 2010, the Company was served with a complaint in connection with civil action number 10-295 in U.S. District Court for the District of Delaware, entitled Sumitomo Electric Industries, Ltd. v. TranSwitch Corporation, in which Sumitomo Electric Industries, Ltd. (‘SEI’) was claiming breach of contract by the Company and damages in an amount of at least $2.6 million plus interest, costs and attorneys fees. On December 29, 2010, the Company entered into a settlement agreement with SEI which resulted in SEI filing a dismissal of its claim. As a result of the settlement agreement, the Company will pay an aggregate of approximately $0.7 million, in a combination of cash and future purchase credits. This amount was offset against the reversal of accrued royalties in the statement of operations.
Note 17. Supplemental Cash Flow Information Supplemental cash flow information follows:
Note 18. Stock Repurchase Program On February 13, 2008, the Company announced that its Board of Directors authorized a stock repurchase program under which the Company may repurchase up to $10 million of its outstanding common stock. The share repurchase program authorized the Company to repurchase shares through February 2010, from time to time, through transactions in the open market or in privately negotiated transactions. The number of shares to be purchased and the timing of the purchases were based on market conditions and other factors. The stock repurchase program did not require the Company to repurchase any specific dollar value or number of shares, and the Company could terminate the repurchase program at any time.
The share repurchase program expired in 2010 and there were no repurchases in 2009, 2010 or 2011.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19. Subsequent Events On February 10, 2012, the Company entered into an At Market Issuance Sales Agreement (the “Agreement”) with MLV & Co. LLC (“MLV”), pursuant to which the Company may issue and sell shares of its common stock, $0.001 par value per share, having an aggregate offering price of up to $10,000,000 (the “Shares”) from time to time through MLV (the “Offering”). Also on February 10, 2012, the Company filed a prospectus supplement with the Securities and Exchange Commission in connection with the Offering (the “Prospectus Supplement”). The shares of common stock to be sold under the Agreement are registered pursuant to an effective shelf Registration Statement on Form S-3 (Registration No. 333-162609) and the Prospectus Supplement.
Upon delivery of a placement notice and subject to the terms and conditions of the Agreement, MLV may sell the common stock by methods deemed to be an “at-the-market” offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended (the “Securities Act”), including sales made directly on The NASDAQ Capital Market, on any other existing trading market for the common stock or to or through a market maker. With the Company’s prior written approval, MLV may also sell the common stock by any other method permitted by law, including in privately negotiated transactions. The Company or MLV may suspend or terminate the offering of common stock upon notice and subject to other conditions. Unless otherwise terminated pursuant to the terms of the Agreement, the Agreement automatically terminates upon the earlier to occur of the three-year anniversary of the date hereof, or the issuance and sale of all of the Shares. MLV will act as sales agent on a commercially reasonable best efforts basis consistent with its normal trading and sales practices and applicable state and federal laws, rules and regulations and the rules of NASDAQ.
The Company agreed to pay MLV a commission equal to 3.0% of the gross sales price per share sold and provide indemnification and contribution to MLV against certain civil liabilities, including liabilities under the Securities Act.
TRANSWITCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20. Quarterly Information (Unaudited) The table below shows selected unaudited quarterly information of operating results. The Company believes that this information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. Interim operating results are not necessarily indicative of future period results.
(1) The sum of quarterly per share amounts may not equal per share amounts reported for year-to-date periods due to changes in the number of weighted average shares outstanding and the effects of rounding.
(2) The reported net loss for 2011 and 2010 reflects stock-based compensation expense of 2.5 million (first quarter of $0.5 million, second quarter of $0.6 million, third quarter of 0.7 million, and fourth quarter of $0.7 million) and $2.4 million (first quarter of $0.4 million, second quarter of $0.6 million, third quarter of $0.6 million and fourth quarter of $0.8 million), respectively.
SCHEDULE II
TRANSWITCH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no disagreements with accountants related to accounting and financial disclosures in 2011.
Item 9A.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the evaluation date, our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Management’s Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2011.
Our independent registered public accounting firm has issued their report on the effectiveness of our internal control over financial reporting as of December 31, 2011. That report appears under Item 8.
Changes in Internal Control over Financial Reporting No change in our internal control over financial reporting occurred during the quarter ended December 31, 2011, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information with respect to directors, the Audit Committee of the Board of Directors and Audit Committee financial experts is incorporated herein by reference to the sections entitled “Election of Directors”, “Audit Committee Report” and “Compensation and Other Information Concerning Named Executive Officers”, respectively, contained in our definitive proxy statement for the annual meeting of shareholders of the Company to be held on May 17, 2012, which is to be filed with the Securities and Exchange Commission not later than 120 days after the close of the year ended December 31, 2011 (the “2012 Proxy Statement”). Information with respect to executive officers is included in the section entitled “Executive Officers of the Registrant” in Item 1 of this Form 10-K. Information concerning Section 16(a) compliance is incorporated by reference to the section of the 2012 Proxy Statement entitled “Section 16(a) Beneficial Ownership Reporting Compliance.”
Code of Ethics The Company has a code of ethics that applies to all its directors, officers, employees and representatives. This code is publicly available at the investor relations section of the Company’s website located at http://www.transwitch.com. Amendments to the code of ethics and any grant of a waiver from a provision of the code requiring disclosure under applicable SEC rules will be disclosed within the investor relations section of the Company’s website located at http://www.transwitch.com. These materials may also be requested in print by writing to the Company’s Investor Relations Department at TranSwitch Corporation, Attention: Investor Relations, Three Enterprise Drive, Shelton, CT 06484.
Corporate Governance Principles and Charters The Company’s corporate governance principles and the charters of Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee are available at the investor relations section of the Company’s website at http://www.transwitch.com. These materials may also be requested in print by writing to the Company’s Investor Relations Department at TranSwitch Corporation, Attention: Investor Relations, Three Enterprise Drive, Shelton, CT 06484.
Item 11.
Item 11. Executive Compensation
Information with respect to executive compensation is incorporated herein by reference to the section entitled “Compensation and Other Information Concerning Named Executive Officers” contained in the 2012 Proxy Statement.
Information with respect to the Compensation Committee and its report is incorporated herein by reference to the sections entitled “Compensation Committee Interlocks and Insider Participation”, “Compensation Committee”, “Role of Executives in Establishing Compensation” under the heading “Compensation Discussion and Analysis” and “Compensation Committee Report” contained in the 2012 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding equity compensation plans is included in Item 5 of this Form 10-K. Information regarding security ownership of certain beneficial owners, directors and executive officers is incorporated herein by reference to the information in the section entitled “Security Ownership of Certain Beneficial Owners and Management”, “Related Party Transactions” and “Indemnification Matters” contained in the 2012 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information regarding certain relationships, related transactions, and the Company’s policies and procedures with respect to related party transactions is incorporated herein by reference to the sections entitled “Compensation Committee Interlocks and Insider Participation”, “Related Party Transactions” and “Review, Approval or Ratification of Transactions with Related Persons” contained in the 2012 Proxy Statement.
Information regarding director independence is incorporated herein by reference to the section entitled “Independence of Members of the Board of Directors” contained in the 2012 Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
Information regarding principal accountant fees and services is incorporated herein by reference to the section entitled “Principal Accountant Fees and Services” contained in the 2012 Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) The following financial statements of TranSwitch Corporation are filed as part of this Form 10-K under Item 8 “Financial Statements and Supplementary Data.”
(a)(2) All other schedules are omitted because they are either not applicable, not required or because the information is presented in the Consolidated Financial Statements and Financial Statement Schedule or the notes thereto.
(a)(3) Exhibits
* Indicates management contract or compensatory plan, contract or arrangement identified as required in Item 15(a)(3) of Form 10-K
(b) Exhibits
We hereby file as exhibits to this Form 10-K those exhibits listed in Item 15 (a)(3) above.
(c) Financial Statement Schedule
TranSwitch files as a financial statement schedule to this Form 10-K, the financial statement schedule listed in Item 8 and 15(a) (2) above.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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.
TranSwitch Corporation
By:
/s/ Dr. M. Ali Khatibzadeh
Dr. M. Ali Khatibzadeh
President and Chief Executive Officer
March 12, 2012
POWER OF ATTORNEY AND SIGNATURES We, the undersigned named executive officers and directors of TranSwitch Corporation, hereby severally constitute and appoint Dr. M. Ali Khatibzadeh and Mr. Robert A. Bosi, and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all amendments to this report, and generally to do all things in our names and on our behalf in such capacities to enable TranSwitch Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended and all requirements of the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.