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Note 1. Summary of Significant Accounting Policies
Business Description
Align Technology, Inc. ("We", "Our", or "Align") was incorporated in April 1997 and designs, manufactures and markets the Invisalign system, a proprietary method for treating malocclusion, or the misalignment of teeth. Invisalign corrects malocclusion using a series of clear, nearly invisible, removable appliances that gently move teeth to a desired final position.
Basis of presentation and preparation
The consolidated financial statements include the accounts of the Align and our wholly-owned subsidiaries after elimination of intercompany transactions and balances. Amounts within revenues and cost of revenues in prior period amounts have been reclassified to conform with the current period presentation. These reclassifications had no impact on previously reported gross profit or financial position.
In connection with the preparation of the consolidated financial statements, we evaluated events subsequent to the balance sheet date through the financial statement issuance date and determined that all material transactions have been recorded and disclosed properly.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.
Fair value of financial instruments
The carrying amounts of our cash and cash equivalents, accounts receivable, accounts payable and other current liabilities approximate the fair value.
Cash equivalents and marketable securities
Cash equivalents consist of highly liquid instruments purchased with an original maturity of three months or less. We invest primarily in money market funds, commercial paper, foreign and domestic corporate bonds, and United States government securities, accordingly, these investments are subject to minimal credit and market risks.
Marketable securities are classified as available-for-sale and are carried at fair value. Marketable securities classified as current assets have maturities of less than one year. Unrealized gains or losses on such securities are included in accumulated other comprehensive income (loss) in stockholders' equity. Realized gains and losses from maturities of all such securities are reported in earnings and computed using the specific identification cost method. Realized gains or losses and charges for other-than-temporary declines in value, if any, on available-for-sale securities are reported in other income (expense) as incurred. We periodically evaluate these investments for other-than-temporary impairment.
We measure our cash equivalents and marketable securities at fair value. Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Foreign currency
We analyze the functional currency for each of our international subsidiaries on an annual basis, or more often if necessary, to determine if a significant change in facts and circumstances indicate that the primary economic currency has changed. Adjustments from translating certain European subsidiaries' financial statements from the local currency to the U.S. dollar are recorded as a separate component of accumulated other comprehensive income (loss), net in the stockholders' equity section of the Consolidated Balance Sheets. This foreign currency translation adjustment reflects the translation of the balance sheet at period end exchange rates, and the income statement at an average exchange rate in effect during the period. As of December 31, 2010 and 2009, we had $0.1 million and $0.5 million, respectively, in accumulated other comprehensive income, net related to the translation of our foreign subsidiaries' financial statements. See Note 15 "Comprehensive Income (Loss)" in the Notes to our Consolidated Financial Statements for additional disclosures.
Our other international entities operate in a U.S. dollar functional currency environment, and therefore, the foreign currency assets and liabilities are remeasured into the U.S. dollar at current exchange rates except for non-monetary assets and liabilities which are remeasured at historical exchange rates. Revenues and expenses are generally remeasured at an average exchange rate in effect during each period. Gains or losses from foreign currency remeasurement are included in other income (expense). For the years ended December 31, 2010, 2009, and 2008, we incurred a foreign currency loss of $0.6 million, a gain of $0.3 million, and a loss of $0.7 million, respectively, which were included in other income (expense).
Certain risks and uncertainties
Our operating results depend to a significant extent on our ability to market and develop our products. The life cycles of our products are difficult to estimate due in part to the effect of future product enhancements and competition. Our inability to successfully develop and market our products as a result of competition or other factors would have a material adverse effect on our business, financial condition and results of operations.
Financial instruments which potentially expose us to concentrations of credit risk consist primarily of cash equivalents, marketable securities and accounts receivable. We invest excess cash primarily in money market funds of major financial institutions, commercial paper, foreign and domestic corporate bonds, and certificate of deposits. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments, which could materially harm our results of operations and financial condition. Moreover, the performance of certain securities in our investment portfolio correlates with the credit condition of the U.S. financial sector. We provide credit to customers in the normal course of business. Collateral is not required for accounts receivable, but ongoing evaluations of customers' credit worthiness are performed. We maintain reserves for potential credit losses and such losses have been within management's expectations. No individual customer accounted for 10% or more of our accounts receivable at December 31, 2010 and 2009, or net revenues in 2010, 2009, and 2008.
In the United States of America, the Food and Drug Administration ("FDA") regulates the design, manufacture, distribution, preclinical and clinical study, clearance and approval of medical devices. Products developed by us may require approvals or clearances from the FDA or other international regulatory agencies prior to commercialized sales. There can be no assurance that our products will receive any of the required approvals or clearances. If we were denied approval or clearance or such approval was delayed, it may have a material adverse impact on us.
We have manufacturing operations located outside the United States of America. We currently rely on our manufacturing facilities in Costa Rica to prepare digital treatment plans using a sophisticated, internally developed computer-modeling program. In addition, we manufacture our clear aligners at our facility in Juarez, Mexico. Our reliance on international operations exposes us to related risks and uncertainties, including difficulties in staffing and managing international operations, including difficulties in hiring and retaining qualified personnel; controlling production volume and quality of manufacture; political, social and economic instability, particularly as a result of increased levels of violence in Juarez, Mexico; interruptions and limitations in telecommunication services; product and material transportation delays or disruption; trade restrictions and changes in tariffs; import and export license requirements and restrictions; fluctuations in foreign currency exchange rates; and potential adverse tax consequences. If any of these risks materialize, our international manufacturing operations, as well as our operating results, may be harmed.
We purchase certain inventory from sole suppliers. Additionally, we rely on a limited number of hardware manufacturers. The inability of any supplier or manufacturer to fulfill our supply requirements could materially and adversely impact our future operating results.
Inventories
Inventories are valued at the lower of cost or market, with costs computed on a first-in, first-out basis.
Property, equipment, long-lived assets, and finite purchased intangible assets
Property and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Upon sale or retirement, the asset's cost and related accumulated depreciation are removed from the general ledger and any related gains or losses are reflected in the Consolidated Statements of Operations. Maintenance and repairs are expensed as incurred.
Other intangible assets primarily consist of intangible assets purchased as part of the OrthoClear Agreement. These assets are amortized using the straight-line method over their estimated useful lives of five years, reflecting the period in which the economic benefits of the assets are expected to be realized.
We evaluate long-lived assets (including intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. An asset is considered impaired if its carrying amount exceeds the future net cash flows the asset is expected to generate. If an asset is considered to be impaired, the impairment to be recognized is calculated as the amount by which the carrying amount of the asset exceeds its fair market value which is estimated based on projected discounted future net cash flows. In 2008, management decided to no longer invest in an internally developed software tool for business process management resulting in an asset impairment charge of $1.7 million which was recorded in general and administrative expense in the fourth quarter of 2008. There were no asset impairments during 2010 or 2009.
Development costs for internal use software
Costs relating to internal use software are accounted for in accordance with the provisions of accounting for the costs of computer software developed or obtained for internal use. As of December 31, 2010 and 2009, capitalized internal use software at cost was $7.1 million and $7.0 million, respectively. The associated accumulated amortization was $6.1 million and $5.3 million as of December 31, 2010 and 2009, respectively. Capitalized software costs are amortized over the estimated useful lives of three years.
Goodwill
Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired in business combinations. Goodwill is reviewed annually in the fourth quarter and whenever events or circumstances occur which indicate that goodwill might be impaired. We completed our annual evaluation of goodwill during the fourth quarter of 2010 and determined that there was no impairment.
Product Warranty
We warrant our products against material defects until the Invisalign cases are completed. We accrue for product warranty in cost of revenues upon shipment of products. Product warranty costs are primarily based on historical experience as to product failures as well as current information on repair costs. Actual warranty costs could differ materially from the estimated amounts. We regularly review the accrued balances and update these balances based on historical warranty cost trends. Actual warranty costs incurred have not materially differed from those accrued.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make payments. We periodically review these allowances, including an analysis of the customers' payment history and information regarding the customers' creditworthiness. Actual write-offs have not been materially differed from the estimated allowance.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. Revenues are recognized from product sales, net of discounts and rebates. Service revenues related to the training of dental professionals and staff on the Invisalign treatment process is recorded when the services are completed.
We enter into arrangements that involve multiple future product deliverables. Included in the price of Invisalign Full, Invisalign Teen and Invisalign Assist, we offer case refinement, which is a finishing tool used to adjust a patient's teeth to the desired final position. Case refinement may be elected by the dental professional at any time during treatment however it is generally ordered in the last stages of orthodontic treatment. We use vendor specific objective evidence of fair value to allocate revenue to the case refinement deliverable and recognize the residual revenue upon shipment. We defer the fair value of case refinement upon shipment based on a breakage factor, which is determined by sufficient historical experience of case refinement usage. Actual usage rates could differ from the historical breakage factor requiring future adjustments to revenue.
Revenues are deferred for certain products that include staged delivery. Depending on the product, revenues are recognized based on usage, case completion, ratably over a subscription period or upon shipment of the final staged shipment. Invisalign Teen is delivered in a single shipment except for six replacement aligners that are included in the price of the product and may be ordered at any time throughout treatment. We use vendor specific objective evidence of fair value to allocate revenue to the replacement aligners and recognize the residual revenue upon initial shipment. Through the second quarter of 2010, we deferred 100 percent of the fair value for the six replacement aligners. This deferred revenue was subsequently recognized as the replacement aligners were shipped or when the case was completed. Management evaluated the actual usage of replacement aligners since the launch of Invisalign Teen over two years ago and believes that there is sufficient historical evidence to establish an estimated usage rate. As a result, in June 2010, we reduced deferred revenue for Invisalign Teen replacement aligners by $14.3 million to reflect the estimated usage for in-process cases and starting in July 2010, we began deferring the fair value of the replacement aligners based on the estimated usage rate. We believe that this estimated usage is reasonable and appropriate because of the relative stability of the Invisalign Teen replacement utilization since it was first offered. Although we are not expecting any material changes, we will continue to analyze the usage of replacement aligners and may adjust the estimated usage rate as necessary.
The Vivera retainer includes four shipments per year, and revenue is deferred upon the first shipment and recognized as each shipment occurs. For Invisalign Assist, when the progress tracking feature is selected, aligners are shipped to the dental professional after every nine stages. For these cases, revenue is deferred upon the first staged shipment and is recognized upon shipment of the final staged shipment.
We estimate and record a provision for amounts of estimated losses on sales, if any, in the period such sales occur. Provisions for discounts and rebates to customers are provided for in the same period that the related product sales are recorded based upon historical discounts and rebates.
Shipping and Handling Costs
Shipping and handling charges to customers are included in net revenues, and the associated costs incurred are recorded in cost of revenues.
Research and development
Research and development costs are expensed as incurred.
Advertising costs
The cost of advertising and media is expensed as incurred. For the years ended December 31, 2010, 2009 and 2008 advertising costs totaled $20.2 million, $18.1 million, and $18.3 million, respectively.
Income taxes
We estimate income taxes based on the various jurisdictions where business is conducted. Significant judgment is required in determining the income tax provision. Deferred tax assets and liabilities are recognized for differing treatments of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be realized. To the extent we believe that realization is not likely, we will establish a valuation allowance.
We account for the impact of an uncertain income tax position on the income tax return by recognizing the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority under the guidance of Financial Accounting Standard Board ("FASB") Accounting Standards Codification ("ASC") 740-10. Uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.
Stock-based compensation
We recognize stock-based compensation cost for only those shares ultimately expected to vest on a straight-line basis over the requisite service period of the award, net of an estimated forfeiture rate. We estimate the fair value of stock options using a Black-Scholes valuation model, which requires the input of highly subjective assumptions, including the option's expected term and stock price volatility. In addition, judgment is also required in estimating the number of stock-based awards that are expected to be forfeited. Forfeitures are estimated based on historical experience at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. See Note 10 "Stockholders' Equity" in the Notes to our Consolidated Financial Statements for additional information.
Comprehensive income (loss)
Comprehensive income (loss) includes all changes in equity during a period from non-owner sources. Comprehensive income (loss), including unrealized gains and losses on available-for-sale securities and foreign currency translation adjustments, are reported net of their related tax effect.
Recent Accounting Pronouncements
In September 2009, FASB amended ASC 605 as summarized in Accounting Standards Update (ASU) 2009-13, "Revenue Recognition: Multiple-Deliverable Revenue Arrangements." Guidance in ASC 605-25 on revenue arrangements with multiple deliverables has been amended to require an entity to allocate revenue to deliverables in an arrangement using its best estimate of selling prices if the vendor does not have vendor-specific objective evidence or third-party evidence of selling prices, and to eliminate the use of the residual method and require the entity to allocate revenue using the relative selling price method. The new guidance also requires expanded quantitative and qualitative disclosures about revenue from arrangements with multiple deliverables. The update is effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. Adoption may either be on a prospective basis for new revenue arrangements entered into after adoption of the update, or by retrospective application. We adopted this guidance on a prospective basis effective January 1, 2011, and do not expect the adoption to have a material impact to our 2011 consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06, "Fair Value Measurements and Disclosures (ASC 820): Improving Disclosures about Fair Value Measurements." This update will require (1) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (2) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This guidance clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and require disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosure are effective for fiscal years beginning after December 15, 2009, except for the disclosure requirements related to the purchases, sales, issuances and settlements in the rollforward activity of Level 3 fair value measurements. Those disclosure requirements are effective for fiscal years ending after December 31, 2010. The adoption of this guidance did not have a material impact to our consolidated financial statements.
In February 2010, FASB issued ASU 2010-09, "Subsequent Events (ASC 855): Amendments to Certain Recognition and Disclosure Requirements." The amendments in the ASU remove the requirement for a Securities and Exchange Commission (SEC) filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. GAAP. We adopted this guidance in the first quarter of 2010.
In December 2010, FASB issued ASU 2010-28, "Intangibles—Goodwill and Other (ASC 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." The amendments in this guidance modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this guidance are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of this guidance did not have a material impact to our consolidated financial statements.
In December 2010, FASB issued ASU 2010-29, "Business Combinations (ASC 805): Disclosure of Supplementary Pro Forma Information for Business Combinations." This guidance clarifies that pro forma disclosures should be presented as if a business combination occurred at the beginning of the prior annual period for purposes of preparing both the current reporting period and the prior reporting period pro forma financial information. These disclosures should be accompanied by a narrative description about the nature and amount of material, nonrecurring pro forma adjustments. The new accounting guidance is effective for business combinations consummated in periods beginning after December 15, 2010, and should be applied prospectively as of the date of adoption. Early adoption is permitted. The adoption of this guidance did not have a material impact to our consolidated financial statements.
Management does not believe that other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants or the SEC have a material impact on our present or future consolidated financial statements.
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Note 2. Marketable Securities and Fair Value Measurements
We had the following investments as of December 31, 2010 (in thousands):
Short-term
|
December 31, 2010 |
Amortized Costs |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | ||||||||||||
|
Corporate bonds and certificate of deposit |
$ | 3,012 | $ | — | $ | (1 | ) | $ | 3,011 | |||||||
|
Foreign bonds |
705 | — | — | 705 | ||||||||||||
|
Commercial paper |
1,900 | — | — | 1,900 | ||||||||||||
|
Discount notes |
2,998 | 1 | — | 2,999 | ||||||||||||
|
Total |
$ | 8,615 | $ | 1 | $ | (1 | ) | $ | 8,615 | |||||||
Long-term
|
December 31, 2010 |
Amortized Costs |
Gross Unrealized Losses |
Fair Value | |||||||||
|
Corporate bonds |
$ | 5,748 | $ | (11 | ) | $ | 5,737 | |||||
|
Foreign bonds |
1,307 | (1 | ) | 1,306 | ||||||||
|
Agency bonds |
2,047 | (1 | ) | 2,046 | ||||||||
|
Total |
$ | 9,102 | $ | (13 | ) | $ | 9,089 | |||||
We had the following investments as of December 31, 2009 (in thousands):
Short-term
|
December 31, 2009 |
Amortized Cost |
Gross Unrealized Gains |
Fair Value | |||||||||
|
U.S. government notes and bonds |
$ | 18,972 | $ | 6 | $ | 18,978 | ||||||
|
Corporate bonds |
1,000 | — | 1,000 | |||||||||
|
Total |
$ | 19,972 | $ | 6 | $ | 19,978 | ||||||
As of December 31, 2010 and 2009, all short-term investments have maturity dates of less than one year. For the years ended December 31, 2010 and 2009, realized losses were immaterial.
Fair Value Measurements
We measure the fair value of our cash equivalents and marketable securities as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We use the GAAP fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value:
Level 1—Quoted (unadjusted) prices in active markets for identical assets or liabilities.
Our Level 1 assets consist of money market funds. We did not hold any Level 1 liabilities as of December 31, 2010.
Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Our Level 2 assets consist of corporate bonds, certificates of deposits, discount notes, foreign bonds, agency bonds, and commercial paper. We did not hold any Level 2 liabilities as of December 31, 2010.
Level 3—Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
We did not hold any Level 3 assets or liabilities as of December 31, 2010.
The following table summarizes our financial assets measured at fair value on a recurring basis as of December 31, 2010 (in thousands):
|
Description |
Balance as of December 31, 2010 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
|||||||||
|
Cash equivalents: |
||||||||||||
|
Money market funds |
$ | 164,722 | $ | 164,722 | $ | — | ||||||
|
Short-term investments: |
||||||||||||
|
Corporate bonds and certificate of deposit |
3,011 | 3,011 | ||||||||||
|
Foreign bonds |
705 | 705 | ||||||||||
|
Discount notes |
2,999 | 2,999 | ||||||||||
|
Commercial paper |
1,900 | 1,900 | ||||||||||
|
Long-term investments: |
||||||||||||
|
Corporate bonds |
5,737 | 5,737 | ||||||||||
|
Foreign bonds |
1,306 | 1,306 | ||||||||||
|
Agency bonds |
2,046 | 2,046 | ||||||||||
| $ | 182,426 | $ | 164,722 | $ | 17,704 | |||||||
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Note 3. Balance Sheet Components
Inventories
Inventories consist of the following (in thousands):
| December 31, | ||||||||
| 2010 | 2009 | |||||||
|
Raw materials |
$ | 1,272 | $ | 1,079 | ||||
|
Work in process |
1,030 | 746 | ||||||
|
Finished goods |
242 | 221 | ||||||
| $ | 2,544 | $ | 2,046 | |||||
Work in process includes costs to produce the Invisalign product. Finished goods primarily represent ancillary products that support the Invisalign system.
Property and equipment
Property and equipment consist of the following (in thousands):
| Useful Life (in years) |
December 31, | |||||||||||
| 2010 | 2009 | |||||||||||
|
Clinical and manufacturing equipment |
5 | $ | 48,373 | $ | 46,620 | |||||||
|
Computer hardware |
3 | 16,246 | 13,895 | |||||||||
|
Computer software |
3 | 12,776 | 12,511 | |||||||||
|
Furniture and fixtures |
5 | 4,873 | 5,468 | |||||||||
|
Leasehold improvements |
Term of the lease | 3,406 | 10,046 | |||||||||
|
Construction in progress |
12,784 | 6,437 | ||||||||||
| 98,458 | 94,977 | |||||||||||
|
Less: Accumulated depreciation and amortization |
N/A | (67,774 | ) | (70,006 | ) | |||||||
| $ | 30,684 | $ | 24,971 | |||||||||
As of December 31, 2010, construction in progress consisted primarily of costs for capital equipment and internal use software expected to be placed in service in the next year. Depreciation and amortization was $11.4 million, $10.2 million, and $10.0 million, for the years ended December 31, 2010, 2009 and 2008, respectively.
Accrued liabilities
Accrued liabilities consist of the following (in thousands):
| December 31, | ||||||||
| 2010 | 2009 | |||||||
|
Accrued payroll and benefits |
$ | 26,551 | $ | 25,847 | ||||
|
Accrued litigation settlement |
4,549 | — | ||||||
|
Accrued income taxes |
1,936 | 2,920 | ||||||
|
Accrued sales rebate |
3,826 | 2,610 | ||||||
|
Accrued sales tax and value added tax |
2,940 | 2,392 | ||||||
|
Accrued warranty |
2,607 | 2,376 | ||||||
|
Accrued sales and marketing expenses |
2,955 | 1,954 | ||||||
|
Other |
5,994 | 4,723 | ||||||
| $ | 51,358 | $ | 42,822 | |||||
Warranty
Warranty accrual as of December 31, 2010 and 2009 consists of the following activity (in thousands):
|
Warranty accrual, December 31, 2008 |
$ | 2,031 | ||
|
Charged to cost of revenues |
2,926 | |||
|
Actual warranty expenditures |
(2,581 | ) | ||
|
Warranty accrual, December 31, 2009 |
2,376 | |||
|
Charged to cost of revenues |
2,793 | |||
|
Actual warranty expenditures |
(2,562 | ) | ||
|
Warranty accrual, December 31, 2010 |
$ | 2,607 | ||
|
|||
Note 4. Impairment of Long-Lived Assets
We evaluate the recoverability of property and equipment whenever events or changes in circumstances indicate that the carrying value of a long-lived asset may not be recoverable. Our management decided to cease further investment in an internally developed software tool for business process management resulting in an asset impairment charge of $1.7 million which was recorded in general and administrative expense in the fourth quarter of 2008. The impairment indicators which management considered included the fact that this internally developed software tool was not completed and management concluded that no market participant would be willing to purchase an unfinished customized application, therefore the fair value was determined to be zero, and the capitalized amount of the software tool was written off. There were no impairment charges in 2010 and 2009.
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Note 5. Intangible Assets
The intangible assets represent non-compete agreements received in conjunction with the October 2006 OrthoClear Agreement at gross value of $14.0 million. These assets are amortized on a straight-line basis over the expected useful life of five years. As of December 31, 2010 and December 31, 2009, the net carrying value of these non-compete agreements was $2.2 million (net of $11.8 million of accumulated amortization) and $5.0 million (net of $9.0 million of accumulated amortization), respectively.
For each of the three years ended December 31, 2010, 2009 and 2008, total amortization expense for intangible assets was $2.8 million. The total estimated annual future amortization expense for 2011 is $2.2 million.
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Note 6. Litigation Settlements
Ormco
On August 16, 2009, we entered into three agreements with Ormco Corporation ("Ormco"), an affiliate of Danaher Corporation ("Danaher"): a Settlement Agreement, a Stock Purchase Agreement, and a Joint Development, Marketing and Sales agreement ("Collaboration Agreement"). The Settlement Agreement ended all pending litigations between the parties, and we agreed to (1) make a cash payment of $13.2 million upon the execution of the agreement and (2) issue a total of 7.6 million non-assessable shares of common stock pursuant to the Stock Purchase Agreement. The settlement value was allocated between past infringement and future use of the patent based on total case shipments during the period of infringement. We attributed $69.7 million to past infringement claims, based on case shipments from September 9, 2003 through August 16, 2009. This was recorded as litigation settlement costs and included in our operating expenses. Additional royalty costs based on case shipments between August 17, 2009 through January 19, 2010 totaling $7.0 million were recorded as prepaid royalties as of the settlement date. We amortized $6.2 million of the prepaid royalties to cost of sales for the year ended December 31, 2009 and the remaining $0.8 million was amortized during first quarter of 2010.
OrthoClear Insurance Settlement
In June 2010, we received an $8.7 million insurance settlement over a disputed coverage under our general liability umbrella that was not previously reimbursed by our insurer related to the OrthoClear litigation. This insurance settlement was included in our 2010 operating expenses.
Leiszler
On May 10, 2010, Christopher J. Leiszler filed a complaint against us in the United States District Court for the Northern District of California. The complaint alleges that we implemented unfair and fraudulent requirements for the prescription of Invisalign through the Invisalign Proficiency Requirements. In January 2010 Dr. Leiszler's Invisalign provider status was suspended for failing to meet the Proficiency Requirements. Dr. Leiszler sued on behalf of himself and all others similarly situated. The complaint seeks a refund of the price paid to us for Invisalign training. On October 19, 2010, we entered into a memorandum of understanding to resolve this litigation, and on November 30, 2010, we executed a formal Stipulation of Settlement which must be approved by the Court. On December 23, 2010, the Court granted preliminary approval of the proposed settlement. The Court has scheduled a hearing in April 2011 to determine whether to grant final approval of the proposed settlement. Under terms of the proposed settlement, class members can be reinstated to prescribe Invisalign treatment under certain circumstances (the "Reinstatement Benefit"). Certain class members will have the option to elect a cash remedy instead of the Reinstatement Benefit. Pursuant to the proposed settlement, in January 2011, we deposited approximately $8.0 million into an escrow account to pay eligible class members who elect the cash remedy, as well as legal fees and other costs. We recorded a total litigation settlement charge of $4.5 million during 2010 for our estimated liability related to this settlement. We will continue to assess and evaluate the matter with our legal counsel and update the estimated settlement charge as appropriate as new information becomes available.
|
|||
Note 7. Legal Proceedings
Weber
On May 18, 2007, Debra A. Weber filed a consumer class action lawsuit against us, OrthoClear, Inc. and OrthoClear Holdings, Inc. (d/b/a OrthoClear, Inc.) in Syracuse, New York, U.S. District Court. The complaint alleges two causes of action against the OrthoClear defendants and one cause of action against us for breach of contract. The cause of action against us titled "Breach of Third Party Benefit Contract" references our agreement to make Invisalign treatment available to OrthoClear patients, alleging that we failed "to provide the promised treatment to Plaintiff or any of the class members." On June 2, 2010, the Court granted our motion for summary judgment and dismissed us from the action.
On June 29, 2010, Weber requested that the Court enter final judgment as to Align pursuant to Federal Rule of Civil Procedure 54(b) in order to certify Align's dismissal for immediate appeal. We filed an opposition to Weber's request on July 19, 2010, on the grounds that Weber failed to show that exceptional circumstances warranted the entry of a final judgment where fewer than all claims or parties had been dismissed. On August 20, 2010, the Court denied Weber's motion. On October 29, 2010, the Court dismissed the action against OrthoClear and OrthoClear Holdings Inc. with prejudice at the request of the remaining parties pursuant to a settlement. The Stipulation and Order of Dismissal with Prejudice entered by the Court provides that the settlement and dismissal does not affect any rights Weber may have to appeal dismissal of the action as against us. We believe there is no evidence to indicate that a reasonable possibility exists that a loss had been incurred as of December 31, 2010.
Securities Litigation
In August 2009, Plaintiff Charles Wozniak filed a lawsuit against us and our Chief Executive Officer and President, Thomas M. Prescott ("Mr. Prescott"), in District Court for the Northern District of California on behalf of a claimed class consisting of all persons or entities who purchased our common stock between January 30, 2007 and October 24, 2007. The complaint alleges that Align and Mr. Prescott violated Section 10(b) of the Securities Exchange Act of 1934 and that Mr. Prescott violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the complaint alleges that during the class period, we failed to disclose that we had shifted the focus of our sales force to clearing backlog, causing a significant decrease in the number of new case starts. On November 13, 2009, the Court appointed Plumbers and Pipefitters National Pension Fund as lead plaintiff. The lead plaintiff filed an amended complaint on January 29, 2010. The amended complaint alleges that we and Mr. Prescott issued a number of purportedly false and misleading statements throughout the class period concerning the Patients First program, our production capacity, a purported backlog, and the focus of our sales force. On March 26, 2010, we and Mr. Prescott filed a motion to dismiss the amended complaint. The motion was heard by the Court on July 9, 2010, and the Court has not yet released a ruling on the motion. We believe the lawsuit to be without merit and intend to vigorously defend ourselves. We believe there is not sufficient evidence to conclude that a reasonable possibility exists that a loss had been incurred as of December 31, 2010.
|
|||
Note 8. Credit Facilities
On December 14, 2010, we renegotiated and amended our existing credit facility with Comerica Bank. Under this revolving line of credit, we have $30.0 million of available borrowings with a maturity date of December 31, 2012. The interest rate on borrowings will range from Libor plus 1.5% to 2.0% depending upon the amount of cash we maintain at Comerica Bank. This credit facility requires a quick ratio covenant and also requires us to maintain a minimum unrestricted cash balance of $10.0 million. Additionally, in the event our unrestricted cash deposited is less than $55.0 million, the unused facility fee will increase from 0.050% per quarter to 0.125% per quarter. As of December 31, 2010, we had no outstanding borrowings under this credit facility and are in compliance with the financial covenants.
|
|||
Note 9. Commitments and Contingencies
Operating leases
We rent our facilities and certain equipment and automobiles under non-cancelable operating lease arrangements. Facility leases expire at various dates through 2015 and thereafter and provides for pre-negotiated fixed rental rates during the terms of the lease.
We have a facility in San Jose, Costa Rica. The facility comprises approximately 63,000 square feet of manufacturing and office space. The monthly rent in 2010 for the Costa Rica facility is approximately $84,000. We renewed the lease in March 2008 for an additional five year term, which commenced in October 2008 and expires in September 2013.
We also have a facility in Juarez, Mexico used to manufacture clear aligners. This facility comprises of approximately 68,000 square feet of manufacturing and office space with a monthly rent in 2010 of approximately $32,000. We assumed the lease from International Manufacturing Solutions in December 2008 and will expire in July 2013.
Our European headquarters are located in Amsterdam, The Netherlands. On August 3, 2007, the original lease agreement was amended to expand our Amsterdam facility to approximately 16,000 square feet of office space. This lease will expire in June 2012, with an option to renew for an additional five year term. We may also terminate this lease in June 2012 for a fee of approximately $125,000. The monthly rent in 2010 for the Amsterdam facility is approximately $45,000.
On January 26, 2010, we entered into an agreement to lease new corporate headquarters of approximately 129,024 square feet in San Jose, California. The lease agreement commenced on June 28, 2010 and will continue for an initial term of seven years and two months. The monthly rent in 2010 for our San Jose, California corporate headquarters is approximately $130,000. The agreement for our previous corporate headquarters in Santa Clara, California, expired on June 30, 2010.
We recognize rent expense on a straight-line basis over the lease period, and accrued for rent expense incurred but not paid. Total rent expense was $4.7 million, $3.8 million, and $3.8 million, for the years ended December 31, 2010, 2009 and 2008, respectively.
Minimum future lease payments for non-cancelable leases as of December 31, 2010, are as follows (in thousands):
|
Fiscal Year |
Operating leases | |||
|
2011 |
$ | 5,596 | ||
|
2012 |
4,405 | |||
|
2013 |
3,492 | |||
|
2014 |
2,491 | |||
|
2015 |
2,533 | |||
|
Thereafter |
4,319 | |||
|
Total minimum lease payments |
$ | 22,836 | ||
|
|||
Note 10. Stockholders' Equity
Preferred Stock Rights Agreement
The Preferred Stock Rights Agreement (the "Rights Agreement") is intended to protect stockholders from unfair or coercive takeover practices. In accordance with the Rights Agreement, the Board of Directors declared a dividend distribution of one preferred stock purchase right (a "Right") for each outstanding share of our common stock to stockholders of record on November 22, 2005. Each Right entitles stockholders to buy one one-thousandth of a share of our Series A Participating Preferred Stock, par value $0.0001 per share, at an exercise price of $37.00, subject to adjustment. Rights will become exercisable upon the occurrence of certain events, including a person or group acquiring or the announcing the intention to acquire beneficial ownership of 15% or more of the then outstanding common stock without the approval of the Board of Directors. Each holder of a Right will have the right to receive, upon exercise, shares of common stock having a value equal to two times the purchase price. The Rights will expire on November 22, 2015 or upon the exercise of the Rights, whichever occurs earlier.
Common Stock
The holders of common stock are entitled to receive dividends whenever funds are legally available and when and if declared by the Board of Directors. We have never declared or paid dividends on our common stock.
Stock-based Compensation Expense
Stock-based compensation expense is based on the estimated fair value of awards, net of estimated forfeitures and recognized over the requisite service period. Estimated forfeitures are based on historical experience at the time of grant and may be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The stock-based compensation expense related to all of our stock-based awards and employee stock purchases for the years ended December 31, 2010, 2009, 2008 is as follows (in thousands):
| For the Years Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Cost of revenues |
$ | 1,629 | $ | 1,502 | $ | 1,753 | ||||||
|
Sales and marketing |
4,430 | 4,308 | 5,289 | |||||||||
|
General and administrative |
7,931 | 7,641 | 8,011 | |||||||||
|
Research and development |
2,082 | 1,637 | 2,004 | |||||||||
|
Total stock-based compensation |
$ | 16,072 | $ | 15,088 | $ | 17,057 | ||||||
Stock-based Compensation Plans
Our 2005 Incentive Plan provides for the granting of incentive stock options, non-statutory stock options, restricted stock units, stock appreciation rights, performance units and performance shares to employees, non-employee directors, and consultants. Options are granted for terms not to exceed ten years and generally vest over 4 years with 25% vesting one year from the date of grant and 1/48th each month thereafter. Any shares granted as an award of restricted stock, restricted stock unit, performance share or performance unit are counted against the authorized share reserve as two (2) shares for every one (1) share subject to the award, and any shares cancelled will be returned at the same ratio. In addition, an aggregate of 5,000,000 shares that would have been returned to our expired 2001 Stock Incentive Plan as a result options cancelled or shares repurchased, can be added to the shares available under the 2005 Incentive Plan. This plan expired on December 31, 2010.
On May 20, 2010 our stockholders voted to amend the 2005 Incentive Plan. The amended plan extended the plan expiration date to December 31, 2020, increased the number of shares reserved for issuance by 3,300,000 shares, and reduced the maximum option term to seven years. The amended 2005 Incentive Plan also changed the share reserve ratio such that shares subject to an award of restricted stock, restricted stock units, performance shares or performance units will now be counted against the authorized share reserve as one and one-half (1 1/2) shares for every one (1) share subject to the award, and any shares cancelled will be returned at the same ratio.
As of December 31, 2010, we have a total of 4,110,981 shares reserved and available for issuance which includes 2,375,766 shares that have been transferred from the 2001 Stock Incentive Plan.
Stock Options
Activity for the years ended December 31, 2010, 2009 and 2008 under the stock option plans are set forth below (in thousands, except years and per share amounts):
| Stock Options | ||||||||||||||||
| Number of Shares Underlying Stock Options |
Weighted Average Exercise Price per Share |
Weighted Average Remaining Contractual Term (in years) |
Aggregate Intrinsic Value |
|||||||||||||
|
Outstanding at of December 31, 2007 |
7,133 | $ | 10.99 | |||||||||||||
|
Granted |
2,182 | 12.78 | ||||||||||||||
|
Exercised |
(912 | ) | 6.50 | |||||||||||||
|
Cancelled or expired |
(1,094 | ) | 14.02 | |||||||||||||
|
Outstanding at December 31, 2008 |
7,309 | 11.63 | ||||||||||||||
|
Granted |
1,134 | 8.62 | ||||||||||||||
|
Exercised |
(586 | ) | 7.05 | |||||||||||||
|
Cancelled or expired |
(369 | ) | 12.45 | |||||||||||||
|
Outstanding at of December 31, 2009 |
7,488 | 11.49 | ||||||||||||||
|
Granted |
1,501 | 17.65 | ||||||||||||||
|
Exercised |
(913 | ) | 7.87 | |||||||||||||
|
Cancelled or expired |
(261 | ) | 14.63 | |||||||||||||
|
Outstanding at of December 31, 2010 |
7,815 | $ | 12.99 | 5.71 | $ | 51,645 | ||||||||||
|
Vested and expected to vest at December 31, 2010 |
7,604 | $ | 12.93 | 5.68 | $ | 50,719 | ||||||||||
|
Exercisable at December 31, 2010 |
5,151 | $ | 12.08 | 5.12 | $ | 38,877 | ||||||||||
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day in 2010 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on the last day of each fiscal year. This amount will fluctuate based on the fair market value of our stock. The total intrinsic value of stock options exercised for the years ended December 31, 2010, 2009 and 2008 was $9.2 million, $3.2 million, and $5.2 million, respectively. We issue new shares upon the exercise of options.
The fair value of stock options granted was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:
| 2010 | 2009 | 2008 | ||||||||||
|
Stock options: |
||||||||||||
|
Expected term (in years) |
4.4 | 4.4 | 4.4 | |||||||||
|
Expected volatility |
63.3 | % | 62.0 | % | 60.0 | % | ||||||
|
Risk-free interest rate |
1.9 | % | 1.6 | % | 2.8 | % | ||||||
|
Expected dividend |
— | — | — | |||||||||
|
Weighted average fair value at grant date |
$ | 9.08 | $ | 4.32 | $ | 6.40 | ||||||
The expected term of stock options represents the weighted-average period the stock options are expected to remain outstanding. We used a mid-point model to determine the expected term of stock options based on our historical exercise, post-vesting cancellation experience, and the remaining contractual term of our outstanding options.
We use our own historical volatility.
The risk-free interest rate is based on the implied yield on a U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the option.
We have not paid any cash dividends since inception and do not anticipate paying cash dividends in the foreseeable future, therefore we used an expected dividend of zero.
As of December 31, 2010, there was $13.8 million of total unamortized compensation costs related to stock options and these costs are expected to be recognized over a weighted average period of 2.3 years. For the year ended December 31, 2010, the total recognized tax effect from exercised options was $0.9 million.
The options outstanding and exercisable by exercise price at December 31, 2010 are as follows:
| Options Outstanding | Options Exercisable | |||||||||||||||||||
|
Range of Exercise Prices |
Shares | Weighted Average Remaining Contractual Term (in years) |
Weighted Average Exercise Price per Share |
Shares | Weighted Average Exercise Price per Share |
|||||||||||||||
|
$ 2.18 - $ 7.81 |
2,088,638 | 5.20 | $ | 7.11 | 1,664,197 | $ | 6.94 | |||||||||||||
|
7.84 - 13.00 |
2,464,744 | 6.31 | 11.26 | 1,783,261 | 10.78 | |||||||||||||||
|
13.04 - 17.94 |
2,324,711 | 6.19 | 17.54 | 873,361 | 17.58 | |||||||||||||||
|
17.97 - 27.06 |
936,878 | 4.08 | 19.35 | 830,376 | 19.36 | |||||||||||||||
|
$ 2.18 - $27.06 |
7,814,971 | 5.71 | $ | 12.99 | 5,151,195 | $ | 12.08 | |||||||||||||
Restricted Stock Units
The fair value of restricted stock units is based on our closing stock price on the date of grant. A summary of the nonvested shares for the years ended December 31, 2010, 2009 and 2008 is as follows (in thousands, except years and per share amounts):
| Shares Underlying RSUs |
Average Grant Date Fair Value Price per Share |
Contractual Term (in years) |
Aggregate Intrinsic Value |
|||||||||||||
|
Nonvested as of December 31, 2007 |
651 | $ | 15.78 | |||||||||||||
|
Granted |
685 | 12.78 | ||||||||||||||
|
Vested and released |
(258 | ) | 15.55 | |||||||||||||
|
Forfeited |
(206 | ) | 15.00 | |||||||||||||
|
Nonvested as of December 31, 2008 |
872 | 13.68 | ||||||||||||||
|
Granted |
326 | 8.56 | ||||||||||||||
|
Vested and released |
(257 | ) | 13.39 | |||||||||||||
|
Forfeited |
(65 | ) | 12.44 | |||||||||||||
|
Nonvested as of December 31, 2009 |
876 | 11.95 | ||||||||||||||
|
Granted |
427 | 17.59 | ||||||||||||||
|
Vested and released |
(327 | ) | 12.72 | |||||||||||||
|
Forfeited |
(71 | ) | 13.80 | |||||||||||||
|
Nonvested as of December 31, 2010 |
905 | $ | 14.19 | 1.16 | $ | 17,702 | ||||||||||
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (calculated by multiplying our closing stock price on the last trading day of 2010 by the number of non-vested RSUs) that would have been received by the unit holders had all RSUs been vested and released on the last day of each fiscal year. This amount will fluctuate based on the fair market value of our stock. During 2010, of the 327,020 shares vested and released, approximately 60,793 vested shares were withheld for executive RSU tax payments, resulting in a net issuance of 266,227 shares.
The total intrinsic value of RSUs vested and released during 2010, 2009 and 2008 was $5.8 million, $2.9 million and $2.9 million, respectively. As of December 31, 2010, there was $7.6 million of total unamortized compensation costs related to RSUs, and these costs are expected to be recognized over a weighted average period of 2.1 years.
Employee Stock Purchase Plan
Our 2001 Employee Stock Purchase Plan (the "2001 Purchase Plan") consists of consecutive overlapping twenty-four month offering periods with four six-month purchase periods in each offering period. Employees purchase shares at 85% of the fair market value of the common stock at either the beginning of the offering period or the end of the purchase period, whichever is lower. During the year ended December 31, 2010, we issued 643,129 shares under the 2001 Purchase Plan. As of December 31, 2010, we reserved 14,933,456 shares of common stock for future issuance and 10,981,603 shares remain available for future issuance. These reserved shares will be cancelled upon the expiration of the final purchase period under the 2001 Purchase Plan.
In May 2010, our shareholders approved the 2010 Employee Stock Purchase Plan (the "2010 Purchase Plan") to replace the 2001 Purchase Plan which expired on January 31, 2011. The terms and features of the 2010 Purchase Plan are substantially the same as the 2001 Purchase Plan and will continue until terminated by either the Board or its administrator. The maximum number of shares available for issuance under the 2010 Purchase Plan is 2,400,000 shares.
The fair value of the option component of the Purchase Plan shares was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:
| December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Employee Stock Purchase Plan: |
||||||||||||
|
Expected term (in years) |
1.3 | 1.3 | 1.2 | |||||||||
|
Expected volatility |
55.8 | % | 74.6 | % | 67.2 | % | ||||||
|
Risk-free interest rate |
0.4 | % | 0.6 | % | 2.2 | % | ||||||
|
Expected dividend |
— | — | — | |||||||||
|
Weighted average fair value at grant date |
$ | 7.22 | $ | 3.78 | $ | 4.89 | ||||||
As of December 31, 2010, there was $0.3 million of total unamortized compensation costs related to employee stock purchases. These costs are expected to be recognized over a weighted average period of 0.6 years.
|
|||
Note 11. Common Stock Repurchase Program
In April 2008, our Board of Directors approved a common stock repurchase program authorizing management to repurchase up to $50 million of our outstanding common stock. During 2008, we purchased approximately 4.7 million shares of common stock at an average price of $10.76 per share for an aggregate purchase price of $50.1 million including commissions and completed the stock repurchase program. The common stock repurchases reduced additional paid-in capital by $38.6 million and increased accumulated deficit by $11.6 million. All repurchased shares were retired, and there were no stock repurchases during 2010 and 2009.
|
|||
Note 12. Employee Benefit Plan
In January 1999, we adopted a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. In 2009, our Board of Directors authorized us to match 50% of our employee's salary deferral contributions up to a 6% of the employee's eligible compensation effective 2010. We contributed approximately $1.6 million to the 401(k) plan in 2010.
|
|||
Note 13. Income Taxes
Deferred tax assets and liabilities were as follows (in thousands):
| Years Ended December 31, | ||||||||
| 2010 | 2009 | |||||||
|
Deferred tax assets: |
||||||||
|
Net operating loss and capital loss carryforwards |
$ | 27,486 | $ | 47,607 | ||||
|
Credit carryforwards |
7,080 | 7,583 | ||||||
|
Reserves & accruals |
9,247 | 8,947 | ||||||
|
Depreciation and amortization |
5,103 | 6,196 | ||||||
|
Stock-based compensation |
7,919 | 5,606 | ||||||
|
Other |
929 | 785 | ||||||
| 57,764 | 76,724 | |||||||
|
Deferred tax liabilities: |
||||||||
|
Prepaid expenses |
913 | 1,739 | ||||||
|
Translation gains |
(5 | ) | 239 | |||||
|
Other |
864 | 1,344 | ||||||
| 1,772 | 3,322 | |||||||
|
Net deferred tax assets before valuation allowance |
55,992 | 73,402 | ||||||
|
Valuation allowance |
(6,079 | ) | (6,182 | ) | ||||
|
Net deferred tax assets |
$ | 49,913 | $ | 67,220 | ||||
With the exception of certain capital loss and foreign net operating loss carryforwards, we released the tax valuation allowance on most of the deferred tax assets and recorded an income tax benefit of $64.6 million for the year ended December 31, 2008. As of December 31, 2010, we believed, except for the items noted above that it was more likely than not, that the amount of deferred tax assets recorded on the balance sheet will be realized. However, should there be a change in our ability to recover our deferred tax assets, the tax provision would increase in the period in which it is more likely than not that we cannot recover our deferred tax assets.
At December 31, 2010, we had net operating loss carryforwards of approximately $134.5 million for federal purposes and $67.6 million for California state tax purposes. If not utilized, these carryforwards will begin to expire beginning in 2020 for federal purposes and 2013 for California purposes.
We have research credit carryforwards of approximately $4.5 million for federal purposes and $3.8 million for California state tax purposes. If not utilized, the federal credit carryforwards will begin to expire in 2017. The California state credit can be carried forward indefinitely.
During fiscal year 2010, the amount of unrecognized tax benefits was increased by $5.0 million. The total amount of unrecognized tax benefits was $11.0 million as of December 31, 2010, which would impact our effective tax rate if recognized. We recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. Interest and penalties are immaterial and are included in our unrecognized tax benefits.
The following is a rollforward of our total gross unrecognized tax benefit for 2010 (in thousands):
|
Unrecognized tax benefit as of January 1, 2008 |
$ | 2,816 | ||
|
Tax positions related to current year: |
||||
|
Additions for uncertain tax positions |
314 | |||
|
Tax positions related to prior year: |
||||
|
Reductions for uncertain tax positions |
(252 | ) | ||
|
Unrecognized tax benefit as of December 31, 2008 |
$ | 2,878 | ||
|
Tax positions related to current year: |
||||
|
Additions for uncertain tax positions |
1,691 | |||
|
Tax positions related to prior year: |
||||
|
Additions for uncertain tax positions |
1,738 | |||
|
Reductions for uncertain tax positions |
(378 | ) | ||
|
Unrecognized tax benefit as of December 31, 2009 |
$ | 5,929 | ||
|
Tax positions related to current year: |
||||
|
Additions for uncertain tax positions |
2,742 | |||
|
Tax positions related to prior year: |
||||
|
Additions for uncertain tax positions |
2,290 | |||
|
Unrecognized tax benefit as of December 31, 2010 |
$ | 10,961 | ||
We are subject to taxation in the U.S. and various states and foreign jurisdictions. All of our tax years will be open to examination by the U.S. federal and most state tax authorities due to our net operating loss and overall credit carryforward position. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2006.
The differences between income taxes using the federal statutory income tax rate of 35% and our effective tax rate were as follows:
| Years Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
U.S. federal statutory income tax rate |
35.00 | % | 35.00 | % | 35.00 | % | ||||||
|
State income taxes, net of federal tax benefit |
2.97 | 1.89 | 7.74 | |||||||||
|
Deferred tax benefits utilized |
— | — | (67.04 | ) | ||||||||
|
Foreign losses not benefited |
— | — | 4.16 | |||||||||
|
Impact of differences in foreign tax rates |
(11.18 | ) | (14.99 | ) | (8.13 | ) | ||||||
|
Amortization of stock-based compensation |
1.55 | (6.53 | ) | 32.30 | ||||||||
|
Non-deductible foreign exchange losses |
— | — | (0.91 | ) | ||||||||
|
Non-deductible meals & entertainment charges |
0.50 | (1.31 | ) | 3.21 | ||||||||
|
Valuation allowance release |
— | — | (378.34 | ) | ||||||||
|
Other items not individually material |
(1.64 | ) | (6.40 | ) | 3.57 | |||||||
| 27.20 | % | 7.66 | % | (368.44 | %) | |||||||
The domestic and foreign components of income (loss) before provision for income taxes were as follows (in thousands):
| Years ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Domestic |
$ | 57,145 | $ | (23,075 | ) | $ | 13,333 | |||||
|
Foreign |
44,858 | (10,818 | ) | 3,743 | ||||||||
|
Total |
$ | 102,003 | $ | (33,893 | ) | $ | 17,076 | |||||
In June 2009, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted a twelve year extension of the tax incentives, which were previously granted in 2002. Under these incentives, all of the income in Costa Rica during these twelve year incentive periods is subject to reduced rates of Costa Rica income tax. The incentive tax rates will expire in various years beginning in 2017. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2010. As a result of these incentives, income taxes were reduced by $12.7 million in 2010. Because Costa Rica incurred a net loss in 2009, no tax benefit was realized from these incentives in 2009. In order to receive the benefit of the incentives, we must hire specified numbers of employees and maintain minimum levels of fixed asset investment in Costa Rica. If we do not fulfill these conditions for any reason, our incentive could lapse and our income in Costa Rica would be subject to taxation at higher rates, which could have a negative impact on our operating results.
The provision for (benefit from) income taxes consisted of the following (in thousands):
| Years Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Federal |
||||||||||||
|
Current |
$ | — | $ | (1,196 | ) | $ | 268 | |||||
|
Deferred |
23,193 | (1,437 | ) | (56,934 | ) | |||||||
| 23,193 | (2,633 | ) | (56,666 | ) | ||||||||
|
State |
||||||||||||
|
Current |
386 | (96 | ) | 784 | ||||||||
|
Deferred |
2,914 | (1,115 | ) | (7,674 | ) | |||||||
| 3,300 | (1,211 | ) | (6,890 | ) | ||||||||
|
Foreign |
||||||||||||
|
Current |
1,197 | 1,280 | 645 | |||||||||
|
Deferred |
60 | (60 | ) | — | ||||||||
| 1,257 | 1,220 | 645 | ||||||||||
|
Provision for (benefit from) income taxes |
$ | 27,750 | $ | (2,624 | ) | $ | (62,911 | ) | ||||
We have not provided additional U.S. income taxes on undistributed earnings from non- U.S. operations as of December 31, 2010 because such earnings are intended to be reinvested indefinitely outside of the United States.
|
|||
Note 15. Comprehensive Income (Loss)
Comprehensive income (loss) includes net profit (loss), foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. The components of comprehensive income (loss) are as follows (in thousands):
| Years Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Net profit (loss) |
$ | 74,253 | $ | (31,269 | ) | $ | 79,987 | |||||
|
Foreign currency translation adjustments |
(302 | ) | 168 | (421 | ) | |||||||
|
Change in unrealized gain/(loss) on available-for-sale securities |
(19 | ) | 18 | 33 | ||||||||
|
Comprehensive income (loss) |
$ | 73,932 | $ | (31,083 | ) | $ | 79,599 | |||||
|
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Note 16. Supplemental Cash Flow Information
The supplemental cash flow information consists of the following (in thousands):
| Years Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Taxes paid |
$ | 1,894 | $ | 2,004 | $ | 1,510 | ||||||
|
Interest paid |
$ | 19 | $ | 84 | $ | — | ||||||
|
Non-cash investing and financing activities: |
||||||||||||
|
Fixed assets acquired with accounts payable or accrued liabilities |
$ | 906 | $ | 1,790 | $ | 1,322 | ||||||
|
Stock component of litigation settlement costs |
$ | — | $ | 63,518 | $ | — | ||||||
|
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Note 17. Segments and Geographical Information
Segments
We report segment data based on the management approach which designates the internal reporting that is used by management for making operating decisions and assessing performance as the source of our reportable operating segments. During all periods presented, we operated as a single business segment.
Geographical Information
Net revenues and long-lived assets are presented below by geographic area (in thousands):
| For the Years Ended December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Net revenues: |
||||||||||||
|
North America |
$ | 290,847 | $ | 237,033 | $ | 240,210 | ||||||
|
Europe |
92,032 | 72,245 | 61,652 | |||||||||
|
Other international |
4,247 | 3,055 | 2,114 | |||||||||
|
Total net revenues |
$ | 387,126 | $ | 312,333 | $ | 303,976 | ||||||
| As of December 31, | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
|
Long-lived assets: |
||||||||||||
|
North America |
$ | 85,576 | $ | 91,548 | $ | 99,086 | ||||||
|
Europe |
837 | 1,018 | 960 | |||||||||
|
Other international |
1,919 | 1,375 | 1,388 | |||||||||
|
Total long-lived assets |
$ | 88,332 | $ | 93,941 | $ | 101,434 | ||||||
|
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Note 18. Restructurings
During 2008, we announced restructuring plans in July and October to increase efficiencies across the organization and lower the overall cost structure. In July 2008, we implemented a restructuring plan to reduce its full time headcount by 67 employees including a phased-consolidation of order acquisition operations from our former corporate headquarters in Santa Clara, California to Juarez, Mexico, which was completed by the end of 2008. The October restructuring plan included a total reduction of 111 full time headcount in Santa Clara, California by July 2009 as we moved our customer care, accounts receivable, credit and collections, and customer event registration organizations, in Santa Clara, California to existing facilities in Costa Rica.
In 2008, we incurred approximately $6.2 million in restructuring expenses relating to these actions which included $0.7 million related to the acceleration of stock option vesting and $5.5 million related to severance and termination benefits, of which $3.0 million was paid during the year.
In 2009, we incurred approximately $1.3 million of costs related to severance and termination benefits. There were no costs incurred relating to the restructuring plans during 2010.
Activity and liability balances related to restructuring plans for 2008 through 2009 are as follows (in thousands):
| Severance and Benefits |
||||
|
Balance at January 1, 2008 |
$ | — | ||
|
Restructuring cost |
5,568 | |||
|
Cash payments |
(3,067 | ) | ||
|
Balance at December 31, 2008 |
2,501 | |||
|
Restructuring cost |
1,319 | |||
|
Cash payments |
(3,820 | ) | ||
|
Balance at December 31, 2009 |
— | |||
All liability balances related to the restructuring plans were paid by the end of 2009.
|
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SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
| Balance at Beginning of Period |
Additions (reductions) to Costs and Expenses |
Write offs |
Reclass from Other Accounts |
Balance at End of Period |
||||||||||||||||
| (in thousands) | ||||||||||||||||||||
|
Allowance for doubtful accounts: |
||||||||||||||||||||
|
Year ended December 31, 2008 |
$ | 760 | $ | 71 | $ | (184 | ) | $ | (35 | ) | $ | 612 | ||||||||
|
Year ended December 31, 2009 |
$ | 612 | $ | 708 | $ | (305 | ) | $ | 18 | $ | 1,033 | |||||||||
|
Year ended December 31, 2010 |
$ | 1,033 | $ | 195 | $ | (482 | ) | $ | (11 | ) | $ | 735 | ||||||||
|
Allowance for deferred tax assets: |
||||||||||||||||||||
|
Year ended December 31, 2008 |
$ | 93,157 | $ | (86,957 | ) | $ | — | $ | — | $ | 6,200 | |||||||||
|
Year ended December 31, 2009 |
$ | 6,200 | $ | (18 | ) | $ | — | $ | — | $ | 6,182 | |||||||||
|
Year ended December 31, 2010 |
$ | 6,182 | $ | (103 | ) | $ | — | $ | — | $ | 6,079 | |||||||||
|
Allowance for excess and obsolete inventory and abandoned product: |
||||||||||||||||||||
|
Year ended December 31, 2008 |
$ | 216 | $ | 110 | $ | (188 | ) | $ | — | $ | 138 | |||||||||
|
Year ended December 31, 2009 |
$ | 138 | $ | 73 | $ | (107 | ) | $ | — | $ | 104 | |||||||||
|
Year ended December 31, 2010 |
$ | 104 | $ | 20 | $ | — | $ | — | $ | 124 | ||||||||||
| (b) | The following Exhibits are included in this Annual Report on Form 10-K: |