CARTER LEDYARD & MILBURN LLP
Counselors at Law
2 Wall Street
New York, NY 10005-2072
701 8th Street, N.W., Suite 410
Washington, DC 20005-3893
Steven J. Glusband o (202) 898-1515
Partner o
o Tel (212) 732-3200 570 Lexington Avenue
Direct Dial: 212-238-8605 Fax (212) 732-3232 New York, NY 10022-6856
E-mail: glusband@clm.com (212) 371-2720
January 14, 2010
VIA EDGAR
- ---------
Mr. Larry Spirgel
Assistant Director
Division of Corporation Finance
Securities and Exchange Commission
100 F Street N.E.
Washington D.C. 20549
Re: Gilat Satellite Networks Ltd.
Form 20-F for Fiscal Year Ended December 31, 2008
File No. 0-21218
----------------
Dear Mr. Spirgel:
On behalf of our client, Gilat Satellite Networks Ltd. (the "Company"),
we are submitting this letter in response to the written comments of the Staff
of the Securities and Exchange Commission, in a letter to Mr. Ari Krashin, Chief
Financial Officer of the Company, dated December 8, 2009 (the "Comment Letter"),
with respect to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2008. We have repeated the numbered comments below and have
provided a response to each comment.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES, PAGE 32
---------------------------------------------------
1) Please disclose your basis for recognizing revenues from large-scale
gaming networks which you rolled out in the US as referred to on page 36.
Response
--------
As further detailed below and as will be clarified in future filings,
the Company does not derive revenues directly from the revenues generated by
large-scale gaming networks; rather it derives revenues from the sale of
VSAT-based network equipment or connectivity services to customers who provide
lottery technology services to states and other governmental authorities. The
revenues generated by the Company are not derived from gaming. The lottery
technology companies enter into, large-scale contracts with Gilat or its
competitors that are awarded from time to time in a competitive bidding process.
These large-scale contracts involve the sale of equipment, installation and
provision of services over the life of the contract. Revenues are recognized,
consistent with Gilat's revenue recognition policy, based on the nature of the
transaction (sale or services), as appropriate.
2
The Company reviews each contract and determines whether it meets SAB
104 criteria for recognizing revenues, i.e. whether persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
seller's price to the buyer is fixed or determinable and collectability is
reasonably assured.
2) Impairment of Intangible Assets and Long-lived Assets, page 35
Note 2.a. Concentration of credit risks, Page F-19 Note 11:
Impairment of Long-lived Assets and Other Charges, page F-39
------------------------------------------------------------
Per your disclosure, "if the Company will not meet certain milestones
as determined in the re-negotiated agreements effective on December 26, 2008
with the Colombian government, the Company may be unable to receive this
unrestricted cash." Tell us the following:
o The nature of the milestones and the performance period.
o The estimated costs for "removal of thousands of telephony
sites which were determined to be no longer needed or used
by the rural population in Columbia and the upgrade of
technology, primarily in existing sited entailing capital
expenditure." Refer to SFAS 146.
o The nature of any remaining obligation you are required to
perform past the Compartel contract period. In this regard,
we note your statements with respect to your continuing
obligation to provide non-revenue generating telephony and
internet services for Compartel even if you are not able to
extend related agreements as detailed in the Q3 2009
Earnings Call Transcript at http://seekingalpha.com/173654-
gilat-satellite-networks-ltd-q3-2009-earnings-call-
transcript..
o Why would it be appropriate to recognize revenues on a
straight-line basis when the earnings from the Compartel
project and release of the remaining funds from the trusts
are only realizable upon fulfillment of project milestones
as stipulated in the renegotiated agreement.
Response
--------
o The nature of the milestones and the performance period.
The milestones in the renegotiated agreement were consistent with the
milestones in the original agreements and were divided into two categories:
The first set of milestones is related to presentation of invoices
relating to expenses the Company incurred in establishing the infrastructure for
the networks. The second set of milestones is performance indicators relating to
various measurements on the network (i.e. indications that the sites are active,
measurement of traffic on the network, timeliness of repair of reported
failures, etc.). The performance period under the renegotiated agreements was
for the provision of services through October 15, 2009.
o The estimated costs for "removal of thousands of telephony
sites which were determined to be no longer needed or used
by the rural population in Columbia and the upgrade of
technology, primarily in existing sited entailing capital
expenditure." Refer to SFAS 146.
3
The estimated costs for removal of those telephony sites which were
determined to be no longer needed or used by the rural population in Colombia
was approximately $600,000. As part of the Company's negotiations with the
Colombian government it requested and negotiated the removal of certain sites
which were no longer being used or had very low traffic usage by end-users due
to the increased presence of competing technologies, such as cellular coverage,
or sites in which the maintenance efforts and expenses were high. The Company
estimated that the continued maintenance of these sites would cost more than the
cost of removal. On the other hand, in order to meet the negotiated requirements
and in order to increase the Company's income from the use of other sites, the
Company agreed to invest in the upgrade of certain other sites. The estimated
cost for upgrading the existing sites was approximately $5,800,000, of which
$3,500,000 was incurred and expensed by the Company during 2008. The remaining
amount was incurred and expensed during 2009.
The agreements with the Colombian government and the amendment are for
the provision of telecommunication services over a defined period of time by the
Company through its wholly owned subsidiaries in Colombia. The agreements have
been accounted for by the Company since their initial term in 2002 as revenue
generating agreements under which the company is obliged to provide rural
telecommunication services. Hence, these agreements are regarded as executory
contracts. Accordingly, although the amendments were expected to generate a
loss, the Company as further explained below was precluded from recognizing a
liability and an expense with respect to the expected loss from ongoing
operations that were necessary to provide such services. As such, costs to
upgrade or remove the sites (as well as other costs such as payroll, rent,
overhead, etc) were expensed as incurred. The Company believes that a liability
generally should not be recognized for expected losses on executory contracts
except, when an arrangement is within the scope of authoritative literature that
specifically provides for the accrual of such losses (such as a firm purchase
commitment for goods or inventory subject to Chapter 4 of Accounting Research
Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins (ARB
43), or asset impairments under Statements 142 or 144 etc).
During 2008, the Company determined that it had incurred a loss of $4.1
million related to $ 3.5 million of unavoidable costs of firm purchase orders
for equipment having no recoverable value which the Company had either already
paid for or engaged third parties to purchase and $0.6 million of equipment
purchased during 2008 having no recoverable value.
To specifically address the Staff's comment with respect to FAS 146,
the Company believes that the costs relating to the removal and/or upgrade of
sites do not fall within the guidance of FAS 146 since these costs do not
represent exit costs nor costs to terminate an agreement. On the contrary, these
costs are part of the same executory contract that was renegotiated as of
December 31, 2008 and the underlying obligation of the Company to provide rural
telecommunications service to certain populations in Colombia continues. It
should be noted that the removal of sites and upgrades were only performed
during the course of 2009. As such, the Company believes that even if scoped
into FAS 146 as an exit cost, the costs relating to the removal of such sites
did not meet the threshold for recognition as a liability in 2008, since they
did not represent a present obligation to a third party as it was the Company's
right to remove these sites, for which the government's preapproval was
obtained, although such approval was not contractually required. Therefore, if
the Company had applied the provisions of FAS 146, these costs would have been
recorded at the "cease use" date as defined under FAS 146. Since these sites
continued to be operated in 2009, the cost of removal was recorded in 2009.
Furthermore, the Company does not believe that the costs to upgrade or
maintain the existing sites represent exit costs, nor do they represent a cost
to terminate an agreement within the scope of FAS 146; but rather, that these
costs are within the scope of an executory contract and should be evaluated in
the context of the same executory contracts. As such, since the contracts are
loss generating, the related
4
cost to upgrade or maintain the sites should be expensed as incurred. It should
be further noted that the carrying amount for these sites was reduced to zero as
part the Company's FAS 144 impairment analysis during 2008.
o The nature of any remaining obligation you are required to
perform past the Compartel contract period. In this regard,
we note your statements with respect to your continuing
obligation to provide non-revenue generating telephony and
internet services for Compartel even if you are not able to
extend related agreements as detailed in the Q3 2009
Earnings Call Transcript at http://seekingalpha.com/173654-
gilat-satellite-networks-ltd-q3-2009-earnings-call-
transcript.
The Company is a service provider in Colombia. A significant portion of
the revenues generated in Colombia during 2009 related to the renegotiated
agreements. These agreements stipulated performance and subsidy payments from
the Colombian government through October 15, 2009 and did not provide for
further obligations subsequent to that date. In October 2009 (as reported in the
Company's third quarter earnings release) an extension of these agreements was
signed and accordingly, the Company continued to provide services under these
agreements for an additional three months. At present, the Company is
negotiating a further extension of these agreements through 2010. In addition to
these agreements, the Company had a prior commitment to continue to provide
services through 2010 under an earlier contract with respect to certain other
sites. While those services are not subsidized by the Colombian government, the
Company generates revenues from third parties for the provision of services. For
example, the Company generates revenues from traffic, hubbing services and
interconnection fees. The statement made by our CEO, Mr. Amiram Levinberg,
referred to the expected cessation of revenues from governmental subsidies only
and not to the remainder of the operations.
As indicated above, if the ongoing negotiations are successful, the
Company will continue to receive subsidies from the Colombian government in
connection with the continued provision of services.
o Why would it be appropriate to recognize revenues on a
straight-line basis when the earnings from the Compartel
project and release of the remaining funds from the trusts
are only realizable upon fulfillment of project milestones
as stipulated in the renegotiated agreement.
We respectfully refer the Staff to the response provided by the company
in its November 17, 2005 response letter with respect to comment 1 of the
Staff's comment letter dated August 19, 2005 referring to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2004. In that
response, the Company explained that most of the subsidy was to be released
based upon certain operational milestones such as site surveys, network
planning, design of the network and the installation of sites. The remainder of
the subsidy was to be released from the trust based on performance indicators
during the term that the service is provided. The re-negotiated agreements have
a similar breakdown. As such, subsidy revenues for this project are recognized
over the life of each operational site, based on SAB 104 which gives reference
to Concept Statement 5 paragraph 84(d), that states, "if services are rendered
or rights to use assets extend continuously over time (for example, interest or
rent) ... revenues may be recognized as earned as time passes."
Furthermore, as the re-negotiated terms of the agreement do not provide
for new functionality, rather for the continued provision of network services
being provided over a specified period of time, the Company believes that
recognizing the remaining amounts held in trust on a straight line basis was
appropriate. The Staff is further advised, that the Company believes that
separating the re-negotiated
5
terms into two units of accounts (based on (i) the milestones of presentation of
invoices relating to expenses the Company incurred in establishing the
infrastructure for the networks, and (ii) performance indicators relating to
various measurements on the network), would not be appropriate under the
provisions of EITF 00-21, and would potentially lead to an accelerated
recognition of revenues, while the substance of the agreements provides for the
maintenance of services over a specified period of time.
In addition, we refer the Staff to the Company's disclosure in Note 11
to its financial statements for the year ended December 31, 2008 (page F-39), in
which it discloses the fact that even while adopting the straight-line basis for
recognition of revenues from the subsidy, the Company will not and did not
recognize revenues in an amount that exceeds the accumulated amounts actually
released from the trust. Given the fact that the re-negotiated terms were agreed
at year end and since no amounts were released from the trusts during 2008, no
subsidy revenues were recognized during 2008.
3) Tell us how you evaluated the terms of your renegotiated agreements
and whether continued consolidation of the trusts based on the guidance in FIN
46(R) would be appropriate. In this regard, we note the likelihood that you may
be unable to receive all of the remaining amounts in the Trust. Additionally,
please disclose your consolidation policy as appropriate and provide us your
proposed disclosures.
Response
--------
The renegotiated agreement included commercial changes to the
agreements as further detailed in the response to question 2, however, these
re-negotiated terms made no changes to the terms of the trusts. As such,
management believes that the trusts were still considered VIE under the
provision of FIN46R. Based on a similar analysis as further detailed in the
Company's response letter dated November 17, 2005, and as summarized below, the
Company has concluded that it was appropriate to continue to consolidate the
trusts.
Given the changes to the agreements and the new terms that the Company
was required to meet, the Company analyzed whether it would still be appropriate
to continue consolidation of the trusts. Management assessed at the date of
signing the renegotiated terms that the likelihood that the restricted cash
would not be released due to the Company's failure to meet the new milestones
was remote. This assessment was reaffirmed by the fact that a portion of the
funds were released based on the Company's achieving certain milestones even
prior to the publication of the Company's Annual Report on Form 20-F for the
year ended December 31, 2008. As such, management believes that under the
provisions of FIN46R, it was probable that the Company would be entitled to the
majority, if not all, of the residual returns of the trusts. It was therefore
determined that the Company continued to be the primary beneficiary under the
provisions of FIN46R.
In addition, in the remote event that the Company would fail to meet
the new milestones, it would still have been considered the primary beneficiary
since it was the party that would bear most of the expected losses derived from
the operations of the trusts, as it would not receive a guaranteed return on its
investment.
As an aside, it should be noted that during 2009, all the restricted
cash in the trusts was released to the Company as was foreseen by management.
Below is the Company's proposed disclosure with respect to this matter for its
forthcoming Annual Report on Form 20-F for the year ended December 31, 2009. At
the time of filing of the 2009 20-F the proposed disclosure will reflect
references to the FASB's new Accounting Standards Codification.
6
Disclosure of Consolidation Policy:
Principles of consolidation:
----------------------------
The consolidated financial statements include the accounts of the
Company and its subsidiaries, in which the Company has a controlling voting
interest or entities consolidated under the provisions of Financial Accounting
Standards Board ("FASB") Interpretation No. 46(R), "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51" ("FIN 46"). Inter-company
balances and transactions have been eliminated upon consolidation.
The Company applies the provisions of FIN 46 which provides a framework
for identifying variable interest entities ("VIE") and determining when a
company should include the assets, liabilities, noncontrolling interests and
results of activities of a VIE in its consolidated financial statements.
In general, a VIE is a corporation, partnership, limited-liability
corporation, trust, or any other legal structure used to conduct activities or
hold assets that either: (i) has an insufficient amount of equity to carry out
its principal activities without additional subordinated financial support; (ii)
has a group of equity owners that is unable to make significant decisions about
its activities; (iii) has a group of equity owners that does not have the
obligation to absorb losses or the right to receive returns generated by its
operations; or (iv) the voting rights of some investors are not proportional to
their obligations to absorb the expected losses of the entity, their rights to
receive the expected residual returns of the entity, or both and substantially
all of the entity's activities (for example, providing financing or buying
assets) either involve or are conducted on behalf of an investor that has
disproportionately few voting rights.
FIN 46 requires a VIE to be consolidated by the party with an
ownership, contractual or other financial interest in the VIE (a variable
interest holder) that will absorb a majority of the risk of loss from the VIE's
activities, is entitled to receive a majority of the VIE's residual returns (if
no other variable interests absorb a majority of the VIE's losses), or both.
A variable interest holder that consolidates the VIE is called the
primary beneficiary. Upon consolidation, the primary beneficiary generally must
initially record all of the VIE's assets, liabilities and noncontrolling
interests at fair value and subsequently account for the VIE as if it were
consolidated based on a majority voting interest. FIN 46 also requires
disclosures about VIEs in which the variable interest holder is not required to
consolidate but in which it has a significant variable interest.
Liquidity and Capital Resources, pages 42-43
--------------------------------------------
4. In future filings, please provide an enhanced analysis and
explanation of the sources and uses of cash and related material underlying
transactions, rather than a recitation of the items in the statements of cash
flows. Additionally, please disclose how you will be financially impacted by the
expiration of the Compartel projects. Please provide us your proposed disclosure
for the latter issue.
Response
--------
With respect to cash flow analysis and providing an enhanced analysis
and explanation of the sources and uses of cash and related material underlying
transactions the Company has noted the Staff's comments and will enhance the
disclosure in future filings.
With respect to how the Company will be financially impacted after the
expiration of the Compartel projects, the Company believes that providing such
information is not possible at present as it
7
is speculative and cannot be reasonably estimated at this point in time. As
mentioned above, the Company has operations in Colombia which generate revenues
other than the subsidy revenues. Based on the outcome of the current
negotiations regarding the potential extension of the agreement with the
Colombian government, the Company will evaluate and determine its ongoing
business in Colombia.
Depending on whether the government extends the current agreements and under
what subsidy terms, the Company will determine if and for how long to continue
the operations, whether to downsize the operations in order to reduce expenses,
or whether to participate in new bids in Colombia in order to expand the
business. Alternatively, the Company could choose to sell its Colombian
operations. These alternatives have not yet been analyzed nor decided upon. As
such, the Company is currently unable to determine what will be the financial
impact after the expiration of the Compartel projects.
NOTE 2(J). LONG-TERM TRADE RECEIVABLES, PAGE F-15
--------------------------------------------------
NOTE 12: (B) LONG-TERM TRADE RECEIVABLES IN RESPECT OF CAPITAL LEASES
---------------------------------------------------------------------
AND OTHER RECEIVABLES, PAGE F-46
- --------------------------------
5. Tell us more in detail and disclose the nature of receivables (*)
that are scheduled to be received by 2010 and how you evaluated their
collectability. Tell us your basis for recognizing the related revenues.
Response
--------
The total amount presented as long term trade receivables of $4,540,000
is derived from a contract to sell equipment and provide services to a certain
governmental entity.. The revenues from this contract were recognized in
accordance with the Company's revenue recognition policy and were recorded net
of imputed interest. The collection of the receivable is based on predetermined
payment terms, and is being collected over the years. Some of the outstanding
receivable amount was presented under the caption "short term receivables" and
some was presented as "long term receivables," as appropriate at each year end.
The remainder of the receivable is expected to be received during 2010. Since
the Company has a good collection experience related to this particular customer
and for other long term receivables in general, and based on analysis of its
collectability, such as the customer's financial position, the customer's
geographic location, the nature of guarantees provided by the customer etc. made
at the outset of the agreement, the Company assessed the collectability of these
receivables as reasonably assured. By applying the provisions of APB 21,
long-term payment agreements are initially recognized at estimated present
values determined based on the rates of interest applicable to such customer at
the time of the transaction and reported at the net amounts in the consolidated
financial statements. Imputed interest is recognized, using the effective
interest method, as a component of financial income (expenses) in the statements
of operations. As of December 2009, most of the long term debt outstanding in
2008 was collected by the Company.
Very truly yours,
/s/Steven J. Glusband
Steven J. Glusband
SJG:gb