UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended March 31, 2013
OR
For the Transition Period from to
Commission File Number 0-24612
ADTRAN, INC.
(Exact name of Registrant as specified in its charter)
(State of
Incorporation)
(I.R.S. Employer
Identification No.)
901 Explorer Boulevard, Huntsville, Alabama 35806-2807
(Address of principal executive offices, including zip code)
(256) 963-8000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (232.405 of this chapter) during the preceding 12 months (or for shorter period that the Registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date:
Class
Outstanding at April 25, 2013
Quarterly Report on Form 10-Q
For the Three Months Ended March 31, 2013
Table of Contents
Item
Number
Financial Statements:
Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012 – (Unaudited)
Consolidated Statements of Income for the three months ended March 31, 2013 and 2012 – (Unaudited)
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and 2012 – (Unaudited)
Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012 – (Unaudited)
Notes to Consolidated Financial Statements – (Unaudited)
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Controls and Procedures
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Exhibits
FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of ADTRAN. ADTRAN and its representatives may from time to time make written or oral forward-looking statements, including statements contained in this report, our other filings with the Securities and Exchange Commission (SEC) and other communications with our stockholders. Generally, the words, “believe,” “expect,” “intend,” “estimate,” “anticipate,” “will,” “may,” “could” and similar expressions identify forward-looking statements. We caution you that any forward-looking statements made by us or on our behalf are subject to uncertainties and other factors that could cause such statements to be wrong. A list of factors that could materially affect our business, financial condition or operating results is included under “Factors that Could Affect Our Future Results” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report. They have also been discussed in Item 1A of Part I in our most recent Annual Report on Form 10-K for the year ended December 31, 2012 filed on February 28, 2013 with the SEC. Though we have attempted to list comprehensively these important factors, we caution investors that other factors may prove to be important in the future in affecting our operating results. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or a combination of factors may have on our business.
You are further cautioned not to place undue reliance on these forward-looking statements because they speak only of our views as of the date that the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share amounts)
ASSETS
Current Assets
Cash and cash equivalents
Short-term investments
Accounts receivable, less allowance for doubtful accounts of $21 and $6 at March 31, 2013 and December 31, 2012, respectively
Other receivables
Inventory
Prepaid expenses
Deferred tax assets, net
Total Current Assets
Property, plant and equipment, net
Goodwill
Other assets
Long-term investments
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts payable
Unearned revenue
Accrued expenses
Accrued wages and benefits
Income tax payable, net
Total Current Liabilities
Non-current unearned revenue
Other non-current liabilities
Bonds payable
Total Liabilities
Commitments and contingencies (see Note 15)
Stockholders’ Equity
Common stock, par value $0.01 per share; 200,000 shares authorized; 79,652 shares issued and 61,322 shares outstanding at March 31, 2013 and 79,652 shares issued and 62,310 shares outstanding at December 31, 2012
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Less treasury stock at cost: 18,330 and 17,342 shares at March 31, 2013 and December 31, 2012, respectively
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
See notes to consolidated financial statements
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CONSOLIDATED STATEMENTS OF INCOME
Sales
Cost of sales
Gross Profit
Selling, general and administrative expenses
Research and development expenses
Operating Income
Interest and dividend income
Interest expense
Net realized investment gain
Other income (expense), net
Income before provision for income taxes
Provision for income taxes
Net Income
Weighted average shares outstanding – basic
Weighted average shares outstanding – diluted
Earnings per common share – basic
Earnings per common share – diluted
Dividend per share
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other Comprehensive Income (Loss), net of tax:
Unrealized gains (losses) on available-for-sale securities
Foreign currency translation
Other Comprehensive Income (Loss), net of tax
Comprehensive Income, net of tax
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Amortization of net premium on available-for-sale investments
Net realized gain on long-term investments
Net (gain) loss on disposal of property, plant and equipment
Stock-based compensation expense
Deferred income taxes
Tax benefit from stock option exercises
Excess tax benefits from stock-based compensation arrangements
Changes in operating assets and liabilities:
Accounts receivable, net
Prepaid expenses and other assets
Accrued expenses and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of property, plant and equipment
Proceeds from disposals of property, plant and equipment
Proceeds from sales and maturities of available-for-sale investments
Purchases of available-for-sale investments
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from stock option exercises
Purchases of treasury stock
Dividend payments
Net cash used in financing activities
Net decrease in cash and cash equivalents
Effect of exchange rate changes
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements of ADTRAN®, Inc. and its subsidiaries (ADTRAN) have been prepared pursuant to the rules and regulations for reporting on Quarterly Reports on Form 10-Q. Accordingly, certain information and notes required by generally accepted accounting principles for complete financial statements are not included herein. The December 31, 2012 Consolidated Balance Sheet is derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.
In the opinion of management, all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. The results of operations for an interim period are not necessarily indicative of the results for the full year. The interim statements should be read in conjunction with the financial statements and notes thereto included in ADTRAN’s Annual Report on Form 10-K for the year ended December 31, 2012, filed on February 28, 2013 with the SEC.
Changes in Classifications
Certain changes in classifications have been made to the prior period balances in other comprehensive income to conform to the current period’s presentation as a result of our adoption of Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Comprehensive Income.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expense during the reporting period. Our more significant estimates include the allowance for doubtful accounts, obsolete and excess inventory reserves, warranty reserves, customer rebates, allowance for sales returns, determination of the deferred revenue components of multiple element sales agreements, estimated costs to complete obligations associated with deferred revenues, estimated income tax contingencies, the fair value of stock-based compensation, impairment of goodwill, value and estimated lives of intangible assets, estimated working capital adjustments under negotiation related to the Nokia Siemens Networks Broadband Access business acquisition, and the evaluation of other-than-temporary declines in the value of investments. Actual amounts could differ significantly from these estimates.
Recent Accounting Pronouncements
During the three months ended March 31, 2013, we adopted the following accounting standard, which had no material effect on our consolidated results of operations or financial condition:
In February 2013, the FASB issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02). ASU 2013-02 requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component either on the face of the financial statements or in the footnotes. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in the financial statements. This update is effective prospectively for reporting periods beginning after December 15, 2012. We adopted this amendment during the first quarter of 2013, and we have provided the disclosures required for the period ended March 31, 2013 in Note 10 of Notes to Consolidated Financial Statements.
2. BUSINESS COMBINATIONS
On May 4, 2012, we acquired the Nokia Siemens Networks Broadband Access business (NSN BBA business). This acquisition provides us with an established customer base in key markets and complementary, market-focused products and was accounted for as a business combination. We have included the financial results of the NSN BBA business in our consolidated financial statements since the date of acquisition. These revenues are included in the Carrier Networks division in the Broadband Access subcategory.
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We received a cash payment of $7.5 million from NSN and recorded a bargain purchase gain of $1.8 million, net of income taxes, in the second quarter of 2012, subject to customary working capital adjustments between the parties as defined in the purchase agreement. As of March 31, 2013, the parties were in the process of resolving the working capital adjustments. We adjusted the purchase price allocation during the fourth quarter of 2012 to record additional estimated liabilities and an estimated receivable from NSN related to working capital adjustments under negotiation. The bargain purchase gain of $1.8 million represents the excess of the consideration exchanged over the fair value of the assets acquired and liabilities assumed. We have assessed the recognition and measurements of the assets acquired and liabilities assumed based on historical and pro forma data for future periods and have concluded that our valuation procedures and resulting measures were appropriate.
The preliminary allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date is as follows:
Property, plant and equipment
Deferred tax liability
Net liabilities assumed
Customer relationships
Developed technology
Other
Gain on bargain purchase of a business, net of tax
Net consideration received by buyer
The fair value of the customer relationships acquired was calculated using a discounted cash flow method (excess earnings) and is being amortized using a declining balance method derived from projected customer revenue over an average estimated useful life of 13 years. The fair value of the developed technology acquired was calculated using a discounted cash flow method (relief from royalty) and is being amortized using the straight-line method over an estimated useful life of five years.
The following supplemental pro forma information presents the financial results of the acquired NSN BBA business for the three months ended March 31, 2012. These results are not included in our consolidated financial statements.
This supplemental pro forma information does not purport to be indicative of what would have occurred had the acquisition of the NSN BBA business been completed on January 1, 2012, nor are they indicative of any future results.
Pro forma revenue
Pro forma pre-tax loss
Weighted average exchange rate during the period (EURO/USD)
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For the three months ended March 31, 2013, we incurred acquisition and integration related expenses and amortization of acquired intangibles of $0.9 million related to this acquisition.
3. INCOME TAXES
Our effective tax rate decreased from 35.4% in the three months ended March 31, 2012 to 18.9% in the three months ended March 31, 2013. The tax provision rate in the three months ended March 31, 2013 included a benefit for the research tax credit, which was extended for 2012 and 2013 by legislation passed in January 2013. The inclusion of an annual benefit for 2012 and a quarterly benefit for 2013 during the three months ended March 31, 2013 resulted in a 24.5 percentage point decrease in our effective tax rate. This decrease was partially offset by a valuation allowance related to a foreign subsidiary, which resulted in a 6.2 percentage point increase in our effective tax rate, and other miscellaneous items that increased our tax rate 1.8 percentage points for the three months ended March 31, 2013.
4. PENSION BENEFIT PLAN
As a result of our acquisition of the NSN BBA business, we assumed a defined benefit obligation of $17.0 million as of May 4, 2012. We established a Contribution Trust Arrangement (CTA) to hold the pension assets, and NSN has transferred assets to us equal to the defined benefit obligation.
The following table summarizes the components of net periodic pension cost for the three months ended March 31, 2013:
Service cost
Interest cost
Expected return on plan assets
Net periodic pension cost
5. STOCK-BASED COMPENSATION
The following table summarizes the stock-based compensation expense related to stock options, restricted stock units (RSUs) and restricted stock for the three months ended March 31, 2013 and 2012, which was recognized as follows:
Stock-based compensation expense included in cost of sales
Selling, general and administrative expense
Research and development expense
Stock-based compensation expense included in operating expenses
Total stock-based compensation expense
Tax benefit for expense associated with non-qualified options
Total stock-based compensation expense, net of tax
The fair value of our stock options was estimated using the Black-Scholes model. The determination of the fair value of stock options on the date of grant using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables that may have a significant impact on the fair value estimate.
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There were no options granted during the three months ended March 31, 2013 or 2012.
The fair value of our RSUs is calculated using a Monte Carlo Simulation valuation method. There were no RSU grants during the three months ended March 31, 2013 or 2012.
The fair value of restricted stock is equal to the closing price of our stock on the date of grant. There were no restricted stock grants during the three months ended March 31, 2013 or 2012.
Stock-based compensation expense recognized in our Consolidated Statements of Income for the three months ended March 31, 2013 and 2012 is based on options, RSUs and restricted stock ultimately expected to vest, and has been reduced for estimated forfeitures. Estimated forfeitures for stock options were based upon historical experience and approximate 1.6% annually. We estimated a 0% forfeiture rate for our RSUs and restricted stock due to the limited number of recipients and historical experience for these awards.
As of March 31, 2013, total compensation expense related to non-vested stock options, RSUs and restricted stock not yet recognized was approximately $16.9 million, which is expected to be recognized over an average remaining recognition period of 2.4 years.
The following table is a summary of our stock options outstanding as of December 31, 2012 and March 31, 2013 and the changes that occurred during the three months ended March 31, 2013:
Options outstanding, December 31, 2012
Options granted
Options cancelled/forfeited
Options exercised
Options outstanding, March 31, 2013
Options exercisable, March 31, 2013
The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between ADTRAN’s closing stock price on the last trading day of the quarter 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 March 31, 2013. The aggregate intrinsic value will change based on the fair market value of ADTRAN’s stock.
The total pre-tax intrinsic value of options exercised during the three month period ended March 31, 2013 was $21 thousand.
The following table is a summary of our RSUs and restricted stock outstanding as of December 31, 2012 and March 31, 2013 and the changes that occurred during the three months ended March 31, 2013:
Unvested RSUs and restricted stock outstanding, December 31, 2012
RSUs and restricted stock granted
RSUs and restricted stock vested
RSUs and restricted stock cancelled/forfeited
Unvested RSUs and restricted stock, March 31, 2013
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6. INVESTMENTS
At March 31, 2013, we held the following securities and investments, recorded at either fair value or cost.
Deferred compensation plan assets
Corporate bonds
Municipal fixed-rate bonds
Municipal variable rate demand notes
Marketable equity securities
Available-for-sale securities held at fair value
Restricted investment held at cost
Other investments held at cost
Total carrying value of available-for-sale investments
At December 31, 2012, we held the following securities and investments, recorded at either fair value or cost.
Fixed income bond fund
As of March 31, 2013, our corporate bonds and municipal fixed-rate bonds had the following contractual maturities:
Less than one year
One to two years
Two to three years
Three to five years
Total
Our investment policy provides limitations for issuer concentration, which limits, at the time of purchase, the concentration in any one issuer to 5% of the market value of our total investment portfolio.
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At March 31, 2013, we held a $48.3 million restricted certificate of deposit, which is carried at cost. This investment serves as a collateral deposit against the principal amount outstanding under loans made to ADTRAN pursuant to an Alabama State Industrial Development Authority revenue bond (the Bond). At March 31, 2013, the estimated fair value of the Bond was approximately $47.9 million, based on a debt security with a comparable interest rate and maturity and a Standard and Poor’s credit rating of A-. For more information on the Bond, see “Debt” under “Liquidity and Capital Resources” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report.
We review our investment portfolio for potential “other-than-temporary” declines in value on an individual investment basis. We assess, on a quarterly basis, significant declines in value which may be considered other-than-temporary and, if necessary, recognize and record the appropriate charge to write-down the carrying value of such investments. In making this assessment, we take into consideration qualitative and quantitative information, including but not limited to the following: the magnitude and duration of historical declines in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a fair value that has declined from its original or adjusted cost basis by 25% or more for six or more consecutive months. We then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. As a result of our review, we recorded an other-than-temporary impairment charge of $4 thousand during the three months ended March 31, 2013 related to one marketable equity security. For the three months ended March 31, 2012, we recorded an other-than-temporary impairment charge of $33 thousand related to seven marketable equity securities.
Realized gains and losses on sales of securities are computed under the specific identification method. The following table presents gross realized gains and losses related to our investments.
Gross realized gains
Gross realized losses
As of March 31, 2013 and 2012, gross unrealized losses related to individual securities that had been in a continuous loss position for 12 months or longer were not significant.
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We have categorized our cash equivalents held in money market funds and our investments held at fair value into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique for the cash equivalents and investments as follows: Level 1 – Values based on unadjusted quoted prices for identical assets or liabilities in an active market; Level 2 – Values based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly; Level 3 – Values based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs include information supplied by investees.
Cash equivalents
Money market funds
Available-for-sale securities
Available-for-sale debt securities
Available-for-sale marketable equity securities
Equity securities – technology industry
Equity securities – other
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The fair value of our Level 2 securities is calculated using a weighted average market price for each security. Market prices are obtained from a variety of industry standard data providers, security master files from large financial institutions, and other third-party sources. These multiple market prices are used as inputs into a distribution-curve-based algorithm to determine the daily market value of each security.
Our municipal variable rate demand notes have a structure that implies a standard expected market price. The frequent interest rate resets make it reasonable to expect the price to stay at par. These securities are priced at the expected market price.
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We have certain international customers who are billed in their local currency. Changes in the monetary exchange rates may adversely affect our results of operations and financial condition. When appropriate, we enter into various derivative transactions to enhance our ability to manage the volatility relating to these typical business exposures. We do not hold or issue derivative instruments for trading or other speculative purposes. Our derivative instruments are recorded in the Consolidated Balance Sheets at their fair values. Our derivative instruments are not designated as hedges, and accordingly, all changes in the fair value of the instruments are recognized as other income (expense) in the Consolidated Statements of Income. The maximum time frame for our derivatives is currently less than twelve months. Our derivative instruments are not subject to master netting arrangements and are not offset in the Consolidated Balance Sheets.
As of March 31, 2013, we had forward contracts and swaps outstanding with notional amounts totaling €4.9 million ($6.3 million) and €1.8 million ($2.4 million), respectively, which mature through 2013.
The fair values of our derivative instruments recorded in the Consolidated Balance Sheet as of March 31, 2013 were as follows:
Derivatives Not Designated as Hedging Instruments:
Foreign exchange contracts – asset derivatives
Foreign exchange contracts – liability derivatives
The change in the fair values of our derivative instruments recorded in the Consolidated Statements of Income during the three months ended March 31, 2013 were as follows:
Foreign exchange contracts
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8. INVENTORY
At March 31, 2013 and December 31, 2012, inventory consisted of the following:
Raw materials
Work in process
Finished goods
We establish reserves for estimated excess, obsolete, or unmarketable inventory equal to the difference between the cost of the inventory and the estimated fair value of the inventory based upon assumptions about future demand and market conditions. At March 31, 2013 and December 31, 2012, raw materials reserves totaled $14.1 million and $9.9 million, respectively, and finished goods inventory reserves totaled $2.5 million and $2.1 million, respectively.
9. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying value of goodwill, all of which is included in our Enterprise Networks division, for the three months ended March 31, 2013 are as follows:
Balance, December 31, 2012
Acquisitions
Impairment losses
Balance, March 31, 2013
Balance as of March 31, 2013
Accumulated impairment losses
Total goodwill
We evaluate the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. When evaluating whether goodwill is impaired, we first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. If we determine that the two-step quantitative test is necessary, then we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, then the amount of the impairment loss is measured. There were no impairment losses recorded during the three months ended March 31, 2013 or 2012.
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Intangible assets are included in other assets in the accompanying Consolidated Balance Sheets and include intangibles acquired in conjunction with our acquisition of Objectworld Communications Corporation on September 15, 2009, Bluesocket, Inc. on August 4, 2011, and the NSN BBA business on May 4, 2012.
The following table presents our intangible assets as of March 31, 2013 and December 31, 2012:
Intellectual property
Trade names
Amortization expense, all of which relates to business acquisitions, was $0.6 million and $0.3 million for the three months ended March 31, 2013 and 2012, respectively.
As of March 31, 2013, the estimated future amortization expense of our intangible assets is as follows:
Remainder of 2013
2014
2015
2016
2017
Thereafter
10. STOCKHOLDERS’ EQUITY
A summary of the changes in stockholders’ equity for the three months ended March 31, 2013 is as follows:
Dividends accrued for unvested restricted stock units
Unrealized gains and losses on available-for-sale securities (net of tax)
Foreign currency translation adjustment
Purchase of treasury stock
Stock Repurchase Program
Since 1997, our Board of Directors has approved multiple share repurchase programs that have authorized open market repurchase transactions of up to 35 million shares of our common stock. During the three months ended March 31, 2013, we repurchased 1.0 million shares of our common stock at an average price of $22.46 per share. We currently have the authority to purchase an additional 3.1 million shares of our common stock under the current plan approved by the Board of Directors.
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Stock Option Exercises
We issued four thousand shares of treasury stock during the three months ended March 31, 2013 to accommodate employee stock option exercises. The stock options had exercise prices of $15.29. We received proceeds totaling $55 thousand from the exercise of these stock options during the three months ended March 31, 2013.
Dividend Payments
During the three months ended March 31, 2013, we paid cash dividends as follows (in thousands except per share amount):
Record Date
February 7, 2013
Other Comprehensive Income
Other comprehensive income consists of unrealized gains (losses) on available-for-sale securities, reclassification adjustments for amounts included in net income related to impairments of available-for-sale securities and realized gains (losses) on available-for-sale securities, defined benefit plan adjustments and foreign currency translation adjustments.
The following tables present the details of reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2013 and 2012:
Details about Accumulated Other
Comprehensive Income Components
Unrealized gains (losses) on available-for-sale securities:
Realized gain on sales of securities
Impairment expense
Total reclassifications for the period, before tax
Tax (expense) benefit
Total reclassifications for the period, net of tax
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The following tables present changes in accumulated other comprehensive income, net of tax, by component for the three months ended March 31, 2013 and 2012:
Beginning balance
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income
Net current period other comprehensive income (loss)
Ending balance
The following table presents the tax effects related to the change in each component of other comprehensive income for the three months ended March 31, 2013 and 2012:
Reclassification adjustment for amounts included in net income
Total Other Comprehensive Income (Loss)
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11. EARNINGS PER SHARE
A summary of the calculation of basic and diluted earnings per share for the three months ended March 31, 2013 and 2012 is as follows:
Numerator
Denominator
Weighted average number of shares – basic
Effect of dilutive securities
Stock options
Restricted stock and restricted stock units
Weighted average number of shares – diluted
Net income per share – basic
Net income per share – diluted
Anti-dilutive options to purchase common stock outstanding were excluded from the above calculations. Anti-dilutive options totaled 5.4 million and 1.9 million for the three months ended March 31, 2013 and 2012, respectively.
12. SEGMENT INFORMATION
We operate in two reportable segments: (1) the Carrier Networks Division and (2) the Enterprise Networks Division. We evaluate the performance of our segments based on gross profit; therefore, selling, general and administrative expense, research and development expenses, interest income and dividend income, interest expense, net realized investment gain/loss, other income/expense and provision for taxes are reported on an entity-wide basis only. There are no inter-segment revenues.
The following table presents information about the reported sales and gross profit of our reportable segments for the three months ended March 31, 2013 and 2012. Asset information by reportable segment is not reported, since we do not produce such information internally.
Carrier Networks
Enterprise Networks
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Sales by Product
Our three major product categories are Carrier Systems, Business Networking and Loop Access.
Carrier Systems products are used by communications service providers to provide data, voice and video services to consumers and enterprises. This category includes the following product areas and related services:
Broadband Access
Total Access®5000 Multi-Service Access and Aggregation Platform (MSAP)
hiX family of MSAPs
Total Access 1100/1200 Series of Fiber to the Node (FTTN) products
Ultra Broadband Ethernet (UBE)
Digital Subscriber Line Access Multiplexer (DSLAM) products
Optical
Optical Networking Edge (ONE)
NetVanta 8000 Series
OPTI and TA 3000 optical products
Small Form-Factor Pluggable (SFP) products
TDM systems
Network Management Solutions
Business Networking products provide access to telecommunication services and facilitate the delivery of cloud connectivity, enterprise communications and virtual mobility to the small and mid-sized enterprise (SME) market. This category includes the following product areas and related services:
Internetworking products
Total Access IP Business Gateways
Optical Network Terminals (ONTs)
Bluesocket®virtual Wireless LAN (WLAN)
NetVanta®
Multiservice Routers
Managed Ethernet Switches
IP Business Gateways
Unified Communications (UC) solutions
Carrier Ethernet Network Terminating Equipment (NTE)
Integrated Access Devices (IADs)
Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications networks. The Loop Access category includes the following product areas:
High bit-rate Digital Subscriber Line (HDSL) products
Digital Data Service (DDS)
Integrated Services Digital Network (ISDN) products
T1/E1/T3 Channel Service Units/Data Service Units (CSUs/DSUs)
TRACER fixed-wireless products
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The table below presents sales information by product category for the three months ended March 31, 2013 and 2012:
Carrier Systems
Business Networking
Loop Access
In addition, we identify subcategories of product revenues, which we divide into our core products and legacy products. Our core products consist of Broadband Access and Optical products (included in Carrier Systems) and Internetworking products (included in Business Networking). Our legacy products include HDSL products (included in Loop Access) and other products not included in the aforementioned core products.
The table below presents subcategory revenues for the three month ended March 31, 2013 and 2012:
Core Products
Broadband Access (included in Carrier Systems)
Optical (included in Carrier Systems)
Internetworking (NetVanta & Multi-service Access Gateways) (included in Business Networking)
Subtotal
Legacy Products
HDSL (does not include T1) (included in Loop Access)
Other products (excluding HDSL)
The following table presents sales information by geographic area for the three months ended March 31, 2013 and 2012. International sales correlate to shipments with a non-U.S. destination.
United States
International
13. LIABILITY FOR WARRANTY RETURNS
Our products generally include warranties of 90 days to ten years for product defects. We accrue for warranty returns at the time revenue is recognized based on our estimate of the cost to repair or replace the defective products. We engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers. Our products continue to become more complex in both size and functionality as many of our product offerings migrate from line card applications to systems products. The increasing complexity of our products will cause warranty incidences, when they arise, to be more costly. Our estimates regarding future warranty obligations may change due to product failure rates, material usage, and other rework costs incurred in correcting a product failure. In addition, from time to time, specific warranty accruals may be recorded if unforeseen problems arise. Should our actual experience relative to these factors be worse than our estimates, we will be required to record additional warranty expense. Alternatively, if we provide for more reserves than we require, we will reverse a portion of such provisions in future periods. The liability for warranty obligations totaled $8.8 million at March 31, 2013 and $9.7 million at December 31, 2012. These liabilities are included in accrued expenses in the accompanying Consolidated Balance Sheets.
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A summary of warranty expense and write-off activity for the three months ended March 31, 2013 and 2012 is as follows:
Balance at beginning of period
Plus: Amounts charged to cost and expenses
Less: Deductions
Balance at end of period
14. RELATED PARTY TRANSACTIONS
We employ the law firm of our director emeritus for legal services. All bills for services rendered by this firm are reviewed and approved by our Chief Financial Officer. We believe that the fees for such services are comparable to those charged by other firms for services rendered to us. For the three month periods ended March 31, 2013 and 2012, we incurred fees of $10 thousand per month for these legal services.
15. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, we may be subject to various legal proceedings and claims, including employment disputes, patent claims, disputes over contract agreements and other commercial disputes. In some cases, claimants seek damages or other relief, such as royalty payments related to patents, which, if granted, could require significant expenditures. Although the outcome of any claim or litigation can never be certain, it is our opinion that the outcome of all contingencies of which we are currently aware will not materially affect our business, operations, financial condition or cash flows.
We have committed to invest up to an aggregate of $7.9 million in two private equity funds, and we have contributed $8.4 million as of March 31, 2013, of which $7.7 million has been applied to these commitments.
16. SUBSEQUENT EVENTS
On April 9, 2013, we announced that our Board of Directors declared a quarterly cash dividend of $0.09 per common share to be paid to stockholders of record at the close of business on April 25, 2013. The payment date will be May 9, 2013. The quarterly dividend payment will be approximately $5.3 million. In July 2003, our Board of Directors elected to begin declaring quarterly dividends on our common stock considering the tax treatment of dividends and adequate levels of Company liquidity.
During the second quarter of 2013 and as of May 8, 2013, we repurchased 2.7 million shares of our common stock through open market purchases at an average cost of $21.03 per share. We currently have the authority to purchase an additional 0.3 million shares of our common stock under the current plan approved by the Board of Directors.
On May 1, 2013, we announced that our Board of Directors authorized the repurchase of an additional 5.0 million shares of our common stock to commence upon completion of the repurchase plan announced on October 11, 2011. This new authorization will be implemented through open market or private purchases from time to time as conditions warrant.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this document.
OVERVIEW
ADTRAN, Inc. designs, manufactures and markets solutions and provides services and support for communications networks. Our solutions are widely deployed by providers of communications services (serviced by our Carrier Networks Division), and small, mid-sized and distributed enterprises (serviced by our Enterprise Networks Division), and enable voice, data, video and Internet communications across a variety of network infrastructures. Many of these solutions are currently in use by every major United States service provider, many global service providers, as well as many public, private and governmental organizations worldwide.
Our success depends upon our ability to increase unit volume and market share through the introduction of new products and succeeding generations of products having lower selling prices and increased functionality as compared to both the prior generation of a product and to the products of competitors. An important part of our strategy is to reduce the cost of each succeeding product generation and then lower the product’s selling price based on the cost savings achieved in order to gain market share and/or improve gross margins. As a part of this strategy, we seek in most instances to be a high-quality, low-cost provider of products in our markets. Our success to date is attributable in large measure to our ability to design our products initially with a view to their subsequent redesign, allowing both increased functionality and reduced manufacturing costs in each succeeding product generation. This strategy enables us to sell succeeding generations of products to existing customers, while increasing our market share by selling these enhanced products to new customers.
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In addition, we identify subcategories of product revenues, which we divide into our core products and legacy products. Our core products consist of Broadband Access and Optical products (included in Carrier Systems) and Internetworking products (included in Business Networking). Our legacy products include HDSL products (included in Loop Access) and other products not included in the aforementioned core products. Many of our customers are migrating their networks to deliver higher bandwidth services by utilizing newer technologies. We believe that products and services offered in our core product areas position us well for this migration. Despite occasional increases, we anticipate that revenues of many of our legacy products, including HDSL, will decline over time; however, revenues from these products may continue for years because of the time required for our customers to transition to newer technologies.
See Note 12 of Notes to Consolidated Financial Statements in this report for further information regarding these product categories.
Sales were $143.0 million for the three months ended March 31, 2013 compared to $134.7 million for the three months ended March 31, 2012. Product revenues for our three core areas, Broadband Access, Optical and Internetworking, were $118.0 million for the three months ended March 31, 2013 compared to $104.7 million for the three months ended March 31, 2012. Our gross margin decreased to 48.7% for the three months ended March 31, 2013 from 55.0% for the three months ended March 31, 2012. Our operating income margin decreased to 4.6% for the three months ended March 31, 2013 from 12.0% for the three months ended March 31, 2012. Net income was $7.9 million for the three months ended March 31, 2013 compared to $13.0 million for the three months ended March 31, 2012. Our effective tax rate decreased to 18.9% for the three months ended March 31, 2013 from 35.4% for the three months ended March 31, 2012. Earnings per share, assuming dilution, were $0.13 for the three months ended March 31, 2013 compared to $0.20 for the three months ended March 31, 2012.
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Our operating results have fluctuated on a quarterly basis in the past, and may vary significantly in future periods due to a number of factors, including customer order activity and backlog. Backlog levels vary because of seasonal trends, the timing of customer projects and other factors that affect customer order lead times. Many of our customers require prompt delivery of products. This requires us to maintain sufficient inventory levels to satisfy anticipated customer demand. If near-term demand for our products declines, or if potential sales in any quarter do not occur as anticipated, our financial results could be adversely affected. Operating expenses are relatively fixed in the short term; therefore, a shortfall in quarterly revenues could significantly impact our financial results in a given quarter.
Our operating results may also fluctuate as a result of a number of other factors, including a decline in general economic and market conditions, increased competition, customer order patterns, changes in product and services mix, timing differences between price decreases and product cost reductions, product warranty returns, expediting costs and announcements of new products by us or our competitors. Additionally, maintaining sufficient inventory levels to assure prompt delivery of our products increases the amount of inventory that may become obsolete and increases the risk that the obsolescence of this inventory may have an adverse effect on our business and operating results. Also, not maintaining sufficient inventory levels to assure prompt delivery of our products may cause us to incur expediting costs to meet customer delivery requirements, which may negatively impact our operating results in a given quarter.
Accordingly, our historical financial performance is not necessarily a meaningful indicator of future results, and, in general, management expects that our financial results may vary from period to period. A list of factors that could materially affect our business, financial condition or operating results is included under “Factors That Could Affect Our Future Results” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report. These factors have also been discussed in more detail in Item 1A of Part I in our most recent Annual Report on Form 10-K for the year ended December 31, 2012, filed on February 28, 2013 with the SEC.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our critical accounting policies and estimates have not changed significantly from those detailed in our most recent Annual Report on Form 10-K for the year ended December 31, 2012, filed on February 28, 2013 with the SEC.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of Notes to Consolidated Financial Statements in Item 1 of this Form 10-Q for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein by reference.
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ACQUISITION EXPENSES
On May 4, 2012, we closed on the acquisition of the Nokia Siemens Networks Broadband Access business (NSN BBA). Acquisition related expenses, amortizations and adjustments for the three months ended March 31, 2013 and 2012 for that transaction is as follows:
Amortization of acquired intangible assets
Amortization of other purchase accounting adjustments
Acquisition related professional fees, travel and other expenses
Total acquisition related expenses, amortizations and adjustments
Tax effect
Total acquisition related expenses, amortizations and adjustments, net of tax
The acquisition related expenses, amortizations and adjustments above were recorded in the following Consolidated Statements of Income categories for the three months ended March 31, 2013 and 2012:
Revenue (adjustments to deferred revenue recognized in the period)
Cost of goods sold
See Note 9 of Notes to Consolidated Financial Statements in Item 1 of this Form 10-Q for additional information on amortization of intangible assets acquired in previous business acquisitions.
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RESULTS OF OPERATIONS – THREE MONTHS ENDED MARCH 31, 2013 COMPARED TO THREE MONTHS ENDED MARCH 31, 2012
SALES
ADTRAN’s sales increased 6.1% from $134.7 million in the three months ended March 31, 2012 to $143.0 million in the three months ended March 31, 2013. The increase in sales is primarily attributable to a $22.8 million increase in sales of our Broadband Access products, partially offset by a $5.4 million decrease in sales of our Optical products, a $5.0 million decrease in sales of our HDSL and other legacy products, and a $4.1 million decrease in sales of our Internetworking products.
Carrier Networks sales increased 13.7% from $96.7 million in the three months ended March 31, 2012 to $109.9 million in the three months ended March 31, 2013. The increase in sales for the three months ended March 31, 2013 is primarily attributable to an increase in sales of our Broadband Access products, partially offset by decreases in sales of our Optical products, HDSL and other legacy products. The increase in Broadband Access sales was primarily attributable to the added sales of the acquired broadband access business. The decrease in sales of Optical products is primarily attributable to the market transitioning to Ethernet and our transition to new products to address this market. The decreases in HDSL and other legacy product revenues have been expected as we evolve our products towards packet-based technologies.
Enterprise Networks sales decreased 13.0% from $38.1 million in the three months ended March 31, 2012 to $33.1 million in the three months ended March 31, 2013. The decrease in sales for the three months ended March 31, 2013 is primarily attributable to decreases in sales of Internetworking products and legacy products. The decrease in Internetworking product sales is primarily due to uncertainties caused by the macro-economic environment, which resulted in delays in end-customer purchases. The impact of this environment was partially offset by increases in sales of our WLAN solutions and switches. Internetworking product sales attributable to Enterprise Networks were 94.1% of the division’s sales in the three months ended March 31, 2013, compared to 91.2% in the three months ended March 31, 2012. Legacy products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales decreased from 28.3% for the three months ended March 31, 2012 to 23.2% for the three months ended March 31, 2013.
International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, increased 90.8% from $18.3 million in the three months ended March 31, 2012 to $34.9 million in the three months ended March 31, 2013. International sales, as a percentage of total sales, increased from 13.6% for the three months ended March 31, 2012 to 24.4% for the three months ended March 31, 2013. International sales increased in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 primarily due to sales attributable to the acquired broadband access business, partially offset by a decrease in organic sales in Latin America.
Carrier System product sales increased $21.5 million in the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The increase for the three months ended March 31, 2013 is primarily due to a $22.8 million increase in Broadband Access product sales and a $4.2 million increase in legacy product sales, partially offset by a decrease of $5.4 million in Optical product sales. The increase in Broadband Access sales was due to the added sales of the acquired broadband access business. The decrease in sales of Optical products for the three months ended March 31, 2013 is primarily attributable to the market transitioning to Ethernet and our transition to new products to address this market.
Business Networking product sales decreased $5.1 million in the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The decrease for the three months ended March 31, 2013 is primarily due to a $4.1 million decrease in Interworking product sales across both divisions and a $1.0 million decrease in legacy product sales. The decrease in Internetworking product sales is primarily due to uncertainties caused by the macro-economic environment, which resulted in delays in end-customer purchases. The impact of this environment was partially offset by increases in sales of our WLAN solutions and switches. The decrease in sales of legacy products is a result of customers shifting to newer technologies. Many of these newer technologies are integral to our Internetworking product area.
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Loop Access product sales decreased $8.2 million in the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The decrease for the three months ended March 31, 2013 is primarily due to a $7.6 million decrease in HDSL product sales. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies.
COST OF SALES
As a percentage of sales, cost of sales increased from 45.0% in the three months ended March 31, 2012 to 51.3% in the three months ended March 31, 2013. This increase is primarily attributable to lower gross margins related to the acquired broadband access business, lower cost absorption due to lower production volumes on the organic business, customer price movements to achieve market share position and shifts in customer mix.
Carrier Networks cost of sales, as a percent of division sales, increased from 45.3% in the three months ended March 31, 2012 to 53.1% in the three months ended March 31, 2013. The increase in Carrier Networks cost of sales as a percentage of sales is primarily attributable to the factors outlined above.
Enterprise Networks cost of sales, as a percent of division sales, increased from 44.3% in the three months ended March 31, 2012 to 45.4% in the three months ended March 31, 2013. The increase is primarily attributable to lower cost absorption due to lower production volumes and customer price movements to achieve market share position.
An important part of our strategy is to reduce the product cost of each succeeding product generation and then to lower the product’s price based on the cost savings achieved. This may cause variations in our gross profit percentage due to timing differences between the recognition of cost reductions and the lowering of product selling prices.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased 7.6% from $33.1 million in the three months ended March 31, 2012 to $30.6 million in the three months ended March 31, 2013. The decrease in selling, general and administrative expenses is primarily related to decreases in professional services, legal services and travel expense, which were higher in 2012 due to pre-acquisition activities related to the acquired broadband access business.
Selling, general and administrative expenses as a percentage of sales decreased from 24.6% in the three months ended March 31, 2012 to 21.4% in the three months ended March 31, 2013. Selling, general and administrative expenses as a percentage of sales may fluctuate whenever there is a significant fluctuation in revenues for the periods being compared.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased 31.1% from $24.8 million in the three months ended March 31, 2012 to $32.5 million in the three months ended March 31, 2013. The increase in research and development expenses is primarily related to increases in staffing and fringe benefit costs due to increased headcount related to the broadband access business acquired on May 4, 2012, and increases in amortization of acquired intangible assets, independent contractor expense and office lease expense related to this acquisition.
As a percentage of sales, research and development expenses increased from 18.4% in the three months ended March 31, 2012 to 22.7% in the three months ended March 31, 2013. Research and development expenses as a percentage of sales will fluctuate whenever there are incremental product development activities or a significant fluctuation in revenues for the periods being compared.
We expect to continue to incur research and development expenses in connection with our new and existing products and our expansion into international markets. We continually evaluate new product opportunities and engage in intensive research and product development efforts which provides for new product development, enhancement of existing products and product cost reductions. We may incur significant research and development expenses prior to the receipt of revenues from a major new product group.
INTEREST AND DIVIDEND INCOME
Interest and dividend income remained consistent at $1.9 million and $1.8 million in the three months ended March 31, 2012 and 2013, respectively, as we had no substantial change in interest-bearing investment balances or interest rates.
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INTEREST EXPENSE
Interest expense, which is primarily related to our taxable revenue bond, remained constant at $0.6 million in each of the three months ended March 31, 2013 and 2012, as we had no substantial change in our fixed-rate borrowing. See “Liquidity and Capital Resources” below for additional information on our revenue bond.
NET REALIZED INVESTMENT GAIN
Net realized investment gain increased 47.8% from $2.5 million in the three months ended March 31, 2012 to $3.6 million in the three months ended March 31, 2013. The higher amount of realized gains in the period ended March 31, 2013 is primarily driven by higher sales of equity securities and reallocation of the marketable equity security portfolio. See “Investing Activities” in “Liquidity and Capital Resources” below for additional information.
OTHER INCOME (EXPENSE), NET
Other income (expense), net, comprised primarily of miscellaneous income, gains and losses on foreign currency transactions, investment account management fees, scrap raw material sales, and gains and losses on the disposal of property, plant and equipment occurring in the normal course of business, changed from $0.1 million of income in the three months ended March 31, 2012 to $1.7 million of expense in the three months ended March 31, 2013. This change was primarily attributable to losses on foreign currency transactions during the first quarter of 2013.
INCOME TAXES
NET INCOME
As a result of the above factors, net income decreased $5.1 million from $13.0 million in the three months ended March 31, 2012 to $7.9 million in the three months ended March 31, 2013.
As a percentage of sales, net income decreased from 9.6% in the three months ended March 31, 2012 to 5.5% in the three months ended March 31, 2013.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
We intend to finance our operations with cash flow from operations. We have used, and expect to continue to use, the cash generated from operations for working capital, purchases of treasury stock, dividend payments, and other general corporate purposes, including (i) product development activities to enhance our existing products and develop new products and (ii) expansion of sales and marketing activities. We believe our cash and cash equivalents, investments and cash generated from operations to be adequate to meet our operating and capital needs for the foreseeable future.
At March 31, 2013, cash on hand was $58.6 million and short-term investments were $189.2 million, which resulted in available short-term liquidity of $247.9 million. At December 31, 2012, our cash on hand of $68.5 million and short-term investments of $160.5 million resulted in available short-term liquidity of $228.9 million. The increase in short-term liquidity from December 31, 2012 to March 31, 2013 primarily reflects funds provided by our operating activities and long-term corporate bonds moving to short-term status, partially offset by equipment acquisitions, share repurchases and dividends.
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Operating Activities
Our working capital, which consists of current assets less current liabilities, increased 2.4% from $339.4 million as of December 31, 2012 to $347.6 million as of March 31, 2013. The quick ratio, defined as cash, cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, increased from 2.90 as of December 31, 2012 to 2.95 as of March 31, 2013. The current ratio, defined as current assets divided by current liabilities, decreased from 4.18 as of December 31, 2012 to 4.11 as of March 31, 2013. The increase in our working capital is primarily attributable to an increase in short-term investments and a decrease in unearned revenue, partially offset by a decrease in inventory and an increase in accounts payable. Generally, fluctuations in unearned revenue result from variations in the timing of customer payments received in advance of revenue recognition and our revenue recognition under contract terms for hardware acceptance, installation services and post-sale support and maintenance services. We expect inventory levels to fluctuate as we attempt to maintain sufficient inventory in response to seasonal cycles of our business ensuring competitive lead times while managing the risk of inventory obsolescence that may occur due to rapidly changing technology and customer demand. Generally, fluctuations in accounts payable result from variations in the timing of the receipt of supplies, inventory and services and our subsequent payments for these purchases.
Net accounts receivable increased 1.1% from $81.2 million at December 31, 2012 to $82.1 million at March 31, 2013. Our allowance for doubtful accounts was $6 thousand at December 31, 2012 and $21 thousand at March 31, 2013. Quarterly accounts receivable days sales outstanding (DSO) decreased from 53 days as of December 31, 2012 to 52 days as of March 31, 2013.
Quarterly inventory turnover increased from 2.8 turns as of December 31, 2012 to 3.0 turns as of March 31, 2013. Inventory decreased 6.6% from December 31, 2012 to March 31, 2013. We expect inventory levels to fluctuate as we attempt to maintain sufficient inventory in response to seasonal cycles of our business ensuring competitive lead times while managing the risk of inventory obsolescence that may occur due to rapidly changing technology and customer demand.
Accounts payable increased 16.0% from $42.2 million at December 31, 2012 to $48.9 million at March 31, 2013. Accounts payable will fluctuate due to variations in the timing of the receipt of supplies, inventory and services and our subsequent payments for these purchases.
Investing Activities
Capital expenditures totaled approximately $0.7 million and $4.1 million for the three months ended March 31, 2013 and 2012, respectively. These expenditures were primarily used to purchase manufacturing and test equipment and computer software and hardware.
Our combined short-term and long-term investments increased $6.5 million from $493.2 million at December 31, 2012 to $499.7 million at March 31, 2013. This increase reflects the impact of additional funds available for investment provided by our operating activities and stock option exercises by our employees, reduced by our cash needs for equipment acquisitions, share repurchases and dividends, as well as net realized and unrealized losses and amortization of net premiums on our combined investments.
We invest all available cash not required for immediate use in operations primarily in securities that we believe bear minimal risk of loss. At March 31, 2013 these investments included corporate bonds of $191.3 million, municipal fixed-rate bonds of $172.1 million and municipal variable rate demand notes of $40.8 million. At December 31, 2012, these investments included corporate bonds of $186.4 million, municipal fixed-rate bonds of $175.1 million and municipal variable rate demand notes of $34.4 million. As of March 31, 2013, our corporate bonds, municipal fixed-rate bonds, and municipal variable rate demand notes were classified as available-for-sale and had a combined duration of 1.0 years with an average credit rating of AA-. Because our bond portfolio has a high quality rating and contractual maturities of a short duration, we are able to obtain prices for these bonds derived from observable market inputs, or for similar securities traded in an active market, on a daily basis.
Our long-term investments decreased 6.7% from $332.7 million at December 31, 2012 to $310.5 million at March 31, 2013. The primary reason for the decrease in our long-term investments during 2013 was the movement of certain long-term corporate bonds and long-term municipal bonds to short-term status. Long-term investments at March 31, 2013 and December 31, 2012 included an investment in a certificate of deposit of $48.3 million, which serves as collateral for our revenue bonds, as discussed below. We have various equity investments included in long-term investments at a cost of $22.2 million and $21.0 million, and with a fair value of $33.1 million and $35.2 million, at March 31, 2013 and December 31, 2012, respectively.
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Long-term investments at March 31, 2013 also includes $12.4 million related to our deferred compensation plans; $1.8 million of other investments carried at cost, consisting of interests in two private equity funds and an investment in a privately held telecommunications equipment manufacturer.
Financing Activities
Dividends
In July 2003, our Board of Directors elected to begin declaring quarterly dividends on our common stock considering the tax treatment of dividends and adequate levels of Company liquidity. During the three months ended March 31, 2013, we paid dividends totaling $5.6 million.
Debt
We have amounts outstanding under loans made pursuant to an Alabama State Industrial Development Authority revenue bond (the Bond) which totaled $46.5 million at March 31, 2013 and December 31, 2012. At March 31, 2013, the estimated fair value of the Bond was approximately $47.9 million, based on a debt security with a comparable interest rate and maturity and a Standard & Poor’s credit rating of A-. Included in long-term investments are restricted funds in the amount of $48.3 million at March 31, 2013 and December 31, 2012, which is a collateral deposit against the principal amount of the Bond. We have the right to set-off the balance of the Bond with the collateral deposit in order to reduce the balance of the indebtedness. The Bond matures on January 1, 2020, and bears interest at the rate of 5% per annum. In conjunction with this program, we are eligible to receive certain economic incentives from the state of Alabama that reduce the amount of payroll withholdings we are required to remit to the state for those employment positions that qualify under this program.
We are required to make payments in the amounts necessary to pay the principal and interest on the amounts currently outstanding. Based on positive cash flow from operating activities, we have decided to continue early partial redemptions of the Bond. It is our intent to make annual principal payments in addition to the interest amounts that are due. In connection with this decision, $0.5 million of the Bond debt has been classified as a current liability in accounts payable in the Consolidated Balance Sheet at March 31, 2013.
To accommodate employee stock option exercises, we issued four thousand shares of treasury stock for $55 thousand during the three months ended March 31, 2013. During the three months ended March 31, 2012, we issued 0.2 million shares of treasury stock for $3.6 million.
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Off-Balance Sheet Arrangements and Contractual Obligations
We do not have off-balance sheet financing arrangements and have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources. During the three months ended March 31, 2013, there have been no material changes in contractual obligations and commercial commitments from those discussed in our most recent Annual Report on Form 10-K for the year ended December 31, 2012 filed on February 28, 2013 with the SEC.
FACTORS THAT COULD AFFECT OUR FUTURE RESULTS
The following are some of the risks that could affect our financial performance or could cause actual results to differ materially from those expressed or implied in our forward-looking statements:
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The foregoing list of risks is not exclusive. For a more detailed description of the risk factors associated with our business, see Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012, filed on February 28, 2013 with the SEC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to financial market risks, including changes in interest rates, foreign currency rates and prices of marketable equity and fixed-income securities. The primary objective of the large majority of our investment activities is to preserve principal while at the same time achieving appropriate yields without significantly increasing risk. To achieve this objective, a majority of our marketable securities are investment grade, municipal, fixed-rate bonds, municipal variable rate demand notes and municipal money market instruments denominated in United States dollars. Our investment policy provides limitations for issuer concentration, which limits, at the time of purchase, the concentration in any one issuer to 5% of the market value of our total investment portfolio.
We maintain depository investments with certain financial institutions. Although these depository investments may exceed government insured depository limits, we have evaluated the credit worthiness of these financial institutions, and determined the risk of material financial loss due to exposure of such credit risk to be minimal. As of March 31, 2013, $57.8 million of our cash and cash equivalents, primarily certain domestic money market funds and foreign depository accounts, were in excess of government provided insured depository limits.
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As of March 31, 2013, approximately $400.9 million of our cash and investments may be directly affected by changes in interest rates. We have performed a hypothetical sensitivity analysis assuming market interest rates increase or decrease by 50 basis points (bps) for an entire year, while all other variables remain constant. At March 31, 2013, we held $171.1 million of cash and investments where a change in interest rates would impact our interest income. A hypothetical 50 bps decline in interest rates as of March 31, 2013 would reduce annualized interest income on our cash and investments by approximately $0.7 million. In addition, we held $340.4 million of fixed-rate municipal bonds and corporate bonds whose fair values may be directly affected by a change in interest rates. A hypothetical 50 bps increase in interest rates as of March 31, 2013 would reduce the fair value of our municipal fixed-rate bonds and corporate bonds by approximately $1.7 million.
As of March 31, 2012, approximately $433.8 million of our cash and investments was subject to being directly affected by changes in interest rates. We have performed a hypothetical sensitivity analysis assuming market interest rates increase or decrease by 50 bps for the entire year, while all other variables remain constant. A hypothetical 50 bps decline in interest rates as of March 31, 2012 would have reduced annualized interest income on our cash, money market instruments and municipal variable rate demand notes by approximately $0.7 million. In addition, a hypothetical 50 bps increase in interest rates as of March 31, 2012 would have reduced the fair value of our municipal fixed-rate bonds and corporate bonds by approximately $2.1 million.
We have certain international customers who are invoiced in their local currency. Changes in the monetary exchange rates used to invoice such customers versus the functional currency of the entity billing such customers may adversely affect our results of operations and financial condition. To manage the volatility relating to these typical business exposures, we may enter into various derivative transactions, when appropriate. We do not hold or issue derivative instruments for trading or other speculative purposes. The Yen and Riyal are the predominant currencies of the customers who are billed in their local currency. Taking into account the effects of foreign currency fluctuations of the Yen and Riyal versus the Euro, a hypothetical 10% weakening of the Euro as of March 31, 2013 would provide a gain on foreign currency of approximately $0.3 million. Conversely, a hypothetical 10% strengthening of the Euro as of March 31, 2013 would provide a loss on foreign currency of approximately $0.3 million. Any gain or loss would be significantly mitigated by the hedges as discussed below.
As of March 31, 2013, we had no material contracts, other than accounts receivable and accounts payable, denominated in foreign currencies. As of March 31, 2013, we had forward contracts and swaps outstanding with notional amounts totaling €4.9 million ($6.3 million) and €1.8 million ($2.4 million), respectively, which mature at various times throughout 2013. The fair value of these forward contracts and swaps was a net liability of approximately $0.2 million as of March 31, 2013.
For further information about the fair value of our available-for-sale investments as of March 31, 2013 see Notes 6 and 7 of Notes to Consolidated Financial Statements.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for ADTRAN. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are effective.
(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1A. RISK FACTORS
A list of factors that could materially affect our business, financial condition or operating results is included under “Factors That Could Affect Our Future Results” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report. There have been no material changes to the risk factors as disclosed in Item 1A of Part I of our most recent Annual Report on Form 10-K for the year ended December 31, 2012, filed on February 28, 2013 with the SEC.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table sets forth repurchases of our common stock for the months indicated:
Period
January 1, 2013 – January 31, 2013
February 1, 2013 – February 28, 2013
March 1, 2013 – March 31, 2013
On October 11, 2011, our Board of Directors approved repurchases of up to 5,000,000 shares of our common stock. This plan is being implemented through open market or private purchases from time to time as conditions warrant.
On May 1, 2013, our Board of Directors authorized the repurchase of an additional 5.0 million shares of our common stock to commence upon completion of the repurchase plan announced on October 11, 2011. This new authorization will be implemented through open market or private purchases from time to time as conditions warrant.
ITEM 6. EXHIBITS
Exhibits.
Exhibit No.
Description
35
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
(Registrant)
/s/ James E. Matthews
36
EXHIBIT INDEX
37