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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended June 30, 2012 OR
For the Transition Period from to Commission File Number 0-24612
ADTRAN, INC. (Exact name of Registrant as specified in its charter)
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:
Table of ContentsADTRAN, INC. Quarterly Report on Form 10-Q For the Three and Six Months Ended June 30, 2012
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, 2011 filed on February 29, 2012 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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Table of ContentsADTRAN, INC. (Unaudited) (In thousands, except per share amounts)
See notes to consolidated financial statements
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Table of ContentsADTRAN, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share amounts)
See notes to consolidated financial statements
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Table of ContentsADTRAN, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (In thousands)
See notes to consolidated financial statements
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Table of ContentsADTRAN, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
See notes to consolidated financial statements
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Table of ContentsADTRAN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (In thousands, except per share amounts) 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, 2011 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, 2011, filed on February 29, 2012 with the SEC. 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, 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 six months ended June 30, 2012, we adopted the following accounting standards, which had no material effect on our consolidated results of operations or financial condition: In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-05 requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. While ASU 2011-05 changes the presentation of comprehensive income, it does not change the components that are recognized in net income or comprehensive income under current accounting guidance. This update is effective for fiscal years, and interim periods within those years, ending after December 15, 2011, with early adoption permitted. We adopted this amendment during the first quarter of 2012, and we have provided the disclosures required for the three and six months ended June 30, 2012 and 2011. In December 2011, the FASB issued Accounting Standards Update No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (ASU 2011-12). ASU 2011-12 defers the effective date for certain presentation requirements that relate to reclassification adjustments and the effect of those reclassification adjustments on the financial statements. This update is effective for fiscal years, and interim periods within those years, ending after December 15, 2011, with early adoption permitted. We adopted this amendment during the first quarter of 2012. The adoption of this amendment had no effect on our consolidated results of operations and financial condition for the three and six months ended June 30, 2012.
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Table of ContentsIn May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU 2011-04). ASU 2011-04 is intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRS. The amendments are of two types: (i) those that clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements and (ii) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. This update is effective for annual periods beginning after December 15, 2011. We adopted this amendment during the first quarter of 2012. The adoption of this amendment had no effect on our consolidated results of operations and financial condition for the three and six months ended June 30, 2012. 2. BUSINESS COMBINATIONS On May 4, 2012, we acquired the Nokia Siemens Networks (NSN) 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. 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, subject to customary working capital adjustments between the parties. The bargain purchase gain 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 gain is included in the line item “Gain on bargain purchase of a business” in the 2012 Consolidated Statements of Income. 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:
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.
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Table of ContentsThe following supplemental pro forma information presents the financial results as if the acquisition of the NSN BBA business had occurred on January 1, 2011. 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, 2011, nor are they indicative of any future results. The actual revenue and pre-tax income excluding the bargain purchase gain included in our Consolidated Statements of Income from May 4, 2012 to June 30, 2012 was $22.6 million and $(0.4) million, respectively.
For the three and six months ended June 30, 2012, we incurred acquisition and integration related expenses and amortization of acquired intangibles of $3.9 million and $5.5 million, respectively, related to this acquisition. On August 4, 2011, we acquired all of the outstanding stock of Bluesocket, Inc., a provider of wireless network solutions with virtual control, for $23.7 million in cash. The acquisition provides us with IEEE802.11N enterprise class wireless LAN expertise, technology, and products to address the growing transition within small-medium enterprises and large enterprises to wireless networks and mobile devices. We have included the financial results of Bluesocket in our consolidated financial statements since the date of acquisition. Pro forma results of operations prior to the closing date for the acquisition have not been presented because the effect of the acquisition was not material to our financial results. The allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date is as follows:
During the fourth quarter of 2011, the purchase price and purchase price allocation were adjusted for our final valuations. The adjustments resulted in a decrease to the goodwill recognized in the transaction. The net deferred tax assets acquired are primarily related to net operating losses and previously capitalized and unamortized research and development expense for tax deduction purposes.
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Table of ContentsThe fair value of the customer relationships, developed technology and intellectual property acquired was calculated using an income approach (excess earnings method) and is being amortized using the straight-line method. The customer relationships and intellectual property are being amortized over an estimated useful life of 7 years and the developed technology is being amortized over an average estimated useful life of 4.5 years. The fair value of the trade names acquired was calculated using an income approach (relief from royalty method) and is being amortized using the straight-line method over the estimate useful life of 4.5 years. The goodwill of $3.5 million generated from this acquisition is primarily related to expected synergies and was assigned to our Enterprise Networks division. The goodwill will not be deductible for U.S. federal income tax purposes. For the three and six months ended June 30, 2012, we incurred acquisition and integration related expenses and amortization of acquired intangibles of $0.4 million and $0.9 million, respectively, related to this acquisition. 3. INCOME TAXES Our effective tax rate increased from 32.5% in the six months ended June 30, 2011 to 35.6% in the six months ended June 30, 2012. The tax provision rate in the six months ended June 30, 2012 did not include the benefit of the research tax credit, which expired on December 31, 2011. The exclusion of this benefit during the six months ended June 30, 2012 resulted in a 2.2 percentage point increase in our effective tax rate. Also, decreased benefits from a lower volume of stock option exercises in the six months ended June 30, 2012 resulted in a 1.4 percentage point increase in our effective tax rate. Finally, the closure of an audit resulted in a 0.4 percentage point decrease in our effective tax rate for the six months ended June 30, 2012. During the three months ended June 30, 2012, we acquired the NSN BBA business, which resulted in a bargain purchase gain reported on the income statement. The bargain purchase gain is presented net of tax in the income statement and a deferred tax liability was established in the opening balance sheet for the acquired entity. 4. PENSION BENEFIT PLAN As a result of our acquisition of the NSN BBA business, we assumed a defined benefit obligation plan from NSN. As a result, we established a Contribution Trust Arrangement (CTA) as a vehicle to hold the pension assets. NSN has estimated the amount of the defined benefit obligation to be approximately $17.8 million. We are in the process of verifying the estimated defined benefit obligation in order to determine the value of assets to be transferred from NSN to us to fund the pension obligation. We anticipate the assets to be transferred will be equal to the defined benefit obligation as of the date of the acquisition. The following table summarizes the components of net periodic pension cost for the period May 4, 2012 to June 30, 2012:
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Table of Contents5. 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 and six months ended June 30, 2012 and 2011, which was recognized as follows:
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. There were no options granted during the three and six months ended June 30, 2012. The weighted-average assumptions and value of options granted for the three and six months ended June 30, 2011 are summarized as follows:
The fair value of our RSUs is calculated using a Monte Carlo Simulation valuation method. There were no RSU grants during the six months ended June 30, 2012 or 2011. 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 six months ended June 30, 2012 or 2011. Stock-based compensation expense recognized in our Consolidated Statements of Income for the three and six months ended June 30, 2012 and 2011 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 June 30, 2012, total compensation expense related to non-vested stock options, RSUs and restricted stock not yet recognized was approximately $17.3 million, which is expected to be recognized over an average remaining recognition period of 2.5 years.
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Table of ContentsThe following table is a summary of our stock options outstanding as of December 31, 2011 and June 30, 2012 and the changes that occurred during the six months ended June 30, 2012:
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 June 30, 2012. 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 and six month periods ended June 30, 2012 was $0.6 million and $3.6 million, respectively. The following table is a summary of our RSUs and restricted stock outstanding as of December 31, 2011 and June 30, 2012 and the changes that occurred during the six months ended June 30, 2012:
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Table of Contents6. INVESTMENTS At June 30, 2012, we held the following securities and investments, recorded at either fair value or cost.
At December 31, 2011, we held the following securities and investments, recorded at either fair value or cost.
As of June 30, 2012, our corporate bonds and municipal fixed-rate bonds had the following contractual maturities:
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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Table of ContentsWe 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 $33 thousand during the six months ended June 30, 2012 related to eight marketable equity securities. For the six months ended June 30, 2011, we recorded an other-than-temporary impairment charge of $12 thousand related to three 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.
As of June 30, 2012 and 2011, gross unrealized losses related to individual securities that had been in a continuous loss position for 12 months or longer were not significant. In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, 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.
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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.
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Table of ContentsOur 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. INVENTORY At June 30, 2012 and December 31, 2011, inventory consisted of the following:
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 June 30, 2012 and December 31, 2011, raw materials reserves totaled $8.6 million and $7.9 million, respectively, and finished goods inventory reserves totaled $1.6 million and $1.5 million, respectively. 8. GOODWILL AND INTANGIBLE ASSETS The changes in the carrying value of goodwill, all of which is included in our Enterprise Networks division, for the six months ended June 30, 2012 are as follows:
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 during the six months ended June 30, 2012.
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Table of ContentsThe following table presents our intangible assets as of June 30, 2012 and December 31, 2011. 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.
Amortization expense was $0.5 million and $0.1 million for the three months ended June 30, 2012 and 2011, respectively, and $0.8 million and $0.1 million for the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, the estimated future amortization expense of our intangible assets is as follows:
9. STOCKHOLDERS’ EQUITY A summary of the changes in stockholders’ equity for the six months ended June 30, 2012 is as follows:
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 six months ended June 30, 2012, we repurchased 0.5 million shares of our common stock at an average price of $29.51 per share. We have the authority to purchase an additional 5.4 million shares of our common stock under plans approved by the Board of Directors on April 14, 2008 and October 11, 2011.
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Table of ContentsStock Option Exercises We issued 0.2 million shares of treasury stock during the six months ended June 30, 2012 to accommodate employee stock option exercises. The stock options had exercise prices ranging from $8.70 to $33.70. We received proceeds totaling $4.3 million from the exercise of these stock options during the six months ended June 30, 2012. Dividend Payments During the six months ended June 30, 2012, we paid cash dividends as follows (in thousands except per share amount):
Other Comprehensive Income Other comprehensive income consists of the net change in unrealized gains and losses on marketable securities, reclassification adjustments for amounts included in net income related to realized gains on previously impaired marketable securities and foreign currency translation adjustments. The components of other comprehensive income for the three months ended June 30, 2012 and 2011 are as follows:
The components of other comprehensive income for the six months ended June 30, 2012 and 2011 are as follows:
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Table of Contents10. EARNINGS PER SHARE A summary of the calculation of basic and diluted earnings per share for the three and six months ended June 30, 2012 and 2011 is as follows:
Anti-dilutive options to purchase common stock outstanding were excluded from the above calculations. Anti-dilutive options totaled 2.5 million and 0.9 million for the three months ended June 30, 2012 and 2011, respectively, and 2.1 million and 0.9 million for the six months ended June 30, 2012 and 2011, respectively. 11. 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 and six months ended June 30, 2012 and 2011. Asset information by reportable segment is not reported, since we do not produce such information internally.
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Table of ContentsSales 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. The Carrier Systems category includes our broadband access products comprised of Total Access® 5000 multi-service access and aggregation platform products, Total Access 1100/1200 Series Fiber-To-The-Node (FTTN) products, hiX 5600 Series Multi-Service Access Node (MSAN), Ultra Broadband Ethernet (UBE) and Digital Subscriber Line Access Multiplexer (DSLAM) products. Our broadband access products are used by service providers around the world to deliver high-speed Internet access, Plain Old Telephone Service (POTS), Voice over Internet Protocol (VoIP), IP Television (IPTV), and/or Ethernet services from the central office or remote terminal locations to customer premises. The Carrier Systems category also includes our optical products. These products consist of optical multiplexers and transceivers including those used in our Optical Networking Edge (ONE) products, NetVanta 8000 series products, and our family of OPTI products. Optical products are used to deliver higher bandwidth services, aggregate large numbers of low bandwidth services, or transport wavelength services across a fiber optic infrastructure. Total Access 1500 products, 303 concentrator products, M13 multiplexer products, and a number of mobile backhaul products are also included in the Carrier Systems product category. Business Networking products provide access to telecommunication services, facilitating the delivery of converged services and Unified Communications to the small and mid-sized enterprises (SME) market. The Business Networking category includes Internetworking products and Integrated Access Devices (IADs). Internetworking products consist of our Total Access IP Business Gateways, Optical Network Terminals (ONTs), Virtual Wireless LAN products and NetVanta product lines. NetVanta products include multi-service routers, managed Ethernet switches, IP Private Branch Exchange (PBX) products, IP phone products, Unified Communications solutions, Unified Threat Management (UTM) solutions, and Carrier Ethernet Network Terminating Equipment (NTE). IAD products consist of our Total Access 600 Series and the Total Access 850. Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications networks. The Loop Access category includes products such as: Digital Data Service (DDS) and Integrated Services Digital Network (Total Reach) products, High bit-rate Digital Subscriber Line (HDSL) products including Total Access 3000 HDSL and Time Division Multiplexed-Symmetrical HDSL (TDM-SHDSL) products, T1/E1/T3, Channel Service Units/Data Service Units, and TRACER fixed wireless products. The table below presents sales information by product category for the three and six months ended June 30, 2012 and 2011.
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) and our legacy products include HDSL products (included in Loop Access) and other products not included in the aforementioned core products.
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Table of ContentsSubcategory revenues included in the above are as follows:
Sales by Geographic Region The table below presents sales information by geographic area for the three and six months ended June 30, 2012 and 2011. International sales correlate to shipments with a non-U.S. destination.
12. 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 $7.2 million at June 30, 2012 and $4.1 million at December 31, 2011. These liabilities are included in accrued expenses in the accompanying Consolidated Balance Sheets. A summary of warranty expense and write-off activity for the six months ended June 30, 2012 and 2011 is as follows:
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Table of Contents13. 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 and six month periods ended June 30, 2012 and 2011, we incurred fees of $10 thousand per month for these legal services. 14. 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 June 30, 2012, of which $7.7 million has been applied to these commitments. 15. SUBSEQUENT EVENTS On July 10, 2012, 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 July 26, 2012. The payment date will be August 9, 2012. The quarterly dividend payment will be approximately $5.7 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 third quarter of 2012 and as of August 3, 2012, we repurchased 0.5 million shares of our common stock through open market purchases at an average cost of $21.08 per share. We have the authority to purchase an additional 4.9 million shares of our common stock under plans approved by the Board of Directors on April 14, 2008 and October 11, 2011.
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Table of ContentsITEM 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 and mid-sized enterprises (SMEs) (serviced by our Enterprise Networks Division), and enable voice, data, video and Internet communications across wireline and wireless networks. Many of these solutions are currently in use by every major United States and many global service providers, as well as by 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. 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. Business Networking products provide access to telecommunication services, facilitating the delivery of converged services and Unified Communications to the SME market. Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications networks. 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) and 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 11 of Notes to Consolidated Financial Statements in this report for further information regarding these product categories. Sales were $184.0 million and $318.7 million for the three and six months ended June 30, 2012 compared to $184.2 million and $349.7 million for the three and six months ended June 30, 2011. Product revenues for our three primary growth areas, Broadband Access, Optical Access and Internetworking, were $155.0 million and $259.7 million for the three and six months ended June 30, 2012 compared to $132.1 million and $237.7 million for the three and six months ended June 30, 2011. Our gross margin decreased to 51.7% and 53.1% for the three and six months ended June 30, 2012 from 58.0% and 58.8% for the three and six months ended June 30, 2011. Our operating income margin decreased to 14.6% and 13.5% for the three and six months ended June 30, 2012 from 27.9% and 27.7% for the three and six months ended June 30, 2011. Net income was $21.1 million and $34.0 million for the three and six months ended June 30, 2012 compared to $36.9 million and $71.2 million for the three and six months ended June 30, 2011. Our effective tax rate increased to 35.7% for the three months ended June 30, 2012 from 34.0% for the three months ended June 30, 2011 and increased to 35.6% for the six months ended June 30, 2012 from 32.5% for the six months ended June 30, 2011. Earnings per share, assuming dilution, were $0.33 and $0.53 for the three and six months ended June 30, 2012 compared to $0.56 and $1.08 for the three and six months ended June 30, 2011.
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Table of ContentsOur 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 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, 2011, filed on February 29, 2012 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, 2011, filed on February 29, 2012 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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Table of ContentsACQUISITION EXPENSES On August 4, 2011, we closed on the acquisition of Bluesocket, Inc. and on May 4, 2012, we closed on the acquisition of the Nokia Siemens Networks (NSN) Broadband Access business (NSN BBA business). Acquisition related expenses, amortizations and adjustments for the three and six months ended June 30, 2012 for both transactions are as follows:
The acquisition related expenses, amortizations and adjustments above were recorded in the following Consolidated Statements of Income categories for the three and six months ended June 30, 2012:
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Table of ContentsRESULTS OF OPERATIONS – THREE AND SIX MONTHS ENDED JUNE 30, 2012 COMPARED TO THREE AND SIX MONTHS ENDED JUNE 30, 2011 SALES ADTRAN’s sales decreased 0.1% from $184.2 million in the three months ended June 30, 2011 to $184.0 million in the three months ended June 30, 2012, and decreased 8.9% from $349.7 million in the six months ended June 30, 2011 to $318.7 million in the six months ended June 30, 2012. The decrease in sales for the three months ended June 30, 2012 is primarily attributable to a $23.1 million decrease in sales of our HDSL and other legacy products and an $8.0 million decrease in sales of our Optical products, substantially offset by a $29.0 million increase in sales of our Broadband Access products and a $1.9 million increase in sales of our Internetworking products. The decrease in sales for the six months ended June 30, 2012 is primarily attributable to a $53.0 million decrease in sales of our HDSL and other legacy products, a $14.7 million decrease in sales of our Optical products, partially offset by a $26.7 million increase in sales of our Broadband Access products and a $10.0 million increase in sales of our Internetworking products. Carrier Networks sales increased 1.5% from $150.5 million in the three months ended June 30, 2011 to $152.7 million in the three months ended June 30, 2012, and decreased 11.8% from $282.9 million in the six months ended June 30, 2011 to $249.4 in the six months ended June 30, 2012. The increase in sales for the three months ended June 30, 2012 is primarily attributable to increases in sales of our Broadband Access products and Internetworking NTE products, partially offset by decreases in sales of our Optical products and HDSL and other legacy products. The decrease in sales for the six months ended June 30, 2012 is primarily attributable to decreases in sales of our Optical products and HDSL and other legacy products. This decline was partially offset by the added sales of the NSN BBA business and an increase in sales of our Internetworking NTE products and organic Broadband Access products. Our organic Broadband Access sales for the six months ended June 30, 2012 were impacted by a delay in both the start and ramp-up of orders during the first quarter of this year from one of our larger carrier customers due to a new systems implementation. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies. Enterprise Networks sales decreased 7.2% from $33.7 million in the three months ended June 30, 2011 to $31.3 million in the three months ended June 30, 2012, and increased 3.7% from $66.9 million in the six months ended June 30, 2011 to $69.4 million in the six months ended June 30, 2012. The decrease for the three months ended June 30, 2012 is primarily attributable to a decrease in sales of Internetworking products and legacy products. The increase for the six months ended June 30, 2012 is primarily attributable to an increase in Internetworking product sales, partially offset by a decrease in sales of legacy products. Internetworking product sales attributable to Enterprise Networks were 91.1% of the division’s sales in the three and six months ended June 30, 2012, compared to 85.4% and 85.2% in the three and six months ended June 30, 2011. Legacy products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales decreased from 18.3% for the three months ended June 30, 2011 to 17.0% for the three months ended June 30, 2012 and increased from 19.1% for the six months ended June 30, 2011 to 21.8% for the six months ended June 30, 2012. International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, increased 128.9% from $23.4 million in the three months ended June 30, 2011 to $53.6 million in the three months ended June 30, 2012, and increased 100.7% from $35.8 million in the six months ended June 30, 2011 to $71.9 million in the six months ended June 30, 2012. International sales, as a percentage of total sales, increased from 12.7% for the three months ended June 30, 2011 to 29.1% for the three months ended June 30, 2012, and increased from 10.2% for the six months ended June 30, 2011 to 22.6% for the six months ended June 30, 2012. International sales increased in the three and six months ended June 30, 2012 compared to the three and six months ended June 30, 2011 primarily due to sales attributable to the acquired NSN BBA business and an increase in organic sales in Latin America. Carrier System product sales increased $14.5 million in the three months ended June 30, 2012 and decreased $1.0 million in the six months ended June 30, 2012 compared to the three and six months ended June 30, 2011. The increase for the three months ended June 30, 2012 is primarily due to a $29.0 million increase in Broadband Access product sales, partially offset by an $8.0 million decrease in Optical product sales and a $6.5 million decrease in legacy product sales. The decrease for the six months ended June 30, 2012 is primarily due to a $14.7 million decrease in Optical product sales and a $13.0 million decrease in legacy product sales. This decline was partially offset by the added sales of the NSN BBA business and an increase in sales of our Internetworking NTE products and organic Broadband Access products.
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Table of ContentsOur organic Broadband Access sales for the six months ended June 30, 2012 were impacted by a delay in both the start and ramp-up of orders during the first quarter of this year from one of our larger carrier customers due to a new systems implementation. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies. Business Networking product sales increased $0.9 million and $7.7 million in the three and six months ended June 30, 2012 compared to the three and six months ended June 30, 2011. The increase for the three months ended June 30, 2012 is primarily due to a $1.9 million increase in Interworking product sales across both divisions, partially offset by a $1.0 million decrease in legacy product sales. The increase for the six months ended June 30, 2012 is primarily due to a $10.0 million increase in Interworking product sales across both divisions, partially offset by a $2.3 million decrease in legacy product sales. The decrease in sales of traditional products is a result of customers shifting to newer technologies. Many of these newer technologies are integral to our Internetworking product area. Loop Access product sales decreased $15.6 million and $37.7 million in the three and six months ended June 30, 2012 compared to the three and six months ended June 30, 2011. The decrease for the three months ended June 30, 2012 is primarily due to a $14.6 million decrease in HDSL product sales. The decrease for the six months ended June 30, 2012 is primarily due to a $36.6 million decrease in HDSL product sales. COST OF SALES As a percentage of sales, cost of sales increased from 42.0% in the three months ended June 30, 2011 to 48.3% in the three months ended June 30, 2012 and increased from 41.2% in the six months ended June 30, 2011 to 46.9% in the six months ended June 30, 2012. This increase is primarily attributable to lower gross margins related to the recently acquired NSN BBA business, customer price movements to achieve market share position and higher warranty costs. Carrier Networks cost of sales, as a percent of division sales, increased from 41.9% in the three months ended June 30, 2011 to 48.4% in the three months ended June 30, 2012 and increased from 41.0% in the six months ended June 30, 2011 to 47.2% in the six months ended June 30, 2012. The increase in Carrier Networks cost of sales as a percentage of sales is primarily attributable to lower gross margins related to the recently acquired NSN BBA business, customer price movements to achieve market share position and higher warranty costs. Enterprise Networks cost of sales, as a percent of division sales, increased from 42.6% in the three months ended June 30, 2011 to 47.4% in the three months ended June 30, 2012 and increased from 42.2% in the six months ended June 30, 2011 to 45.7% in the six months ended June 30, 2012. The increase is primarily attributable to lower cost absorption due to the lower production volumes, customer price movements to achieve market share position, and the impact of cost allocations between divisions. 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 increased 16.2% from $30.9 million in the three months ended June 30, 2011 to $35.9 million in the three months ended June 30, 2012 and increased 14.2% from $60.5 million in the six months ended June 30, 2011 to $69.0 million in the six months ended June 30, 2012. The increase in selling, general and administrative expenses for the three and six month periods ended June 30, 2012 is primarily related to increases in staffing and fringe benefit costs due to increased headcount, including expenses and increased headcount related to the NSN BBA business acquired on May 4, 2012 and Bluesocket, Inc., which was acquired on August 4, 2011, professional services, legal services and travel expenses. The increases in professional services, legal services and travel expenses were primarily attributable to the acquired NSN BBA business. Selling, general and administrative expenses as a percentage of sales increased from 16.8% in the three months ended June 30, 2011 to 19.5% in the three months ended June 30, 2012 and increased from 17.3% in the six months ended June 30, 2011 to 21.7% in the six months ended June 30, 2012. 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.
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Table of ContentsRESEARCH AND DEVELOPMENT EXPENSES Research and development expenses increased 31.8% from $24.6 million in the three months ended June 30, 2011 to $32.5 million in the three months ended June 30, 2012 and increased 18.6% from $48.3 million in the six months ended June 30, 2011 to $57.3 million in the six months ended June 30, 2012. The increase in research and development expenses for the three and six months ended June 30, 2012 is primarily related to increases in staffing and fringe benefit costs due to increased headcount, including expenses and increased headcount related to the NSN BBA business acquired on May 4, 2012 and Bluesocket, Inc., which was acquired on August 4, 2011, and amortization of acquired intangible assets related to both acquisitions. As a percentage of sales, research and development expenses increased from 13.4% in the three months ended June 30, 2011 to 17.6% in the three months ended June 30, 2012 and increased from 13.8% in the six months ended June 30, 2011 to 18.0% in the six months ended June 30, 2012. 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 decreased 3.8% from $2.0 million in the three months ended June 30, 2011 to $1.9 million in the three months ended June 30, 2012 and was flat at $3.8 million for the six months ended June 30, 2011 and June 30, 2012. The decrease for the three months ended June 30, 2012 is primarily driven by a 6.6% reduction in the average rate of return on our investments as a result of lower interest rates, partially offset by a 13.2% increase in our average investment balances. 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 June 30, 2012 and 2011 and $1.2 million in each of the six months ended June 30, 2012 and 2011, respectively. See “Liquidity and Capital Resources” below for additional information on our revenue bond. NET REALIZED INVESTMENT GAIN Net realized investment gain decreased 30.1% from $3.4 million in the three months ended June 30, 2011 to $2.4 million in the three months ended June 30, 2012 and decreased 21.4% from $6.1 million in the six months ended June 30, 2011 to $4.8 million in the six months ended June 30, 2012. The higher amount of realized gains in the period ended June 30, 2011 is primarily driven by the sales of previously impaired assets in the deferred compensation plans and sales of other equity securities. 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 expense in the three months ended June 30, 2011 to $0.5 million of income in the three months ended June 30, 2012 and changed from $0.2 million of expense in the six months ended June 30, 2011 to $0.6 million of income in the six months ended June 30, 2012. INCOME TAXES Our effective tax rate increased from 32.5% in the six months ended June 30, 2011 to 35.6% in the six months ended June 30, 2012. The tax provision rate in the six months ended June 30, 2012 did not include the benefit of the research tax credit, which expired on December 31, 2011. The exclusion of this benefit during the six months ended June 30, 2012 resulted in a 2.2 percentage point increase in our effective tax rate. Also, decreased benefits from a lower volume of stock option exercises in the six months ended June 30, 2012 resulted in a 1.4 percentage point increase in our effective tax rate. Finally, the closure of an audit resulted in a 0.4 percentage point decrease in our effective tax rate for the six months ended June 30, 2012.
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Table of ContentsDuring the three months ended June 30, 2012, we acquired the NSN BBA business, which resulted in a bargain purchase gain reported on the income statement. The bargain purchase gain is presented net of tax in the income statement and a deferred tax liability was established in the opening balance sheet for the acquired entity. NET INCOME As a result of the above factors, net income decreased $15.9 million from $36.9 million in the three months ended June 30, 2011 to $21.1 million in the three months ended June 30, 2012 and decreased $37.2 million from $71.2 million in the six months ended June 30, 2011 to $34.0 million in the six months ended June 30, 2012. As a percentage of sales, net income decreased from 20.1% in the three months ended June 30, 2011 to 11.5% in the three months ended June 30, 2012 and decreased from 20.4% in the six months ended June 30, 2011 to 10.7% in the six months ended June 30, 2012. 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 June 30, 2012, cash on hand was $37.0 million and short-term investments were $169.4 million, which resulted in available short-term liquidity of $206.4 million. At December 31, 2011, our cash on hand of $43.0 million and short-term investments of $159.3 million resulted in available short-term liquidity of $202.3 million. The increase in short-term liquidity from December 31, 2011 to June 30, 2012 primarily reflects funds provided by our operating activities, proceeds from stock option exercises and cash received from NSN as a result of our acquisition of the NSN BBA business, offset by an increase in the purchase of long-term investments, equipment acquisitions and dividends. Operating Activities Our working capital, which consists of current assets less current liabilities, increased 3.6% from $329.3 million as of December 31, 2011 to $341.1 million as of June 30, 2012. The quick ratio, defined as cash, cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, decreased from 4.50 as of December 31, 2011 to 2.87 as of June 30, 2012. The current ratio, defined as current assets divided by current liabilities, decreased from 6.32 as of December 31, 2011 to 4.01 as of June 30, 2012. The increase in our working capital and decreases in the quick ratio and the current ratio are primarily attributable to changes in the underlying assets and liabilities, including deferred revenue balances, relating to the acquired NSN BBA business. Net accounts receivable increased 55.7% from $76.1 million at December 31, 2011 to $118.5 million at June 30, 2012. Our allowance for doubtful accounts was $8 thousand at December 31, 2011 and $5 thousand at June 30, 2012. Quarterly accounts receivable days sales outstanding (DSO) increased from 40 days as of December 31, 2011 to 59 days as of June 30, 2012. Net accounts receivable and DSO increased for the quarter ended June 30, 2012 due to trade receivables incurred during the months of May and June in the acquired NSN BBA business and the timing of shipments in the organic business during the quarter. Other receivables decreased from $9.7 million at December 31, 2011 to $8.1 million at June 30, 2012. Generally, the change in other receivables is due to the timing of shipments and payments received for raw materials supplied to our contract manufacturers. Quarterly inventory turnover increased from 3.5 turns as of December 31, 2011 to 3.6 turns as of June 30, 2012. Inventory increased 18.2% from December 31, 2011 to June 30, 2012. The increase in inventory is primarily attributable to inventories acquired during the acquisition of the NSN BBA business. 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.
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Table of ContentsAccounts payable increased 59.8% from $29.4 million at December 31, 2011 to $47.0 million at June 30, 2012. The increase in accounts payable is primarily attributable to accounts payable incurred during the months of May and June in the acquired NSN BBA business. Additionally, 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 $7.8 million and $6.3 million for the six months ended June 30, 2012 and 2011, respectively. These expenditures were primarily used to purchase manufacturing and test equipment and computer software and hardware. On May 4, 2012, we acquired the 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 received a cash payment of $7.5 million from NSN and recorded a bargain purchase gain of $1.8 million, net of income taxes, subject to customary working capital adjustments between the parties. Our combined short-term and long-term investments increased $26.5 million from $491.4 million at December 31, 2011 to $517.9 million at June 30, 2012. 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 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 June 30, 2012 these investments included municipal variable rate demand notes of $46.8 million, municipal fixed-rate bonds of $189.5 million and corporate bonds of $183.7 million. At December 31, 2011, these investments included municipal variable rate demand notes of $69.7 million, municipal fixed-rate bonds of $174.8 million and corporate bonds of $156.8 million. As of June 30, 2012, 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 0.97 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 increased 4.9% from $332.0 million at December 31, 2011 to $348.4 million at June 30, 2012. The primary reason for the increase in our long-term investments during 2012 was cash generated from operations. Long-term investments at June 30, 2012 and December 31, 2011 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 $18.1 million and $12.8 million, and with a fair value of $35.9 million and $31.3 million, at June 30, 2012 and December 31, 2011, respectively. Long-term investments at June 30, 2012 also include $10.8 million related to our deferred compensation plans; $2.1 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; and $0.8 million of a fixed income bond fund. 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 $33 thousand during the six months ended June 30, 2012 related to eight marketable equity securities. For the six months ended June 30, 2011, we recorded an other-than-temporary impairment charge of $12 thousand related to three marketable equity securities.
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Table of ContentsFinancing 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 six months ended June 30, 2012, we paid dividends totaling $11.5 million. Debt We have amounts outstanding under loans made pursuant to an Alabama State Industrial Development Authority revenue bond (the Bond) which totaled $47.0 million at June 30, 2012 and December 31, 2011. At June 30, 2012, the estimated fair value of the Bond was approximately $48.4 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 June 30, 2012 and December 31, 2011, 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 June 30, 2012. 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 six months ended June 30, 2012, we repurchased 0.5 million shares of our common stock at an average price of $29.51 per share. We have the authority to purchase an additional 5.4 million shares of our common stock under plans approved by the Board of Directors on April 14, 2008 and October 11, 2011. Stock Option Exercises To accommodate employee stock option exercises, we issued 0.2 million shares of treasury stock for $4.3 million during the six months ended June 30, 2012. During the six months ended June 30, 2011, we issued 1.7 million shares of treasury stock for $33.0 million. 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 six months ended June 30, 2012, 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, 2011 filed on February 29, 2012 with the SEC. 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 June 30, 2012, of which $7.7 million has been applied to these commitments.
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Table of ContentsFACTORS 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, 2011, filed on February 29, 2012 with the SEC. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in interest 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 June 30, 2012, $30.8 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. As of June 30, 2012, approximately $427.5 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 June 30, 2012, we held $165.0 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 June 30, 2012 would reduce annualized interest income on our cash and investments by approximately $0.7 million. In addition, we held $356.8 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 June 30, 2012 would reduce the fair value of our municipal fixed-rate bonds and corporate bonds by approximately $1.7 million. As of June 30, 2011, approximately $437.9 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 June 30, 2011 would have reduced annualized interest income on our cash, money market instruments and municipal variable rate demand notes by approximately $0.2 million. In addition, a hypothetical 50 bps increase in interest rates as of June 30, 2011 would have reduced the fair value of our municipal fixed-rate bonds and corporate bonds by approximately $3.0 million. For further information about the fair value of our available-for-sale investments as of June 30, 2012 see Note 6 of Notes to Consolidated Financial Statements.
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Table of ContentsITEM 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. 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, 2011, filed on February 29, 2012 with the SEC. 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:
On April 14, 2008, our Board of Directors approved additional repurchases of up to 5,000,000 shares of our common stock. This plan will be implemented through open market purchases from time to time as conditions warrant. On October 11, 2011, our Board of Directors approved additional repurchases of up to 5,000,000 shares of our common stock. Upon completion of the current plan, this plan will be implemented through open market purchases from time to time as conditions warrant.
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Table of ContentsExhibits.
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Table of ContentsPursuant 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.
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