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| ADTN > SEC Filings for ADTN > Form 10-Q on 4-Aug-2008 | All Recent SEC Filings |
4-Aug-2008
Quarterly Report
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, markets and services network access solutions for communications networks. Our solutions are widely deployed by providers of telecommunications services (serviced by our Carrier Networks Division), and small and mid-sized businesses and enterprises (serviced by our Enterprise Networks Division), and enable voice, data, video and Internet communications across copper, fiber and wireless networks. Many of these solutions are currently in use by every major United States service provider and many global ones, 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 Loop Access, Carrier Systems and Business Networking. Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications networks. Carrier Systems products are used by telecommunications service providers to provide last mile access in support of data, voice and video services to consumers and enterprises. Business Networking products provide enterprises access to telecommunication networks and facilitate networking capabilities for voice, data and video networks.
In addition, we identify sub-categories of product revenues, which we divide into growth products, representing our primary growth areas, and traditional products. Our growth products consist of broadband access and optical access products (included in Carrier Systems) and Internetworking products (included in Business Networking) and our traditional products include HDSL products (included in Loop Access) and other products. Many of our customers are migrating their networks to deliver higher bandwidth services by utilizing newer technologies. We believe that products in our primary growth areas position the Company well for this migration. We anticipate that revenues of many of our traditional products, including HDSL, may continue for years because of the time required for our customers to transition to newer technologies.
See Note 7 of Notes to Consolidated Financial Statements in this report for further information regarding these product categories.
Sales increased 6.1% and 7.3% for three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007 due to increased product sales in our three primary growth areas, Broadband Access, Optical Access and Internetworking. Total sales of products in these growth areas were $60.7 million and $115.4 million for the three and six months ended June 30, 2008 compared to $43.6 million and $81.6 million for the three and six months ended June 30, 2007. Our gross margin increased for the three months ended June 30, 2008 to 60.5% from 59.5% for the three months ended June 30, 2007, while remaining at 59.6% for both six month periods ended June 30, 2008 and 2007. Our operating margin increased to 25.5% for the three months ended June 30, 2008 from 22.5% for the three months ended June 30, 2007 and increased to 23.3% for the six months ended June 30, 2008 from 20.9% for the six months ended June 30, 2007. The increase in our operating margin is primarily the result of higher margins achieved on increased sales and lower selling, general and administrative costs in relation to these higher sales. Earnings per share, assuming dilution, were $0.34 and $0.60 for the three and six months ended June 30, 2008 compared to $0.28 and $0.52 for the three and six months ended June 30, 2007.
The results for the six months ended June 30, 2007 included a benefit of $0.9 million in "Provision for Income Taxes" primarily relating to closure of tax audits from prior years and also included a pre-tax life insurance benefit of $1.0 million. These two items increased earnings per share, assuming dilution, by approximately $0.02 in the six months ended June 30, 2007. The higher earnings per share for the three and six months ended June 30, 2008 compared to the same period in 2007 reflects higher net income as well as a lower weighted average number of shares outstanding in 2008 due to stock repurchases under the share repurchase plans approved by our Board of Directors.
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. We normally operate with very little order backlog. A majority of our sales in each quarter result from orders booked in that quarter and firm purchase orders released in that quarter by customers under agreements containing non-binding purchase commitments. Many of our customers require prompt delivery of products. This results in a limited backlog of orders for these products and 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. 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 such 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 impact our operating results in a given quarter.
Our operating results may also fluctuate as a result of a number of other factors, including increased competition, customer order patterns, changes in product mix, timing differences between price decreases and product cost reductions, product warranty returns, and announcements of new products by us or our competitors. 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 filed on February 28, 2008 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, 2007.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 to the 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 operation and financial condition, which is incorporated herein by reference.
RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED JUNE 30, 2008 COMPARED TO THREE AND SIX MONTHS ENDED JUNE 30, 2007
SALES
ADTRAN's sales increased 6.1% from $123.7 million in the three months ended June 30, 2007 to $131.2 million in the three months ended June 30, 2008, and increased 7.3% from $234.0 million in the six months ended June 30, 2007 to $251.1 million in the six months ended June 30, 2008.
The increase in sales for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 is primarily attributable to an $11.2 million increase in sales of our Carrier Systems products. Carrier Systems product sales increased due to an $11.1 million increase in Broadband Access product sales, primarily attributable to increased shipments of our 1100 series fiber-to-the-node products and Total Access 5000 products. Carrier Systems products sales also increased due to a $3.6 million increase in Optical Access product sales, resulting from increased shipments of our Opti-6100 products and market share gains across numerous customers including the top three U.S. carriers. Partially offsetting these increases in Carrier Systems product sales were decreases in shipments of traditional TDM products as customers shifted emphasis to newer technologies. Many of these newer technologies are integral to our Broadband Access and Optical Access product areas.
Business Networking product sales decreased $0.4 million in the three months ended June 30, 2008 compared to the three months ended June 30, 2007 primarily due to a decline in shipments of traditional IAD products as customers shifted to newer technologies. Many of these newer technologies are integral to our Internetworking product area, and Internetworking product sales increased $2.4 million in the three months ended June 30, 2008 compared to the three months ended June 30, 2007. The increase in Internetworking product sales is primarily a result of increased product shipments due to customers shifting to newer technologies and our efforts to improve our focus on addressing traditional enterprise channels and leveraging our carrier distribution channels.
Loop Access product sales decreased $3.3 million in the three months ended June 30, 2008 compared to the three months ended June 30, 2007 primarily due to a 2.1% or $1.0 million decrease in HDSL product revenues as well as declines in Enterprise T1 product sales and DDS product sales.
The increase in sales for the six months ended June 30, 2008 compared to the six months ended June 30, 2007 is primarily attributable to a $21.5 million increase in sales of our Broadband Access products, a $6.1 million increase in sales of our Optical Access products and a $6.2 million increase in sales of our Internetworking products. HDSL product revenues decreased 3.1% or $2.8 million and other traditional products decreased 22.4% or $13.9 million.
Carrier Networks sales increased 12.1% from $93.3 million in the three months ended June 30, 2007 to $104.6 million in the three months ended June 30, 2008. Carrier Networks sales increased 12.0% from $177.7 million in the six months ended June 30, 2007 to $199.1 million in the six months ended June 30, 2008. The increase in Carrier Networks sales for the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007 is primarily attributable to the aforementioned increases in Broadband Access and Optical Access products sales, partially offset by declines in HDSL and other TDM product sales.
Enterprise Networks sales decreased 12.5% from $30.4 million in the three months ended June 30, 2007 to $26.6 million in the three months ended June 30, 2008 and decreased 7.6% from $56.3 million in the six months ended June 30, 2007 to $52.0 million in the six months ended June 30, 2008. The decrease in Enterprise Network sales for the three and six month period of 2008 compared to the three and six month period of 2007 is primarily attributable to the aforementioned
declines in sales of traditional IAD products, Enterprise T1 products and DDS products, partially offset by increased sales of Internetworking products. Enterprise Networks sales as a percentage of total sales decreased from 24.6% for the three months ended June 30, 2007 to 20.3% for the three months ended June 30, 2008 and decreased from 24.0% for the six months ended June 30, 2007 to 20.7% for the six months ended June 30, 2008.
International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, decreased 6.0% from $8.3 million in the three months ended June 30, 2007 to $7.8 million in the three months ended June 30, 2008 and decreased 11.8% from $16.1 million in the six months ended June 30, 2007 to $14.2 million in the six months ended June 30, 2008. International sales, as a percentage of total sales, decreased from 6.7% for the three months ended June 30, 2007 to 5.9% for the three months ended June 30, 2008, and decreased from 6.9% for the six months ended June 30, 2007 to 5.7% for the six months ended June 30, 2008. International sales decreased in the three and six month periods of 2008 compared to the 2007 periods primarily due to a reduction in product shipments to the Asia Pacific region.
COST OF SALES
As a percentage of sales, cost of sales decreased from 40.5% in the three months ended June 30, 2007 to 39.5% in the three months ended June 30, 2008 and remained at 40.4% in both the six months ended June 30, 2007 and the six months ended June 30, 2008. The decrease in cost of sales as a percentage of sales for the three month period is primarily related to a more favorable product mix and lower manufacturing costs, primarily associated with a consistent order flow throughout the quarter that allowed us to more efficiently and effectively plan for shipments, lowering freight, labor and expediting costs.
Carrier Networks cost of sales, as a percent of division sales, decreased from 40.8% in the three months ended June 30, 2007 to 38.6% in the three months ended June 30, 2008 and decreased from 40.3% in the six months ended June 30, 2007 to 39.7% in the six months ended June 30, 2008. These decreases were primarily related to the more favorable product mix and lower cost of sales discussed above.
Enterprise Networks cost of sales, as a percent of division sales, increased from 39.7% in the three months ended June 30, 2007 to 42.9% in the three months ended June 30, 2008 and increased from 40.8% in the six months ended June 30, 2007 to 42.9% in the six months ended June 30, 2008. These increases were primarily related to the impact of lower sales volume on allocated cost of sales elements to the division.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased 1.9% from $26.2 million in the three months ended June 30, 2007 to $25.7 million in the three months ended June 30, 2008 and decreased 2.5% from $52.6 million in the six months ended June 30, 2007 to $51.3 million in the six months ended June 30, 2008. The decrease in selling, general and administrative expenses for the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007 is primarily related to a decrease in certain senior management compensation costs and, to a lesser extent, a reduction in stock option and other fringe benefit expenses.
Selling, general, and administrative expenses as a percentage of sales decreased from 21.2% in the three months ended June 30, 2007 to 19.6% in the three months ended June 30, 2008 and decreased from 22.5% in the six months ended June 30, 2007 to 20.4% in the six months ended June 30, 2008. These decreases are the result of higher sales in the current periods in relation to selling, general and administrative costs that are largely fixed.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased 3.6% from $19.5 million in the three months ended June 30, 2007 to $20.2 million in the three months ended June 30, 2008 and increased 5.0% from $37.9 million in the six months ended June 30, 2007 to $39.8 million in the six months ended June 30, 2008. The increase in research and development expenses primarily reflects increased staffing expense related to customer specific product development activities, as well as costs related to product approvals, primarily for one or more of the top three U.S. carriers.
As a percentage of sales, research and development expenses decreased from 15.8% in the three months ended June 30, 2007 to 15.4% in the three months ended June 30, 2008 and decreased from 16.2% in the six months ended June 30, 2007 to 15.8% in the six months ended June 30, 2008.
ADTRAN expects to continue to incur research and development expenses in connection with its new and existing products and its expansion into international markets. ADTRAN continually evaluates new product opportunities and engages in intensive research and product development efforts which provide for new product development, enhancement of existing products and product cost reductions. ADTRAN expenses all product research and development costs as incurred. As a result, ADTRAN may incur significant research and development expenses prior to the receipt of revenues from a major new product group or market expansion.
INTEREST AND DIVIDEND INCOME
Interest and dividend income decreased 26.7% from $3.0 million in the three months ended June 30, 2007 to $2.2 million in the three months ended June 30, 2008 and decreased 23.7% from $5.9 million in the six months ended June 30, 2007 to $4.5 million in the six months ended June 30, 2008. The decreases in interest and dividend income were driven primarily by a reduction in our investment balances as a result of our share repurchase activity and a reduction in interest rates.
INTEREST EXPENSE
Total interest expense increased slightly in the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007. Interest expense on our taxable revenue bond remained constant at $0.6 million in each of the three months ended June 30, 2008 and 2007, and $1.2 million in the six month periods ended June 30, 2008 and 2007. See "Liquidity and Capital Resources" below for additional information on our revenue bond.
NET REALIZED INVESTMENT GAIN (LOSS)
Net realized investment gain decreased from a $0.2 million gain in the three months ended June 30, 2007 to a $15 thousand loss in the three months ended June 30, 2008 and decreased from a $0.3 million gain in the six months ended June 30, 2007 to a $0.1 million loss in the six months ended June 30, 2008. These changes primarily resulted from an impairment charge of approximately $0.2 million for certain equity investments and from lower realized gains on investments. See Note 3 of Notes to Consolidated Financial Statements.
OTHER INCOME, NET
Other income, net, comprised primarily of miscellaneous income, gains and losses on foreign currency transactions, investment account management fees and scrap raw material sales, increased from $0.2 million in the three months ended June 30, 2007 to $0.3 million in the three months ended June 30, 2008 and remained at $0.5 million in the six months ended June 30, 2007 and 2008.
LIFE INSURANCE PROCEEDS
We realized a gain on life insurance proceeds of $1.0 million during the first quarter of 2007 as a result of the death of our co-founder and then Chairman of the Board, Mark Smith.
INCOME TAXES
Our effective tax rate increased from 35.2% in the three months ended June 30, 2007 to 36.6% in the three months ended June 30, 2008 and from 33.4% in the six months ended June 30, 2007 to 36.6% in the six months ended June 30, 2008. The lower effective tax rate in the first six months of 2007 included a benefit recorded in the first quarter of 2007 relating to the closure of tax audits from prior years, which resulted in approximately a 2.0 percentage point decrease in our effective tax rate. The effective tax rate for the first six months of 2008 was unusually high due to the delay in legislation extending research tax credits that expired December 31, 2007, which resulted in approximately a 2.0 percentage point increase in our effective tax rate assuming the same basis for research and development credits used in 2007. Federal legislation to extend research tax credits has been drafted, but we have no assurances regarding the outcome of this potential legislation.
NET INCOME
As a result of the above factors, net income increased $2.6 million from $19.8 million in the three months ended June 30, 2007 to $22.4 million in the three months ended June 30, 2008 and increased $2.7 million from $36.8 million in the six months ended June 30, 2007 to $39.5 million in the six months ended June 30, 2008.
As a percentage of sales, net income increased from 16.0% in the three months ended June 30, 2007 to 17.1% in the three months ended June 30, 2008 and remained at 15.7% in both six month periods ended June 30, 2007 and June 30, 2008.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
At June 30, 2008, cash on hand was $57.9 million and short-term investments were $120.9 million, which resulted in available short-term liquidity of $178.8 million. At December 31, 2007, our cash on hand of $13.9 million and short-term investments of $148.4 million resulted in available short-term liquidity of $162.3 million.
Operating Activities
Our working capital, which consists of current assets less current liabilities, increased 0.5% from $251.3 million as of December 31, 2007 to $252.6 million as of June 30, 2008. The quick ratio, defined as cash, cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, decreased from 5.41 as of December 31, 2007 to 4.70 as of June 30, 2008. The current ratio, defined as current assets divided by current liabilities, decreased from 6.83 as of December 31, 2007 to 5.92 as of June 30, 2008. We expect these liquidity ratios to fluctuate as revenues fluctuate and as our inventory, accounts receivable and income tax position change. The quick ratio and the current ratio decreased from 2007 to 2008 mainly due to a $4.5 million increase in income taxes payable in 2008.
Net accounts receivable decreased from $70.7 million at December 31, 2007 to $62.7 million at June 30, 2008. Our allowance for doubtful accounts was $0.1 million at December 31, 2007 and June 30, 2008. Quarterly accounts receivable days sales outstanding (DSO) decreased from 55 days as of December 31, 2007 to 43 days as of June 30, 2008. Net accounts receivables and DSO decreased for the quarter ended June 30, 2008 primarily because sales were recognized more evenly throughout the quarter and were therefore weighted less in the last month of the quarter compared to the quarter ended December 31, 2007.
Quarterly inventory turnover was 4.1 turns as of December 31, 2007 and 4.3 turns as of June 30, 2008. Inventory increased 2.6% from December 31, 2007 to June 30, 2008. We expect inventory levels to fluctuate as we attempt to maintain sufficient inventory to ensure competitive lead times while managing the risk of inventory obsolescence that may occur due to rapidly changing technology and customer demand.
Accounts payable increased 10.4% from $22.2 million at December 31, 2007 to $24.5 million at June 30, 2008. The lower balance at December 31, 2007 was primarily attributable to the timing of receipt and subsequent payment for finished product assemblies manufactured by our subcontractors. Generally, the change in accounts payable is due to variations in the timing of the receipt of supplies, inventory and services and our subsequent payments for these purchases.
At June 30, 2008, we had income taxes payable of $5.7 million primarily related to estimated tax payments for current year taxable income. At December 31, 2007, we had income taxes payable of $1.2 million.
Investing Activities
Capital expenditures totaled approximately $4.6 million and $3.8 million for the six months ended June 30, 2008 and 2007, respectively. These expenditures were primarily used to purchase computer hardware, software and manufacturing and test equipment.
Our combined short-term and long-term investments decreased $11.7 million from $255.7 million at December 31, 2007 to $244.0 million at June 30, 2008, primarily reflecting the impact of our treasury share repurchase program.
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, 2008, these investments included municipal variable rate demand notes of $40.6 million and municipal fixed-rate bonds of $129.4 million. At December 31, 2007, these investments included municipal variable rate demand notes of $47.5 million, municipal auction rate securities of $9.0 million and municipal fixed-rate bonds of $122.1 million.
Our municipal variable rate demand notes are classified as available-for-sale short-term investments and had a credit rating of A-1+ at June 30, 2008. Despite the long-term nature of their stated contractual maturities, we believe that we have the ability to quickly liquidate these securities. Our investments in these securities are recorded at fair value and the interest rates typically reset every seven, 28 or 35 days. As a result, we had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from these investments. All income generated from these investments was recorded as interest income. Further, we have not been required to record any losses relating to municipal variable rate demand notes or municipal auction rate securities, and we have held no municipal auction rate securities since February 7, 2008.
At June 30, 2008, approximately 41% of our municipal fixed-rate bonds had a credit rating of AAA, 57% had a credit rating of AA and the balance had a credit rating of A. These bonds are classified as available-for-sale investments and had an average duration of 0.8 years at June 30, 2008. 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 14.7% from $107.3 million at December 31, 2007 to $123.1 million at June 30, 2008. Municipal fixed-rate bonds classified as long-term investments increased $18.8 million from $30.2 million at December 31, 2007 to $49.0 million at June 30, 2008. Long-term investments at June 30, 2008 and December 31, 2007 included an investment in a certificate of deposit of $49.0 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 $16.4 million and $16.1 million, and with a fair value of $20.2 million and $22.9 million, at June 30, 2008 and December 31, 2007, . . .
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