Summary of ADTRAN INC - Yahoo! Finance

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this document.
OVERVIEW
ADTRAN, Inc. designs, manufactures, 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 Carrier Systems, Business Networking and Loop Access. 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. Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications 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 8 of Notes to Condensed Consolidated Financial Statements in this report for further information regarding these product categories.
Sales were $128.1 million and $360.0 million for the three and nine months ended September 30, 2009 compared to $137.2 million and $388.3 million for the three and nine months ended September 30, 2008. Product revenues for our three primary growth areas, Broadband Access, Optical Access and Internetworking, were $70.9 million and $184.4 million for the three and nine months ended September 30, 2009 compared to $58.9 million and $174.2 million for the three and nine months ended September 30, 2008. Our gross margin decreased for the three and nine months ended September 30, 2009 to 58.1% and 59.3% respectively, compared to 59.5% and 59.6% for the three and nine months ended September 30, 2008. Our operating margin decreased to 22.6% and 21.7% for the three and nine months ended September 30, 2009 from 24.5% and 23.8% for the three and nine months ended September 30, 2008. Net income was $21.6 million and $55.6 million for the three and nine months ended September 30, 2009 compared to $22.4 million and $61.9 million for the three and nine months ended September 30, 2008. Our effective tax rate decreased from 36.8% and 36.6% for the three and nine months ended September 30, 2008 to 30.4% and 30.6% for the three and nine months ended September 30, 2009.

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Earnings per share, assuming dilution, were $0.34 and $0.88 for the three and nine months ended September 30, 2009 compared to $0.35 and $0.95 for the three and nine months ended September 30, 2008. Earnings per share for the three and nine months ended September 30, 2009 compared to the same period in 2008 reflects a lower weighted average number of shares outstanding in 2009 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 our 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.
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. 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 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. 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, 2008, filed on February 27, 2009 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, 2008, filed on February 27, 2009 with the SEC.
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.

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RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008
SALES
ADTRAN's sales decreased 6.7% from $137.2 million in the three months ended September 30, 2008 to $128.1 million in the three months ended September 30, 2009, and decreased 7.3% from $388.3 million in the nine months ended September 30, 2008 to $360.0 million in the nine months ended September 30, 2009.
Carrier Networks sales decreased 7.3% from $106.4 million in the three months ended September 30, 2008 to $98.6 million in the three months ended September 30, 2009. Carrier Networks sales decreased 9.2% from $305.5 million in the nine months ended September 30, 2008 to $277.5 million in the nine months ended September 30, 2009. The decrease in Carrier Networks sales for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 is primarily attributable to decreases in sales of HDSL and other traditional TDM products, partially offset by increases in Broadband and Optical Access products. The decrease in Carrier Networks sales for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 is primarily attributable to decreases in sales of HDSL, DDS, and other traditional TDM products, partially offset by an increase in Optical Access products. Enterprise Networks sales decreased 4.5% from $30.8 million in the three months ended September 30, 2008 to $29.4 million in the three months ended September 30, 2009 and decreased 0.4% from $82.8 million in the nine months ended September 30, 2008 to $82.5 million in the nine months ended September 30, 2009. The decrease in Enterprise Networks sales for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 is primarily attributable to a decrease in traditional IAD and enterprise T1 products, partially offset by an increase in Internetworking products sales. The decrease in Enterprise Networks sales for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 is primarily attributable to a decrease in traditional IAD and enterprise T1 products, partially offset by an increase in Internetworking products sales. Internetworking product sales were 69.3% and 66.3% of Enterprise Network sales in the three and nine months ended September 30, 2009 compared with 59.5% and 58.3% in the three and nine months ended September 30, 2008. Traditional products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales increased from 22.4% for the three months ended September 30, 2008 to 23.0% for the three months ended September 30, 2009 and increased from 21.3% for the nine months ended September 30, 2008 to 22.9% for the nine months ended September 30, 2009. International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, decreased 15.0% from $7.8 million in the three months ended September 30, 2008 to $6.7 million in the three months ended September 30, 2009 and decreased 9.1% from $22.0 million in the nine months ended September 30, 2008 to $20.0 million in the nine months ended September 30, 2009. International sales, as a percentage of total sales, decreased from 5.7% for the three months ended September 30, 2008 to 5.2% for the three months ended September 30, 2009, and decreased from 5.7% for the nine months ended September 30, 2008 to 5.6% for the nine months ended September 30, 2009. International sales decreased in the three and nine month periods of 2009 compared to the 2008 periods due primarily to slowing macroeconomic conditions. Carrier Systems product sales increased $6.0 million in the three months ended September 30, 2009 compared to the three months ended September 30, 2008 primarily due to increases in Broadband and Optical Access products, partially offset by decreases in traditional TDM products. Carrier Systems product sales decreased $4.0 million in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 primarily due to decreases in sales of traditional TDM products, partially offset by an increase in Optical Access products.
Business Networking product sales increased $0.7 million and $4.4 million in the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008 primarily due to an increase in sales of Internetworking products, partially offset by a decrease in sales of traditional IAD products.
Loop Access product sales decreased $15.9 million and $28.8 million in the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008 primarily due to decreases in sales of HDSL, DDS, enterprise T1 products, and wireless products.

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COST OF SALES
As a percentage of sales, cost of sales increased from 40.5% in the three months ended September 30, 2008 to 41.9% in the three months ended September 30, 2009 and increased from 40.4% in the nine months ended September 30, 2008 to 40.7% in the nine months ended September 30, 2009. The increases for the three and nine month periods ended September 30, 2009 were primarily related to costs incurred to expedite delivery of materials and costs related to a new product release, which were partially offset by cost reductions generated through improved manufacturing efficiencies.
Carrier Networks cost of sales, as a percent of division sales, increased from 40.3% in the three months ended September 30, 2008 to 42.5% in the three months ended September 30, 2009 and increased from 39.9% in the nine months ended September 30, 2008 to 40.7% in the nine months ended September 30, 2009. The increases for the three and nine month periods ended September 30, 2009 were primarily related to costs incurred to expedite delivery of materials and costs related to a new product release.
Enterprise Networks cost of sales, as a percent of division sales, decreased from 41.1% in the three months ended September 30, 2008 to 39.7% in the three months ended September 30, 2009 and decreased from 42.3% in the nine months ended September 30, 2008 to 40.4% in the nine months ended September 30, 2009. These decreases for the three and nine month periods ended September 30, 2009 were primarily related to lower production costs.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses decreased 5.0% from $26.3 million in the three months ended September 30, 2008 to $25.0 million in the three months ended September 30, 2009 and decreased 5.1% from $77.6 million in the nine months ended September 30, 2008 to $73.6 million in the nine months ended September 30, 2009. The decrease in selling, general, and administrative expenses for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008 is primarily related to a reduction in discretionary expenditures including temporary labor, travel, and various promotional expenses.
Selling, general, and administrative expenses as a percentage of sales increased from 19.2% in the three months ended September 30, 2008 to 19.5% in the three months ended September 30, 2009 and increased from 20.0% in the nine months ended September 30, 2008 to 20.4% in the nine months ended September 30, 2009, due primarily to a decrease in sales.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses decreased 5.5% from $21.7 million in the three months ended September 30, 2008 to $20.5 million in the three months ended September 30, 2009 and increased 0.9% from $61.5 million in the nine months ended September 30, 2008 to $62.0 million in the nine months ended September 30, 2009. The decrease in research and development expenses for the three months ended September 30, 2009 compared to September 30, 2008 primarily reflects lower employee benefits costs and lower design and testing costs. The increase in research and development expenses for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 primarily reflects increased staffing, engineering and testing expense primarily 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 increased from 15.8% in the three months ended September 30, 2008 to 16.0% in the three months ended September 30, 2009 and increased from 15.8% in the nine months ended September 30, 2008 to 17.2% in the nine months ended September 30, 2009. 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.

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INTEREST AND DIVIDEND INCOME
Interest and dividend income decreased 17.8% from $2.2 million in the three months ended September 30, 2008 to $1.8 million in the three months ended September 30, 2009 and decreased 21.2% from $6.7 million in the nine months ended September 30, 2008 to $5.3 million in the nine months ended September 30, 2009. The decrease is primarily driven by a 57% reduction in the average rate of return on our investments for the nine month period of 2009 compared to 2008 as a result of lower interest rates, partially offset by a 38% increase in our average investment balances.
INTEREST EXPENSE
Interest expense, which is primarily related to our taxable revenue bond, remained relatively constant at $0.6 million for the three months ended September 30, 2008 and 2009 and $1.9 million and $1.8 million for the nine months ended September 30, 2008 and September 30, 2009, respectively. See "Liquidity and Capital Resources" below for additional information on our revenue bond.
NET REALIZED INVESTMENT GAIN (LOSS)
Net realized investment gain (loss) changed from a $47 thousand loss in the three months ended September 30, 2008 to a $0.8 million gain in the three months ended September 30, 2009 and increased from a $0.2 million loss in the nine months ended September 30, 2008 to a $1.4 million loss in the nine months ended September 30, 2009. See "Investing Activities" in "Liquidity and Capital Resources" below for additional information.
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, decreased from $0.2 million in the three months ended September 30, 2008 to $0.1 million in the three months ended September 30, 2009 and decreased from $0.7 million in the nine months ended September 30, 2008 to $72 thousand in the nine months ended September 30, 2009.
INCOME TAXES
Our effective tax rate decreased from 36.8% in the three months ended September 30, 2008 to 30.4% in the three months ended September 30, 2009 and from 36.6% in the nine months ended September 30, 2008 to 30.6% in the nine months ended September 30, 2009. During the first quarter of 2009, we completed a review of our estimated tax deductions for the years 2005, 2006, and 2007 relating to the deduction for manufacturer's domestic production activities concerning the domestic content of the products that we manufacture, under Internal Revenue Code Section 199. This review resulted in a $1.7 million benefit for the first nine months of 2009, or a 2.1 percentage point decrease in our effective tax rate in the first nine months of 2009. Amended income tax returns were filed during the first quarter of 2009 in association with this benefit. This review also resulted in a higher domestic content deduction for the nine months ended September 30, 2009, which resulted in an additional 0.8 percentage point decrease in our effective tax rate in the first nine months of 2009. The tax provision for the first nine months of 2009 also included the benefit from the research and development tax credit. The tax provision rate for the first nine months of 2008 did not include the benefit from the research and development tax credit which had expired as of December 31, 2007. Legislation to extend the research and development tax credits to the tax years 2008 and 2009 was signed into law on October 3, 2008. The exclusion of the benefit from the research and development tax credits resulted in approximately a 2.0 percentage point increase in our effective tax rate in the first nine months of 2008.
NET INCOME
As a result of the above factors, net income decreased $0.8 million from $22.4 million in the three months ended September 30, 2008 to $21.6 million in the three months ended September 30, 2009 and decreased $6.3 million from $61.9 million in the nine months ended September 30, 2008 to $55.6 million in the nine months ended September 30, 2009.
As a percentage of sales, net income increased from 16.3% in the three months ended September 30, 2008 to 16.9% in the three months ended September 30, 2009 and decreased from 15.9% in the nine months ended September 30, 2008 to 15.4% in the nine months ended September 30, 2009.

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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
At September 30, 2009, cash on hand was $25.2 million and short-term investments were $169.5 million, which resulted in available short-term liquidity of $194.7 million. At December 31, 2008, our cash on hand of $41.9 million and short-term investments of $96.3 million resulted in available short-term liquidity of $138.2 million. The increase in liquidity from December 31, 2008 to September 30, 2009 primarily reflects an increase in investments of variable rate demand notes purchased as a result of cash generated from operations. Operating Activities
Our working capital, which consists of current assets less current liabilities, increased 26.8% from $212.7 million as of December 31, 2008 to $269.7 million as of September 30, 2009. The quick ratio, defined as cash, cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, increased from 4.76 as of December 31, 2008 to 5.14 as of September 30, 2009. The current ratio, defined as current assets divided by current liabilities, increased from 6.30 as of December 31, 2008 to 6.33 as of September 30, 2009. The quick ratio and the current ratio increased primarily due to an increase in short-term investments of $73.2 million.
Net accounts receivable increased 23.8% from $52.7 million at December 31, 2008 to $65.3 million at September 30, 2009. Our allowance for doubtful accounts was $38 thousand at December 31, 2008 and $46 thousand at September 30, 2009. Quarterly accounts receivable days sales outstanding (DSO) increased from 43 days as of December 31, 2008 to 47 days as of September 30, 2009. Net accounts receivable and DSO increased for the quarter ended September 30, 2009 due to the timing of sales during the quarter.
Quarterly inventory turnover increased from 3.8 turns as of December 31, 2008 to 4.6 turns as of September 30, 2009. Inventory decreased 5.7% from December 31, 2008 to September 30, 2009. 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 28.7% from $20.3 million at December 31, 2008 to $26.1 million at September 30, 2009. 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. Investing Activities
Capital expenditures totaled approximately $6.7 million and $7.0 million for the nine months ended September 30, 2009 and 2008, respectively. These expenditures were primarily used to purchase manufacturing equipment, test equipment, computer software, and computer hardware.
Our combined short-term and long-term investments increased $90.8 million from $237.5 million at December 31, 2008 to $328.3 million at September 30, 2009, primarily reflecting our investment of cash generated from operations. We invest all available cash not required for immediate use in operations primarily in securities that we believe bear minimal risk of loss. At September 30, 2009, these investments included municipal variable rate demand notes of $88.0 million, municipal fixed-rate bonds of $141.0 million and corporate bonds of $20.5 million that are guaranteed by the Federal Deposit Insurance Corporation (FDIC) and issued by various banks. At December 31, 2008, these investments included municipal variable rate demand notes of $52.6 million, municipal fixed-rate bonds of $116.9 million and a government agency security of $2.0 million.
Our municipal variable rate demand notes are classified as available-for-sale short-term investments and 95% had a credit rating of VMIG-1 or A-1+ with the remaining 5% rated A-2 at September 30, 2009. 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 reset every seven 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. We have not been required to record any losses relating to municipal variable rate demand notes.

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At September 30, 2009, approximately 54% of our municipal fixed-rate bond portfolio had a credit rating of AAA, 41% had a credit rating of AA, and the remaining 5% had a credit rating of A. These bonds are classified as available-for-sale investments and had an average duration of 1.0 years at September 30, 2009. 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.
At September 30, 2009, we held $20.5 million of corporate bonds issued by various banks that are guaranteed by the FDIC. These bonds are classified as available-for-sale and had an average duration of 2.4 years at September 30, 2009. All of these bonds had a credit rating of AAA at September 30, 2009. Because of the high quality and short duration of these issues, we are able to obtain prices for these bonds derived from observable market inputs on a daily basis.
Our long-term investments increased 12.5% from $141.2 million at December 31, 2008 to $158.9 million at September 30, 2009. The primary reason for the increase in our long-term investments during the first nine months of 2009 was a 453% increase in fair value of a single equity security. Long-term investments at September 30, 2009 and December 31, 2008 included an investment in a . . .