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ADTN > SEC Filings for ADTN > Form 10-Q on 5-Nov-2012All Recent SEC Filings

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Form 10-Q for ADTRAN INC


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this document.

OVERVIEW

ADTRAN, Inc. designs, manufactures and markets solutions and provides services and support for communications networks. Our solutions are widely deployed by providers of communications services (serviced by our Carrier Networks Division), and small 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 $162.1 million and $480.9 million for the three and nine months ended September 30, 2012 compared to $192.2 million and $541.9 million for the three and nine months ended September 30, 2011. Product revenues for our three primary growth areas, Broadband Access, Optical Access and Internetworking, were $141.0 million and $400.7 million for the three and nine months ended September 30, 2012 compared to $151.8 million and $389.4 million for the three and nine months ended September 30, 2011. Our gross margin decreased to 49.3% and 51.8% for the three and nine months ended September 30, 2012 from 57.0% and 58.1% for the three and nine months ended September 30, 2011. Our operating income margin decreased to 6.3% and 11.1% for the three and nine months ended September 30, 2012 from 26.6% and 27.3% for the three and nine months ended September 30, 2011. Net income was $9.3 million and $43.3 million for the three and nine months ended September 30, 2012 compared to $36.2 million and $107.4 million for the three and nine months ended September 30, 2011. Our effective tax rate decreased to 32.4% for the three months ended September 30, 2012 from 34.6% for the three months ended September 30, 2011 and increased to 34.9% for the nine months ended September 30, 2012 from 33.2% for the nine months ended September 30, 2011. Earnings per share, assuming dilution, were $0.15 and $0.68 for the three and nine months ended September 30, 2012 compared to $0.56 and $1.63 for the three and nine months ended September 30, 2011.


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Our operating results have fluctuated on a quarterly basis in the past, and may vary significantly in future periods due to a number of factors, including customer order activity and backlog. Backlog levels vary because of seasonal trends, the timing of customer projects and other factors that affect customer order lead times. Many of our customers require prompt delivery of products. This requires us to maintain sufficient inventory levels to satisfy anticipated customer demand. If near-term demand for our products declines, or if potential sales in any quarter do not occur as anticipated, our financial results could be adversely affected. Operating expenses are relatively fixed in the short term; therefore, a shortfall in quarterly revenues could significantly impact our financial results in a given quarter.

Our operating results may also fluctuate as a result of a number of other factors, including a decline in general economic and market conditions, increased competition, customer order patterns, changes in product 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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ACQUISITION 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 nine months ended September 30,
2012 and 2011 for both transactions are as follows:



                                                       Three Months                 Nine Months
                                                           Ended                       Ended
                                                       September 30,               September 30,
                                                    2012          2011           2012          2011
Bluesocket, Inc. acquisition
Amortization of acquired intangible assets         $   268       $   198       $    753       $   198
Amortization of other purchase accounting
adjustments                                             37           217            414           217
Acquisition related professional fees, travel
and other expenses                                      -            630             -            630

Subtotal                                               305         1,045          1,167         1,045

NSN BBA acquisition
Amortization of acquired intangible assets             300            -             472            -
Amortization of other purchase accounting
adjustments                                            666            -           1,718            -
Acquisition related professional fees, travel
and other expenses                                     252           931          4,537           992

Subtotal                                             1,218           931          6,727           992

Total acquisition related expenses,
amortizations and adjustments                        1,523         1,976          7,894         2,037
Tax effect                                            (496 )        (751 )       (2,660 )        (776 )

Total acquisition related expenses,
amortizations and adjustments, net of tax          $ 1,027       $ 1,225       $  5,234       $ 1,261


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The acquisition related expenses, amortizations and adjustments above were recorded in the following Consolidated Statements of Income categories for the three and nine months ended September 30, 2012 and 2011:

                                                    Three Months Ended             Nine Months Ended
                                                      September 30,                  September 30,
                                                   2012            2011           2012           2011
Revenue (adjustments to deferred revenue
recognized in the period)                        $     497        $   155       $   1,151       $   155
Cost of goods sold                                     126             66             932            66

Subtotal                                               623            221           2,083           221

Selling, general and administrative expenses           258          1,374           4,180         1,424
Research and development expenses                      642            381           1,631           392

Subtotal                                               900          1,755           5,811         1,816

Total acquisition related expenses,
amortizations and adjustments                        1,523          1,976           7,894         2,037
Tax effect                                            (496 )         (751 )        (2,660 )        (776 )

Total acquisition related expenses,
amortizations and adjustments, net of tax        $   1,027        $ 1,225       $   5,234       $ 1,261

RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011

SALES

ADTRAN's sales decreased 15.6% from $192.2 million in the three months ended September 30, 2011 to $162.1 million in the three months ended September 30, 2012, and decreased 11.3% from $541.9 million in the nine months ended September 30, 2011 to $480.9 million in the nine months ended September 30, 2012. The decrease in sales for the three months ended September 30, 2012 is primarily attributable to a $19.3 million decrease in sales of our HDSL and other legacy products, an $11.1 million decrease in sales of our Optical products, and a $7.1 million decrease in sales of our Internetworking products, partially offset by a $7.5 million increase in sales of our Broadband Access products. The decrease in sales for the nine months ended September 30, 2012 is primarily attributable to a $72.4 million decrease in sales of our HDSL and other legacy products, a $25.8 million decrease in sales of our Optical products, partially offset by a $34.2 million increase in sales of our Broadband Access products and a $2.9 million increase in sales of our Internetworking products.

Carrier Networks sales decreased 13.5% from $152.5 million in the three months ended September 30, 2011 to $131.9 million in the three months ended September 30, 2012, and decreased 12.4% from $435.3 million in the nine months ended September 30, 2011 to $381.3 in the nine months ended September 30, 2012. The decrease in sales for the three and nine months ended September 30, 2012 is primarily attributable to decreases in sales of Optical products, HDSL and other legacy products. These declines were partially offset by the added sales of the NSN BBA business and an increase in sales of our Internetworking NTE products. Our organic Broadband Access sales for the nine months ended September 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 and significant project delays at another customer. The decrease in Optical products for the three and nine months ended September 30, 2012 is primarily attributable to the market transitioning to Ethernet and our transition to new products to address this market. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies, but was larger than anticipated due to a large carrier customer that initiated a significant acceleration of their installed inventory reuse program.


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Enterprise Networks sales decreased 24.0% from $39.7 million in the three months ended September 30, 2011 to $30.2 million in the three months ended September 30, 2012, and decreased 6.6% from $106.6 million in the nine months ended September 30, 2011 to $99.6 million in the nine months ended September 30, 2012. The decrease for the three and nine months ended September 30, 2012 is primarily attributable to decreases in sales of Internetworking products and legacy products. The decrease in Internetworking product sales for the three and nine months ended September, 30, 2012, is primarily due to uncertainties caused by the macro-economic environment, which resulted in delays in end-customer purchases. The impact of this environment was partially offset by market share gains in the competitive service provider markets, value-added reseller recruitment, and by the addition of our vWLAN solutions. Internetworking product sales attributable to Enterprise Networks were 92.3% and 91.5% of the division's sales in the three and nine months ended September 30, 2012, compared to 88.6% and 86.6% in the three and nine months ended September 30, 2011. Legacy products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales decreased from 20.7% for the three months ended September 30, 2011 to 18.6% for the three months ended September 30, 2012 and increased from 19.7% for the nine months ended September 30, 2011 to 20.7% for the nine months ended September 30, 2012.

International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, increased 124.9% from $21.9 million in the three months ended September 30, 2011 to $49.2 million in the three months ended September 30, 2012, and increased 109.9% from $57.7 million in the nine months ended September 30, 2011 to $121.1 million in the nine months ended September 30, 2012. International sales, as a percentage of total sales, increased from 11.4% for the three months ended September 30, 2011 to 30.3% for the three months ended September 30, 2012, and increased from 10.6% for the nine months ended September 30, 2011 to 25.2% for the nine months ended September 30, 2012. International sales increased in the three and nine months ended September 30, 2012 compared to the three and nine months ended September 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 decreased $8.4 million and $9.4 million in the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011. The decrease for the three months ended September 30, 2012 is primarily due to an $11.1 million decrease in Optical product sales and a $4.8 million decrease in legacy product sales, partially offset by an increase of $7.5 million in Broadband Access product sales. The decrease for the nine months ended September 30, 2012 is primarily due to a $25.8 million decrease in Optical product sales and a $17.8 million decrease in legacy product sales, partially offset by an increase of $34.2 million in Broadband Access product sales. The decrease in Optical products for the three and nine months ended September 30, 2012 is primarily attributable to the market transitioning to Ethernet and our transition to new products to address this market. The increase in Broadband Access was due to the added sales of the NSN BBA business, partially offset by a decline in organic Broadband Access sales. Our organic Broadband Access sales for the nine months ended September 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 and significant project delays at another customer.

Business Networking product sales decreased $8.3 million and $0.6 million in the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011. The decrease for the three months ended September 30, 2012 is primarily due to a $7.1 million decrease in Interworking product sales across both divisions and a $1.2 million decrease in legacy product sales. The decrease for the nine months ended September 30, 2012 is primarily due to a $3.4 million decrease in legacy product sales, partially offset by a $2.9 million increase in Interworking product sales across both divisions. 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 $13.3 million and $51.0 million in the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011. The decrease for the three months ended September 30, 2012 is primarily due to a $12.4 million decrease in HDSL product sales. The decrease for the nine months ended September 30, 2012 is primarily due to a $48.9 million decrease in HDSL product sales. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies, but was larger than anticipated due to a large carrier customer that initiated a significant acceleration of their installed inventory reuse program.


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COST OF SALES

As a percentage of sales, cost of sales increased from 43.0% in the three months ended September 30, 2011 to 50.7% in the three months ended September 30, 2012 and increased from 41.9% in the nine months ended September 30, 2011 to 48.2% in the nine months ended September 30, 2012. This increase is primarily attributable to lower gross margins related to the recently acquired NSN BBA business, lower cost absorption due to the lower production volumes and customer price movements to achieve market share position.

Carrier Networks cost of sales, as a percent of division sales, increased from 43.6% in the three months ended September 30, 2011 to 51.6% in the three months ended September 30, 2012 and increased from 41.9% in the nine months ended September 30, 2011 to 48.7% in the nine months ended September 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, lower cost absorption due to the lower production volumes and customer price movements to achieve market share position.

Enterprise Networks cost of sales, as a percent of division sales, increased from 40.7% in the three months ended September 30, 2011 to 46.5% in the three months ended September 30, 2012 and increased from 41.7% in the nine months ended September 30, 2011 to 45.9% in the nine months ended September 30, 2012. The increase is primarily attributable to lower cost absorption due to the lower production volumes and customer price movements to achieve market share position.

An important part of our strategy is to reduce the product cost of each succeeding product generation and then to lower the product's price based on the cost savings achieved. This may cause variations in our gross profit percentage due to timing differences between the recognition of cost reductions and the lowering of product selling prices.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses increased 8.4% from $31.5 million in the three months ended September 30, 2011 to $34.1 million in the three months ended September 30, 2012 and increased 12.2% from $91.9 million in the nine months ended September 30, 2011 to $103.1 million in the nine months ended September 30, 2012. The increase in selling, general and administrative expenses for the three month period ended September 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, travel expenses, and amortization of intangible assets related to the acquired NSN BBA business, partially offset by a decrease in professional services and legal services. The increase in selling, general and administrative expenses for the nine month periods ended September 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, travel expenses and amortization of intangible assets related to the acquired NSN BBA business. 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 16.4% in the three months ended September 30, 2011 to 21.0% in the three months ended September 30, 2012 and increased from 17.0% in the nine months ended September 30, 2011 to 21.4% in the nine months ended September 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.

RESEARCH AND DEVELOPMENT EXPENSES

Research and development expenses increased 32.3% from $26.9 million in the three months ended September 30, 2011 to $35.6 million in the three months ended September 30, 2012 and increased 23.5% from $75.2 million in the nine months ended September 30, 2011 to $92.8 million in the nine months ended September 30, 2012. The increase in research and development expenses for the three and nine months ended September 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, amortization of acquired intangible assets related to both acquisitions, increases in independent contractor expense and office lease expense.


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As a percentage of sales, research and development expenses increased from 14.0% in the three months ended September 30, 2011 to 21.9% in the three months ended September 30, 2012 and increased from 13.9% in the nine months ended September 30, 2011 to 19.3% in the nine months ended September 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 8.5% from $2.0 million in the three months ended September 30, 2011 to $1.9 million in the three months ended September 30, 2012 and decreased 3.1% from $5.8 million in the nine months ended September 30, 2011 to $5.7 million in the nine months ended September 30, 2012. The decrease for the three months ended September 30, 2012 is primarily driven by a 5.1% reduction in the average rate of return on our investments as a result of lower interest rates, partially offset by a 19.9% increase in our average investment balances. The decrease for the nine months ended September 30, 2012 is primarily driven by a 7.7% reduction in the average rate of return on our investments as a result of lower interest rates, partially offset by an 18.3% increase on 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 September 30, 2012 and 2011 and $1.8 million in each of the nine months ended September 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 15.2% from $3.0 million in the three months ended September 30, 2011 to $2.5 million in the three months ended September 30, 2012 and decreased 19.4% from $9.1 million in the nine months ended September 30, 2011 to $7.4 million in the nine months ended September 30, 2012. The higher amount of realized gains in the period ended September 30, 2011 is primarily driven by the sales of previously impaired assets in the deferred compensation plans and sales of other equity securities. In addition, for the . . .

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