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ADTN > SEC Filings for ADTN > Form 10-Q on 7-May-2014All Recent SEC Filings

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Form 10-Q for ADTRAN INC


7-May-2014

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. is a leading global provider of networking and communications equipment. Our solutions enable voice, data, video and Internet communications across a variety of network infrastructures. These solutions are deployed by some of the world's largest service providers, distributed enterprises and small and medium-sized businesses, public and private enterprises, and millions of individual users 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. This category includes the following product areas and related services:

• Broadband Access

• Total Access® 5000 Multi-Service Access Node (MSAN)

• hiX family of MSANs

• Total Access 1100/1200 Series of Fiber to the Node (FTTN) products

• Ultra Broadband Ethernet (UBE)

• Digital Subscriber Line Access Multiplexer (DSLAM) products

• Optical

• Optical Networking Edge (ONE)

• NetVanta 8000 Series of Fiber Ethernet Access Devices (EAD)

• OPTI-6100 and Total Access 3000 optical Multi-Service Provisioning Platforms (MSPP)

• Pluggable Optical Products, including SFP, XFP, and SFP+

• TDM systems


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Business Networking products provide access to communication services and facilitate the delivery of cloud connectivity and enterprise communications to the small and mid-sized enterprise (SME) market. This category includes the following product areas and related services:

• Internetworking products

• Total Access IP Business Gateways

• Optical Network Terminals (ONTs)

• Bluesocket® virtual Wireless LAN (vWLAN®)

• NetVanta®

• Multiservice Routers

• Managed Ethernet Switches

• IP Business Gateways

• Unified Communications (UC) solutions

• Carrier Ethernet Network Terminating Equipment (NTE)

• Network Management Solutions

• Integrated Access Devices (IADs)

Loop Access products are used by carrier and enterprise customers for access to copper-based communications networks. The Loop Access category includes the following product areas and related services:

• High bit-rate Digital Subscriber Line (HDSL) products

• Digital Data Service (DDS)

• Integrated Services Digital Network (ISDN) products

• T1/E1/T3 Channel Service Units/Data Service Units (CSUs/DSUs)

• TRACER fixed-wireless products

In addition, we identify subcategories of product revenues, which we divide into core products and legacy products. Our core products consist of Broadband Access and Optical products (included in Carrier Systems) and Internetworking products (included in Business Networking). Our legacy products include HDSL products (included in Loop Access) and other products not included in the aforementioned core products. Many of our customers are migrating their networks to deliver higher bandwidth services by utilizing newer technologies. We believe that products and services offered in our core product areas position us well for this migration. Despite occasional increases, we anticipate that revenues of many of our legacy products, including HDSL, will decline over time; however, revenues from these products may continue for years because of the time required for our customers to transition to newer technologies.

See Note 11 of Notes to Consolidated Financial Statements in this report for further information regarding these product categories.

Sales were $147.0 million for the three months ended March 31, 2014 compared to $143.0 million for the three months ended March 31, 2013. Product revenues for our three core areas, Broadband Access, Optical and Internetworking, were $131.3 million for the three months ended March 31, 2014 compared to $118.0 million for the three months ended March 31, 2013. Our gross margin increased to 52.9% for the three months ended March 31, 2014 from 48.7% for the three months ended March 31, 2013. Our operating income margin increased to 7.7% for the three months ended March 31, 2014 from 4.6% for the three months ended March 31, 2013. Net income was $9.6 million for the three months ended March 31, 2014 compared to $7.9 million for the three months ended March 31, 2013. Our effective tax rate increased to 34.6% for the three months ended March 31, 2014 from 18.9% for the three months ended March 31, 2013. Earnings per share, assuming dilution, were $0.17 for the three months ended March 31, 2014 compared to $0.13 for the three months ended March 31, 2013.


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

Our operating results may also fluctuate as a result of a number of other factors, including a decline in general economic and market conditions, increased competition, customer order patterns, changes in product and services mix, timing differences between price decreases and product cost reductions, product warranty returns, expediting costs and announcements of new products by us or our competitors. Additionally, maintaining sufficient inventory levels to assure prompt delivery of our products increases the amount of inventory that may become obsolete and increases the risk that the obsolescence of this inventory may have an adverse effect on our business and operating results. Also, not maintaining sufficient inventory levels to assure prompt delivery of our products may cause us to incur expediting costs to meet customer delivery requirements, which may negatively impact our operating results in a given quarter.

Accordingly, our historical financial performance is not necessarily a meaningful indicator of future results, and, in general, management expects that our financial results may vary from period to period. A list of factors that could materially affect our business, financial condition or operating results is included under "Factors That Could Affect Our Future Results" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in Item 2 of Part I of this report. These factors have also been discussed in more detail in Item 1A of Part I in our most recent Annual Report on Form 10-K for the year ended December 31, 2013, filed on February 27, 2014 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, 2013, filed on February 27, 2014 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.

RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2014 COMPARED TO THREE MONTHS ENDED MARCH 31, 2013

SALES

ADTRAN's sales increased 2.8% from $143.0 million in the three months ended March 31, 2013 to $147.0 million in the three months ended March 31, 2014. The increase in sales is primarily attributable to a $9.3 million increase in sales of our Broadband Access products and a $3.9 million increase in sales of our Optical products, partially offset by a $9.3 million decrease in sales of our HDSL and other legacy products.


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Carrier Networks sales increased 7.5% from $109.9 million in the three months ended March 31, 2013 to $118.2 million in the three months ended March 31, 2014. The increase in sales for the three months ended March 31, 2014 is primarily attributable to increases in sales of our Broadband Access products, Optical products, and Internetworking products, partially offset by decreases in sales of our HDSL and other legacy products. The increase in sales of our Broadband Access products for the three months ended March 31, 2014 is primarily attributable to increases in hiX and FTTN product sales. The increase in sales of our Optical products for the three months ended March 31, 2014 is primarily attributable to increased shipments of optical products for broadband access and increased shipments of our OPTI-6100 products for wireless backhaul to a domestic tier 1 carrier. The increase in sales of our Internetworking products for the three months ended March 31, 2014 is primarily attributable to increases in Carrier Ethernet sales and FTTP ONT sales to carriers. The decrease in sales of HDSL and other legacy products for the three months ended March 31, 2014 has been expected as customers continue to upgrade their networks to deliver higher bandwidth services by migrating to newer technologies, including to our core products from our Broadband Access, Internetworking and Optical product lines. While we expect that revenues from HDSL and our other legacy products will continue to decline over time, these revenues may continue for years because of the time required for our customers to transition to newer technologies.

Enterprise Networks sales decreased 12.9% from $33.1 million in the three months ended March 31, 2013 to $28.8 million in the three months ended March 31, 2014. The decrease in sales for the three months ended March 31, 2014 is primarily attributable to decreases in sales of our Internetworking products and sales of our legacy products. The decrease in sales of our Internetworking products was primarily attributable to lower sales of products through service provider channels. The decrease in legacy products was expected and discussed further above. Internetworking product sales attributable to Enterprise Networks were 94.3% of the division's sales in the three months ended March 31, 2014, compared to 94.1% in the three months ended March 31, 2013. Legacy products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales decreased from 23.2% for the three months ended March 31, 2013 to 19.6% for the three months ended March 31, 2014.

International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, increased 55.6% from $34.9 million in the three months ended March 31, 2013 to $54.3 million in the three months ended March 31, 2014. International sales, as a percentage of total sales, increased from 24.4% for the three months ended March 31, 2013 to 36.9% for the three months ended March 31, 2014. International sales increased in the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to an increase in sales in the EMEA region and Latin America, partially offset by a decrease in sales in the Asia-Pacific region.

Carrier System product sales increased $6.7 million in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase for the three months ended March 31, 2014 is primarily attributable to a $9.3 million increase in Broadband Access product sales, a $3.9 million increase in Optical product sales, partially offset by a $6.5 million decrease in sales of our legacy products. The changes for the three months ended March 31, 2014 are primarily attributable to the factors discussed above.

Business Networking product sales decreased $0.2 million in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The decrease for the three months ended March 31, 2014 is primarily due to a $0.2 million decrease in legacy product sales. The changes for the three months ended March 31, 2014 are primarily attributable to the factors discussed above.

Loop Access product sales decreased $2.6 million in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The decrease for the three months ended March 31, 2014 is primarily due to a $2.5 million decrease in HDSL product sales, which is discussed further above.

COST OF SALES

As a percentage of sales, cost of sales decreased from 51.3% in the three months ended March 31, 2013 to 47.1% in the three months ended March 31, 2014. The decrease for the three months ended March 31, 2014 is primarily attributable to reduced manufacturing costs and favorable shifts in product mix.

Carrier Networks cost of sales, as a percent of division sales, decreased from 53.1% in the three months ended March 31, 2013 to 48.1% in the three months ended March 31, 2014. The decrease for the three months ended March 31, 2014 is primarily attributable to reduced manufacturing costs and favorable shifts in product mix.


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Enterprise Networks cost of sales, as a percent of division sales, decreased from 45.4% in the three months ended March 31, 2013 to 43.0% in the three months ended March 31, 2014. The decrease for the three months ended March 31, 2014 is primarily attributable to reduced manufacturing costs and favorable shifts in product mix.

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 10.9% from $30.6 million in the three months ended March 31, 2013 to $33.9 million in the three months ended March 31, 2014. The increase in selling, general and administrative expenses for the three months ended March 31, 2014 is primarily attributable to increases in compensation and fringe benefit costs, legal expenses, travel expenses and marketing expenses.

Selling, general and administrative expenses as a percentage of sales increased from 21.4% in the three months ended March 31, 2013 to 23.1% in the three months ended March 31, 2014. 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 remained constant at $32.5 million in the three months ended March 31, 2013 and $32.6 million in the three months ended March 31, 2014.

As a percentage of sales, research and development expenses decreased from 22.7% in the three months ended March 31, 2013 to 22.1% in the three months ended March 31, 2014. 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 26.8% from $1.8 million in the three months ended March 31, 2013 to $1.3 million in the three months ended March 31, 2014. The decrease in interest and dividend income is primarily attributable to a reduction in the average rate of return on our investments as well as a decrease in our average investment balances.

INTEREST EXPENSE

Interest expense, which is primarily related to our taxable revenue bond, decreased 60.9% from $0.6 million in the three months ended March 31, 2013 to $0.2 million in the three months ended March 31, 2014. The decrease is primarily attributable to a $16.5 million principal payment made on our taxable revenue bond during the quarter and a reduction in the interest rate of that bond from 5% to 2%. See "Liquidity and Capital Resources" below for additional information on our revenue bond.


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NET REALIZED INVESTMENT GAIN

Net realized investment gain decreased 39.9% from $3.6 million in the three months ended March 31, 2013 to $2.2 million in the three months ended March 31, 2014. The decrease in realized investment gains is primarily attributable to lower gains from the sale of equity securities compared to the same period in 2013. 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 $1.7 million of expense in the three months ended March 31, 2013 to $0.1 million of income in the three months ended March 31, 2014. This change was primarily attributable to losses on foreign currency transactions during the first quarter of 2013.

INCOME TAXES

Our effective tax rate increased from 18.9% in the three months ended March 31, 2013 to 34.6% in the three months ended March 31, 2014. The increase in the effective tax rate between the two periods is primarily attributable to the net effect of recording the benefit for the research tax credit for the 2012 tax year in January 2013 pursuant to the American Taxpayer Relief Act of 2012, and the inclusion of the benefit of the estimated 2013 research tax credit in the estimated annual effective rate for 2013. Additionally, the effective tax rate in the first quarter of 2014 did not include a benefit for the research tax credit, which expired on December 31, 2013. This increase was partially offset by the release of a valuation allowance attributable to a foreign subsidiary.

NET INCOME

As a result of the above factors, net income increased $1.7 million from $7.9 million in the three months ended March 31, 2013 to $9.6 million in the three months ended March 31, 2014.

As a percentage of sales, net income increased from 5.5% in the three months ended March 31, 2013 to 6.5% in the three months ended March 31, 2014.

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, shareholder dividends, 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 at least the next 12 months.

At March 31, 2014, cash on hand was $52.8 million and short-term investments were $89.2 million, which resulted in available short-term liquidity of $142.0 million. At December 31, 2013, our cash on hand of $58.3 million and short-term investments of $105.8 million resulted in available short-term liquidity of $164.1 million. The decrease in short-term liquidity from December 31, 2013 to March 31, 2014 primarily reflects funds used for equipment acquisitions, share repurchases and dividends, partially offset by funds provided by our operating activities.

Operating Activities

Our working capital, which consists of current assets less current liabilities, decreased 6.6% from $277.3 million as of December 31, 2013 to $259.0 million as of March 31, 2014. The quick ratio, defined as cash, cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, decreased from 2.44 as of December 31, 2013 to 2.02 as of March 31, 2014. The current ratio, defined as current assets divided by current liabilities, decreased from 3.71 as of December 31, 2013 to 3.16 as of March 31, 2014. The decreases in our working capital, quick ratio and current ratio are primarily attributable to an increase in accounts payable and unearned revenue during the three months ended March 31, 2014.


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Net accounts receivable increased 17.1% from $85.8 million at December 31, 2013 to $100.5 million at March 31, 2014. Our allowance for doubtful accounts was $130 thousand at December 31, 2013 and $133 thousand at March 31, 2014. Quarterly accounts receivable days sales outstanding (DSO) increased from 50 days as of December 31, 2013 to 62 days as of March 31, 2014. The change in net accounts receivable and DSO is due to changes in customer mix and the timing of sales and collections during the quarter. Certain international customers can have longer payment terms than U.S. customers. Other receivables increased from $18.2 million at December 31, 2013 to $29.0 million at March 31, 2014. The increase in other receivables is primarily attributable to an increase in deferred revenues in the acquired business and the timing of filing returns and collections of VAT receivables in our international subsidiaries. Other receivables will also fluctuate due to the timing of shipments and collections for materials supplied to our contract manufacturers during the quarter.

Quarterly inventory turnover decreased from 3.6 turns as of December 31, 2013 to 3.1 turns as of March 31, 2014. Inventory decreased 3.0% from December 31, 2013 to March 31, 2014. We expect inventory levels to fluctuate as we attempt to maintain sufficient inventory in response to seasonal cycles of our business ensuring competitive lead times while managing the risk of inventory obsolescence that may occur due to rapidly changing technology and customer demand.

Accounts payable increased 22.4% from $48.3 million at December 31, 2013 to $59.1 million at March 31, 2014. 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 $2.0 million and $0.6 million for the three months ended March 31, 2014 and 2013, respectively. These expenditures were primarily used to purchase manufacturing and test equipment and computer software and hardware.

Our combined short-term and long-term investments decreased $16.4 million from $415.0 million at December 31, 2013 to $398.6 million at March 31, 2014. This decrease reflects the impact of our cash needs for equipment acquisitions, share repurchases, dividends, and bond payment, as well as net realized and unrealized losses and amortization of net premiums on our combined investments, partially offset by additional funds available for investment provided by our operating activities and stock option exercises by our employees.

We invest all available cash not required for immediate use in operations primarily in securities that we believe bear minimal risk of loss. At March 31, 2014 these investments included corporate bonds of $130.9 million, municipal fixed-rate bonds of $158.4 million, and municipal variable rate demand notes of $24.8 million. At December 31, 2013, these investments included corporate bonds of $166.9 million, municipal fixed-rate bonds of $136.3 million, and municipal variable rate demand notes of $8.3 million. As of March 31, 2014, our corporate bonds, municipal fixed-rate bonds, and municipal variable rate demand notes were classified as available-for-sale and had a combined duration of 1.0 years with an average credit rating of AA-. Because our bond portfolio has a high quality rating and contractual maturities of a short duration, we are able to obtain prices for these bonds derived from observable market inputs, or for similar securities traded in an active market, on a daily basis.

Our long-term investments increased 0.1% from $309.2 million at December 31, 2013 to $309.5 million at March 31, 2014. Long-term investments at March 31, 2014 and December 31, 2013 included an investment in a certificate of deposit of $30.0 million and $48.3 million, respectively, 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 $25.2 million and $24.7 million, and with a fair value of $37.6 million and $38.5 million, at March 31, 2014 and December 31, 2013, respectively.

Long-term investments at March 31, 2014 and December 31, 2013 also included $15.3 million and $15.1 million, respectively, related to our deferred compensation plans, and $1.7 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.


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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 . . .

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