10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2014

OR

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from                      to                     

Commission File Number 0-24612

 

 

ADTRAN, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware     63-0918200
(State of Incorporation)    

(I.R.S. Employer

Identification No.)

901 Explorer Boulevard, Huntsville, Alabama 35806-2807

(Address of principal executive offices, including zip code)

(256) 963-8000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (232.405 of this chapter) during the preceding 12 months (or for shorter period that the Registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer   x    Accelerated Filer   ¨
Non-accelerated Filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date:

 

Class

 

Outstanding at April 23, 2014

Common Stock, $.01 Par Value   56,417,196 shares

 

 

 


Table of Contents

ADTRAN, INC.

Quarterly Report on Form 10-Q

For the Three Months Ended March 31, 2014

Table of Contents

 

Item
Number

  PART I. FINANCIAL INFORMATION    Page
Number
 
1   Financial Statements:   
  Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013 – (Unaudited)      3   
  Consolidated Statements of Income for the three months ended March 31, 2014 and 2013 – (Unaudited)      4   
  Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and 2013 – (Unaudited)      5   
  Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013 – (Unaudited)      6   
  Notes to Consolidated Financial Statements – (Unaudited)      7   
2   Management’s Discussion and Analysis of Financial Condition and Results of Operations      22   
3   Quantitative and Qualitative Disclosures About Market Risk      31   
4   Controls and Procedures      32   
  PART II. OTHER INFORMATION   
1A   Risk Factors      33   
2   Unregistered Sales of Equity Securities and Use of Proceeds      33   
6   Exhibits      33   
  SIGNATURE      34   
  EXHIBIT INDEX      35   

FORWARD LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of ADTRAN. ADTRAN and its representatives may from time to time make written or oral forward-looking statements, including statements contained in this report, our other filings with the Securities and Exchange Commission (SEC) and other communications with our stockholders. Generally, the words, “believe,” “expect,” “intend,” “estimate,” “anticipate,” “will,” “may,” “could” and similar expressions identify forward-looking statements. We caution you that any forward-looking statements made by us or on our behalf are subject to uncertainties and other factors that could cause such statements to be wrong. A list of factors that could materially affect our business, financial condition or operating results is included under “Factors that Could Affect Our Future Results” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report. They have also been discussed in Item 1A of Part I in our most recent Annual Report on Form 10-K for the year ended December 31, 2013 filed on February 27, 2014 with the SEC. Though we have attempted to list comprehensively these important factors, we caution investors that other factors may prove to be important in the future in affecting our operating results. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or a combination of factors may have on our business.

You are further cautioned not to place undue reliance on these forward-looking statements because they speak only of our views as of the date that the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ADTRAN, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except per share amounts)

 

     March 31,     December 31,  
     2014     2013  

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 52,815      $ 58,298   

Short-term investments

     89,160        105,760   

Accounts receivable, less allowance for doubtful accounts of $133 and $130 at March 31, 2014 and December 31, 2013, respectively

     100,524        85,814   

Other receivables

     28,967        18,249   

Inventory

     87,396        90,111   

Prepaid expenses

     5,005        4,325   

Deferred tax assets, net

     15,181        17,083   
  

 

 

   

 

 

 

Total Current Assets

     379,048        379,640   

Property, plant and equipment, net

     75,885        76,739   

Deferred tax assets, net

     11,491        9,622   

Goodwill

     3,492        3,492   

Other assets

     11,933        11,180   

Long-term investments

     309,452        309,225   
  

 

 

   

 

 

 

Total Assets

   $ 791,301      $ 789,898   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current Liabilities

    

Accounts payable

   $ 59,097      $ 48,282   

Unearned revenue

     27,533        22,205   

Accrued expenses

     10,683        12,776   

Accrued wages and benefits

     17,448        14,040   

Income tax payable, net

     5,272        5,002   
  

 

 

   

 

 

 

Total Current Liabilities

     120,033        102,305   

Non-current unearned revenue

     15,116        14,643   

Other non-current liabilities

     23,476        22,144   

Bonds payable

     30,000        46,200   
  

 

 

   

 

 

 

Total Liabilities

     188,625        185,292   

Commitments and contingencies (see Note 14)

    

Stockholders’ Equity

    

Common stock, par value $0.01 per share; 200,000 shares authorized; 79,652 shares issued and 56,646 shares outstanding at March 31, 2014 and 79,652 shares issued and 56,918 shares outstanding at December 31, 2013

     797        797   

Additional paid-in capital

     235,624        233,511   

Accumulated other comprehensive income

     10,084        10,753   

Retained earnings

     888,121        884,451   

Less treasury stock at cost: 23,006 and 22,734 shares at March 31, 2014 and December 31, 2013, respectively

     (531,950     (524,906
  

 

 

   

 

 

 

Total Stockholders’ Equity

     602,676        604,606   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 791,301      $ 789,898   
  

 

 

   

 

 

 

See notes to consolidated financial statements

 

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Table of Contents

ADTRAN, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)

 

     Three Months Ended  
     March 31,  
     2014     2013  

Sales

   $ 147,004      $ 143,013   

Cost of sales

     69,214        73,336   
  

 

 

   

 

 

 

Gross Profit

     77,790        69,677   

Selling, general and administrative expenses

     33,939        30,603   

Research and development expenses

     32,553        32,511   
  

 

 

   

 

 

 

Operating Income

     11,298        6,563   

Interest and dividend income

     1,294        1,768   

Interest expense

     (227     (581

Net realized investment gain

     2,192        3,645   

Other income (expense), net

     122        (1,672
  

 

 

   

 

 

 

Income before provision for income taxes

     14,679        9,723   

Provision for income taxes

     (5,072     (1,833
  

 

 

   

 

 

 

Net Income

   $ 9,607      $ 7,890   
  

 

 

   

 

 

 

Weighted average shares outstanding – basic

     56,751        61,847   

Weighted average shares outstanding – diluted

     57,368        62,030   

Earnings per common share – basic

   $ 0.17      $ 0.13   

Earnings per common share – diluted

   $ 0.17      $ 0.13   

Dividend per share

   $ 0.09      $ 0.09   

See notes to consolidated financial statements

 

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ADTRAN, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(In thousands)

 

     Three Months Ended  
     March 31,  
     2014     2013  

Net Income

   $ 9,607      $ 7,890   
  

 

 

   

 

 

 

Other Comprehensive Loss, net of tax:

    

Net unrealized losses on available-for-sale securities

     (921     (1,644

Foreign currency translation

     252        323   
  

 

 

   

 

 

 

Other Comprehensive Loss, net of tax

     (669     (1,321
  

 

 

   

 

 

 

Comprehensive Income, net of tax

   $ 8,938      $ 6,569   
  

 

 

   

 

 

 

See notes to consolidated financial statements

 

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ADTRAN, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

     Three Months Ended
March 31,
 
     2014     2013  

Cash flows from operating activities:

    

Net income

   $ 9,607      $ 7,890   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     3,580        3,663   

Amortization of net premium on available-for-sale investments

     1,135        1,754   

Net realized gain on long-term investments

     (2,192     (3,645

Net (gain) loss on disposal of property, plant and equipment

     (3     17   

Stock-based compensation expense

     2,057        2,232   

Deferred income taxes

     627        715   

Tax benefit from stock option exercises

     57        —     

Excess tax benefits from stock-based compensation arrangements

     (55     —     

Changes in operating assets and liabilities:

    

Accounts receivable, net

     (14,668     (1,306

Other receivables

     (10,710     (224

Inventory

     2,739        6,540   

Prepaid expenses and other assets

     (2,024     (217

Accounts payable

     11,043        7,170   

Accrued expenses and other liabilities

     8,431        1,188   

Income tax payable, net

     275        379   
  

 

 

   

 

 

 

Net cash provided by operating activities

     9,899        26,156   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of property, plant and equipment

     (2,042     (643

Proceeds from disposals of property, plant and equipment

     1        —     

Proceeds from sales and maturities of available-for-sale investments

     85,072        118,133   

Purchases of available-for-sale investments

     (69,182     (125,411
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     13,849        (7,921
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from stock option exercises

     1,541        55   

Purchases of treasury stock

     (9,427     (22,546

Dividend payments

     (5,102     (5,586

Payments on long-term debt

     (16,500     —     

Excess tax benefits from stock-based compensation arrangements

     55        —     
  

 

 

   

 

 

 

Net cash used in financing activities

     (29,433     (28,077
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (5,685     (9,842

Effect of exchange rate changes

     202        25   

Cash and cash equivalents, beginning of period

     58,298        68,457   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 52,815      $ 58,640   
  

 

 

   

 

 

 

Supplemental disclosure of non-cash investing activities

    

Purchases of property, plant and equipment included in accounts payable

   $ 85      $ 92   

See notes to consolidated financial statements

 

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Table of Contents

ADTRAN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except per share amounts)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements of ADTRAN®, Inc. and its subsidiaries (ADTRAN) have been prepared pursuant to the rules and regulations for reporting on Quarterly Reports on Form 10-Q. Accordingly, certain information and notes required by generally accepted accounting principles for complete financial statements are not included herein. The December 31, 2013 Consolidated Balance Sheet is derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.

In the opinion of management, all adjustments necessary for a fair presentation of these interim statements have been recorded and are of a normal and recurring nature. The results of operations for an interim period are not necessarily indicative of the results for the full year. The interim statements should be read in conjunction with the financial statements and notes thereto included in ADTRAN’s Annual Report on Form 10-K for the year ended December 31, 2013, filed on February 27, 2014 with the SEC.

Changes in Classifications

We corrected immaterial misclassifications between the operating and investing sections of our consolidated statements of cash flows and adjusted our cash flows for the three months ended March 31, 2013 in these categories by $0.1 million in order to be consistent with the 2014 presentation.

Out of Period Adjustment

During the year ended December 31, 2013, we identified two adjustments in the acquired NSN (formerly Nokia Siemens Networks) Broadband Access business (NSN BBA business) relating to customer payment discounts for one customer, and recoverable VAT taxes on certain vendor freight invoices that should have been recorded in prior periods. These adjustments resulted from a $0.3 million understatement of net income in the first quarter of 2013. We evaluated the impact of the adjustments on the results of our previously issued financial statements for first quarter of 2013 and concluded that the impact was not material. We also evaluated the impact of the cumulative effect of the adjustments in 2013 and concluded that the impact was not material to our results for the year 2013. Accordingly, during the three months ended September 30, 2013 we recorded an out of period adjustment to correct these issues.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expense during the reporting period. Our more significant estimates include the obsolete and excess inventory reserves, warranty reserves, customer rebates, determination of the deferred revenue components of multiple element sales agreements, estimated costs to complete obligations associated with deferred revenues, estimated income tax provision and income tax contingencies, the fair value of stock-based compensation, impairment of goodwill, valuation and estimated lives of intangible assets, estimated working capital adjustments under negotiation related to the NSN BBA business acquisition, estimated pension liability, fair value of investments, and the evaluation of other-than-temporary declines in the value of investments. Actual amounts could differ significantly from these estimates.

Recent Accounting Pronouncements

During the three months ended March 31, 2014, no accounting pronouncements were issued that would have a material effect on our consolidated results of operations or financial condition.

 

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2. 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.

3. PENSION BENEFIT PLAN

We maintain a defined benefit pension plan covering employees in certain foreign countries.

The following table summarizes the components of net periodic pension cost for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended
March 31,
 
(In thousands)    2014     2013  

Service cost

   $ 305      $ 300   

Interest cost

     215        187   

Expected return on plan assets

     (279     (253
  

 

 

   

 

 

 

Net periodic pension cost

   $ 241      $ 234   
  

 

 

   

 

 

 

4. STOCK-BASED COMPENSATION

The following table summarizes the stock-based compensation expense related to stock options, restricted stock units (RSUs) and restricted stock for the three months ended March 31, 2014 and 2013, which was recognized as follows:

 

     Three Months Ended
March 31,
 
(In thousands)    2014     2013  

Stock-based compensation expense included in cost of sales

   $ 116      $ 106   
  

 

 

   

 

 

 

Selling, general and administrative expense

     1,026        1,063   

Research and development expense

     915        1,063   
  

 

 

   

 

 

 

Stock-based compensation expense included in operating expenses

     1,941        2,126   
  

 

 

   

 

 

 

Total stock-based compensation expense

     2,057        2,232   

Tax benefit for expense associated with

non-qualified options

     (284     (307
  

 

 

   

 

 

 

Total stock-based compensation expense, net of tax

   $ 1,773      $ 1,925   
  

 

 

   

 

 

 

The fair value of our stock options was estimated using the Black-Scholes model. The determination of the fair value of stock options on the date of grant using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables that may have a significant impact on the fair value estimate.

 

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There were no options granted during the three months ended March 31, 2013. The weighted-average assumptions and value of options granted for the three months ended March 31, 2014 are summarized as follows:

 

     Three Months Ended
March 31,

2014
 

Expected volatility

     39.57

Risk-free interest rate

     1.86

Expected dividend yield

     1.38

Expected life (in years)

     6.25   

Weighted-average estimated value

   $ 9.28   

The fair value of our RSUs is calculated using a Monte Carlo Simulation valuation method. No RSUs were granted, forfeited, or vested during the three months ended March 31, 2014 or 2013.

The fair value of restricted stock is equal to the closing price of our stock on the date of grant. No restricted stock was granted, forfeited, or vested during the three months ended March 31, 2014 or 2013.

Stock-based compensation expense recognized in our Consolidated Statements of Income for the three months ended March 31, 2014 and 2013 is based on options, RSUs and restricted stock ultimately expected to vest, and has been reduced for estimated forfeitures. Estimated forfeitures for stock options were based upon historical experience and approximate 2.5% annually. We estimated a 0% forfeiture rate for our RSUs and restricted stock due to the limited number of recipients and historical experience for these awards.

As of March 31, 2014, total compensation expense related to non-vested stock options, RSUs and restricted stock not yet recognized was approximately $16.4 million, which is expected to be recognized over an average remaining recognition period of 2.5 years.

The following table is a summary of our stock options outstanding as of December 31, 2013 and March 31, 2014 and the changes that occurred during the three months ended March 31, 2014:

 

(In thousands, except per share amounts)    Number of
Options
    Weighted Avg.
Exercise Price
     Weighted Avg.
Remaining
Contractual
Life In Years
     Aggregate
Intrinsic
Value
 

Options outstanding, December 31, 2013

     6,358      $ 24.43         6.60       $ 25,878   

Options granted

     2      $ 26.03         

Options cancelled/forfeited

     (61   $ 25.16         

Options exercised

     (78   $ 19.71         
  

 

 

   

 

 

    

 

 

    

 

 

 

Options outstanding, March 31, 2014

     6,221      $ 24.48         6.35       $ 14,478   
  

 

 

   

 

 

    

 

 

    

 

 

 

Options exercisable, March 31, 2014

     3,826      $ 24.84         4.93       $ 8,526   
  

 

 

   

 

 

    

 

 

    

 

 

 

The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between the closing price of our stock on the last trading day of the quarter and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2014. The aggregate intrinsic value will change based on the fair market value of our stock.

The total pre-tax intrinsic value of options exercised during the three months ended March 31, 2014 was $0.5 million.

 

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5. INVESTMENTS

At March 31, 2014, we held the following securities and investments, recorded at either fair value or cost.

 

(In thousands)    Amortized
Cost
     Gross Unrealized     Carrying
Value
 
      Gains      Losses    

Deferred compensation plan assets

   $ 12,523       $ 2,770       $ (16   $ 15,277   

Corporate bonds

     130,437         456         (30     130,863   

Municipal fixed-rate bonds

     157,851         673         (137     158,387   

Municipal variable rate demand notes

     24,840         —           —          24,840   

Marketable equity securities

     25,166         12,798         (378     37,586   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-sale securities held at fair value

   $ 350,817       $ 16,697       $ (561   $ 366,953   
  

 

 

    

 

 

    

 

 

   

Restricted investment held at cost

             30,000   

Other investments held at cost

             1,659   
          

 

 

 

Total carrying value of available-for-sale investments

           $ 398,612   
          

 

 

 

At December 31, 2013, we held the following securities and investments, recorded at either fair value or cost.

 

(In thousands)    Amortized
Cost
     Gross Unrealized     Carrying
Value
 
      Gains      Losses    

Deferred compensation plan assets

   $ 12,300       $ 2,847       $ (24   $ 15,123   

Corporate bonds

     166,370         534         (45     166,859   

Municipal fixed-rate bonds

     135,773         583         (54     136,302   

Municipal variable rate demand notes

     8,310         —           —          8,310   

Marketable equity securities

     24,654         13,975         (177     38,452   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-sale securities held at fair value

   $ 347,407       $ 17,939       $ (300   $ 365,046   
  

 

 

    

 

 

    

 

 

   

Restricted investment held at cost

             48,250   

Other investments held at cost

             1,689   
          

 

 

 

Total carrying value of available-for-sale investments

           $ 414,985   
          

 

 

 

 

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As of March 31, 2014, our corporate bonds and municipal fixed-rate bonds had the following contractual maturities:

 

(In thousands)    Corporate
bonds
     Municipal
fixed-rate
bonds
 

Less than one year

   $ 34,248       $ 34,630   

One to two years

     52,222         60,991   

Two to three years

     44,393         47,713   

Three to five years

     —           15,053   
  

 

 

    

 

 

 

Total

   $ 130,863       $ 158,387   
  

 

 

    

 

 

 

Our investment policy provides limitations for issuer concentration, which limits, at the time of purchase, the concentration in any one issuer to 5% of the market value of our total investment portfolio.

At March 31, 2014, we held a $30.0 million restricted certificate of deposit, which is carried at cost. This investment serves as a collateral deposit against the principal amount outstanding under loans made to ADTRAN pursuant to an Alabama State Industrial Development Authority revenue bond (the Bond). During the first quarter of 2014, we made a principal payment on the Bond of $16.5 million. At March 31, 2014, the estimated fair value of the Bond using a level 2 valuation technique was approximately $29.6 million, based on a debt security with a comparable interest rate and maturity and a Standard and Poor’s credit rating of AAA-. For more information on the Bond, see “Debt” under “Liquidity and Capital Resources” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report.

We review our investment portfolio for potential “other-than-temporary” declines in value on an individual investment basis. We assess, on a quarterly basis, significant declines in value which may be considered other-than-temporary and, if necessary, recognize and record the appropriate charge to write-down the carrying value of such investments. In making this assessment, we take into consideration qualitative and quantitative information, including but not limited to the following: the magnitude and duration of historical declines in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a fair value that has declined from its original or adjusted cost basis by 25% or more for six or more consecutive months. We then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. As a result of our review, we recorded no other-than-temporary impairment charges during the three months ended March 31, 2014. For the three months ended March 31, 2013, we recorded an other-than-temporary impairment charge of $4 thousand related to one marketable equity security.

Realized gains and losses on sales of securities are computed under the specific identification method. The following table presents gross realized gains and losses related to our investments.

 

     Three Months Ended
March 31,
 
(In thousands)    2014     2013  

Gross realized gains

   $ 2,228      $ 3,727   

Gross realized losses

   $ (36   $ (82

As of March 31, 2014 and 2013, gross unrealized losses related to individual securities in a continuous loss position for 12 months or longer were not significant.

 

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We have categorized our cash equivalents held in money market funds and our investments held at fair value into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique for the cash equivalents and investments as follows: Level 1—Values based on unadjusted quoted prices for identical assets or liabilities in an active market; Level 2—Values based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly; Level 3—Values based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs include information supplied by investees.

 

     Fair Value Measurements at March 31, 2014 Using  
(In thousands)    Fair Value      Quoted Prices
in Active
Market for
Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Cash equivalents

           

Money market funds

   $ 11,742       $ 11,742       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale securities

           

Deferred compensation plan assets

     15,277         15,277         —           —     

Available-for-sale debt securities

           

Corporate bonds

     130,863         —           130,863         —     

Municipal fixed-rate bonds

     158,387         —           158,387         —     

Municipal variable rate demand notes

     24,840         —           24,840         —     

Available-for-sale marketable equity securities

           

Equity securities – technology industry

     10,639         10,639         —           —     

Equity securities – other

     26,947         26,947         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale securities

     366,953         52,863         314,090         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 378,695       $ 64,605       $ 314,090       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     Fair Value Measurements at December 31, 2013 Using  
(In thousands)    Fair Value      Quoted Prices
in Active
Market for
Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Cash equivalents

           

Money market funds

   $ 3,949       $ 3,949       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale securities

           

Deferred compensation plan assets

     15,123         15,123         —           —     

Available-for-sale debt securities

           

Corporate bonds

     166,859         —           166,859         —     

Municipal fixed-rate bonds

     136,302         —           136,302         —     

Municipal variable rate demand notes

     8,310         —           8,310         —     

Available-for-sale marketable equity securities

           

Equity securities – technology industry

     11,398         11,398         —           —     

Equity securities – other

     27,054         27,054         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale securities

     365,046         53,575         311,471         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 368,995       $ 57,524       $ 311,471       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The fair value of our Level 2 securities is calculated using a weighted average market price for each security. Market prices are obtained from a variety of industry standard data providers, security master files from large financial institutions, and other third-party sources. These multiple market prices are used as inputs into a distribution-curve-based algorithm to determine the daily market value of each security.

Our municipal variable rate demand notes have a structure that implies a standard expected market price. The frequent interest rate resets make it reasonable to expect the price to stay at par. These securities are priced at the expected market price.

6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We have certain international customers who are billed in their local currency. Changes in the monetary exchange rates may adversely affect our results of operations and financial condition. When appropriate, we enter into various derivative transactions to enhance our ability to manage the volatility relating to these typical business exposures. We do not hold or issue derivative instruments for trading or other speculative purposes. Our derivative instruments are recorded in the Consolidated Balance Sheets at their fair values. Our derivative instruments do not qualify for hedge accounting, and accordingly, all changes in the fair value of the instruments are recognized as other income (expense) in the Consolidated Statements of Income. The maximum contractual period for our derivatives is currently less than twelve months. Our derivative instruments are not subject to master netting arrangements and are not offset in the Consolidated Balance Sheets.

As of March 31, 2014, we had forward contracts outstanding with notional amounts totaling €20.7 million ($28.5 million), which mature through 2014.

The fair values of our derivative instruments recorded in the Consolidated Balance Sheet as of March 31, 2014 and December 31, 2013 were as follows:

 

(In thousands)   

Balance Sheet
Location

   March 31,
2014
    December 31,
2013
 

Derivatives Not Designated as Hedging Instruments (Level 2):

       

Foreign exchange contracts – asset derivatives

   Other receivables    $ 1      $ 18   

Foreign exchange contracts – liability derivatives

   Accounts payable    $ (8   $ (15

The change in the fair values of our derivative instruments recorded in the Consolidated Statements of Income during the three months ended March 31, 2014 were as follows:

 

          Three Months Ended  
(In thousands)   

Income Statement Location

   March 31, 2014     March 31, 2013  

Derivatives Not Designated as Hedging Instruments:

       

Foreign exchange contracts

   Other income (expense)    $ (110   $ (224

 

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7. INVENTORY

At March 31, 2014 and December 31, 2013, inventory consisted of the following:

 

     March 31,      December 31,  
(In thousands)    2014      2013  

Raw materials

   $ 41,546       $ 44,093   

Work in process

     3,217         3,484   

Finished goods

     42,633         42,534   
  

 

 

    

 

 

 

Total

   $ 87,396       $ 90,111   
  

 

 

    

 

 

 

We establish reserves for estimated excess, obsolete, or unmarketable inventory equal to the difference between the cost of the inventory and the estimated fair value of the inventory based upon assumptions about future demand and market conditions. At March 31, 2014 and December 31, 2013, raw materials reserves totaled $17.0 million and $16.9 million, respectively, and finished goods inventory reserves totaled $4.9 million and $6.1 million, respectively. The decrease in finished goods inventory reserve from December 31, 2013 to March 31, 2014 is primarily attributable to the disposal of inventory that was fully reserved.

8. GOODWILL AND INTANGIBLE ASSETS

The change in the carrying value of goodwill, all of which is included in our Enterprise Networks division, for the three months ended March 31, 2014 is as follows:

 

(In thousands)       

Balance, December 31, 2013

   $  3,492   

Acquisitions

     —     

Impairment losses

     —     
  

 

 

 

Balance, March 31, 2014

   $ 3,492   
  

 

 

 

Balance as of March 31, 2014

  

Goodwill

   $ 3,492   

Accumulated impairment losses

     —     
  

 

 

 

Total goodwill

   $ 3,492   
  

 

 

 

We evaluate the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. When evaluating whether goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, then the amount of the impairment loss is measured. There were no impairment losses recorded during the three months ended March 31, 2014 or 2013.

Intangible assets are included in other assets in the accompanying Consolidated Balance Sheets and include intangibles acquired in conjunction with our acquisition of Objectworld Communications Corporation on September 15, 2009, Bluesocket, Inc. on August 4, 2011, and the NSN BBA business on May 4, 2012.

The following table presents our intangible assets as of March 31, 2014 and December 31, 2013:

 

(In thousands)    March 31, 2014      December 31, 2013  
   Gross
Value
     Accumulated
Amortization
    Net Value      Gross
Value
     Accumulated
Amortization
    Net Value  

Customer relationships

   $ 6,963       $ (1,742   $ 5,221       $ 6,996       $ (1,555   $ 5,441   

Developed technology

     6,392         (2,939     3,453         6,537         (2,692     3,845   

Intellectual property

     2,340         (1,269     1,071         2,340         (1,185     1,155   

Trade names

     270         (160     110         270         (145     125   

Other

     14         (9     5         14         (8     6   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 15,979       $ (6,119   $ 9,860       $ 16,157       $ (5,585   $ 10,572   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Amortization expense, all of which relates to business acquisitions, was $0.6 million for the three months ended March 31, 2014 and 2013.

As of March 31, 2014, the estimated future amortization expense of our intangible assets is as follows:

 

(In thousands)    Amount  

Remainder of 2014

   $ 1,718   

2015

     2,168   

2016

     1,893   

2017

     1,290   

2018

     782   

Thereafter

     2,009   
  

 

 

 

Total

   $ 9,860   
  

 

 

 

9. STOCKHOLDERS’ EQUITY

A summary of the changes in stockholders’ equity for the three months ended March 31, 2014 is as follows:

 

     Stockholders’  
(In thousands)    Equity  

Balance, December 31, 2013

   $  604,606   

Net income

     9,607   

Dividend payments

     (5,102

Dividends accrued for unvested restricted stock units

     6   

Net unrealized gains (losses) on available-for-sale securities (net of tax)

     (921

Foreign currency translation adjustment

     252   

Proceeds from stock option exercises

     1,541   

Purchase of treasury stock

     (9,427

Income tax benefit from exercise of stock options

     57   

Stock-based compensation expense

     2,057   
  

 

 

 

Balance, March 31, 2014

   $ 602,676   
  

 

 

 

Stock Repurchase Program

Since 1997, our Board of Directors has approved multiple share repurchase programs that have authorized open market repurchase transactions of up to 40.0 million shares of our common stock. During the three months ended March 31, 2014, we repurchased 0.4 million shares of our common stock at an average price of $25.13 per share. We currently have the authority to purchase an additional 3.1 million shares of our common stock under the current plan approved by the Board of Directors on May 1, 2013.

Stock Option Exercises

We issued 0.1 million shares of treasury stock during the three months ended March 31, 2014 to accommodate employee stock option exercises. The stock options had exercise prices ranging from $15.29 to $23.46. We received proceeds totaling $1.5 million from the exercise of these stock options during the three months ended March 31, 2014.

Dividend Payments

During the three months ended March 31, 2014, we paid cash dividends as follows (in thousands except per share amounts):

 

Record Date

   Payment Date      Per Share Amount      Total Dividend Paid  

February 6, 2014

     February 20, 2014       $ 0.09       $ 5,102   

 

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Table of Contents

Other Comprehensive Income

Other comprehensive income consists of unrealized gains (losses) on available-for-sale securities, reclassification adjustments for amounts included in net income related to impairments of available-for-sale securities and realized gains (losses) on available-for-sale securities, defined benefit plan adjustments and foreign currency translation adjustments.

The following tables present changes in accumulated other comprehensive income, net of tax, by component for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended March 31, 2014  
(In thousands)    Unrealized
Gains
(Losses) on
Available-
for-Sale
Securities
    Defined
Benefit Plan
Adjustments
    Foreign
Currency
Adjustments
     Total  

Beginning balance

   $  10,737      $ (891   $ 907       $ 10,753   

Other comprehensive income (loss) before reclassifications

     402        —          252         654   

Amounts reclassified from accumulated other comprehensive income

     (1,323     —          —           (1,323
  

 

 

   

 

 

   

 

 

    

 

 

 

Net current period other comprehensive income (loss)

     (921     —          252         (669
  

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance

   $ 9,816      $ (891   $ 1,159       $ 10,084   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

     Three Months Ended March 31, 2013  
(In thousands)    Unrealized
Gains
(Losses) on
Available-
for-Sale
Securities
    Defined
Benefit Plan
Adjustments
    Foreign
Currency
Adjustments
     Total  

Beginning balance

   $  10,108      $ (1,952   $ 3,112       $ 11,268   

Other comprehensive income (loss) before reclassifications

     454        —          323         777   

Amounts reclassified from accumulated other comprehensive income

     (2,098     —          —           (2,098
  

 

 

   

 

 

   

 

 

    

 

 

 

Net current period other comprehensive income (loss)

     (1,644     —          323         (1,321
  

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance

   $ 8,464      $ (1,952   $ 3,435       $ 9,947   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents

The following tables present the details of reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2014 and 2013:

 

(In thousands)    Three Months Ended March 31, 2014

Details about Accumulated Other

Comprehensive Income Components

   Amount Reclassified
from Accumulated
Other Comprehensive
Income
   

Affected Line Item in the
Statement Where Net Income Is
Presented

Unrealized gains (losses) on available-for-sale securities:

    

Net realized gain on sales of securities

   $ 2,170      Net realized investment gain

Impairment expense

     —        Net realized investment gain
  

 

 

   

Total reclassifications for the period, before tax

     2,170     

Tax (expense) benefit

     (847  
  

 

 

   

Total reclassifications for the period, net of tax

   $ 1,323     
  

 

 

   

 

(In thousands)    Three Months Ended March 31, 2013

Details about Accumulated Other

Comprehensive Income Components

   Amount Reclassified
from Accumulated
Other Comprehensive
Income
   

Affected Line Item in the
Statement Where Net Income Is
Presented

Unrealized gains (losses) on available-for-sale securities:

    

Net realized gain on sales of securities

   $ 3,444      Net realized investment gain

Impairment expense

     (4   Net realized investment gain
  

 

 

   

Total reclassifications for the period, before tax

     3,440     

Tax (expense) benefit

     (1,342  
  

 

 

   

Total reclassifications for the period, net of tax

   $ 2,098     
  

 

 

   

The following table presents the tax effects related to the change in each component of other comprehensive income for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended
March 31, 2014
    Three Months Ended
March 31, 2013
 
(In thousands)    Before-Tax
Amount
    Tax
(Expense)
Benefit
    Net-of-Tax
Amount
    Before-Tax
Amount
    Tax
(Expense)
Benefit
    Net-of-Tax
Amount
 

Unrealized gains (losses) on available-for-sale securities

   $ 659      $ (257   $ 402      $ 744      $ (290   $ 454   

Reclassification adjustment for amounts included in net income

     (2,170     847        (1,323     (3,440     1,342        (2,098

Foreign currency translation adjustment

     252        —          252        323        —          323   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Comprehensive Income (Loss)

   $ (1,259   $ 590      $ (669   $ (2,373   $ 1,052      $ (1,321
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

10. EARNINGS PER SHARE

A summary of the calculation of basic and diluted earnings per share for the three months ended March 31, 2014 and 2013 is as follows:

 

     Three Months Ended
March 31,
 
(In thousands, except per share amounts)    2014      2013  

Numerator

     

Net income

   $ 9,607       $ 7,890   
  

 

 

    

 

 

 

Denominator

     

Weighted average number of shares – basic

     56,751         61,847   

Effect of dilutive securities

     

Stock options

     602         162   

Restricted stock and restricted stock units

     15         21   
  

 

 

    

 

 

 

Weighted average number of shares – diluted

     57,368         62,030   
  

 

 

    

 

 

 

Net income per share – basic

   $ 0.17       $ 0.13   

Net income per share – diluted

   $ 0.17       $ 0.13   

Anti-dilutive options to purchase common stock outstanding were excluded from the above calculations. Anti-dilutive options totaled 3.1 million and 5.4 million for the three months ended March 31, 2014 and 2013, respectively.

11. SEGMENT INFORMATION

We operate in two reportable segments: (1) the Carrier Networks Division and (2) the Enterprise Networks Division. We evaluate the performance of our segments based on gross profit; therefore, selling, general and administrative expense, research and development expenses, interest income and dividend income, interest expense, net realized investment gain/loss, other income/expense and provision for taxes are reported on an entity-wide basis only. There are no inter-segment revenues.

The following table presents information about the reported sales and gross profit of our reportable segments for the three months ended March 31, 2014 and 2013. Asset information by reportable segment is not reported, since we do not produce such information internally.

 

     Three Months Ended  
     March 31, 2014      March 31, 2013  
(In thousands)    Sales      Gross Profit      Sales      Gross Profit  

Carrier Networks

   $ 118,162       $ 61,353       $ 109,887       $ 51,591   

Enterprise Networks

     28,842         16,437         33,126         18,086   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 147,004       $ 77,790       $ 143,013       $ 69,677   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Sales by Product

Our three major product categories are Carrier Systems, Business Networking and Loop Access.

Carrier Systems products are used by communications service providers to provide data, voice and video services to consumers and enterprises. 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

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

 

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Table of Contents

The table below presents sales information by product category for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended
March 31,
 
(In thousands)    2014      2013  

Carrier Systems

   $ 99,553       $ 92,804   

Business Networking

     37,919         38,076   

Loop Access

     9,532         12,133   
  

 

 

    

 

 

 

Total

   $ 147,004       $ 143,013   
  

 

 

    

 

 

 

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.

The table below presents subcategory revenues for the three months ended March 31, 2014 and 2013:

 

     Three Months Ended
March 31,
 
(In thousands)    2014      2013  

Core Products

     

Broadband Access (included in Carrier Systems)

   $ 81,527       $ 72,234   

Optical (included in Carrier Systems)

     12,789         8,874   

Internetworking (included in Business Networking)

     36,946         36,912   
  

 

 

    

 

 

 

Subtotal

     131,262         118,020   

Legacy Products

     

HDSL (does not include T1) (included in Loop Access)

     8,877         11,407   

Other products (excluding HDSL)

     6,865         13,586   
  

 

 

    

 

 

 

Subtotal

     15,742         24,993   
  

 

 

    

 

 

 

Total

   $ 147,004       $ 143,013   
  

 

 

    

 

 

 

12. LIABILITY FOR WARRANTY RETURNS

Our products generally include warranties of 90 days to ten years for product defects. We accrue for warranty returns at the time revenue is recognized based on our estimate of the cost to repair or replace the defective products. We engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers. Our products continue to become more complex in both size and functionality as many of our product offerings migrate from line card applications to systems products. The increasing complexity of our products will cause warranty incidences, when they arise, to be more costly. Our estimates regarding future warranty obligations may change due to product failure rates, material usage, and other rework costs incurred in correcting a product failure. In addition, from time to time, specific warranty accruals may be recorded if unforeseen problems arise. Should our actual experience relative to these factors be worse than our estimates, we will be required to record additional warranty expense. Alternatively, if we provide for more reserves than we require, we will reverse a portion of such provisions in future periods. The liability for warranty obligations totaled $7.4 million at March 31, 2014 and $9.0 million at December 31, 2013. The decrease from December 31, 2013 to March 31, 2014 includes a $1.5 million decrease related to the settlement of an outstanding warranty claim, which corresponds to a reduction in Other Receivables. These liabilities are included in accrued expenses in the accompanying Consolidated Balance Sheets.

 

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Table of Contents

A summary of warranty expense and write-off activity for the three months ended March 31, 2014 and 2013 is as follows:

 

     Three Months Ended
March 31,
 
     2014     2013  
(In thousands)             

Balance at beginning of period

   $ 8,977      $ 9,653   

Plus: Amounts charged to cost and expenses

     434        397   

Less: Deductions

     (2,019     (1,258
  

 

 

   

 

 

 

Balance at end of period

   $ 7,392      $ 8,792   
  

 

 

   

 

 

 

Deductions for the three months ended March 31, 2014 include a $1.5 million reduction that relates to the settlement of an outstanding warranty claim, which corresponds to a reduction in Other Receivables.

13. RELATED PARTY TRANSACTIONS

We employ the law firm of our director emeritus for legal services. All bills for services rendered by this firm are reviewed and approved by our Chief Financial Officer. We believe that the fees for such services are comparable to those charged by other firms for services rendered to us. For the three months ended March 31, 2014 and 2013, we incurred fees of $10 thousand per month for these legal services.

14. COMMITMENTS AND CONTINGENCIES

In the ordinary course of business, we may be subject to various legal proceedings and claims, including employment disputes, patent claims, disputes over contract agreements and other commercial disputes. In some cases, claimants seek damages or other relief, such as royalty payments related to patents, which, if granted, could require significant expenditures. Although the outcome of any claim or litigation can never be certain, it is our opinion that the outcome of all contingencies of which we are currently aware will not materially affect our business, operations, financial condition or cash flows.

We have committed to invest up to an aggregate of $7.9 million in two private equity funds, and we have contributed $8.4 million as of March 31, 2014, of which $7.7 million has been applied to these commitments.

15. SUBSEQUENT EVENTS

On April 15, 2014, we announced that our Board of Directors declared a quarterly cash dividend of $0.09 per common share to be paid to stockholders of record at the close of business on May 1, 2014. The payment date will be May 15, 2014. The quarterly dividend payment will be approximately $5.0 million. In July 2003, our Board of Directors elected to begin declaring quarterly dividends on our common stock considering the tax treatment of dividends and adequate levels of Company liquidity.

During the second quarter and as of May 7, 2014, we have repurchased 1.3 million shares of our common stock through open market purchases at an average cost of $22.63 per share. We currently have the authority to purchase an additional 1.8 million shares of our common stock under the current plan approved by the Board of Directors.

 

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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 carrying value of such investments. In making this assessment, we take into consideration qualitative and quantitative information, including but not limited to the following: the magnitude and duration of historical declines in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a fair value that has declined from its original or adjusted cost basis by 25% or more for six or more consecutive months. We then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. As a result of our review, we recorded no other-than-temporary impairment charges during the three months ended March 31, 2014. For the three months ended March 31, 2013, we recorded an other-than-temporary impairment charge of $4 thousand related to one marketable equity security.

Financing Activities

Dividends

In July 2003, our Board of Directors elected to begin declaring quarterly dividends on our common stock considering the tax treatment of dividends and adequate levels of Company liquidity. During the three months ended March 31, 2014, we paid dividends totaling $5.1 million.

Debt

We have amounts outstanding under loans made pursuant to an Alabama State Industrial Development Authority revenue bond (the Bond) which totaled $30.0 million and $46.5 million at March 31, 2014 and December 31, 2013, respectively. At March 31, 2014, the estimated fair value of the Bond was approximately $29.6 million, based on a debt security with a comparable interest rate and maturity and a Standard & Poor’s credit rating of AAA-. Included in long-term investments are restricted funds in the amount of $30.0 million and $48.3 million at March 31, 2014 and December 31, 2013, which is a collateral deposit against the principal amount of the Bond. We have the right to set-off the balance of the Bond with the collateral deposit in order to reduce the balance of the indebtedness. The Bond matures on January 1, 2020, and bears interest at the rate of 2% per annum. In conjunction with this program, we are eligible to receive certain economic incentives from the state of Alabama that reduce the amount of payroll withholdings we are required to remit to the state for those employment positions that qualify under this program. We are required to make payments in the amounts necessary to pay the interest on the amounts currently outstanding. During the first quarter of 2014, we made a principal payment on the Bond of $16.5 million.

Stock Repurchase Program

Since 1997, our Board of Directors has approved multiple share repurchase programs that have authorized open market repurchase transactions of up to 40.0 million shares of our common stock. During the three months ended March 31, 2014, we repurchased 0.4 million shares of our common stock at an average price of $25.13 per share. We currently have the authority to purchase an additional 3.1 million shares of our common stock under the current plan approved by the Board of Directors on May 1, 2013.

Stock Option Exercises

To accommodate employee stock option exercises, we issued 0.1 million shares of treasury stock for $1.5 million during the three months ended March 31, 2014. During the three months ended March 31, 2013, we issued four thousand shares of treasury stock for $55 thousand.

Off-Balance Sheet Arrangements and Contractual Obligations

We do not have off-balance sheet financing arrangements and have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources. During the three months ended March 31, 2014, the only material change in contractual obligations and commercial commitments from those discussed in our most recent Annual Report on Form 10-K for the year ended December 31, 2013 filed on February 27, 2014 with the SEC was due to a $16.5 million principal payment on our taxable revenue bond.

 

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We have committed to invest up to an aggregate of $7.9 million in two private equity funds, and we have contributed $8.4 million as of March 31, 2014, of which $7.7 million has been applied to these commitments.

FACTORS THAT COULD AFFECT OUR FUTURE RESULTS

The following are some of the risks that could affect our financial performance or could cause actual results to differ materially from those expressed or implied in our forward-looking statements:

 

    Our operating results may fluctuate in future periods, which may adversely affect our stock price.

 

    Our revenue for a particular period can be difficult to predict, and a shortfall in revenue may harm our operating results.

 

    The failure to realize future benefits from the acquisition of the NSN BBA business as significantly as we expect may affect our future results of operations and financial condition, and could affect our stock price.

 

    General economic conditions may reduce our revenues and harm our operating results.

 

    Our exposure to the credit risks of our customers and distributors may make it difficult to collect accounts receivable and could adversely affect our operating results and financial condition.

 

    We expect gross margin to vary over time, and our level of product gross margin may not be sustainable.

 

    We must continue to update and improve our products and develop new products in order to compete and to keep pace with improvements in communications technology.

 

    Our products may not continue to comply with evolving regulations governing their sale, which may harm our business.

 

    Our failure or the failure of our contract manufacturers to comply with applicable environmental regulations could adversely impact our results of operations.

 

    If our products do not interoperate with our customers’ networks, installations may be delayed or cancelled, which could harm our business.

 

    The lengthy approval process required by major and other service providers for new products could result in fluctuations in our revenue.

 

    We engage in research and development activities to improve the application of developed technologies, and as a consequence may miss certain market opportunities enjoyed by larger companies with substantially greater research and development efforts who may focus on more leading edge development.

 

    We depend heavily on sales to certain customers; the loss of any of these customers would significantly reduce our revenues and net income.

 

    Our strategy of outsourcing a portion of our manufacturing requirements to subcontractors located in Asia or other international regions may result in us not meeting our cost, quality or performance standards.

 

    Our dependence on a limited number of suppliers may prevent us from delivering our products on a timely basis, which could have a material adverse effect on customer relations and operating results.

 

    We compete in markets that have become increasingly competitive, which may result in reduced gross profit margins and market share.

 

    Our estimates regarding future warranty obligations may change due to product failure rates, shipment volumes, field service obligations and other rework costs incurred in correcting product failures. If our estimates change, the liability for warranty obligations may be increased or decreased, impacting future cost of goods sold.

 

    Managing our inventory is complex and may include write-downs of excess or obsolete inventory.

 

    The continuing growth of our international operations could expose us to additional risks, increase our costs and adversely affect our operating results and financial condition.

 

    We may be adversely affected by fluctuations in currency exchange rates.

 

    Our success depends on our ability to reduce the selling prices of succeeding generations of our products.

 

    Breaches in our information systems could cause significant damage to our business and reputation.

 

    Our failure to maintain rights to intellectual property used in our business could adversely affect the development, functionality, and commercial value of our products.

 

    Software under license from third parties for use in certain of our products may not continue to be available to us on commercially reasonable terms.

 

    We may incur liabilities or become subject to litigation that would have a material effect on our business.

 

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    Consolidation and deterioration in the competitive service provider market could result in a significant decrease in our revenue.

 

    We depend on distributors who maintain inventories of our products. If the distributors reduce their inventories of these products, our sales could be adversely affected.

 

    If we are unable to successfully develop relationships with system integrators, service providers, and enterprise value added resellers, our sales may be negatively affected.

 

    If we fail to manage our exposure to worldwide financial and securities markets successfully, our operating results and financial statements could be materially impacted.

 

    Changes in our effective tax rate or assessments arising from tax audits may have an adverse impact on our results.

 

    We are required to periodically evaluate the value of our long-lived assets, including the value of intangibles acquired and goodwill resulting from business acquisitions. Any future impairment charges required may adversely affect our operating results.

 

    Our success depends on attracting and retaining key personnel.

 

    Regulatory and potential physical impacts of climate change and other natural events may affect our customers and our production operations, resulting in adverse effects on our operating results.

 

    While we believe our internal control over financial reporting is adequate, a failure to maintain effective internal control over financial reporting as our business expands could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

 

    The price of our common stock has been volatile and may continue to fluctuate significantly.

The foregoing list of risks is not exclusive. For a more detailed description of the risk factors associated with our business, see Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013, filed on February 27, 2014 with the SEC.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to financial market risks, including changes in interest rates, foreign currency rates and prices of marketable equity and fixed-income securities. The primary objective of the large majority of our investment activities is to preserve principal while at the same time achieving appropriate yields without significantly increasing risk. To achieve this objective, a majority of our marketable securities are investment grade, municipal, fixed-rate bonds, municipal variable rate demand notes and municipal money market instruments denominated in United States dollars. Our investment policy provides limitations for issuer concentration, which limits, at the time of purchase, the concentration in any one issuer to 5% of the market value of our total investment portfolio.

We maintain depository investments with certain financial institutions. Although these depository investments may exceed government insured depository limits, we have evaluated the credit worthiness of these financial institutions, and determined the risk of material financial loss due to exposure of such credit risk to be minimal. As of March 31, 2014, $48.0 million of our cash and cash equivalents, primarily certain domestic money market funds and foreign depository accounts, were in excess of government provided insured depository limits.

As of March 31, 2014, approximately $329.9 million of our cash and investments may be directly affected by changes in interest rates. We have performed a hypothetical sensitivity analysis assuming market interest rates increase or decrease by 50 basis points (bps) for an entire year, while all other variables remain constant. At March 31, 2014, we held $142.8 million of cash and investments where a change in interest rates would impact our interest income. A hypothetical 50 bps decline in interest rates as of March 31, 2014 would reduce annualized interest income on our cash and investments by approximately $0.6 million. In addition, we held $289.3 million of fixed-rate municipal bonds and corporate bonds whose fair values may be directly affected by a change in interest rates. A hypothetical 50 bps increase in interest rates as of March 31, 2014 would reduce the fair value of our municipal fixed-rate bonds and corporate bonds by approximately $1.5 million.

 

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As of March 31, 2013, approximately $400.9 million of our cash and investments was subject to being directly affected by changes in interest rates. We have performed a hypothetical sensitivity analysis assuming market interest rates increase or decrease by 50 bps for the entire year, while all other variables remain constant. A hypothetical 50 bps decline in interest rates as of March 31, 2013 would have reduced annualized interest income on our cash, money market instruments and municipal variable rate demand notes by approximately $0.7 million. In addition, a hypothetical 50 bps increase in interest rates as of March 31, 2013 would have reduced the fair value of our municipal fixed-rate bonds and corporate bonds by approximately $1.7 million.

We are directly exposed to changes in foreign currency exchange rates to the extent that such changes affect our revenue derived from international customers, expenses related to our foreign sales offices, and our foreign assets and liabilities. We attempt to manage these risks by primarily denominating contractual and other foreign arrangements in U.S. dollars. Our primary exposure in regard to our foreign assets and liabilities is with our German subsidiary whose functional currency is the Euro and our Australian subsidiary whose functional currency is the Australian dollar. We are indirectly exposed to changes in foreign currency exchange rates to the extent of our use of foreign contract manufacturers and foreign raw material suppliers whom we pay in U.S. dollars. As a result, changes in the local currency rates of these vendors in relation to the U.S. dollar could cause an increase in the price of products that we purchase.

We have certain international customers who are invoiced in their local currency. Changes in the monetary exchange rates used to invoice such customers versus the functional currency of the entity billing such customers may adversely affect our results of operations and financial condition. To manage the volatility relating to these typical business exposures, we may enter into various derivative transactions, when appropriate. We do not hold or issue derivative instruments for trading or other speculative purposes. The Yen and Riyal are the predominant currencies of the customers who are billed in their local currency. Taking into account the effects of foreign currency fluctuations of the Yen and Riyal versus the Euro, a hypothetical 10% weakening of the Euro as of March 31, 2014 would provide a gain on foreign currency of approximately $0.5 million. Conversely, a hypothetical 10% strengthening of the Euro as of March 31, 2014 would provide a loss on foreign currency of approximately $0.5 million. Any gain or loss would be significantly mitigated by the hedges discussed in the following paragraph.

As of March 31, 2014, we had no material contracts, other than accounts receivable, accounts payable, and loans to a subsidiary, denominated in foreign currencies. As of March 31, 2014, we had forward contracts outstanding with notional amounts totaling €20.7 million ($28.5 million), which mature at various times throughout 2014. The fair value of these forward contracts and swaps was a net liability of approximately $7 thousand as of March 31, 2014.

For further information about the fair value of our available-for-sale investments and our derivative and hedging activities as of March 31, 2014, see Notes 5 and 6 of Notes to Consolidated Financial Statements.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for ADTRAN. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are effective.

(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

A list of factors that could materially affect our business, financial condition or operating results is included under “Factors That Could Affect Our Future Results” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this report. There have been no material changes to the risk factors as disclosed in Item 1A of Part I of our most recent Annual Report on Form 10-K for the year ended December 31, 2013, filed on February 27, 2014 with the SEC.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth repurchases of our common stock for the months indicated:

 

Period

   Total
Number of
Shares
Purchased
     Average
Price
Paid per
Share
     Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
     Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
 

January 1, 2014 – January 31, 2014

     106,829       $ 25.40         106,829         3,355,302   

February 1, 2014 – February 28, 2014

     268,271       $ 25.02         268,271         3,087,031   

March 1, 2014 – March 31, 2014

     —           —           —           3,087,031   
  

 

 

       

 

 

    

Total

     375,100            375,100      
  

 

 

       

 

 

    

On May 1, 2013, our Board of Directors authorized the repurchase of an additional 5.0 million shares of our common stock. This new authorization is being implemented through open market or private purchases from time to time as conditions warrant.

ITEM 6. EXHIBITS

Exhibits.

 

Exhibit No.

  

Description

  31    Rule 13a-14(a)/15d-14(a) Certifications
  32    Section 1350 Certifications
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*    XBRL Taxonomy Extension Labels Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document

 

* Pursuant to Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

ADTRAN, INC.

(Registrant)

Date: May 7, 2014     /s/ James E. Matthews
    James E. Matthews
   

Senior Vice President – Finance,

Chief Financial Officer, Treasurer,

Secretary and Director

(Principal Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description

  31    Rule 13a-14(a)/15d-14(a) Certifications
  32    Section 1350 Certifications
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*    XBRL Taxonomy Extension Labels Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document

 

* Pursuant to Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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