[August 08, 2011] CITRIX SYSTEMS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) Our operating results and financial condition have varied in the past and could in the future vary significantly depending on a number of factors. From time to time, information provided by us or statements made by our employees contain "forward-looking" information that involves risks and uncertainties. In particular, statements contained in this Quarterly Report on Form 10-Q, and in the documents incorporated by reference into this Quarterly Report on Form 10-Q, that are not historical facts, including, but not limited to, statements concerning new products, development and offerings of products and services, market positioning and opportunities, customer demand, financial information and results of operations for future periods, product and price competition, strategy and growth initiatives, seasonal factors, stock-based compensation, licensing and subscription renewal programs, computer system enhancements, international operations and expansion, valuations of investments and derivative instruments, reinvestment or repatriation of foreign earnings, fluctuations in foreign exchange rates, contractual obligations, our Credit Facility, tax matters, the finalization of our tax settlement and written agreement with the IRS, the Netviewer, Kaviza Inc. and Cloud.com, Inc. acquisitions, the FASB's authoritative guidance, leasing activities and obligations, stock repurchases, investment transactions (including our investment in bonds issued by AIG Matched Funding Corporation, changes in domestic and foreign economic conditions and credit markets, acquired in-process technology, liquidity, litigation matters, intellectual property matters, distribution channels, stock price and payment of dividends, constitute forward-looking statements and are made under the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are neither promises nor guarantees. Our actual results of operations and financial condition have varied and could in the future vary materially from those stated in any forward-looking statements. The factors described in Part I, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2010, as updated in Part II, Item 1A in this Quarterly Report on Form 10-Q, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q, in the documents incorporated by reference into this Quarterly Report on Form 10-Q or presented elsewhere by our management from time to time. Such factors, among others, could have a material adverse effect upon our business, results of operations and financial condition. We caution readers not to place undue reliance on any forward-looking statements, which only speak as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made. Executive Summary Overview Management's discussion and analysis of financial condition and results of operations is intended to help the reader understand our financial condition and results of operations. This section is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for the three months ended June 30, 2011. The results of operations for the periods presented in this report are not necessarily indicative of the results expected for the full year or for any future period, due in part to the seasonality of our business. Historically, our revenue for the fourth quarter of any year is typically higher than our revenue for the first quarter of the subsequent year. We design, develop and market technology solutions that enable IT services to be securely delivered on demand - independent of location, device or network. Our customers achieve lower IT operating costs, increased information security, and greater business agility using Citrix technologies that enable virtual computing. We market and license our products directly to enterprise customers, over the web, and through systems integrators, or SIs, in addition to indirectly through value-added resellers, or VARs, value-added distributors, or VADs, and original equipment manufacturers, or OEMs. Our solutions can fundamentally change an information technology organization's approach and strategic value, transforming IT into an on-demand service by centralizing the delivery of applications and desktops, and by providing and enabling software-as-a-service. Further, this approach to IT transforms data centers, making them far more flexible to adapt to the changing needs of an enterprise. We believe our approach is unique in the market because we have combined innovative technologies in the area of desktop management, including but not limited to desktop virtualization and application virtualization, marketed as our Desktop Solutions, and server virtualization, cloud networking and cloud infrastructure products, marketed as our Datacenter and Cloud Solutions, to deliver a comprehensive end-to-end application delivery solution, and one that, when considered as a whole, is competitively differentiated by its feature set and interoperability. We saw uncertainties surrounding IT spending, particularly in the European markets in 2010. This trend has continued in 2011 as we still see uneven demand in many European countries, especially in the public sector. This overall economic uncertainty may adversely affect sales of our products and services and may result in longer sales cycles, slower adoption of technologies and increased price competition, particularly in Europe. Offsetting the uneven demand in European countries, we continue to see demand growth in tha Americas and Asia-Pacific regions. 25 -------------------------------------------------------------------------------- Table of Contents In today's business environment, however, there is a sharp focus on IT products and services that can reduce cost and deliver a quick, tangible return on investment, or ROI. With our customers focused on economic value in technology solutions, we intend to continue highlighting our solutions' abilities to reduce IT costs, increase business flexibility and deliver ROI with a simpler more flexible approach to computing. Our Desktop Solutions are built to transform and reduce the cost of traditional desktop management by virtualizing the desktop, with our XenDesktop product, and virtualizing applications, with our XenApp product, in a customer's datacenter. We are moving the delivery of desktops and related applications to an on-demand service as opposed to the delivery of a device. We continue to see growing customer interest in XenDesktop and, in addition, by making the XenDesktop trade-up program a standard program, we are maximizing our XenApp install base and driving continued XenDesktop adoption. Our Datacenter and Cloud Solutions, which include our cloud networking products, cloud infrastructure and server virtualization products, can alter the traditional economies of the datacenter by providing much greater levels of flexibility of computing resources, especially with respect to servers, by improving application performance and thereby reducing the amount of processing power involved, and allowing easy reconfiguration of servers by allowing storage and network infrastructure to be added in virtually rather than physically. Our cloud networking products are also enhancing our differentiation and driving customer interest around desktop virtualization, as enterprises are finding good leverage in deploying these technologies together. In July 2011, we acquired Cloud.com, Inc., or Cloud.com a market leading provider of software infrastructure platforms for cloud providers. Cloud.com's CloudStack™ product line helps providers of all types deploy and manage simple, cost-effective cloud services that are scalable, secure, and open by design. See 2011 Acquisitions below for more information related to our acquisition of Cloud.com. Our Online Services division is focused on developing and marketing Web-based access, support and collaboration services. These services are primarily marketed via the Web to large enterprises, medium and small businesses, prosumers and individuals. Our Online Services division's web collaboration services offer secure and cost-effective solutions that allow users to host and actively participate in online meetings, webinars and training sessions remotely and reduce costs associated with business travel. Our remote access solution offers a secure, simple and cost efficient way for users to access their desktops remotely, and our remote support solutions offer secure, on-demand support over the Internet. In addition, we continue to grow our Online Services division by increasing our addressable market geographically and offering services that appeal to a wider range of customers. To accelerate the European expansion of our Online Services division, in February 2011, we acquired Netviewer AG, or Netviewer, a privately held European SaaS vendor in collaboration and IT services. Netviewer is part of our Online Services division and enable the extension of our SaaS leadership in Europe. Our priorities for 2011 are to sustain the long-term growth of our businesses and enhance our current solutions through expanding our go-to-market reach and customer attach points, technological innovation, engineering excellence, selective and strategic acquisitions of technology, talent and/or businesses, and through a commitment to delivering high-quality products and services to customers and partners. We continue to make strategic investments in research and development of existing and new products, and to invest in research and development of advanced and innovative technologies for future application, including increasing research and development capacity and headcount. We believe that delivering innovative and high-value solutions through our Enterprise division's products and our Online Services division's services is the key to meeting customer and partner needs and achieving our future growth. We also intend to continue making significant investments to expand our brand awareness in virtualization, networking and cloud computing spaces. We also plan to increase sales, consulting and technical services capacity and headcount to support larger strategic customer engagements and more focus on SI partnerships as well as investing in new channel programs that allow our partners to upgrade their capabilities in desktop virtualization, which we currently believe is our largest area of opportunity. Summary of Results For the three months ended June 30, 2011 compared to the three months ended June 30, 2010, a summary of our results included: • Product License revenue increased 15.2% to $171.3 million; • License Updates revenue increased 9.1% to $183.9 million; • Online Services revenue increased 19.4% to $106.5 million; • Technical Services revenue increased 33.2% to $69.1 million; • Operating income increased 29.5% to $95.6 million; and • Diluted net income per share increased 70.4% to $0.43. 26 -------------------------------------------------------------------------------- Table of Contents The increase in our Product License revenue was driven by increased sales of our Datacenter and Cloud Solutions products, led by NetScaler and our Desktop Solutions products, led by XenDesktop. We currently target our Product License revenue to increase when comparing the third quarter of 2011 to the second quarter of 2011. The increase in License Updates revenue was primarily driven by an increase in renewals of our Subscription Advantage product. Our Online services revenue increased due to increased sales of our web collaboration services. Technical Services revenue increased due to increases in support revenues of $9.2 million driven by increased sales of our support related to our Datacenter and Cloud Solutions and a $5.0 million increase in sales of consulting services related to our Enterprise division's products. We currently target that total revenue will increase when comparing the third quarter of 2011 to the second quarter of 2011, as well as when comparing the 2011 fiscal year to the 2010 fiscal year. The increase in operating income is primarily due to an increase in gross margin attributable to an increase in total revenues due to the factors discussed above. 2011 Acquisitions Netviewer AG In February 2011, we acquired all of the issued and outstanding securities of Netviewer AG, or the Netviewer Acquisition or Netviewer, a privately held European software-as-a-service, or SaaS, vendor in collaboration and IT services. Netviewer became part of our Online Services division and the acquisition enables the extension of our Online Services business in Europe. The total consideration for this transaction was approximately $107.5 million, net of $6.3 million of cash acquired, and was payable in cash. Transaction costs associated with the acquisition were approximately $2.8 million, of which we expensed $0.4 million and $0.8 million during the three and six months ended June 30, 2011, respectively, and are included in general and administrative expense in our condensed consolidated statement of income. In addition, in connection with the acquisition, we converted and assumed approximately 99,100 non-vested stock units for which the vesting period reset fully upon the closing of the transaction. Revenues from Netviewer are included in our Online Services division's revenue. We have included the effect of the Netviewer Acquisition in our results of operations prospectively from the date of the acquisition, which effect was not material to our consolidated results. Accordingly, pro forma financial disclosures have not been presented. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. Weighted-Average Fair Value Asset (in thousands) Life Current assets $ 11,683 Other assets 330 Property and equipment 2,350 Various Intangible assets 28,806 4-7 years Goodwill 109,368 Indefinite Assets acquired 152,537 Current liabilities assumed (18,144 ) Long-term liabilities assumed (11,949 ) Deferred tax liabilities, non-current (8,606 ) Net assets acquired $ 113,838 Current assets acquired in connection with the Netviewer Acquisition consisted primarily of cash and accounts receivable. Current liabilities acquired in the acquisition of Netviewer consisted primarily of deferred revenues, short-term payables, and other accrued expenses and long-term liabilities consisted of long term debt which was paid in full subsequent to the acquisition date in the first quarter of 2011. Approximately $109.4 million of goodwill related to the Netviewer Acquisition was assigned to our Online Services division and is not deductible for tax purposes. See Note 10 to our condensed consolidated financial statements for segment information. The amount of goodwill is comprised primarily of expected synergies from combining operations and other intangible assets that do not qualify for separate recognition. We continue to evaluate certain tax assets and liabilities related to the Netviewer Acquisition. 27-------------------------------------------------------------------------------- Table of Contents Identifiable intangible assets purchased in the Netviewer Acquisition, in thousands, and their weighted-average lives are as follows: Fair Value (in thousands) Weighted-Average Life Trade names 541 4.0 years Customer relationships 25,019 7.0 years Core and product technologies 3,246 4.0years Total $ 28,806 Kaviza Inc. We present non-controlling interests of less-than-wholly-owned subsidiaries within the equity section of our condensed consolidated financial statements in accordance with the authoritative guidance for the presentation and disclosure of non-controlling interests of consolidated subsidiaries. In May 2011, we acquired all of the non-controlling interest of Kaviza Inc., or Kaviza, a provider of virtual desktop infrastructure solutions, for $17.2 million. In addition, we also deposited an additional $3.0 million to be held in escrow. As a result of this transaction, we have obtained a 100% interest in this subsidiary. In accordance with the authoritative guidance, the excess of the proceeds paid over the carrying amount of the non-controlling interest of Kaviza has been reflected as a reduction of paid in capital. In addition, in connection with the purchase of the non-controlling interest of Kaviza, we converted and assumed 88,687 non-vested stock units and 33,301 stock options with existing vesting periods. Cloud.com In July 2011, we acquired all of the issued and outstanding securities of Cloud.com, Inc., or Cloud.com, a privately held provider of software infrastructure platforms for cloud providers. Cloud.com will become part of our Enterprise division and the acquisition further establishes us as a leader in infrastructure for the growing cloud provider market. The total preliminary consideration for this transaction was approximately $158.9 million, net of cash acquired, and was paid in cash. In addition, in connection with the acquisition we converted and assumed approximately 288,742 non-vested stock units and 183,780 stock options for which the vesting period reset fully upon the closing of the transaction. Transaction costs associated with the acquisition are currently estimated at $3.5 million, of which we expensed $0.6 million during the three months ended June 30, 2011 and are included in general and administrative expense in our condensed consolidated statements of income. Other Acquisition During the first quarter of 2011, we acquired certain assets of a wholly-owned subsidiary of a privately-held company for a total cash consideration of approximately $10.5 million. We accounted for this acquisition as a business combination in accordance with the authoritative guidance and it became part of our Enterprise division, thereby expanding our solutions portfolio for service providers and developing unique integrations with our cloud application delivery solutions. We recorded approximately $5.9 million of goodwill, which is not deductible for tax purposes, and acquired $4.7 million of identifiable intangible assets, of which $3.0 million is related to product related intangible assets with a useful life of 5.0 years and $1.7 million is related to other intangible assets with a weighted-average useful life of 7.3 years. In addition, we assumed liabilities of approximately $0.1 million in conjunction with the acquisition. We have included the effect of this transaction in our results of operations prospectively from the date of the acquisition, which effect was not material to our consolidated results. 2010 Acquisitions On September 7, 2010, we acquired all of the issued and outstanding securities of VMLogix Inc., or VMLogix, a privately held corporation headquartered in Santa Clara, California. VMLogix is a provider of virtualization management software for private and public cloud computing systems. The total consideration for this transaction was approximately $13.2 million, comprised of approximately $10.4 million in cash, net of cash acquired, and approximately $2.8 million related to VMLogix liabilities settled in conjunction with the acquisition. The sources of funds for this transaction consisted of available cash. We recorded approximately $7.7 million of goodwill, which is not deductible for tax purposes, and acquired $10.6 million in assets including $7.5 million of identifiable intangible assets, of which $6.2 million is related to product related intangible assets with a useful life of 5.0 years and $1.3 million is related to other intangible assets with a useful life of 4.0 years. We assumed liabilities of approximately $5.1 million in conjunction with the acquisition. In addition, we also assumed stock options for which the vesting period reset fully upon the closing of the transaction. When these stock options vest, they will be exercisable for up to 47,784 shares of our common stock. We have included the effect of this transaction in our results of operations prospectively from the date of the acquisition, which effect was not material to our consolidated results. During the first quarter of 2010, we acquired two privately-held companies for a total cash consideration of approximately $9.2 million, net of cash acquired. We recorded approximately $2.6 million of goodwill, which is not deductible for tax purposes, and acquired $9.4 million in assets including $7.1 million of identifiable intangible assets, of which $6.2 million is related to product related intangible assets with a weighted-average useful life of 5.0 years and $0.9 million is related to other intangible assets with a weighted-average useful life of 2.0 years. In addition, we assumed liabilities of approximately $2.8 million in conjunction with the acquisitions. We have included the effects of these transactions in our results of operations prospectively from the respective dates of the acquisitions, which were not material to our consolidated results. 28 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. We base these estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, and these estimates form the basis for our judgments concerning the carrying values of assets and liabilities that are not readily apparent from other sources. We periodically evaluate these estimates and judgments based on available information and experience. Actual results could differ from our estimates under different assumptions and conditions. If actual results significantly differ from our estimates, our financial condition and results of operations could be materially impacted. For more information regarding our critical accounting policies and estimates please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" contained in our Annual Report on Form 10-K for the year ended December 31, 2010, or the Annual Report, and Note 2 to our condensed consolidated financial statements. There have been no material changes to the critical accounting policies disclosed in the Annual Report except as described below. Revenue Recognition We recognize revenue when it is earned and when all of the following criteria are met: persuasive evidence of the arrangement exists; delivery has occurred or the service has been provided and we have no remaining obligations; the fee is fixed or determinable; and collectability is probable. We define these four criteria as follows: • Persuasive evidence of the arrangement exists. We recognize revenue on packaged products and appliances upon shipment to distributors and resellers. For packaged product and appliance sales, it is our customary practice to require a purchase order from distributors and resellers who have previously negotiated a master packaged product distribution or resale agreement. For electronic and paper license arrangements, we typically require a purchase order from the distributor, reseller or end-user (depending on the arrangement) and an executed product license agreement from the end-user. For technical support, product training and consulting services, we require a purchase order and an executed agreement. For online services, we require the customer or the reseller to electronically accept the terms of an online services agreement or execute a contract. • Delivery has occurred and we have no remaining obligations. For product license and hardware appliance sales, our standard delivery method is free-on-board shipping point. Consequently, it considers delivery of packaged products and appliances to have occurred when the products are shipped pursuant to an agreement and purchase order. We consider delivery of licenses under electronic licensing agreements to have occurred when the related products are shipped and the end-user has been electronically provided the software activation keys that allow the end-user to take immediate possession of the product. For online services, delivery occurs upon providing the users with their login id and password. For product training and consulting services, we fulfill our obligation when the services are performed. For license updates, technical support and online services, we assume that our obligation is satisfied ratably over the respective terms of the agreements, which are typically 12 to 24 months. • The fee is fixed or determinable. In the normal course of business, we do not provide customers the right to a refund of any portion of their license fees or extended payment terms. The fees are considered fixed and determinable upon establishment of an arrangement that contains the final terms of the sale including description, quantity and price of each product or service purchased. For online services, the fee is considered fixed or determinable if it is not subject to refund or adjustment. • Collectability is probable. We determine collectability on a customer-by-customer basis and generally do not require collateral. We typically sell product licenses and license updates to distributors or resellers for whom there are histories of successful collection. New customers are typically subject to a credit review process that evaluates their financial position and ultimately their ability to pay. Customers are also subject to an ongoing credit review process. If we determine from the outset of an arrangement that collectability is not probable, revenue recognition is deferred until customer payment is received and the other parameters of revenue recognition described above have been achieved. Management's judgment is required in assessing the probability of collection, which is generally based on an evaluation of customer specific information, historical experience and economic market conditions. The majority of our product license revenue consists of revenue from the sale of stand-alone software products. Stand-alone software sales generally include a perpetual license to our software and are subject to the industry specific software revenue recognition guidance. In accordance with this guidance, we allocate revenue to license updates related to our stand-alone software and any other undelivered elements of the arrangement based on vendor specific objective evidence, or VSOE, of fair value of each element and such amounts are deferred until the applicable delivery criteria and other revenue recognition criteria described above have been met. The balance of the revenues, net of any discounts inherent in the arrangement, is recognized at the outset of the arrangement using the residual method as the product licenses are delivered. If management cannot objectively determine the fair value of each undelivered element based on VSOE of fair value, revenue recognition is deferred until all elements are delivered, all services have been performed, or until fair value can be objectively determined. 29 -------------------------------------------------------------------------------- Table of Contents Our hardware appliances contain software components that are essential to the overall functionality of the products. For hardware appliance transactions entered into prior to January 1, 2011, revenue for arrangements with multiple elements, such as sales of products that included services, was allocated to each element using the residual method based on the VSOE of the fair value of the undelivered items pursuant to authoritative guidance. Under the residual method, the amount of revenue allocated to delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements. If VSOE of one or more undelivered items does not exist, revenue from the entire arrangement is deferred and recognized at the earlier of: (i) delivery of those elements or (ii) when fair value can be established unless maintenance is the only undelivered element, in which case, the entire arrangement fee is recognized ratably over the contractual support period. In October 2009, the Financial Accounting Standards Board, or the FASB, amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product's essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to: (i) provide updated guidance on how the deliverables in a multiple deliverable arrangement should be separated, and how the consideration should be allocated; (ii) require an entity to allocate revenue in an arrangement using estimated selling prices, or ESP, of deliverables if a vendor does not have VSOE of selling price or third-party evidence of selling price, or TPE; and (iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. Effective January 1, 2011, we adopted these standards on a prospective basis for new and materially modified arrangements originating after December 31, 2010. The adoption of these standards did not have a material impact on our financial position and results of operations for the three and six months ended June 30, 2011. We do not expect the adoption of these standards to have a material impact on our financial position and results of operations in the future. However, we expect that this amended accounting guidance will facilitate our efforts to optimize our offerings due to better alignment between the economics of an arrangement and the accounting. This may lead us to engage in new go-to-market practices in the future. In particular, we expect that the amended accounting standards will enable us to better integrate products and services without VSOE into existing offerings and solutions. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP. For new and materially modified hardware appliance transactions subsequent to the adoption of the amended revenue recognition standards that are multiple-element arrangements, the arrangement consideration is allocated to stand-alone software deliverables as a group and the non-software deliverables based on the relative selling prices of using the selling price hierarchy in the amended revenue recognition guidance. The selling price hierarchy for a deliverable is based on its VSOE if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. We then recognize revenue on each deliverable in accordance with our policies for product and service revenue recognition. VSOE of selling price is based on the price charged when the element is sold separately. In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonable range based on historical discounting trends for specific products and services. TPE of selling price is established by evaluating competitor products or services in stand-alone sales to similarly situated customers. However, as our products contain a significant element of proprietary technology and our solutions offer substantially different features and functionality, the comparable pricing of products with similar functionality typically cannot be obtained. Additionally, as we are unable to reliably determine what competitors products' selling prices are on a stand-alone basis, we are not typically able to determine TPE. The estimate of selling price is established considering multiple factors including, but not limited to, pricing practices in different geographies and through different sales channels and competitor pricing strategies. For our non-software deliverables we allocate the arrangement consideration based on the relative selling price of the deliverables. For our hardware appliances we use ESP as our selling price. For our support and services, we generally use VSOE as our selling price. When we are unable to establish selling price using VSOE for our support and services, we use ESP in our allocation of arrangement consideration. Online services are sold separately. Our online services are purchased by large enterprises, small and medium-sized businesses, as well as individuals, and are centrally hosted within our datacenters. Our online services are considered service arrangements per the authoritative guidance; accordingly, fees related to online service agreements are recognized ratably over the contract term. In addition, Online Services revenues may also include set-up fees, which are recognized ratably over the contract term or the expected customer life, whichever is longer. Generally, our online services are sold separately and not bundled with the Enterprise division's products and services. 30-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our condensed consolidated statements of income data and presentation of that data as a percentage of change from period-to-period (in thousands). Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 Revenues: Product licenses $ 171,326 $ 148,733 $ 321,586 $ 271,439 15.2 % 18.5 % License updates 183,875 168,601 361,751 331,556 9.1 9.1 Online services 106,479 89,211 206,251 174,161 19.4 18.4 Technical services 69,110 51,888 132,090 95,549 33.2 38.2 Total net revenues 530,790 458,433 1,021,678 872,705 15.8 17.1 Cost of net revenues: Cost of license revenues 18,448 15,149 32,489 27,800 21.8 16.9 Cost of services revenues 37,906 25,989 68,572 49,679 45.9 38.0 Amortization of product related intangible assets 12,542 12,417 25,241 24,775 1.0 1.9 Total cost of net revenues 68,896 53,555 126,302 102,254 28.6 23.5 Gross margin 461,894 404,878 895,376 770,451 14.1 16.2 Operating expenses: Research and development 83,312 79,543 166,030 157,245 4.7 5.6 Sales, marketing and services 199,359 186,601 393,602 357,121 6.8 10.2 General and administrative 79,696 60,805 151,801 121,424 31.1 25.0 Amortization of other intangible assets 3,937 3,776 7,446 7,933 4.3 (6.1 ) Restructuring - 335 24 835 * * Total operating expenses 366,304 331,060 718,903 644,558 10.6 11.5 Income from operations 95,590 73,818 176,473 125,893 29.5 40.2 Interest income 3,727 3,837 7,666 7,393 (2.9 ) 3.7 Other income (expense), net 1,361 (2,962 ) 4,994 (2,585 ) * * Income before income taxes 100,678 74,693 189,133 130,701 34.8 44.7 Income taxes 19,270 27,136 34,378 35,795 (29.0 ) (4.0 ) Consolidated net income 81,408 47,557 154,755 94,906 71.2 63.1 Less: Net loss attributable to non-controlling interest 536 - 692 - * * Net income attributable to Citrix Systems, Inc. $ 81,944 $ 47,557 $ 155,447 $ 94,906 72.3 % 63.8 % * not meaningful Revenues Net revenues of our Enterprise division include the following categories: Product Licenses, License Updates and Technical Services. Product Licenses primarily represent fees related to the licensing of the following major products: • Our Desktop Solutions, comprised primarily of our desktop virtualization product XenDesktop and our application virtualization product XenApp; and • Our Datacenter and Cloud Solutions, comprised primarily of our cloud networking products NetScaler, Access Gateway and Branch Repeater and our cloud infrastructure products, XenServer and Essentials for Hyper-V. 31 -------------------------------------------------------------------------------- Table of Contents In addition, we offer incentive programs to our VADs and VARs to stimulate demand for our products. Product license revenues associated with these programs are partially offset by these incentives to our VADs and VARs. License Updates consist of fees related to our Subscription Advantage program that are recognized ratably over the term of the contract, which is typically 12 to 24 months. Subscription Advantage is an annual renewable program that provides subscribers with automatic delivery of unspecified software upgrades, enhancements and maintenance releases when and if they become available during the term of the subscription. Technical Services revenues are comprised of fees from technical support services which are recognized ratably over the contract term, as well as revenues from product training and certification, and consulting services revenue related to implementation of our products, which is recognized as the services are provided. Our Online Services division's revenues consist of fees related to online service agreements from our web collaboration products which primarily include our GoToMeeting, GoToWebinar, Hi-Def Audio, and GoToTraining services, our connectivity product, GoToMyPC, and our remote IT support which primarily include GoToAssist and GoToManage. Our Online Services revenue is recognized ratably over the contract term. Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, June 30, 2011 2010 2011 2010 2011 vs. June 30, 2010 2011 vs. June 30, 2010 (In thousands) Product Licenses $ 171,326 $ 148,733 $ 321,586 $ 271,439 $ 22,593 $ 50,147 License Updates 183,875 168,601 361,751 331,556 15,274 30,195 Online Services 106,479 89,211 206,251 174,161 17,268 32,090 Technical Services 69,110 51,888 132,090 95,549 17,222 36,541 Total net revenues $ 530,790 $ 458,433 $ 1,021,678 $ 872,705 $ 72,357 $ 148,973 Product Licenses Product License revenue increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to increased sales of our Datacenter and Cloud Solutions, led by NetScaler of $12.3 million and due to increased sales of our of our Desktop Solutions, led by XenDesktop of $9.7 million. Product License revenues increased for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to increases in sales of our Desktop Solutions products of $26.8 million and our Datacenter and Cloud Solutions of $22.4 million. These increases in Product License revenue were primarily due to the factors discussed in the Executive Summary above. We currently target Product license sales to increase when comparing the third quarter of 2011 to the third quarter of 2010 due to the factors discussed in the Executive Summary Overview above. License Updates License Updates revenue increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to renewals related to our Subscription Advantage product over a larger base of subscribers. License Updates revenue increased for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 due to renewals related to our Subscription Advantage product over a larger base of subscribers of $15.8 million and an increase in new Subscription Advantage license sales related to increased sales of XenDesktop of $14.4 million. We currently anticipate that License Updates revenue will increase when comparing the third quarter of 2011 to the third quarter of 2010. Online Services Online Services revenue increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 and for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to increased sales of our web collaboration products. We are currently targeting that Online Services revenue will increase when comparing the third quarter of 2011 to the third quarter of 2010. Technical Services Technical Services revenue increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to increases in support revenues of $9.2 million driven by increased sales of our Datacenter and Cloud Solutions, primarily NetScaler, and an increase in consulting revenues of $5.0 million related to increased implementation sales of our Enterprise division's products. Technical Services revenue increased for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to increases in support revenues of $17.7 million driven by increased sales of our Datacenter and Cloud Solutions, primarily NetScaler, and an increase in consulting revenues of $11.2 million related to increased implementation sales of our Enterprise division's products. We currently anticipate that Technical Services revenues will increase when comparing the third quarter of 2011 to the third quarter of 2010 consistent with the targeted increase in Product License revenue described above. 32 -------------------------------------------------------------------------------- Table of Contents Deferred Revenue Deferred revenues are primarily comprised of License Updates revenue from Subscription Advantage, Technical Services revenues related to our support services and consulting contracts and Online Services revenues from annual service agreements for our Online Services. Deferred revenues increased approximately $50.8 million as of June 30, 2011 compared to December 31, 2010 primarily due to increased sales of our Subscription Advantage product of $19.7 million, increased sales of our online service agreements of $18.4 million and increased sales of our support services of $12.5 million. We currently anticipate that deferred revenues will continue to increase for the remainder of 2011. International Revenues International revenues (sales outside the United States) accounted for approximately 43.4% of our net revenues for the three months ended June 30, 2011 and 42.5% of our net revenues for the three months ended June 30, 2010. International revenues accounted for approximately 44.9% of our net revenues for the six months ended June 30, 2011 and 42.7% of our net revenues for the six months ended June 30, 2010. See Note 10 to our condensed consolidated financial statements for detailed information on net revenues by geography. Segment Revenues Our revenues are derived from sales of Enterprise division products which include our Desktop Solutions, Datacenter and Cloud Solutions products and related technical services and from our Online Services division's web collaboration, connectivity and remote support services. The Enterprise division and the Online Services division constitute our two reportable segments. An analysis of our reportable segment net revenue is presented below (in thousands): Increase for the Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 Enterprise division $ 424,311 $ 369,222 $ 815,427 $ 698,544 14.9 % 16.7 % Online Services division 106,479 89,211 206,251 174,161 19.4 18.4 Net revenues $ 530,790 $ 458,433 $ 1,021,678 $ 872,705 15.8 % 17.1 % With respect to our segment revenues, the increase in net revenues for the comparative periods presented was due primarily to the factors previously discussed above. See Note 10 of our condensed consolidated financial statements for additional information on our segment revenues. Cost of Net Revenues Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 (In thousands) Cost of product license revenues $ 18,448 $ 15,149 $ 32,489 $ 27,800 $ 3,299 $ 4,689 Cost of services revenues 37,906 25,989 68,572 49,679 11,917 18,893 Amortization of product related intangible assets 12,542 12,417 25,241 24,775 125 466 Total cost of net revenues $ 68,896 $ 53,555 $ 126,302 $ 102,254 $ 15,341 $ 24,048 Cost of product license revenues consists primarily of hardware, product media and duplication, manuals, packaging materials, shipping expense and royalties. Cost of services revenue consists primarily of compensation and other personnel-related costs of providing technical support and consulting, as well as the costs related to providing our online services. Also included in cost of net revenues is amortization of product related intangible assets. Cost of product license revenues increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 and for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to increased revenue of our Datacenter and Cloud products, many of which contain hardware components that have a higher cost than our other software products. We currently anticipate cost of product license revenues will increase when comparing the third quarter of 2011 to the third quarter of 2010 consistent with the targeted increase in Product License sales. 33-------------------------------------------------------------------------------- Table of Contents Cost of services revenues increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 by $5.5 million consistent with the increase in sales of our technical services related to our Enterprise products and $4.4 million primarily due to an increase in sales of our web collaboration products consistent with the increase in revenue as described above. Cost of services revenues increased for six months ended June 30, 2011 compared to the six months ended June 30, 2010 by $9.7 million consistent with the increase in revenue of technical services related to our Enterprise products and increased $7.3 million primarily due to an increase in sales of our web collaboration products as described above. We currently anticipate cost of services revenues will increase when comparing the third quarter of 2011 to the third quarter of 2010 consistent with the targeted increase in Online Services and Technical Services revenues as discussed above. Gross Margin Gross margin as a percentage of revenue was 87.0% for the three months ended June 30, 2011 and 88.3% for the three months ended June 30, 2010. Gross margin as a percentage of revenue was 87.6% for the six months ended June 30, 2011 and 88.3% for the six months ended June 30, 2010. Operating Expenses Foreign Currency Impact on Operating Expenses A substantial majority of our overseas operating expenses and capital purchasing activities are transacted in local currencies and are therefore subject to fluctuations in foreign currency exchange rates. In order to minimize the impact on our operating results, we generally initiate our hedging of currency exchange risks up to 15 months in advance of anticipated foreign currency expenses. When the dollar is weak, the resulting increase to foreign currency denominated expenses will be partially offset by the gain in our hedging contracts. When the dollar is strong, the resulting decrease to foreign currency denominated expenses will be partially offset by the loss in our hedging contracts. There is a risk that there will be fluctuations in foreign currency exchange rates beyond the one-year timeframe for which we hedge our risk. Research and Development Expenses Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 (In thousands) Research and development $ 83,312 $ 79,543 $ 166,030 $ 157,245 $ 3,769 $ 8,785 Research and development expenses consisted primarily of personnel related costs and facility and equipment costs directly related to our research and development activities. We expensed substantially all development costs included in the research and development of our products. Research and development expenses increased during the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to a $11.4 million increase in compensation and other employee related costs primarily related to increased headcount due to strategic hiring and acquisitions and annual merit increases. Partially offsetting the increases in research and development costs when comparing the three months ended June 30, 2011 to the three months ended June 30, 2010 is an $8.5 million decrease in stock-based compensation expense due to stock-based awards related to certain acquisitions becoming fully vested. Research and development expenses increased during the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to a $22.1 million increase in compensation and other employee related costs. Also contributing to the increase in research and development expenses was a $4.0 million increase in facilities and related depreciation. These increases primarily relate to increased headcount due to strategic hiring and acquisitions and annual merit increases. Partially offsetting the increases in research and development costs when comparing the six months ended June 30, 2011 to the six months ended June 30, 2010 is a $16.7 million decrease in stock-based compensation expense due to stock-based awards related to certain acquisitions becoming fully vested. We are currently targeting an increase in research and development expense when comparing the third quarter of 2011 to the second quarter of 2011 due to our Cloud.com acquisition, development of existing and new products, and investments in research and development of advanced technologies for future application. 34 -------------------------------------------------------------------------------- Table of Contents Sales, Marketing and Services Expenses Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 (In thousands) Sales, marketing and services $ 199,359 $ 186,601 $ 393,602 $ 357,121 $ 12,758 $ 36,481 Sales, marketing and services expenses consisted primarily of personnel-related costs, including sales commissions, the costs of marketing programs aimed at increasing revenue, such as brand development, advertising, trade shows, public relations and other market development programs and costs related to our facilities, equipment and information systems that are directly related to our sales, marketing and services activities. Sales, marketing and services expenses increased during the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to a $13.6 million increase in compensation, including annual merit increases, and employee related costs due to additional headcount in our sales force and technical services group, as well as from our acquisition of Netviewer. Sales, marketing and services expenses increased during the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to a $27.4 million increase in compensation, including annual merit increases, and employee related costs due to additional headcount in our sales force and technical services group, as well as from our acquisition of Netviewer. Also contributing to the increase in sales, marketing and services expense was a $5.4 million increase in marketing program costs related to various marketing campaigns and events. We are currently targeting an increase in sales, marketing and services expenses when comparing the third quarter of 2011 to the second quarter of 2011 due to our Cloud.com acquisition and as we continue to increase our sales and technical services capacity. General and Administrative Expenses Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 (In thousands) General and administrative $ 79,696 $ 60,805 $ 151,801 $ 121,424 $ 18,891 $ 30,377 General and administrative expenses consisted primarily of personnel related costs and expenses related to outside consultants assisting with information systems, as well as accounting and legal fees. General and administrative expenses increased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 primarily due to an $11.0 million increase in compensation and employee related costs due to annual merit increases and additional headcount, primarily in IT as well as from our acquisition of Netviewer. Also contributing to the increase in general and administrative expense is a $4.0 million increase in professional fees primarily related to acquisition and strategic investment activity. General and administrative expenses increased for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 primarily due to a $22.2 million increase in compensation and employee related costs due to annual merit increases and additional headcount, primarily in IT as well as from our acquisition of Netviewer. Also contributing to the increase in general and administrative expense is a $3.4 million increase in professional fees primarily related to acquisition and strategic investment activity. We currently anticipate that general and administrative expenses will increase when comparing the third quarter of 2011 to the second quarter of 2011 due primarily to the acquisition of Cloud.com and related transaction costs and professional fees and to a lesser extent costs to support the growth in our business. 35 -------------------------------------------------------------------------------- Table of Contents Other Income (Expense), Net Three Months Ended Six Months Ended Three Months Ended Six Months Ended June 30, June 30, June 30, 2011 June 30, 2011 2011 2010 2011 2010 vs. June 30, 2010 vs. June 30, 2010 (In thousands) Other income (expense) $ 1,361 $ (2,962 ) $ 4,994 $ (2,585 ) $ 4,323 $ 7,579 Other income (expense), net is primarily comprised of remeasurement of foreign currency transaction gains (losses) and realized gains (losses) related to changes in the fair value of our investments that have a decline in fair value that is considered other-than-temporary, if any, recognized gains (losses) related to available-for-sale investments and interest expense which was not material for all periods presented. The increase in other income (expense), net, during the three months ended June 30, 2011 compared to the three months ended June 30, 2010 and during the six months ended June 30, 2011 compared to the six months ended June 30, 2010 is primarily due to an increase in gains related to remeasurement of our foreign currency transactions. For more information on our investments, see "- Liquidity and Capital Resources." Income Taxes As of June 30, 2011, our net unrecognized tax benefits totaled approximately $65.5 million. There was $0.8 million included in the balance at June 30, 2011 for tax positions which would affect the annual effective tax rate. During the quarter ended June 30, 2011, we recognized $0.1 million of expense related to interest, which is included in income tax expense. We have approximately $1.4 million for the payment of interest and penalties accrued at June 30, 2011. We and certain of our subsidiaries are subject to U.S. federal income taxes, as well as income taxes of multiple state and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S., income tax examinations by tax authorities for years prior to 2004. In the ordinary course of global business, there are transactions for which the ultimate tax outcome is uncertain and judgment is required in determining the worldwide provision for income taxes. We provide for income taxes on transactions based on our estimate of the probable liability. We adjust our provision as appropriate for changes that impact our underlying judgments. Changes that impact provision estimates include such items as jurisdictional interpretations on tax filing positions based on the results of tax audits and general tax authority rulings. Due to the evolving nature of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability and the realizability of our deferred tax assets could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows. In June 2010, we reached a settlement in principle with the IRS regarding certain previously disclosed income tax deficiencies asserted in a Revenue Agent's Report, or RAR. Under the terms of the settlement in principle, we would agree to an assessment of income tax deficiencies in full settlement of all open claims under the RAR and would resolve with finality for future years all of the transfer pricing issues raised in the RAR. Based on this, we incurred a charge of $13.1 million in 2010 in accordance with the authoritative guidance. Among other things, the authoritative guidance requires application of a "more likely than not" threshold to the recognition and non-recognition of tax positions. It further requires that a change in management judgment related to prior years' tax positions be recognized in the quarter of such change. The final settlement requires the finalization of tax deficiency calculations with the IRS and a written agreement signed by the IRS. It is uncertain how long it will take to reach a final settlement with the IRS. There can be no assurances that a final written agreement will be obtained or that this matter will otherwise be resolved in our favor. An adverse outcome of this matter could have a material adverse effect on our results of operations and financial condition. We are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our condensed consolidated financial statements. At June 30, 2011, we had approximately $119.4 million in net deferred tax assets. The authoritative guidance requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We review deferred tax assets periodically for recoverability and make estimates and judgments regarding the expected geographic sources of taxable income and gains from investments, as well as tax planning strategies in assessing the need for a valuation allowance. 36 -------------------------------------------------------------------------------- Table of Contents We maintain certain strategic management and operational activities in overseas subsidiaries and our foreign earnings are taxed at rates that are generally lower than in the United States. We do not expect to remit earnings from our foreign subsidiaries. The decrease in the effective tax rate when comparing the three and six months ended June 30, 2011 to the three and six months ended June 30, 2010 was primarily due to the charge recorded in the second quarter of 2010 related to the settlement in principle with the IRS. Our effective tax rate was approximately 19.1% for the three months ended June 30, 2011, 36.3% for the three months ended June 30, 2010, 18.2% for the six months ended June 30, 2011 and 27.4% for the six months ended June 30, 2010. Our effective tax rate generally differs from the U.S. federal statutory rate of 35% due primarily to lower tax rates on earnings generated by our foreign operations that are taxed primarily in Switzerland. We have not provided for U.S. taxes for those earnings because we plan to reinvest all of those earnings indefinitely outside the United States. Our effective tax rate will fluctuate based on the mix of earnings from our U.S. and foreign jurisdictions. Accordingly, earnings from the production and distribution of our products and services through our foreign headquarters in Switzerland are currently taxed at lower income tax rates than earnings from our U.S. operations. Liquidity and Capital Resources During the six months ended June 30, 2011, we generated operating cash flows of $321.5 million. These operating cash flows related primarily to net income of $154.8 million, adjusted for, among other things, non-cash charges, including depreciation and amortization expenses of $72.7 million and stock-based compensation expense of $38.6 million. Also contributing to these cash inflows was an aggregate increase in operating assets and liabilities of $53.2 million, net of effects of our acquisitions. Our investing activities used $170.2 million of cash consisting primarily of cash paid for acquisitions of $118.4 million and the purchase of property and equipment of $59.5 million. Our financing activities used cash of $120.7 million primarily due to stock repurchases of $199.9 million. This financing cash outflow was partially offset by proceeds received from the issuance of common stock under our employee stock-based compensation plans of $85.1 million. During the six months ended June 30, 2010, we generated operating cash flows of $246.8 million. These operating cash flows related primarily to net income of $94.9 million, adjusted for, among other things, non-cash charges, including depreciation and amortization expenses of $68.2 million and stock-based compensation expense of $53.1 million. Also contributing to these cash inflows was an aggregate increase in operating assets and liabilities of $27.8 million, net of effects of our acquisitions. Our investing activities used $161.5 million of cash consisting primarily of cash paid for net purchases of investments of $110.0 million and the purchase of property and equipment of $30.1 million. Also contributing to these cash outflows was cash paid for acquisitions and licensing agreements and product-related intangible assets of $20.5 million. Our financing activities used cash of $1.8 million primarily due to stock repurchases of $199.9 million. This financing cash outflow was partially offset by proceeds received from the issuance of common stock under our employee stock-based compensation plans of $184.2 million. Historically, significant portions of our cash inflows were generated by our operations. We currently expect this trend to continue throughout 2011. We believe that our existing cash and investments together with cash flows expected from operations will be sufficient to meet expected operating and capital expenditure requirements for the next 12 months. Cash, Cash Equivalents and Investments 2011 Compared to June 30, 2011 December 31, 2010 2010 (In thousands)Cash, cash equivalents and investments $ 1,699,070 $ 1,685,659 $ 13,411 The increase in cash, cash equivalents and investments when comparing June 30, 2011 to December 31, 2010, is primarily due to cash provided by our operating activities of $321.5 million and cash received from the issuance of common stock under our employee stock-based compensation plans of $85.1 million partially offset by expenditures made on stock repurchases of $199.9 million, cash paid for acquisitions, net of cash acquired, of $118.4 million, purchases of property and equipment of $59.5 million and purchases of cost method investments and product-related intangible assets of $15.7 million. As of June 30, 2011, $794.2 million of the $1,699.1 million of cash, cash equivalents and available-for-sale investments was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we would be required to accrue and pay U.S. taxes to repatriate these funds. Our current plans are not expected to require repatriation of cash and investments to fund our U.S. operations and, as a result, we intend to permanently reinvest our foreign earnings. See "- Liquidity and Capital Resources." We generally invest our cash and cash equivalents in investment grade, highly liquid securities to allow for flexibility in the event of immediate cash needs. Our short-term and long-term investments primarily consist of interest-bearing securities. 37-------------------------------------------------------------------------------- Table of Contents Fair Value Measurements The authoritative guidance defines fair value as an exit price, representing the amount that would either be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: • Level 1. Observable inputs such as quoted prices in active markets for identical assets or liabilities; • Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and • Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Available-for-sale securities included in Level 1 are valued using closing prices for identical instruments that are traded on active exchanges. Available-for-sale securities included in Level 2 are valued utilizing inputs obtained from an independent pricing service, or the Service, which uses quoted market prices for identical or comparable instruments rather than direct observations of quoted prices in active markets. The Service gathers observable inputs for all of our fixed income securities from a variety of industry data providers, for example, large custodial institutions and other third-party sources. Once the observable inputs are gathered by the Service, all data points are considered and an average price is determined. The Service's providers utilize a variety of inputs to determine their quoted prices. These inputs may include interest rates, known historical trades, yield curve information, benchmark data, prepayment speeds, credit quality and broker/dealer quotes. Substantially all of our available-for-sale investments are valued utilizing inputs obtained from the Service and accordingly are categorized as Level 2. We do not adjust the prices obtained from the Service. Available-for-sale securities are included in Level 3 when relevant observable inputs for a security are not available. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the classification of assets and liabilities within the fair value hierarchy. In certain instances, the inputs used to measure fair value may meet the definition of more than one level of the fair value hierarchy. The input with the lowest level priority is used to determine the applicable level in the fair value hierarchy. Assets and Liabilities Measured at Fair Value on a Recurring Basis Our fixed income available-for-sale securities consist of high quality, investment grade securities from diverse issuers with a minimum credit rating of A- and a weighted average credit rating of AA. We previously classified these investments as Level 1 because we did not make adjustments to the prices obtained from the Service. However, as we value these securities based on pricing from the Service, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value; we began classifying all of our fixed income available-for-sale securities as Level 2 in the first quarter of 2011. We measure our cash flow hedges at fair value based on indicative prices in active markets (Level 2 inputs). We currently hold one available-for-sale investment for which quoted prices are not readily available, our $50.0 million face value investment, which matures in September 2011, issued by AIG Matched Funding Corporation, or the AIG Capped Floater. In order to measure the AIG Capped Floater at fair value we used a discounted cash flow model. We then discounted those cash flows at a rate reflecting the market risk inherent in holding an AIG security with a similar maturity as evidenced by pricing in the markets. Since utilizing a discounted cash flow model required us to make assumptions that were not directly or indirectly observable regarding the AIG Capped Floater's fair value. Accordingly, it is a Level 3 valuation and is included in the table below. Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3) Long-term Investments (in thousands) Balance at December 31, 2010 $ 49,340 Decrease in previously recognized unrealized losses included in accumulated other comprehensive income 441 Balance at June 30, 2011 $ 49,781 38 -------------------------------------------------------------------------------- Table of Contents Accounts Receivable, Net 2011 Compared to June 30, 2011 December 31, 2010 2010 (In thousands) Accounts receivable $ 343,569 $ 382,654 $ (39,085 ) Allowance for returns (1,412 ) (850 ) (562 ) Allowance for doubtful accounts (3,423 ) (3,409 ) (14 ) Accounts receivable, net $ 338,734 $ 378,395 $ (39,661 ) The decrease in accounts receivable when comparing June 30, 2011 to December 31, 2010 was primarily due to increased collections in the first quarter of 2011 on higher fourth quarter 2010 sales. The activity in our allowance for returns was comprised primarily of $2.2 million of provisions for returns recorded in the first half of 2011 partially offset by $1.7 million in credits issued for returns during the first half of 2011. The activity in our allowance for doubtful accounts was comprised primarily of $0.7 million in additional provisions for doubtful accounts recorded during the first half of 2011 partially offset by $0.7 million of uncollectible accounts written off, net of recoveries. From time to time, we could maintain individually significant accounts receivable balances from our distributors or customers, which are comprised of large business enterprises, governments and small and medium-sized businesses. If the financial condition of our distributors or customers deteriorates, our operating results could be adversely affected. Credit Facility Effective on August 9, 2005, we entered into a revolving credit facility, or the Credit Facility, with a group of financial institutions, or the Lenders. Effective September 27, 2006, we entered into an amendment and restatement of the Credit Facility, or the Amendment. The Amendment decreased the overall range of interest we will pay on amounts outstanding on the Credit Facility and lowered the facility fee. In addition, the Amendment extended the term of the Credit Facility. The Credit Facility, as amended, allows us to increase the revolving credit commitment up to a maximum aggregate revolving credit commitment of $175.0 million. The Credit Facility, as amended, will expire on September 27, 2011 and it currently provides for a revolving line of credit in the aggregate amount of $100.0 million, subject to continued covenant compliance. A portion of the revolving line of credit (1) in the aggregate amount of $25.0 million may be available for issuances of letters of credit and (2) in the aggregate amount of $15.0 million may be available for swing line loans. The Credit Facility, as amended, currently bears interest at the London Interbank Offered Rate, or LIBOR, plus 0.32% and adjusts in the future in the range of 0.32% to 0.80% above LIBOR based on the level of our total debt and our adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA. In addition, we are required to pay an annual facility fee ranging from 0.08% to 0.20% based on the aggregate amount available under the Credit Facility, as amended, and the level of our total debt and adjusted EBITDA. During the three months ended June 30, 2011, no funds were borrowed under the Credit Facility, as amended, and as of June 30, 2011 there were no amounts outstanding under the Credit Facility, as amended. The Credit Facility, as amended, contains customary default provisions, and we must comply with various financial and non-financial covenants. The financial covenants consist of a minimum interest coverage ratio and a maximum consolidated leverage ratio. The primary non-financial covenants contain certain limits on our ability to pay dividends, conduct certain mergers or acquisitions, make certain investments and loans, incur future indebtedness or liens, alter our capital structure or sell stock or assets. As of June 30, 2011, we were in compliance with all covenants of the Credit Facility. We currently do not plan to renew the credit facility upon expiration on September 27, 2011. Stock Repurchase Program Our Board of Directors authorized an ongoing stock repurchase program with a total repurchase authority granted to us of $3.0 billion, of which $500.0 million was approved in April 2011. We may use the approved dollar authority to repurchase stock at any time until the approved amounts are exhausted. The objective of our stock repurchase program is to improve stockholders' returns. At June 30, 2011, approximately $411.6 million was available to repurchase common stock pursuant to the stock repurchase program. All shares repurchased are recorded as treasury stock. A portion of the funds used to repurchase stock over the course of the program was provided by proceeds from employee stock option exercises and the related tax benefit. We are authorized to make open market purchases of our common stock using general corporate funds. Additionally, from time to time, we may enter into structured stock repurchase arrangements with large financial institutions using general corporate funds in order to lower the average cost to acquire shares. These programs include terms that require us to make up-front payments to the counterparty financial institution and result in the receipt of stock during or at the end of the agreement or the receipt of either stock or cash at the maturity of the agreement, depending on market conditions. As of June 30, 2011, we did not have any prepaid notional amounts outstanding under structured stock repurchase programs and we did not make any up-front payments to financial institutions related to structured stock repurchase agreements in 2011. 39-------------------------------------------------------------------------------- Table of Contents During the three months ended June 30, 2011, we expended approximately $100.0 million on open market purchases, repurchasing 1,208,400 shares of outstanding common stock at an average price of $82.72. During the six months ended June 30, 2011, we expended approximately $199.9 million on open market purchases, repurchasing 2,660,500 shares of outstanding common stock at an average price of $75.14. During the three months ended June 30, 2010, we expended approximately $100.0 million on open market purchases, repurchasing 2,138,500 shares of outstanding common stock at an average price of $46.74. During the six months ended June 30, 2010, we expended approximately $199.9 million on open market purchases, repurchasing 4,427,100 shares of outstanding common stock at an average price of $45.16. Shares for Tax Withholding During the three months ended June 30, 2011, we withheld 39,145 shares from stock units that vested totaling $3.3 million to satisfy minimum tax withholding obligations that arose on the vesting of stock units. During the six months ended June 30, 2011, we withheld 163,740 shares from stock units that vested totaling $12.1 million to satisfy minimum tax withholding obligations that arose on the vesting of stock units. These shares are reflected as treasury stock in our condensed consolidated balance sheets and the related cash outlays reduce our total stock repurchase authority. During the three months ended June 30, 2010, we withheld 31,126 shares from stock units that vested totaling $1.5 million to satisfy minimum tax withholding obligations that arose on the vesting of stock units. During the six months ended June 30, 2010, we repurchased 91,601 shares from stock units that vested totaling $4.1 million to satisfy minimum tax withholding obligations that arose on the vesting of shares of stock units. These shares are reflected as treasury stock in our condensed consolidated balance sheets and the related cash outlays reduce our total stock repurchase authority. Office Leases We have operating lease obligations through 2018 related to two properties that are not utilized. At June 30, 2011, the total remaining obligation on these leases was approximately $6.1 million, of which $2.8 million was accrued as of June 30, 2011, and is reflected in accrued expenses and other current liabilities and other liabilities in our condensed consolidated financial statements. In calculating this accrual, we made estimates, based on market information, including the estimated vacancy periods and sublease rates and opportunities. We periodically re-evaluate our estimates related to these vacant facilities. Off-Balance Sheet Arrangements The Company does not have any special purpose entities or off-balance sheet financing arrangements. [ Back To TMCnet.com's Homepage ]