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PLANTRONICS INC /CA/ - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis is intended to help you understand our results of operations and financial condition. It is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements. Please see the "Cautionary Statement" and "Risk Factors" above for discussions of the uncertainties, risks, and assumptions associated with these statements. Our fiscal year-end financial reporting periods are 52 or 53 week years ending on the Saturday closest to March 31st. Fiscal year 2012 had 52 weeks and ended on March 31, 2012. Fiscal year 2011 had 52 weeks and ended on April 2, 2011. Fiscal year 2010 had 53 weeks, with the extra week occurring in the fourth quarter of the year, and ended on April 3, 2010. Except as noted, financial results are for continuing operations; Altec Lansing, our former AEG segment, was sold effective December 1, 2009 and is reported as discontinued operations. OVERVIEW We are a leading designer, manufacturer, and marketer of lightweight communications headsets, telephone headset systems, and accessories for the worldwide business and consumer markets under the Plantronics brand. In addition, we manufacture and market, under our Clarity brand, specialty telephone products, such as telephones for the hearing impaired, and other related products for people with special communication needs. Our priorities during fiscal year 2012 were to win in Unified Communications ("UC"), to improve our execution effectiveness, and to deliver strong financial results. We sharply increased revenues from UC products, growing by 76% over the prior year to $93.4 million, and believe we continue to lead the market in this category. We improved our execution effectiveness by extending our Simply Smarter CommunicationsTM technology branding to become an integral part of the value proposition available through UC solutions. We also created the Plantronics Developer Connection ("PDC"), subsequently launched on May 9, 2012, to extend the opportunities in UC to the vast ecosystem of vendors, application developers and vertical markets. Even with continued pressures from the macroeconomic environment, we delivered strong financial results. As part of our continued commitment to a strong and innovative set of integrated solutions, we increased research, development and engineering spending by approximately 10% over the prior year, yet still achieved $109.0 million in net income, representing approximately 15% of our net revenues. We believe UC represents our key long-term driver of revenue and profit growth, and it continues to be our primary focus area. Business communications are being transformed from voice-centric systems supported by traditional PBX infrastructure to communication systems that are fully integrated with voice, video, and data and are supported by feature rich UC software. With this transformation, the requirement for a traditional headset used only for voice communications continues to evolve into a device that delivers contextual intelligence, providing the ability to reach people using the mode of communication that is most effective, on the device that is most convenient, and with control over when and how they can be reached. Our portfolio of UC solutions combines hardware with advanced sensor technology and capitalizes on contextual intelligence, addressing the needs of the constantly changing business environments and evolving work styles to make connecting easier and by sharing presence information to convey user availability and other contextual information. We believe UC systems will become more commonly adopted by enterprises to reduce costs and improve collaboration, and we believe our solutions with Simply Smarter CommunicationsTM technology will be an important part of the UC environment. The contact center is the most mature market in which we participate, and we expect this market to grow slowly over the long-term. Given the migration to UC by corporations globally, we also expect the market for headsets for non-UC enterprise applications to grow very slowly. We believe the growth of UC will increase overall headset adoption in enterprise environments and we therefore expect most of the growth in Office and Contact Center ("OCC") over the next five years to come from headsets designed for UC. Based on the prioritization of UC investments in fiscal years 2010 and 2011, our Bluetooth product portfolio for mobile phone applications was less competitive during the first half of fiscal year 2012, contributing to a decline in our Mobile market share. However, by the beginning of our third quarter, we were in volume production on several new models that were well-received and our market share position began recovering. Over the course of the year, we also invested in the stereo Bluetooth mobile category and, at the end of the fourth quarter of fiscal year 2012, introduced the BackBeat GO, our first stereo Bluetooth product in several years. While we experienced an approximate 4% decline in the Mobile category in fiscal year 2012 over fiscal year 2011, due in part to weakness in the Bluetooth product category, we believe our recent and planned investments will help position us to maintain share in the overall market for Bluetooth headsets. 30-------------------------------------------------------------------------------- Table of Contents Integral to our core research and development in fiscal year 2012 were investments in firmware and software engineering to enhance the broad compatibility of our products in the enterprise systems with which they will be deployed and development of value-added software applications for business users. We believe our investments in strategic architecting may allow us to differentiate our products and sustain strong long-term gross margins. During fiscal year 2012, we continued to strengthen our strategic partnerships with platform suppliers to ensure that our products are compatible with all major platforms as UC usage becomes an essential part of a unified work environment. Looking forward, we continue to believe that UC is a key long-term driver of revenue and profit growth. We remain cautious about the macroeconomic environment and will monitor our expenditures accordingly; however, we will continue to invest strategically in our long-term growth opportunities. We will continue focusing on innovative product development through our core research and development efforts, including the use of software and services as part of our portfolio. As part of our commitment to UC, we recently announced the PDC, which provides a software developer kit allowing registered developers access to a rich set of tools and providing a forum to interact, share ideas and develop innovative applications. We believe the PDC is a valuable resource for application developers to leverage the contextual intelligence built into our headsets, ultimately providing an endless array of capabilities such as user authentication, customer information retrieval based on incoming mobile calls, and connection of a user's physical actions in the real world to the virtual world. We will also continue to grow our sales force and increase marketing and other customer service and support as we expand key strategic partnerships to market our UC products. We believe we have an excellent position in the market and a well-deserved reputation for quality and service that we will continually strive to earn through ongoing investment and strong execution. RESULTS OF OPERATIONS The following tables set forth, for the periods indicated, the consolidated statements of operations data. The financial information and the ensuing discussion should be read in conjunction with the accompanying consolidated financial statements and notes thereto. Except as noted, financial results are for continuing operations. Altec Lansing, our former AEG segment, was sold effective December 1, 2009. We have classified the AEG operating results as discontinued operations in the Consolidated statement of operations for all periods presented. (in thousands) Fiscal Year Ended March 31, 2012 2011 2010 Net revenues $ 713,368 100.0 % $ 683,602 100.0 % $ 613,837 100.0 % Cost of revenues 329,017 46.1 % 321,846 47.1 % 312,767 51.0 % Gross profit 384,351 53.9 % 361,756 52.9 % 301,070 49.0 % Operating expenses: Research, development and engineering 69,664 9.8 % 63,183 9.2 % 57,784 9.4 % Selling, general and administrative 173,334 24.3 % 163,389 23.9 % 143,784 23.4 % Gain from litigation settlement - - % (5,100 ) (0.7 )% - - Restructuring and other related charges - - % (428 ) (0.1 )% 1,867 0.3 % Total operating expenses 242,998 34.1 % 221,044 32.3 % 203,435 33.1 % Operating income 141,353 19.8 % 140,712 20.6 % 97,635 15.9 % Interest and other income (expense), net 1,249 0.2 % (56 ) - % 3,105 0.5 % Income from continuing operations before income taxes 142,602 20.0 % 140,656 20.6 % 100,740 16.4 % Income tax expense from continuing operations 33,566 4.7 % 31,413 4.6 % 24,287 4.0 % Income from continuing operations, net of tax 109,036 15.3 % 109,243 16.0 % 76,453 12.5 % Discontinued operations: Loss from operations of discontinued AEG segment (including loss on sale) - - - - % (30,468 ) (5.0 )% Income tax benefit on discontinued operations - - - - % (11,393 ) (1.9 )% Loss on discontinued operations - - - - % (19,075 ) (3.1 )% Net income $ 109,036 15.3 % $ 109,243 16.0 % $ 57,378 9.3 % 31-------------------------------------------------------------------------------- Table of Contents Net Revenues Fiscal Year Ended Fiscal Year Ended (in March 31, March 31, March 31, March 31, thousands) 2012 2011 Increase (Decrease) 2011 2010 Increase (Decrease) Net revenues: Office and Contact Center $ 531,709 $ 490,472 $ 41,237 8.4 % $ 490,472 $ 404,397 $ 86,075 21.3 % Mobile 131,825 137,530 (5,705 ) (4.1 )% 137,530 149,756 (12,226 ) (8.2 )% Gaming and Computer Audio 31,855 36,736 (4,881 ) (13.3 )% 36,736 39,260 (2,524 ) (6.4 )% Clarity 17,979 18,864 (885 ) (4.7 )% 18,864 20,424 (1,560 ) (7.6 )% Total net revenues $ 713,368 $ 683,602 $ 29,766 4.4 % $ 683,602 $ 613,837 $ 69,765 11.4 % OCC products represent our largest source of revenues, while Mobile products represent our largest unit volumes. Net revenues may vary due to seasonality, the timing of new product introductions and discontinuation of existing products, discounts and other incentives, and channel mix. Net revenues derived from sales of consumer goods into the retail channel typically account for a seasonal increase in our net revenues in the third quarter of our fiscal year. Our consolidated net revenues increased in fiscal year 2012 compared to fiscal year 2011 driven by growth in OCC product revenues as a result of growth in demand for UC. In addition, favorable foreign exchange fluctuations in the Euro ("EUR") and Great Britain Pound ("GBP") contributed approximately $4.0 million to the growth in our net revenues. Our consolidated net revenues increased in fiscal year 2011 compared to fiscal year 2010 primarily in our OCC product category as a result of growth in demand for UC, offset partly by weakness in the Bluetooth market and loss of market share which resulted in a decrease in our Mobile product revenues. While we experienced foreign exchange fluctuations in our net revenues during the first half of both fiscal years 2011 and 2010, the overall foreign exchange impact for each of the fiscal years was not material. Fluctuations in net revenues in fiscal year 2012 compared to fiscal year 2011 resulted primarily from the following: • $41.2 million increase in OCC net revenues as a result of higher volumes due to growth in demand for UC products; • $5.7 million decrease in Mobile net revenues due mostly to overall weakness in the product category, which resulted in a lower unit volume of sales. We also believe our share of the total global market decreased, with reductions in U.S. market share offset partially by gains achieved internationally; and, • $4.9 million decrease in Gaming and Computer Audio net revenues due primarily to market share loss as a result of decreased investment in this category over the last two years as we have prioritized our investments in UC products and development. We are currently planning to increase our investments in this area to enable future growth. Fluctuations in net revenues in fiscal year 2011 compared to fiscal year 2010 resulted primarily from the following: • $86.1 million increase in OCC net revenues as a result of higher volumes due to improved global economic conditions and growth in demand for UC products; and, • $12.2 million decrease in Mobile net revenues due primarily to overall weakness in the product category, which resulted in a lower unit volume of sales. 32-------------------------------------------------------------------------------- Table of Contents Geographical Information Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Net revenues: United States $ 406,233 $ 400,292 $ 5,941 1.5 % $ 400,292 $ 378,119 $ 22,173 5.9 % As a percentage of net revenues 56.9 % 58.6 % (1.7 ) ppt. 58.6 % 61.6 % (3.0 ) ppt. Europe, Middle East and Africa 181,761 169,521 12,240 7.2 % 169,521 148,070 21,451 14.5 % Asia Pacific 74,249 62,697 11,552 18.4 % 62,697 46,494 16,203 34.8 % Americas, excluding United States 51,125 51,092 33 0.1 % 51,092 41,154 9,938 24.1 % Total international net revenues 307,135 283,310 23,825 8.4 % 283,310 235,718 47,592 20.2 % As a percentage of net revenues 43.1 % 41.4 % 1.7 ppt. 41.4 % 38.4 % 3.0 ppt. Total consolidated net revenues $ 713,368 $ 683,602 $ 29,766 4.4 % $ 683,602 $ 613,837 $ 69,765 11.4 % As a percentage of total net revenues, consolidated U.S. net revenues decreased by 1.7 percentage points to 57% in fiscal year 2012 from 59% in fiscal year 2011 due mostly to strong international growth in OCC net revenues and by weakness in the Mobile product category in the U.S. As a percentage of total net revenues, consolidated international net revenues increased to 43% in fiscal year 2012 from 41% in fiscal year 2011. The increase in absolute dollars in U.S. net revenues resulted from increased OCC net revenues due to growth in demand for UC. The increase in absolute dollars in international revenues was also due to increased OCC net revenues along with an increase in Mobile net revenues as we gained market share in markets outside the U.S. As a percentage of total net revenues, consolidated U.S. net revenues decreased by 3.0 percentage points to 59% in fiscal year 2011 from 62% in fiscal year 2010 due mostly to weakness in the Mobile product category in the U.S. As a percentage of total net revenues, consolidated international net revenues increased to 41% in fiscal year 2011 from 38% in fiscal year 2010. The increase in absolute dollars in U.S. net revenues was a result of increased OCC net revenues due to growth in demand for UC. The increase in absolute dollars in international net revenues was also due to increased OCC net revenues along with an increase in Mobile net revenues from market share gains in markets outside the U.S. Cost of Revenues and Gross Profit Cost of revenues consists primarily of direct manufacturing and contract manufacturer costs, warranty expense, freight expense, depreciation, duty expense, reserves for excess and obsolete inventory, royalties, and an allocation of overhead expenses, including IT and facilities costs. Fiscal Year Ended Fiscal Year Ended(in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Net revenues $ 713,368 $ 683,602 $ 29,766 4.4 % $ 683,602 $ 613,837 $ 69,765 11.4 % Cost of revenues 329,017 321,846 7,171 2.2 % 321,846 312,767 9,079 2.9 % Gross profit $ 384,351 $ 361,756 $ 22,595 6.2 % $ 361,756 $ 301,070 $ 60,686 20.2 % Gross profit % 53.9 % 52.9 % 1.0 ppt. 52.9 % 49.0 % 3.9 ppt. The increase in gross profit in fiscal year 2012 compared to fiscal year 2011 was due primarily to increased net revenues of $29.8 million along with operational efficiencies. As a percentage of net revenues, gross profit increased due primarily to operational efficiencies such as lower freight and logistics costs and the benefits from a weaker U.S. dollar, offset partially by the net effect of unfavorable component sourcing costs, slightly higher warranty obligations and reserves for excess and obsolete inventory. 33-------------------------------------------------------------------------------- Table of Contents The increase in gross profit in fiscal year 2011 compared to fiscal year 2010 was due primarily to increased net revenues of $69.8 million along with improved margins on those revenues. As a percentage of net revenues, gross profit increased due primarily to higher product margins, driven by a greater proportion of net revenues from our higher margin OCC products and improved Bluetooth margins resulting from our decision to outsource manufacturing which commenced in July 2009, and lower depreciation expenses in fiscal year 2011 due to accelerated depreciation expenses in fiscal year 2010 related to the closure of our Suzhou, China manufacturing facility. There are significant variances in gross profit percentages between our higher and lower margin products; therefore, small variations in product mix, which can be difficult to predict, can have a significant impact on gross profit. In addition, if we do not accurately anticipate changes in demand, we have in the past, and may in the future, incur significant costs associated with writing off excess and obsolete inventory or incur charges for adverse purchase commitments. Gross profit may also vary based on distribution channel, return rates, and other factors. Research, Development and Engineering Research, development, and engineering costs are expensed as incurred and consist primarily of compensation costs, outside services, including legal fees associated with protecting our intellectual property, expensed materials, depreciation, and an allocation of overhead expenses, including facilities, IT and human resources costs. Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Research, development and engineering $ 69,664 $ 63,183 $ 6,481 10.3 % $ 63,183 $ 57,784 $ 5,399 9.3 % % of total consolidated net revenues 9.8 % 9.2 % 0.6 ppt. 9.2 % 9.4 % (0.2 ) ppt. The increase in research, development and engineering expenses in fiscal year 2012 compared to fiscal year 2011was due primarily to $4.2 million in higher compensation costs resulting from increased headcount and related costs to support investments in UC and software and $1.8 million in increased investments in UC product development, offset partially by lower performance-based compensation related to lower achievement of targets. The increase in research, development and engineering expenses in fiscal year 2011 compared to fiscal year 2010 was due primarily to increased compensation costs resulting from increased headcount and higher performance-based compensation on higher achievement of targets, and increased project expenses, all reflecting our increased investments in UC. Selling, General and Administrative Selling, general and administrative expense consists primarily of compensation costs, marketing costs, travel expenses, expensed equipment, professional service fees, and allocations of overhead expenses, including IT, facilities, and human resources costs. Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Selling, general and administrative $ 173,334 $ 163,389 $ 9,945 6.1 % $ 163,389 $ 143,784 $ 19,605 13.6 % % of total consolidated net revenues 24.3 % 23.9 % 0.4 ppt. 23.9 % 23.4 % 0.5 ppt. The increase in selling, general and administrative expenses in fiscal year 2012 compared to fiscal year 2011was due primarily to $8.2 million in higher compensation costs resulting from increased headcount and $2.3 million in increased marketing and sales promotions and travel-related costs associated with increased net revenues. These increases were offset in part by a $1.6 million decrease in professional service fees related to litigation that was settled favorably in the fourth quarter of fiscal year 2011 and lower performance-based compensation from lower achievement of targets. 34-------------------------------------------------------------------------------- Table of Contents The increase in selling, general and administrative expenses in fiscal year 2011 compared to fiscal year 2010 was due primarily to $8.9 million in increased compensation costs resulting from increased headcount and higher performance-based compensation on higher achievement of targets, $7.1 million in increased marketing and sales promotions, travel-related expenses and external sales representative fees and commissions associated with higher net revenues, and $2.5 million in increased legal costs due to additional litigation that was settled favorably in fiscal year 2011. These increases were offset in part by a decrease of $1.1 million in depreciation expense due to assets being fully depreciated during fiscal year 2010 and a majority of the current capital projects were not completed and placed in service as of the end of fiscal year 2011. Gain from Litigation Settlement Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Gain from Litigation Settlement $ - $ (5,100 ) $ 5,100 100.0 % $ (5,100 ) $ - $ (5,100 ) 100.0 % % of total consolidated net revenues - % (0.7 )% 0.7 ppt. (0.7 )% - % (0.7 ) ppt. During the fourth quarter of fiscal year 2011, we entered into a binding settlement agreement to dismiss litigation involving the alleged theft of our trade secrets by a competitor in mobile headsets, and in the same quarter, pursuant to the settlement agreement, we received a $5.1 million payment in exchange for a full release and settlement of the claims. Restructuring and Other Related Charges Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Restructuring and other related charges $ - $ (428 ) $ 428 (100.0 )% $ (428 ) $ 1,867 $ (2,295 ) (122.9 )% % of total consolidated net revenues - % (0.1 )% 0.1 ppt. (0.1 )% 0.3 % (0.4 ) ppt. In fiscal year 2009, we announced various restructuring activities that were completed as of December 31, 2010. There were no charges during the years ended March 31, 2012 or 2011; however, in fiscal year 2011 we recorded an immaterial net gain upon the sale of a facility located in China in connection with the restructuring activities. In fiscal year 2010, we recorded restructuring charges of $1.9 million, consisting of severance and benefits along with facilities and equipment charges. Operating Income Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Operating income $ 141,353 $ 140,712 $ 641 0.5 % $ 140,712 $ 97,635 $ 43,077 44.1 % % of total consolidated net revenues 19.8 % 20.6 % (0.8 ) ppt. 20.6 % 15.9 % 4.7 ppt. In fiscal year 2012, we reported operating income of $141.4 million compared to $140.7 million in fiscal year 2011 due to increased net revenues and higher margins resulting primarily from a favorable product mix that consisted of a greater proportion of OCC net revenues, which generally have higher gross margins than other product categories, offset partially by higher operating expenses reflecting our investments in UC. In fiscal year 2011, we reported operating income of $140.7 million compared to $97.6 million in fiscal year 2010 due to increased net revenues and higher margins resulting primarily from a favorable product mix that consisted of a greater proportion of OCC net revenues. In addition, we experienced improved Bluetooth margins resulting primarily from lower costs as a result of outsourcing our manufacturing operations in China, which began in July 2009. 35-------------------------------------------------------------------------------- Table of Contents Operating income may vary based on product mix shifts, product life cycles, and seasonality. Interest and Other Income (Expense), Net Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Interest and other income (expense), net $ 1,249 $ (56 ) $ 1,305 (2,330.4 )% $ (56 ) $ 3,105 $ (3,161 ) 101.8 % % of total net revenues 0.2 % - % 0.2 ppt. - % 0.5 % (0.5 ) ppt. Interest and other income (expense), net in fiscal year 2012 increased from fiscal year 2011 due primarily to the prior year including an expense related to penalties and interest recorded upon settlement of an indirect tax matter in Brazil. In addition, we had greater interest income resulting from increased interest on a higher average investment portfolio in fiscal year 2012. Interest and other income (expense), net in fiscal year 2011 decreased from fiscal year 2010 due primarily to greater foreign currency exchange gains in fiscal year 2010 as a result of a weaker U.S. Dollar in fiscal year 2010 than in fiscal year 2011, in addition to penalties and interest recorded in fiscal year 2011 related to the settlement of an indirect tax matter in Brazil. In addition, we generated income from a government stimulus program in Mexico in fiscal year 2010 that did not recur in fiscal year 2011. Income Tax Expense Fiscal Year Ended Fiscal Year Ended (in thousands) March 31, 2012 March 31, 2011 Increase (Decrease) March 31, 2011 March 31, 2010 Increase (Decrease) Income from continuing operations before income taxes $ 142,602 $ 140,656 $ 1,946 1.4 % $ 140,656 $ 100,740 $ 39,916 39.6 % Income tax expense from continuing operations 33,566 31,413 2,153 6.9 % 31,413 24,287 7,126 29.3 % Income from continuing operations, net of tax $ 109,036 $ 109,243 $ (207 ) (0.2 )% $ 109,243 $ 76,453 $ 32,790 42.9 % Effective tax rate 23.5 % 22.3 % 1.2 ppt. 22.3 % 24.1 % (1.8 ) ppt. In comparison to fiscal year 2011, the increase in the effective tax rate for fiscal year 2012 was due primarily to the reduced benefit from the U.S. federal research tax credit as the credit expired in December 2011; therefore, the effective tax rate in fiscal year 2012 included the benefit of the credit for only three quarters. The effective tax rate for fiscal year 2011 includes the impact of credits earned in our fourth quarter of fiscal year 2010 because the credit was reinstated in December 2010 retroactively to January 2010. In comparison to fiscal year 2010, the decrease in the effective tax rate for fiscal year 2011 was due primarily to the increased benefit from the U.S. federal research tax credit. Our effective tax rate for fiscal year 2012, 2011 and 2010 differs from the statutory rate due to the impact of foreign operations taxed at different statutory rates, income tax credits, state taxes, and other factors. Our future tax rate could be impacted by a shift in the mix of domestic and foreign income, tax treaties with foreign jurisdictions, changes in tax laws in the U.S. or internationally or a change in estimate of future taxable income which could result in a valuation allowance being required. As of March 31, 2012, we had $11.1 million of unrecognized tax benefits compared to $10.5 million as of March 31, 2011 and $11.2 million as of March 31, 2010. The unrecognized tax benefits as of the end of fiscal year 2012 would favorably impact the effective tax rate in future periods if recognized. 36-------------------------------------------------------------------------------- Table of Contents It is our continuing practice to recognize interest and/or penalties related to income tax matters in income tax expense. As of March 31, 2012, 2011 and 2010, we had approximately $1.7 million of accrued interest related to uncertain tax positions. No penalties have been accrued. Although the timing and outcome of income tax audits is highly uncertain, it is possible that certain unrecognized tax benefits may be reduced as a result of the lapse of the applicable statutes of limitations in federal, state, and foreign jurisdictions within the next twelve months. Currently, we cannot reasonably estimate the amount of reductions, if any, during the next twelve months. Any such reduction could be impacted by other changes in unrecognized tax benefits. We are subject to taxation in various foreign and state jurisdictions as well as in the U.S. We are no longer subject to U.S. federal tax examinations by tax authorities for years prior to 2009. We are under examination by the California Franchise Tax Board for our 2007 and 2008 tax years. Foreign income tax matters for material tax jurisdictions have been concluded for tax years prior to fiscal year 2006, except for the United Kingdom which has been concluded for tax years prior to fiscal year 2010. Discontinued Operations We entered into an Asset Purchase Agreement ("APA") on October 2, 2009, as subsequently amended, to sell Altec Lansing, our AEG segment. The sale was completed effective December 1, 2009. All of the revenues in the AEG segment were derived from sales of Altec Lansing products. All operations of AEG have been classified as discontinued operations in the Consolidated statement of operations for all periods presented. There was no income or loss from discontinued operations for the fiscal years ended March 31, 2012 and 2011. The results from discontinued operations for the fiscal year ended March 31, 2010 were as follows (in thousands): Net revenues $ 64,916 Cost of revenues (53,127 ) Operating expenses (16,433 ) Impairment of goodwill and long-lived assets (25,194 ) Restructuring and other related charges (19 ) Loss on sale of AEG (611 ) Loss from operations of discontinued AEG segment (including loss on sale of AEG) (30,468 ) Tax benefit from discontinued operations (11,393 ) Loss on discontinued operations, net of tax $ (19,075 ) In addition, the results from discontinued operations in fiscal year 2010 included a loss of $0.6 million on sale of Altec Lansing, which is calculated as follows (in thousands): Proceeds received upon close $ 11,075 Escrow payments received to date 2,065 Remaining escrow payments to be received (subsequently received in fiscal 2011) 1,625 Payment to purchaser for adjustment for final value of net assets under APA (3,956 ) Total estimated proceeds 10,809 Book value of net assets sold (11,057 ) Costs incurred upon closing (363 ) Loss on sale of AEG $ (611 ) 37-------------------------------------------------------------------------------- Table of Contents FINANCIAL CONDITION The table below provides selected consolidated cash flow information for the periods indicated: (in thousands) March 31, 2012 March31, 2011 March 31, 2010 Cash provided by operating activities $ 140,448 $ 158,232 $ 143,729 Capital expenditures and other assets $ (19,140 ) $ (18,667 ) $ (6,262 ) Cash provided by maturities and sales of investments, net of investment purchases 9,725 (168,937 ) 64,760 Proceeds received from sale of AEG segment - 1,625 9,121 Cash provided by other investing activities - 9,066 277 Cash (used for) provided by investing activities $ (9,415 ) $ (176,913 ) $ 67,896 Repurchase of common stock, including equity forward contract $ (273,791 ) $ (105,522 ) $ (49,652 ) Proceeds from issuance of common stock 38,222 50,109 32,581 Net proceeds from revolving line of credit 37,000 - - Payment of cash dividends (9,040) (9,703) (9,781) Cash provided by other financing activities 9,348 9,939 5,870 Cash used for financing activities $ (198,261 ) $ (55,177 ) $ (20,982 ) Cash Provided by Operating Activities Cash provided by operating activities in fiscal year 2012 was $140.4 million and consisted of net income of $109.0 million, non-cash charges of $25.9 million and working capital sources of cash of $5.5 million. Non-cash charges consisted primarily of $17.5 million of stock-based compensation expense, $13.8 million of depreciation and amortization and a $5.6 million income tax benefit associated with stock option exercises, offset in part by a $9.1 million benefit from deferred income taxes and $7.0 million in excess tax benefits from stock-based compensation expense. Working capital sources of cash consisted primarily of an $18.5 million net increase in accrued income taxes due to refunds received in fiscal year 2012 related to over-payments made in fiscal year 2011 and the timing of current year income tax accruals, partly offset by a $9.4 million increase in accounts receivable and a $4.3 million decrease in accrued liabilities. Inventory turns increased to 6.1 as of March 31, 2012 from 5.8 as of March 31, 2011 as a result of lower inventory balances on higher cost of revenues in the fourth quarter of fiscal year 2012 compared to the same period in fiscal year 2011 due to better inventory management. Days Sales Outstanding ("DSO") increased to 57 days as of March 31, 2012 from 54 days as of March 31, 2011, resulting from a higher accounts receivable balance due to timing of revenues earned during the fourth quarter of fiscal year 2012 as compared to the fourth quarter of fiscal year 2011. The net decrease in accrued liabilities resulted primarily from the payout in fiscal year 2012 of performance-based compensation related to fiscal year 2011 and lower accruals for performance-based compensation in fiscal year 2012 due to lower achievement of targets than in fiscal year 2011. Cash provided by operating activities in fiscal year 2011 was $158.2 million and consisted of net income of $109.2 million, non-cash charges of $29.1 million and working capital sources of cash of $19.9 million. Non-cash charges consisted primarily of $16.3 million of depreciation and amortization, $15.9 million of stock-based compensation expense and a $6.2 million income tax benefit associated with stock option exercises, offset in part by $5.7 million in excess tax benefits from stock-based compensation expense and a $5.2 million benefit from deferred income taxes. Working capital sources of cash consisted primarily of a decrease in inventory of $13.0 million as we continued to improve the management of our inventory levels, increases in accounts payable and accrued liabilities of $10.2 million and $9.9 million, respectively, due to timing of payments along with an increase in income taxes of $4.2 million. Working capital uses of cash consisted primarily of an increase in accounts receivable of $15.1 million due to higher revenues in the fourth quarter of fiscal year 2011 than in the prior year quarter. Inventory turns, which is calculated using Cost of revenues from continuing operations only and consolidated inventory balances, increased to 5.8 as of March 31, 2011 from 4.2 as of March 31, 2010 as a result of our lower inventory balances on higher cost of revenues in the fourth quarter of fiscal year 2011 compared to the same period in fiscal year 2010. DSO, which is calculated using Net revenues from continuing operations only and consolidated accounts receivable balances, increased to 54 days as of March 31, 2011 from 49 days as of March 31, 2010 as a result of higher accounts receivable balance due to timing of revenues earned during the fourth quarter of fiscal year 2011 as compared to the fourth quarter of fiscal year 2010. 38-------------------------------------------------------------------------------- Table of Contents Cash provided by operating activities in fiscal year 2010 was $143.7 million and consisted of net income of $57.4 million, non-cash charges of $54.3 million and working capital sources of cash of $32.0 million. Non-cash charges consisted primarily of $25.2 million related to the AEG impairment charge on long-lived assets recorded in discontinued operations, $18.1 million of depreciation and amortization, $14.6 million of stock-based compensation expense, and non-cash restructuring charges of $6.3 million offset in part by a $12.5 million benefit from deferred income taxes. Working capital sources of cash consisted primarily of a decrease in inventory of $27.6 million as we continued to improve the management of our inventory levels, income tax refunds received and decreases in other assets. Working capital uses of cash consisted primarily of decreases in accounts payable and accrued liabilities from reduced spending during the fiscal year as a result of the sale of Altec Lansing in December 2009. Inventory turns, which is calculated using Cost of revenues from continuing operations only and consolidated inventory balances, increased to 4.2 as of March 31, 2010 from 3.1 as of March 31, 2009 as a result of our lower inventory balances on higher revenues in the fourth quarter of fiscal year 2010 compared to the same period in fiscal year 2009. Accounts receivable remained relatively flat from fiscal year 2009 to fiscal year 2010; however, DSO, which is calculated using Net revenues from continuing operations only and consolidated accounts receivable balances, decreased to 49 days as of March 31, 2010 from 59 days as of March 31, 2009 as a result of collections of the accounts receivable related to our AEG business which were retained by us upon the sale of Altec Lansing on December 1, 2009. We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors including fluctuations in our net revenues and operating results, collection of accounts receivable, changes to inventory levels and timing of payments. Cash Used for Investing Activities In fiscal year 2012, net cash used for investing activities was $9.4 million, consisting primarily of $176.9 million and $91.0 million for the purchase of short-term and long-term investments, respectively, along with capital expenditures of $19.1 million. These uses of cash were offset in part by net proceeds of $277.6 million from sales and maturities of short-term and long-term investments. Capital expenditures during fiscal year 2012 related primarily to building and leasehold improvements, tooling and various IT projects and equipment. In fiscal year 2011, net cash used for investing activities was $169.9 million, consisting primarily of $256.3 million and $48.9 million for the purchase of short-term and long-term investments, respectively, along with capital expenditures of $18.6 million. These uses of cash were offset in part by net proceeds of $142.5 million from sales and maturities of short-term investments, $9.1 million from the sale of Assets held for sale and $1.6 million in net proceeds from the release of escrow related to the sale of Altec Lansing, our AEG segment. Capital expenditures during fiscal year 2011 related primarily to building and leasehold improvements, including the installation of an expanded solar energy system in our headquarters in Santa Cruz, California, tooling and various IT projects and equipment. In fiscal year 2010, net cash provided by investing activities was $67.9 million, consisting primarily of net maturities and sales of short-term investments of $64.0 million and $9.1 million in net proceeds from the sale of Altec Lansing, offset in part by capital expenditures of $6.3 million. Capital expenditures during fiscal year 2010 related primarily to tooling and various IT projects. We anticipate our capital expenditures in fiscal year 2013 to range from $51.0 million to $54.0 million. The increase from fiscal year 2012 is primarily related to the potential purchase of a new manufacturing facility in Mexico that would replace and consolidate our existing leased facilities. The estimated cost of the facility includes the purchase of an existing building, solar upgrades, labs, and other building furnishings including furniture and fixtures. If we complete the purchase of the facility in the first half of fiscal year 2013, we expect to complete the required upgrades and to move into the new facility in the first quarter of fiscal year 2014. In addition, we would not renew our existing leases and will consolidate all of our operations into the new facility. As a result of purchasing the building, we would record significant non-cash charges, including approximately $2.0 million in accelerated depreciation related to the remaining useful lives of the leasehold improvements and, once we stop using the leased facilities, a one-time lease charge of approximately $2.0 million representing the costs we would otherwise continue to incur under the original lease terms. In addition to the potential new facility in Mexico, we plan to migrate to a new enterprise resource planning ("ERP") environment, with capital expenditures commencing in the second half of fiscal year 2013 and continuing through the start of our fiscal year 2015. The remainder of the anticipated capital expenditures for fiscal year 2013 consists primarily of building and leasehold improvements in our U.S. headquarters, other IT related expenditures and tooling for new products. We will continue to evaluate new business opportunities and new markets; as a result, our future growth within the existing business or new opportunities and markets may dictate the need for additional facilities and capital expenditures to support that growth. 39-------------------------------------------------------------------------------- Table of Contents Cash Used for Financing Activities Net cash used for financing activities in fiscal year 2012 was $198.3 million and consisted of $273.8 million used for the repurchase of common stock and $9.0 million for dividend payments, offset in part by $37.0 million in proceeds from our revolving line of credit, net of principal payments, $38.2 million in proceeds from the exercise of employee stock options, $7.0 million of excess tax benefits from stock-based compensation and $4.9 million in proceeds from the sale of treasury stock issued for purchases under our Employee Stock Purchase Plan ("ESPP"). Net cash used for financing activities in fiscal year 2011 was $55.4 million and consisted of $105.5 million used for the repurchase of common stock and $9.7 million in dividend payments, partially offset by $50.1 million in proceeds from the exercise of employee stock options, $4.2 million in proceeds from the sale of treasury stock issued for purchases under our ESPP and $5.7 million of excess tax benefits from stock-based compensation. Net cash used for financing activities in fiscal year 2010 was $21.0 million and consisted of $49.7 million related to repurchases of common stock and $9.8 million in dividend payments, partially offset by $32.6 million in proceeds from the exercise of employee stock options, $3.6 million in proceeds from the sale of treasury stock issued for purchases under our ESPP and $2.2 million of excess tax benefits from stock-based compensation. On May 1, 2012, we announced that our Board of Directors ("Board") had declared a cash dividend of $0.10 per share of our common stock, payable on June 8, 2012 to stockholders of record on May 18, 2012. This represents a doubling of the per share cash dividend amount in comparison to historical levels. We expect to continue paying a quarterly dividend of $0.10 per share of our common stock; however, the actual declaration of dividends and the establishment of record and payment dates are subject to final determination by the Audit Committee of the Board each quarter after its review of our financial performance and financial position. Liquidity and Capital Resources Our primary discretionary cash uses have historically been for repurchases of our common stock. At March 31, 2012, we had working capital of $438.0 million, including $334.5 million of cash, cash equivalents and short-term investments, compared to working capital of $524.1 million, including $430.0 million of cash, cash equivalents and short-term investments at March 31, 2011. The decrease in working capital at March 31, 2012 compared to March 31, 2011 is a result of the decrease in cash and cash equivalents due primarily to significant payments for repurchases of our common stock during the fiscal year ended March 31, 2012, which were funded primarily from cash, cash equivalents and short-term investments on hand at March 31, 2011 and from net borrowings under our revolving line of credit. Our cash and cash equivalents as of March 31, 2012 consist of Commercial Paper, U.S. Treasury Bills and bank deposits with third party financial institutions. We monitor bank balances in our operating accounts and adjust the balances as appropriate. Cash balances are held throughout the world, including substantial amounts held outside of the U.S. As of March 31, 2012, of our $334.5 million of cash, cash equivalents and short-term investments, $11.6 million is held domestically while $322.9 million is held by foreign subsidiaries. The costs to repatriate our foreign earnings to the U.S. would likely be material; however, our intent is to permanently reinvest our earnings from foreign operations, and our current plans do not require us to repatriate them to fund our U.S. operations as we generate sufficient domestic operating cash flow and have access to external funding under our current revolving line of credit. For information regarding tax considerations surrounding the undistributed earnings of our foreign operations, refer to Note 17, Income Taxes, of the Notes to Consolidated Financial Statements in this Form 10-K. Our investments are intended to establish a high-quality portfolio that preserves principal and meets liquidity needs. As of March 31, 2012, our investments are composed of U.S. Treasury Bills, Government Agency Securities, Commercial Paper, U.S. Corporate Bonds and Certificates of Deposit ("CDs"). From time to time, our Board authorizes programs under which we may repurchase shares of our common stock, depending on market conditions, in the open market or through privately negotiated transactions, including accelerated share repurchase ("ASR") agreements. During the fiscal years ended March 31, 2012, 2011 and 2010, we repurchased 8,027,287, 3,315,000 and 1,935,100 shares, respectively, of our common stock as part of these publicly announced repurchase programs for a total cost of $273.8 million, $105.5 million and $49.7 million, respectively. In addition, we withheld 74,732 shares valued at $2.6 million during the fiscal year ended March 31, 2012, compared to an immaterial amount in fiscal year 2011 and none in fiscal year 2010, in satisfaction of employee tax withholding obligations upon the vesting of restricted stock granted under our stock plans. 40-------------------------------------------------------------------------------- Table of Contents As of March 31, 2012, there were a total of 633,613 remaining shares authorized for repurchase, all of which are under our program approved by the Board of Directors on March 8, 2012. Refer to Note 13, Common Stock Repurchases, of our Notes to Consolidated Financial Statements in this Form 10-K for more information regarding our stock repurchase programs. On December 28, 2011, December 7, 2010 and December 2, 2009, we retired 5,000,000, 4,000,000 and 2,000,000 shares of treasury stock, respectively, which were returned to the status of authorized but unissued shares. These were non-cash equity transactions in which the cost of the reacquired shares was recorded as a reduction to both Retained earnings and Treasury stock. In May 2011, we entered into a Credit Agreement ("Credit Agreement") with Wells Fargo Bank, National Association ( "Bank") which provides for a $100.0 million unsecured revolving line of credit (the "line of credit") to augment our financial flexibility to facilitate the ASR Program and if requested by us, the Bank may increase its commitment thereunder by up to $100.0 million, for a total facility of up to $200.0 million. Principal, together with accrued and unpaid interest, is due on the maturity date, May 9, 2014 and our obligations under the Credit Agreement are guaranteed by our domestic subsidiaries, subject to certain exceptions. As of March 31, 2012, we had outstanding borrowings of $37.0 million under the line of credit. Loans under the Credit Agreement bear interest at the election of the Company (1) at the Bank's announced prime rate less 1.50% per annum, (2) at a daily one month LIBOR rate plus 1.10% per annum or (3) at an adjusted LIBOR rate, for a term of one, three or six months, plus 1.10% per annum. The line of credit requires us to comply with the following two financial covenant ratios, in each case at each fiscal quarter end and determined on a rolling four-quarter basis: • maximum ratio of funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA"); and, • minimum EBITDA coverage ratio, which is calculated as interest payments divided by EBITDA. As of March 31, 2012, we were in compliance with these ratios by a substantial margin. In addition, we and our subsidiaries are required to maintain unrestricted cash, cash equivalents and marketable securities plus availability under the Credit Agreement at the end of each fiscal quarter of at least $200.0 million. The line of credit contains affirmative covenants including covenants regarding the payment of taxes and other liabilities, maintenance of insurance, reporting requirements and compliance with applicable laws and regulations. The credit facility also contains negative covenants, among other things, limiting our ability to incur debt, make capital expenditures, grant liens, make acquisitions and make investments. The events of default under the line of credit include payment defaults, cross defaults with certain other indebtedness, breaches of covenants, judgment defaults and bankruptcy and insolvency events involving us or any of our subsidiaries. As of March 31, 2012, we were in compliance with all covenants under the line of credit. We enter into foreign currency forward-exchange contracts, which typically mature in one month intervals, to hedge our exposure to foreign currency fluctuations of Euro, Great Britain Pound and Australian Dollar denominated cash, receivables and payables balances. We record the fair value of our forward-exchange contracts in the Consolidated balance sheets at each reporting period and record any fair value adjustments in our Consolidated statements of operations. Gains and losses associated with currency rate changes on contracts are recorded within Interest and other income (expense), net in our Consolidated statements of operations, offsetting transaction gains and losses on the related assets and liabilities. Please see Item 7A, Quantitative and Qualitative Disclosures About Market Risk, for additional information. We also have a hedging program to hedge a portion of forecasted revenues denominated in the Euro and Great Britain Pound with put and call option contracts used as collars. We also hedge a portion of the forecasted expenditures in Mexican Pesos with a cross-currency swap. At each reporting period, we record the net fair value of our unrealized option contracts in the Consolidated balance sheets with related unrealized gains and losses as a component of Accumulated other comprehensive income, a separate element of Stockholders' equity. Gains and losses associated with realized option contracts and swap contracts are recorded within Net revenues and Cost of revenues, respectively, in our Consolidated statements of operations. Please see Item 7A, Quantitative and Qualitative Disclosures About Market Risk, for additional information. Our liquidity, capital resources, and results of operations in any period could be affected by the exercise of outstanding stock options, restricted stock grants to employees and the issuance of common stock under our ESPP. The resulting increase in the number of outstanding shares from these equity grants and issuances could affect our earnings per share; however, we cannot predict the timing or amount of proceeds from the sale or exercise of these securities or whether they will be exercised at all. We believe that our current cash and cash equivalents, short-term investments, cash provided by operations and the availability of additional funds under the Credit Agreement will be sufficient to fund operations for at least the next twelve months; however, any projections of future financial needs and sources of working capital are subject to uncertainty. See "Certain Forward-Looking Information" and "Risk Factors" in this Annual Report on Form 10-K for factors that could affect our estimates for future financial needs and sources of working capital. 41-------------------------------------------------------------------------------- Table of Contents OFF BALANCE SHEET ARRANGEMENTS We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing and liquidity support or market risk or credit risk support to the Company. CONTRACTUAL OBLIGATIONS The following table summarizes the contractual obligations that we were reasonably likely to incur as of March 31, 2012 and the effect that such obligations are expected to have on our liquidity and cash flows in future periods. Payments Due by Period Less than 1 More than 5 (in thousands) Total year 1-3 years 3-5 years years Revolving line of credit $ 37,000 $ - $ 37,000 $ - $ - Operating leases 13,210 5,355 6,041 1,128 686 Unconditional purchase obligations 58,323 58,323 - - - Total contractual cash obligations $ 108,533 $ 63,678 $ 43,041 $ 1,128 $ 686 As of March 31, 2012, the unrecognized tax benefits and related interest under the Income Tax Topic of the FASB ASC were $11.1 million and $1.7 million, respectively, and are included in Long-term income taxes payable in our Consolidated balance sheet. We are unable to reliably estimate the timing of future payments related to unrecognized tax benefits and they are not included in the contractual obligations table above. We do not anticipate any material cash payments associated with our unrecognized tax benefits to be made within the next twelve months. CRITICAL ACCOUNTING ESTIMATES Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP"). In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with U.S. GAAP. Because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. Our significant accounting policies are discussed in Note 2, Significant Accounting Policies, of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. We believe the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require our most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board of Directors. • Revenue Recognition and Related Allowances • Inventory Valuation • Product Warranty Obligations • Income Taxes 42-------------------------------------------------------------------------------- Table of Contents Revenue Recognition and Related Allowances We sell our products directly to customers and through other distribution channels, including distributors, retailers, carriers and original equipment manufacturers ("OEMs"). Commercial distributors and retailers represent our largest sources of net revenues. Sales through our distribution and retail channels are made primarily under agreements allowing for rights of return and include various sales incentive programs, such as rebates, advertising, price protection and other sales incentives. We have an established sales history for these arrangements and we record the estimated reserves and allowances at the time the related revenue is recognized. Customer sales returns are estimated based on historical data, relevant current data and the monitoring of inventory build-up in the distribution channel. The primary factors affecting our reserve for estimated customer sales returns include the general timing of historical returns and estimated return rates. The allowance for sales incentive programs is based on historical experience and contractual terms in the form of lump sum payments or sell-through credits. Future market conditions and product transitions may require us to take actions to increase customer incentive offerings, possibly resulting in an incremental reduction of revenue at the time the incentive is offered. Additionally, certain incentive programs require us to estimate, based on historical experience, the specific terms and conditions of the incentive and the estimated number of customers that will actually redeem the incentive. We have not made any material changes in the accounting methodology we use to measure sales return reserves or incentive allowances during the past three fiscal years. Substantially all credits associated with these activities are processed within the following fiscal year and, therefore, do not require subjective long-term estimates; however, if actual results are not consistent with the assumptions and estimates used, we may be exposed to losses or gains that could be material. If we increased our estimate as of March 31, 2012 by a hypothetical 10%, our sales returns reserve and sales incentive allowance would have increased by approximately $0.8 million and $1.3 million, respectively. Net of the estimated value of the inventory that would be returned, this would have decreased gross profit and net income by approximately $1.7 million and $1.3 million, respectively. Inventory Valuation Inventories are valued at the lower of cost or market. The Company writes down inventories that have become obsolete or are in excess of anticipated demand or net realizable value. Our estimate of write downs for excess and obsolete inventory are based on a detailed analysis of on-hand inventory and purchase commitments in excess of forecasted demand. Our products require long-lead time parts available from a limited number of vendors and, occasionally, last-time buys of raw materials for products with long lifecycles. The effects of demand variability, long-lead times and last-time buys have historically contributed to inventory write-downs. Our demand forecast considers projected future shipments, market conditions, inventory on hand, purchase commitments, product development plans and product life cycle, inventory on consignment and other competitive factors. We have not made any material changes in the accounting methodology we use to estimate our inventory write-downs during the past three fiscal years. If the demand or market conditions for our products are less favorable than forecasted or if unforeseen technological changes negatively impact the utility of our inventory, we may be required to record additional write-downs, which would negatively affect our results of operations in the period the write-downs were recorded. If we increased our estimate as of March 31, 2012 by a hypothetical 10%, our inventory reserves and cost of revenues would have each increased by approximately $0.6 million and our net income would have been reduced by approximately $0.4 million. Product Warranty Obligations The Company records a liability for the estimated costs of warranties at the time the related revenue is recognized. Factors that affect the warranty obligation include product failure rates, estimated return rates, material usage and service related costs incurred in correcting product failures. If actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material. If we increased our estimate as of March 31, 2012 by a hypothetical 10%, our warranty obligation and cost of revenues would have each increased by approximately $1.3 million and our net income would have been reduced by approximately $1.0 million. Income Taxes We account for income taxes under an asset and liability approach that requires the expected future tax consequences of temporary differences between the book and tax bases of assets and liabilities to be recognized as deferred tax assets and liabilities. Valuation allowances are established to reduce deferred tax assets when, based on available objective evidence, it is more likely than not that the benefit of such assets will not be realized. 43-------------------------------------------------------------------------------- Table of Contents We are subject to income taxes in the U.S. and foreign jurisdictions and our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years may be subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we record a liability for such exposures. A number of years may elapse before a particular matter for which we have established a liability is audited and fully resolved or clarified. We recognize the impact of an uncertain income tax position on income tax expense at the largest amount that is more-likely-than-not to be sustained. An unrecognized tax benefit will not be recognized unless it has a greater than 50% likelihood of being sustained. We adjust our tax liability for unrecognized tax benefits in the period in which an uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position, or when more information becomes available. We recognize interest and penalties related to income tax matters as part of our provision for income taxes. Our liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and apply judgment to estimate the exposures associated with our various filing positions. Our effective income tax rate is also affected by changes in tax law, the level of earnings and the results of tax audits. Our provision for income taxes does not include provisions for U.S. income taxes and foreign withholding taxes associated with the repatriation of undistributed earnings of certain foreign operations that we intend to reinvest indefinitely in the foreign operations. If these earnings were distributed to the U.S. in the form of dividends or otherwise, we would be subject to additional U.S. income taxes, subject to an adjustment for foreign tax credits, and foreign withholding taxes. Our current plans do not require repatriation of earnings from foreign operations to fund the U.S. operations because we generate sufficient domestic operating cash flow and have access to external funding under our line of credit. As a result, we do not expect a material impact on our business or financial flexibility with respect to undistributed earnings of our foreign operations. Although we believe that our judgments and estimates are reasonable, actual results could differ and we may be exposed to losses or gains that could be material. To the extent we prevail in matters for which a liability has been established, or are required to pay amounts in excess of our established liability, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would generally require use of our cash and may result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would be recognized as a reduction in our effective income tax rate in the period of resolution. RECENT ACCOUNTING PRONOUNCEMENTS Recently Adopted Pronouncements In September 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This ASU allows entities to first assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If this is the case, the entity is required to perform a more detailed two-step goodwill impairment test that is used to identify potential goodwill impairment and to measure the amount of goodwill impairment losses, if any, to be recognized. We adopted ASU 2011-08 in the fourth quarter of fiscal year 2012 and it did not have an impact on our financial statements. Refer to Note 8, Goodwill and Purchased Intangible Assets, of the Notes to Consolidated Financial Statements in this Form 10-K for details of our goodwill impairment analysis. Recently Issued Pronouncements In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This ASU requires an entity to disclose both net and gross information about assets and liabilities that have been offset, if any, and the related arrangements. The disclosures under this new guidance are required to be provided retrospectively for all comparative periods presented. We are required to implement this guidance effective for the first quarter of fiscal year 2014. We do not expect the adoption of ASU 2011-11 to have a material impact on our consolidated financial statements. In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income, as amended, which requires us to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Certain of the provisions are effective for the us in the first quarter of fiscal year 2013 and will be applied retrospectively. 44-------------------------------------------------------------------------------- Table of Contents We intend to present other comprehensive income in two separate and consecutive statements. |