TMCnet News
F5 NETWORKS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These statements include, but are not limited to, statements about our plans, objectives, expectations, strategies, intentions or other characterizations of future events or circumstances and are generally identified by the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and similar expressions. These forward-looking statements are based on current information and expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially from those expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under "Item 1A. Risk Factors" herein and in other documents we file from time to time with the Securities and Exchange Commission. We assume no obligation to revise or update any such forward-looking statements. Overview We are a global provider of appliances consisting of software and hardware and services that help companies efficiently and securely manage the delivery, optimization and security of application and data traffic on Internet-based networks, and to optimize the performance and utilization of data storage infrastructure and other network resources. We market and sell our products primarily through multiple indirect sales channels in the Americas (primarily the United States); Europe, the Middle East, and Africa (EMEA); Japan; and the Asia Pacific region (APAC). Enterprise customers (Fortune 1000 or Business Week Global 1000 companies) in the technology, telecommunications, financial services, transportation, education, manufacturing and health care industries, along with government customers, continue to make up the largest percentage of our customer base. Our management team monitors and analyzes a number of key performance indicators in order to manage our business and evaluate our financial and operating performance. Those indicators include: • Revenues. The majority of our revenues are derived from sales of our application delivery networking (ADN) products including our high end VIPRION chassis and related software modules; BIG-IP Local Traffic Manager, BIG-IP Global Traffic Manager, BIG-IP Link Controller, BIG-IP Application Security Manager, BIG-IP Edge Gateway, BIG-IP WAN Optimization module, BIG-IP Access Policy Manager, and WebAccelerator; FirePass SSL VPN appliance; and our ARX file virtualization products. We also derive revenues from the sales of services including annual maintenance contracts, training and consulting services. We carefully monitor the sales mix of our revenues within each reporting period. We believe customer acceptance rates of our new products and feature enhancements are indicators of future trends. We also consider overall revenue concentration by customer and by geographic region as additional indicators of current and future trends. • Cost of revenues and gross margins. We strive to control our cost of revenues and thereby maintain our gross margins. Significant items impacting cost of revenues are hardware costs paid to our contract manufacturers, third-party software license fees, amortization of developed technology and personnel and overhead expenses. Our margins have remained relatively stable; however, factors such as sales price, product mix, inventory obsolescence, returns, component price increases and warranty costs could significantly impact our gross margins from quarter to quarter and represent significant indicators we monitor on a regular basis. • Operating expenses. Operating expenses are substantially driven by personnel and related overhead expenses. Existing headcount and future hiring plans are the predominant factors in analyzing and 33 -------------------------------------------------------------------------------- Table of Contents forecasting future operating expense trends. Other significant operating expenses that we monitor include marketing and promotions, travel, professional fees, computer costs related to the development of new products, facilities and depreciation expenses. • Liquidity and cash flows. Our financial condition remains strong with significant cash and investments and no long term debt. The increase in cash and investments for fiscal year 2012 was primarily due to cash provided by operating activities of $495.4 million. This increase was partially offset by $184.8 million of cash used to repurchase outstanding common stock under our share repurchase program in fiscal year 2012. Going forward, we believe the primary driver of cash flows will be net income from operations. On February 22, 2012, we acquired all of the capital stock of Traffix Communication Systems Ltd. (Traffix Systems) for cash of $133.7 million. Capital expenditures of $29.9 million for fiscal year 2012 were comprised primarily of information technology infrastructure and equipment to support the growth of our core business activities. We will continue to evaluate possible acquisitions of, or investments in businesses, products, or technologies that we believe are strategic, which may require the use of cash. • Balance sheet. We view cash, short-term and long-term investments, deferred revenue, accounts receivable balances and days sales outstanding as important indicators of our financial health. Deferred revenues continued to increase in fiscal 2012 due to growth in the amount of annual maintenance contracts purchased on new products and maintenance renewal contracts related to our existing product installation base. Our days sales outstanding for the fourth quarter of fiscal year 2012 was 46. Critical Accounting Policies Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. 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 assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant estimates and judgments used in the preparation of our financial statements. Revenue Recognition. We sell products through distributors, resellers, and directly to end users. Revenue is recognized provided that all of the following criteria have been met: • Persuasive evidence of an arrangement exists. Evidence of an arrangement generally consists of a purchase order issued pursuant to the terms and conditions of a distributor, reseller or end user agreement. • Delivery has occurred. We use shipping or related documents, or written evidence of customer acceptance, when applicable, to verify delivery or completion of any performance terms. • The sales price is fixed or determinable. We assess whether the sales price is fixed or determinable based on payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. • Collectability is reasonably assured. We assess collectability primarily based on the creditworthiness of the customer as determined by credit checks and related analysis, as well as the Customer's payment history. In certain regions where we do not have the ability to reasonably estimate returns, we defer revenue on sales to our distributors until they have received information from the channel partner indicating that the product has been sold to the end-user customer. Payment terms to domestic customers are generally net 30 days to net 45 34 -------------------------------------------------------------------------------- Table of Contents days. Payment terms to international customers range from net 30 days to net 120 days based on normal and customary trade practices in the individual markets. We offer extended payment terms to certain customers, in which case, revenue is recognized when payments are due. Whenever product, training services and post-contract customer support (PCS) elements are sold together, a portion of the sales price is allocated to each element based on their respective fair values as determined when the individual elements are sold separately. Revenue from the sale of products is recognized when the product has been shipped and the customer is obligated to pay for the product. When rights of return are present and we cannot estimate returns, we recognize revenue when such rights of return lapse. Revenues for PCS are recognized on a straight-line basis over the service contract term. PCS includes a limited period of telephone support updates, repair or replacement of any failed product or component that fails during the term of the agreement, bug fixes and rights to upgrades, when and if available. Consulting services are customarily billed at fixed hourly rates, plus out-of-pocket expenses, and revenues are recognized when the consulting has been completed. Training revenue is recognized when the training has been completed. In October 2009, the Financial Accounting Standards Board (FASB) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance any tangible products containing software components and non-software components that operate together to deliver the products essential functionality. In addition, the FASB amended the accounting standards for certain multiple element revenue arrangements to: • Provide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to the separate elements; • Require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, where the selling price for an element is based on vendor-specific objective evidence (VSOE), if available, third-party evidence (TPE), if available and VSOE is not available; or the best estimate of selling price (BESP), if neither VSOE or TPE is available; and • Eliminate the use of the residual method and require an entity to allocate arrangement consideration using the selling price hierarchy. The majority of our products are hardware appliances that contain software essential to the overall functionality of the products. Accordingly, we no longer recognize revenue on sales of these products in accordance with the industry-specific software revenue recognition guidance. For all transactions entered into prior to the first quarter of fiscal year 2011 and for sales of nonessential and stand-alone software after October 1, 2010, we allocate revenue for arrangements with multiple elements based on the software revenue recognition guidance. Software revenue recognition guidance requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. The fair value of an element must be based on VSOE. Where fair value of certain elements is not available, revenue is recognized on the "residual method" based on the fair value of undelivered elements. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized at the earlier of the delivery of those elements or the establishment of fair value of the remaining undelivered elements. For transactions entered into subsequent to the adoption of the amended revenue recognition standards that are multiple-element arrangements, the arrangement consideration is allocated to each element based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue recognition guidance. Consistent with the methodology used under the previous accounting guidance, we establish VSOE for our products, training services, PCS and consulting services based on the sales price charged for each element when 35-------------------------------------------------------------------------------- Table of Contents sold separately. The sales price is discounted from the applicable list price based on various factors including the type of customer, volume of sales, geographic region and program level. Our list prices are generally not fair value as discounts may be given based on the factors enumerated above. We believe that the fair value of our consulting services is represented by the billable consulting rate per hour, based on the rates we charge customers when they purchase standalone consulting services. The price of consulting services is not based on the type of customer, volume of sales, geographic region or program level. We use historical sales transactions to determine whether VSOE can be established for each of the elements. In most instances, VSOE is the sales price of actual standalone (unbundled) transactions within the past 12 month period that are priced within a reasonable range, which we have determined to be plus or minus 15% of the median sales price of each respective price list. VSOE of PCS is based on standalone sales since we do not provide stated renewal rates to our customers. In accordance with our PCS pricing practice (supported by standalone renewal sales), renewal contracts are priced as a percentage of the undiscounted product list price. The PCS renewal percentages may vary, depending on the type and length of PCS purchased. We offer standard and premium PCS, and the term generally ranges from one to three years. We employ a bell-shaped-curve approach in evaluating VSOE of fair value of PCS. Under this approach, we consider VSOE of the fair value of PCS to exist when a substantial majority of our standalone PCS sales fall within a narrow range of pricing. We are typically not able to determine TPE for our products or services. TPE is based on competitor prices for similar elements when sold separately. Generally, our go-to-market strategy differs from that of other competitive products or services in our markets and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine the selling prices on a stand-alone basis of similar products offered by our competitors. When we are unable to establish the selling price of our non-software elements using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We are generally not able to establish VSOE for non-software product sales. Under software revenue recognition guidance, these product sales were accounted for utilizing the residual method. With the adoption of the new revenue recognition guidance, we have been able to establish BESP for non-software product sales through the list price, less a discount deemed appropriate to maintain a reasonable gross margin. Management regularly reviews the gross margin information. Non-software product BESP is determined through our review of historical sales transactions within the past 12 month period. Additional factors considered in determining an appropriate BESP include, but are not limited to, cost of products, pricing practices, geographies, customer classes, and distribution channels. We have established and regularly validate the VSOE of fair value and BESP for elements in our multiple element arrangements. We account for taxes collected from customers and remitted to governmental authorities on a net basis and excluded from revenues. Reserve for Doubtful Accounts. Estimates are used in determining our allowance for doubtful accounts and are based upon an assessment of selected accounts and as a percentage of our remaining accounts receivable by aging category. In determining these percentages, we evaluate historical write-offs, current trends in the credit quality of our customer base, as well as changes in the credit policies. We perform ongoing credit evaluations of our customers' financial condition and do not require any collateral. If there is deterioration of a major customer's credit worthiness or actual defaults are higher than our historical experience, our allowance for doubtful accounts may not be sufficient. Reserve for Product Returns. In some instances, product revenue from distributors is subject to agreements allowing rights of return. Product returns are estimated based on historical experience and are recorded at the 36-------------------------------------------------------------------------------- Table of Contents time revenues are recognized. Accordingly, we reduce recognized revenue for estimated future returns at the time revenue is recorded. When rights of return are present and we cannot estimate returns, revenue is recognized when such rights lapse. The estimates for returns are adjusted periodically based upon changes in historical rates of returns and other related factors. It is possible that these estimates will change in the future or that the actual amounts could vary from our estimates. Accounting for Income Taxes. 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 consolidated financial statements. This process involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Due to the evolving nature and complexity of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows. Stock-Based Compensation. We account for stock-based compensation using the straight-line attribution method for recognizing compensation expense over the requisite service period of the related award. We recognized $95.3 million and $89.7 million of stock-based compensation expense for the years ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was $134.9 million of total unrecognized stock-based compensation cost, the majority of which will be recognized over the next two years. Going forward, stock-based compensation expenses may increase as we issue additional equity-based awards to continue to attract and retain key employees. We issue incentive awards to our employees through stock-based compensation consisting of restricted stock units (RSUs). The value of RSUs is determined using the fair value method, which in this case, is based on the number of shares granted and the quoted price of our common stock on the date of grant. We recognize compensation expense for only the portion of RSUs that are expected to vest. Therefore, we apply estimated forfeiture rates that are derived from historical employee termination behavior. Based on historical differences with forfeitures of stock-based awards granted to our executive officers and Board of Directors versus grants awarded to all other employees, we developed separate forfeiture expectations for these two groups. In fiscal year 2012, the estimated forfeiture rate for grants awarded to our executive officers and Board of Directors was approximately 6% and the estimated forfeiture rate for grants awarded to all other employees was approximately 9%. If the actual number of forfeitures differs from those estimated by management, additional adjustments to stock-based compensation expense may be required in future periods. We recognize compensation costs for awards with performance conditions when we conclude it is probable that the performance condition will be achieved. We reassess the probability of vesting at each balance sheet date and adjust compensation costs based on our probability assessment. Common stock repurchase. On October 25, 2011, we announced that our Board of Directors authorized an additional $200 million for our common stock share repurchase program. This new authorization is incremental to the existing $400 million program, initially approved in October 2010 and expanded in August 2011. Acquisitions for the share repurchase programs will be made from time to time in private transactions or open market purchases as permitted by securities laws and other legal requirements. The programs can be terminated at any time. As of November 15, 2012, we had repurchased and retired 9,327,774 shares at an average price of $67.63 per share and we had $168.7 million remaining to purchase shares as part of our repurchase programs. Goodwill and intangible assets. We have goodwill and intangible assets on our balance sheet related to acquisitions. Intangible assets are carried and reported at acquisition cost, net of accumulated amortization subsequent to acquisition. Intangible assets are amortized over the estimated useful lives, which generally range from three to five years. Intangible assets are reviewed for impairment whenever events or circumstances 37-------------------------------------------------------------------------------- Table of Contents indicate impairment might exist. Projected undiscounted net cash flows expected to be derived from the use of those assets are compared to the respective net carrying amounts to determine whether any impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. The determination of the net carrying value of goodwill and intangible assets and the extent to which, if any, there is impairment are dependent on material estimates and judgments on our part, including the useful life over which the intangible assets are to be amortized, and the estimates of the value of future net cash flows, which are based upon further estimates of future revenues, expenses and operating margins. We review our goodwill annually for impairment in the second fiscal quarter, or whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. We first perform a qualitative assessment to determine whether further impairment testing is necessary. If we believe, as a result of our qualitative assessment, that it is more-likely-than-not (i.e. greater than 50% chance) that the fair value of a reporting unit is less than its carrying amount, a quantitative impairment test will be required. Otherwise, no further testing will be required. Examples of events and circumstances that might indicate that a reporting unit's fair value is less than its carrying amount include macro-economic conditions such as deterioration in the entity's operating environment or industry or market considerations; entity-specific events such as increasing costs, declining financial performance, or loss of key personnel; or other events such as an expectation that a reporting unit will be sold or a sustained decrease in the stock price on either an absolute basis or relative to peers. If it is determined, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the provisions of authoritative guidance require that we perform a two-step impairment test on goodwill. The first step of the test identifies whether potential impairment may have occurred, while the second step of the test measures the amount of the impairment, if any. Impairment is recognized when the carrying amount of goodwill exceeds its fair value. For our annual goodwill impairment analysis, we operate under one reporting unit and the fair value of the reporting unit is based on the Company's enterprise value. In March 2012, we completed a qualitative assessment of potential impairment indicators and concluded that it was more-likely-than-not that the fair value of our reporting unit exceeded its carrying amount. Additionally, we considered potential impairment indicators at September 30, 2012 and noted no indicators of impairment. Investments. Our investments are diversified among high-credit quality debt securities in accordance with our investment policy. We classify our investments as available-for-sale, which are reported at fair market value with the related unrealized gains and losses included in accumulated other comprehensive income or loss in stockholders' equity. Realized gains and losses and declines in value of these investments judged to be other than temporary are included in other income (expense). To date, we have not deemed it necessary to record any charges related to other-than-temporary declines in the estimated fair values of our marketable debt securities. However, the fair value of our investments is subject to volatility. Declines in the fair value of our investments judged to be other than temporary could adversely affect our future operating results. Our investments also include auction rate securities (ARS) that are classified as available-for-sale. ARS are reported at fair market value with the related unrealized gains and losses included in accumulated other comprehensive income or loss in stockholders' equity. We believe these investments may remain illiquid for longer than twelve months and as a result, we have classified these investments as long-term as of September 30, 2012. We used the income approach to determine the fair value of our ARS using a discounted cash flow analysis. The assumptions we used in preparing the discounted cash flow model include estimates for interest rates; estimates for discount rates using yields of comparable traded instruments adjusted for illiquidity and other risk factors, amount of cash flows and expected holding periods for the ARS. 38-------------------------------------------------------------------------------- Table of Contents Results of Operations The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Years Ended September 30, 2012 2011 2010 (in thousands, except percentages) Net Revenues Products $ 818,555 $ 721,975 $ 561,142 Services 558,692 429,859 320,830 Total $ 1,377,247 $ 1,151,834 $ 881,972 Percentage of net revenues Products 59.4 % 62.7 % 63.6 % Services 40.6 37.3 36.4 Total 100.0 % 100.0 % 100.0 % Net Revenues. Total net revenues increased 19.6% in fiscal year 2012 from fiscal year 2011, compared to an increase of 30.6% in fiscal year 2011 from the prior year. Overall revenue growth for the year ended September 30, 2012 was primarily due to increased service and product revenues as a result of our increased installed base of products and increased demand for our core ADN products, including application security products. International revenues represented 47.1%, 45.5% and 45.4% of net revenues in fiscal years 2012, 2011 and 2010, respectively. We expect international sales will continue to represent a significant portion of net revenues, although we cannot provide assurance that international revenues as a percentage of net revenues will remain at current levels. Net product revenues increased 13.4% in fiscal year 2012 from fiscal year 2011, compared to an increase of 28.7% in fiscal year 2011 from the prior year. The increase of $96.6 million in net product sales for fiscal year 2012 was primarily due to growth in the volume of product sales of our ADN products. The increase of $160.8 million in net product sales for fiscal year 2011 was also primarily due to growth in the volume of product sales of our ADN products. Sales of our ADN products represented 98.6%, 97.4% and 97.2% of total product revenues in fiscal years 2012, 2011 and 2010, respectively. Net service revenues increased 30.0% in fiscal year 2012 from fiscal year 2011, compared to an increase of 34.0% in fiscal year 2011 from the prior year. The increases in service revenue were the result of increased purchases or renewals of maintenance contracts driven by additions to our installed base of products. Avnet Technology Solutions, one of our worldwide distributors, accounted for 17.1%, 18.1% and 14.5% of our total net revenues in fiscal years 2012, 2011 and 2010, respectively. Ingram Micro, Inc., another worldwide distributor, accounted for 13.8% and 10.7% of our total net revenues in fiscal year 2012 and 2011, respectively. Tech Data, another worldwide distributor, accounted for 10.2% of our total net revenues in fiscal year 2010. Avnet Technology Solutions and Ingram Micro, Inc. accounted for 13.4% and 12.0% of our accounts receivable as of September 30, 2012, respectively. Avnet Technology Solutions and Ingram Micro, Inc. accounted for 15.0% and 14.5% of our accounts receivable as of September 30, 2011, respectively. No other distributors accounted for more than 10% of total net revenue or receivables. 39-------------------------------------------------------------------------------- Table of Contents Years Ended September 30, 2012 2011 2010 (in thousands, except percentages) Cost of net revenues and Gross Margin Products $ 137,102 $ 129,325 $ 113,834 Services 99,066 78,679 58,118 Total 236,168 208,004 171,952 Gross profit $ 1,141,079 $ 943,830 $ 710,020 Percentage of net revenues and Gross Margin (as a percentage of related net revenue) Products 16.7 % 17.9 % 20.3 % Services 17.7 18.3 18.1 Total 17.1 18.1 19.5 Gross profit 82.9 % 81.9 % 80.5 % Cost of Net Product Revenues. Cost of net product revenues consist of finished products purchased from our contract manufacturers, manufacturing overhead, freight, warranty, provisions for excess and obsolete inventory and amortization expenses in connection with developed technology from acquisitions. Cost of net product revenues increased to $137.1 million in fiscal year 2012, up 6.0% from the prior year, primarily due to a higher volume of units shipped. The increase in cost of net product revenues for fiscal year 2012 was partially offset by a reduction in warranty expense of $3.5 million from the prior year. Cost of net product revenues increased to $129.3 million in fiscal year 2011 from $113.8 million in fiscal year 2010. The year over year increase was primarily due to a higher volume of units shipped along with an increase in warranty expense. Cost of Net Service Revenues. Cost of net service revenues consist of the salaries and related benefits of our professional services staff, travel, facilities and depreciation expenses. Cost of net service revenues as a percentage of net service revenues decreased to 17.7% in fiscal year 2012 compared to 18.3% in fiscal year 2011, primarily due to the scalability of our existing customer support infrastructure and increased revenue from maintenance contracts. Cost of net service revenues as a percentage of net service revenues in fiscal year 2011 remained relatively consistent with the prior year at 18.3%. Professional services headcount at the end of fiscal year 2012 increased to 654 from 528 at the end of fiscal year 2011 and 421 at the end of fiscal year 2010. In addition, cost of net service revenues included stock-based compensation expense of $10.9 million, $7.8 million and $6.0 million for fiscal years 2012, 2011 and 2010, respectively. Years Ended September 30, 2012 2011 2010 (in thousands, except percentages) Operating expenses Sales and marketing $ 445,595 $ 370,735 $ 293,201 Research and development 177,406 138,910 118,314 General and administrative 91,775 83,523 68,503 Total $ 714,776 $ 593,168 $ 480,018 Operating expenses (as a percentage of net revenue) Sales and marketing 32.3 % 32.2 % 33.2 % Research and development 12.9 12.1 13.4 General and administrative 6.7 7.2 7.8 Total 51.9 % 51.5 % 54.4 % 40 -------------------------------------------------------------------------------- Table of Contents Sales and Marketing. Sales and marketing expenses consist of the salaries, commissions and related benefits of our sales and marketing staff, the costs of our marketing programs, including public relations, advertising and trade shows, travel, facilities, and depreciation expenses. Sales and marketing expense increased 20.2% in fiscal year 2012 from the prior year, as compared to a year over year increase of 26.4% in fiscal year 2011. The increase in sales and marketing expense for fiscal year 2012 was primarily due to increases in commissions and personnel costs of $58.9 million, compared to the prior year. The increases in commissions and personnel costs were driven by growth in sales and marketing employee headcount and increased sales volume for fiscal year 2012 over the prior year. In fiscal year 2011, the increase in sales and marketing expense was also primarily due to increases in commissions and personnel costs of $45.4 million, compared to the prior year. The increases in commissions and personnel costs were driven by growth in sales and marketing employee headcount and increased sales volume for fiscal year 2011 over the prior year. The increase in sales and marketing expense for fiscal year 2011 was also due to an increase of $14.5 million in marketing promotions and initiatives aimed at promoting our brand and creating market awareness of our technology and our products. Sales and marketing headcount at the end of fiscal 2012 increased to 1,278 from 1,080 at the end of fiscal 2011 and 856 at the end of fiscal 2010. Sales and marketing expense included stock-based compensation expense of $37.0 million, $34.7 million and $27.3 million for fiscal years 2012, 2011 and 2010, respectively. Research and Development. Research and development expenses consist of the salaries and related benefits of our product development personnel, prototype materials and other expenses related to the development of new and improved products, facilities and depreciation expenses. Research and development expense increased 27.7% in fiscal year 2012, compared to the prior year. The increase in research and development expense for fiscal year 2012 was primarily due to increased personnel costs of $25.5 million. In addition, research and development expense included a year over year increase in computer equipment and software costs of $4.4 million to support the development of new and improved products. In fiscal year 2011, research and development expense increased 17.4%, compared to the prior year. The increase in research and development expense for fiscal year 2011 was primarily due to increased personnel costs of $14.0 million. In addition, research and development expense included a year over year increase in computer equipment and software costs of $1.5 million to support the development of new and improved products. Research and development headcount at the end of fiscal 2012 increased to 774 from 610 at the end of fiscal 2011 and 509 at the end of fiscal 2010. Research and development expense included stock-based compensation expense of $27.9 million, $23.3 million and $19.4 million for fiscal years 2012, 2011 and 2010, respectively. We expect research and development expenses to remain consistent as a percentage of net revenue in the foreseeable future. General and Administrative. General and administrative expenses consist of the salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, bad debt charges, facilities and depreciation expenses. General and administrative expense increased 9.9% in fiscal year 2012, compared to the prior year. The increase in general and administrative expense for fiscal year 2012 was primarily due to an increase in personnel costs of $5.5 million, compared to the prior year. In addition, fees paid to outside consultants for legal, accounting and information technology services increased $2.3 million for fiscal year 2012 compared to the prior year. In fiscal year 2011, general and administrative expense increased 21.9% compared to the prior year. The increase in general and administrative expense for fiscal year 2011 was primarily due to an increase in personnel costs of $5.3 million, compared to the prior year. In addition, fees paid to outside consultants for legal, accounting and information technology services increased $4.2 million for fiscal year 2011 compared to the prior year. General and administrative headcount at the end of fiscal 2012 increased to 323 from 270 at the end of fiscal 2011 and 226 at the end of fiscal 2010. General and administrative expense included stock-based compensation expense of $19.6 million, $22.4 million and $17.0 million for fiscal years 2012, 2011 and 2010, respectively. 41 -------------------------------------------------------------------------------- Table of Contents Years Ended September 30, 2012 2011 2010 (in thousands, except percentages)\ Other income and income taxes Income from operations $ 426,303 $ 350,662 $ 230,002 Other income, net 5,911 10,089 7,625 Income before income taxes 432,214 360,751 237,627 Provision for income taxes 157,028 119,354 86,474 Net income $ 275,186 $ 241,397 $ 151,153 Other income and income taxes (as percentage of net revenue) Income from operations 31.0 % 30.4 % 26.1 % Other income, net 0.4 0.9 0.8 Income before income taxes 31.4 31.3 26.9 Provision for income taxes 11.4 10.4 9.8 Net income 20.0 % 20.9 % 17.1 % Other Income, Net. Other income, net, consists primarily of interest income and foreign currency transaction gains and losses. Other income, net decreased 41.4% in fiscal year 2012, as compared to fiscal year 2011 and increased 32.3% in fiscal year 2011, as compared to fiscal year 2010. Interest income was $6.9 million, $8.1 million and $8.1 million for fiscal years 2012, 2011 and 2010, respectively. The decrease in other income, net for fiscal year 2012 as compared to fiscal year 2011 was primarily due to a reduction in interest income of $1.2 million and foreign currency transaction losses of $2.4 million. The increase in other income, net for fiscal year 2011 as compared to fiscal year 2010 was primarily due to a one-time charge of $1.5 million related to a legal settlement in fiscal year 2010 that was not incurred in fiscal year 2011. In addition, foreign currency transaction gains increased by $1.0 million in fiscal year 2011, compared to the prior year. Provision for Income Taxes. We recorded a 36.3% provision for income taxes for fiscal year 2012 compared to 33.1% in fiscal year 2011 and 36.4% in fiscal year 2010. The increase in the effective tax rate from fiscal year 2011 to fiscal year 2012 was primarily due to the expiration of the United States federal credit for Increasing Research Activities at December 31, 2011 and an increase in nondeductible stock-based compensation attributable to foreign based employees. At September 30, 2012, there have been no material valuation allowances established on any of our deferred tax assets in any of the jurisdictions in which we operate because we believe that these assets are more likely than not to be realized. In making these determinations we have considered projected future taxable income and ongoing prudent and feasible tax planning strategies in assessing the appropriateness of a valuation allowance. Our net deferred tax assets as of fiscal year end 2012, 2011 and 2010 were $45.8 million, $43.2 million, and $46.6 million, respectively. Our worldwide effective tax rate may fluctuate based on a number of factors, including variations in projected taxable income in our various geographic locations in which we operate, changes in the valuation of our net deferred tax assets, the tax effects of stock-based compensation, resolution of potential exposures, tax positions taken on tax returns filed in the various geographic locations in which we operate, and the introduction of new accounting standards or changes in tax laws or interpretations thereof in the various geographic locations in which we operate. We have recorded liabilities to address potential tax exposures related to business and income tax positions we have taken that could be challenged by taxing authorities. The ultimate resolution of these potential exposures may be greater or less than the liabilities recorded which could result in an adjustment to our future tax expense. 42-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources We have funded our operations with our cash balances, cash generated from operations and proceeds from public offerings of our securities. Years Ended September 30, 2012 2011 2010 (in thousands) Liquidity and Capital Resources Cash and cash equivalents and investments $ 1,194,954 $ 1,012,753 $ 862,066 Cash provided by operating activities 495,437 416,938 313,612 Cash used in investing activities (352,279 ) (139,719 ) (238,223 ) Cash used in financing activities (149,231 ) (226,664 ) (16,798 ) Cash and cash equivalents, short-term investments and long-term investments totaled $1,195.0 million as of September 30, 2012 compared to $1,012.8 million as of September 30, 2011, representing an increase of $182.2 million. The increase was primarily due to cash provided by operating activities of $495.4 million for fiscal year 2012, compared to $416.9 million for fiscal year 2011, which was partially offset by $184.8 million of additional cash required for the repurchase of outstanding common stock under our share repurchase program in fiscal 2012, and $128.3 million for the acquisition of Traffix Systems. In fiscal year 2011, the increase was primarily due to cash provided by operating activities of $416.9 million, compared to $313.6 million for fiscal year 2010, which was partially offset by $271.5 million of additional cash required for the repurchase of outstanding common stock under our share repurchase program in fiscal 2011. Cash provided by operating activities during fiscal year 2012 was $495.4 million compared to $416.9 million in fiscal year 2011 and $313.6 million in fiscal year 2010. Cash provided by operating activities resulted primarily from cash generated from net income, after adjusting for non-cash charges such as stock-based compensation, depreciation and amortization charges and changes in operating assets and liabilities. Cash used in investing activities during fiscal year 2012 was $352.3 million compared to $139.7 million in fiscal year 2011 and $238.2 million in fiscal year 2010. Cash used in investing activities for fiscal year 2012 was primarily the result of the purchase of investments and capital expenditures related to maintaining our operations worldwide partially offset by the sale and maturity of investments, and $128.3 million for the acquisition of Traffix Systems. Cash used in investing activities for fiscal year 2011 was primarily the result of the purchase of investments and capital expenditures related to maintaining our operations worldwide partially offset by the sale and maturity of investments. Cash used in investing activities for fiscal year 2010 was primarily the result of the purchase of investments and capital expenditures related to maintaining our operations worldwide partially offset by the sale and maturity of investments. Cash used in financing activities was $149.2 million for fiscal year 2012, compared to $226.7 million for fiscal year 2011 and $16.8 million for fiscal year 2010. Cash used in financing activities for fiscal year 2012 included $184.8 million to repurchase common stock under our share repurchase program, which was partially offset by cash received from the exercise of employee stock options and stock purchases under our employee stock purchase plan of $25.2 million and excess tax benefits related to share-based compensation of $10.4 million. Cash used in financing activities for fiscal year 2011 included $271.5 million to repurchase common stock under our share repurchase program, which was partially offset by cash received from the exercise of employee stock options and stock purchases under our employee stock purchase plan of $21.2 million and excess tax benefits related to share-based compensation of $23.6 million. Cash used in financing activities for fiscal 2010 included $75.0 million to repurchase common stock under our share repurchase program, which was partially offset by cash received from the exercise of employee stock options and stock purchases under our employee stock purchase plan of $31.7 million and excess tax benefits related to share-based compensation of $26.5 million. Based on our current operating and capital expenditure forecasts, we believe that our existing cash and investment balances, excluding ARS, together with cash generated from operations should be sufficient to meet our operating requirements for the next twelve months. Our future capital requirements will depend on many 43 -------------------------------------------------------------------------------- Table of Contents factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of expansion into new territories, the timing of introductions of new products and enhancements of existing products, and the continuing market acceptance of our products. Obligations and Commitments The following table summarizes our contractual payment obligations and commitments as of September 30, 2012: Payment Obligations by Year 2013 2014 2015 2016 2017 Thereafter Total (in thousands) Operating leases $ 19,336 $ 18,154 $ 16,427 $ 15,779 $ 15,913 $ 54,434 $ 140,043 Purchase obligations 16,187 - - - - - 16,187 Total $ 35,523 $ 18,154 $ 16,427 $ 15,779 $ 15,913 $ 54,434 $ 156,230 We lease our facilities under operating leases that expire at various dates through 2023. We adopted the provisions of FASB Interpretation No. 48, "Accounting for Income Taxes" on October 1, 2007. As of September 30, 2012, we had approximately $5.8 million of tax liabilities, including interest and penalties, related to uncertain tax positions (See Note 6 to our Consolidated Financial Statements). Because of the high degree of uncertainty regarding the settlement of these liabilities, we are unable to estimate the years in which future cash outflows may occur. Purchase obligations are comprised of purchase commitments with our contract manufacturers. The agreement with our primary contract manufacturer allows it to procure component inventory on our behalf based on our production forecast. We are obligated to purchase component inventory that the contract manufacturer procures in accordance with the forecast, unless cancellation is given within applicable lead times. Recent Accounting Pronouncements In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS (ASU 2011-04), which amends current fair value measurement and disclosure guidance to converge with International Financial Reporting Standards (IFRS) and provides increased transparency around valuation inputs and investment categorization. We adopted ASU 2011-04 in the second quarter of fiscal 2012. The adoption of ASU 2011-04 did not have a material impact on our consolidated financial position, results of operations or cash flows. In June 2011, the FASB issued ASU 2011-05, Comprehensive Income, Presentation of Comprehensive Income (ASU 2011-05), which eliminates the option of presenting other comprehensive income as part of the statement of changes in stockholders' equity and instead requires the entity to present other comprehensive income as either a single statement of comprehensive income combined with net income or as two separate but continuous statements. The amendments in this standard are to be applied retrospectively and are effective for fiscal years, and interim periods within those years beginning after December 15, 2011. We will adopt ASU 2011-05 in the first quarter of fiscal 2013 and do not expect the adoption of this standard to have an impact on our consolidated financial statements. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (ASU 2011-12), which defers the changes in ASU 2011-05 that relate to the presentation of reclassification adjustments to other comprehensive income. No other requirements in ASU 2011-05 are affected by this deferral. Similar to ASU 2011-05, we will adopt ASU 2011-12 in the first quarter of fiscal 2013 and do not expect the adoption of this standard to have an impact on our consolidated financial statements. 44-------------------------------------------------------------------------------- Table of Contents |