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ADTRAN INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Overview ADTRAN, Inc. designs, manufactures and markets solutions and provides services and support for communications networks. Our solutions are widely deployed by providers of communications services (serviced by our Carrier Networks Division), and small, mid-sized and distributed enterprises (serviced by our Enterprise Networks Division), and enable voice, data, video and Internet communications across a variety of network infrastructures. Many of these solutions are currently in use by every major United States service provider, many global service providers, as well as many public, private and governmental organizations worldwide. Our success depends upon our ability to increase unit volume and market share through the introduction of new products and succeeding generations of products having lower selling prices and increased functionality as compared to both the prior generation of a product and to the products of competitors. An important part of our strategy is to reduce the cost of each succeeding product generation and then lower the product's selling price based on the cost savings achieved in order to gain market share and/or improve gross margins. As a part of this strategy, we seek in most instances to be a high-quality, low-cost provider of products in our markets. Our success to date is attributable in large measure to our ability to design our products initially with a view to their subsequent redesign, allowing both increased functionality and reduced manufacturing costs in each succeeding product generation. This strategy enables us to sell succeeding generations of products to existing customers, while increasing our market share by selling these enhanced products to new customers. Our three major product categories are Carrier Systems, Business Networking and Loop Access. Carrier Systems products are used by communications service providers to provide data, voice and video services to consumers and enterprises. This category includes the following product areas and related services: • Broadband Access • Total Access®5000 Multi-Service Access and Aggregation Platform (MSAP) • hiX family of MSAPs • Total Access 1100/1200 Series of Fiber to the Node (FTTN) products • Ultra Broadband Ethernet (UBE) • Digital Subscriber Line Access Multiplexer (DSLAM) products • Optical • Optical Networking Edge (ONE) • NetVanta 8000 Series • OPTI and TA 3000 optical products • Small Form-Factor Pluggable (SFP) products • TDM systems • Network Management Solutions Business Networking products provide access to telecommunication services and facilitate the delivery of cloud connectivity, enterprise communications and virtual mobility to the small and mid-sized enterprise (SME) market. This category includes the following product areas and related services: • Internetworking products • Total Access IP Business Gateways • Optical Network Terminals (ONTs) • Bluesocket®virtual Wireless LAN (vWLAN®) • NetVanta® • Multiservice Routers • Managed Ethernet Switches • Unified Communications (UC) solutions • Carrier Ethernet Network Terminating Equipment (NTE) • Network Management Solutions • Integrated Access Devices (IADs) 26 -------------------------------------------------------------------------------- Table of Contents Loop Access products are used by carrier and enterprise customers for access to copper-based telecommunications networks. The Loop Access category includes the following product areas: • High bit-rate Digital Subscriber Line (HDSL) products • Digital Data Service (DDS) • Integrated Services Digital Network (ISDN) products • T1/E1/T3 Channel Service Units/Data Service Units (CSUs/DSUs) • TRACER fixed-wireless products In addition, we identify subcategories of product revenues, which we divide into core products and legacy products. Our core products consist of Broadband Access and Optical products (included in Carrier Systems) and Internetworking products (included in Business Networking). Our legacy products include HDSL products (included in Loop Access) and other products not included in the aforementioned core products. Many of our customers are migrating their networks to deliver higher bandwidth services by utilizing newer technologies. We believe that products and services offered in our core product areas position us well for this migration. Despite occasional increases, we anticipate that revenues of many of our legacy products, including HDSL, will decline over time; however, revenues from these products may continue for years because of the time required for our customers to transition to newer technologies. Sales were $620.6 million in 2012 compared to $717.2 million in 2011 and $605.7 million in 2010. Total sales of products in our three core areas, Broadband Access, Optical and Internetworking, decreased 1.7% in 2012 compared to 2011 and increased 48.2% in 2011 compared to 2010. Our gross profit margin decreased in 2012 to 51.0% from 57.8% in 2011 and 59.3% in 2010. Net income was $47.3 million in 2012 compared to $138.6 million in 2011 and $114.0 million in 2010. Earnings per share, assuming dilution, were $0.74 in 2012 compared to $2.12 in 2011 and $1.78 in 2010. Earnings per share in 2012, 2011 and 2010 include the effect of the repurchase of 1.8 million, 1.1 million and 0.7 million shares of our stock in those years, respectively. Our operating results have fluctuated on a quarterly basis in the past, and may vary significantly in future periods due to a number of factors, including customer order activity and backlog. Backlog levels vary because of seasonal trends, the timing of customer projects and other factors that affect customer order lead times. Many of our customers require prompt delivery of products. This requires us to maintain sufficient inventory levels to satisfy anticipated customer demand. If near-term demand for our products declines, or if potential sales in any quarter do not occur as anticipated, our financial results could be adversely affected. Operating expenses are relatively fixed in the short term; therefore, a shortfall in quarterly revenues could significantly impact our financial results in a given quarter. Our operating results may also fluctuate as a result of a number of other factors, including a decline in general economic and market conditions, increased competition, customer order patterns, changes in product and services mix, timing differences between price decreases and product cost reductions, product warranty returns, expediting costs and announcements of new products by us or our competitors. Additionally, maintaining sufficient inventory levels to assure prompt delivery of our products increases the amount of inventory that may become obsolete and increases the risk that the obsolescence of this inventory may have an adverse effect on our business and operating results. Also, not maintaining sufficient inventory levels to assure prompt delivery of our products may cause us to incur expediting costs to meet customer delivery requirements, which may negatively impact our operating results in a given quarter. Accordingly, our historical financial performance is not necessarily a meaningful indicator of future results, and, in general, management expects that our financial results may vary from period to period. See Note 14 of Notes to Consolidated Financial Statements for additional information. For a discussion of risks associated with our operating results, see Item 1A of this report. Critical Accounting Policies and Estimates An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the accounting estimate that are reasonably likely to occur could materially impact the results of financial operations. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. These policies have been consistently applied across our two reportable segments: (1) Carrier Networks Division and (2) Enterprise Networks Division. 27 -------------------------------------------------------------------------------- Table of Contents • We review customer contracts to determine if all of the requirements for revenue recognition have been met prior to recording revenues from sales transactions. We generally record sales revenue upon shipment of our products, net of any rebates or discounts, since: (i) we generally do not have significant post-delivery obligations, (ii) the product price is fixed or determinable, (iii) collection of the resulting receivable is probable, and (iv) product returns are reasonably estimable. We generally ship products upon receipt of a purchase order from a customer. We evaluate shipping terms and we record revenue on products shipped in accordance with the terms of each respective contract where applicable, or under our standard shipping terms for purchase orders accepted without a contract, generally FOB shipping point. In the case of consigned inventory, revenue is recognized when the customer assumes ownership of the product. Contracts that contain multiple deliverables are evaluated to determine the units of accounting, and the revenue from the arrangement is allocated to each item requiring separate revenue recognition based on the relative selling price and corresponding terms of the contract. We strive to use vendor-specific objective evidence of selling price. When this evidence is not available, we are generally not able to determine third-party evidence of selling price because of the extent of customization among competing products or services from other companies. We record revenue associated with installation services when all contractual obligations are complete. Contracts that include both installation services and product sales are evaluated for revenue recognition in accordance with the respective contract terms. As a result, depending on contract terms, installation services may be considered as a separate deliverable item or may be considered an element of the delivered product. Either the purchaser, ADTRAN, or a third party can perform installation of our products. Revenues related to maintenance services are recognized on a straight line basis over the contract term. • Sales returns are accrued based on historical sales return experience, which we believe provides a reasonable estimate of future returns. A significant portion of Enterprise Networks products are sold in the United States through a non-exclusive distribution network of major technology distributors. These organizations then distribute to an extensive network of value-added resellers and system integrators. Value-added resellers and system integrators may be affiliated with us as a channel partner, or they may purchase from the distributor on an unaffiliated basis. Additionally, with certain limitations, our distributors may return unused and unopened product for stock-balancing purposes when these returns are accompanied by offsetting orders for products of equal or greater value. We participate in cooperative advertising and market development programs with certain customers. We use these programs to reimburse customers for certain forms of advertising, and in general, to allow our customers credits up to a specified percentage of their net purchases. Our costs associated with these programs are estimated and accrued at the time of sale and are included in selling, general and administrative expenses in our consolidated statements of income. We also participate in rebate programs to provide sales incentives for certain products. Our costs associated with these programs are estimated and accrued at the time of sale and are recorded as a reduction of sales in our consolidated statements of income. Prior to issuing payment terms to a new customer, we perform a detailed credit review of the customer. Credit limits and payment terms are established for each new customer based on the results of this credit review. Collection experience is reviewed periodically in order to determine if the customer's payment terms and credit limits need to be revised. We maintain allowances for doubtful accounts for losses resulting from the inability of our customers to make required payments. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, we may be required to make additional allowances. If circumstances change with regard to individual receivable balances that have previously been determined to be uncollectible (and for which a specific reserve has been established), a reduction in our allowance for doubtful accounts may be required. Our allowance for doubtful accounts was $6 thousand at December 31, 2012 and $8 thousand at December 31, 2011. • We carry our inventory at the lower of cost or market, with cost being determined using the first-in, first-out method. We use standard costs for material, labor, and manufacturing overhead to value our inventory. Our standard costs are updated on at least a quarterly basis and any variances are expensed in the current period; therefore, our inventory costs approximate actual costs at the end of each reporting period. We write down our inventory for estimated obsolescence or unmarketable inventory by an amount equal to the difference between the cost of inventory and the estimated fair value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, we may be required to make additional inventory write-downs. Our reserve for excess and obsolete inventory was $12.0 million and $9.4 million at December 31, 2012 and 2011, respectively. Inventory write-downs charged to the reserve were $0.5 million, $0.7 million and $0.8 million for the years ended December 31, 2012, 2011 and 2010, respectively. • The objective of our short-term investment policy is to preserve principal and maintain adequate liquidity with appropriate diversification, while achieving market returns. The objective of our long-term investment policy is principal preservation and total return; that is, the aggregate return from capital appreciation, dividend income, and interest income. These objectives are achieved through investments with appropriate diversification in fixed and variable rate income securities, public equity, and private equity portfolios. Our investment policy provides limitations for issuer concentration, which limits, at the time of purchase, the concentration in any one issuer to 5% of the market value of our total investment portfolio. We have experienced significant volatility in the market prices of our publicly traded equity investments. These investments are recorded on the consolidated balance sheets at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income, net of tax. The ultimate realized value on these equity investments is subject to market price volatility. 28 -------------------------------------------------------------------------------- Table of Contents We have categorized our cash equivalents held in money market funds and our investments held at fair value into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique for the cash equivalents and investments as follows: Level 1 - Values based on unadjusted quoted prices for identical assets or liabilities in an active market; Level 2 - Values based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability; Level 3 - Values based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs include information supplied by investees. At December 31, 2012, we categorized $47.2 million and $395.9 million of our available-for-sale investments as Level 1 and Level 2, respectively, and $28.1 million of our cash equivalents as Level 1. At December 31, 2011, we categorized $39.7 million and $401.2 million of our available-for-sale investments as Level 1 and Level 2, respectively, and $13.7 million of our cash equivalents as Level 1. We review our investment portfolio for potential "other-than-temporary" declines in value on an individual investment basis. We assess, on a quarterly basis, significant declines in value which may be considered other-than-temporary and, if necessary, recognize and record the appropriate charge to write-down the carrying value of such investments. In making this assessment, we take into consideration qualitative and quantitative information, including but not limited to the following: the magnitude and duration of historical declines in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a fair value that has declined from its original or adjusted cost basis by 25% or more for six or more consecutive months. We then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. As a result of our review, we recorded an other-than-temporary impairment charge of $17 thousand during the fourth quarter of 2012. For the years ended December 31, 2012, 2011 and 2010, we recorded charges of $0.7 million, $68 thousand and $43 thousand, respectively, related to the other-than-temporary impairment of certain publicly traded equity securities, a fixed income bond fund, and our deferred compensation plan assets. Actual losses, if any, could ultimately differ from these estimates. Future adverse changes in market conditions or poor operating results of underlying investments could result in additional losses that may not be reflected in an investment's current carrying value, thereby possibly requiring an impairment charge in the future. See Note 4 of Notes to the Consolidated Financial Statements in this report for more information about our investments. We also invest in privately held entities and private equity funds and record these investments at cost. We review these investments periodically in order to determine if circumstances (both financial and non-financial) exist that indicate that we will not recover our initial investment. Impairment charges are recorded on investments having a cost basis that is greater than the value that we would reasonably expect to receive in an arm's length sale of the investment. We have not been required to record any impairment losses relating to these investments in 2012, 2011 or 2010. • For purposes of determining the estimated fair value of our stock option awards on the date of grant, we use the Black-Scholes Model. This model requires the input of certain assumptions that require subjective judgment. These assumptions include, but are not limited to, expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Because our stock option awards have characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect the fair value estimate, the existing model may not provide a reliable single measure of the fair value of our stock option awards. For purposes of determining the estimated fair value of our performance-based restricted stock unit awards on the date of grant, we use a Monte Carlo Simulation valuation method. The restricted stock units are subject to a market condition based on the relative total shareholder return of ADTRAN against all of the companies in the NASDAQ Telecommunications Index and vest at the end of a three-year performance period. The fair value of restricted stock issued to our Directors in 2012 is equal to the closing price of our stock on the date of grant. Management will continue to assess the assumptions and methodologies used to calculate the estimated fair value of stock-based compensation. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies and thereby materially impact our fair value determination. If factors change in future periods, the compensation expense that we record may differ significantly from what we have recorded in the current period. 29 -------------------------------------------------------------------------------- Table of Contents • We estimate our income tax provision or benefit in each of the jurisdictions in which we operate, including estimating exposures related to examinations by taxing authorities. We also make judgments regarding the realization of deferred tax assets, and establish reserves where we believe it is more likely than not that future taxable income in certain jurisdictions will be insufficient to realize these deferred tax assets. Our estimates regarding future taxable income and income tax provision or benefit may vary due to changes in market conditions, changes in tax laws, or other factors. If our assumptions, and consequently our estimates, change in the future, the valuation allowances we have established may be increased or decreased, impacting future income tax expense. At December 31, 2012 and 2011 respectively, the valuation allowance was $10.9 million and $7.6 million. As of December 31, 2012, we have state research tax credit carry-forwards of $3.1 million, which will expire between 2015 and 2027. These carry-forwards were caused by tax credits in excess of our annual tax liabilities to an individual state where we no longer generate sufficient state income. In addition, as of December 31, 2012, we have a deferred tax asset of $8.2 million relating to current losses and net operating loss carry-forwards generated by our domestic and foreign subsidiaries which will expire between 2013 and 2030. These carry-forwards are the result of acquisitions in 2009 and in 2011, plus losses generated in 2012 by a foreign entity. The acquired net operating losses are in excess of the amount of estimated earnings. We believe it is more likely than not that we will not realize the full benefits of our deferred tax asset arising from these credits and net operating losses, and accordingly, have provided a valuation allowance against them. This valuation allowance is included in non-current deferred tax liabilities in the accompanying balance sheets. • Our products generally include warranties of 90 days to ten years for product defects. We accrue for warranty returns at the time revenue is recognized based on our estimate of the cost to repair or replace the defective products. We engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers. Our products continue to become more complex in both size and functionality as many of our product offerings migrate from line card applications to systems products. The increasing complexity of our products will cause warranty incidences, when they arise, to be more costly. Our estimates regarding future warranty obligations may change due to product failure rates, material usage, and other rework costs incurred in correcting a product failure. In addition, from time to time, specific warranty accruals may be recorded if unforeseen problems arise. Should our actual experience relative to these factors be worse than our estimates, we will be required to record additional warranty expense. Alternatively, if we provide for more reserves than we require, we will reverse a portion of such provisions in future periods. The liability for warranty returns totaled $9.7 million and $4.1 million at December 31, 2012 and 2011, respectively. These liabilities are included in accrued expenses in the accompanying consolidated balance sheets. • We use the acquisition method to account for business combinations. Under the acquisition method of accounting, we recognize the assets acquired and liabilities assumed at their fair value on the acquisition date. Goodwill is measured as the excess of the consideration transferred over the net assets acquired. The acquisition method of accounting requires us to exercise judgment and make significant estimates and assumptions regarding the fair value of the assets acquired and liabilities assumed, including the fair values of inventory, unearned revenue, warranty liabilities, identifiable intangible assets and deferred tax asset valuation allowances. This method also requires us to refine these estimates over a one-year measurement period to reflect information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the asset and liabilities recorded on that date, which could affect our net income. • We evaluate the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. When evaluating whether goodwill is impaired, we first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. If we determine that the two-step quantitative test is necessary, then we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit's carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, then the amount of the impairment loss is measured. We passed the qualitative assessment in 2012 and 2011; therefore, we did not complete a quantitative assessment. As a result, there were no impairment losses recognized during 2012 or 2011. 30 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table presents selected financial information derived from our consolidated statements of income expressed as a percentage of sales for the years indicated. Year Ended December 31, 2012 2011 2010 Sales Carrier Networks Division 79.3 % 79.4 % 78.6 % Enterprise Networks Division 20.7 20.6 21.4 Total sales 100.0 % 100.0 % 100.0 % Cost of sales 49.0 42.2 40.7 Gross profit 51.0 57.8 59.3 Selling, general and administrative expenses 21.7 17.4 19.0 Research and development expenses 20.3 14.0 14.9 Operating income 9.1 26.4 25.4 Interest and dividend income 1.2 1.1 1.1 Interest expense (0.4 ) (0.3 ) (0.4 ) Net realized investment gain 1.5 1.7 1.8 Other income (expense), net - (0.1 ) (0.1 ) Gain on bargain purchase of a business 0.3 - - Income before provision for income taxes 11.8 28.7 27.8 Provision for income taxes (4.1 ) (9.4 ) (9.0 ) Net income 7.6 % 19.3 % 18.8 % 31 -------------------------------------------------------------------------------- Table of Contents Acquisition Expenses On August 4, 2011, we closed on the acquisition of Bluesocket, Inc. and on May 4, 2012, we closed on the acquisition of the NSN BBA business. Acquisition related expenses, amortizations and adjustments for the twelve months ended December 31, 2012 and 2011 for both transactions are as follows: (In Thousands) 2012 2011 Bluesocket, Inc. acquisition Amortization of acquired intangible assets $ 1,020 $ 495 Amortization of other purchase accounting adjustments 443 521 Acquisition related professional fees, travel and other expenses - 730 Subtotal 1,463 1,746 NSN BBA acquisition Amortization of acquired intangible assets 762 - Amortization of other purchase accounting adjustments 2,305 - Acquisition related professional fees, travel and other expenses 4,860 2,027 Subtotal 7,927 2,027 Total acquisition related expenses, amortizations and adjustments 9,390 3,773 Tax effect (3,148 ) (1,434 ) Total acquisition related expenses, amortizations and adjustments, net of tax $ 6,242 $ 2,339 The acquisition related expenses, amortizations and adjustments above were recorded in the following Consolidated Statements of Income categories for the twelve months ended December 31, 2012 and 2011: (In Thousands) 2012 2011 Revenue (adjustments to unearned revenue recognized in the period) $ 1,528 $ 362 Cost of goods sold 1,086 165 Subtotal 2,614 527 Selling, general and administrative expenses 4,510 2,557 Research and development expenses 2,266 689 Subtotal 6,776 3,246 Total acquisition related expenses, amortizations and adjustments 9,390 3,773 Tax effect (3,148 ) (1,434 ) Total acquisition related expenses, amortizations and adjustments, net of tax $ 6,242 $ 2,339 2012 Compared to 2011 Sales ADTRAN's sales decreased 13.5% from $717.2 million in 2011 to $620.6 million in 2012. The decrease in sales is primarily attributable to an $87.6 million decrease in sales of our HDSL and other legacy products, a $30.8 million decrease in sales of our Optical products, an $8.6 million decrease in sales of our Internetworking products, partially offset by a $30.3 million increase in sales of our Broadband Access products. 32 -------------------------------------------------------------------------------- Table of Contents Carrier Networks sales decreased 13.6% from $569.6 million in 2011 to $492.1 million in 2012. The decrease is primarily attributable to decreases in sales of Optical products, HDSL products and other legacy products. These declines were partially offset by the added sales of the NSN BBA business and an increase in sales of our Internetworking NTE products. Our organic Broadband Access sales in 2012 were negatively impacted by decreased capital expenditures at two substantial Broadband Access customers. The decrease in sales of Optical products in 2012 is primarily attributable to the market transitioning to Ethernet and our transition to new products to address this market. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies, but was larger than anticipated due to a large carrier customer that initiated a significant acceleration of their installed inventory reuse program. Enterprise Networks sales decreased 13.0% from $147.7 million in 2011 to $128.5 million in 2012. The decrease is attributable to decreases in sales of Internetworking products and legacy products. The decrease in Internetworking product sales in 2012 is primarily due to a decline in Carrier spending caused by the macroeconomic environment, partially offset by growth in the value-added reseller channel and by the addition of our vWLAN solutions. Internetworking product sales attributable to Enterprise Networks were 91.5% of the division's sales in 2012 compared with 87.4% in 2011. Legacy products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales increased from 20.6% in 2011 to 20.7% in 2012. International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, increased 77.9% from $84.4 million in 2011 to $150.2 million in 2012. International sales, as a percentage of total sales, increased from 11.8% in 2011 to 24.2% in 2012. The increase in international sales in 2012 was primarily due to sales attributable to the acquired NSN BBA business and an increase in organic sales in Latin America. Carrier Systems product sales decreased $20.6 million in 2012 compared to 2011 primarily due to a $30.8 million decrease in Optical product sales and a $20.2 million decrease in legacy product sales, partially offset by an increase of $30.3 million in Broadband Access product sales. The decrease in sales of Optical products in 2012 is primarily attributable to the market transitioning to Ethernet and our transition to new products to address this market. The increase in Broadband Access product sales was due to the added sales of the NSN BBA business, partially offset by a decline in organic Broadband Access product sales. Our organic Broadband Access sales in 2012 were negatively impacted by decreased capital expenditures at two substantial Broadband Access customers. Business Networking product sales decreased $12.9 million in 2012 compared to 2011 primarily due to an $8.6 million decrease in Internetworking product sales across both divisions and a $4.3 million decrease in legacy product sales. The decrease in Internetworking product sales in 2012 is primarily due to a decline in Carrier spending caused by the macroeconomic environment, partially offset by growth in the value-added reseller channel and by the addition of our vWLAN solutions. The decrease in sales of legacy products is a result of customers shifting to newer technologies. Many of these newer technologies are integral to our Internetworking product area. Loop Access product sales decreased $63.1 million in 2012 compared to 2011 primarily due to a $60.0 million decrease in HDSL product sales. The declining trend in HDSL and other legacy products has been expected as we evolve our products towards packet-based technologies, but was larger than anticipated due to a large carrier customer that initiated a significant acceleration of their installed inventory reuse program. Cost of Sales As a percentage of sales, cost of sales increased from 42.2% in 2011 to 49.0% in 2012. The increase was primarily attributable to lower gross margins related to the acquired NSN BBA business, lower cost absorption due to the lower production volumes, customer price movements to achieve market share position and higher warranty costs. Carrier Networks cost of sales increased from 42.4% of sales in 2011 to 49.7% of sales in 2012. The increase in Carrier Networks cost of sales as a percentage of sales was primarily attributable to lower gross margins related to the acquired NSN BBA business, lower cost absorption due to the lower production volumes, customer price movements to achieve market share position and higher warranty costs. Enterprise Networks cost of sales increased from 41.4% of sales in 2011 to 46.1% of sales in 2012. The increase in Enterprise Networks cost of sales as a percentage of sales was primarily attributable to lower cost absorption due to the lower production volumes and customer price movements to achieve market share position. An important part of our strategy is to reduce the product cost of each succeeding product generation and then to lower the product's price based on the cost savings achieved. This may cause variations in our gross profit percentage due to timing differences between the recognition of cost reductions and the lowering of product selling prices. 33 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses increased 7.7% from $124.9 million in 2011 to $134.5 million in 2012. Selling, general and administrative expenses include personnel costs for administration, finance, information systems, human resources, sales and marketing, and general management, as well as rent, utilities, legal and accounting expenses, bad debt expense, advertising, promotional material, trade show expenses, and related travel costs. The increase in selling, general and administrative expenses is primarily related to increases in staffing and fringe benefit costs due to increased headcount, professional services, legal services and amortization of acquired intangible assets. These increases were primarily related to the NSN BBA business, which was acquired on May 4, 2012, and Bluesocket Inc., which was acquired on August 4, 2011. Selling, general and administrative expenses as a percentage of sales increased from 17.4% for the year ended December 31, 2011 to 21.7% for the year ended December 31, 2012. Selling, general and administrative expenses as a percent of sales will generally fluctuate whenever there is a significant fluctuation in revenues for the periods being compared. Research and Development Expenses Research and development expenses increased 25.6% from $100.3 million in 2011 to $126.0 million in 2012. The increase in research and development expense is primarily related to increases in staffing and fringe benefit costs due to increased headcount, including expenses and increased headcount related to the NSN BBA business acquired on May 4, 2012 and Bluesocket, Inc., which was acquired on August 4, 2011, amortization of acquired intangible assets related to both acquisitions, and increases in independent contractor expense and office lease expense related to the NSN BBA business. Research and development expenses as a percentage of sales increased from 14.0% for the year ended December 31, 2011 to 20.3% for the year ended December 31, 2012. Research and development expenses as a percentage of sales will fluctuate whenever there are incremental product development activities or a significant fluctuation in revenues for the periods being compared. We expect to continue to incur research and development expenses in connection with our new and existing products and our expansion into international markets. We continually evaluate new product opportunities and engage in intensive research and product development efforts which provide for new product development, enhancement of existing products and product cost reductions. We may incur significant research and development expenses prior to the receipt of revenues from a major new product group. Interest and Dividend Income Interest and dividend income remained consistent at $7.6 million in 2011 and $7.7 million in 2012, as we had no substantial change in interest-bearing investment balances or interest rates. Interest Expense Interest expense remained consistent at $2.4 million in 2011 and $2.3 million in 2012, as we had no substantial change in our fixed rate borrowing. See "Liquidity and Capital Resources" below for additional information. Net Realized Investment Gain (Loss) Net realized investment gain (loss) decreased from a $12.5 million gain in 2011 to a $9.6 million gain in 2012. This change is primarily related to a $1.3 million decrease related to sales of marketable equity securities and impaired marketable equity securities, a $0.6 million decrease in distributions from two private equity funds, and a $0.6 million increase in impairment of deferred compensation plan assets. See "Investing Activities" in "Liquidity and Capital Resources" below for additional information. Other Income (Expense), net Other income (expense), net, comprised primarily of miscellaneous income, gains and losses on foreign currency transactions, investment account management fees, and gains or losses on the disposal of property, plant and equipment occurring in the normal course of business, changed from $0.7 million of expense in 2011 to $0.2 million of income in 2012. Income Taxes Our effective tax rate increased from 32.8% in 2011 to 35.2% in 2012. This increase is primarily attributable to the exclusion of the research tax credit in 2012 and our inability to utilize losses generated by our foreign subsidiaries where a full valuation allowance was provided. These tax rate increases were partially offset by increased state tax incentives in 2012. In 2013, we will recognize a benefit from the research tax credit related to 2012 and 2013, of which we estimate $3.1 million will be attributable to 2012. 34 -------------------------------------------------------------------------------- Table of Contents Net Income As a result of the above factors, net income decreased from $138.6 million in 2011 to $47.3 million in 2012. As a percentage of sales, net income decreased from 19.3% in 2011 to 7.6% in 2012. 2011 Compared to 2010 Sales ADTRAN's sales increased 18.4% from $605.7 million in 2010 to $717.2 million in 2011. This increase in sales is primarily attributable to a $113.7 million increase in sales of our Broadband Access products, a $40.4 million increase in sales of our Internetworking products, a $16.3 million increase in sales of our Optical products, partially offset by a $58.8 million decrease in sales of our HDSL and other legacy products. Carrier Networks sales increased 19.7% from $476.0 million in 2010 to $569.6 million in 2011. The increase is primarily attributable to increases in Broadband Access, Optical and Internetworking NTE product sales, partially offset by a decrease in HDSL and other legacy product sales. Enterprise Networks sales increased 13.9% from $129.6 million in 2010 to $147.7 million in 2011. The increase is primarily attributable to an increase in sales of Internetworking products, partially offset by decreases in sales of legacy products. Internetworking product sales attributable to Enterprise Networks were 87.4% of the division's sales in 2011 compared with 77.3% in 2010. Legacy products primarily comprise the remainder of Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales decreased from 21.4% in 2010 to 20.6% in 2011. International sales, which are included in the Carrier Networks and Enterprise Networks amounts discussed above, increased 165.3% from $31.8 million in 2010 to $84.4 million in 2011. International sales, as a percentage of total sales, increased from 5.3% in 2010 to 11.8% in 2011. The increase in international sales in 2011 was primarily due to an increase in sales to Latin America, Asia-Pacific and Europe regions. Carrier Systems product sales increased $131.0 million in 2011 compared to 2010 primarily due to a $113.7 million increase in Broadband Access product sales and a $16.3 million increase in Optical product sales. The increase in Broadband Access product sales was primarily attributable to continued growth in deployments of our Total Access 5000 and Fiber-to-the-Node platforms. Business Networking product sales increased $35.0 million in 2011 compared to 2010 primarily due to a $40.4 million increase in Internetworking product sales across both divisions, partially offset by a $5.8 million decrease in legacy product sales. The decrease in sales of legacy products is a result of customers shifting to newer technologies. Many of these newer technologies are integral to our Internetworking product area. Loop Access product sales decreased $54.4 million in 2011 compared to 2010 primarily due to a $50.3 million decrease in HDSL product sales. Cost of Sales As a percentage of sales, cost of sales increased from 40.7% in 2010 to 42.2% in 2011. The increase was primarily the result of higher services related revenue including cabinet shipments, and specific customer price movements related to market share expansion. These effects were partially offset by cost absorption and manufacturing efficiencies achieved at the higher production volumes. Carrier Networks cost of sales increased from 40.5% of sales in 2010 to 42.4% of sales in 2011. The increase in Carrier Networks cost of sales as a percentage of sales was primarily attributable to higher services related revenue including cabinet shipments, and specific customer price movements related to market share expansion. Enterprise Networks cost of sales decreased from 41.7% of sales in 2010 to 41.4% of sales in 2011. The decrease in Enterprise Networks cost of sales as a percentage of sales was primarily attributable to cost absorption and manufacturing efficiencies achieved at higher production volumes. 35 -------------------------------------------------------------------------------- Table of Contents An important part of our strategy is to reduce the product cost of each succeeding product generation and then to lower the product's price based on the cost savings achieved. This may cause variations in our gross profit percentage due to timing differences between the recognition of cost reductions and the lowering of product selling prices. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 8.9% from $114.7 million in 2010 to $124.9 million in 2011. Selling, general and administrative expenses include personnel costs for administration, finance, information systems, human resources, sales and marketing, and general management, as well as rent, utilities, legal and accounting expenses, bad debt expense, advertising, promotional material, trade show expenses, and related travel costs. The increase in selling, general and administrative expenses is primarily related to increases in staffing and fringe benefit costs due to increased headcount, contract services, professional services, recruiting expenses and travel expenses. These increases included expenses related to Bluesocket, Inc., which was acquired on August 4, 2011, and the announced planned acquisition of Nokia Siemens Networks Broadband Access business. Selling, general and administrative expenses as a percentage of sales decreased from 18.9% for the year ended December 31, 2010 to 17.4% for the year ended December 31, 2011. Selling, general and administrative expenses as a percent of sales will generally fluctuate whenever there is a significant fluctuation in revenues for the periods being compared. Research and Development Expenses Research and development expenses increased 11.1% from $90.3 million in 2010 to $100.3 million in 2011. The increase in research and development expense is primarily related to increases in staffing and fringe benefit costs due to increased headcount. These increases included research and development expenses related to Bluesocket, Inc., and amortization of intangible assets related to the acquisition of Bluesocket, Inc. Research and development expenses as a percentage of sales decreased from 14.9% for the year ended December 31, 2010 to 14.0% for the year ended December 31, 2011. Research and development expenses as a percentage of sales will fluctuate whenever there are incremental product development activities or a significant fluctuation in revenues for the periods being compared. We expect to continue to incur research and development expenses in connection with our new and existing products and our expansion into international markets. We continually evaluate new product opportunities and engage in intensive research and product development efforts which provide for new product development, enhancement of existing products and product cost reductions. We may incur significant research and development expenses prior to the receipt of revenues from a major new product group. Interest and Dividend Income Interest and dividend income increased 16.5% from $6.6 million in 2010 to $7.6 million in 2011. This increase was primarily attributable to a 19.9% increase in our average investment balances, partially offset by a 22.6% reduction in the average rate of return on our investments as a result of lower interest rates. Interest Expense Interest expense remained consistent at $2.4 million in 2011 and 2010, as we had no substantial change in our fixed rate borrowing. See "Liquidity and Capital Resources" below for additional information. Net Realized Investment Gain (Loss) Net realized investment gain (loss) increased from an $11.0 million gain in 2010 to a $12.5 million gain in 2011. This change is related to a $0.7 million increase related to sales of marketable equity securities and an increase of $0.8 million related to distributions from two private equity funds. See "Investing Activities" in "Liquidity and Capital Resources" below for additional information. Other Income (Expense), net Other income (expense), net, comprised primarily of miscellaneous income, gains and losses on foreign currency transactions, investment account management fees, and gains or losses on the disposal of property, plant and equipment occurring in the normal course of business, decreased from $0.8 million of expense in 2010 to $0.7 million of expense in 2011. 36 -------------------------------------------------------------------------------- Table of Contents Income Taxes Our effective tax rate increased from 32.2% in 2010 to 32.8% in 2011. This increase is primarily due to the reduced impact of available statutory tax benefits applied to the increased level of pretax income in 2011. The statutory benefits include the research tax credit, deduction for domestic manufacturing under Internal Revenue Code Section 199 and stock option related tax benefits. Net Income As a result of the above factors, net income increased from $114.0 million in 2010 to $138.6 million in 2011. As a percentage of sales, net income increased from 18.8% in 2010 to 19.3% in 2011. Liquidity and Capital Resources Liquidity We intend to finance our operations with cash flow from operations. We have used, and expect to continue to use, the cash generated from operations for working capital, purchases of treasury stock, shareholder dividends, and other general corporate purposes, including (i) product development activities to enhance our existing products and develop new products and (ii) expansion of sales and marketing activities. We believe our cash and cash equivalents, investments and cash generated from operations to be adequate to meet our operating and capital needs for the foreseeable future. At December 31, 2012, cash on hand was $68.5 million and short-term investments were $160.5 million, which placed our short-term liquidity at $228.9 million. At December 31, 2011, our cash on hand of $43.0 million and short-term investments of $159.3 million placed our short-term liquidity at $202.3 million. The increase in short-term liquidity from 2011 to 2012 primarily reflects funds provided by our operating activities, proceeds from stock option exercises, cash received from NSN as a result of our acquisition of the NSN BBA business and long-term corporate bonds moving to short-term status, partially offset by equipment acquisitions, share repurchases and shareholder dividends. Operating Activities Our working capital, which consists of current assets less current liabilities, increased 3.1% from $329.3 million as of December 31, 2011 to $339.4 million as of December 31, 2012. The quick ratio, defined as cash and cash equivalents, short-term investments, and net accounts receivable, divided by current liabilities, decreased from 4.50 as of December 31, 2011 to 2.90 as of December 31, 2012. The current ratio, defined as current assets divided by current liabilities, decreased from 6.32 as of December 31, 2011 to 4.18 as of December 31, 2012. The changes in our working capital, quick ratio and current ratio are primarily attributable to changes in the underlying assets and liabilities, including unearned revenue balances, relating to the acquired NSN BBA business. Net accounts receivable increased 6.7% from $76.1 million at December 31, 2011 to $81.2 million at December 31, 2012. Our allowance for doubtful accounts decreased from $8 thousand at December 31, 2011 to $6 thousand at December 31, 2012. Quarterly accounts receivable days sales outstanding (DSO) increased from 40 days as of December 31, 2011 to 53 days as of December 31, 2012. The change in net accounts receivable and DSO is due to an increase in international sales as a percentage of our total sales, which typically have longer payment terms than our U.S. customers. Other receivables increased from $9.7 million at December 31, 2011 to $16.3 million at December 31, 2012. At December 31, 2012, other receivables included an estimated receivable due from NSN related to working capital adjustments under negotiation. Other receivables will also fluctuate due to the timing of shipments and collections for materials supplied to our contract manufacturers during the quarter. Quarterly inventory turnover decreased from 3.5 turns as of December 31, 2011 to 2.8 turns as of December 31, 2012. Inventory increased 16.8% from December 31, 2011 to December 31, 2012. The increase in inventory is primarily attributable to inventories acquired during the acquisition of the NSN BBA business, increased installation services business and the timing of acceptances of broadband stimulus projects. We expect inventory levels to fluctuate as we attempt to maintain sufficient inventory in response to seasonal cycles of our business ensuring competitive lead times while managing the risk of inventory obsolescence that may occur due to rapidly changing technology and customer demand. Accounts payable increased 43.4% from $29.4 million at December 31, 2011 to $42.2 million at December 31, 2012. The increase in accounts payable is primarily attributable to accounts payable related to the acquired NSN BBA business. Additionally, accounts payable will fluctuate due to variations in the timing of the receipt of supplies, inventory and services and our subsequent payments for these purchases. 37 -------------------------------------------------------------------------------- Table of Contents Investing Activities Capital expenditures totaled approximately $12.1 million, $11.9 million and $9.9 million for the years ended December 31, 2012, 2011 and 2010, respectively. These expenditures were primarily used to purchase computer hardware, software and manufacturing and test equipment. On May 4, 2012, we acquired the NSN BBA business. This acquisition provides us with an established customer base in key markets and complementary, market-focused products and was accounted for as a business combination. We received a cash payment of $7.5 million from NSN and recorded a bargain purchase gain of $1.8 million, net of income taxes, subject to customary working capital adjustments between the parties. We are currently negotiating the final working capital adjustments in accordance with the provisions of the underlying purchase agreement. Our combined short-term and long-term investments increased $1.9 million from $491.4 million at December 31, 2011 to $493.2 million at December 31, 2012. This increase reflects the impact of additional funds available for investment provided by our operating activities and proceeds from stock option exercises by our employees, reduced by our cash needs for equipment acquisitions, share repurchases and shareholder dividends, as well as net realized and unrealized losses and amortization of net premiums on our combined investments. We invest all available cash not required for immediate use in operations primarily in securities that we believe bear minimal risk of loss. At December 31, 2012 these investments included corporate bonds of $186.4 million, municipal fixed-rate bonds of $175.1 million and municipal variable rate demand notes of $34.4 million. At December 31, 2011, these investments included corporate bonds of $156.8 million, municipal fixed-rate bonds of $174.8 million and municipal variable rate demand notes of $69.7 million. As of December 31, 2012, our corporate bonds, municipal fixed-rate bonds, and municipal variable rate demand notes were classified as available-for-sale and had a combined duration of 1.03 years with an average credit rating of AA-. Because our bond portfolio has a high quality rating and contractual maturities of a short duration, we are able to obtain prices for these bonds derived from observable market inputs, or for similar securities traded in an active market, on a daily basis. Our long-term investments increased 0.2% from $332.0 million at December 31, 2011 to $332.7 million at December 31, 2012. Long-term investments at December 31, 2012 and December 31, 2011 included an investment in a certificate of deposit of $48.3 million, which serves as collateral for our revenue bonds, as discussed below. We have various equity investments included in long-term investments at a cost of $21.0 million and $12.8 million, and with a fair value of $35.2 million and $31.3 million, at December 31, 2012 and December 31, 2011, respectively. Long-term investments at December 31, 2012 and 2011 also included $11.5 million and $7.7 million, respectively, related to our deferred compensation plan; $1.9 million and $2.1 million, respectively, of other investments carried at cost, consisting of interests in two private equity funds and an investment in a privately held telecommunications equipment manufacturer; and $0.5 million and $0.7 million, respectively, of a fixed income bond fund. We review our investment portfolio for potential "other-than-temporary" declines in value on an individual investment basis. We assess, on a quarterly basis, significant declines in value which may be considered other-than-temporary and, if necessary, recognize and record the appropriate charge to write-down the carrying value of such investments. In making this assessment, we take into consideration qualitative and quantitative information, including but not limited to the following: the magnitude and duration of historical declines in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a fair value that has declined from its original or adjusted cost basis by 25% or more for six or more consecutive months. We then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. As a result of our review, we recorded an other-than-temporary impairment charge of $17 thousand during the fourth quarter of 2012 related to three marketable equity securities. For the years ended December 31, 2012, 2011 and 2010 we recorded charges of $0.7 million, $68 thousand and $43 thousand, respectively, related to the other-than-temporary impairment of certain publicly traded equity securities, a fixed income bond fund, and our deferred compensation plan assets. Financing Activities In conjunction with an expansion of our Huntsville, Alabama, facility, we were approved for participation in an incentive program offered by the State of Alabama Industrial Development Authority (the "Authority"). Pursuant to the program, on January 13, 1995, the Authority issued $20.0 million of its taxable revenue bonds and loaned the proceeds from the sale of the bonds to ADTRAN. The bonds were originally purchased by AmSouth Bank of Alabama, Birmingham, Alabama (the "Bank"). Wachovia Bank, N.A., Nashville, Tennessee (formerly First Union National Bank of Tennessee) (the "Bondholder"), which was acquired by Wells Fargo & Company on December 31, 2008, purchased the original bonds from the Bank and made further advances to the Authority, bringing the total amount outstanding to $50.0 million. An Amended and Restated Taxable Revenue Bond ("Amended and Restated Bond") was issued and the original financing agreement was amended. The Amended and Restated Bond bears interest, payable monthly. The interest rate is 5% per annum. The Amended and Restated Bond matures on January 1, 2020. The estimated fair value of the bond at December 31, 2012 was approximately $48.8 million, based on a debt security with a comparable interest rate and maturity and a Standard & Poor's credit rating of A. We are required to make payments to the Authority in amounts necessary to pay the principal of and interest on the Amended and Restated Bond. Included in long-term investments at December 31, 2012 is $48.3 million which is invested in a restricted certificate of deposit. These funds serve as a collateral deposit against the principal of this bond, and we have the right to set-off the balance of the Bond with the collateral deposit in order to reduce the balance of the indebtedness. 38 -------------------------------------------------------------------------------- Table of Contents In conjunction with this program, we are eligible to receive certain economic incentives from the state of Alabama that reduce the amount of payroll withholdings that we are required to remit to the state for those employment positions that qualify under the program. For the years ended December 31, 2012, 2011 and 2010, we realized economic incentives related to payroll withholdings totaling $1.4 million, $1.9 million and $1.5 million, respectively. We are required to make payments in the amounts necessary to pay the principal and interest on the amounts currently outstanding. Based on positive cash flow from operating activities, we have decided to continue early partial redemptions of the Bond. We made principal payments of $0.5 million and $1.0 million for the years ended December 31, 2012 and 2011, respectively. It is our intent to make annual principal payments in addition to the interest amounts that are due. In connection with this decision, $0.5 million of the bond debt has been reclassified to a current liability in accounts payable in the Consolidated Balance Sheets at December 31, 2012 and 2011. The following table shows dividends paid to our shareholders in each quarter of 2012, 2011 and 2010. During 2012, 2011 and 2010, we paid shareholder dividends totaling $22.8 million, $23.1 million and $22.5 million, respectively. The Board of Directors presently anticipates that it will declare a regular quarterly dividend so long as the present tax treatment of dividends exists and adequate levels of liquidity are maintained. Dividends per Common Share 2012 2011 2010 First Quarter $ 0.09 $ 0.09 $ 0.09 Second Quarter $ 0.09 $ 0.09 $ 0.09 Third Quarter $ 0.09 $ 0.09 $ 0.09 Fourth Quarter $ 0.09 $ 0.09 $ 0.09 Stock Repurchase Program Since 1997, our Board of Directors has approved multiple share repurchase programs that have authorized open market repurchase transactions of up to 35 million shares of our common stock. For the years 2012, 2011 and 2010, we repurchased 1.8 million shares, 1.1 million shares and 0.7 million shares, respectively, for a cost of $39.4 million, $35.6 million and $18.3 million, respectively, at an average price of $22.03, $31.97 and $25.12 per share, respectively. We currently have the authority to purchase an additional 4.1 million shares of our common stock under the current plan approved by the Board of Directors. Stock Option Exercises To accommodate employee stock option exercises, we issued 0.4 million shares of treasury stock for $6.0 million during the year ended December 31, 2012, 1.8 million shares of treasury stock for $34.1 million during the year ended December 31, 2011, and 1.5 million shares of treasury stock for $24.9 million during the year ended December 31, 2010. 39 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements and Contractual Obligations We do not have off-balance sheet financing arrangements and have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources. We have various contractual obligations and commercial commitments. The following table sets forth, in millions, the annual payments we are required to make under contractual cash obligations and other commercial commitments at December 31, 2012. Contractual Obligations (In millions) Total 2013 2014 2015 2016 After 2016 Long-term debt $ 46.5 $ 0.5 $ - $ - $ - $ 46.0 Interest on long-term debt 16.3 2.3 2.3 2.3 2.3 7.1 Purchase obligations 53.3 52.4 0.9 - - - Operating lease obligations 16.3 4.4 3.7 3.2 2.3 2.7 Totals $ 132.4 $ 59.6 $ 6.9 $ 5.5 $ 4.6 $ 55.8 We are required to make payments necessary to pay the interest on the Taxable Revenue Bond, Series 1995, as amended, currently outstanding in the aggregate principal amount of $46.5 million. The bond matures on January 1, 2020, and bears interest at the rate of 5% per annum. Included in long-term investments are $48.3 million of restricted funds, which is a collateral deposit against the principal amount of this bond. Due to continued positive cash flow from operating activities, we made a business decision in 2006 to begin an early partial redemption of the Bond. We made principal payments of $0.5 million and $1.0 million for the years ended December 31, 2012 and 2011, respectively. It is our intent to make annual principal payments in addition to the interest amounts that are due. In connection with this decision, $0.5 million of the bond debt has been reclassified to a current liability in accounts payable in the Consolidated Balance Sheets at December 31, 2012. See Note 8 of Notes to Consolidated Financial Statements for additional information. We have committed to invest up to an aggregate of $7.9 million in two private equity funds, and we have contributed $8.4 million as of December 31, 2012, of which $7.7 million has been applied to these commitments. The additional $0.2 million commitment has been excluded from the table above due to uncertainty of when it will be applied. We also have obligations related to uncertain income tax positions that have been excluded from the table above due to the uncertainty of when the related expense will be recognized. See Note 9 of Notes to Consolidated Financial Statements for additional information. Effect of Recent Accounting Pronouncements During 2012, we adopted the following accounting standards, which had no material effect on our consolidated results of operations or financial condition: In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-05 requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. While ASU 2011-05 changes the presentation of comprehensive income, it does not change the components that are recognized in net income or comprehensive income under current accounting guidance. This update is effective for fiscal years, and interim periods within those years, ending after December 15, 2011, with early adoption permitted. We adopted this amendment during the first quarter of 2012, and we have provided the revised financial statement presentation required for the period ended December 31, 2012. In December 2011, the FASB issued Accounting Standards Update No. 2011-12, 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). ASU 2011-12 defers the effective date for certain presentation requirements that relate to reclassification adjustments and the effect of those reclassification adjustments on the financial statements. This update is effective for fiscal years, and interim periods within those years, ending after December 15, 2011, with early adoption permitted. We adopted this amendment during the first quarter of 2012. The adoption of this amendment had no effect on our consolidated results of operations and financial condition for the period ended December 31, 2012. In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU 2011-04). ASU 2011-04 is intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRS. The amendments are of two types: (i) those that clarify the Board's intent about the application of existing fair value measurement and disclosure requirements and (ii) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. This update is effective for annual periods beginning after December 15, 2011. We adopted this amendment during the first quarter of 2012, and we have provided the disclosures required for the period ended December 31, 2012. 40 -------------------------------------------------------------------------------- Table of Contents In February 2013, the FASB issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02). ASU 2013-02 requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component either on the face of the financial statements or in the footnotes. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in the financial statements. This update is effective prospectively for reporting periods beginning after December 15, 2012. We do not expect the adoption of this amendment will have an effect on our consolidated results of operations, financial condition or cash flows. Subsequent Events On January 15, 2013, the Board declared a quarterly cash dividend of $0.09 per common share to be paid to shareholders of record at the close of business on February 7, 2013. The quarterly dividend payment was $5.6 million and was paid on February 21, 2013. As of February 28, 2013, we have repurchased 0.9 million shares of our common stock through open market purchases at an average cost of $22.45 per share. We currently have the authority to purchase an additional 3.2 million shares of our common stock under the current plan approved by the Board of Directors. |