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WESTELL TECHNOLOGIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Overview The following discussion should be read together with the Consolidated Financial Statements and the related Notes thereto and other financial information appearing elsewhere in this Form 10-K. All references herein to the term "fiscal year" shall mean a year ended March 31 of the year specified. The Company commenced operations in 1980 as a provider of telecommunications network transmission products that enable advanced telecommunications services over copper telephone wires. The Company currently has two reportable segments: Westell and Customer Networking Solutions ("CNS"). Until fiscal 1994, the Company derived substantially all of its revenues from its Westell segment products, particularly the sale of Network Interface Unit ("NIU") products and related products. The Company introduced its first CNS products in fiscal 1993. The Company also provided audio teleconferencing services from fiscal 1989 until Conference Plus, Inc was sold on December 31, 2011. The Company realizes the majority of its revenues from the North American market. On April 1, 2013, the Company acquired Kentrox, Inc. ("Kentrox") for $30.0 million, subject to an adjustment for working capital. Kentrox is a worldwide leader in intelligent site management solutions. The Company expects to report Kentrox as a separate segment during fiscal year 2014. The acquisition qualifies as a business combination and will be accounted for from the date of acquisition using the acquisition method of accounting. On May 15, 2012, the Company acquired certain assets and liabilities of ANTONE Wireless Corporation ("ANTONE"), including rights to ANTONE products, for $2.5 million cash, subject to an adjustment for working capital, plus contingent cash consideration of up to an additional $3.5 million. The contingent consideration is based upon profitability of the acquired products for post-closing periods through June 30, 2016, and may be offset by working capital adjustments and indemnification claims. The acquisition included inventories, property and equipment, contract rights, customer relationships, technology, and certain specified operating liabilities that existed at the closing date. The Company hired nine of ANTONE's employees. ANTONE products include high-performance tower-mounted amplifiers, multi-carrier power amplifier boosters, and cell-site antenna sharing products. The acquisition qualifies as a business combination and has been accounted for using the acquisition method of accounting from the date of acquisition. On December 31, 2011, the Company sold its wholly owned subsidiary, Conference Plus, Inc. including Conference Plus Global Services, Ltd ("CGPS"), a wholly owned subsidiary of ConferencePlus (collectively, "ConferencePlus") to Arkadin for $40.3 million in cash (the "ConferencePlus sale"). Of the total purchase price, $4.1 million was placed in escrow at closing for one year as security for certain indemnity obligations of the Company. The Company subsequently agreed to extend the escrow period to June 10, 2013. During the three months ended December 31, 2012, the Company recorded a contingent liability of $1.5 million, pre-tax, relating to impending claims raised by Arkadin under the indemnity provisions of the purchase sales agreement. In the quarter ended March 31, 2013, $1.6 million of the escrow was released. The Company expects the cash held in escrow that is in excess of the obligation covered by the indemnity provisions to be released to the Company during fiscal year 2014. On April 15, 2011, the Company sold certain assets and transferred certain liabilities of the CNS segment to NETGEAR, Inc. for $36.7 million in cash (the "CNS asset sale"). As part of the CNS asset sale, most of the CNS segment's customer relationships, contracts and employees were transferred to NETGEAR. The Company retained a major CNS customer relationship and contract. The Company completed the remaining contracted product shipments under this contract in December 2011. During the first three quarters of fiscal year 2013, the Company continued to provide warranty services under its contractual obligations and to sell ancillary products and software on a project basis to the retained customer. The Company expects no CNS activity with that retained customer going forward. The Company also retained the Homecloud product development program. The Homecloud product family aims to provide a new suite of services into the home, with an initial focus on media and information management, sharing and delivery, and with prospective functionality applicable to enhanced security, home control, and network management. In the Westell segment, the Company designs, distributes, markets and services a broad range of carrier-class products. The Company's Westell product family consists of indoor and outdoor cabinets, enclosures and mountings; power distribution products; network interface devices ("NIDs") for TDM/SONET networks and service demarcation; span powering equipment; remote monitoring devices; copper/fiber connectivity panels; managed Ethernet switches for utility and industrial networks; Ethernet extension devices for providing native Ethernet service handoff in carrier applications; wireless signal conditioning and monitoring products for cellular networks; tower-mounted amplifiers; cell site antenna-sharing products for cell site -16--------------------------------------------------------------------------------- Table of Contents optimization; and custom systems integration ("CSI") services. Legacy products are sold primarily into wireline markets, but the Company also is actively moving to develop revenues from wireless telecommunications products. In the quarter ended September 30, 2012, the Company completed the relocation of the production of power distribution and remote monitoring products, which were manufactured at the Company's Noran Tel subsidiary located in Regina, Saskatchewan, Canada, to its location in Aurora, Illinois. The remaining operations in Regina, Canada, are focused on power distribution product development and on sales of Westell products in Canada. Effective as of April 1, 2013 with the acquisition of Kentrox, the Company designs, distributes, markets and services intelligent site management solutions, which provide comprehensive monitoring, management and control of a broad range of devices. The machine-to-machine (M2M) communications Kentrox provides enable service providers, tower operators, and other network operators to reduce operating costs while improving network performance. The Company provides a suite of Remote monitoring and control devices, which when combined with its Optima management system provide a comprehensive, bi-directional solution. The Kentrox solution addresses customer needs such as power management (generator management, battery, fuel, and rectifier monitoring, tenant power metering, etc.), environmental management (HVAC monitoring, energy monitoring and control, aircraft warning light management, and environmental monitoring), security management (access management, asset tampering, and surveillance), and communications management (microwave and distributed antenna systems management). Customers include major wireless and fixed-line telecommunications carriers, tower providers, cable and broadband network providers, utility companies, and enterprises. Kentrox provides solutions to customers in North and South America, Australia, Africa, and Europe. The prices for the Company's products vary based upon volume, customer specifications and other criteria, and they are subject to change for a variety of reasons, including cost and competitive factors. The Company's customer base for its products is highly concentrated and comprised primarily of major telecommunications service providers, independent domestic local exchange carriers and public telecom administrations located in the U.S. and Canada. Due to the stringent quality specifications of its customers and the regulated environment in which its customers operate, the Company must undergo lengthy approval and procurement processes prior to selling most of its products. Accordingly, the Company must make significant up-front investments in product and market development prior to actual commencement of sales of new products. To remain competitive, the Company must continue to invest in new product development and in targeted sales and marketing efforts to launch new product lines. Failure to increase revenues from new products, whether due to lack of market acceptance, competition, technological change meeting technical specifications or otherwise, could have a material adverse effect on the Company's business and results of operations. The Company expects to continue to evaluate new product opportunities and invest in product research and development activities. In view of the Company's reliance on the telecommunications market for revenues and the unpredictability of orders and pricing pressures, the Company believes that period-to-period comparisons of its financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. The Company has experienced quarterly fluctuations in customer ordering and purchasing activity that appear to result from seasonal factors, including reductions in order volume and product deliveries for outdoor equipment as colder months approach and occur, and including the effects of customer vacation, budgeting and procurement patterns toward the end of the calendar year which may cause reductions or increases in activity. This seasonality can result in weaker revenue primarily in the third quarter of the fiscal year. The seasonal effects do not apply consistently and may not always correlate to financial results. Accordingly, they should not be considered a reliable indicator of our future revenue or results of operations. Critical Accounting Policies The preparation of financial statements in accordance with GAAP requires management to make use of certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and that affect the reported amounts of revenue and expenses during the reported periods. The Company bases estimates on historical experience and on various other assumptions that management believes are reasonable under the circumstances. These estimates and assumptions form the basis for judgments about carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results could differ from the amounts reported. In Note 2 to the consolidated financial statements, the Company includes a discussion of its significant accounting policies. The Company believes the following are the most critical accounting policies and estimates used in the preparation of the financial statements. The Company considers an accounting policy or estimate to be critical if it requires assumptions to be made concerning uncertainties, and if changes in these assumptions could have a material impact on financial condition or results of operations. -17--------------------------------------------------------------------------------- Table of Contents Business Combinations The Company applies the guidance of ASC topic 805, Business Combinations. This guidance requires the acquiring entity in a business combination to recognize the fair value of assets acquired and liabilities assumed in transaction; establish the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of transaction and restructuring costs; and requires the acquirer to disclose the information needed to evaluate and understand the nature and financial effect of the business combination. Inventory Valuation The Company reviews inventory for excess quantities and obsolescence based on its best estimates of future demand, product lifecycle status and product development plans. The Company uses historical information along with these future estimates to reserve for obsolete and potentially obsolete inventory. The Company also evaluates inventory to adjust valuations to be the lower of cost or market value. Prices anticipated for future inventory demand are compared to current and committed inventory values. Inventory Purchase Commitments In the normal course of business, the Company enters into non-cancellable commitments for the purchase of inventory. The commitments are negotiated to be at market rates. Should there be a significant decline in revenues the Company may absorb excess inventory and subsequent losses as a result of these commitments. The Company establishes reserves for potential losses on at-risk commitments. Income Taxes The Company accounts for income taxes under the provisions of ASC topic 740, Income Taxes ("ASC 740"). ASC 740 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets, including net operating loss ("NOL") and certain tax credit carryovers and liabilities, are recorded based on the differences between the financial statement and tax bases of assets and liabilities, applying enacted statutory tax rates in effect for the year in which the tax differences are expected to reverse. Valuation allowances are provided against deferred tax assets which are assessed as not likely to be realized. On a quarterly basis, management evaluates the recoverability of deferred tax assets and the need for a valuation allowance. This evaluation requires the use of estimates and assumptions and considers all positive and negative evidence and factors, such as the scheduled reversal of temporary differences, the mix of earnings in the jurisdictions in which the Company operates, and prudent and feasible tax planning strategies. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the dates of enactment. The Company accounts for unrecognized tax benefits based upon its assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. The Company reports a liability for unrecognized tax benefits resulting from unrecognized tax benefits taken or expected to be taken in a tax return and recognizes interest and penalties, if any, related to its unrecognized tax benefits in income tax expense. See Note 3 for further discussion of the Company's income taxes. Goodwill and Other Intangibles Goodwill is not amortized, but it is tested for impairment at the reporting unit level by first performing a qualitative approach to test goodwill for impairment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the two-step, quantitative, goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. Goodwill and indefinite-lived intangible assets are reviewed for impairment at least annually or when an event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying value. The Company performs its annual impairment test in the fourth quarter of each fiscal year and begins with a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value. If the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, it is necessary to perform a two-step goodwill impairment test. The first step tests for impairment by applying fair value-based tests at the reporting unit level. Fair value of a reporting unit is determined by using both an income approach and a market approach, because this combination is considered to produce the most reasonable indication of fair value in an orderly transaction between market participants. Under the income approach, the Company determines fair value based on estimated future cash flows of a reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the level of risk inherent in a reporting unit and its associated estimates of future cash flows as well as the rate of return an experienced investor might expect to earn. Under the market approach, the Company utilizes valuation multiples derived from publicly -18--------------------------------------------------------------------------------- Table of Contents available information for comparable companies to provide an indication of how much a knowledgeable investor in the marketplace might be willing to pay for a company. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to individual assets and liabilities within each reporting unit. If the Company concludes that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value, a quantitative fair value assessment is performed and compared to the carrying value. If the fair value is less than the carrying value, impairment is recorded. Intangible assets with determinable lives are amortized on a straight-line basis over their respective estimated useful lives. If the Company were to determine that a change to the remaining estimated useful life of an intangible asset was necessary, then the remaining carrying amount of the intangible asset would be amortized prospectively over that revised remaining useful life. On an ongoing basis, the Company reviews intangible assets with a definite life and other long-lived assets other than goodwill for impairment whenever events and circumstances indicate that carrying values may not be recoverable. If such events or changes in circumstances occur, the Company will recognize an impairment loss if the undiscounted future cash flow expected to be generated by the asset is less than the carrying value of the related asset. Any impairment loss would adjust the asset to its implied fair value. Revenue Recognition The Company records revenue from sales transactions when title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed or determinable, and collectability is reasonably assured. Revenue recognition on equipment where software is incidental to the product as a whole, or where software is essential to the equipment's functionality and falls under software accounting scope exceptions, generally occurs when products are shipped, risk of loss has transferred to the customer, objective evidence exists that customer acceptance provisions have been met, no significant obligations remain, collection is reasonably assured and warranty can be estimated. Where multiple element arrangements exist, fair value of each element is established using the relative selling price method, which requires the Company to use vendor-specific objective evidence ("VSOE"), reliable third-party objective evidence ("TPE") or management's best estimate of selling price, in that order. Stock-based Compensation The Company recognizes stock-based compensation expense for all employee stock-based payments based upon the fair value on the award's grant date over the requisite service period. Determining the fair value of equity-based options requires the Company to estimate the expected volatility of its stock, the risk-free interest rate, expected option term, expected dividend yield and expected forfeitures. Product Warranties Most of the Company's products carry a limited warranty of up to seven years. The Company accrues for estimated warranty costs as products are shipped based on historical sales and cost of repair or replacement trends relative to sales. New Accounting Standards Adopted In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 provides entities with an option to first assess qualitative factors to determine whether events or circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is impaired. If an entity concludes that it is more than 50% likely that an indefinite-lived intangible asset is not impaired, no further analysis is required. However, if an entity concludes otherwise, it would be required to determine the fair value of the indefinite-lived intangible asset to measure the amount of actual impairment, if any, as currently required under the accounting principles generally accepted in the United States ("GAAP"). ASU 2012-02 is effective for fiscal years beginning after September 15, 2012. The adoption of this pronouncement did not materially impact the Company's financial condition or results of operations. -19--------------------------------------------------------------------------------- Table of Contents Results of Operations Fiscal Years Ended March 31, 2013, 2012 and 2011 Revenue Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 38,808 $ 43,629 $ 58,770 $ (4,821 ) $ (15,141 ) CNS 1,236 26,026 89,079 (24,790 ) (63,053 ) Consolidated revenue $ 40,044 $ 69,655 $ 147,849 $ (29,611 ) $ (78,194 ) In fiscal year 2013, consolidated revenue decreased 43% compared to fiscal year 2012. The 11% decrease in the Westell segment resulted primarily from lower demand for legacy products, as a result of a shift from T1 to Ethernet technology for the backhaul of cellular traffic and customer programs to constrain spending, manage inventory levels, and reuse of decommissioned products. The decrease in CNS revenue was due to the CNS asset sale, which closed on April 15, 2011, and the deliberate wind-down of CNS business transacted with the sole customer remaining thereafter. The Company expects no CNS activity with that retained customer going forward. In fiscal year 2012, consolidated revenue decreased 53% compared to the prior year. The 26% decrease in Westell segment revenue was due primarily to lower demand that the Company believes resulted from a combination of factors, including a technology shift from T1 to Ethernet for the backhaul of cellular traffic, customer inventory management and reuse programs, customer budget constraints, and effects of the Verizon strike which occurred in the quarter ended September 30, 2011. CNS segment revenue decreased 71% due primarily to the CNS asset sale. CNS segment revenue in fiscal year 2012 contained $1.0 million that was realized prior to the April 15, 2011, closing date and related to customers that transferred with the CNS asset sale. The remaining CNS revenue is from a single customer that did not transfer with the sale and represents revenue from modem, gateway, and ancillary products and from product screening, software projects and other services. Gross profit and margin Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 13,325 $ 17,272 $ 25,667 $ (3,947 ) $ (8,395 ) 34.3 % 39.6 % 43.7 % (5.3 )% (4.1 )% CNS 999 5,985 15,885 (4,986 ) (9,900 ) 80.8 % 23.0 % 17.8 % 57.8 % 5.2 % Consolidated gross profit $ 14,324 $ 23,257 $ 41,552 $ (8,933 ) $ (18,295 ) Consolidated gross margin 35.8 % 33.4 % 28.1 % 2.4 % 5.3 % In fiscal year 2013, consolidated margin increased 2.4% compared to fiscal year 2012. Westell segment gross margin decreased 5.3% year-over-year. The decrease was primarily because of higher excess and obsolete inventory charges and lower absorption of overhead costs due to lower revenue. Fiscal year 2013 included a $1.0 million charge for excess and obsolete inventory compared to a $0.6 million charge in fiscal year 2012. The inventory charges resulted primarily from the technology shift that decreased demand for T1-related products. CNS segment gross margin increased 57.8% compared to the prior year primarily due to high-margin project-based software revenue, which was the majority of the revenue in fiscal year 2013, compared to lower-margin product revenue, which was the majority of the revenue in fiscal year 2012. In fiscal year 2012, consolidated gross margin increased 5.3% compared to fiscal year 2011. Westell segment gross margin decreased 4.1% because of disproportionately reduced sales of higher margin products and lower absorption of overhead costs. CNS segment gross margin increased 5.2% due primarily to higher sales of higher margin ancillary, screening and software products compared to lower margin device sales. -20--------------------------------------------------------------------------------- Table of Contents Sales and marketing ("S&M") Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 7,492 $ 5,573 $ 5,922 $ 1,919 $ (349 ) CNS (53 ) 923 4,891 (976 ) (3,968 ) Consolidated S&M expense $ 7,439 $ 6,496 $ 10,813 $ 943 $ (4,317 ) Percentage of Revenue 19 % 9 % 7 % In fiscal year 2013, consolidated sales and marketing expense increased by 15% or $0.9 million compared to fiscal year 2012. Sales and marketing expense in the Westell segment increased 34% primarily due to higher compensation and related expenses which resulted from the addition of employees hired with the ANTONE acquisition, the addition of a Senior Vice President of Sales and Marketing and increased commission expense. Sales and marketing expense in the CNS segment decreased compared to the prior fiscal year due to the CNS asset sale. The reversal of expense in fiscal year 2013 resulted from adjustments in accrued warranty. In fiscal year 2012, consolidated sales and marketing expense decreased 40% or $4.3 million compared to the prior year. Sales and marketing expense in the Westell segment decreased 6% resulting primarily from lower bonus and commission expenses caused by decreased Westell segment revenue in fiscal year 2012 compared to fiscal year 2011. Sales and marketing expense in the CNS segment decreased 81% due to the CNS asset sale. CNS segment expenses in fiscal year 2012 are primarily for management, shipping and warranty costs for the one CNS remaining customer, plus limited marketing costs related to the Homecloud product. Research and development ("R&D") Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 5,725 $ 5,117 $ 3,825 $ 608 $ 1,292 CNS 1,601 2,610 7,949 (1,009 ) (5,339 ) Consolidated R&D expense $ 7,326 $ 7,727 $ 11,774 $ (401 ) $ (4,047 ) Percentage of Revenue 18 % 11 % 8 % In fiscal year 2013, consolidated research and development expenses declined 5% or $0.4 million. Research and development expenses in the Westell segment increased by 12% compared to the prior fiscal year. The increase was due primarily to the addition of development costs for ANTONE products and increased investment in DAS and Ethernet product development. Research and development expenses in the CNS segment decreased by $1.0 million compared to the prior fiscal year due to the CNS asset sale and the deliberate wind-down of business transacted with the sole customer remaining thereafter. The Company continued to invest in the development of the Homecloud product, which was launched as a limited release on September 26, 2012. The Company is actively marketing the Homecloud technology for sale and expects limited CNS expense in fiscal year 2014. In fiscal year 2012, consolidated research and development expenses declined 34% or $4.0 million. Research and development in the Westell segment increased 34% or $1.3 million. The increase was due primarily to increased investment in the development of Ethernet and wireless products. Research and development expenses in the CNS segment decreased 67% due to the CNS asset sale. The Company continued to invest in Homecloud product development, the costs of which are included in the CNS segment as R&D expense. General and administrative ("G&A") Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 4,401 $ 2,834 $ 2,023 $ 1,567 $ 811 CNS 600 976 3,365 (376 ) (2,389 ) Unallocated corporate costs 4,909 3,805 3,235 1,104 570 Consolidated G&A expense $ 9,910 $ 7,615 $ 8,623 $ 2,295 $ (1,008 ) Percentage of Revenue 25 % 11 % 6 % In fiscal year 2013, G&A changed among segments and unallocated corporate costs primarily because of changes in allocations of such costs. For fiscal year 2013, the CNS segment absorbed only direct costs and the Westell segment absorbed -21--------------------------------------------------------------------------------- Table of Contents substantially all allocated G&A costs. In fiscal year 2012, certain operating expenses were allocated between the Westell and CNS segments, including rent, information technology costs, and accounting costs. The Westell and CNS segment received 72% and 28% of these resource costs in fiscal year 2012, respectively. In fiscal year 2013, consolidated G&A expense increased 30% or $2.3 million. The CNS segment expense includes a $0.5 million expense related to a dispute with NETGEAR that was resolved in fiscal year 2013. The remaining increase in general and administrative expense, on a consolidated basis, resulted primarily from: increased personnel costs resulting from higher bonus and stock based compensation expense, the addition of a Vice President of Corporate Development; legal costs and acquisition costs relating to the Kentrox and ANTONE acquisitions; legal costs associated with the NETGEAR claim; and increased net expense for building rent resulting from a sublease that had reduced rent expense during fiscal year 2012, but not in fiscal year 2013. In fiscal year 2012, consolidated G&A expense decreased 12% or $1.0 million. The Westell segment G&A expense increased 40% and the CNS segment G&A expense decreased 71%. The Westell and CNS segments shared G&A resources in fiscal years 2012 and 2011. The Westell segment received 72% and 38% of these resource costs and the CNS segment was allocated 28% and 62% of the costs in fiscal years 2012 and 2011, respectively. The Company determined allocation percentages by estimating G&A resources spent supporting each segment. G&A costs in the combined Westell and CNS segments were down due primarily to lower bonus expense and a decreased allocation of building rent expense. Rent associated with resources supporting the assets sold to NETGEAR was not reallocated between the segments and is reflected in unallocated corporate costs. In addition, in fiscal year 2011, the CNS segment incurred $0.8 million of expense for the defense and settlement costs of a patent infringement claim. In fiscal year 2012, unallocated corporate G&A expense increased by 18%. The increase resulted primarily from increased stock-based compensation expense and increased building rent expense charged to the unallocated portion of G&A, as referenced above. Restructuring Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 149 $ 275 $ - $ (126 ) $ 275 CNS - 275 - (275 ) 275 Consolidated restructuring expense $ 149 $ 550 $ - $ (401 ) $ 550 In fiscal years 2013 and 2012, the Company's Westell business segment recorded a restructuring charge of $0.1 million and $0.3 million, respectively, related to the relocation of Noran Tel production from Canada to the Company's headquarters in Aurora, IL, primarily for employee termination benefits. Additionally, in fiscal year 2012, the CNS segment has a restructuring charge of $0.3 million for a reduction in force resulting from the CNS asset sale in April 2011. There were no restructuring expenses in fiscal year 2011. Intangible amortization Fiscal Year Ended March 31, Increase (Decrease) 2013 vs. 2012 vs. (in thousands) 2013 2012 2011 2012 2011 Westell $ 887 $ 544 $ 540 $ 343 $ 4 CNS 5 4 5 1 (1 ) Consolidated intangible amortization $ 892 $ 548 $ 545 $ 344 $ 3 The intangibles assets consist of product technology and customer relationships derived from acquisitions. The increase in intangible amortization in fiscal year 2013, compared to fiscal year 2012, resulted from the ANTONE acquisition. Goodwill impairment The Company recognized goodwill impairment of $2.9 million in fiscal year 2013. The goodwill impairment was the result of the Company's annual impairment testing which was significantly influenced by continuing operating losses and challenges in forecasting demand for the Company's products. The goodwill related to the Westell reporting unit and included $0.8 million relating to the 2007 acquisition of Noran Tel and $2.1 million relating to the fiscal 2013 acquisition of ANTONE. Gain on CNS asset sale During the fiscal year 2012, the Company recorded a pre-tax gain of $31.7 million on the CNS asset sale. -22--------------------------------------------------------------------------------- Table of Contents Other income (expense) Other income (expense), net was $0.2 million, $0.3 million, and $20,000 for fiscal years 2013, 2012, and 2011, respectively. Other income (expense), net contains interest income earned on short-term investments and foreign currency gains and losses. Income tax (expense) benefit Income tax in fiscal years 2013 and 2012 was expense of $29.4 million and $12.9 million, respectively, compared to an income tax benefit of $53.3 million in fiscal year 2011. In fiscal year 2013, the Company considered both the positive and negative evidence available to assess the realizability of its deferred tax assets. The Company considered negative factors which included recent losses and a forecasted three-year cumulative loss position, as well as positive evidence consisting primarily of projected future earnings. The Company concluded that the negative evidence outweighed the objectively verifiable positive evidence. As a result, the Company increased the valuation allowance against deferred income tax assets by $34.0 million, which taken together with the liability for uncertain tax positions, has the effect of reserving in full all of the Company's deferred tax assets as of March 31, 2013. In fiscal year 2012, the Company sold its ConferencePlus subsidiary and completed the CNS asset sale. These events resulted in a $64.5 million taxable gain in fiscal year 2012 and changed the outlook for future taxable income, positively with regards to the CNS business which contributed to the majority of the Company's historical losses and negatively in certain states where income generated by ConferencePlus was apportioned. In addition, certain states for which the Company has net operating loss carryforwards, such as Illinois, suspended the use of those carryforwards. The Company therefore was not able to utilize those carryforwards to offset fiscal year 2012 taxable income. The Company considered both the positive and negative evidence and established a forecast of future taxable income to evaluate the deferred tax assets for realizability. On this basis, the Company concluded that it was more likely than not that it would be able to utilize the majority of its deferred tax assets, but that certain state net operating loss carryforwards would expire prior to utilization. As a result, the Company increased the valuation allowance reserve by $1.7 million to $(2.3) million in fiscal year 2012. In addition, the Company recognized $(2.1) million of net tax benefits relating to the change in uncertain tax positions. In fiscal year 2011, after considering both the positive and negative evidence, including improved financial performance, expected future taxable income, the exit from a three-year cumulative loss, and the sale of the majority of its CNS business for a $31.7 million taxable gain, the Company concluded that it was more likely than not that it would be able to utilize the majority of its deferred tax assets. Prior to fiscal year 2011, a full valuation allowance on deferred tax assets was in place. As a result of the fiscal year 2011 assessment of realizability of deferred tax assets and current year income, the valuation allowance decreased by $60.8 million, which was recorded as an income tax benefit in fiscal year 2011. The Company also recognized an additional $0.7 million of tax benefits relating to changes in or expirations of uncertain tax positions. Discontinued operations On December 31, 2011, the Company sold its ConferencePlus subsidiary for a gain of $20.5 million after income taxes. The results of operations of ConferencePlus along with the gain on the sale have been classified as income from discontinued operations. In fiscal year 2013, net loss from discontinued operations was $0.5 million. The loss resulted from a charge taken for a potential indemnification claim that related to the ConferencePlus sale transaction, partially offset by associated tax effects and unrelated discrete tax items. Net income from discontinued operations was $22.6 million and $4.8 million in fiscal years 2012 and 2011, respectively. Net income (loss) In fiscal year 2013, the Company incurred a net loss of $44.0 million. Net income was $42.0 million and $67.9 million in fiscal years 2012 and 2011, respectively. The changes were due to the cumulative effects of the variances identified above. Quarterly Results of Operations The Company has experienced, and may continue to experience, fluctuations in quarterly results of operations. Such fluctuations in quarterly results may correspond to substantial fluctuations in the market price of the Class A Common Stock. Some factors which have had an influence on and may continue to influence the Company's results of operations in a particular quarter include, but are not limited to, the size and timing of customer orders and subsequent shipments, customer order deferrals in anticipation of new products, timing of product introductions or enhancements by the Company or its competitors, market acceptance of new products, technological changes in the telecommunications industry, competitive pricing pressures, accuracy of customer forecasts of end-user demand, write-offs for excess or obsolete inventory, changes in the Company's operating expenses, personnel changes, foreign currency fluctuations, changes in the mix of products sold, quality control of products sold, disruption in sources of supply, regulatory changes, capital spending, delays of payments by customers, working capital deficits and general economic conditions. Sales to the Company's customers typically involve long approval and procurement cycles and can involve large purchase commitments. Accordingly, cancellation or deferral of orders could cause significant fluctuations in the Company's quarterly results of operations. As a result, the Company believes that period-to-period comparisons of its results of operations are not -23--------------------------------------------------------------------------------- Table of Contents necessarily meaningful and caution should be used when placing reliance upon such comparisons as indications of future performance. For a detailed comparison of the eight quarters ended March 31, 2013, see Note 14, Quarterly Results of Operations (Unaudited), in the Notes to the consolidated financial statements. Liquidity and Capital Resources Overview At March 31, 2013, the Company had $88.2 million in cash and cash equivalents and $24.3 million in short-term investments, consisting of bank deposits, money market funds, certificates of deposit and pre-refunded municipal bonds. The Company does not have any significant debt nor does it have material capital expenditure requirements, balloon payments or other payments due on long term obligations. Off-balance sheet arrangements of the Company include the Enginuity note described in Note 9 of the Consolidated Financial Statements and standard operating leases. Total future obligations and commitments as of March 31, 2013, were $16.6 million. The Company believes that the existing sources of liquidity and cash from operations will satisfy cash flow requirements for the foreseeable future. The Company did not seek renewal on its $12.0 million asset-based revolving credit facility that expired on March 31, 2013, because the facility had never been used and it was determined that other sources of liquidity are expected to be sufficient to meet liquidity needs. On April 1, 2013, the Company used $30.0 million to acquire Kentrox, subject to an adjustment for working capital. On May 15, 2012, the Company acquired certain assets and liabilities of ANTONE for $2.5 million cash, subject to an adjustment for working capital, plus contingent cash consideration of up to an additional $3.5 million. The contingent consideration is based upon profitability of the acquired products for post-closing periods through June 30, 2016, and may be offset by working capital adjustments and indemnification claims. The contingent consideration is paid quarterly through June 30, 2016. Cash Flows The Consolidated Statements of Cash Flows include the ConferencePlus discontinued operations and therefore the explanations below include cash flows of ConferencePlus. The Company's operating activities used cash of $12.1 million and $5.0 million in fiscal years 2013 and 2012, respectively, and generated cash of $24.2 million in fiscal year 2011. Cash used in fiscal year 2013 resulted primarily from a $44.0 million net loss that includes $2.8 million of depreciation, amortization and stock-based compensation expense, a $29.9 million decrease in deferred tax assets and a $3.8 million decrease in working capital. Cash used in fiscal year 2012 resulted primarily from net income of $42.0 million that includes $3.3 million of depreciation, amortization and stock-based compensation expense, a $12.4 million decrease in deferred tax assets and an $11.4 million decrease in working capital. The changes in working capital in fiscal year 2012 resulted predominantly from the sale of the CNS business combined with the wind-down of that business. Cash generated in fiscal year 2011 resulted primarily from net income of $67.9 million that includes $3.7 million of depreciation, amortization and stock-based compensation expense, a $54.2 million increase in deferred tax assets and a $6.8 million increase in working capital. The Company's investing activities used $7.8 million and $1.3 million in fiscal years 2013 and 2011, respectively and generated $55.2 million in fiscal year 2012. In fiscal year 2013, the Company had net purchases of investments of $9.9 million, used $2.5 million for the ANTONE acquisition, and released $5.0 million of restricted stock. In fiscal year 2012, the Company generated $69.6 million from the CNS asset sale and the ConferencePlus business exclusive of cash held in escrow. In addition, the Company used $14.0 million in cash to purchase short-term investments and $0.8 million to make capital expenditures. Approximately half of the capital expenditures was in the Westell segment and half was in the discontinued ConferencePlus segment. In fiscal year 2011, the Company used $0.8 million on capital expenditures, primarily in its discontinued ConferencePlus segment, and $0.5 million in purchases of short-term investments. The Company's financing activities used cash of $12.6 million and $15.7 million in fiscal years 2013 and 2012, respectively, and provided cash of $2.0 million in fiscal year 2011. The Company purchased $12.7 million, $17.4 million, and $0.6 million of its outstanding stock, which is recorded as treasury stock, and received proceeds from the exercise of stock options of $0.1 million, $1.7 million, and $2.6 million in fiscal years 2013, 2012 and 2011, respectively. -24--------------------------------------------------------------------------------- Table of Contents Purchase obligations consist of inventory that arises in the normal course of business operations. Future obligations and commitments as of March 31, 2013 consisted of the following: Payments due by fiscal year (in thousands) 2014 2015 2016 2017 2018 Thereafter Total Purchase obligations $ 6,542 $ - $ - $ - $ - $ - $ 6,542 Future minimum lease payments for operating leases 2,608 2,111 2,131 2,152 1,076 - 10,078 Future obligations and commitments $ 9,150 $ 2,111 $ 2,131 $ 2,152 $ 1,076 $ - $ 16,620 As of March 31, 2013, the Company had deferred tax assets of approximately $38.7 million before a valuation allowance of $36.3 million, resulting in a net deferred tax asset of $2.4 million. Also, as of March 31, 2013, the Company had a $2.8 million tax contingency reserve related to uncertain tax positions. Federal net operating loss carryforwards begin to expire in fiscal year 2023. Realization of deferred tax assets associated with the Company's future deductible temporary differences, net operating loss carryforwards and tax credit carryforwards is dependent upon generating sufficient taxable income prior to their expiration, among other factors. The Company weighed positive and negative evidence to assess the need for a valuation allowance against deferred tax assets and whether a tax benefit should be recorded when taxable losses are incurred. The existence of a valuation allowance does not limit the availability of tax assets to reduce taxes payable when taxable income arises. Management periodically evaluates the recoverability of the deferred tax assets and may adjust the valuation allowance against deferred tax assets accordingly. Off-Balance Sheet Arrangements In fiscal year 2005, the Company sold its Data Station Termination product lines and specified fixed assets to Enginuity Communications Corporation ("Enginuity"). The Company provided an unconditional guarantee relating to a 10-year term note payable by Enginuity to a third-party lender that financed the transaction (the "Enginuity Note"). The Enginuity Note had an unpaid balance of $0.3 million as of March 31, 2013. Certain owners of Enginuity personally guaranteed the note and pledged assets as collateral. These personal guarantees will stay in place until the note is paid in full, as will the Company's. Under the Company's guarantee, the Company must pay all amounts due under the note payable upon demand from the lender; however, the Company would have recourse against the assets of Enginuity, the personal guarantees, and pledged assets. The Company evaluated ASC 810 and concluded that Enginuity is a VIE as a result of the debt guarantee. The Company is not considered the primary beneficiary of the VIE and consolidation therefore is not required. At the time of the product sale, the Company assessed its obligation under this guarantee pursuant to the provisions of ASC topic 460: Guarantees ("ASC 460"), and recorded a $0.3 million liability for the value of the guarantee. The Company evaluates the fair value of the liability based on Enginuity's operating performance and the current status of the guaranteed debt obligation and determined no liability is needed as of March 31, 2013. |