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CITRIX SYSTEMS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Overview Citrix is a leader in virtualization, networking and cloud infrastructure to enable new ways for people to work better. Citrix solutions help IT and service providers to build, manage and secure virtual and mobile workspaces that seamlessly deliver apps, desktops, data and services to virtually anyone, on any device, over any network or cloud. We market and license our products directly to customers, over the Web, and through systems integrators, or SIs, in addition to indirectly through value-added resellers, or VARs, value-added distributors, or VADs, original equipment manufacturers, or OEMs and service providers. Citrix is a Delaware corporation founded on April 17, 1989. Executive Summary We believe our approach is unique in the market because we have combined innovative technologies into solutions that enable and power mobile workstyles. Our technologies mobilize desktops, apps, data and people to help our customers drive business value. Our Mobile and Desktop products are leaders in the area of desktop and app management, including Desktop and Application Virtualization products, marketed as XenDesktop and XenApp and mobile device management, or MDM, and mobile application management, including XenMobile products. Our Networking and Cloud products also offer customers a value-added approach to building and delivering cloud services to end-users. Our Cloud Networking products allow our customers to deliver IT services to users with high performance, security and reliability, and our Cloud Platform products allow our customers to build scalable and reliable private and public cloud computing environments. We believe this combination of products allows us to deliver a comprehensive end-to-end mobile workstyles solution; and one that we believe, when considered as a whole, is competitively differentiated by its feature set and interoperability. Collaboration and Data products allow organizations to enable mobile workstyles and offer employees the ability to move seamlessly across a diverse mix of devices and collaborate and share information. In today's business environment there is a sharp focus on IT products and services that can reduce cost and deliver a quick, tangible return on investment, or ROI. We are focused on helping our customers, as they invest in IT products and services, to reduce IT costs, increase business flexibility and deliver ROI by offering a simpler more flexible approach to computing. In 2013, we generally saw unevenness in the global IT spending environment and encountered hesitancy on the part of customers in initiating large capital projects while transitioning their top priorities to mobile workstyles. In addition, during the second half of 2013, we introduced new product offerings in our Desktop and Application Virtualization business focused on reducing installation time and total cost of ownership. Although we expect a multi-year product cycle from this offering, we initially experienced longer than normal customer evaluations causing longer than anticipated sales cycles. We found this dynamic across all markets and all geographies contributing to the Product and licenses revenue results in our Desktop products when comparing the year ended December 31, 2013 to the year ended December 31, 2012. See our Summary of Results section below. We believe that continued economic uncertainty and the transition of computing and legacy platforms to mobile, cloud, big data and social solutions may adversely affect sales of our products and services and may result in longer sales cycles, slower adoption of technologies and increased price competition. We are focused on helping our customers embrace and power mobile workstyles and build cloud infrastructure so cloud services can be delivered virtually anywhere with a high quality user experience. We plan to sustain the long-term growth of our businesses around the world by expanding our go-to-market reach and direct customer touch; investing in product innovation and improving integration across our product portfolio to drive simplicity and end-user experience. Enterprise and Service Provider division Our Desktop and Application Virtualization products are built to transform and reduce the cost of traditional desktop management by virtualizing the desktop, with our XenDesktop product, and virtualizing applications, with our XenApp product, in a customer's datacenter. We are providing the capabilities for our customers to transform the delivery of desktops and related applications to an on-demand service rather than the delivery of a device. In January 2013, we completed our acquisition of Zenprise Inc., or Zenprise, a privately held leading innovator in MDM, which we market as XenMobile. We have integrated and expanded the XenMobile MDM technologies into a new solution, which is now offered as XenMobile Enterprise edition. This new offering offers our enterprise IT customers a comprehensive 31 -------------------------------------------------------------------------------- product that make it easier to manage and secure mobile devices, apps and data, while allowing users to embrace mobile workstyles and access enterprise apps from virtually any device. We believe our Mobility products offer a comprehensive approach that can transform organizations into mobile enterprises with the security and control IT requires, the ease of use and flexibility users desire, and the productivity business demands. Our Cloud Networking products power mobile workstyles while altering the traditional economics of the datacenter by providing greater levels of flexibility of computing resources, especially with respect to servers, improving application performance and thereby reducing the amount of processing power involved, and allowing easy reconfiguration of servers by permitting storage and network infrastructure to be added-in virtually rather than physically. Our ByteMobile Smart Capacity products combined with our Citrix NetScaler line of Cloud Networking products enhance our broader strategy of powering mobile workstyles and cloud services and allow us to offer mobile operators combined solutions that deliver a high quality user experience to mobile subscribers. Our Cloud Platform products allow our customers to build scalable and reliable private and public cloud computing environments where customers can quickly and easily build cloud services within their existing infrastructure and provision hosted applications, desktops, services and infrastructure as a service, or IaaS, from the cloud. As we enhance the feature set and interoperability of our Mobility and Cloud Networking products, we drive increased customer interest around desktop and application virtualization and data sharing, because enterprises find leverage in deploying these technologies together for an end-to-end mobile workstyles solution. SaaS division Our SaaS division is focused on developing and marketing Collaboration and Data products. These products are primarily marketed via the web to enterprises, medium and small businesses, prosumers and individuals. Our SaaS segment's Collaboration products offer secure and cost-effective solutions that allow users to host and actively participate in online meetings, webinars and training sessions remotely and reduce costs associated with business travel. Our Data Sharing product, ShareFile, makes it easy for businesses of all sizes to securely store, sync and share business documents and files, both inside and outside the company. ShareFile's centralized cloud storage capability also allows users to share files across multiple devices and access them from any location. In addition, through our Remote Access and IT Support solutions, we offer products that provide users a secure, simple and cost efficient way to access their desktops remotely and provide support over the Internet on-demand. Summary of Results For the year ended December 31, 2013 compared to the year ended December 31, 2012, we delivered the following financial performance: • Product and license revenue increased 7.3% to $891.6 million; • Software as a service revenue increased 14.0% to $582.9 million; • License updates and maintenance revenue increased 16.0% to $1,305.1 million; • Professional services revenue increased 16.6% to $138.9 million; • Gross margin as a percentage of revenue decreased 1.6% to 82.8%; • Operating income decreased 2.6% to $380.7 million; and • Diluted earnings per share decreased 3.2% to $1.80. The increase in our Product and licenses revenue was primarily driven by sales of our Networking and Cloud products, led by NetScaler, partially offset by a decrease in sales of our desktop and application virtualization products. Our Software as a service revenue increased due to increased sales of our Collaboration products, led by GoToMeeting and our Data Sharing product, ShareFile. The increase in License updates and maintenance revenue was primarily due to an increase in maintenance revenues, primarily driven by increased sales of maintenance and support across all of our Enterprise and Service Provider division's products and increased renewals of our Subscription Advantage product. The increase in Professional services revenue was primarily due to increases in consulting revenues related to increased implementation sales of our Enterprise and Service Provider division's products. We currently target total revenue to increase when comparing the first quarter of 2014 to the first quarter of 2013. In addition, when comparing the 2014 fiscal year to the 2013 fiscal year we target total revenue to increase. The decrease in 2013 in gross margin as a percentage of net revenue is primarily due to the increase in sales of our Networking and Cloud products with a hardware component and increased sales of our services, both of which have a higher cost than our software products. We currently target gross margin as a percentage of net revenue to decline slightly when comparing the first quarter of 2014 to the first quarter of 2013, consistent with our targeted increase in sales of our hardware products and services. The decrease in Operating income and diluted net income per share when comparing 2013 to 2012 was primarily due to an increase in stock-based compensation costs primarily related to our retention-focused annual stock grant to 32 -------------------------------------------------------------------------------- key employees and our recent acquisitions and an increase in amortization of intangible assets primarily related to our recent acquisitions. Also contributing to the decrease in Operating income and diluted net income per share is the decrease in gross margin as a percentage of net revenue, as discussed above. 2013 Acquisitions Zenprise In January 2013, we acquired all of the issued and outstanding securities of Zenprise, a privately-held leader in mobile device management. Zenprise became part of our Enterprise and Service Provider division, in which Citrix has integrated the Zenprise offering for mobile device management into its XenMobile Enterprise edition. The total consideration for this transaction was approximately $324.0 million, net of $2.9 million of cash acquired, and was paid in cash. Transaction costs associated with the acquisition were approximately $0.6 million, of which we expensed approximately $0.1 million during the year ended December 31, 2013 and are included in General and administrative expense in the accompanying consolidated statements of income. In addition, in connection with the acquisition, we assumed certain stock options, which are exercisable for 285,817 shares of our common stock, for which the vesting period reset fully upon the closing of the transaction. 2013 Other Acquisitions During the third quarter of 2013, we acquired all of the issued and outstanding securities of a privately-held company. The total cash consideration for this transaction was approximately $5.3 million. We will pay contingent consideration of up to $3.0 million in cash upon the satisfaction of certain milestone achievements, as defined pursuant to the share purchase agreement. This business became part of our SaaS division. Transaction costs associated with the acquisition were approximately $0.2 million, all of which we expensed during the year ended December 31, 2013, and are included in General and administrative expense in the accompanying consolidated statements of income. During the fourth quarter of 2013, we acquired all of the issued and outstanding securities of a privately-held company. The total cash consideration for this transaction was approximately $5.5 million. This business became part of our Enterprise and Service Provider division. Transaction costs associated with the acquisition were approximately $0.2 million, all of which we expensed during the year ended December 31, 2013, and are included in General and administrative expense in the accompanying consolidated statements of income. We have included the effects of all of the companies acquired in 2013 in our results of operations prospectively from the date of each acquisition. 2012 Acquisitions ByteMobile In July 2012, we acquired all of the issued and outstanding securities of ByteMobile, a privately-held provider of data and video optimization solutions for mobile network operators. ByteMobile became part of our Enterprise and Service Provider division and extends our industry reach into the mobile and cloud markets. The total consideration for this transaction was approximately $399.5 million, net of $5.6 million of cash acquired, and was paid in cash. Transaction costs associated with the acquisition were approximately $2.1 million, all of which we expensed during the year ended December 31, 2012 and are included in General and administrative expense in the accompanying consolidated statements of income. Podio In April 2012, we acquired all of the issued and outstanding securities of Podio, a privately-held provider of a cloud-based collaborative work platform. Podio became part of our SaaS division and expands our offerings of integrated cloud-based support for team-based collaboration. The total consideration for this transaction was approximately $43.6 million, net of $1.7 million of cash acquired, and was paid in cash. Transaction costs associated with the acquisition were approximately $0.5 million, all of which we expensed during the year ended December 31, 2012 and are included in General and administrative expense in our accompanying consolidated statements of income. In addition, in connection with the acquisition, we assumed non-vested stock units which were converted into the right to receive up to 127,668 shares of our common stock, for which the vesting period reset fully upon the closing of the transaction. 2012 Other Acquisitions During the first quarter of 2012, we acquired all of the issued and outstanding securities of a privately-held company for total cash consideration of approximately $24.6 million, net of $0.6 million of cash acquired. This business became part of our Enterprise and Service Provider division. Transaction costs associated with the acquisition were approximately $0.5 million, of which we expensed $0.4 million during the year ended December 31, 2012 and are included in General and administrative expense in the accompanying consolidated statements of income. In addition, in connection with this acquisition, we assumed non-vested stock units which were converted into the right to receive up to 13,481 shares of our common stock and assumed 33 -------------------------------------------------------------------------------- certain stock options which are exercisable for 12,017 shares of our common stock, for which the vesting period reset fully upon the closing of the transaction. During the second quarter of 2012, we acquired all of the issued and outstanding securities of two privately-held companies for a total cash consideration of approximately $15.4 million, net of $0.2 million of cash acquired. The businesses became part of our Enterprise and Service Provider division. Transaction costs associated with the acquisitions were approximately $0.4 million, all of which we expensed during the year ended December 31, 2012 and are included in General and administrative expense in the accompanying consolidated statements of income. In addition, in connection with the acquisitions, we assumed non-vested stock units which were converted into the right to receive, in the aggregate, up to 66,459 shares of our common stock, for which the vesting period reset fully upon the closing of each respective transaction. During the third quarter of 2012, we acquired all of the issued and outstanding securities of two privately-held companies for a total cash consideration of approximately $5.3 million. One of the businesses became part of our Enterprise and Service Provider division and the other became part of our SaaS division. Transaction costs associated with the acquisitions were approximately $0.2 million, all of which we expensed during the year ended December 31, 2012 and are included in General and administrative expense in the accompanying consolidated statements of income. In addition, in connection with the acquisitions, we assumed non-vested stock units which were converted into the right to receive, in the aggregate, up to 13,487 shares of our common stock, for which the vesting period reset fully upon the closing of each respective transaction. Subsequent Events On January 8, 2014, we acquired all of the issued and outstanding securities of Framehawk. The Framehawk solution, which optimizes the delivery of virtual desktops and applications to mobile devices, will be combined with Citrix HDX technologies in the Citrix XenApp and XenDesktop products to deliver an unparalleled user experience over highly latent and erratic mobile network conditions. The total preliminary consideration for this transaction was approximately $27.9 million, net of $0.3 million of cash acquired, and was paid in cash. Transaction costs associated with the acquisition are currently estimated at $0.1 million, all of which we expensed during the year ended December 31, 2013 and are included in General and administrative expense in the accompanying consolidated statements of income. Critical Accounting Policies and Estimates Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. We base these estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, and these estimates form the basis for our judgments concerning the carrying values of assets and liabilities that are not readily apparent from other sources. We periodically evaluate these estimates and judgments based on available information and experience. Actual results could differ from our estimates under different assumptions and conditions. If actual results significantly differ from our estimates, our financial condition and results of operations could be materially impacted. We believe that the accounting policies described below are critical to understanding our business, results of operations and financial condition because they involve more significant judgments and estimates used in the preparation of our consolidated financial statements. 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, and if different estimates that could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements. We have discussed the development, selection and application of our critical accounting policies with the Audit Committee of our Board of Directors and our independent auditors, and our Audit Committee has reviewed our disclosure relating to our critical accounting policies and estimates in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." Note 2 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 describes the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. 34 -------------------------------------------------------------------------------- Revenue Recognition We recognize revenue when it is earned and when all of the following criteria are met: persuasive evidence of the arrangement exists; delivery has occurred or the service has been provided and we have no remaining obligations; the fee is fixed or determinable; and collectability is probable. We define these four criteria as follows: • Persuasive evidence of the arrangement exists. We primarily sell our software products via electronic or paper licenses and typically require a purchase order from the distributor, reseller or end-user (depending on the arrangement) who have previously negotiated a master distribution or resale agreement and an executed product license agreement from the end-user. For appliance sales, our customary practice is to require a purchase order from distributors and resellers who have previously negotiated a master packaged product distribution or resale agreement. We typically recognize revenue upon shipment for our appliance sales. For maintenance, technical support, product training and consulting services, we require a purchase order and an executed agreement. For SaaS, we generally require the customer or the reseller to electronically accept the terms of an online services agreement or execute a contract. • Delivery has occurred and we have no remaining obligations. We consider delivery of licenses under electronic licensing agreements to have occurred when the related products are shipped and the end-user has been electronically provided the software activation keys that allow the end-user to take immediate possession of the product. For hardware appliance sales, our standard delivery method is free-on-board shipping point. Consequently, we consider delivery of appliances to have occurred when the products are shipped pursuant to an agreement and purchase order. For SaaS, delivery occurs upon providing the users with their login id and password. For product training and consulting services, we fulfill our obligation when the services are performed. For license updates and maintenance, we assume that our obligation is satisfied ratably over the respective terms of the agreements, which are typically 12 to 24 months. For SaaS, we assume that our obligation is satisfied ratably over the respective terms of the agreements, which are typically 12 months. • The fee is fixed or determinable. In the normal course of business, we do not provide customers with the right to a refund of any portion of their license fees or extended payment terms. The fees are considered fixed or determinable upon establishment of an arrangement that contains the final terms of the sale including description, quantity and price of each product or service purchased. For SaaS, the fee is considered fixed or determinable if it is not subject to refund or adjustment. • Collectability is probable. We determine collectability on a customer-by-customer basis and generally do not require collateral. We typically sell product licenses and license updates to distributors or resellers for whom there are histories of successful collection. New customers are typically subject to a credit review process that evaluates their financial position and ultimately their ability to pay. Customers are also subject to an ongoing credit review process. If we determine from the outset of an arrangement that collectability is not probable, revenue recognition is deferred until customer payment is received and the other parameters of revenue recognition described above have been achieved. Management's judgment is required in assessing the probability of collection, which is generally based on an evaluation of customer specific information, historical experience and economic market conditions. The majority of our product and license revenue consists of revenue from the sale of stand-alone software products. Stand-alone software sales generally include a perpetual license to our software and are subject to the industry specific software revenue recognition guidance. In accordance with this guidance, we allocate revenue to license updates related to our stand-alone software and any other undelivered elements of the arrangement based on VSOE of fair value of each element and such amounts are deferred until the applicable delivery criteria and other revenue recognition criteria described above have been met. The balance of the revenues, net of any discounts inherent in the arrangement, is recognized at the outset of the arrangement using the residual method as the product licenses are delivered. If management cannot objectively determine the fair value of each undelivered element based on VSOE of fair value, revenue recognition is deferred until all elements are delivered, all services have been performed, or until fair value can be objectively determined. We also make certain judgments to record estimated reductions to revenue for customer programs and incentive offerings including volume-based incentives, at the time sales are recorded. For hardware appliance and software transactions, the arrangement consideration is allocated to stand-alone software deliverables as a group and the non-software deliverables based on the relative selling prices of using the selling price hierarchy in the revenue recognition guidance. The selling price hierarchy for a deliverable is based on its VSOE if available, third-party evidence, or TPE, if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. We then recognize revenue on each deliverable in accordance with our policies for product and service revenue recognition. VSOE of selling price is based on the price charged when the element is sold separately. In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonable range based on historical discounting trends for specific products and services. TPE 35 -------------------------------------------------------------------------------- of selling price is established by evaluating competitor products or services in stand-alone sales to similarly situated customers. However, as our products contain a significant element of proprietary technology and our solutions offer substantially different features and functionality, the comparable pricing of products with similar functionality typically cannot be obtained. Additionally, as we are unable to reliably determine what competitors products' selling prices are on a stand-alone basis, we are not typically able to determine TPE. The estimate of selling price is established considering multiple factors including, but not limited to, pricing practices in different geographies and through different sales channels and competitor pricing strategies. For our non-software transactions we allocate the arrangement consideration based on the relative selling price of the deliverables. For our hardware appliances we use ESP as our selling price. For our support and services, we generally use VSOE as our selling price. When we are unable to establish selling price using VSOE for our support and services, we use ESP in our allocation of arrangement consideration. Our SaaS products are considered service arrangements per the authoritative guidance; accordingly, fees related to online service agreements are recognized ratably over the contract term. In addition, SaaS revenues may also include set-up fees, which are recognized ratably over the contract term or the expected customer life, whichever is longer. Generally, our SaaS is sold separately and not bundled with Enterprise and Service Provider division products and services. See Note 2 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for further information on our revenue recognition. Stock-Based Compensation Under the fair value recognition provisions of the authoritative guidance, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service or performance period, which is the vesting period. We currently use the Black-Scholes option pricing model to determine the fair value of stock options and a Monte Carlo simulation model to determine the fair of non-vested stock unit awards that vest based on market and service conditions. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, the expected term of the award, the risk-free interest rate and any expected dividends. For stock options, we determine the expected volatility factor, by utilizing the implied volatility in two-year market-traded options on our common stock based on third party volatility quotes in accordance with the provisions of Staff Accounting Bulletin, or SAB, No. 107. Our decision to use implied volatility was based upon the availability of actively traded options on our common stock and our assessment that implied volatility is more representative of future stock price trends than historical volatility. The expected term of our options is based on historical employee exercise patterns. In years when a significant number of stock options are granted, we analyze our historical pattern of option exercises based on certain demographic characteristics annually and have historically determined that there were no meaningful differences in option exercise activity based on demographic characteristics. The approximate risk free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with remaining terms equivalent to the expected term on our options. We do not intend to pay dividends on our common stock in the foreseeable future and, accordingly, we used a dividend yield of zero in the option pricing model. For non-vested stock unit awards that vest based on market and service conditions, the attainment level under each award will be based on our total return to stockholders over the performance period compared to the return on the Nasdaq Composite Total Return Index, or the XCMP. The range of expected volatilities utilized was based on the historical volatilities of our common stock and the XCMP. We utilize historical volatility to value these awards because historical stock prices were used to develop the correlation coefficients between our stock performance and the XCMP in order to model the stock price movements. The volatilities used were calculated over the most recent 2.75 year period, which was the remaining term of the performance period at the date of grant. The risk free interest rate was based on the implied yield available on U.S. Treasury zero-coupon issues with remaining terms equivalent to the remaining performance period. We do not intend to pay dividends on our common stock in the foreseeable future; accordingly, we used a dividend yield of zero in our model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards that vest based on service, including those with graded vesting schedules, are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. As of December 31, 2013, there was $267.6 million of total unrecognized compensation cost related to options and non-vested stock units. That cost is expected to be recognized over a weighted-average period of 2.14 years. 36 -------------------------------------------------------------------------------- If factors change and we employ different assumptions for estimating grant date fair value for our stock-based awards or in future periods if we decide to use a different valuation model, the stock-based compensation expense we recognize in future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and earnings per share. This may result in a lack of consistency in future periods and materially affect the fair value estimate of stock-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. These characteristics are not present in our option grants. Existing valuation models, including the Black-Scholes models and Monte Carlo simulations, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire with little or no intrinsic value compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, the value realized from these instruments may be significantly higher than the fair values originally estimated on the grant date and reported in our financial statements. There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. See Notes 2 and 7 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for further information regarding our adoption of the authoritative guidance for stock-based compensation. Valuation and Classification of Investments The authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). Our available-for-sale investments are measured to fair value on a recurring basis. In addition, we hold investments that are accounted for based on the cost method. These investments are periodically reviewed for impairment and when indicators of impairment exist, are measured to fair value as appropriate on a non-recurring basis. In determining the fair value of our investments we are sometimes required to use various alternative valuation techniques. The authoritative guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1, observable inputs such as quoted prices in active markets for identical assets or liabilities, Level 2, inputs, other than quoted prices in active markets, that are observable either directly or indirectly, and Level 3, unobservable inputs in which there is little or no market data, which requires us to develop our own assumptions. Observable inputs are those that market participants would use in pricing the asset or liability that are based on market data obtained from independent sources, such as market quoted prices. When Level 1 observable inputs for our investments are not available to determine their fair value, we must then use other inputs which may include indicative pricing for securities from the same issuer with similar terms, yield curve information, benchmark data, prepayment speeds and credit quality or unobservable inputs that reflect our estimates of the assumptions market participants would use in pricing the investments based on the best information available in the circumstances. When valuation techniques, other than those described as Level 1 are utilized, management must make estimations and judgments in determining the fair value for its investments. The degree to which management's estimation and judgment is required is generally dependent upon the market pricing available for the investments, the availability of observable inputs, the frequency of trading in the investments and the investment's complexity. If we make different judgments regarding unobservable inputs we could potentially reach different conclusions regarding the fair value of our investments. After we have determined the fair value of our investments, for those that are in an unrealized loss position, we must then determine if the investment is other-than-temporarily impaired. We review our investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment and if different judgments are used the classification of the losses related to our investments could differ. In making this judgment, we employ a systematic methodology that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the carrying value of an available-for-sale investment exceeds its fair value, we evaluate, among other factors, general market conditions, the duration and extent to which the fair value is less than carrying value our intent to retain or sell the investment and whether it is more likely than not that we will not be required to sell the investment before the recovery of its amortized cost basis, which may not be until maturity. We also consider specific adverse conditions related to the financial health of and business outlook for the issuer, including industry and sector performance, rating agency actions and changes in credit default swap levels. For our cost method investments, our quarterly review of impairment indicators encompasses the analysis of specific criteria of the entity, such as cash position, financing needs, operational performance, management changes, competition and turnaround potential. If any of the above impairment indicators are present, we further evaluate whether an other-than-temporary impairment should be recorded. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in the investment is established. See Notes 4 and 5 to our consolidated 37 -------------------------------------------------------------------------------- financial statements and "Liquidity and Capital Resources" for more information on our investments and fair value measurements. Intangible Assets We have acquired product related technology assets and other intangible assets from acquisitions and other third party agreements. We allocate the purchase price of acquired intangible assets acquired through third party agreements based on their estimated relative fair values. We allocate a portion of purchase price of acquired companies to the product related technology assets and other intangible assets acquired based on their estimated fair values. We typically engage third party appraisal firms to assist us in determining the fair values and useful lives of product related technology assets and other intangible assets acquired. Such valuations and useful life determinations require us to make significant estimates and assumptions. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Critical estimates in determining the fair value and useful lives of the product related technology assets include but are not limited to future expected cash flows earned from the product related technology and discount rates applied in determining the present value of those cash flows. Critical estimates in valuing certain other intangible assets include but are not limited to future expected cash flows from customer contracts, customer lists, distribution agreements, patents, brand awareness and market position, as well as discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. We monitor acquired intangible assets for impairment on a periodic basis by reviewing for indicators of impairment. If an indicator exists we compare the estimated net realizable value to the unamortized cost of the intangible asset. The recoverability of the intangible assets is primarily dependent upon our ability to commercialize products utilizing the acquired technologies, retain existing customers and customer contracts, and maintain brand awareness. The estimated net realizable value of the acquired intangible assets is based on the estimated undiscounted future cash flows derived from such intangible assets. Our assumptions about future revenues and expenses require significant judgment associated with the forecast of the performance of our products, customer retention rates and ability to secure and maintain our market position. Actual revenues and costs could vary significantly from these forecasted amounts. As of December 31, 2013, the estimated undiscounted future cash flows expected from product related technology assets and other intangible assets from these acquisitions is sufficient to recover their carrying value. If these products are not ultimately accepted by our customers and distributors, and there is no alternative future use for the technology; or if we fail to retain acquired customers or successfully market acquired brands, we could determine that some or all of the remaining $509.6 million carrying value of our acquired intangible assets is impaired. In the event of impairment, we would record an impairment charge to earnings that could have a material adverse effect on our results of operations. Goodwill The excess of the fair value of purchase price over the fair values of the identifiable assets and liabilities from our acquisitions is recorded as goodwill. At December 31, 2013, we had $1,768.9 million in goodwill related to our acquisitions. The goodwill recorded in relation to these acquisitions is not deductible for tax purposes. Our revenues are derived from sales of our Enterprise and Service Provider division products, which include our Mobile and Desktop products, Networking and Cloud products and related license updates and maintenance and from sales of our SaaS division's Collaboration and Data products. The Enterprise and Service Provider division and the SaaS division constitute our two reportable segments. See Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for additional information regarding our reportable segments. We evaluate goodwill between these segments, which represent our reporting units. We account for goodwill in accordance with FASB's authoritative guidance, which requires that goodwill and certain intangible assets are not amortized, but are subject to an annual impairment test. We complete our goodwill and certain intangible assets impairment test on an annual basis, during the fourth quarter of our fiscal year, or more frequently, if changes in facts and circumstances indicate that an impairment in the value of goodwill and certain intangible assets recorded on our balance sheet may exist. In the fourth quarter of 2013, we performed a qualitative assessment to determine whether further quantitative impairment testing for goodwill and certain intangible assets is necessary, which we refer to this assessment as the Qualitative Screen. In performing the Qualitative Screen, we are required to make assumptions and judgments including but not limited to the following: the evaluation of macroeconomic conditions as related to our business, industry and market trends, and the overall future financial performance of our reporting units and future opportunities in the markets in which they operate. If after performing the Qualitative Screen impairment indicators are present, we would perform a quantitative impairment test to estimate the fair value of goodwill and certain intangible assets. In doing so, we would estimate future revenue, consider 38 -------------------------------------------------------------------------------- market factors and estimate our future cash flows. Based on these key assumptions, judgments and estimates, we determine whether we need to record an impairment charge to reduce the value of the goodwill and certain intangible assets carried on our balance sheet to its estimated fair value. Assumptions, judgments and estimates about future values are complex and often subjective and can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy or our internal forecasts. Although we believe the assumptions, judgments and estimates we have made have been reasonable and appropriate, different assumptions, judgments and estimates could materially affect our results of operations. As a result of the Qualitative Screen, no further quantitative impairment test was deemed necessary. There was no impairment of goodwill as a result of the annual impairment tests completed during the fourth quarters of 2013 and 2012. Income Taxes We are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. At December 31, 2013, we had approximately $150.4 million in net deferred tax assets. The authoritative guidance requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We review deferred tax assets periodically for recoverability and make estimates and judgments regarding the expected geographic sources of taxable income and gains from investments, as well as tax planning strategies in assessing the need for a valuation allowance. At December 31, 2013, we determined that a $26.5 million valuation allowance relating to deferred tax assets for net operating losses and tax credits was necessary. If the estimates and assumptions used in our determination change in the future, we could be required to revise our estimates of the valuation allowances against our deferred tax assets and adjust our provisions for additional income taxes. In the ordinary course of global business, there are transactions for which the ultimate tax outcome is uncertain, thus judgment is required in determining the worldwide provision for income taxes. We provide for income taxes on transactions based on our estimate of the probable liability. We adjust our provision as appropriate for changes that impact our underlying judgments. Changes that impact provision estimates include such items as jurisdictional interpretations on tax filing positions based on the results of tax audits and general tax authority rulings. Due to the evolving nature of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability and the realizability of our deferred tax assets could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows. The following discussion relating to the individual financial statement captions, our overall financial performance, operations and financial position should be read in conjunction with the factors and events described in "- Overview" and Part 1 - Item 1A entitled "Risk Factors," included in this Annual Report on Form 10-K for the year ended December 31, 2013, which could impact our future performance and financial position. 39 -------------------------------------------------------------------------------- Results of Operations The following table sets forth our consolidated statements of income data and presentation of that data as a percentage of change from year-to-year (in thousands other than percentages): Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 Revenues: Product and licenses $ 891,630 $ 830,645 $ 744,513 7.3 % 11.6 % Software as a service 582,872 511,323 430,213 14.0 18.9License updates and maintenance 1,305,053 1,125,094 940,181 16.0 19.7 Professional services 138,879 119,061 91,485 16.6 30.1 Total net revenues 2,918,434 2,586,123 2,206,392 12.8 17.2 Cost of net revenues: Cost of product and license revenues 114,932 96,962 74,393 18.5 30.3 Cost of services and maintenance revenues 289,990 227,150 164,465 27.7 38.1 Amortization of product related intangible assets 97,873 80,025 54,741 22.3 46.2 Total cost of net revenues 502,795 404,137 293,599 24.4 37.6 Gross margin 2,415,639 2,181,986 1,912,793 10.7 14.1 Operating expenses: Research and development 516,338 450,571 380,674 14.6 18.4 Sales, marketing and services 1,216,680 1,060,829 885,066 14.7 19.9 General and administrative 260,236 245,259 213,673 6.1 14.8 Amortization of other intangible assets 41,668 34,549 16,390 20.6 110.8 Restructuring - - 24 * * Total operating expenses 2,034,922 1,791,208 1,495,827 13.6 19.7 Income from operations 380,717 390,778 416,966 (2.6 ) (6.3 ) Interest income 8,194 10,152 13,819 (19.3 ) (26.5 ) Other (expense) income, net (1,021 ) 9,299 (288 ) * * Income before income taxes 387,890 410,229 430,497 (5.4 ) (4.7 ) Income taxes 48,367 57,682 74,867 (16.1 ) (23.0 ) Consolidated net income 339,523 352,547 355,630 (3.7 ) (0.9 ) Less: Net loss attributable to non-controlling interest - - 692 * * Net income attributable to Citrix Systems, Inc. $ 339,523 $ 352,547 $ 356,322 (3.7 )% (1.1 )% * not meaningful Revenues by Segment Net revenues of our Enterprise and Service Provider division include Product and licenses, License updates and maintenance, and Professional services. Product and licenses primarily represent fees related to the licensing of the following major products: • Mobile and Desktop is primarily comprised of our desktop and application virtualization products, which include XenDesktop and XenApp and our mobility products which include XenMobile products; and • Networking and Cloud is primarily comprised of our cloud networking products, which include NetScaler, Cloud Bridge and ByteMobile Smart Capacity, and our cloud platform products, which include XenServer, CloudPlatform and CloudPortal. In addition, we offer incentive programs to our VADs and VARs to stimulate demand for our products. Product and license revenues associated with these programs are partially offset by these incentives to our VADs and VARs. 40 --------------------------------------------------------------------------------License updates and maintenance consists of: • Our Subscription Advantage program, an annual renewable program that provides subscribers with automatic delivery of unspecified software upgrades, enhancements and maintenance releases when and if they become available during the term of the subscription, for which fees are recognized ratably over the term of the contract, which is typically 12 to 24 months; and • Our maintenance fees, which include technical support and hardware and software maintenance, and which are recognized ratably over the contract term. Professional services revenues are comprised of: • Fees from consulting services related to implementation of our products, which are recognized as the services are provided; and • Fees from product training and certification, which are recognized as the services are provided. Our SaaS revenues, which are recognized ratably over the contractual term, consist of fees related to our SaaS products including: • Collaboration products, which primarily include GoToMeeting, GoToWebinar and GoToTraining; • Data Sharing product, which primarily includes ShareFile; • Remote Access product, GoToMyPC; and • Remote IT Support products, which primarily include GoToAssist. Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands) Revenues: Product and licenses $ 891,630 $ 830,645 $ 744,513 $ 60,985 $ 86,132 Software as a Service 582,872 511,323 430,213 71,549 81,110 License updates and maintenance 1,305,053 1,125,094 940,181 179,959 184,913 Professional Services 138,879 119,061 91,485 19,818 27,576 Total net revenues $ 2,918,434 $ 2,586,123 $ 2,206,392 $ 332,311 $ 379,731 Product and licenses Product and licenses revenue increased during 2013 when compared to 2012 primarily due to increased sales of our cloud networking products of $92.0 million, led by NetScaler, and increased sales of our mobility products of $26.2 million, partially offset by a decrease in sales of our desktop and application virtualization products of $60.0 million. Product and licenses revenue increased during 2012 when compared to 2011 primarily due to increased sales of our cloud networking products of $60.0 million, led by NetScaler, and increased sales of our desktop and application virtualization products, led by XenDesktop of $27.1 million. We currently target Product and licenses revenue to increase when comparing the first quarter of 2014 to the first quarter of 2013. Software as a Service Software as a Service revenue increased during 2013 when compared to 2012 primarily due to increased sales of our Collaboration products of $45.4 million and due to increased sales of our Data Sharing products of $15.9 million. Software as a Service revenue increased during 2012 compared to 2011 primarily due to increased sales of our Collaboration products of $61.0 million and increased sales of our Data Sharing products of $19.3 million. We currently target our Software as a Service revenue to increase when comparing the first quarter of 2014 to the first quarter of 2013 and when comparing the first quarter of 2014 to the fourth quarter of 2013. License updates and maintenance License updates and maintenance revenue increased during 2013 when compared to 2012 primarily due to an increase in maintenance revenues of $100.3 million, primarily driven by increased sales of maintenance and support contracts across all of our Enterprise and Service Provider division's products and an increase in sales and renewals of our Subscription Advantage product of $79.7 million. License updates and maintenance revenue increased during 2012 when compared to 2011 primarily due to an increase in sales and renewals of our Subscription Advantage product of $114.6 million and an increase in 41 -------------------------------------------------------------------------------- maintenance revenues of $45.2 million, primarily driven by increased sales of our Networking and Cloud products, led by NetScaler. We currently are targeting that License updates and maintenance revenue will increase when comparing the first quarter of 2014 to the first quarter of 2013. Professional services Professional services revenue increased during 2013 when compared to 2012 and during 2012 when compared to 2011 primarily due to increases in consulting revenues related to increased implementation sales of our Enterprise and Service Provider division's products. We currently target Professional services revenue to increase when comparing the first quarter of 2014 to the first quarter of 2013 consistent with the increase in Product and license revenue described above. Deferred Revenue Deferred revenues are primarily comprised of License updates and maintenance revenue from our Subscription Advantage product as well as maintenance and support contracts for our software and hardware products. Deferred revenues also include revenue from annual service agreements for our SaaS products and Professional services revenue primarily related to our consulting contracts. Deferred revenues increased approximately $213.7 million as of December 31, 2013 compared to December 31, 2012 primarily due to increased new and renewal sales of our Subscription Advantage product of $106.2 million; increased sales of our hardware and software maintenance contracts of $44.4 million and increased support contracts primarily related to our Mobile and Desktop products of $34.8 million. We currently target deferred revenue to increase in 2014. While it is generally our practice to promptly ship our products upon receipt of properly finalized purchase orders, we sometimes have product license orders that have not shipped. Although the amount of such product license orders may vary, the amount, if any, of such product license orders at the end of a particular period has not been material to total revenue at the end of any reporting period. We do not believe that backlog, as of any particular date, is a reliable indicator of future performance. International Revenues International revenues (sales outside the United States) accounted for approximately 45.4% of our net revenues for the year ended December 31, 2013, 45.3% of our net revenues for the year ended December 31, 2012 and 43.2% of our net revenues for the year ended December 31, 2011. For detailed information on international revenues, please refer to Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013. Segment Revenues Our revenues are derived from sales of Enterprise and Service Provider division products which primarily include Mobility and Desktop products, Networking and Cloud products and related License updates and maintenance and Professional services and from our SaaS division's Collaboration and Data products. The Enterprise and Service Provider division and the SaaS division constitute our two reportable segments. An analysis of our reportable segment net revenue is presented below: Year Ended December 31, Revenue Growth Revenue Growth 2013 2012 2011 2013 to 2012 2012 to 2011 (In thousands) Enterprise and Service Provider division $ 2,335,562 $ 2,074,800 $ 1,778,646 12.6 % 16.7 % SaaS division 582,872 511,323 427,746 14.0 % 19.5 % Consolidated net revenues $ 2,918,434 $ 2,586,123 $ 2,206,392 12.8 % 17.2 % With respect to our segment revenues, the increase in net revenues for the comparative periods presented was due primarily to the factors previously discussed above. See Note 11 of our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for additional information on our segment revenues. 42 --------------------------------------------------------------------------------Cost of Net Revenues Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands) Cost of product and license revenues $ 114,932 $ 96,962 $ 74,393 $ 17,970 $ 22,569 Cost of services and maintenance revenues 289,990 227,150 164,465 62,840 62,685 Amortization of product related intangible assets 97,873 80,025 54,741 17,848 25,284 Total cost of net revenues $ 502,795 $ 404,137 $ 293,599 $ 98,658 $ 110,538 Cost of product and license revenues consists primarily of hardware, shipping expense, royalties, product media and duplication, manuals and packaging materials. Cost of services and maintenance revenues consists primarily of compensation and other personnel-related costs of providing technical support and consulting, as well as the costs related to providing our SaaS, which includes the cost to support the voice and video offerings in our Collaboration products. Also included in Cost of net revenues is amortization of product related intangible assets. Cost of product and license revenues increased during 2013 when compared to 2012 and during 2012 when compared to 2011 primarily due to increased sales of our Networking and Cloud products, as described above, many of which contain hardware components that have a higher cost than our other software products. We currently are targeting cost of product and license revenues will increase when comparing the first quarter of 2014 to the first quarter of 2013 consistent with the targeted increase in sales of our hardware products. Cost of services and maintenance revenues increased during 2013 compared to 2012 consistent with the increase in sales of our Collaboration products and cost for infrastructure to support the voice and video offerings in our Collaboration products of $30.5 million. Also contributing to the increase in Cost of services and maintenance revenues is an increase in consulting costs of $16.8 million and maintenance and support costs of $15.1 million related to increased sales of our Enterprise and Service Provider division's products as described above. Cost of services and maintenance revenues increased during 2012 compared to 2011 consistent with the increase in sales of our Collaboration products and continuing investment in infrastructure to support the voice and video offerings in our Collaboration products of $20.0 million. Also contributing to the increase in Cost of services and maintenance revenues is an increase in maintenance and support costs of $16.6 million and consulting costs of $15.7 million related to increased sales of our Enterprise and Service Provider division's products as described above. We currently are targeting cost of services and maintenance revenues will increase when comparing the first quarter of 2014 to the first quarter of 2013 consistent with the increase in Software as a Service and Professional services revenues as discussed above. Gross Margin Gross margin as a percent of revenue was 82.8% for 2013, 84.4% for 2012 and 86.7% for 2011. The decrease in gross margin as a percentage of net revenue is primarily due to the increase in sales of our Networking and Cloud products with a hardware component and increased sales of our services, both of which have a higher cost than our software products. When comparing the first quarter of 2014 to the first quarter of 2013, we expect a slight decline in gross margin, consistent with our targeted increase in sales of our hardware products and services. Operating Expenses Foreign Currency Impact on Operating Expenses The functional currency for all of our wholly-owned foreign subsidiaries in our Enterprise and Service Provider division is the U.S. dollar. A substantial majority of our overseas operating expenses and capital purchasing activities are transacted in local currencies and are therefore subject to fluctuations in foreign currency exchange rates. In order to minimize the impact on our operating results, we generally initiate our hedging of currency exchange risks up to 12 months in advance of anticipated foreign currency expenses. When the dollar is weak, the resulting increase to foreign currency denominated expenses will be partially offset by the gain in our hedging contracts. When the dollar is strong, the resulting decrease to foreign currency denominated expenses will be partially offset by the loss in our hedging contracts. There is a risk that there will be fluctuations in foreign currency exchange rates beyond the timeframe for which we hedge our risk. 43 --------------------------------------------------------------------------------Research and Development Expenses Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands) Research and development $ 516,338 $ 450,571 $ 380,674 $ 65,767 $ 69,897 Research and development expenses consisted primarily of personnel related costs and facility and equipment costs directly related to our research and development activities. We expensed substantially all development costs included in the research and development of our products. Research and development expenses increased during 2013 as compared to 2012 primarily due to an increase in compensation, including stock-based compensation and employee-related costs, primarily related to increased headcount from strategic hiring and acquisitions. Research and development expenses increased during 2012 as compared to 2011 due to a $35.8 million increase in compensation and other employee-related costs, primarily related to increased headcount due to strategic hiring and acquisitions, and an increase in stock-based compensation expense of $22.0 million, primarily related to retention-focused awards granted to new and existing employees and assumed in conjunction with our acquisitions. Also contributing to the increase in Research and development expenses when comparing 2012 to 2011 is a $13.5 million increase in facilities costs and related depreciation, consistent with the increase in headcount. Sales, Marketing and Services Expenses Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands)Sales, marketing and services $ 1,216,680 $ 1,060,829 $ 885,066 $ 155,851 $ 175,763 Sales, marketing and services expenses consisted primarily of personnel related costs, including sales commissions, pre-sales support, the costs of marketing programs aimed at increasing revenue, such as brand development, advertising, trade shows, public relations and other market development programs and costs related to our facilities, equipment and information systems that are directly related to our sales, marketing and services activities. Sales, marketing and services expenses increased during 2013 compared to 2012 primarily due to a $91.5 million increase in compensation, including variable and stock-based compensation and employee-related costs due to additional headcount in our sales force and professional services group, as well as from our acquisitions. Also contributing to the increase in Sales, marketing and services expense when comparing 2013 to 2012 is a $30.9 million increase in facilities costs and related depreciation, consistent with the increase in headcount and a $21.0 million increase in marketing program costs related to various marketing campaigns and events. Sales, marketing and services expenses increased during 2012 compared to 2011 primarily due to a $132.9 million increase in compensation, including variable and stock-based compensation and employee-related costs due to additional headcount in our sales force and professional services group, as well as from our acquisitions. Also contributing to the increase in Sales, marketing and services expense when comparing 2012 to 2011 is an $18.7 million increase in facilities costs and related depreciation, consistent with the increase in headcount. General and Administrative Expenses Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands) General and administrative $ 260,236 $ 245,259 $ 213,673 $ 14,977 $ 31,586 General and administrative expenses consisted primarily of personnel related costs and expenses related to outside consultants assisting with information systems, as well as accounting and legal fees. General and administrative expenses increased during 2013 compared to 2012 primarily due to an increase in compensation and employee related costs of $11.8 million due to additional headcount, primarily in information technology 44 -------------------------------------------------------------------------------- and facilities, as well as from our acquisitions. Also contributing to the increase in General and administrative expense when comparing 2013 to 2012 is an increase in stock-based compensation expense of $10.7 million related to retention-focused stock-based awards granted to new and existing employees and assumed in connection with acquisitions. These increases were partially offset by a decrease in certain facility and depreciation costs of $7.7 million due to a lower allocation of these costs as employees are being added at a slower rate in general and administrative functions compared to research and development and sales, marketing and services. General and administrative expenses increased during 2012 compared to 2011 primarily due to an increase in compensation and employee related costs of $20.2 million due to additional headcount, primarily in operations, as well as from our acquisitions. Also contributing to the increase in General and administrative expense when comparing 2012 to 2011 is an increase in stock-based compensation expense of $13.6 million related to retention-focused stock-based awards granted to new and existing employees and assumed in connection with acquisitions. 2014 Operating Expense Outlook When comparing the first quarter of 2014 to the fourth quarter of 2013, we are targeting operating expenses to increase in Research and development as we continue to bring to market new technologies and improve integration of existing technologies and in Sales, marketing and services as we continue to focus on hiring to expand our go-to-market capacity and customer direct touch, as well as increasing consulting and technical support capacity. Amortization of Other Intangible Assets Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands) Amortization of other intangible assets $ 41,668 $ 34,549 $ 16,390 $ 7,119 $ 18,159 Amortization of other intangible assets consists of amortization of customer relationships, trade names and covenants not to compete primarily related to our acquisitions. The increase in Amortization of other intangible assets when comparing 2013 to 2012 was primarily due to amortization of other intangible assets acquired in conjunction with our acquisitions, primarily Zenprise. The increase in Amortization of other intangible assets when comparing 2012 to 2011 was primarily due to amortization of other intangible assets acquired in conjunction with our acquisitions, primarily ByteMobile. Also contributing to the increase is a $5.2 million impairment related to our decision to contribute our CloudStack tradename acquired in conjunction with our acquisition of Cloud.com to the Apache Software Foundation in 2012. As of December 31, 2013, we had unamortized other identified intangible assets with estimable useful lives in the net amount of $260.5 million. For more information regarding our acquisitions see, "- Overview" and Note 3 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013. Other (expense) income, net Year Ended December 31, 2013 Compared 2012 Compared 2013 2012 2011 to 2012 to 2011 (In thousands)Other (expense) income, net $ (1,021 ) $ 9,299 $ (288 ) $ (10,320 ) $ 9,587 Other (expense) income, net is primarily comprised of remeasurement of foreign currency transaction gains (losses), realized losses related to changes in the fair value of our investments that have a decline in fair value considered other-than-temporary and recognized gains (losses) related to our investments and interest expense, which was not material for all periods presented. The change in Other (expense) income, net when comparing 2013 to 2012 is primarily driven by strategic investment activity. 2013 included a gain of $6.0 million and 2012 included a gain of $16.5 million from the sales of companies we invest in. The change in Other (expense) income, net when comparing 2012 to 2011 is primarily due to a $16.5 million increase in gain on our strategic investments due to the sale of companies that we invested in, partially offset by a loss on remeasurement of our foreign currency transactions of $7.9 million. For more information see "- Liquidity and Capital Resources" and Note 4 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013. 45 -------------------------------------------------------------------------------- Income Taxes We and certain of our subsidiaries are subject to U.S. federal income taxes, as well as income taxes of multiple state and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S., income tax examinations by tax authorities for years prior to 2009. In the ordinary course of global business, there are transactions for which the ultimate tax outcome is uncertain and judgment is required in determining the worldwide provision for income taxes. We provide for income taxes on transactions based on our estimate of the probable liability. We adjust our provision as appropriate for changes that impact our underlying judgments. Changes that impact provision estimates include such items as jurisdictional interpretations on tax filing positions based on the results of tax audits and general tax authority rulings. Due to the evolving nature of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability and the realizability of our deferred tax assets could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows. We are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. At December 31, 2013, we had approximately $150.4 million in net deferred tax assets. The authoritative guidance requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We review deferred tax assets periodically for recoverability and make estimates and judgments regarding the expected geographic sources of taxable income and gains from investments, as well as tax planning strategies in assessing the need for a valuation allowance. At December 31, 2013, we determined that $26.5 million valuation allowance relating to deferred tax assets for net operating losses and tax credits was necessary. If the estimates and assumptions used in our determination change in the future, we could be required to revise our estimates of the valuation allowances against our deferred tax assets and adjust our provisions for additional income taxes. We maintain certain strategic management and operational activities in overseas subsidiaries and our foreign earnings are taxed at rates that are generally lower than in the United States. We do not expect to remit earnings from our foreign subsidiaries. Our effective tax rate was approximately 12.5% for the year ended December 31, 2013 and 14.1% for the year ended December 31, 2012. The decrease in the effective tax rate when comparing the year ended December 31, 2013 to the year ended December 31, 2012 was primarily due to 2012 not including the U.S. research and development tax credit and 2013 including the U.S. research and development tax credit for both the 2012 and 2013 tax years as the law extending the credit for 2012 was not enacted until 2013. Our effective tax rate generally differs from the U.S. federal statutory rate of 35% due primarily to lower tax rates on earnings generated by our foreign operations that are taxed primarily in Switzerland. We have not provided for U.S. taxes for those earnings because we plan to reinvest all of those earnings indefinitely outside the United States. Our effective tax rate will fluctuate based on the mix of earnings from our U.S. and foreign jurisdictions. Accordingly, earnings from the production and distribution of our products and services through our foreign headquarters in Switzerland are currently taxed at lower income tax rates than earnings from our U.S. operations. The federal research and development credit expired on December 31, 2011. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law. Under this act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2011 and before January 1, 2014. The effects of these changes in the tax law resulted in net tax benefits of approximately $10.7 million, which were recognized in 2013, the year in which the law was enacted. We currently target our effective tax rate to increase in 2014 compared to 2013 due to the expiration of the U.S. research and development tax credit, which has not been renewed. 46 -------------------------------------------------------------------------------- Liquidity and Capital Resources During 2013, we generated operating cash flows of $928.3 million. These operating cash flows related primarily to net income of $339.5 million, adjusted for, among other things, non-cash charges, including depreciation and amortization expenses of $267.5 million and stock-based compensation expense of $183.9 million. Also contributing to these cash inflows was an aggregate increase in operating assets and liabilities of $182.3 million, net of effects of acquisitions. Our investing activities used $938.2 million of cash consisting primarily of net purchases of investments of $433.5 million, cash paid for acquisitions of $334.9 million and cash paid for the purchase of property and equipment of $162.9 million. Our financing activities used cash of $352.3 million primarily due to stock repurchases of $406.3 million. This financing cash outflow was partially offset by proceeds received from the issuance of common stock under our employee stock-based compensation plans of $73.7 million. During 2012, we generated operating cash flows of $818.5 million. These operating cash flows related primarily to net income of $352.5 million, adjusted for, among other things, non-cash charges including depreciation and amortization expenses of $214.9 million and stock-based compensation expense of $149.9 million. Also contributing to these cash inflows was an aggregate increase in operating assets and liabilities of $180.5 million, net of the effects of acquisitions. Our investing activities used $357.9 million of cash consisting primarily of cash paid for acquisitions of $487.2 million, the purchase of property and equipment of $123.0 million and $34.4 million in cash paid for licensing agreements and product related intangible assets and other investments. These investing cash outflows were partially offset by net sales of investments of $258.9 million. Our financing activities used cash of $149.8 million primarily due to stock repurchases of $251.0 million. This financing cash outflow was partially offset by proceeds received from the issuance of common stock under our employee stock-based compensation plans of $108.4 million. Historically, significant portions of our cash inflows were generated by our operations. We currently expect this trend to continue throughout 2014. We believe that our existing cash and investments together with cash flows expected from operations will be sufficient to meet expected operating and capital expenditure requirements for the next 12 months. We continue to search for suitable acquisition candidates and could acquire or make investments in companies we believe are related to our strategic objectives. We could from time to time seek to raise additional funds through the issuance of debt or equity securities for larger acquisitions. Cash, Cash Equivalents and Investments December 31, 2013 Compared 2013 2012 to 2012 (In thousands)Cash, cash equivalents and investments $ 1,590,416 $ 1,523,944 $ 66,472 The increase in cash, cash equivalents and investments at December 31, 2013 as compared to December 31, 2012, is primarily due to cash provided by our operating activities of $928.3 million and cash received from the issuance of common stock under our employee stock-based compensation plans of $73.7 million, partially offset by expenditures made on stock repurchases of $406.3 million, cash paid for acquisitions, net of cash acquired, of $334.9 million and purchases of property and equipment of $162.9 million. As of December 31, 2013, $1,059.9 million of the $1,590.4 million of cash, cash equivalents and investments was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we would be required to accrue and pay U.S. taxes to repatriate these funds. Our current plans are not expected to require repatriation of cash and investments to fund our U.S. operations and, as a result, we intend to permanently reinvest our foreign earnings. See "- Liquidity and Capital Resources." We generally invest our cash and cash equivalents in investment grade, highly liquid securities to allow for flexibility in the event of immediate cash needs. Our short-term and long-term investments primarily consist of interest-bearing securities. Fair Value Measurements The authoritative guidance defines fair value as an exit price, representing the amount that would either be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: • Level 1. Observable inputs such as quoted prices in active markets for identical assets or liabilities; • Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and 47-------------------------------------------------------------------------------- • Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Available-for-sale securities included in Level 2 are valued utilizing inputs obtained from an independent pricing service, or the Service, which uses quoted market prices for identical or comparable instruments rather than direct observations of quoted prices in active markets. The Service gathers observable inputs for all of our fixed income securities from a variety of industry data providers including, for example, large custodial institutions and other third-party sources. Once the observable inputs are gathered by the Service, all data points are considered and an average price is determined. The Service's providers utilize a variety of inputs to determine their quoted prices. These inputs may include interest rates, known historical trades, yield curve information, benchmark data, prepayment speeds, credit quality and broker/dealer quotes. Substantially all of our available-for-sale investments are valued utilizing inputs obtained from the Service and accordingly are categorized as Level 2 in the table below. We periodically independently assess the pricing obtained from the Service and historically have not adjusted the Service's pricing as a result of this assessment. Available-for-sale securities are included in Level 3 when relevant observable inputs for a security are not available. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the classification of assets and liabilities within the fair value hierarchy. In certain instances, the inputs used to measure fair value may meet the definition of more than one level of the fair value hierarchy. The input with the lowest level priority is used to determine the applicable level in the fair value hierarchy. Assets and Liabilities Measured at Fair Value on a Recurring Basis Our fixed income available-for-sale security portfolio generally consists of high quality, investment grade securities from diverse issuers with a minimum credit rating of A-/A3 and a minimum weighted-average credit rating of AA-/Aa3. We values these securities based on pricing from the Service, whose sources may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value, and accordingly, we classify all of our fixed income available-for-sale securities as Level 2. See Note 4 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for more information regarding our available-for-sale investments. We measure our cash flow hedges, which are classified as Prepaid expenses and other current assets and Accrued expenses and other current liabilities, at fair value based on indicative prices in active markets (Level 2 inputs). Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3) We have invested in convertible debt securities of certain early-stage entities that are classified as available-for-sale investments. As quoted prices in active markets or other observable inputs were not available for these investments, in order to measure them at fair value, we utilized a discounted cash flow model using a discount rate reflecting the market risk inherent in holding securities of an early-stage enterprise, adjusted by the probability-weighted exit possibilities associated with the convertible debt securities. This methodology required us to make assumptions that were not directly or indirectly observable regarding the fair value of the convertible debt securities; accordingly they are a Level 3 valuation and included in the table below. Investments (in thousands) Balance at December 31, 2012 $ 3,341 Purchases of Level 3 securities 9,700 Transfers out of Level 3 (2,750 ) Balance at December 31, 2013 $ 10,291 Transfers out of Level 3 relate to certain of our investments in convertible debt securities of early-stage entities that were classified as available-for-sale investments to cost method investments upon conversion to equity ownership, which are included in Other assets in our accompanying consolidated balance sheets. Assets Measured at Fair Value on a Non-recurring Basis Using Significant Unobservable Inputs (Level 3) During 2013, certain cost method investments with a combined carrying value of $9.3 million were determined to be impaired and have been written down to their fair values of $5.6 million, resulting in impairment charges of $3.7 million. During 2012, certain cost method investments with a combined carrying value of $13.0 million were determined to be impaired and have been written down to their fair values of $9.5 million resulting in impairment charges of $3.5 million. 48 -------------------------------------------------------------------------------- The impairment charges are included in Other (expense) income, net in the accompanying consolidated financial statements for the years ended December 31, 2013 and 2012. In determining the fair value of cost method investments, we consider many factors including but not limited to operating performance of the investee, the amount of cash that the investee has on-hand, the ability to obtain additional financing and the overall market conditions in which the investee operates. The fair value of the cost method investment represents a Level 3 valuation as the assumptions used in valuing this investment were not directly or indirectly observable. See Note 4 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for further information regarding cost method investments. Additional Disclosures Regarding Fair Value Measurements The carrying value of accounts receivable, accounts payable and accrued expenses and other current liabilities approximate their fair value due to the short maturity of these items. Accounts Receivable, Net December 31, 2013 2012 2013 Compared to 2012 (In thousands) Accounts receivable $ 660,175 $ 637,403 $ 22,772 Allowance for returns (2,062 ) (2,564 ) 502 Allowance for doubtful accounts (3,292 ) (3,883 ) 591 Accounts receivable, net $ 654,821 $ 630,956 $ 23,865 The increase in accounts receivable at December 31, 2013 compared to December 31, 2012 was primarily due to an increase in sales, particularly in the last month of 2013 compared to the last month of 2012. The activity in our allowance for returns was comprised primarily of $5.0 million in credits issued for returns partially offset by $4.5 million of provisions for returns recorded during 2013. The activity in our allowance for doubtful accounts was comprised primarily of $1.6 million of uncollectible accounts written off, net of recoveries, partially offset by $1.0 million in additional provisions for doubtful accounts. From time to time, we could maintain individually significant accounts receivable balances from our distributors or customers, which are comprised of large business enterprises, governments and small and medium-sized businesses. If the financial condition of our distributors or customers deteriorates, our operating results could be adversely affected. At December 31, 2013, one distributor, Ingram Micro, accounted for 10% of our accounts receivable. At December 31, 2012, one distributor, Ingram Micro, accounted for 11% of our accounts receivable. For more information regarding significant customers see Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013. Stock Repurchase Program Our Board of Directors authorized an ongoing stock repurchase program with a total repurchase authority granted to us of $3.9 billion, of which $500.0 million was approved in October 2013. We may use the approved dollar authority to repurchase stock at any time until the approved amounts are exhausted. The objective of our stock repurchase program is to improve stockholders' returns. At December 31, 2013, approximately $429.3 million was available to repurchase common stock pursuant to the stock repurchase program. All shares repurchased are recorded as treasury stock in our consolidated balance sheets included in this Annual Report on Form 10-K for the year ended December 31, 2013. A portion of the funds used to repurchase stock over the course of the program was provided by proceeds from employee stock option exercises and the related tax benefit. We are authorized to make open market purchases of our common stock using general corporate funds through open market purchases or pursuant to a Rule 10b5-1 plan. During the year ended December 31, 2013, we expended approximately $406.3 million on open market purchases, repurchasing 6,563,986 shares of outstanding common stock at an average price of $61.90. During the year ended December 31, 2012, we expended approximately $251.0 million on open market purchases, repurchasing 3,550,817 shares of outstanding common stock at an average price of $70.69. During the year ended December 31, 2011, we expended approximately $424.8 million on open market purchases, repurchasing 6,275,470 shares of outstanding common stock at an average price of $67.70. 49 -------------------------------------------------------------------------------- Shares for Tax Withholding During the years ended December 31, 2013, we withheld 444,657 shares, in 2012 we withheld 269,745 shares and in 2011, we withheld 182,203 shares from stock units that vested. Amounts withheld to satisfy minimum tax withholding obligations that arose on the vesting of stock unit awards was $31.0 million for 2013, $20.2 million for 2012 and $13.3 million for 2011. These shares are reflected as treasury stock in our consolidated balance sheets included in this Annual Report on Form 10-K for the year ended December 31, 2013 and the related cash outlays reduce our total stock repurchase authority. Contractual Obligations and Off-Balance Sheet Arrangement Contractual Obligations We have certain contractual obligations that are recorded as liabilities in our consolidated financial statements. Other items, such as operating lease obligations, are not recognized as liabilities in our consolidated financial statements, but are required to be disclosed in the notes to our consolidated financial statements. The following table summarizes our significant contractual obligations at December 31, 2013 and the future periods in which such obligations are expected to be settled in cash. Additional details regarding these obligations are provided in the notes to our consolidated financial statements (in thousands): Payments due by period Total Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Operating lease obligations(1) $ 276,590 $ 60,982 $ 86,123 $ 40,600 $ 88,885 Purchase obligations(2) 31,300 31,300 - - - Total contractual obligations(3) $ 307,890 $ 92,282 $ 86,123 $ 40,600 $ 88,885 (1) In 2012, we entered into a lease to acquire additional office space in Santa Clara, CA. The rental commencement date will not begin until 2015 and the pricing for the lease will not be finalized until a future date. Accordingly, the future payment obligations related to this lease are not included in the table above. (2) Purchase obligations represent non-cancelable commitments to purchase inventory ordered before year-end of approximately $13.1 million and a contingent obligation to purchase inventory, which is based on amount of usage, of approximately $18.2 million. (3) Total contractual obligations do not include agreements where our commitment is variable in nature or where cancellations without payment provisions exist and excludes $63.8 million of liabilities related to uncertain tax positions recorded in accordance with authoritative guidance, because we could not make reasonably reliable estimates of the period or amount of cash settlement with the respective taxing authorities. See Note 10 to our consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2013 for further information. As of December 31, 2013, we did not have any individually material capital lease obligations or other material long-term commitments reflected on our consolidated balance sheets. Off-Balance Sheet Arrangements We do not have any special purpose entities or off-balance sheet financing arrangements. 50-------------------------------------------------------------------------------- |