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CITRIX SYSTEMS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Our operating results and financial condition have varied in the past and could in the future vary significantly depending on a number of factors. From time to time, information provided by us or statements made by our employees contain "forward-looking" information that involves risks and uncertainties. In particular, statements contained in this Quarterly Report on Form 10-Q, and in the documents incorporated by reference into this Quarterly Report on Form 10-Q, that are not historical facts, including, but not limited to, statements concerning new products, research and development, offerings of products and services, market positioning and opportunities, headcount, customer demand, distribution and sales channels, financial information and results of operations for future periods, other expense, net, product and price competition, strategy and growth initiatives, seasonal factors, restructuring activities, international operations and expansion, investment transactions and valuations of investments and derivative instruments, reinvestment or repatriation of foreign earnings, fluctuations in foreign exchange rates, tax matters, tax rates, the expected benefits of acquisitions, changes in domestic and foreign economic conditions and credit markets, liquidity and debt obligations, share repurchase activity, litigation and intellectual property matters, constitute forward-looking statements and are made under the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are neither promises nor guarantees. Our actual results of operations and financial condition have varied and could in the future vary materially from those stated in any forward-looking statements. The factors described in Part I, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2013, as may be updated in Part II, Item 1A in this Quarterly Report on Form 10-Q, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this Quarterly Report on Form 10-Q, in the documents incorporated by reference into this Quarterly Report on Form 10-Q or presented elsewhere by our management from time to time. Such factors, among others, could have a material adverse effect upon our business, results of operations and financial condition. We caution readers not to place undue reliance on any forward-looking statements, which only speak as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made. Overview Management's discussion and analysis of financial condition and results of operations is intended to help the reader understand our financial condition and results of operations. This section is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for the three months ended March 31, 2014. The results of operations for the periods presented in this report are not necessarily indicative of the results expected for the full year or for any future period, due in part to the seasonality of our business. Historically, our revenue for the fourth quarter of any year is typically higher than our revenue for the first quarter of the subsequent year. We are a leader in mobile workspaces, providing virtualization, mobility management, networking and cloud services to enable new ways to work better. Our solutions power business mobility through secure, personal workspaces that provide people with instant access to apps, desktops, data and communications on any device, over any network and cloud. virtualization, networking and cloud infrastructure to enable new ways for people to work better. This year we are celebrating 25 years of innovation, making IT simpler and people more productive. 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. 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. Communications and Documents Cloud (formerly 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. 28 -------------------------------------------------------------------------------- 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, 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 these offerings, we initially experienced longer than normal customer evaluations causing longer than anticipated sales cycles in the second half of 2013. In the first quarter of 2014, we found that the investments that we have been making in go-to-market coverage has led to growth in our Cloud Networking business which outweighs the results in our Desktop and Application Virtualization business. 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. Further, from an operations standpoint, in order to operate more efficiently, we announced the implementation of the 2014 Restructuring Program to better align resource allocation with the Company's strategic imperatives. The 2014 Restructuring Program included steps to reduce our headcount by approximately 125 full-time positions. In the first quarter of 2014, we incurred a pre-tax charge of $9.7 million related to employee severance and related costs. 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. Our Mobility products offer our enterprise IT customers a comprehensive solution that makes 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. 29 -------------------------------------------------------------------------------- SaaS division Our SaaS division is focused on developing and marketing Communications and Documents Cloud, Remote Access and Remote IT Support products. These products are primarily marketed via the web to enterprises, medium and small businesses, prosumers and individuals. Our SaaS segment's Communications Cloud 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 Documents Cloud 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 three months ended March 31, 2014 compared to the three months ended March 31, 2013, a summary of our results included: • Product and licenses revenue increased 7.4% to $207.4 million; • Software as a service revenue increased 14.2% to $157.1 million; • License updates and maintenance revenue increased 8.9% to $343.8 million; • Professional services revenue increased 60.3% to $42.5 million; • Gross margin as a percentage of revenue decreased 0.8% to 82.1%; • Operating income increased 27.0% to $71.9 million; and • Diluted net income per share decreased 4.6% to $0.30. The increase in our Product and licenses revenue was driven by sales of our Networking and Cloud products, led by NetScaler, partially offset by lower sales of desktop and application virtualization products most pronounced in the Americas. Our Software as a service revenue increased primarily due to increased sales of our Communications Cloud products, led by GoToMeeting. The increase in License updates and maintenance revenue was driven by increased sales of maintenance and support across all of our Enterprise and Service Provider products and increased renewals of our Subscription Advantage product. The increase in Professional services revenue was primarily due to increased product training and certification and implementation sales of our Enterprise and Service Provider products. We currently target total revenue to increase when comparing the second quarter of 2014 to the second quarter of 2013. In addition, when comparing the 2014 fiscal year to the 2013 fiscal year, we target total revenue to increase. Operating income increased as a result of our Operating expenses increasing at a slower rate than our revenues. The decrease in diluted net income per share was due to a decrease in Other expense, net, primarily due to a loss recognized on a cost method investment, partially offset by an increase in Operating income when comparing the first quarter of 2014 to the first quarter of 2013. 2014 Acquisition On January 8, 2014, we acquired all of the issued and outstanding securities of Framehawk, Inc., or (Framehawk). The Framehawk solution optimizes the delivery of virtual desktops and applications to mobile devices and will be combined with HDX technology in the Citrix XenApp and XenDesktop products to deliver an improved user experience under adverse network conditions. The total consideration for this transaction was approximately $24.2 million, net of $0.3 million of cash acquired, and was paid in cash. We recorded approximately $14.6 million of goodwill, which is not deductible for tax purposes, and acquired $28.9 million in assets including $14.0 million of identifiable product related intangible assets with a useful life of 7.0 years. We continue to evaluate certain income tax assets and liabilities related to this acquisition. Transaction costs associated with the acquisition were approximately $0.1 million, all of which we expensed during the three months ended March 31, 2014 and are included in General and administrative expense in the accompanying condensed consolidated statements of income. We have included the effect of this transaction in our results of operations prospectively from the date of the acquisition, which was not material to our consolidated results. On May 2, 2014, we acquired all of the issued and outstanding securities of a privately-held company. The total preliminary consideration for this transaction was approximately $17.2 million, net of $0.8 million of cash acquired, and was paid in cash. Transaction costs associated with the acquisition is currently estimated at $0.2 million, all of which we expensed during the three months ended March 31, 2014 and are included in General and administrative expense in the accompanying consolidated statements of income. 30 -------------------------------------------------------------------------------- 2013 Acquisitions Zenprise In January 2013, we acquired all of the issued and outstanding securities of Zenprise, Inc., or Zenprise, a privately-held leader in mobile device management. Zenprise became part of our Enterprise and Service Provider segment, in which we have integrated the Zenprise offering for mobile device management into our 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 three months ended March 31, 2014 and are included in General and administrative expense in the accompanying condensed 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, and are included in General and administrative expense in the accompanying condensed consolidated statements of income. No transaction costs were recorded for this transaction during the three months ended March 31, 2014 and 2013. 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, and are included in General and administrative expense in the accompanying condensed consolidated statements of income. No transaction costs were recorded for this transaction during the three months ended March 31, 2014 and 2013. We have included the effects of all of the companies acquired in our results of operations prospectively from the dates of the acquisition. Critical Accounting Policies and Estimates Our discussion and analysis of financial condition and results of operations are based upon our condensed 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. For more information regarding our critical accounting policies and estimates please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" contained in our Annual Report on Form 10-K for the year ended December 31, 2013, or the Annual Report, and Note 2 to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. There have been no material changes to the critical accounting policies disclosed in the Annual Report. 31 -------------------------------------------------------------------------------- Results of Operations The following table sets forth our unaudited condensed consolidated statements of income data and presentation of that data as a percentage of change from period-to-period (in thousands): Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 Revenues: Product and licenses $ 207,424 $ 193,083 7.4 % Software as a service 157,132 137,566 14.2 License updates and maintenance 343,758 315,738 8.9 Professional services 42,505 26,512 60.3 Total net revenues 750,819 672,899 11.6 Cost of net revenues: Cost of product and license revenues 31,337 25,794 21.5 Cost of services and maintenance revenues 78,683 64,411 22.2 Amortization of product related intangible assets 24,306 24,709 (1.6 ) Total cost of net revenues 134,326 114,914 16.9 Gross margin 616,493 557,985 10.5 Operating expenses: Research and development 133,618 130,492 2.4 Sales, marketing and services 316,496 297,682 6.3 General and administrative 72,388 62,785 15.3 Amortization of other intangible assets 12,454 10,418 19.5 Restructuring 9,650 - * Total operating expenses 544,606 501,377 8.6 Income from operations 71,887 56,608 27.0 Interest income 2,153 1,962 9.7 Other expense, net (5,285 ) (766 ) * Income before income taxes 68,755 57,804 18.9 Income tax expense (benefit) 12,816 (1,884 ) * Net income $ 55,939 $ 59,688 (6.3 ) * not meaningful Revenues 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. 32 --------------------------------------------------------------------------------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 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: • Communications Cloud products, which primarily include GoToMeeting, GoToWebinar and GoToTraining; • Documents Cloud products, which primarily include ShareFile; • Remote Access product, GoToMyPC; and • Remote IT Support products, which primarily include GoToAssist. Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (In thousands) Product and licenses $ 207,424 $ 193,083 $ 14,341 Software as a service 157,132 137,566 19,566 License updates and maintenance 343,758 315,738 28,020 Professional services 42,505 26,512 15,993 Total net revenues $ 750,819 $ 672,899 $ 77,920 Product and Licenses The increase in Product and licenses revenue for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 was primarily due to increased sales of our cloud networking products of $19.8 million, led by NetScaler, partially offset by a decrease in sales of our desktop and application virtualization products of $7.4 million. These Product and licenses revenue results were primarily due to the factors discussed in the Executive Summary Overview above. We currently target Product and licenses revenue to increase when comparing the second quarter of 2014 to the second quarter of 2013. Software as a Service Software as a service revenue increased for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to increased sales of our Communications Cloud products of $13.7 million, led by GoToMeeting, and increased sales of our Documents Cloud products of $5.1 million. We currently target Software as a service revenue to increase when comparing the second quarter of 2014 to the second quarter of 2013. License Updates and Maintenance License updates and maintenance revenue increased for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to an increase in maintenance revenues of $18.6 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 renewals of our Subscription Advantage product of $13.5 million. We currently target License updates and maintenance revenue to increase when comparing the second quarter of 2014 to the second quarter of 2013. 33 -------------------------------------------------------------------------------- Professional Services The increase in Professional services revenue when comparing the three months ended March 31, 2014 to the three months ended March 31, 2013 was primarily due to increased product training and certification and implementation sales of our Enterprise and Service Provider products. We currently target Professional services revenue to increase when comparing the second quarter of 2014 to the second quarter of 2013 consistent with the targeted increase in Product and licenses 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 contracts for our software and hardware products. Deferred revenues also include SaaS revenue from annual service agreements for our online services and Professional services revenue primarily related to our consulting contracts. The change in deferred revenues was not significant when comparing March 31, 2014 to December 31, 2013, however, the change was primarily due to decreased new and renewal sales of our Subscription Advantage product due to seasonality of $12.5 million, partially offset by increased sales of our maintenance and support contracts of $11.9 million. We currently anticipate that deferred revenues will increase throughout the remainder of 2014. International Revenues International revenues (sales outside the United States) accounted for approximately 44.4% of our net revenues for the three months ended March 31, 2014 and 43.3% of our net revenues for the three months ended March 31, 2013. See Note 9 to our condensed consolidated financial statements for detailed information on net revenues by geography. Segment Revenues Our revenues are derived from sales of Enterprise and Service Provider products which include our Mobile and Desktop products, Networking and Cloud products and related License updates and maintenance and Professional services and from our SaaS products which include Communications Cloud, Documents Cloud, Remote Access and Remote IT Support products. Enterprise and Service Provider and SaaS constitute our two reportable segments. An analysis of our reportable segment net revenue is presented below (in thousands): Increase for the Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 Enterprise and Service Provider $ 593,687 $ 535,333 10.9 % SaaS 157,132 137,566 14.2 % Net revenues $ 750,819 $ 672,899 11.6 % 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 9 of our condensed consolidated financial statements for additional information on our segment revenues. Cost of Net Revenues Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (Inthousands) Cost of product and license revenues $ 31,337 $ 25,794 $ 5,543 Cost of services and maintenance revenues 78,683 64,411 14,272 Amortization of product related intangible assets 24,306 24,709 (403 ) Total cost of net revenues $ 134,326 $ 114,914 $ 19,412 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 34 -------------------------------------------------------------------------------- SaaS, which includes the cost to support the voice and video offerings in our Communications Cloud products. Also included in Cost of net revenues is amortization of product related intangible assets. Cost of product and license revenues increased for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 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 target Cost of product and license revenues to increase when comparing the second quarter of 2014 to the second quarter of 2013 consistent with the targeted increase in sales of our hardware products. Cost of services and maintenance revenues increased for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to an increase in sales of our Communications and Documents Cloud products of $6.3 million. Also contributing to the increase in Cost of services and maintenance revenues is an increase in product training and certification and implementation costs of $5.3 million related to increased sales of our Enterprise and Service Provider division's products as described above. We currently target Cost of services and maintenance revenues to increase when comparing the second quarter of 2014 to the second quarter of 2013, consistent with the targeted increases in Software as a service revenue, License updates and maintenance revenue and Professional services revenue as discussed above. Gross Margin Gross margin as a percentage of revenue was 82.1% for the three months ended March 31, 2014 and 82.9% for the three months ended March 31, 2013. When comparing the second quarter of 2014 to the second quarter of 2013 and the full year 2014 to the full year 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 segment 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. Research and Development Expenses Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (In thousands) Research and development $ 133,618 $ 130,492 $ 3,126 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 the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to an increase in compensation, including stock-based compensation and employee-related costs, primarily related to increased headcount from strategic hiring. 35 --------------------------------------------------------------------------------Sales, Marketing and Services Expenses Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (In thousands) Sales, marketing and services $ 316,496 $ 297,682 $ 18,814 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 the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to an 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. General and Administrative Expenses Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (In thousands) General and administrative $ 72,388 $ 62,785 $ 9,603 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 for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to an increase in compensation and employee related costs of $4.9 million due to additional headcount, primarily in finance and operations. Also contributing to the increase in General and administrative expense when comparing the three months ended March 31, 2014 to the three months ended March 31, 2013 is an increase in professional services of $4.4 million primarily related to projects to support business growth. Restructuring Expenses Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (In thousands) Restructuring $ 9,650 $ - $ 9,650 In March 2014, we implemented the 2014 Restructuring Program, which primarily included the reduction of our headcount by approximately 125 full-time positions. The pre-tax charges we incurred were primarily related to severance and other costs directly related to the reduction of our workforce. The restructuring program is expected to be completed by the end of 2014. For more information, see "-Executive Summary- Overview" and Note 15 to our condensed consolidated financial statements. 2014 Operating Expense Outlook When comparing the second quarter of 2014 to the second quarter of 2013, we are targeting Operating expenses to increase across all functional areas primarily related to increases in headcount and ongoing investments in the business including acquisitions. When comparing the second quarter of 2014 to the first quarter of 2014, we are targeting operating expenses to increase in Research and development and Sales, marketing and services primarily due to the factors discussed in the Executive Summary Overview above. We also expect to incur additional charges in the second quarter of 2014 related to the 2014 Restructuring Program. 36 --------------------------------------------------------------------------------Other Expense, Net Three Months Ended Three Months Ended March 31, March 31, 2014 2014 2013 vs. March 31, 2013 (In thousands) Other expense, net $ (5,285 ) $ (766 ) $ (4,519 ) Other expense, 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, net, during the three months ended March 31, 2014 compared to the three months ended March 31, 2013 is primarily due to an impairment recognized on a cost method investment. For more information on our cost method investments, see Note 5 to our condensed consolidated financial statements. Income Taxes As of March 31, 2014, our net unrecognized tax benefits totaled approximately $68.6 million as compared to $63.8 million as of December 31, 2013. All amounts included in this balance affect the annual effective tax rate. We have no amounts accrued for the payment of interest and penalties as of March 31, 2014. 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 condensed consolidated financial statements. At March 31, 2014, we had approximately $107.0 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. The federal research and development tax 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 tax 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 $9.4 million, which we recognized in the first quarter of 2013, the quarter in which the law was enacted. We maintain certain strategic management and operational activities in overseas subsidiaries and its foreign earnings are taxed at rates that are generally lower than in the United States. We do not expect to remit earnings from its foreign subsidiaries. Our effective tax rate was approximately 18.6% and (3.3)% for the three months ended March 31, 2014 and 2013. The increase in the effective tax rate when comparing the three months ended March 31, 2014 to the three months ended March 31, 2013 was primarily due to the impact of the federal research and development tax credit for the 2012 and 2013 taxable years that was extended during the three months ended March 31, 2013 but expired at the end of 2013 for future years. In July 2013, the FASB issued an accounting standard update that provides explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Under the new standard, our unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. We adopted this standard on January 1, 2014, and as of March 31, 2014 we are offsetting 37 -------------------------------------------------------------------------------- unrecognized tax benefits of $1.7 million against short-term deferred tax assets and $28.2 million against long-term deferred tax assets. 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. Liquidity and Capital Resources During the three months ended March 31, 2014, we generated operating cash flows of $287.9 million. These operating cash flows related primarily to a change in operating assets and liabilities of $124.0 million, net of effect of our acquisitions. Also contributing to these cash inflows was net income of $55.9 million, adjusted for, among other things, non-cash charges, depreciation and amortization expenses of $70.0 million and stock-based compensation expense of $40.7 million. Our investing activities used $275.0 million of cash consisting primarily of net purchases of investments of $219.7 million, cash paid for the purchase of property and equipment of $30.5 million and cash paid for acquisitions of $24.2 million. Our financing activities provided cash of $4.2 million primarily due to proceeds received from the issuance of common stock under our employee stock-based compensation plans of $8.0 million. During the three months ended March 31, 2013, we generated operating cash flows of $266.8 million. These operating cash flows related primarily to a change in operating assets and liabilities of $110.3 million, net of effect of our acquisitions. Also contributing to these cash inflows was net income of $59.7 million, adjusted for, among other things, non-cash charges, including depreciation and amortization expenses of $64.5 million, stock-based compensation expense of $43.6 million and the tax effect of stock-based compensation of $14.8 million. These cash inflows were partially offset by operating outflows related to a deferred income tax benefit of $18.2 million. Our investing activities used $629.6 million of cash consisting primarily of cash paid for acquisitions of $324.0 million, cash paid for net purchases of investments of $275.0 million and the purchase of property and equipment of $28.3 million. Our financing activities used cash of $28.9 million primarily due to stock repurchases of $61.4 million, partially offset by proceeds received from the issuance of common stock under our employee stock-based compensation plans of $25.3 million and the excess tax benefit from stock-based compensation of $9.5 million. Historically, significant portions of our cash inflows have been generated by our operations. 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. Subsequent Event - Convertible Notes In April 2014, we completed a private placement of $1.25 billion principal amount of 0.500% Convertible Senior Notes due 2019, or the Convertible Notes. Thereafter, in May 2014, we issued an additional $187.5 million principal amount of Convertible Notes pursuant to the full exercise of the over-allotment option granted to the initial purchasers in the offering, or the Over-Allotment Option. The net proceeds from this offering were approximately $1.42 billion (including the proceeds from the Over-Allotment Option), after deducting the initial purchasers' discounts and commissions and the estimated offering expenses payable by us. We used approximately $82.5 million of the net proceeds to pay the cost of certain bond hedges entered into in connection with the offering (after such cost was partially offset by the proceeds to us from certain warrant transactions). Please see Note 16 to our condensed consolidated financial statements for additional details on the Convertible Notes offering and the related bond hedges and warrant transactions. We used the remainder of the net proceeds from the offering and a portion of our existing cash and investments to purchase an aggregate of approximately $1.5 billion of our common stock under our share repurchase program. We used approximately $101.0 million to purchase shares of our common stock from certain purchasers of the Convertible Notes in privately negotiated transactions concurrently with the closing of the offering, and the remaining $1.4 billion to purchase additional shares of our common stock through an accelerated share repurchase transaction, or the ASR, which we entered into with Citibank, N.A., or Citibank, on April 25, 2014, and which is discussed in further detail in Note 16 to our condensed consolidated financial statements. We intend to use the remaining net proceeds resulting from the exercise of the Over-Allotment Option for working capital and general corporate purposes. 38 --------------------------------------------------------------------------------Cash, Cash Equivalents and Investments 2014 Compared to March 31, 2014 December 31, 2013 2013 (In thousands)Cash, cash equivalents and investments $ 1,828,108 $ 1,590,416 $ 237,692 The increase in Cash, cash equivalents and investments when comparing March 31, 2014 to December 31, 2013, is primarily due to cash provided by our operating activities of $287.9 million and cash received from the issuance of common stock under our employee stock-based compensation plans of $8.0 million, partially offset by purchases of property and equipment of $30.5 million and cash paid for acquisitions, net of cash acquired, of $24.2 million. As of March 31, 2014, $1,244.4 million of the $1,828.1 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. 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 • 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, 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. 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 investment grade securities from diverse issuers with a minimum credit rating of A-/A3 and a weighted average credit rating of AA-/Aa3. We value 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. 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). 39 --------------------------------------------------------------------------------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. Typically the discount rate used by us in measuring the fair value of investments in convertible debt securities of certain early-stage entities is commensurate with the nature and size of these entities. 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 are included in the table below. See Note 5 to our condensed consolidated financial statements for more information regarding our available-for-sale investments. Corporate Securities (in thousands) Balance at December 31, 2013 $ 10,291 Purchases of Level 3 securities 100 Balance at March 31, 2014 $ 10,391 Accounts Receivable, Net 2014 Compared to March 31, 2014 December 31, 2013 2013 (In thousands) Accounts receivable $ 515,822 $ 660,175 $ (144,353 ) Allowance for returns (1,282 ) (2,062 ) 780 Allowance for doubtful accounts (3,678 ) (3,292 ) (386 ) Accounts receivable, net $ 510,862 $ 654,821 $ (143,959 ) The decrease in Accounts receivable, net, when comparing March 31, 2014 to December 31, 2013 was primarily due to increased collections during the three months ended March 31, 2014 on higher sales in the fourth quarter of 2013. The activity in our Allowance for returns was comprised primarily of $1.3 million in credits issued for returns during the three month period ended March 31, 2014, partially offset by $0.6 million of provisions for returns recorded during the three month period ended March 31, 2014. The activity in our Allowance for doubtful accounts was comprised primarily of $0.6 million in additional provisions for doubtful accounts during the three month period ended March 31, 2014, partially offset by $0.2 million of uncollectible accounts written off, net of recoveries during the three month period ended March 31, 2014. 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. Stock Repurchase Program Our Board of Directors authorized an ongoing stock repurchase program with a total repurchase authority granted to us of $5.4 billion, of which $1.5 billion was approved in April 2014. 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 March 31, 2014, approximately $429.3 million was available to repurchase common stock pursuant to the stock repurchase program. All shares repurchased are recorded as treasury stock. 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 three months ended March 31, 2014, we had no open market purchases. During the three months ended March 31, 2013, we expended approximately $61.4 million on open market purchases, repurchasing 860,500 shares of outstanding common stock at an average price of $71.31. In April 2014, in connection with the $1.5 billion increase in repurchase authority granted to us under our ongoing stock repurchase program, we used approximately $101.0 million to purchase shares of our common stock from certain purchasers of the Convertible Notes in privately negotiated transactions concurrently with the closing of the Convertible Notes offering 40 -------------------------------------------------------------------------------- discussed above, and an additional $1.4 billion to purchase additional shares of our common stock through our ASR with Citibank. On April 30, 2014, under the ASR agreement, we paid approximately $1.4 billion to Citibank and received approximately 19.2 million shares of our common stock. The total number of shares of our common stock that we will repurchase under the ASR agreement will be based on the average of the daily volume-weighted average prices of our common stock during the term of the ASR agreement, less a discount. At settlement, Citibank may be required to deliver additional shares of our common stock to us or, under certain circumstances, we may be required to deliver shares of our common stock or make a cash payment to Citibank. Final settlement of the ASR agreement is expected to be completed by the end of December 2014, although the settlement may be accelerated at Citibank's option. See Note 16 to our condensed consolidated financial statements for detailed information on our Convertible Notes offering and the transactions related thereto, including the ASR. Shares for Tax Withholding During the three months ended March 31, 2014, we withheld 368,310 shares from stock units that vested, totaling $21.2 million, to satisfy minimum tax withholding obligations that arose on the vesting of stock units. These shares are reflected as treasury stock in our condensed consolidated balance sheets and the related cash outlays do not reduce our total stock repurchase authority. During the three months ended March 31, 2013, we withheld 322,538 shares from stock units that vested, totaling $23.2 million, to satisfy minimum tax withholding obligations that arose on the vesting of stock units. These shares are reflected as treasury stock in our condensed consolidated balance sheets and the related cash outlays do not 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 March 31, 2014 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 condensed 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 $ 420,462 $ 55,312 $ 93,038 $ 101,845 $ 170,267 Convertible senior notes(1) - - - - Purchase obligations(2) 37,875 37,875 - - - Total contractual obligations(3) $ 458,337 $ 93,187 $ 93,038 $ 101,845 $ 170,267 (1) During the second quarter of 2014, we completed a private placement of $1.44 billion principal amount of 0.500% Convertible Senior Notes due 2019, which are not included in the table above. See Note 16 to our condensed consolidated financial statements for detailed information on the Convertible Notes offering and the transactions related thereto. (2) Purchase obligations represent non-cancelable commitments to purchase inventory ordered before March 31, 2014 of approximately $19.7 million and a contingent obligation to purchase inventory, which is based on amount of usage, of approximately $18.1 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 $68.6 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 12 to our condensed consolidated financial statements. As of March 31, 2014, 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. 41-------------------------------------------------------------------------------- |