TMCnet News
NETGEAR, INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-looking Statements This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words "believes," "anticipates," "plans," "expects," "intends," "could," "may," "will," and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in "Part II-Item 1A-Risk Factors" and "Liquidity and Capital Resources" below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes contained in this quarterly report. Unless expressly stated or the context otherwise requires, the terms "we," "our," "us" and "NETGEAR" refer to NETGEAR, Inc. and our subsidiaries. Business and Executive Overview We are a global networking company that delivers innovative products to consumers, businesses and service providers. Our products are built on a variety of proven technologies such as wireless, Ethernet and powerline, with a focus on reliability and ease-of-use. Our product line consists of wired and wireless devices that enable networking, broadband access and network connectivity. These products are available in multiple configurations to address the needs of our end-users in each geographic region in which our products are sold. We operate in three specific business segments: retail, commercial, and service provider. Each business unit is managed by a Senior Vice President/General Manager. We believe this structure enables us to better focus our efforts on our core customer 35-------------------------------------------------------------------------------- Table of Contents segments and allows us to be more nimble and opportunistic as a company overall. In March 2014, the CEO began temporarily serving as interim General Manager of the retail business unit due to the previous general manager's departure from the Company. The CEO will continue to serve as interim general manager until a replacement is established. The retail business unit is focused on individual consumers and consists of high performance, dependable and easy-to-use home networking, home video monitoring, storage and digital media products. The commercial business unit is focused on small and medium size businesses and consists of business networking, storage and security solutions that bring enterprise class functionality at an affordable price. The service provider business unit is focused on the service provider market and consists of made-to-order and retail proven, whole home networking hardware and software solutions, as well as 4G LTE hotspots sold to service providers for sale to their subscribers. We conduct business across three geographic regions: Americas, Europe, Middle-East and Africa ("EMEA") and Asia Pacific ("APAC"). Our service provider business has grown substantially over the years, particularly as a result of acquisitions, and it is difficult to ascertain a seasonal pattern given that the business is less predictable than our other core businesses. The commercial business, consumer, and broadband service provider markets are intensely competitive and subject to rapid technological change. We believe that the principal competitive factors in the retail, commercial, and service provider markets for networking products include product breadth, size and scope of the sales channel, brand name, timeliness of new product introductions, product availability, performance, features, functionality and reliability, ease-of-installation, maintenance and use, and customer service and support. To remain competitive, we believe we must continue to aggressively invest resources in developing new products and enhancing our current products while continuing to expand our channels and maintaining customer satisfaction worldwide. We sell our networking products through multiple sales channels worldwide, including traditional retailers, online retailers, wholesale distributors, direct market resellers ("DMRs"), value-added resellers ("VARs"), and broadband service providers. Our retail channel includes traditional retail locations domestically and internationally, such as Best Buy, Costco, Fry's Electronics, K-mart, Radio Shack, Sears, Staples, Target, Wal-Mart, Argos (U.K.), Dixons (U.K.), PC World (U.K.), MediaMarkt (Germany, Austria), Dick Smith (Australia), JB HiFi (Australia) and Elkjop (Norway). Online retailers include Amazon.com, Dell, Newegg.com and Buy.com. Our DMRs include CDW Corporation, Insight Corporation and PC Connection in domestic markets and Misco throughout Europe. In addition, we also sell our products through broadband service providers, such as multiple system operators ("MSOs"), DSL, and other broadband technology operators domestically and internationally. Some of these retailers and broadband service providers purchase directly from us, while others are fulfilled through wholesale distributors around the world. A substantial portion of our net revenue to date has been derived from a limited number of wholesale distributors and retailers, including Ingram Micro and Best Buy. We expect that these wholesale distributors and retailers will continue to contribute a significant percentage of our net revenue for the foreseeable future. During the third quarter of 2014, we experienced a 2.4% decrease in net revenue compared to the third quarter of 2013, driven primarily by a reduction in sales of our mobile, multimedia, home wireless products and switches, partially offset by an increase in sales of our broadband gateways. On a geographic basis, net revenue increased in the APAC region, driven primarily by an increase in sales of our home wireless, broadband gateways and mobile products, partially offset by a reduction in sales of wireless products and switches. Net revenue increased in the EMEA region, driven primarily by an increase in sales of our broadband gateways, home wireless products and switches, partially offset by a reduction in sales of our mobile and multimedia products. Net revenue decreased in the Americas region, driven primarily by a reduction in sales of our home wireless, mobile and multimedia products and switches, partially offset by an increase in sales of our broadband gateways. On a segment basis, retail net revenue increased slightly, due primarily to higher gross shipments of broadband gateways, partially offset by the impact of a reduction in weeks of inventory on-hand with our U.S retail partners. Commercial net revenue decreased from prior year, due primarily to a reduction in gross shipments as a result of a reduction in weeks of inventory on-hand in the U.S. distribution channel to be more aligned with historical levels. Service provider net revenue decreased, primarily due to a reduction in gross shipments and weakness in North American carrier spending. Looking forward, we expect to see continued growth in our commercial business unit driven by sales of our 10Gig switches, PoE switches, storage and wireless products among small and medium-sized businesses, end users and resellers. Although service provider results remained strong for the third quarter of 2014, we expect revenues to decline during the fourth quarter due to weakness in capital expense spending by certain service providers in both North America and in Europe. Our focus remains on improving profitability, while investing in key strategic growth areas. The areas that we are targeting continue to be mobile LTE, 802.11ac, home monitoring and automation and the under-served small and medium-sized business market. In addition, we believe the moves to 11ac routers, WiFi extenders and cable modem routers in the US and DSL modem routers in international markets, as well as moves to high end products in home networking, will help us expand the market our retail business unit serves. 36-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth the unaudited condensed consolidated statements of operations and the percentage change for the three and nine months ended September 28, 2014, with the comparable reporting periods in the preceding year. Three Months Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 % Change 2013 2014 % Change 2013 (In thousands, except percentage data) Net revenue $ 353,338 (2.4 )% $ 361,895 $ 1,040,333 2.7 % $ 1,013,013 Cost of revenue 251,005 (3.5 )% 260,236 742,889 3.2 % 720,187 Gross profit 102,333 0.7 % 101,659 297,444 1.6 % 292,826 Operating expenses: Research and development 23,337 0.1 % 23,320 67,994 8.5 % 62,639 Sales and marketing 39,283 (0.5 )% 39,465 117,373 1.0 % 116,260 General and administrative 11,726 (1.7 )% 11,930 34,995 (4.3 )% 36,576 Restructuring and other charges 1,360 ** 400 2,190 11.9 % 1,957 Litigation reserves, net 69 (77.4 )% 305 254 ** 3,908 Impairment charges - ** 2,000 - ** 2,000 Total operating expenses 75,775 (2.1 )% 77,420 222,806 (0.2 )% 223,340 Income from operations 26,558 9.6 % 24,239 74,638 7.4 % 69,486 Interest income 68 (4.2 )% 71 174 (44.8 )% 315 Other income, net 2,246 ** 511 1,911 ** 37 Income before income taxes 28,872 16.3 % 24,821 76,723 9.9 % 69,838 Provision for income taxes 8,847 (14.6 )% 10,364 27,582 5.9 % 26,053 Net income $ 20,025 38.5 % $ 14,457 $ 49,141 12.2 % $ 43,785 ** Percentage change not meaningful. The following table sets forth the unaudited condensed consolidated statements of operations, expressed as a percentage of net revenue, for the periods indicated: Three Months Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net revenue 100 % 100 % 100 % 100 % Cost of revenue 71.0 % 71.9 % 71.4 % 71.1 % Gross margin 29.0 % 28.1 % 28.6 % 28.9 % Operating expenses: Research and development 6.6 % 6.4 % 6.5 % 6.2 % Sales and marketing 11.2 % 10.9 % 11.3 % 11.4 % General and administrative 3.3 % 3.3 % 3.4 % 3.6 % Restructuring and other charges 0.4 % 0.1 % 0.2 % 0.2 % Litigation reserves, net 0.0 % 0.1 % 0.0 % 0.4 % Impairment charges - % 0.6 % - % 0.2 % Total operating expenses 21.5 % 21.4 % 21.4 % 22.0 % Income from operations 7.5 % 6.7 % 7.2 % 6.9 % Interest income 0.1 % 0.1 % 0.0 % 0.0 % Other income, net 0.6 % 0.1 % 0.2 % 0.0 % Income before income taxes 8.2 % 6.9 % 7.4 % 6.9 % Provision for income taxes 2.5 % 2.9 % 2.7 % 2.6 % Net income 5.7 % 4.0 % 4.7 % 4.3 % 37-------------------------------------------------------------------------------- Table of Contents Three Months Ended September 28, 2014 Compared to Three Months Ended September 29, 2013 Net Revenue by Geographic Segment Our net revenue consists of gross product shipments, less allowances for estimated returns for stock rotation and warranty, price protection, end-user customer rebates and other sales incentives deemed to be a reduction of net revenue per the authoritative guidance for revenue recognition, and net changes in deferred revenue. We conduct business across three geographic regions: Americas, EMEA and APAC. For reporting purposes revenue is attributed to each geographic region based upon the location of the customer. Three Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Americas $ 193,904 (12.1 )% $ 220,487 Percentage of net revenue 54.9 % 60.9 % EMEA $ 108,421 11.5 % $ 97,220 Percentage of net revenue 30.7 % 26.9 % APAC $ 51,013 15.4 % $ 44,188 Percentage of net revenue 14.4 % 12.2 % Total net revenue $ 353,338 (2.4 )% $ 361,895 Americas net revenue decreased $26.6 million, or 12.1%, to $193.9 million for the three months ended September 28, 2014 from $220.5 million for the three months ended September 29. 2013. The decrease was driven primarily by a reduction in sales of our home wireless, mobile, multimedia products and switches, partially offset by an increase in sales of our broadband gateways. The decrease was due primarily to a reduction in service provider demand driven, in part, by weakness in North American carrier spending. In our retail and distribution channels, we continue to see strong demand for our products. However, we are managing our inventory levels at our U.S. distribution partners to be more aligned with historic levels, which has contributed to the decline in the Americas net revenue for the three months ended September 28, 2014 compared to the year ago period. EMEA net revenue increased $11.2 million, or 11.5%, to $108.4 million for the three months ended September 28, 2014 from $97.2 million for the three months ended September 29. 2013. The increase was driven primarily by an increase in sales of broadband gateways, home wireless products and switches, partially offset by a reduction in sales of our mobile and multimedia products. In comparison to prior year, whereby the Company was impacted negatively by consolidation among service providers in Europe, consolidation did not have a significant impact in the current quarter, resulting in an increase in net revenue year over year. APAC net revenue increased $6.8 million, or 15.4%, to $51.0 million for the three months ended September 28, 2014 from $44.2 million for the three months ended September 29, 2013. The increase was driven primarily by an increase in sales of home wireless, broadband gateways and mobile products, partially offset by a reduction in sales of wireless products and switches. Increased marketing and promotional efforts focused on new product releases in the region further contributed to the increase in net revenue for the three months ended September 28, 2014 compared to the year ago period. Cost of Revenue and Gross Margin Cost of revenue consists primarily of the following: the cost of finished products from our third party contract manufacturers; overhead costs, including purchasing, product planning, inventory control, warehousing and distribution logistics; third-party software licensing fees; inbound freight; warranty costs associated with returned goods; write-downs for excess and obsolete inventory, amortization expense of certain acquired intangibles and acquisition accounting adjustments to inventory. We outsource our manufacturing, warehousing and distribution logistics. We believe this outsourcing strategy allows us to better manage our product costs and gross margin. Our gross margin can be affected by a number of factors, including fluctuation in foreign exchange rates, sales returns, changes in average selling prices, end-user customer rebates and other sales incentives, changes in our cost of goods sold due to fluctuations in prices paid for components, net of vendor rebates, warranty and overhead costs, inbound freight, conversion costs, charges for excess or obsolete inventory and amortization of acquired intangible assets. The following table presents costs of revenue and gross margin, for the periods indicated: 38-------------------------------------------------------------------------------- Table of Contents Three Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data)Cost of revenue $ 251,005 (3.5 )% $ 260,236 Gross margin percentage 29.0 % 28.1 % Cost of revenue decreased $9.2 million, or 3.5%, to $251.0 million for the three months ended September 28, 2014 from $260.2 million for the three months ended September 29, 2013. The decrease was due primarily to the decrease in net revenue and related product costs driven by lower total shipments, combined with a reduction in excess and obsolete inventory charges of $1.5 million relative to the prior year period. Our gross margin increased to 29.0% for the three months ended September 28, 2014 from 28.1% for the three months ended September 29, 2013. The increase in gross margin percentage was primarily attributable to the positive effects of lower excess and obsolete inventory charges. Our segment product mix remained relatively consistent with the year ago period. Operating Expenses Research and Development Research and development expenses consist primarily of personnel expenses, payments to suppliers for design services, safety and regulatory testing, product certification expenditures to qualify our products for sale into specific markets, prototypes and other consulting fees. Research and development expenses are recognized as they are incurred. We have invested in building our research and development organization to enhance our ability to introduce innovative and easy-to-use products. In the future, we expect research and development expenses will increase in absolute dollars and as a percentage of revenue as we broaden our core competencies and expand into new software and networking product technologies. The following table presents research and development expense, for the periods indicated: Three Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data)Research and development expense $ 23,337 0.1 % $ 23,320 Percentage of net revenue 6.6 % 6.4 % Research and development expense was relatively flat, recognizing $23.3 million for both three months ended September 29, 2014 and September 28, 2013, respectively. An increase of $1.3 million in variable compensation was largely offset by a reduction in personnel and facility-related expenses of $1.1 million, driven by a reduction in headcount in comparison to the prior year period. Headcount decreased by 42 employees to 357 employees at September 28, 2014 compared to 399 employees at September 29, 2013, due primarily to our restructuring efforts implemented in the fourth quarter of 2013. Sales and Marketing Sales and marketing expenses consist primarily of advertising, trade shows, corporate communications and other marketing expenses, product marketing expenses, outbound freight costs, amortization expenses, personnel expenses for sales and marketing staff and technical support expenses. The following table presents sales and marketing expense, for the periods indicated: Three Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Sales and marketing expense $ 39,283 (0.5 )% $ 39,465 Percentage of net revenue 11.2 % 10.9 % Sales and marketing expense was relatively flat, decreasing $0.2 million, or 0.5%, to $39.3 million for the three months ended September 28, 2014 from $39.5 million for the three months ended September 29, 2013. The decrease was due primarily 39-------------------------------------------------------------------------------- Table of Contents to a decrease of $1.7 million in project and outside professional services, driven by a reduction in technical support spending, partially offset by an increase of $0.7 million in variable compensation expense and $0.6 million in marketing expenses. General and Administrative General and administrative expenses consist of salaries and related expenses for executives, finance and accounting, human resources, information technology, professional fees, allowance for doubtful accounts and other general corporate expenses. The following table presents general and administrative expense, for the periods indicated: Three Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data)General and administrative expense $ 11,726 (1.7 )% $ 11,930 Percentage of net revenue 3.3 % 3.3 % General and administrative expense was relatively flat, decreasing $0.2 million, or 1.7% to $11.7 million for the three months ended September 28, 2014 from $11.9 million for the three months ended September 29, 2013. A decrease of $1.1 million in outside professional services was largely offset by an increase of $0.5 million in variable compensation expense and $0.4 million in personnel and facility-related expenses, driven by an increase in headcount in comparison to the prior year period. Headcount increased by 12 employees to 157 employees at September 28, 2014 compared to 145 employees at September 29, 2013. Restructuring and Other Charges We incurred restructuring and other charges of $1.4 million during the three months ended September 28, 2014, as compared to a charge of $0.4 million recognized in the three months ended September 29, 2013. The charges recognized during the three months ended September 28, 2014 are primarily attributable to expenses associated with the early termination of a lease agreement in Canada. During the three months ended September 29, 2013, we recognized transition charges of $0.4 million relating to the AirCard acquisition. For further discussion of restructuring and other charges, refer to Note 15, Restructuring and Other Charges, of the notes to unaudited condensed consolidated financial statements. Litigation Reserves, Net We recorded a litigation reserve charge of $69,000 during the three months ended September 28, 2014, as compared to a charge of $0.3 million recognized in the three months ended September 29, 2013. The decrease was primarily due to a charge of $0.3 million for various incremental fees we were obligated to pay related to the Ericsson judgment in the three months ended September 29, 2013. In comparison, $69,000 was recognized during the third quarter of 2014 for estimated costs related to the settlement of lawsuits. For a detailed discussion of our litigation matters, refer to Note 9, Commitments and Contingencies, in the notes to unaudited condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. 40-------------------------------------------------------------------------------- Table of Contents Impairment Charges The Company did not recognize any impairment charges during the three months ended September 28, 2014. A charge of $2.0 million was recognized in the three months ended September 29, 2013. Impairment charges decreased for the three months ended September 28, 2014 due to the timing that certain IPR&D projects obtained in the AirCard acquisition were abandoned and deemed to be fully impaired in 2013. All of the remaining IPR&D projects obtained as part of the acquisition reached technical feasibility and were reclassified to definite-lived intangible assets as of June 29, 2014. Interest Income and Other Income, Net Interest income represents amounts earned on our cash, cash equivalents and short-term investments. Other income, net, primarily represents gains and losses on transactions denominated in foreign currencies and other miscellaneous income and expenses. The following table presents interest income and other income, net, for the periods indicated: Three Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Interest income $ 68 (4.2 )% $ 71 Other income, net 2,246 ** 511 Total interest income and other income, net $ 2,314 ** $ 582 Interest income decreased slightly to $68,000 for the three months ended September 28, 2013 from $71,000 for the three months ended September 29, 2013. The decrease was due primarily to the reduction in our cash, cash equivalents and short term investment balance resulting from repurchase of shares in the fourth quarter of 2013 and the nine months ended September 28, 2014. Other income, net, increased $1.7 million, to $2.2 million for the three months ended September 28, 2014 from $0.5 million for the three months ended September 29, 2013. The increase was due primarily to $2.8 million received relating to the execution of a litigation settlement agreement during the quarter, partially offset by foreign currency losses incurred. For a detailed discussion of our litigation matters, hedging program and related foreign currency contracts, refer to Note 9, Commitments and Contingencies, and Note 6, Derivative Financial Instruments, in the notes to unaudited condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. Provision for Income Taxes The income tax provision for the three months ended September 28, 2014 was $8.8 million or an effective tax rate of 30.6%, compared to $10.4 million, or an effective tax rate of 41.8%, for the same period a year ago. The decrease in the effective tax rate for the three month period ended September 28, 2014, compared to the same period in the prior year was primarily caused by an increase in earnings in jurisdictions with tax rates lower than the U.S. statutory rate. The improved earnings in these jurisdictions resulted in a decrease in the forecasted effective tax rate compared to the same period of the prior year. Accordingly, the three months ended September 28, 2014 includes a tax benefit for the reduction in the forecasted rate on cumulative earnings. During the three month period ended September 29, 2013, we incurred losses in a jurisdiction where no tax benefit could be recorded. As a result, the forecasted earnings from this jurisdiction were excluded from the determination of the effective tax rate. The exclusion of these losses increased the effective tax rate for the three months ended September 29, 2013. The decrease in the effective tax rate for the three months ended September 28, 2014 was partially offset by changes in US tax law related to the research tax credit. On December 31, 2013 provisions allowing for the research tax credit expired. As of September 28, 2014, the research credit has not been reinstated. Accordingly, no tax benefit has been recorded during the three months ended September 28, 2014. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our future foreign tax rate could be affected by changes in the composition in earnings in countries with tax rates differing from the U.S. federal rate. We are under examination in various US and foreign jurisdictions. Net Income Net income increased $5.6 million, or 38.5%, to $20.0 million for the three months ended September 28, 2014 from $14.5 million for the three months ended September 29, 2013. This increase was primarily due to an increase of $1.7 million in other income, net, primarily attributable to gain on litigation settlement, and reduction in operating expenses of $1.6 million, primarily 41-------------------------------------------------------------------------------- Table of Contents attributable to a reduction in projects and outside professional services of $3.3 million, partially offset by increases in restructuring expense of $1.0 million and personnel and facility-related expenses of $0.6 million, and decrease of $1.5 million in the provision for income taxes. Segment Information A description of our products and services, as well as segment financial data, for each segment and a reconciliation of segment contribution income to income before income taxes can be found in Note 12, Segment Information, Operations by Geographic Area and Significant Customers, in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. Future changes to our organizational structure or business may result in changes to the reportable segments disclosed. The discussions below include the results of each of our segments for the three months ended September 28, 2014 with the comparable reporting periods in the preceding year. Retail Three Months Ended September 28, September 29, 2014 % Change 2013 ( in thousands, except percentage data) Net revenue $ 131,341 0.8 % $ 130,301 Percentage of net revenue 37.1 % 36.0 % Contribution income $ 21,813 12.9 % $ 19,317 Contribution margin 16.6 % 14.8 % Net revenue increased $1.0 million, or 0.8%, to $131.3 million for the three months ended September 28, 2014 from $130.3 million for the three months ended September 29, 2013. The increase was due primarily to slightly higher gross shipments of broadband gateways, partially offset by a reduction in shipments of multimedia, powerline and home security monitoring and automation products. Geographically, we experienced an increase in APAC and a decrease in EMEA and the Americas. We continue to see strong end-user demand for our retail products, however our net revenue was partially constrained by a reduction in weeks of inventory on-hand with our U.S. retail channel partners. Contribution income increased $2.5 million, or 12.9%, to $21.8 million for the three months ended September 28, 2014 from $19.3 million for the three months ended September 29, 2013. The increase was due primarily to the slight increase in net revenue, and incremental operating expense reductions experienced in the current quarter. We continue to focus on our core networking business, demonstrated by the strong product introductions during the three months ended September 28, 2014 including the Nighthawk X4, in effort to grow net revenue as well as contribution income for the segment. Commercial Three Months Ended September 28, September 29, 2014 % Change 2013 (in thousands, except percentage data) Net revenue $ 71,974 (6.5 )% $ 76,957 Percentage of net revenue 20.4 % 21.3 % Contribution income $ 15,112 (10.6 )% $ 16,903 Contribution margin 21.0 % 22.0 % Net revenue decreased $5.0 million, or 6.5%, to $72.0 million for the three months ended September 28, 2014 from $77.0 million for the three months ended September 29, 2013. The decrease was due primarily to a reduction in gross shipments of network storage, wireless products and switches. Geographically, we experienced an increase in EMEA and a decrease in the Americas and APAC. Commercial net revenue was impacted by our proactive efforts to reduce weeks of channel inventory on-hand with our U.S. distribution partners in the three months ended September 28, 2014. Contribution income decreased $1.8 million, or 10.6%, to $15.1 million for the three months ended September 28, 2014 from $16.9 million for the three months ended September 29, 2013. The decrease was due primarily to the reduction in net revenue and a slight increase in sales and marketing expenses. We are working to strengthen our position through increased sales and 42-------------------------------------------------------------------------------- Table of Contents marketing efforts and more focused coordination with our channel partners around the world to drive growth for net revenue as well as contribution income for the segment. Service Provider Three Months Ended September 28, September 29, 2014 % Change 2013 ( in thousands, except percentage data) Net revenue $ 150,023 (3.0 )% $ 154,637 Percentage of net revenue 42.5 % 42.7 % Contribution income $ 14,164 13.5 % $ 12,474 Contribution margin 9.4 % 8.1 % Net revenue decreased $4.6 million, or 3.0%, to $150.0 million for the three months ended September 28, 2014 from $154.6 million for the three months ended September 29, 2013. The decrease was due primarily to a slight reduction in gross shipments of our home wireless products, partially offset by an increase in shipments of our broadband gateways. Geographically, we experienced growth in APAC and EMEA and a slowdown in the Americas driven, in part, by weakness in North American carrier spending. Contribution income increased $1.7 million, or 13.5%, to $14.2 million for the three months ended September 28, 2014 from $12.5 million for the three months ended September 29, 2013. The increase was due primarily to the reduction in excess and obsolete inventory charges of $1.0 million and operating expenses of $0.7 million, partially offset by the decrease in net revenue compared to the prior year period. Nine Months Ended September 28, 2014 Compared to Nine Months Ended September 29, 2013 Net Revenue by Geographic Segment Nine Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Americas $ 576,217 (0.3 )% $ 578,011 Percentage of net revenue 55.4 % 57.0 % EMEA $ 315,650 0.9 % $ 312,712 Percentage of net revenue 30.3 % 30.9 % APAC $ 148,466 21.4 % $ 122,290 Percentage of net revenue 14.3 % 12.1 % Total net revenue $ 1,040,333 2.7 % $ 1,013,013 Americas net revenue decreased $1.8 million, or 0.3%, to $576.2 million for the nine months ended September 28, 2014 from $578.0 million for the nine months ended September 29. 2013. The decrease was driven primarily by a reduction in sales of our home wireless, multimedia, network storage, security monitoring automation products and switches, partially offset by an increase in sales of our mobile products. Net revenue for mobile products increased for the nine months ended September 28, 2014 as a result of the AirCard acquisition which was completed on April 2, 2013. In contrast to 2013, the positive effect of the acquisition is included in our results for the entire nine months ended September 28, 2014. In our retail and distribution channels, we continue to see strong demand for our products. However, we are managing our inventory levels at our U.S. distribution partners to be more aligned with historic levels, which has contributed to the decline in the Americas net revenue for the nine months ended September 28, 2014 compared to the year ago period. EMEA net revenue increased $2.9 million, or 0.9%, to $315.7 million for the nine months ended September 28, 2014 from $312.7 million for the nine months ended September 29. 2013. The increase was driven primarily by an increase in sales of our home wireless products, partially offset by a reduction in sales of our mobile products. In Central Europe, average weeks of channel inventory on-hand increased over the nine month period ended September 28, 2014 compared to prior year, contributing to the increase in net revenue for the nine months ended September 28, 2014 compared to the year ago period. These positive effects to 43-------------------------------------------------------------------------------- Table of Contents net revenue were partially offset by challenges resulting from the macro-economic environment, increased competition and pricing pressures in Europe experienced over the past nine months. APAC net revenue increased $26.2 million, or 21.4%, to $148.5 million for the nine months ended September 28, 2014 from $122.3 million for the nine months ended September 29. 2013. The increase was driven primarily by an increase in sales of our home wireless and mobile products. Net revenue for mobile products specifically increased for the nine months ended September 28, 2014 as a result of the AirCard acquisition which was completed on April 2, 2013. In contrast to 2013, the positive effect of the acquisition is included in our results for the entire nine months ended September 28, 2014. Cost of Revenue and Gross Margin Nine Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Cost of revenue $ 742,889 3.2 % $ 720,187 Gross margin percentage 28.6 % 28.9 % Cost of revenue increased $22.7 million, or 3.2%, to $742.9 million for the nine months ended September 28, 2014 from $720.2 million for the nine months ended September 29, 2013. The increase was due primarily to the increase in net revenue and related product costs driven by higher shipments, combined with an increase in excess and obsolete inventory charges of $2.2 million and amortization expense of $1.2 million relative to the prior year period. Our gross margin decreased slightly to 28.6% for the nine months ended September 28, 2014 from 28.9% for the nine months ended September 29, 2013. The decrease in gross margin percentage was primarily attributable to the increase in segment product mix toward service provider, which generally maintains lower margins. Net revenue from service providers increased as a percentage of net revenue to 43.6% in the nine months ended September 28, 2014, compared to 39.8% in the nine months ended September 29, 2013. Operating Expenses Research and Development Nine Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data)Research and development expense $ 67,994 8.5 % $ 62,639 Percentage of net revenue 6.5 % 6.2 % Research and development expense increased $5.4 million, or 8.5%, to $68.0 million for the nine months ended September 29, 2014 from $62.6 million for the nine months ended September 28, 2013. The increase was due primarily to an increase of $3.6 million in personnel and facility-related expenses driven by the overall growth in research and development headcount in comparison to prior year, and an increase of $2.0 million in variable compensation. In 2013, headcount increased due to the AirCard and Arada acquisitions which were completed in the second quarter. The increase, partially offset by our restructuring efforts initiated in the fourth quarter of 2013, resulted in an overall higher headcount during the nine months of 2014 in comparison to the same period a year ago. Average headcount for the nine months ended September 28, 2014 was approximately 352 compared to 344 in the prior year. Sales and Marketing Nine Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Sales and marketing expense $ 117,373 1.0 % $ 116,260 Percentage of net revenue 11.3 % 11.4 % 44-------------------------------------------------------------------------------- Table of Contents Sales and marketing expense increased $1.1 million, or 1.0%, to $117.4 million for the nine months ended September 28, 2014 from $116.3 million for the nine months ended September 29, 2013. The increase was due primarily to an increase of $1.5 million in personnel-related expense, driven primarily by additional stock-based compensation expense recognized relating to the modification of equity awards in connection with the departure of the retail business unit general manager, $1.3 million in variable compensation expense, and $0.7 million in intangible amortization, partially offset by a decrease of $2.4 million in projects and professional services, due primarily to a reduction in technical support spending. General and Administrative Nine Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data)General and administrative expense $ 34,995 (4.3 )% $ 36,576 Percentage of net revenue 3.4 % 3.6 % General and administrative expense decreased $1.6 million, or 4.3%, to $35.0 million for the nine months ended September 28, 2014 from $36.6 million for the nine months ended September 29, 2013. The decrease was due primarily to a $2.9 million decrease in outside professional services, primarily resulting from the Arada and AirCard acquisitions and the Ericsson litigation incurred in 2013, partially offset by a $1.0 million increase in variable compensation expense. Restructuring and Other Charges We incurred charges of $2.2 million in restructuring and other charges during the nine months ended September 28, 2014, as compared to charges of $2.0 million recognized for the nine months ended September 29, 2013. During the first quarter of 2014, we recognized restructuring charges of $0.8 million in one-time separation charges associated with the departure of the retail business unit general manager. During the third quarter of 2014, we recognized a charge of $1.4 million relating primarily to expenses associated with the early termination of a lease agreement in Canada. During the nine months ended September 29, 2013, the Company recognized transition charges of $1.8 million related to the AirCard acquisition completed in the second quarter of 2013 and $0.2 million in restructuring charges related to an office lease exit liability associated with the AVAAK acquisition completed in the second quarter of 2012. For further discussion of restructuring and other charges, refer to Note 15, Restructuring and Other Charges, of the notes to unaudited condensed consolidated financial statements. Litigation Reserves, Net We recorded a litigation reserve charge of $0.3 million during the nine months ended September 28, 2014, as compared to a charge of $3.9 million recognized in the nine months ended September 29, 2013. The decrease was due primarily to the timing of the Ericsson judgment in 2013. During the second quarter of 2013, judgment in the Ericsson matter was received, resulting in the recognition of litigation charges of $3.6 million. During the three months ended September 29, 2013, we recorded 0.3 million for various incremental fees we were obligated to pay relating to the judgment. In comparison, $0.3 million was recognized during the nine months ended September 28, 2014 for estimated costs related to the settlement of lawsuits. For a detailed discussion of our litigation matters, refer to Note 9, Commitments and Contingencies, in the notes to unaudited condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. Impairment Charges The Company did not recognize any impairment charges during the nine months ended September 28, 2014. A charge of $2.0 million was recognized in the nine months ended September 29, 2013. Impairment charges decreased for the nine months ended September 28, 2014 due to the timing that certain IPR&D projects obtained in the AirCard acquisition were abandoned and deemed to be fully impaired in 2013. All of the remaining IPR&D projects obtained as part of the acquisition reached technical feasibility and were reclassified to definite-lived intangible assets as of June 29, 2014. 45-------------------------------------------------------------------------------- Table of Contents Interest Income and Other Income, Net Nine Months Ended September 28, September 29, 2014 % Change 2013 (In thousands, except percentage data) Interest income $ 174 (44.8 )% $ 315 Other income, net 1,911 ** 37 Total interest income and other income, net $ 2,085 ** $ 352 Interest income decreased $0.1 million, or 44.8%, to $0.2 million for the nine months ended September 28, 2014 from $0.3 million for the nine months ended September 29, 2013. The decrease was due primarily to the reduction in our cash, cash equivalents and short term investment balance attributable to the AirCard and Arada acquisitions completed in the second quarter of 2013 and repurchase of shares in the fourth quarter of 2013 and the nine months ended September 28, 2014. Other income, net increased to $1.9 million for the nine months ended September 28, 2014 from $37,000 for the nine months ended September 29, 2013. The increase was due primarily to $2.8 million received relating to the execution of a litigation settlement agreement during the quarter, partially offset by foreign currency losses incurred. For a detailed discussion of our litigation matters, hedging program and related foreign currency contracts, refer to Note 9, Commitments and Contingencies, and Note 6, Derivative Financial Instruments, in the notes to unaudited condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. Provision for Income Taxes The income tax provision for the nine months ended September 28, 2014 was $27.6 million or an effective tax rate of 36.0%, compared to $26.1 million, or an effective tax rate of 37.3%, for the same period a year ago. The decrease in the effective tax rate for the nine month period ended September 28, 2014, compared to the same period in the prior year was primarily caused by an increase in earnings in jurisdictions with tax rates lower than the U.S. statutory rate. The improved earnings in these jurisdictions resulted in a decrease in the forecasted effective tax rate compared to the same period of the prior year. Accordingly, the three months ended September 28, 2014 includes a tax benefit for the reduction in the forecasted rate on cumulative earnings. During the nine month period ended September 29, 2013, we incurred losses in a jurisdiction where no tax benefit could be recorded. As a result, the forecasted earnings from this jurisdiction were excluded from the determination of the effective tax rate. The exclusion of these losses increased the effective tax rate for the nine months ended September 29, 2013. The decrease was offset by changes in US tax law related to the research tax credit. On December 31, 2011 provisions in the tax law allowing for the research tax credit expired. On January 2, 2013 the American Taxpayer Relief Act of 2012 reinstated the research credit, retroactive to January 1, 2012 through December 31, 2013. Accordingly, the entire benefit for the 2012 research credit of approximately $0.7 million was recognized during the nine months ended September 29, 2013. Additionally, we recorded credits related to 2013 in its tax provision for the nine months ended September 29, 2013. As of September 28, 2014, the research credit has not been reinstated. Accordingly, no tax benefit has been recorded during the nine months ended September 28, 2014. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our future foreign tax rate could be affected by changes in the composition in earnings in countries with tax rates differing from the U.S. federal rate. We are under examination in various US and foreign jurisdictions. Net Income Net income increased $5.4 million, or 12.2%, to $49.1 million for the nine months ended September 28, 2014 from $43.8 million for the nine months ended September 29, 2013. This increase was primarily due to increases of $4.6 million in gross profit, and $1.9 million in other income, net, primarily attributable to gain on litigation settlement. The changes were partially offset by an increase of $1.5 million in the provision for income taxes. 46-------------------------------------------------------------------------------- Table of Contents Segment Information Retail Nine Months Ended September 28, September 29, 2014 % Change 2013 ( in thousands, except percentage data) Net revenue $ 360,236 (3.7 )% $ 374,018 Percentage of net revenue 34.6 % 36.9 % Contribution income $ 51,222 (4.6 )% $ 53,696 Contribution margin 14.2 % 14.4 % Net revenue decreased $13.8 million, or 3.7%, to $360.2 million for the nine months ended September 28, 2014 from $374.0 million for the nine months ended September 29, 2013. The decrease was due primarily to a reduction in gross shipments of our multimedia, home wireless, powerline and home security and monitoring products, partially offset by an increase in gross shipments of broadband gateways. Geographically, we experienced an increase in APAC and a decrease in EMEA and the Americas. We continue to see strong end-user demand for our retail products, however our net revenue was partially constrained by a reduction in weeks of inventory on-hand with our U.S retail channel partners. Contribution income decreased $2.5 million, or 4.6%, to $51.2 million for the nine months ended September 28, 2014 from $53.7 million for the nine months ended September 29, 2013. The decrease was due primarily to the reduction in net revenue and increase in excess and obsolete inventory charges, which increased $1.2 million during the nine months ended September 28, 2014. Commercial Nine Months Ended September 28, September 29, 2014 % Change 2013 (in thousands, except percentage data) Net revenue $ 226,284 (4.2 )% $ 236,254 Percentage of net revenue 21.8 % 23.3 % Contribution income $ 51,781 1.2 % $ 51,190 Contribution margin 22.9 % 21.7 % Net revenue decreased $10.0 million or 4.2%, to $226.3 million for the nine months ended September 28, 2014 from $236.3 million for the nine months ended September 29, 2013. The decrease was due primarily to a reduction in gross shipments of our network storage and wireless products, partially offset by an increase in shipments of switches. Geographically, we experienced an increase in EMEA and a decrease in the Americas and APAC. Commercial net revenue was also impacted by our proactive efforts to reduce weeks of channel inventory on-hand with our U.S distribution partners in the nine months ended September 28, 2014. Contribution income increased $0.6 million, or 1.2%, to $51.8 million for the nine months ended September 28, 2014 from $51.2 million for the nine months ended September 29, 2013. The increase was due primarily to reduction in freight costs of $2.6 million, partially offset by the reduction in net revenue for the nine months ended September 28, 2014 compared to the prior year period. 47-------------------------------------------------------------------------------- Table of Contents Service Provider Nine Months Ended September 28, September 29, 2014 % Change 2013 ( in thousands, except percentage data) Net revenue $ 453,813 12.7 % $ 402,741 Percentage of net revenue 43.6 % 39.8 % Contribution income $ 42,918 19.0 % $ 36,055 Contribution margin 9.5 % 9.0 % Net revenue increased $51.1 million or 12.7%, to $453.8 million for the nine months ended September 28, 2014 from $402.7 million for the nine months ended September 29, 2013. The increase was due primarily to an increase in gross shipments of our mobile products. Net revenue for mobile products increased for the nine months ended September 28, 2014 as a result of the AirCard acquisition which was completed on April 2, 2013. In contrast to 2013, the positive effect of the acquisition is included in our results for the entire nine months ended September 28, 2014. Contribution income increased $6.9 million, or 19.0%, to $42.9 million for the nine months ended September 28, 2014 from $36.1 million for the nine months ended September 29, 2013. The increase was due primarily to the increase in gross profit, partially offset by an increase in operating expenses of $6.6 million, primarily related to research and development and sales and marketing, compared to the prior year period. Liquidity and Capital Resources Our cash and cash equivalents balance decreased from $143.0 million as of December 31, 2013 to $141.8 million as of September 28, 2014. Our short-term investments, which represent the investment of funds available for current operations, decreased from $105.1 million as of December 31, 2013 to $100.8 million as of September 28, 2014, due primarily to the proceeds generated from the maturity of treasuries being used to fund the repurchase of common stock during the period. Operating activities during the nine months ended September 28, 2014 provided cash of $67.6 million, compared to $72.8 million provided in the nine months ended September 29, 2013, resulting primarily from net income. Investing activities during the nine months ended September 28, 2014 used cash of $9.9 million, resulting primarily from final payment of $1.1 million relating to the Arada acquisition and purchases of property and equipment of $13.4 million, partially offset by net proceeds from the sale and maturity of short-term investments of $4.6 million. During the nine months ended September 28, 2014, financing activities used cash of $58.9 million, primarily due to the repurchase of common stock, partially offset by proceeds from the issuance of common stock upon exercise of stock options and our employee stock purchase program. Our days sales outstanding ("DSO") increased from 69 days as of December 31, 2013 to 72 days as of September 28, 2014. DSO of 72 days is in the normal range for the third quarter of the year. Our accounts payable decreased from $114.5 million at December 31, 2013 to $92.1 million at September 28, 2014. The decrease was primarily attributable to timing of payments. Inventory decreased by $18.0 million from $224.5 million at December 31, 2013 to $206.5 million at September 28, 2014. In the three months ended September 29, 2014 we experienced annualized ending inventory turns of approximately 4.9, slightly up from 4.6 turns in the three months ended December 31, 2013. We enter into foreign currency forward-exchange contracts, which typically mature in three to five months, to hedge a portion of our exposure to foreign currency fluctuations of foreign currency-denominated revenue, costs of revenue, certain operating expenses, receivables, payables, and cash balances. We record in the unaudited condensed consolidated balance sheet at each reporting period the fair value of our forward-exchange contracts and record any fair value adjustments in our unaudited condensed consolidated statements of operations and in our unaudited condensed consolidated balance sheet. Gains and losses associated with currency rate changes on hedge contracts that are non-designated under the authoritative guidance for derivatives and hedging are recorded within other income, net, offsetting foreign exchange gains and losses on our monetary assets and liabilities. Gains and losses associated with currency rate changes on hedge contracts that are cash flow hedges under the authoritative guidance for derivatives and hedging are recorded within cumulative other comprehensive income until the related revenue, costs of revenue, or expenses are recognized. In October 2008, the Board of Directors authorized management to repurchase up to 6.0 million shares of our common stock in the open market. The stock repurchase authorization does not have an expiration date and the pace of repurchase activity is at 48-------------------------------------------------------------------------------- Table of Contents the discretion of management and contingent on a number of factors, including levels of cash generation from operations, cash requirements for acquisitions and the price of our common stock. During the nine months ended September 28, 2014, we repurchased and retired, reported based on trade date, approximately 2.1 million shares of common stock at a cost of $68.6 million under this authorization. This leaves approximately 0.7 million shares remaining in our buyback program and we expect to continue to repurchase opportunistically. As of September 28, 2014, common stock repurchases at a cost of $2.2 million were pending settlement. We did not repurchase any shares during the nine months ended September 29, 2013. On October 17, 2014, the Board of Directors authorized the management to repurchase up to 3.0 million shares of our outstanding common stock. This is incremental to the approximate 0.7 million remaining on our previous share repurchase program. In the nine months ended September 28, 2014, we repurchased, as reported based on trade date, approximately 50,000 shares of common stock at a cost of $1.6 million under a repurchase program to help administratively facilitate the withholding and subsequent remittance of personal income and payroll taxes for individuals receiving restricted stock units ("RSUs"). Similarly, during the nine months ended September 29, 2013, we repurchased approximately 14,000 shares, or $0.5 million of our common stock under the same program to help facilitate tax withholding for RSUs. These shares were retired upon repurchase. Based on our current plans and market conditions, we believe that our existing cash, cash equivalents and short-term investments will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months. However, we may require or desire additional funds to support our operating expenses and capital requirements or for other purposes, such as acquisitions, and may seek to raise such additional funds through public or private equity financing or from other sources. We cannot assure you that additional financing will be available at all or that, if available, such financing would be obtainable on terms favorable to us and would not be dilutive. Our future liquidity and cash requirements will depend on numerous factors, including the introduction of new products and potential acquisitions of related businesses or technology. Contractual Obligations There have been no material changes during the nine months ended September 28, 2014 to the contractual obligations disclosed in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. We lease office space, cars and equipment under non-cancelable operating leases with various expiration dates through December 2026. The terms of certain of our facility leases provide for rental payments on a graduated scale. We recognize rent expense on a straight-line basis over the lease period and have accrued for rent expense incurred but not paid. We enter into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 50% of the orders are cancelable by giving notice 46 to 60 days prior to the expected shipment date and 25% of orders are cancelable by giving notice 31 to 45 days prior to the expected shipment date. Orders are non-cancelable within 30 days prior to the expected shipment date. At September 28, 2014, we had approximately $193 million in non-cancelable purchase commitments with suppliers. We establish a loss liability for all products we do not expect to sell for which we have committed purchases from suppliers. Such losses have not been material to date. From time to time our suppliers procure unique complex components on our behalf. If these components do not meet specified technical criteria or are defective, we should not be obligated to purchase the materials. However, disputes may arise as a result and significant resources may be spent resolving such disputes. As of September 28, 2014, we had $15.2 million of total gross unrecognized tax benefits and related interest. The timing of any payments that could result from these unrecognized tax benefits will depend upon a number of factors. The possible reduction in liabilities for uncertain tax positions in multiple jurisdictions that may impact the statement of operations in the next 12 months is approximately $0.8 million, excluding the interest, penalties and the effect of any related deferred tax assets or liabilities. Off-Balance Sheet Arrangements As of September 28, 2014, we did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Critical Accounting Policies and Estimates For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our unaudited condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no changes to our critical accounting policies and estimates during the nine months ended September 28, 2014. Recent Accounting Pronouncements 49-------------------------------------------------------------------------------- Table of Contents See Note 2, Summary of Significant Accounting Policies, in Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Report on Form 10-Q, for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial condition and results of operations, which are hereby incorporated by reference. |