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TRIMBLE NAVIGATION LTD /CA/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The discussion and analysis of our 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 U. S. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. We base our estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on our best knowledge of current events and actions that may impact us in the future, actual results may be different from the estimates. CRITICAL ACCOUNTING POLICIES AND ESTIMATES There have been no material changes to our significant accounting polices during the first three quarters of fiscal 2014 from those disclosed in our 2013 Form 10-K. Recent Accounting Pronouncements In July 2013, the Financial Accounting Standards Board ("FASB") issued a new accounting standard that generally requires the presentation of certain unrecognized tax benefits as reductions to deferred tax assets rather than as liabilities in the Condensed Consolidated Balance Sheets when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. We adopted this new standard on a prospective basis in the first quarter of fiscal 2014. The implementation had no material impact on our Condensed Consolidated Financial Statements. In April 2014, the FASB issued amendments to guidance for reporting discontinued operations and disposals of components of an entity. The amended guidance requires that a disposal representing a strategic shift that has (or will have) a major effect on an entity's financial results or a business activity classified as held for sale should be reported as discontinued operations. The amendments also expand the disclosure requirements for discontinued operations and add new disclosures for individually significant dispositions that do not qualify as discontinued operations. The amendments are effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014; however, early adoption is permitted as is a retrospective application. We will adopt the amendments beginning in the first quarter of fiscal 2015. We do not anticipate a material impact on our Condensed Consolidated Financial Statements as a result of this change. In May 2014, the FASB issued a comprehensive new revenue recognition standard that will amend the current revenue recognition guidance under U.S. GAAP. We will adopt this standard in the first quarter of fiscal 2017. Early adoption is not permitted. Entities have the option of using either a full retrospective or modified retrospective approach for the adoption of the standard. We are unable to determine at this time whether adoption of the standard will have a material impact on our Condensed Consolidated Financial Statements. EXECUTIVE LEVEL OVERVIEW Trimble's focus is on integrating its broad technological and application capabilities to create system-level solutions that transform how work is done within the industries we serve, enhancing productivity, accuracy, safety and regulatory compliance for our customers. The majority of our markets are end-user markets, including engineering and construction firms, surveyors, farmers, governmental organizations, energy and utility companies and organizations that must manage fleets of mobile workers and assets. We also provide components to original equipment manufacturers to incorporate into their products. In the end-user markets, we provide stand-alone systems which may consist of software, hardware or some combination of the two, as well as integrated enterprise or workflow solutions which address the entire work process. We manage our operations in the following four segments: Engineering and Construction, Field Solutions, Mobile Solutions, and Advanced Devices. 20-------------------------------------------------------------------------------- Table of Contents Solutions targeted at the end-user make up a significant majority of our revenue. With the exception of our Mobile Solutions and Advanced Devices segments, our products are primarily sold through dealer channels, and it is crucial that we maintain proficient, global, third-party distribution channels. Some of the more significant developments in our business during the quarter included: Engineering and Construction Segment We acquired Gehry Technologies, which provides design and project management solutions, consulting services, and project collaboration software tools to enable designers, builders and operators to collaborate more efficiently. We collaborated with Bentley Systems to provide advanced levels of information mobility in road and site construction. The solution delivers open exchange of infrastructure information between Bentley's i-model technology and Trimble Business Center-HCE office software. We also announced the integration of Trimble's Mechanical, Electrical and Plumbing (MEP) module for service work order management and billing with Trimble's Field Service Management (FSM) solutions. The integration enables MEP service contractors to efficiently and accurately manage quotes and work orders through to workforce scheduling and invoicing, leading to improved billing and customer satisfaction. We acquired London-based Manhattan Software. The acquisition extends our portfolio of design-build-operate solutions by providing building owners, facilities and real estate managers with integrated, end-to-end systems for property, asset and facilities management. We acquired Load Systems International, Inc., a Canada-based manufacturer of crane safety instrumentation. The acquisition enhances our portfolio of technologies for improving safety, quality, transparency and efficiency of construction and maintenance projects. In the quarter we also continued to execute our global distribution strategy. We established new SITECH Technology Dealers in the U.S. for the Midwest, Kansas, Northwestern Missouri and Intermountain Region as well as in Romania, Ireland and the United Kingdom. We announced our new BuildingPoint global network of distribution partners focused on the building construction industry. We established BuildingPoint distributors in Illinois, Texas and Switzerland. Field Solutions Segment Within the agriculture market, we introduced Trimble OnSwath technology as part of the Autopilot™ automated steering system. Using OnSwath, the farmer can decrease idle driving time, fuel consumption, soil compaction, crop damage and working time in the field. We demonstrated our NextSwath technology, which enables any farm machine to calculate the best possible path to turn around and approach the next crop row or swath. The technology provides improved turning efficiency and repeatability, saving time and fuel costs. We released the new RainWave® Contour Map precipitation monitoring solution that maps precise rainfall amounts within an entire field or farm. Part of Trimble's Connected Farm™ Web-based management solution, this new functionality enables the farmer or trusted advisor to make better management decisions for irrigation planning, resource deployment and timing of applications for nutrient and pest management. We also launched Connected Farm Field, a field data management tool for the farmer; and Connected Farm Advisor, a field data management tool for the farmer's trusted advisor. The two applications make it easier to collect and manage data and easily collaborate through Connected Farm. We also introduced a new version of Trimble Connect cloud-based, Geographic Information System (GIS)-centric software for smart water infrastructure mapping and work management software. The release includes applications to enable water, wastewater and storm water utilities to visualize and efficiently manage their network maintenance and data collection activities. Mobile Solutions Segment We entered into a strategic alliance with 3Gtms, Inc., a privately-held provider of transportation management systems (TMS). The alliance includes an equity investment in 3Gtms by Trimble and a commercial reseller agreement with TMW Systems. Advanced Devices Segment In our Advanced Devices segment, we announced a global distribution agreement with Digi-Key Corporation to offer the ThingMagic embedded UHF RFID modules. 21-------------------------------------------------------------------------------- Table of Contents We also introduced the new Pacific Crest® XDL Rover 2, an advanced, high-speed, wireless data link built to withstand the rigors of GNSS/RTK surveying and precise positioning. The XDL Rover 2 is equipped with Bluetooth® wireless communication for ease in configuration and operation. It can be quickly configured with an Android device in the field and UHF data can be transmitted via Bluetooth to a paired host device for operational efficiency. RECENT BUSINESS DEVELOPMENTS The following companies or business assets were acquired during the fifteen months ended October 3, 2014 and are combined in our results of operations since the date of acquisition: Gehry Technologies On September 5, 2014, we acquired Gehry Technologies, headquartered in Los Angeles, California. Gehry Technologies is a provider of software and consulting services that transform the construction industry by further connecting the office to on-site construction technologies. Gehry Technologies' performance is reported under our Engineering and Construction business segment. Load Systems International On August 20, 2014, we acquired privately-held Load Systems International Inc (LSI), headquartered in Quebec City, Canada. LSI is a manufacturer of wireless and hardwired crane safety instrumentation. LSI's performance is reported under our Engineering and Construction business segment. Manhattan Software On August 15, 2014, we acquired privately-held Manhattan Software, headquartered in London, England. Manhattan Software is an industry provider in real estate and facility management software. Manhattan Software's performance is reported under our Engineering and Construction business segment. Omega Group On June 2, 2014, we acquired the assets of privately-held The Omega Group, headquartered in San Diego, California. The Omega Group is an industry provider of cloud-based and on-premise operational performance support software that integrates mapping, analytics, intelligence and mobile technologies, allowing public safety agencies to optimize patrol strategies and daily field work. Omega Group's performance is reported under our Mobile Solutions business segment. Mining Information Systems On June 2, 2014, we acquired privately-held MIS, headquartered in Perth, Australia. The acquisition will add enterprise-level information management capabilities to Trimble's portfolio of mining solutions. These enterprise-level capabilities can enable improved productivity, profitability, and safety by providing a more complete view of geospatial, productivity, workforce and cost data across functional areas to support better operational and strategic decision making. MIS's performance is reported under our Engineering and Construction business segment. MAYBIM On May 12, 2014, we acquired the assets of privately-held MAYBIM based in Provo, Utah. MAYBIM provides 3D Building Information Modeling services to contractors with a focus on mechanical, electrical and plumbing contractors across the U.S. MAYBIM's performance is reported under our Engineering and Construction business segment. WeoGeo On May 1, 2014, we acquired privately-held WeoGeo based in Portland, Oregon. WeoGeo is a provider of technology for managing spatial data in the online geospatial data marketplace. WeoGeo's performance is reported under our Engineering and Construction business segment. Field3D On March 10, 2014, we acquired SVS Innovations' (SVSi) construction software business and its advanced Field3D mobile technology based in Tampere, Finland. Field3D is an easy-to-use 3D collaboration software solution for BIM that works on mobile devices, enabling stakeholders in a construction workflow to access complete 3D model information for an entire building on smartphones and tablets. Field3D's performance is reported under our Engineering and Construction business segment. GeoDesy Kft On February 24, 2014, we acquired the assets of privately-held GeoDesy and GeoDesy Free Space Optics of Budapest, Hungary. GeoDesy is a European engineering and development company focused on delivering accessories for the geomatics, surveying, 22-------------------------------------------------------------------------------- Table of Contents mapping and construction industries. GeoDesy Kft's performance is reported under our Engineering and Construction business segment. C3 Consulting On November 26, 2013, we acquired the assets of privately-held C3 of Madison, Wisconsin. C3 Consulting is a provider of unique soil information as well as decision recommendations to farmers' trusted advisors-such as agronomists, Trimble resellers or Ag retail suppliers. C3 Consulting's performance is reported under our Field Solutions business segment. CSC On November 14, 2013, we acquired privately-held CSC (UK) Ltd. of Leeds, United Kingdom. CSC's products include software solutions for the analysis and design of steel and concrete buildings. CSC's performance is reported under our Engineering and Construction business segment. Asset Forestry Limited Assets On September 30, 2013, we acquired the assets of privately-held Asset Forestry Limited, a provider of forestry logistics software and services. The addition of Asset Forestry software and domain experience extends Trimble's portfolio of forestry logistics and optimization solutions, already in use in North America and Europe. Asset Forestry's performance is reported under our Mobile Solutions business segment. IQ Irrigation Assets On August 30, 2013, we acquired the assets of privately-held IQ Irrigation of Christchurch, New Zealand. IQ Irrigation is a provider of a hardware and software solution for controlling linear and pivot irrigation systems. IQ Irrigation's performance is reported under our Field Solutions business segment. RainWave and Hydro-Engineering On August 23, 2013, we acquired the assets of privately-held RainWave, LLC and Hydro-Engineering Solutions, LLC of Auburn, Alabama. RainWave provides precipitation monitoring services for agribusinesses, construction and engineering, government and consumer industries. Hydro-Engineering Solutions is a civil engineering company that specializes in hydrology and hydraulics. RainWave and Hydro-Engineering's performance is reported under our Field Solutions business segment. Seasonality of Business * Our individual segment revenue may be affected by seasonal buying patterns. Historically, the second fiscal quarter has been the strongest quarter for the Company driven by the construction buying season. However, as a result of diversification of our business into software and subscription revenue, we may experience less seasonality in the future. RESULTS OF OPERATIONS Overview The following table is a summary of revenue, gross margin and operating income for the periods indicated and should be read in conjunction with the narrative descriptions below. Third Quarter of First Three Quarters of 2014 2013 2014 2013 (Dollars in thousands) Revenue: Product $ 415,490 $ 401,565 $ 1,327,054 $ 1,240,232 Service 98,366 85,521 291,747 251,628 Subscription 70,940 69,416 212,915 197,046 Total revenue 584,796 556,502 1,831,716 1,688,906 Gross margin $ 316,773 $ 295,053 $ 998,236 $ 884,368 Gross margin % 54.2 % 53.0 % 54.5 % 52.4 % Operating income $ 11,089 $ 63,029 $ 183,934 $ 184,391 Operating income % 1.9 % 11.3 % 10.0 % 10.9 % 23-------------------------------------------------------------------------------- Table of Contents Revenue In the third quarter of fiscal 2014, total revenue increased by $28.3 million or 5%, as compared to the third quarter of fiscal 2013. Of this increase, product revenue increased $13.9 million or 3%, service revenue increased $12.8 million or 15%, and subscription revenue increased $1.5 million or 2%. In the first three quarters of fiscal 2014, total revenue increased by $142.8 million or 8%, as compared to the first three quarters of fiscal 2013. Of this increase, product revenue increased $86.8 million or 7%, service revenue increased $40.1 million or 16%, and subscription revenue increased $15.9 million or 8%. For the third quarter and the first three quarters of fiscal 2014, product revenue growth was driven primarily by growth across Engineering and Construction, partially offset by a decrease in Field Solutions product revenue primarily due to softness in agriculture markets. Service revenue was primarily driven by growth in Engineering and Construction and Mobile Solutions software maintenance fees. Subscription revenue was driven by growth in Mobile Solutions subscription services, partially offset by Virtual Site Solutions which was included in subscription revenue in the prior year. However, in fiscal 2014 Virtual Site Solutions became a joint venture, accounted for as an equity method investment. Revenue growth was primarily organic growth and to a lesser extent, the impact of the acquisitions which were not applicable in the prior period. We consider organic growth to include all revenue except for revenue associated with acquisitions made within the last four quarters. On a segment basis, Engineering and Construction revenue for the third quarter of fiscal 2014 increased $31.7 million or 10% and Mobile Solutions increased $7.6 million or 7%, partially offset by a decrease in Field Solutions of $10.7 million or 11% and Advanced Devices of $0.3 million or 1%, as compared to the third quarter of fiscal 2013. Engineering and Construction revenue for the first three quarters of fiscal 2014 increased $128.7 million or 14%, Mobile Solutions increased $23.4 million or 7%, Advanced Devices increased $12.1 million or 13%, partially offset by decrease in Field Solutions of $21.4 million or 6%, as compared to the corresponding period of fiscal 2013. For the third quarter and the first three quarters of fiscal 2014, revenue growth within Engineering and Construction was driven by growth due to continued market penetration and continued improvement in the U.S for construction and geospatial products. Mobile Solutions increased due to growth in the transportation and logistics market. Advanced Devices revenue increased primarily due to stronger sales of embedded and timing component products. Field Solutions revenue decreased primarily due to softness in agricultural markets. Gross Margin Gross margin varies due to a number of factors including product mix, pricing, distribution channel, production volumes and foreign currency translations. Gross margin increased by $21.7 million for the third quarter of fiscal 2014 and increased by $113.9 million for the first three quarters of fiscal 2014, as compared to the corresponding periods of fiscal 2013, primarily due to increased revenue in Engineering and Construction and to a lesser extent, Mobile Solutions. Gross margin as a percentage of total revenue for the third quarter of fiscal 2014 was 54.2%, as compared to 53.0% for the corresponding period of fiscal 2013, and was 54.5% for the first three quarters of fiscal 2014, as compared to 52.4% for the corresponding period of fiscal 2013. The increase was primarily due to an increase in sales of higher margin products, primarily software, maintenance, and subscription revenue, primarily due to organic growth, particularly in Engineering and Construction and in Mobile Solutions. Operating Income Operating income decreased by $51.9 million for the third quarter of fiscal 2014, as compared to the corresponding period of fiscal 2013, and decreased by $0.5 million for the first three quarters of fiscal 2014, as compared to the corresponding period of fiscal 2013. Operating income as a percentage of total revenue was 1.9% for the third quarter of fiscal 2014, as compared to 11.3% for the corresponding period of fiscal 2013, and was 10.0% for the first three quarters of fiscal 2014, as compared to 10.9% for the corresponding period of fiscal 2013. The decrease in operating income for the third quarter of fiscal 2014 was primarily due to a $51.3 million litigation reserve and the impact of acquisitions. The operating income for the first three quarters of fiscal 2014 was relatively flat, due to increased revenue and gross margin expansion, offset by a $51.3 million litigation reserve. The decrease in operating income percentages for both periods was primarily also due to the litigation reserve, partially offset by gross margin improvements due to higher margin software, maintenance, and subscription revenue, particularly in Engineering and Construction. Results by Segment To achieve distribution, marketing, production and technology advantages in our targeted markets, we manage our operations in the following four segments: Engineering and Construction, Field Solutions, Mobile Solutions and Advanced Devices. Operating income equals net revenue less cost of sales and operating expense, excluding general corporate expense, amortization of purchased 24-------------------------------------------------------------------------------- Table of Contents intangible assets, amortization of inventory step-up charges, acquisition costs and restructuring costs. Operating leverage is defined as an increase in operating income as a percentage of the increase in revenue. The following table is a summary of revenue and operating income by segment: Third Quarter of First Three Quarters of 2014 2013 2014 2013 (Dollars in thousands) Engineering and Construction Revenue $ 342,272 $ 310,611 $ 1,019,620 $ 890,928 Segment revenue as a percent of total revenue 58 % 56 % 56 % 53 % Operating income $ 70,553 $ 73,488 $ 219,952 $ 183,301 Operating income as a percent of segment revenue 21 % 24 % 22 % 21 % Field Solutions Revenue $ 88,791 $ 99,466 $ 341,412 $ 362,811 Segment revenue as a percent of total revenue 15 % 18 % 18 % 21 % Operating income $ 25,185 $ 31,373 $ 116,794 $ 134,271 Operating income as a percent of segment revenue 28 % 32 % 34 % 37 % Mobile Solutions Revenue $ 121,171 $ 113,570 $ 362,679 $ 339,258 Segment revenue as a percent of total revenue 21 % 20 % 20 % 20 % Operating income $ 18,209 15,276 $ 54,764 42,284 Operating income as a percent of segment revenue 15 % 13 % 15 % 12 % Advanced Devices Revenue $ 32,562 $ 32,855 $ 108,005 $ 95,909 Segment revenue as a percent of total revenue 6 % 6 % 6 % 6 % Operating income $ 9,091 $ 8,420 $ 32,850 $ 21,419 Operating income as a percent of segment revenue 28 % 26 % 30 % 22 % A reconciliation of our consolidated segment operating income to consolidated income before taxes follows: Third Quarter of First Three Quarters of 2014 2013 2014 2013 (Dollars in thousands) Consolidated segment operating income $ 123,038 $ 128,557 $ 424,360 $ 381,275 Unallocated corporate expense (68,567 ) (21,019 ) (115,241 ) (66,886 ) Amortization of purchased intangible assets (39,326 ) (41,618 ) (117,769 ) (120,713 ) Acquisition costs (4,056 ) (2,891 ) (7,416 ) (9,285 ) Consolidated operating income 11,089 63,029 183,934 184,391 Non-operating income (loss), net (3,934 ) 483 10,464 2,181 Consolidated income before taxes $ 7,155 $ 63,512 $ 194,398 $ 186,572 Unallocated corporate expense includes general corporate expense, amortization of acquisition-related inventory step-up, restructuring costs and litigation reserves of $52.0 million, of which $51.3 million relates to Recreational Data Services, Inc. as discussed further in legal proceedings. Engineering and Construction Engineering and Construction revenue increased by $31.7 million or 10% and $128.7 million or 14% for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. Segment operating income decreased by $2.9 million or 4% for the third quarter, and increased by $36.7 million or 20% for the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. 25-------------------------------------------------------------------------------- Table of Contents Revenue growth for the third quarter and the first three quarters of fiscal 2014 was driven primarily by continued organic growth due to global sales of construction and geospatial products, particularly in the U.S. The U.S. markets continued to improve, however, European markets demonstrated some slowness in growth. Increased market penetration contributed to growth due to continuing adoption of our products, particularly in the construction industry as technology is playing a broader role in increasing productivity and reducing costs. Our newer product solutions integrate both hardware and software technologies across an entire work flow. Segment operating income decreased for the third quarter primarily due to the impact of third quarter acquisitions. Segment operating income increased for the first three quarters primarily due to higher revenue and product mix, including higher software, maintenance and subscription revenue, partially offset by the impact of third quarter acquisitions. Field Solutions Field Solutions revenue decreased by $10.7 million or 11% and $21.4 million or 6% for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. Segment operating income decreased by $6.2 million or 20% and $17.5 million or 13% for the third quarter and the first three quarters of fiscal 2014, as compared to the corresponding periods in fiscal 2013. Field Solution revenue decreased for the third quarter and the first three quarters of fiscal 2014, primarily due to softness in agriculture markets where the market environment grew significantly more difficult in the quarter. On a macroeconomic level, commodity prices and farmer income are both down. Large cutbacks coming from elements of our distribution and OEM customers contributed to the sales slowdown in North America, South America and Europe. To the extent this trend continues, our results of operations will be further impacted. The agriculture decrease was partially offset by an increase in Geographic Information System (GIS) sales. Mobile Solutions Mobile Solutions revenue increased by $7.6 million or 7% and $23.4 million or 7% for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. Segment operating income increased by $2.9 million or 19% and $12.5 million or 30% for the third quarter and the first three quarters of fiscal 2014, as compared to the corresponding periods in fiscal 2013. Mobile Solutions revenue increased for the third quarter and the first three quarters of fiscal 2014, primarily due to continued organic growth in the transportation and logistics market, which focuses on enterprise solutions. The majority of the sales are in the U.S., however there is continuing focus on geographic expansion. Operating income increased due to increased revenue and product mix, including higher software, maintenance and subscription revenue. Advanced Devices Advanced Devices revenue decreased by $0.3 million or 1% for the third quarter, and increased by $12.1 million or 13% for the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. Segment operating income increased by $0.7 million or 8% and $11.4 million or 53% for the third quarter and the first three quarters of fiscal 2014, as compared to the corresponding periods in fiscal 2013. The flat revenue and operating income for the third quarter of fiscal 2014 was primarily due to decreased sales of inertial/GNSS positioning and orientation systems, offset by increased sales of timing components. The increase in revenue and operating income for the first three quarters of fiscal 2014 was due to increased sales of timing, inertial/GNSS positioning and orientation systems, and military specific products. 26-------------------------------------------------------------------------------- Table of Contents Research and Development, Sales and Marketing and General and Administrative Expense Research and development (R&D), sales and marketing (S&M) and general and administrative (G&A) expense are summarized in the following table: Third Quarter of First Three Quarters of 2014 2013 2014 2013 (Dollars in thousands) Research and development $ 78,954 $ 71,622 $ 237,137 $ 221,785 Percentage of revenue 14 % 13 % 13 % 13 % Sales and marketing $ 95,843 $ 85,507 $ 288,818 $ 254,437 Percentage of revenue 16 % 15 % 16 % 15 % General and administrative $ 111,399 $ 53,648 $ 230,196 $ 158,378 Percentage of revenue 19 % 10 % 13 % 10 % Total $ 286,196 $ 210,777 $ 756,151 $ 634,600 Percentage of revenue 49 % 38 % 41 % 38 % Overall, R&D, S&M and G&A expense increased by approximately $75.4 million and $121.6 million for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. Research and development expense increased by $7.3 million and $15.4 million for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. Research and development spending overall was at approximately 14% of revenue in the third quarter of fiscal 2014 and was approximately 13% of revenue in the third quarter of fiscal 2013 and the first three quarters of fiscal 2014 and 2013. The cost of software developed for external sale subsequent to reaching technical feasibility was not material and was expensed as incurred. The increase in R&D expense in the third quarter of fiscal 2014, as compared to the corresponding period of fiscal 2013 was primarily due to a $0.8 million increase in compensation related expense due to headcount increases, the inclusion of $3.5 million in expense from acquisitions not applicable in the prior corresponding period and a $3.0 million increase in other expense. The increase in R&D expense in the first three quarters of fiscal 2014, as compared to the corresponding period in fiscal 2013 was primarily due to a $2.4 million increase in compensation related expense due to headcount increases, the inclusion of $8.4 million in expense from acquisitions not applicable in the prior corresponding period and a $4.6 million increase in other expense. * We believe that the development and introduction of new products are critical to our future success and we expect to continue active development of new products. Sales and marketing expense increased by $10.3 million and $34.4 million for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods of fiscal 2013. Sales and marketing spending overall was at approximately 16% of revenue in both the third quarter and the first three quarters of fiscal 2014 and was approximately 15% of revenue in both the third quarter and first three quarters of fiscal 2013. The increase in Sales and marketing expense in the third quarter of fiscal 2014, as compared to the corresponding period of fiscal 2013 was primarily due to a $3.0 million increase in compensation related expense due to headcount increases, the inclusion $3.6 million in expense from acquisitions not applicable in the prior period, a $1.2 million increase in travel/marketing cost primarily due to global dealer meetings and trade shows and a $2.5 million increase in other expense. The increase in Sales and marketing expense in the first three quarters of fiscal 2014, as compared to the corresponding period in fiscal 2013 was primarily due to a $13.1 million increase in compensation related expense due to headcount increases, the inclusion of $8.1 million in expense from acquisitions not applicable in the prior corresponding period, a $6.5 million increase in travel/marketing cost primarily due to global dealer meetings and trade shows, a $1.2 million increase due to unfavorable foreign currency exchange rates and a $5.5 million increase in other expense. * Our future growth will depend in part on the timely development and continued viability of the markets in which we currently compete, as well as our ability to continue to identify and develop new markets for our products. General and administrative expense increased by $57.8 million and $71.8 million for the third quarter and the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods of fiscal 2013. General and administrative spending overall was at approximately 19% and 13% of revenue in the third quarter and the first three quarters of fiscal 2014, respectively, as compared to 10% in both the corresponding periods of fiscal 2013. 27-------------------------------------------------------------------------------- Table of Contents The increase in G&A expenses in the third quarter of fiscal 2014, as compared to the third quarter of fiscal 2013 was primarily due to a $51.3 million litigation reserve, the inclusion of $3.2 million in expense from acquisitions not applicable in the prior period, a $1.2 million increase in acquisition costs, a $1.1 million increase in bad debt expense and a $1.0 million increase in other expense. The increase in G&A expenses in the first three quarters of fiscal 2014, as compared to the corresponding period in fiscal 2013 was primarily due to a $51.3 million litigation reserve, the inclusion of $6.7 million in expense from acquisitions not applicable in the prior period, a $4.9 million increase in compensation related expense, a $2.0 million increase in bad debt expense, a $3.4 million increase in telecommunication expense and a $5.7 million increase in other expense, partially offset by a $2.2 million decrease in acquisition costs. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets was $39.3 million in the third quarter of fiscal 2014, as compared to $41.6 million in the third quarter of fiscal 2013. Of the total $39.3 million in the third quarter of fiscal 2014, $19.3 million is presented as a separate line within Operating expense and $20.1 million is presented as a separate line within Cost of sales in our Condensed Consolidated Statements of Income. The decrease was due to the expiration of amortization for prior acquisitions, partially offset by acquisitions not included in the third quarter of fiscal 2013. As of the third quarter of fiscal 2014, future amortization of intangible assets is expected to be $39.3 million during the remaining quarter of fiscal 2014, $150.3 million during 2015, $131.6 million during 2016, $110.0 million during 2017, $79.6 million during 2018 and $61.2 million thereafter. Non-operating Income (Loss), Net The components of non-operating income (loss), net, were as follows: Third Quarter of First Three Quarters of 2014 2013 2014 2013 (Dollars in thousands) Interest expense, net $ (2,975 ) $ (4,122 ) $ (9,822 ) $ (13,448 ) Foreign currency transaction loss (3,200 ) (157 ) (3,809 ) (1,126 ) Income from equity method investments, net 2,840 4,494 11,528 15,908 Other income (loss), net (599 ) 268 12,567 847 Total non-operating income (loss), net $ (3,934 ) $ 483 $ 10,464 $ 2,181 Non-operating income (loss), net decreased $4.4 million for the third quarter and increased $8.3 million for the first three quarters of fiscal 2014, respectively, as compared to the corresponding periods in fiscal 2013. The decrease for the third quarter of fiscal 2014 was primarily due to the impact of foreign currency transaction fluctuations and a decrease in profitability from joint ventures, partially offset by lower interest expense. The increase for the first three quarters of fiscal 2014 was primarily due to a gain on a partial equity sale of Virtual Site Solutions (included in Other income (loss), net) and lower interest expense, partially offset by lower profitability from joint ventures and the impact of foreign currency transaction fluctuations. Income Tax Provision Our effective income tax rate for the third quarter of fiscal 2014 was a tax benefit of 66%, as compared to a tax expense of 14% in the corresponding period in 2013, primarily due to the discrete tax benefit of a $51.3 million litigation reserve in the U.S. related to Recreational Data Services, Inc., slightly offset by differences in the geographic mix of pretax income and the expiration of the federal R&D credit. In the first three quarters of fiscal 2014, our effective income tax rate was 19% as compared to 15% in the corresponding period in 2013 due to the difference in the geographic mix of pretax income, the tax effect of a gain on a partial equity sale of VSS, and the expiration of the federal R&D credit, largely offset by the discrete tax benefit of a $51.3 million litigation reserve in the U.S. related to Recreational Data Services, Inc. Historically, our effective tax rate has been lower than the U.S. federal statutory rate of 35% primarily due to the favorable tax rates associated with certain earnings from operations in lower-tax jurisdictions. We have not provided U.S. taxes for all of such earnings due to the indefinite reinvestment of some of those earnings outside the U.S. OFF-BALANCE SHEET FINANCINGS AND LIABILITIES Other than lease commitments incurred in the normal course of business, we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out 28-------------------------------------------------------------------------------- Table of Contents of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not included in the Condensed Consolidated Financial Statements. Additionally, we do not have any interest in, or relationship with, any special purpose entities. In the normal course of business to facilitate sales of our products, we indemnify other parties, including customers, lessors and parties to other transactions with us, with respect to certain matters. We have agreed to hold the other party harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements were not material and no liabilities have been recorded for these obligations on the Condensed Consolidated Balance Sheets as of the third quarter of fiscal 2014 and fiscal year end 2013. LIQUIDITY AND CAPITAL RESOURCES Third Quarter of Fiscal Year End As of 2014 2013 (Dollars in thousands) Cash and cash equivalents $ 139,477 $ 147,227 Total debt 646,739 758,458 First Three Quarters of 2014 2013 (Dollars in thousands) Cash provided by operating activities $ 310,464 $ 278,408 Cash used in investing activities (202,443 ) (256,408 ) Cash used in financing activities (108,530 ) (62,395 ) Effect of exchange rate changes on cash and cash equivalents (7,241 ) (2,119 ) Net decrease in cash and cash equivalents $ (7,750 ) $ (42,514 ) Cash and Cash Equivalents As of the third quarter of fiscal 2014, cash and cash equivalents totaled $139.5 million as compared to $147.2 million as of fiscal year end 2013. Debt was $646.7 million as of the third quarter of fiscal 2014, as compared to $758.5 million as of fiscal year end 2013. * Our ability to continue to generate cash from operations will depend in large part on profitability, the rate of collections of accounts receivable, our inventory turns and our ability to manage other areas of working capital. * We believe that our cash and cash equivalents, together with borrowings under our 2012 Credit Facility as described below under the heading "Debt", will be sufficient to meet our anticipated operating cash needs, debt service, planned capital expenditures, and stock purchases under the stock repurchase program for at least the next twelve months. * We anticipate that planned capital expenditures primarily for an upgrade of our Oracle ERP system, as well as computer equipment, software, manufacturing tools and test equipment and leasehold improvements associated with business expansion, will constitute a partial use of our cash resources. Decisions related to how much cash is used for investing are influenced by the expected amount of cash to be provided by operations. Operating Activities Cash provided by operating activities was $310.5 million for the first three quarters of fiscal 2014, as compared to $278.4 million for the first three quarters of fiscal 2013. The increase of $32.1 million was primarily driven by an increase in net income before non-cash depreciation and amortization and changes in accounts receivable and other liabilities, offset by changes in inventories and accounts payable. Investing Activities 29-------------------------------------------------------------------------------- Table of Contents Cash used in investing activities was $202.4 million for the first three quarters of fiscal 2014, as compared to $256.4 million for the first three quarters of fiscal 2013. The decrease of $54.0 million was due to lower cash requirements for business acquisitions. Financing Activities Cash used in financing activities was $108.5 million for the first three quarters of fiscal 2014, as compared to $62.4 million for the first three quarters of fiscal 2013. The increase of cash used in financing activities of $46.1 million was primarily due to cash used for stock repurchases. Accounts Receivable and Inventory Metrics Third Quarter of Fiscal Year End As of 2014 2013 Accounts receivable days sales outstanding 56 55 Inventory turns per year 4.1 4.1 Accounts receivable days sales outstanding were 56 days as of the end of the third quarter of fiscal 2014, as compared to 55 days as of the end of fiscal 2013. The increase in DSO was primarily due to the impact of acquisitions within the quarter. Accounts receivable days sales outstanding are calculated based on ending accounts receivable, net, divided by revenue for the corresponding fiscal quarter, times a quarterly average of 91 days. Our inventory turns were both 4.1 as of the end of the third quarter of fiscal 2014 and the end of fiscal 2013. Our inventory turnover is calculated based on total cost of sales for the most recent twelve months divided by average ending inventory, net, for this same twelve month period. Repatriation of Foreign Earnings and Income Taxes As of the third quarter of fiscal 2014, $122.9 million of cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would not be required to accrue and pay U.S. taxes to repatriate the funds due to intercompany financing arrangements with our foreign subsidiaries. While a significant portion of our foreign earnings continue to be permanently reinvested in our foreign subsidiaries, it is anticipated this reinvestment will not impede cash needs at the parent company level. In our determination of which foreign earnings are permanently reinvested, we consider numerous factors, including the financial requirements of the U.S. parent company, the financial requirements of the foreign subsidiaries, and the tax consequences of remitting the foreign earnings back to the U.S. There are no other material impediments to our ability to access sources of liquidity and our resulting ability to meet short and long-term liquidity needs, other than in the event we are not in compliance with the covenants under our 2012 Credit Facility or the potential tax costs of remitting foreign earnings back to the U.S. Credit Facilities On November 21, 2012, we entered into an amended and restated credit agreement with a group of lenders (the "2012 Credit Facility"). This credit facility provides for unsecured credit facilities in the aggregate principal amount of $1.4 billion, comprised of a five-year revolving loan facility of $700.0 million and a five-year $700.0 million term loan facility. Subject to the terms of the 2012 Credit Facility, the revolving loan facility and the term loan facility may be increased by $300.0 million in the aggregate. We also have two $75 million uncommitted revolving loan facilities (the "Uncommitted Facilities"), which are callable by the bank at any time and have no covenants. The interest rate for the Uncommitted Facilities is 0.9% to 1.00% plus either LIBOR or the bank's cost of funds or as otherwise agreed upon by the bank and us. As of the third quarter of 2014, our total debt was comprised primarily of a term loan of $638.8 million. Of the total outstanding balance, $577.5 million of the term loan is classified as long-term in the Condensed Consolidated Balance Sheet. The funds available under the 2012 Credit Facility may be used for general corporate purposes, the financing of certain acquisitions and the payment of transaction fees and expenses related to such acquisitions. Under the 2012 Credit Facility, we may borrow, repay and reborrow funds under the revolving loan facility until its maturity on November 21, 2017, at which time the revolving facility will terminate, and all outstanding loans, together with all accrued and unpaid interest, must be repaid. Amounts not borrowed under the revolving facility will be subject to a commitment fee, to be paid in arrears on the last day of each fiscal quarter, ranging from 0.15% to 0.35% per annum depending on our leverage ratio as of the most recently ended fiscal quarter. The term loan will be repaid in quarterly installments, with the last quarterly payment to be made on September 29, 2017, with the remaining outstanding balance being due and payable at maturity on November 21, 2017. We are required to make quarterly principal payments on the term loan facility totaling $8.8 million for the remainder of fiscal 2014, $70.0 million in fiscal 2015, $70.0 million in fiscal 2016, and the remaining balance of $490.0 million in fiscal 2017. The term loan may be prepaid in whole 30-------------------------------------------------------------------------------- Table of Contents or in part, subject to certain minimum thresholds, without penalty or premium. Amounts repaid or prepaid with respect to the term loan facility may not be reborrowed. We may borrow funds under the 2012 Credit Facility in U.S. Dollars, Euros or in certain other agreed currencies, and borrowings will bear interest, at our option, at either: (i) a floating per annum base rate based on the administrative agent's prime rate or other agreed-upon rate, depending on the currency borrowed, plus a margin of between 0.00% and 1.00%, depending on our leverage ratio as of the most recently ended fiscal quarter, or (ii) a reserve-adjusted fixed per annum rate based on LIBOR, EURIBOR, or other agreed-upon rate, depending on the currency borrowed, plus a margin of between 1.00% and 2.00%, depending on our leverage ratio as of the most recently ended fiscal quarter. Interest will be paid on the last day of each fiscal quarter with respect to borrowings bearing interest based on a floating rate, or on the last day of an interest period, but at least every three months, with respect to borrowings bearing interest at a fixed rate. Our obligations under the 2012 Credit Facility are guaranteed by several of our domestic subsidiaries. The 2012 Credit Facility contains various customary representations and warranties by us, which include customary use of materiality, material adverse effect and knowledge qualifiers. The 2012 Credit Facility also contains customary affirmative and negative covenants including, among other requirements, negative covenants that restrict our ability to dispose of assets, create liens, incur indebtedness, repurchase stock, pay dividends, make acquisitions and make investments. Further, the 2012 Credit Facility contains financial covenants that require the maintenance of minimum interest coverage and maximum leverage ratios. Specifically, we must maintain as of the end of each fiscal quarter a ratio of (a) EBITDA (as defined in the 2012 Credit Facility) to (b) interest expenses for the most recently ended period of four fiscal quarters of not less than 3 to 1. We must also maintain, at the end of each fiscal quarter, a ratio of (x) total indebtedness to (y) EBITDA (as defined in the 2012 Credit Facility) for the most recently ended period of four fiscal quarters of not greater than 3 to 1; provided, that on the completion of a material acquisition, we may increase the applicable ratio in the table below by 0.25 for the fiscal quarter during which such acquisition occurred and each of the three subsequent fiscal quarters. We were in compliance with these covenants as of the third quarter of fiscal 2014. The 2012 Credit Facility contains events of default that include, among others, non-payment of principal, interest or fees, breach of covenants, inaccuracy of representations and warranties, cross defaults to certain other indebtedness, bankruptcy and insolvency events, material judgments and events constituting a change of control. Upon the occurrence and during the continuance of an event of default, interest on the obligations will accrue at an increased rate and the lenders may accelerate our obligations under the 2012 Credit Facility, however that acceleration will be automatic in the case of bankruptcy and insolvency events of default. The weighted average interest rate on the current portion of our long-term debt outstanding under the 2012 Credit Facility and Uncommitted Facilities was 1.41% and 1.31% at the end of the third quarter of fiscal 2014 and fiscal year end 2013, respectively. The interest rate on our non-current debt outstanding under the 2012 Credit Facility was 1.41% and 1.67% at the end of the third quarter of fiscal 2014 and fiscal year end 2013, respectively. RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES Our non-GAAP measures are not meant to be considered in isolation or as a substitute for comparable GAAP measures. The non-GAAP financial measures included in the tables below as well as detailed explanations to the adjustments to comparable GAAP measures, are set forth below: Non-GAAP gross margin We believe our investors benefit by understanding our non-GAAP gross margin as a way of understanding how product mix, pricing decisions and manufacturing costs influence our business. Non-GAAP gross margin excludes restructuring costs, amortization of purchased intangible assets, stock-based compensation and amortization of acquisition-related inventory step-up from GAAP gross margin. We believe that these exclusions offer investors additional information that may be useful to view trends in our gross margin performance. Non-GAAP operating expenses We believe this measure is important to investors evaluating our non-GAAP spending in relation to revenue. Non-GAAP operating expenses exclude restructuring costs, amortization of purchased intangible assets, stock-based compensation, and acquisition/divestiture costs associated with external and incremental costs resulting directly from merger and acquisition activities such as legal, due diligence, integration costs and litigation expenses from GAAP operating expenses. We believe that these exclusions offer investors supplemental information to facilitate comparison of our operating expenses to our prior results. Non-GAAP operating income 31-------------------------------------------------------------------------------- Table of Contents We believe our investors benefit by understanding our non-GAAP operating income trends which are driven by revenue, gross margin, and spending. Non-GAAP operating income excludes restructuring costs, amortization of purchased intangible assets, stock-based compensation, amortization of acquisition-related inventory step-up, acquisition/divestiture costs associated with external and incremental costs resulting directly from merger and acquisition activities such as legal, due diligence, integration costs and litigation expenses. We believe that these exclusions offer an alternative means for our investors to evaluate current operating performance compared to results of other periods. Non-GAAP non-operating income, net We believe this measure helps investors evaluate our non-operating income trends. Non-GAAP non-operating income, net excludes acquisition and divestiture gains/losses associated with unusual acquisition related items such as adjustments to the fair value of earn-out liabilities, intangible assets impairment charges and gains or losses related to the acquisition or sale of certain businesses and investments, and a gain on an equity sale. These gains/losses are specific to particular acquisitions and divestitures and vary significantly in amount and timing. We believe that these exclusions provide investors with a supplemental view of our ongoing financial results. Non-GAAP income tax provision (benefit) Investors benefit from the exclusion of the tax impact on an equity sale and on the $51.3 million reserved for the RDS litigation because it facilitates comparisons to our past income tax provision. Non-GAAP items tax effected adjusts the provision for income taxes to reflect the effect of certain non-GAAP items on non-GAAP net income. We believe this information is useful to investors because it provides for consistent treatment of the excluded items in our non-GAAP presentation. Non-GAAP net income This measure provides a supplemental view of net income trends which are driven by non-GAAP income before taxes and our non-GAAP tax rate. Non-GAAP net income excludes restructuring costs, amortization of purchased intangible assets, stock-based compensation, amortization of acquisition-related inventory step-up, acquisition and divestiture costs, a gain on an equity sale, litigation expenses and non-GAAP tax adjustments from GAAP net income. We believe our investors benefit from understanding these exclusions and from an alternative view of our net income performance as compared to our past net income performance. Non-GAAP diluted net income per share We believe our investors benefit by understanding our non-GAAP operating performance as reflected in a per share calculation as a way of measuring non-GAAP operating performance by ownership in the company. Non-GAAP diluted net income per share excludes restructuring costs, amortization of purchased intangible assets, stock-based compensation, amortization of acquisition-related inventory step-up, acquisition and divestiture costs, a gain on an equity sale, litigation expenses and non-GAAP tax adjustments from GAAP diluted net income per share. We believe that these exclusions offer investors a useful view of our diluted net income per share as compared to our past diluted net income per share. Non-GAAP operating leverage We believe this information is beneficial to investors as a measure of how much incremental revenue is contributed to our operating income. Non-GAAP operating leverage is the increase in non-GAAP operating income as a percentage of the increase in revenue. We believe that this information offers investors supplemental information to evaluate our current performance and to compare to our past non-GAAP operating leverage. Non-GAAP segment operating income Non-GAAP segment operating income excludes stock-based compensation from GAAP segment operating income. We believe this information is useful to investors because some may exclude stock-based compensation as an alternative view when assessing trends in the operating income of our segments. These non-GAAP measures can be used to evaluate our historical and prospective financial performance, as well as our performance relative to competitors. We believe some of our investors track our "core operating performance" as a means of evaluating our performance in the ordinary, ongoing, and customary course of our operations. Core operating performance excludes items that are non-cash, not expected to recur or not reflective of ongoing financial results. Management also believes that looking at our core operating performance provides a supplemental way to provide consistency in period to period comparisons. Accordingly, management excludes from non-GAAP those items relating to restructuring, amortization of purchased intangible assets, stock based compensation, amortization of acquisition-related inventory step-up, acquisition and divestiture costs, a gain on an equity sale, litigation expenses and non-GAAP tax adjustments. For detailed explanations of the adjustments made to comparable GAAP measures, see items (A) - ( L ) following the tables below. 32-------------------------------------------------------------------------------- Table of Contents (Dollars in thousands, except per share data) Third Quarter of First Three Quarters of 2014 2013 2014 2013 Dollar % of Dollar % of Dollar % of Dollar % of Amount Revenue Amount Revenue Amount Revenue Amount Revenue GROSS MARGIN: GAAP gross margin: $ 316,773 54.2 % $ 295,053 53.0 % $ 998,236 54.5 % $ 884,368 52.4 % Restructuring ( A ) 108 - % 8 - % 325 - % 829 - % Amortization of purchased intangible assets ( B ) 20,057 3.4 % 20,402 3.7 % 60,963 3.3 % 59,938 3.6 % Stock-based compensation ( C ) 776 0.1 % 609 0.1 % 2,286 0.1 % 1,816 0.1 % Amortization of acquisition-related inventory step-up ( D ) 586 0.1 % 378 0.1 % 662 0.1 % 1,505 0.1 % Non-GAAP gross margin: $ 338,300 57.8 % $ 316,450 56.9 % $ 1,062,472 58.0 % $ 948,456 56.2 % OPERATING EXPENSES: GAAP operating expenses: $ 305,684 52.3 % $ 232,024 41.7 % $ 814,302 44.5 % $ 699,977 41.4 % Restructuring ( A ) (219 ) - % (31 ) - % (1,345 ) (0.1 )% (4,602 ) (0.3 )% Amortization of purchased intangible assets ( B ) (19,269 ) (3.3 )% (21,216 ) (3.9 )% (56,806 ) (3.1 )% (60,775 ) (3.6 )% Stock-based compensation ( C ) (10,262 ) (1.8 )% (8,296 ) (1.5 )% (29,839 ) (1.6 )% (24,342 ) (1.4 )% Acquisition / divestiture items ( E ) (4,056 ) (0.7 )% (2,891 ) (0.5 )% (7,416 ) (0.4 )% (9,285 ) (0.5 )% Litigation (G) (52,011 ) (8.9 )% (1,335 ) (0.2 )% (52,011 ) (2.9 )% (1,335 ) (0.1 )% Non-GAAP operating expenses: $ 219,867 37.6 % $ 198,255 35.6 % $ 666,885 36.4 % $ 599,638 35.5 % OPERATING INCOME: GAAP operating income: $ 11,089 1.9 % $ 63,029 11.3 % $ 183,934 10.0 % $ 184,391 10.9 % Restructuring ( A ) 327 0.1 % 39 - % 1,670 0.1 % 5,431 0.3 % Amortization of purchased intangible assets ( B ) 39,326 6.7 % 41,618 7.5 % 117,769 6.4 % 120,713 7.2 % Stock-based compensation ( C ) 11,038 1.9 % 8,905 1.6 % 32,125 1.8 % 26,158 1.5 % Amortization of acquisition-related inventory step-up ( D ) 586 0.1 % 378 0.1 % 662 - % 1,505 0.1 % Acquisition / divestiture items ( E ) 4,056 0.7 % 2,891 0.5 % 7,416 0.4 % 9,285 0.6 % Litigation (G) 52,011 8.9 % 1,335 0.2 % 52,011 2.9 % 1,335 0.1 % Non-GAAP operating income: $ 118,433 20.3 % $ 118,195 21.2 % $ 395,587 21.6 % $ 348,818 20.7 % NON-OPERATING INCOME, NET: GAAP non-operating income (loss), net: $ (3,934 ) $ 483 $ 10,464 $ 2,181 Acquisition / divestiture items ( E ) 1,699 14 6,004 (846 ) Gain on an equity sale ( F ) - - (15,091 ) - Non-GAAP non-operating income (loss), net: $ (2,235 ) $ 497 $ 1,377 $ 1,335 GAAP and GAAP and GAAP and GAAP and Non-GAAP Non-GAAP Non-GAAP Non-GAAP Tax Rate % Tax Rate % Tax Rate % Tax Rate % ( K ) ( K ) ( K ) ( K ) INCOME TAX PROVISION (BENEFIT): GAAP income tax provision (benefit): $ (4,720 ) (66 )% $ 8,892 14 % $ 36,371 19 % $ 28,067 15 % Non-GAAP items tax effected: ( H ) 13,930 7,725 36,360 24,062 Tax on gain on an equity sale ( I ) - - (5,836 ) - Tax on RDS litigation ( J ) 19,840 - 19,840 - Non-GAAP income tax provision: $ 29,050 25 % $ 16,617 14 % $ 86,735 22 % $ 52,129 15 % NET INCOME: 33-------------------------------------------------------------------------------- Table of Contents GAAP net income attributable to Trimble Navigation Ltd. $ 11,832 $ 54,469 $ 158,290 $ 158,858 Restructuring ( A ) 327 39 1,670 5,431 Amortization of purchased intangible assets ( B ) 39,326 41,618 117,769 120,713 Stock-based compensation ( C ) 11,038 8,905 32,125 26,158 Amortization of acquisition-related inventory step-up ( D ) 586 378 662 1,505 Acquisition / divestiture items ( E ) 5,755 2,905 13,420 8,439 Gain on an equity sale ( F ) - - (15,091 ) - Litigation ( G ) 52,011 1,335 52,011 1,335 (H ), Non-GAAP tax (I), adjustments (J) (33,770 ) (7,725 ) (50,364 ) (24,062 ) Non-GAAP net income attributable to Trimble Navigation Ltd. $ 87,105 $ 101,924 $ 310,492 $ 298,377 DILUTED NET INCOME PER SHARE: GAAP diluted net income per share attributable to Trimble Navigation Ltd. $ 0.04 $ 0.21 $ 0.60 $ 0.61 Restructuring ( A ) - - 0.01 0.02 Amortization of purchased intangible assets ( B ) 0.15 0.16 0.44 0.45 Stock-based compensation ( C ) 0.04 0.03 0.12 0.10 Amortization of acquisition-related inventory step-up ( D ) - - - 0.01 Acquisition / divestiture items ( E ) 0.02 0.01 0.05 0.03 Gain on an equity sale ( F ) - - (0.06 ) - Litigation ( G ) 0.20 0.01 0.20 0.01 (H ), Non-GAAP tax (I), adjustments (J) (0.12 ) (0.03 ) (0.19 ) (0.09 )Non-GAAP diluted net income per share attributable to Trimble Navigation Ltd. $ 0.33 $ 0.39 $ 1.17 $ 1.14 OPERATING LEVERAGE: Increase in non-GAAP operating income $ 238 $ 12,889 $ 46,769 $ 36,541 Increase in revenue $ 28,294 $ 51,739 $ 142,810 $ 164,316 Operating leverage (increase in non-GAAP operating income as a % of increase in revenue) 0.8 % 24.9 % 32.7 % 22.2 % 34-------------------------------------------------------------------------------- Table of Contents Third Quarter of First Three Quarters of 2014 2013 2014 2013(Dollars in % of % of % of % of thousands, except Segment Segment Segment Segment per share data) Revenue Revenue Revenue Revenue SEGMENT OPERATING INCOME: Engineering and Construction GAAP operating income before corporate allocations: $ 70,553 20.6 % $ 73,488 23.7 % $ 219,952 21.6 % $ 183,301 20.6 % Stock-based compensation ( L) 3,599 1.1 % 2,950 0.9 % 11,030 1.1 % 8,702 1.0 % Non-GAAP operating income before corporate allocations: $ 74,152 21.7 % $ 76,438 24.6 % $ 230,982 22.7 % $ 192,003 21.6 % Field Solutions GAAP operating income before corporate allocations: $ 25,185 28.4 % $ 31,373 31.5 % $ 116,794 34.2 % $ 134,271 37.0 % Stock-based compensation ( L ) 909 1.0 % 714 0.8 % 2,585 0.8 % 2,258 0.6 % Non-GAAP operating income before corporate allocations: $ 26,094 29.4 % $ 32,087 32.3 % $ 119,379 35.0 % $ 136,529 37.6 % Mobile Solutions GAAP operating income (loss) before corporate allocations: $ 18,209 15.0 % $ 15,276 13.5 % $ 54,764 15.1 % $ 42,284 12.5 % Stock-based compensation ( L ) 1,313 1.1 % 934 0.8 % 3,773 1.0 % 2,794 0.8 % Non-GAAP operating income before corporate allocations: $ 19,522 16.1 % $ 16,210 14.3 % $ 58,537 16.1 % $ 45,078 13.3 % Advanced Devices GAAP operating income before corporate allocations: $ 9,091 27.9 % $ 8,420 25.6 % $ 32,850 30.4 % $ 21,419 22.3 % Stock-based compensation ( L ) 514 1.6 % 900 2.8 % 1,516 1.4 % 2,650 2.8 % Non-GAAP operating income before corporate allocations: $ 9,605 29.5 % $ 9,320 28.4 % $ 34,366 31.8 % $ 24,069 25.1 % A. Restructuring costs. Included in our GAAP presentation of cost of sales and operating expenses, restructuring costs recorded are primarily for employee compensation resulting from reductions in employee headcount in connection with our company restructurings. We exclude restructuring costs from our non-GAAP measures because we believe they do not reflect expected future operating expenses, they are not indicative of our core operating performance, and they are not meaningful in comparisons to our past operating performance. We have incurred restructuring expense in each of the periods presented however the amount incurred can vary significantly based on whether a restructuring has occurred in the period and the timing of headcount reductions. B. Amortization of purchased intangible assets. Included in our GAAP presentation of gross margin and operating expenses is amortization of purchased intangible assets. US GAAP accounting requires that intangible assets are recorded at fair value and amortized over their useful lives. Consequently, the timing and size of our acquisitions will cause our operating results to vary from period to period, making a comparison to past performance difficult for investors. This accounting treatment may cause differences when comparing our results to companies that grow internally because the fair value 35-------------------------------------------------------------------------------- Table of Contents assigned to the intangible assets acquired through acquisition may significantly exceed the equivalent expenses that a company may incur for similar efforts when performed internally. Furthermore, the useful life that we expense our intangible assets over may be substantially different from the time period that an internal growth company incurs and recognizes such expenses. We believe that by excluding the amortization of purchased intangible assets, which primarily represents technology and/or customer relationships already developed, it provides an alternative way for investors to compare our operations pre-acquisition to those post-acquisition and to those of our competitors that have pursued internal growth strategies. However, we note that companies that grow internally will incur costs to develop intangible assets that will be expensed in the period incurred, which may make a direct comparison more difficult. C. Stock-based compensation. Included in our GAAP presentation of cost of sales and operating expenses, stock-based compensation consists of expenses for employee stock options and awards and purchase rights under our employee stock purchase plan. We exclude stock-based compensation expense from our non-GAAP measures because some investors may view it as not reflective of our core operating performance as it is a non-cash expense. For the third quarter and the first three quarters of fiscal 2014 and 2013, stock-based compensation was allocated as follows: Third Quarter of First Three Quarters of (Dollars in thousands) 2014 2013 2014 2013 Cost of sales $ 776 $ 609 $ 2,286 $ 1,816 Research and development 1,600 1,265 4,815 3,644 Sales and Marketing 2,062 1,816 6,022 5,341 General and administrative 6,600 5,215 19,002 15,357 $ 11,038 $ 8,905 $ 32,125 $ 26,158 D. Amortization of acquisition-related inventory step-up. The purchase accounting entries associated with our business acquisitions require us to record inventory at its fair value, which is sometimes greater than the previous book value of the inventory. Included in our GAAP presentation of cost of sales, the increase in inventory value is amortized to cost of sales over the period that the related product is sold. We exclude inventory step-up amortization from our non-GAAP measures because it is a non-cash expense that we do not believe is indicative of our ongoing operating results. We further believe that excluding this item from our non-GAAP results is useful to investors in that it allows for period-over-period comparability. E. Acquisition / divestiture items. Included in our GAAP presentation of operating expenses, acquisition costs consist of external and incremental costs resulting directly from merger and acquisition activities such as legal, due diligence, and integration costs. Included in our GAAP presentation of non-operating income (loss), net, acquisition / divestiture items includes unusual acquisition, investment, or divestiture gains/losses such as adjustments to the fair value of earn-out liabilities, and gains/losses on acquisitions or divestitures of certain businesses and investments. Although we do numerous acquisitions, the costs that have been excluded from the non-GAAP measures are costs specific to particular acquisitions. These are one-time costs that vary significantly in amount and timing and are not indicative of our core operating performance. F. Gain on an equity sale. Included in our GAAP presentation of non-operating income, net this amount represents a gain on a partial equity sale of Virtual Site Solutions. We excluded the gain from our non-GAAP measures. We believe that investors benefit from excluding this item from our non-GAAP measures because it facilitates an evaluation of our non-operating income trends. G. Litigation. In the third quarter of 2013 this amount represents a settlement of litigation related to a pre-acquisition agreement with a contract manufacturer. In the third quarter of 2014 this amount includes $51.3M of estimated costs based on a jury verdict in favor of the plaintiff, Recreational Data Services, Inc. against the Company as well as $0.7M of costs based on an arbitration agreement. We have excluded these costs from our non-GAAP measures because they are non-recurring expenses that are not indicative of our ongoing operating results. We further believe that excluding these items from our non-GAAP results is useful to investors in that it allows for period-over-period comparability. H. Non-GAAP items tax effected. This amount adjusts the provision for income taxes to reflect the effect of the non-GAAP items ( A ) - ( E ) on non-GAAP net income. We believe this information is useful to investors because it provides for consistent treatment of the excluded items in this non-GAAP presentation. 36-------------------------------------------------------------------------------- Table of Contents I. Tax on gain on an equity sale. This amount represents the tax effect of a gain on a partial equity sale of Virtual Site Solutions. We excluded this item as it represents the tax effect of a non-recurring gain. We believe that investors benefit from excluding this item from our non-GAAP income tax provision because it facilitates a comparison of the non-GAAP tax rate in the current period to the non-GAAP tax rates in prior periods. J. Tax on Recreational Data Services Inc. litigation. This amount represents the tax effect of a loss recorded as a result of a jury verdict in favor of Recreational Data Services, Inc. We excluded this item as it represents the tax effect of a non-recurring expense. We believe that investors benefit from excluding this item from our non-GAAP income tax provision because it allows for period-over-period comparability. K. GAAP and non-GAAP tax rate %. These percentages are defined as GAAP income tax provision as a percentage of GAAP income before taxes and non-GAAP income tax provision as a percentage of non-GAAP income before taxes. We believe that investors benefit from a presentation of non-GAAP tax rate percentage as a way of facilitating a comparison to non-GAAP tax rates in prior periods. L. Stock-based compensation. The amounts consist of expenses for employee stock options and awards and purchase rights under our employee stock purchase plan. As referred to above we exclude stock-based compensation here because investors may view it as not reflective of our core operating performance as it is a non-cash expense. However, management does include stock-based compensation for budgeting and incentive plans as well as for reviewing internal financial reporting. We discuss our operating results by segment with and without stock-based compensation expense, as we believe it is useful to investors. Stock-based compensation not allocated to the reportable segments was approximately $4.7 million and $3.4 million for the third quarter of fiscal 2014 and 2013, respectively, and $13.2 million and $9.8 million for the first three quarters of fiscal 2014 and 2013, respectively. Non-GAAP Operating Income Non-GAAP operating income increased by $0.2 million for the third quarter of fiscal 2014, as compared to the corresponding period in the prior year. Non-GAAP operating income as a percentage of total revenue was 20.3% for the third quarter of fiscal 2014, as compared to 21.2% for the corresponding period in the prior year. Non-GAAP operating income increased by $46.8 million for the first three quarters of fiscal 2014, as compared to the corresponding period in the prior year. Non-GAAP operating income as a percentage of total revenue was 21.6% for the first three quarters of fiscal 2014, as compared to 20.7% for the corresponding period in the prior year. The Non-GAAP operating income for the third quarter of fiscal 2014 was relatively flat, due to higher revenue and gross margin expansion due to higher margin software, maintenance and subscription revenue, which was largely offset by an increase in operating expense, primarily associated with acquisitions. The increase in Non-GAAP operating income for the first three quarters was primarily driven by higher revenue and gross margin expansion due to higher margin software, maintenance, and subscription revenue, partially offset by an increase in operating expense, primarily associated with acquisitions. The decrease in Non-GAAP operating income percentage for the third quarter was due to higher operating expense, primarily associated with acquisitions, partially offset by gross margin expansion due to higher margin software, maintenance, and subscription revenue. The increase in Non-GAAP operating income percentage for the first three quarters was primarily due to gross margin expansion due to higher margin software, maintenance, and subscription revenue, partially offset by higher operating expense, primarily associated with acquisitions. |