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ADTRAN 10-Q 2010 Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended June 30, 2010
OR
For the Transition Period from to
Commission File Number 0-24612
ADTRAN, INC.
(Exact name of Registrant as specified in its charter)
901 Explorer Boulevard, Huntsville, Alabama 35806-2807
(Address of principal executive offices, including zip code) (256) 963-8000
(Registrant’s telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the Registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulations S-T (232.405 of this chapter) during the preceding 12 months
(or for shorter period that the Registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See definition of “large
accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of
the latest practicable date:
ADTRAN, INC.
Quarterly Report on Form 10-Q
For the Three and Six Months Ended June 30, 2010 Table of Contents
FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking
statements made by or on behalf of ADTRAN. ADTRAN and its representatives may from time to time
make written or oral forward-looking statements, including statements contained in this report, our
other filings with the Securities and Exchange Commission (SEC) and other communications with our
stockholders. Generally, the words, “believe,” “expect,” “intend,” “estimate,” “anticipate,”
“will,” “may,” “could” and similar expressions identify forward-looking statements. We caution you
that any forward-looking statements made by us or on our behalf are subject to uncertainties and
other factors that could cause such statements to be wrong. A list of factors that could
materially affect our business, financial condition or operating results is included under “Factors
that Could Affect Our Future Results” in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” contained in Item 2 of Part I of this report. They have also
been discussed in Item 1A of Part I in our most recent Annual Report on Form 10-K for the year
ended December 31, 2009 filed on February 26, 2010 with the SEC. Though we have attempted to list
comprehensively these important factors, we caution investors that other factors may prove to be
important in the future in affecting our operating results. New factors emerge from time to time,
and it is not possible for us to predict all of these factors, nor can we assess the impact each
factor or a combination of factors may have on our business.
You are further cautioned not to place undue reliance on these forward-looking statements because
they speak only of our views as of the date that the statements were made. We undertake no
obligation to publicly update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise, except as required by law.
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PART I. FINANCIAL INFORMATION
ADTRAN, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
See notes to consolidated financial statements
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ADTRAN, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
See notes to consolidated financial statements
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ADTRAN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
See notes to consolidated financial statements
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ADTRAN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements of ADTRAN®, Inc. and its
subsidiaries (ADTRAN) have been prepared pursuant to the rules and regulations for reporting on
Quarterly Reports on Form 10-Q. Accordingly, certain information and notes required by generally
accepted accounting principles for complete financial statements are not included herein. The
December 31, 2009 Consolidated Balance Sheet is derived from audited financial statements, but does
not include all disclosures required by accounting principles generally accepted in the United
States.
In the opinion of management, all adjustments necessary for a fair presentation of these interim
statements have been included and are of a normal and recurring nature. The results of operations
for an interim period are not necessarily indicative of the results for the full year. The interim
statements should be read in conjunction with the financial statements and notes thereto included
in ADTRAN’s Annual Report on Form 10-K for the year ended December 31, 2009, filed on February 26,
2010 with the SEC.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenue and expense during the
reporting period. Our more significant estimates include the allowance for doubtful accounts,
obsolete and excess inventory reserves, warranty reserves, customer rebates, allowance for sales
returns, determination of the deferred revenue components of multiple element sales agreements,
estimated income tax contingencies, the fair value of stock-based compensation, and the evaluation
of other-than-temporary declines in the value of investments. Actual amounts could differ
significantly from these estimates.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued Update No. 2009-13, which
amends the Revenue Recognition topic of the FASB Accounting Standards Codification (Codification).
This update provides amendments to the criteria in Subtopic 605-25 of the Codification for
separating consideration in multiple-deliverable arrangements. As a result of those amendments,
multiple-deliverable arrangements will be separated in more circumstances than under existing U.S.
GAAP. The amendments establish a selling price hierarchy for determining the selling price of a
deliverable and will replace the term fair value in the revenue allocation guidance with selling
price to clarify that the allocation of revenue is based on entity-specific assumptions rather than
assumptions of a marketplace participant. The amendments will also eliminate the residual method
of allocation and require that arrangement consideration be allocated at the inception of the
arrangement to all deliverables using the relative selling price method and will require that a
vendor determine its best estimate of selling price in a manner that is consistent with that used
to determine the price to sell the deliverable on a standalone basis. These amendments will be
effective prospectively for revenue arrangements entered into or materially modified in fiscal
years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the
adoption of this amendment will have a material impact on our consolidated results of operations or
financial condition.
In October 2009, the FASB issued Update No. 2009-14, which amends the Software topic of the
Codification. The amendments in this update change the accounting model for revenue arrangements
that include both tangible products and software elements. Tangible products containing software
components and non-software components that function together to deliver the tangible product’s
essential functionality is no longer within the scope of the software revenue guidance in Subtopic
985-605 of the Codification. In addition, the amendments in this update require that hardware
components of a tangible product containing software components always be excluded from the
software revenue guidance. In that regard, the amendments provide additional guidance on how to
determine which software, if any, relating to the tangible product also would be excluded from the
scope of the software revenue guidance. The amendments also provide guidance on how a vendor
should allocate arrangement consideration to deliverables in an arrangement that includes both
tangible products and software. The amendments also provide further guidance on how to allocate
arrangement consideration when an arrangement includes deliverables both included and excluded from
the scope of the software revenue guidance. These amendments will be effective prospectively for
revenue arrangements entered into or materially modified in fiscal years beginning on or after June
15, 2010, with early adoption permitted. We do not expect the adoption of this amendment will have
a material impact on our consolidated results of operations or financial condition.
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During the six months ended June 30, 2010, we adopted the following accounting standards,
which had no material effect on our consolidated results of operations or financial condition:
In January 2010, the FASB issued Update No. 2010-06, which amends the Fair Value Measurements and
Disclosures topic of the Codification. The amendments in this update require new disclosures about
transfers in and out of Level 1 and Level 2 fair value measurements and the activity in Level 3
fair value measurements and, in addition, clarify existing disclosures required for levels of
disaggregation and inputs and valuation techniques. These amendments will be effective for interim
and annual reporting periods beginning after December 15, 2009, except for the disclosures about
activity in Level 3 fair value measurements, which is effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. We adopted this amendment
for the period ended March 31, 2010, and we have provided the disclosures required for the period
ended June 30, 2010.
In February 2010, the FASB issued Update No. 2010-09, which amends the Subsequent Events topic of
the Codification. The amendments in this update require entities that are SEC filers to evaluate
subsequent events through the date that the financial statements are issued. Additionally, SEC
filers are no longer required to disclose the date through which subsequent events were evaluated.
The amendments in this update were effective upon issuance. We adopted this amendment for the
period ended March 31, 2010, and we have provided the disclosures required for the period ended
June 30, 2010.
2. INCOME TAXES
Our effective tax rate increased from 30.7% in the six months ended June 30, 2009 to 34.6% in the
six months ended June 30, 2010. The increase is primarily due to a one-time tax benefit of $1.7
million recorded in the first quarter of 2009, which decreased our effective tax rate by 3.4
percentage points. The $1.7 million benefit resulted from a review of our deduction for
manufacturer’s domestic production activities for the years 2005, 2006 and 2007 under Internal
Revenue Code Section 199, which was completed during the first quarter of 2009. Amended income tax
returns were filed during the first quarter of 2009 in association with this benefit. In addition,
the manufacturer’s domestic production activities deduction increased from six percent in 2009 to
nine percent in 2010, resulting in approximately a 1.0 percentage point decrease in our effective
tax rate for the six months ended June 30, 2010.
The tax provision for the six months ended June 30, 2009 also included the benefit from the
research and development tax credit. The tax provision for the six months ended June 30, 2010 did
not include a benefit from the research and development tax credit, which expired on December 31,
2009. The exclusion of the benefit from the research and development tax credits resulted in
approximately a 2.0 percentage point increase in our effective tax rate in the six months ended
June 30, 2010. Finally, the completion of an audit for the years 2006 and 2007 by the Internal
Revenue Service resulted in the reversal of several uncertain tax positions, which resulted in
approximately a 1.0 percentage point decrease in our effective tax rate for the six months ended
June 30, 2010.
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3. STOCK-BASED COMPENSATION
The following table summarizes the stock-based compensation expense related to stock options and
restricted stock units (RSUs) under the Stock Compensation Topic of the FASB Codification for the
three and six months ended June 30, 2010 and 2009, which was recognized as follows:
The fair value of our stock options was estimated using the Black-Scholes model. The
determination of the fair value of stock options on the date of grant using the Black-Scholes model
is affected by our stock price as well as assumptions regarding a number of complex and subjective
variables that may have a significant impact on the fair value estimate.
The weighted-average assumptions and value of options granted for the three and six months ended
June 30, 2010 and 2009 are summarized as follows:
ADTRAN uses the Monte Carlo Simulation valuation technique to value its RSUs. No RSUs were granted
to employees during the six months ended June 30, 2010 or 2009.
Stock-based compensation expense recognized in our Consolidated Statements of Income for the three
and six months ended June 30, 2010 and 2009 is based on options and RSUs ultimately expected to
vest, and has been reduced for estimated forfeitures. Estimated forfeitures for stock options were
based upon historical experience and approximate 3% annually. We estimated a 0% forfeiture rate for
our RSUs due to the limited number of recipients and lack of historical experience for these
awards.
As of June 30, 2010, total compensation cost related to non-vested stock options and RSUs not yet
recognized was approximately $12.9 million, which is expected to be recognized over an average
remaining recognition period of 2.5 years.
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The following schedule summarizes the activity in our stock option plans for the six months ended
June 30, 2010:
The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the
difference between ADTRAN’s closing stock price on the last trading day of the quarter and the
exercise price, multiplied by the number of in-the-money options) that would have been received by
the option holders had all option holders exercised their options on June 30, 2010. The aggregate
intrinsic value will change based on the fair market value of ADTRAN’s stock. The total pre-tax
intrinsic value of options exercised during the three and six month period ended June 30, 2010 was
$4.8 million and $6.4 million, respectively.
4. INVESTMENTS
At June 30, 2010, we held the following securities and investments, recorded at either fair value
or cost.
At June 30, 2010, we held $3.5 million of deferred compensation plan assets, carried at fair value.
At June 30, 2010, we held $76.7 million of corporate bonds. Of this amount, we held $41.2 million
in bonds that have been issued by various banks that have been guaranteed by the Federal Deposit
Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program (TLGP). These bonds
are classified as available-for-sale and had an average duration of 2.0 years at June 30, 2010. At
June 30, 2010, approximately 54% of our corporate bond portfolio had a credit rating of AAA, 10%
had a credit rating of AA, 21% had a credit rating of A, and 15% had a credit rating of BBB.
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At June 30, 2010, we held $113.3 million of municipal fixed-rate bonds. At June 30, 2010,
approximately 39% of our municipal fixed-rate bond portfolio had a credit rating of AAA, 52% had a
credit rating of AA, and 9% had a credit rating of A. These bonds are classified as
available-for-sale investments and had an average duration of 1.0 years at June 30, 2010. Because
our bond portfolio has a high quality rating and contractual maturities of a short duration, we are
able to obtain prices for these bonds derived from observable market inputs, or for similar
securities traded in an active market, on a daily basis.
At June 30, 2010, we held $83.6 million of municipal variable rate demand notes, all of which are
classified as available-for-sale short-term investments. At June 30, 2010, 24% of our municipal
variable rate demand notes had a credit rating of AAA, 64% had a credit rating of AA, 12% had a
credit rating of A, and all contained put options of seven days. Despite the long-term nature of
their stated contractual maturities, we believe that we have the ability to quickly liquidate these
securities. Our investments in these securities are recorded at fair value, and the interest rates
reset every seven days. We believe we have the ability to sell our variable rate demand notes to
the remarketing agent, tender agent or issuer at par value plus accrued interest in the event we
decide to liquidate our investment in a particular variable rate demand note. Approximately 41% of
our variable rate demand notes are supported by letters of credit from banks that we believe to be
in good financial condition. The remaining 59% of our variable rate demand notes are supported by
standby purchase agreements. As a result of these factors, we had no cumulative gross unrealized
holding gains (losses) or gross realized gains (losses) from these investments. All income
generated from these investments was recorded as interest income. We have not been required to
record any losses relating to municipal variable rate demand notes.
At June 30, 2010, we held $0.7 million of a fixed income bond fund.
At June 30, 2010, we held $32.3 million of marketable equity securities, including a single
security, of which we held 1.8 million shares, carried at a fair value of $21.6 million. We sold
268 thousand shares of this security during the six months ended June 30, 2010. The sale resulted
in proceeds of $4.1 million and a realized gain of $4.0 million. This single security traded
approximately 1.3 million shares per day in the first six months of 2010 in an active market on a
European stock exchange. This single security comprises $21.0 million of the gross unrealized
gains included in the fair value of our marketable equity securities at June 30, 2010. The
remaining $1.6 million of gross unrealized gains and $0.7 million of gross unrealized losses at
June 30, 2010 were spread among 395 equity securities.
At June 30, 2010, we held a $48.3 million restricted certificate of deposit, which is carried at
cost. This investment serves as a collateral deposit against the principal amount outstanding
under loans made to ADTRAN pursuant to an Alabama State Industrial Development Authority revenue
bond (the Bond). At June 30, 2010, the estimated fair value of the Bond was approximately $45.8
million, based on a debt security with a comparable interest rate and maturity and a Standard and
Poor’s credit rating of A+. We have the right to set-off the balance of the Bond with the
collateral deposit in order to reduce the balance of the indebtedness. For more information on the
Bond, see “Debt” under “Liquidity and Capital Resources” in the “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” contained in Item 2 of Part I of this
report.
At June 30, 2010, we held $2.3 million of other investments carried at cost, consisting of
interests in two private equity funds and an investment in a privately held telecommunications
equipment manufacturer. The fair value of these investments was estimated to be approximately
$10.2 million at June 30, 2010, based on unobservable inputs including information supplied by the
company and the fund managers. We have committed to invest up to an aggregate of $7.9 million in
the two private equity funds, and we have contributed $8.0 million as of June 30, 2010, of which
$7.5 million has been applied toward these commitments. As of June 30, 2010, we have received
distributions related to these two private equity funds of $6.6 million, of which $0.8 million was
recorded as a realized investment gain. These investments are carried at cost, net of
distributions, with distributions in excess of our investment recorded as a realized investment
gain. The duration of each of these commitments is ten years with $0.1 million expiring in 2010
and $0.3 million expiring in 2012. We have not been required to record any impairment losses
related to these investments during the six months ended June 30, 2010.
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We review our investment portfolio for potential “other-than-temporary” declines in value on an
individual investment basis. We assess, on a quarterly basis, significant declines in value which
may be considered other-than-temporary and, if necessary, recognize and record the appropriate
charge to write-down the carrying value of such investments. In making this assessment, we take
into consideration qualitative and quantitative information, including but not limited to the
following: the magnitude and duration of historical declines in market prices, credit rating
activity, assessments of liquidity, public filings, and statements made by the issuer. We
generally begin our identification of potential other-than-temporary impairments by reviewing any
security with a fair value that has declined from its original or adjusted cost basis by 25% or
more for six or more consecutive months. We then evaluate the individual security based on the
previously identified factors to determine the amount of the write-down, if any. As a result of
our review, we recorded an other-than-temporary impairment charge of $42 thousand during the six
months ending June 30, 2010 related to three marketable equity securities. For the six months
ended June 30, 2009, we recorded an other-than-temporary impairment charge of $2.0 million related
to 107 publicly traded equity securities. In addition to the impairment charge we recorded on our
marketable equity securities, we recorded an impairment charge of $0.4 million related to our
investment in a fixed income bond fund and $0.5 million related to our deferred compensation plan
during the first six months of 2009 as a result of similar reviews. There were no impairment
charges related to the fixed income bond fund or deferred compensation plan assets during the six
months ended June 30, 2010.
In accordance with the Fair Value Measurements and Disclosures Topic of the FASB Codification, we
have categorized our cash equivalents held in money market funds and our investments held at fair
value into a three-level fair value hierarchy based on the priority of the inputs to the valuation
technique for the cash equivalents and investments as follows: Level 1 — Values based on
unadjusted quoted prices for identical assets or liabilities in an active market; Level 2 — Values
based on quoted prices in markets that are not active or model inputs that are observable either
directly or indirectly; Level 3 — Values based on prices or valuation techniques that require
inputs that are both unobservable and significant to the overall fair value measurement. These
inputs include information supplied by investees.
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As of June 30, 2010 and December 31, 2009, the fair value of the investments in available-for-sale
Level 2 corporate bonds and municipal fixed-rate bonds was $190.0 million and $161.7 million,
respectively. The fair value of these securities is calculated using a weighted average market
price for each security. Market prices are obtained from a variety of industry standard data
providers, security master files from large financial institutions, and other third-party sources.
These multiple market prices are used as inputs into a distribution-curve-based algorithm to
determine the daily market value of each security.
As of June 30, 2010 and December 31, 2009, the fair value of the investments in available-for-sale
Level 2 municipal variable rate demand notes was $83.6 million and $84.4 million, respectively.
These securities have a structure that implies a standard expected market price. The frequent
interest rate resets make it reasonable to expect the price to stay at par. These securities are
priced at the expected market price.
5. INVENTORY
At June 30, 2010 and December 31, 2009, inventory consisted of the following:
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6. STOCKHOLDERS’ EQUITY
A summary of the changes in stockholders’ equity for the six months ended June 30, 2010 is as
follows:
Stock Repurchase Program
Since 1997, our Board of Directors has approved multiple share repurchase programs that have
authorized open market repurchase transactions of up to 30 million shares of our common stock.
During the six months ended June 30, 2010, we repurchased 0.5 million shares of our common stock at
a weighted average price of $21.62 per share. We have the authority to purchase an additional 2.2
million shares of our common stock under the plan approved by the Board of Directors on April 14,
2008.
Stock Option Exercises
We issued 0.5 million shares of treasury stock during the six months ended June 30, 2010 to
accommodate employee stock option exercises. The stock options had exercise prices ranging from
$8.69 to $26.06. We received proceeds totaling $7.4 million from the exercise of these stock
options during the six months ended June 30, 2010.
Dividend Payments
During the six months ended June 30, 2010, we have paid cash dividends as follows (in thousands
except per share amount):
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Comprehensive Income
Comprehensive income consists of net income, net change in unrealized gains and losses on
marketable securities and foreign currency translation adjustments.
7. EARNINGS PER SHARE
A summary of the calculation of basic and diluted earnings per share for the three and six months
ended June 30, 2010 and 2009 is as follows:
Anti-dilutive options to purchase common stock outstanding were excluded from the above
calculations. Anti-dilutive options totaled 2.1 million and 3.4 million for the three months ended
June 30, 2010 and 2009, respectively, and 2.8 million and 4.7 million for the six months ended June
30, 2010 and 2009, respectively.
8. SEGMENT INFORMATION
ADTRAN operates in two reportable segments: (1) the Carrier Networks Division and (2) the
Enterprise Networks Division. We evaluate the performance of our segments based on gross profit;
therefore, selling, general and administrative expenses, research and development expenses,
interest and dividend income, interest expense, net realized investment gain/loss, other expense,
net and provision for income taxes are reported on an entity-wide basis only. There are no
inter-segment revenues.
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The following table presents information about the reported sales and gross profit of our
reportable segments for the three and six months ended June 30, 2010 and 2009. Asset information
by reportable segment is not reported, since we do not produce such information internally.
Sales by Product
Our three major product categories are Carrier Systems, Business Networking and Loop Access.
Carrier Systems products are used by communications service providers to provide last mile access
in support of data, voice and video services to consumers and enterprises. The Carrier Systems
category includes our broadband access products comprised of Total Access® 5000 multi-service
access and aggregation platform products, Total Access 1100/1200 Series Fiber-To-The-Node (FTTN)
products, and Digital Subscriber Line Access Multiplexer (DSLAM) products. Our broadband access
products are used by service providers to deliver high-speed Internet access, Voice over Internet
Protocol (VoIP), IP Television (IPTV), and/or Ethernet services from the central office or remote
terminal locations to customer premises. The Carrier Systems category also includes our optical
access products. These products consist of optical access multiplexers including our family of
OPTI products. Optical access products are used to deliver higher bandwidth services, or to
aggregate large numbers of low bandwidth services for transportation across fiber optic
infrastructure. Total Access 1500 products, 303 concentrator products, M13 multiplexer products,
and mobile backhaul products are also included in the Carrier Systems product category.
Business Networking products provide access to telecommunication services, facilitating the
delivery of converged services and Unified Communications to the SMB and Enterprise markets. The
Business Networking category includes Internetworking products and Integrated Access Devices
(IADs). Internetworking products consist of our Total Access IP Business Gateways, Optical Network
Terminals (ONTs), and NetVanta product lines. NetVanta products include multi-service routers,
managed Ethernet switches, IP Private Branch Exchange (PBX) products, IP phone products, Unified
Communications solutions, and Carrier Ethernet Network Terminating Equipment (NTE).
Loop Access products are used by carrier and enterprise customers for access to copper-based
telecommunications networks. The Loop Access category includes products such as: Digital Data
Service (DDS) and Integrated Services Digital Network (Total Reach) products, High bit-rate Digital
Subscriber Line (HDSL) products including Total Access 3000 HDSL and Time Division
Multiplexed-Symmetrical HDSL (TDM-SHDSL) products, T1/E1/T3, Channel Service Units/Data Service
Units, and TRACER fixed wireless products.
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The table below presents sales information by product for the three and six months ended June 30,
2010 and 2009.
In addition, we identify sub-categories of product revenues, which we divide into growth products,
representing our primary growth areas, and traditional products. Our growth products consist of
Broadband Access and Optical Access products (included in Carrier Systems) and Internetworking
products (included in Business Networking) and our traditional products include HDSL products
(included in Loop Access) and other products.
Subcategory revenues included in the above are as follows:
Sales by Geographic Region
The table below presents sales information by geographic area for the three and six months ended
June 30, 2010 and 2009. International sales correlate to shipments with a non-U.S. destination.
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9. LIABILITY FOR WARRANTY RETURNS
Our products generally include warranties of one to ten years for product defects. We accrue for
warranty returns at the time revenue is recognized based on our estimate of the cost to repair or
replace the defective products. We engage in extensive product quality programs and processes,
including actively monitoring and evaluating the quality of our component suppliers. Our products
continue to become more complex in both size and functionality as many of our product offerings
migrate from line card applications to systems products. The increasing complexity of our products
will cause warranty incidences, when they arise, to be more costly. Our estimates regarding future
warranty obligations may
change due to product failure rates, material usage, and other rework costs incurred in correcting
a product failure. In addition, from time to time, specific warranty accruals may be recorded if
unforeseen problems arise. Should our actual experience relative to these factors be worse than
our estimates, we will be required to record additional warranty expense. Alternatively, if we
provide for more reserves than we require, we will reverse a portion of such provisions in future
periods. The liability for warranty obligations totaled $3.2 million at June 30, 2010 and $2.8
million at December 31, 2009. These liabilities are included in accrued expenses in the
accompanying Consolidated Balance Sheets.
A summary of warranty expense and write-off activity for the six months ended June 30, 2010 and
2009 is as follows:
10. RELATED PARTY TRANSACTIONS
We employ the law firm of our director emeritus for legal services. All bills for services
rendered by this firm are reviewed and approved by our Chief Financial Officer. We believe that
the fees for such services are comparable to those charged by other firms for services rendered to
us. For the three and six month periods ended June 30, 2010 and 2009, we incurred fees of $10
thousand per month for these legal services.
11. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, we may be subject to various legal proceedings and claims,
including employment disputes, patent claims, disputes over contract agreements and other
commercial disputes. In some cases, claimants seek damages or other relief, such as royalty
payments related to patents, which, if granted, could require significant expenditures. Although
the outcome of any claim or litigation can never be certain, it is our opinion that the outcome of
all contingencies of which we are currently aware will not materially affect our business,
operations, financial condition or cash flows.
We have committed to invest up to an aggregate of $7.9 million in two private equity funds, and we
have contributed $8.0 million as of June 30, 2010, of which $7.5 million has been applied to these
commitments. See Note 4 of Notes to Consolidated Financial Statements for additional information.
12. SUBSEQUENT EVENTS
On July 13, 2010, we announced that our Board of Directors declared a quarterly cash dividend of
$0.09 per common share to be paid to stockholders of record at the close of business on July 29,
2010. The payment date will be August 12, 2010. The quarterly dividend payment will be
approximately $5.6 million. In July 2003, our Board of Directors elected to begin declaring
quarterly dividends on our common stock considering the favorable tax treatment of dividends and
adequate levels of Company liquidity.
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The following discussion should be read in conjunction with the Consolidated Financial Statements
and the related notes that appear elsewhere in this document.
OVERVIEW
ADTRAN, Inc. designs, manufactures, markets and services network access solutions for
communications networks. Our solutions are widely deployed by providers of telecommunications
services (serviced by our Carrier Networks Division), and small and mid-sized businesses (SMBs) and
enterprises (serviced by our Enterprise Networks Division), and enable voice, data, video and
Internet communications across wireline and wireless networks. Many of these solutions are
currently in use by every major United States service provider and many global ones, as well as by
many public, private and governmental organizations worldwide.
Our success depends upon our ability to increase unit volume and market share through the
introduction of new products and succeeding generations of products having lower selling prices and
increased functionality as compared to both the prior generation of a product and to the products
of competitors. An important part of our strategy is to reduce the cost of each succeeding product
generation and then lower the product’s selling price based on the cost savings achieved in order
to gain market share and/or improve gross margins. As a part of this strategy, we seek in most
instances to be a high-quality, low-cost provider of products in our markets. Our success to date
is attributable in large measure to our ability to design our products initially with a view to
their subsequent redesign, allowing both increased functionality and reduced manufacturing costs in
each succeeding product generation. This strategy enables us to sell succeeding generations of
products to existing customers, while increasing our market share by selling these enhanced
products to new customers.
Our three major product categories are Carrier Systems, Business Networking and Loop Access.
Carrier Systems products are used by communications service providers to provide last mile access
in support of data, voice and video services to consumers and enterprises. Business Networking
products provide access to telecommunication services, facilitating the delivery of converged
services and Unified Communications to the SMB and Enterprise markets. Loop Access products are
used by carrier and enterprise customers for access to copper-based telecommunications networks.
In addition, we identify sub-categories of product revenues, which we divide into growth products,
representing our primary growth areas, and traditional products. Our growth products consist of
Broadband Access and Optical Access products (included in Carrier Systems) and Internetworking
products (included in Business Networking) and our traditional products include HDSL products
(included in Loop Access) and other products. Many of our customers are migrating their networks
to deliver higher bandwidth services by utilizing newer technologies. We believe that products in
our primary growth areas position us well for this migration. Despite short-term increases, we
anticipate that revenues of many of our traditional products, including HDSL, will decline over
time; however, revenues from these products may continue for years because of the time required for
our customers to transition to newer technologies.
See Note 8 of Notes to Consolidated Financial Statements in this report for further information
regarding these product categories.
Sales were $150.4 million and $277.4 million for the three and six months ended June 30, 2010
compared to $121.5 million and $231.9 million for the three and six months ended June 30, 2009.
Product revenues for our three primary growth areas, Broadband Access, Optical Access and
Internetworking, were $89.0 million and $158.8 million for the three and six months ended June 30,
2010 compared to $65.3 million and $113.5 million for the three and six months ended June 30, 2009.
Our gross margin increased for the three months ended June 30, 2010 to 59.4% from 59.0% for the
three months ended June 30, 2009, while decreasing for the six months ended June 30, 2010 to 59.4%
from 60.0% for the six months ended June 30, 2009. Our operating margin increased to 25.7% and
23.1% for the three and six months ended June 30, 2010 from 21.5% and 21.1% for the three and six
months ended June 30, 2009. Net income was $27.8 million and $45.9 million for the three and six
months ended June 30, 2010 compared to $18.8 million and $34.0 million for the three and six months
ended June 30, 2009. Our effective tax rate increased to 33.9% and 34.6% for the three and six
months ended June 30, 2010 from 33.8% and 30.7% for the three and six months ended June 30, 2009.
Earnings per share, assuming dilution, were $0.44 and $0.73 for the three and six months ended June
30, 2010 compared to $0.30 and $0.54 for the three and six months ended June 30, 2009.
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Our operating results have fluctuated on a quarterly basis in the past, and may vary
significantly in future periods due to a number of factors. We normally operate with very little
order backlog. A majority of our sales in each quarter result from customer orders received in
that quarter under agreements containing non-binding purchase commitments. Many of our customers
require prompt delivery of products. This results in a limited backlog of orders and requires us
to maintain sufficient inventory levels to satisfy anticipated customer demand. If near-term
demand for our products declines, or if potential sales in any quarter do not occur as anticipated,
our financial results could be adversely affected. Operating expenses are relatively fixed in the
short term; therefore, a shortfall in quarterly revenues could significantly impact our financial
results in a given quarter.
Our operating results may also fluctuate as a result of a number of other factors, including a
decline in general economic and market conditions, increased competition, customer order patterns,
changes in product mix, timing differences between price decreases and product cost reductions,
product warranty returns, expediting costs and announcements of new products by us or our
competitors. Additionally, maintaining sufficient inventory levels to assure prompt delivery of
our products increases the amount of inventory that may become obsolete and increases the risk that
the obsolescence of this inventory may have an adverse effect on our business and operating
results. Also, not maintaining sufficient inventory levels to assure prompt delivery of our
products may cause us to incur expediting costs to meet customer delivery requirements, which may
negatively impact our operating results in a given quarter.
Accordingly, our historical financial performance is not necessarily a meaningful indicator of
future results, and, in general, management expects that our financial results may vary from period
to period. A list of factors that could materially affect our business, financial condition or
operating results is included under “Factors That Could Affect Our Future Results” in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of
Part I of this report. These factors have also been discussed in more detail in Item 1A of Part I
in our most recent Annual Report on Form 10-K for the year ended December 31, 2009, filed on
February 26, 2010 with the SEC.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our critical accounting policies and estimates have not changed significantly from those detailed
in our most recent Annual Report on Form 10-K for the year ended December 31, 2009, filed on
February 26, 2010 with the SEC.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of Notes to Consolidated Financial Statements in Item 1 of this Form 10-Q for a full
description of recent accounting pronouncements, including the expected dates of adoption and
estimated effects on results of operations and financial condition, which is incorporated herein by
reference.
RESULTS OF OPERATIONS — THREE AND SIX MONTHS ENDED JUNE 30, 2010 COMPARED TO THREE AND SIX MONTHS
ENDED JUNE 30, 2009
SALES
ADTRAN’s sales increased 23.7% from $121.5 million in the three months ended June 30, 2009 to
$150.4 million in the three months ended June 30, 2010, and increased 19.6% from $231.9 million in
the six months ended June 30, 2009 to $277.4 million in the six months ended June 30, 2010.
Carrier Networks sales increased 28.1% from $91.8 million in the three months ended June 30, 2009
to $117.6 million in the three months ended June 30, 2010, and increased 21.4% from $178.9 million
in the six months ended June 30, 2009 to $217.1 in the six months ended June 30, 2010. The
increase in Carrier Networks sales for the three and six month periods ended June 30, 2010 compared
to the three and six month periods ended June 30, 2009 is primarily attributable to increases in
Broadband Access, Optical Access, HDSL and Internetworking NTE product sales.
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Enterprise Networks sales increased 10.1% from $29.8 million in the three months ended June 30,
2009 to $32.8 million in the three months ended June 30, 2010, and increased 13.7% from $53.0
million in the six months ended June 30, 2009 to $60.3 million in the six months ended June 30,
2010. The increase in Enterprise Network sales for the three and six month periods ended June 30,
2010 compared to the three and six month periods ended June 30, 2009 is primarily attributable to
an increase in Internetworking product sales, partially offset by a decrease in traditional IAD and
enterprise T1 products. Internetworking product sales were 75.7% and 74.7% of Enterprise Network
sales in the three and six months ended June 30, 2010, compared with 65.8% and 64.7% in the three
and six months ended June 30, 2009. Traditional products primarily comprise the remainder of
Enterprise Networks sales. Enterprise Networks sales as a percentage of total sales decreased from
24.5% for the three months ended June 30, 2009 to 21.8% for the three months ended June 30, 2010
and decreased from 22.9% for the six months ended June 30, 2009 to 21.7% for the six months ended
June 30, 2010.
International sales, which are included in the Carrier Networks and Enterprise Networks amounts
discussed above, increased 29.1% from $6.4 million in the three months ended June 30, 2009 to $8.3
million in the three months ended June 30, 2010, and increased 12.3% from $13.4 million in the six
months ended June 30, 2009 to $15.0 million in the six months ended June 30, 2010. The increase in
international sales for the three and six month periods ended June 30, 2010 was primarily due to an
increase in sales to our Asia-Pacific customers. International sales, as a percentage of total
sales, increased from 5.3% for the three months ended June 30, 2009 to 5.5% for the three months
ended June 30, 2010, and decreased from 5.8% for the six months ended June 30, 2009 to 5.4% for the
six months ended June 30, 2010.
Carrier System product sales increased $16.9 million and $32.3 million in the three and six months
ended June 30, 2010 compared to the three and six months ended June 30, 2009 primarily due to
increases in Broadband Access and Optical Access product sales. The increase in Broadband Access
and Optical Access product sales is primarily attributable to continued growth of our TA5000,
TA1100/1200 FTTN products, and OPTI 6100 products.
Business Networking product sales increased $5.7 million and $12.2 million in the three and six
months ended June 30, 2010 compared to the three and six months ended June 30, 2009, primarily due
to an increase in Internetworking product sales, offset by a decrease in sales of traditional IAD
products as customers shifted to newer technologies. Many of these newer technologies are integral
to our Internetworking product area.
Loop Access product sales increased $6.2 million and $1.0 million in the three and six months ended
June 30, 2010 compared to the three and six months ended June 30, 2009 primarily due to an increase
in HDSL product sales, offset by decreases in other traditional products.
COST OF SALES
As a percentage of sales, cost of sales decreased from 41.0% in the three months ended June
30, 2009 to 40.6% in the three months ended June 30, 2010 and increased from 40.0% in the six
months ended June 30, 2009 to 40.6% in the six months ended June 30, 2010. The decrease for the
three month period ended June 30, 2010 is primarily related to improved cost absorption and
manufacturing efficiencies achieved at the higher production volumes, partially offset by higher
costs incurred to expedite delivery of materials. The increase for the six month period ended June
30, 2010 is primarily related to an increase in costs incurred to expedite delivery of materials
due to the impact of component supply constraints broadly impacting our industry during the period.
Carrier Networks cost of sales, as a percent of division sales, decreased from 41.7% in the three
months ended June 30, 2009 to 40.2% in the three months ended June 30, 2010 and increased from
39.7% in the six months ended June 30, 2009 to 40.3% in the six months ended June 30, 2010. The
decrease for the three month period ended June 30, 2010 is primarily related to the cost elements
discussed above. The increase for the six month period ended June 30, 2010 is primarily related to
the cost elements discussed above.
Enterprise Networks cost of sales, as a percent of division sales, increased from 38.9% in the
three months ended June 30, 2009 to 41.9% in the three months ended June 30, 2010 and increased
from 40.8% in the six months ended June 30, 2009 to 41.7% in the six months ended June 30, 2010.
The increase for the three month and six month periods ended June 30, 2010 is primarily related to
the cost elements discussed above, a higher cost product mix, and the impact of cost allocations
between divisions.
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An important part of our strategy is to reduce the product costs of each succeeding product
generation and then to lower the product’s price based on the cost savings achieved. This may
cause variations in our gross profit percentage due to timing differences between the recognition
of cost reductions and the lowering of product selling prices.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased 14.3% from $24.9 million in the three months
ended June 30, 2009 to $28.5 million in the three months ended June 30, 2010 and increased 14.6%
from $48.6 million in the six months ended June 30, 2009 to $55.7 million in the six months ended
June 30, 2010. The increase in selling, general and administrative expenses in the three and six
month periods ended June 30, 2010 is primarily related to increased staffing costs, fringe
benefits, incentive compensation, and travel expenses.
Selling, general and administrative expenses as a percentage of sales decreased from 20.5% in the
three months ended June 30, 2009 to 18.9% in the three months ended June 30, 2010 and decreased
from 21.0% in the six months ended June 30, 2009 to 20.1% in the six months ended June 30, 2010.
Selling, general and administrative expenses as a percentage of sales may fluctuate whenever there
is a significant fluctuation in revenues for the periods being compared.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased 7.7% from $20.7 million in the three months ended June
30, 2009 to $22.3 million in the three months ended June 30, 2010 and increased 8.4% from $41.5
million in the six months ended June 30, 2009 to $45.0 million in the six months ended June 30,
2010. The increase in research and development expenses in the three and six months ended June 30,
2010 reflects increased staffing and testing expense primarily related to general development
activities for customer specific requirements, as well as costs related to product design approvals
primarily for one or more of the top three U.S. carriers. As a percentage of sales, research and
development expenses decreased from 17.0% in the three months ended June 30, 2009 to 14.8% in the
three months ended June 30, 2010 and decreased from 17.9% in the six months ended June 30, 2009 to
16.2% in the six months ended June 30, 2010.
We expect to continue to incur research and development expenses in connection with our new and
existing products and our expansion into international markets. We continually evaluate new
product opportunities and engage in intensive research and product development efforts which
provides for new product development, enhancement of existing products and product cost reductions.
We may incur significant research and development expenses prior to the receipt of revenues from a
major new product group or market expansion.
INTEREST AND DIVIDEND INCOME
Interest and dividend income decreased 10.0% from $1.8 million in the three months ended June 30,
2009 to $1.7 million in the three month periods ended June 30, 2010 and decreased 8.5% from $3.5
million in the six month periods ended June 30, 2009 to $3.2 million in the six months ended June
30, 2010. This decrease is primarily driven by a 4.4% reduction in the average rate of return on
our investments as a result of lower interest rates, partially offset by an 8.8% increase in our
average investment balances.
INTEREST EXPENSE
Interest expense, which is primarily related to our taxable revenue bond, remained constant at $0.6
million in each of the three months ended June 30, 2010 and 2009 and $1.2 million in each of the
six months ended June 30, 2010 and 2009, respectively. See “Liquidity and Capital Resources” below
for additional information on our revenue bond.
NET REALIZED INVESTMENT GAIN/LOSS
Net realized investment gain/loss changed from a $1.0 million gain in the three months ended June
30, 2009 to a $2.5 million gain in the three months ended June 30, 2010 and changed from a $2.2
million loss in the six months ended June 30, 2009 to a $4.7 million gain in the six months ended
June 30, 2010. This change is primarily a result of the other-than-temporary impairment of certain
securities in our equity portfolio in 2009 and the realized gain on the sale of one security in
2010. See “Investing Activities” in “Liquidity and Capital Resources” below for additional
information.
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OTHER INCOME (EXPENSE), NET
Other income (expense), net, comprised primarily of miscellaneous income, gains and losses on
foreign currency transactions, investment account management fees, scrap raw material sales, and
gains and losses on the disposal of property, plant and equipment occurring in the normal course of
business, changed from $0.1 million of income in the three months ended June 30, 2009 to $0.2
million of expense in the three months ended June 30, 2010 and changed from $35 thousand of expense
in the six months ended June 30, 2009 to $0.4 million of expense in the six months ended June 30,
2010.
INCOME TAXES
Our effective tax rate increased from 30.7% in the six months ended June 30, 2009 to 34.6% in the
six months ended June 30, 2010. The increase is primarily due to a one-time tax benefit of $1.7
million recorded in the first quarter of 2009, which decreased our effective tax rate by 3.4
percentage points. The $1.7 million benefit resulted from a review of our deduction for
manufacturer’s domestic production activities for the years 2005, 2006 and 2007 under Internal
Revenue Code Section 199, which was completed during the first quarter of 2009. Amended income tax
returns were filed during the first quarter of 2009 in association with this benefit. In addition,
the manufacturer’s domestic production activities deduction increased from six percent in 2009 to
nine percent in 2010, resulting in approximately a 1.0 percentage point decrease in our effective
tax rate for the six months ended June 30, 2010.
The tax provision for the six months ended June 30, 2009 also included the benefit from the
research and development tax credit. The tax provision for the six months ended June 30, 2010 did
not include a benefit from the research and development tax credit, which expired on December 31,
2009. The exclusion of the benefit from the research and development tax credits resulted in
approximately a 2.0 percentage point increase in our effective tax rate in the six months ended
June 30, 2010. Finally, the completion of an audit for the years 2006 and 2007 by the Internal
Revenue Service resulted in the reversal of several uncertain tax positions, which resulted in
approximately a 1.0 percentage point decrease in our effective tax rate for the six months ended
June 30, 2010.
NET INCOME
As a result of the above factors, net income increased $8.9 million from $18.8 million in the three
months ended June 30, 2009 to $27.8 million in the three months ended June 30, 2010 and increased
$11.9 million from $34.0 million in the six months ended June 30, 2009 to $45.9 million in the six
months ended June 30, 2010.
As a percentage of sales, net income increased from 15.5% in the three months ended June 30, 2009
to 18.5% in the three months ended June 30, 2010 and increased from 14.7% in the six months ended
June 30, 2009 to 16.6% in the six months ended June 30, 2010.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
At June 30, 2010, cash on hand was $29.5 million and short-term investments were $150.4 million,
which resulted in available short-term liquidity of $179.9 million. At December 31, 2009, our cash
on hand of $24.1 million and short-term investments of $172.5 million resulted in available
short-term liquidity of $196.6 million. The decrease in liquidity from December 31, 2009 to June
30, 2010 primarily reflects a realignment of our investment portfolio from short-term to long-term,
which increased long-term investments by $48.2 million in the first six months of 2010 compared to
December 31, 2009.
Operating Activities
Our working capital, which consists of current assets less current liabilities, decreased 5.7%
from $278.0 million as of December 31, 2009 to $262.3 million as of June 30, 2010. The quick
ratio, defined as cash and cash equivalents, short-term investments, and net accounts receivable,
divided by current liabilities, decreased from 5.54 as of December 31, 2009 to 3.40 as of June 30,
2010. The current ratio, defined as current assets divided by current liabilities, decreased from
6.82 as of December 31, 2009 to 4.55 as of June 30, 2010. Our working capital, the quick ratio,
and the current ratio decreased due to a realignment of our investment portfolio from short-term to
long-term, which increased long-term investments by $48.2 million, and an increase in current
liabilities of $26.1 million, primarily due to increases of $18.5 million in accounts payable and
$4.8 million in accrued wages and benefits at June 30, 2010.
Net accounts receivable increased from $68.0 million at December 31, 2009 to $71.6 million at June
30, 2010. Our allowance for doubtful accounts was $0.1 million at December 31, 2009 and $0.2
million at June 30, 2010. Quarterly accounts receivable days sales outstanding (DSO) decreased
from 50 days as of December 31, 2009 to 43 days as of June 30, 2010. Generally, the change in net
accounts receivable and DSO is due to the timing of sales and collections during the quarter.
Other receivables increased from $4.1 million at December 31, 2009 to $8.0 million at June 30,
2010. The increase in other receivables at June 30, 2010 reflects increased materials supplied to
our contract manufacturers to support current production levels. Additionally, other receivables
may fluctuate due to the timing of collections for materials supplied to our contract
manufacturers.
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Quarterly inventory turnover remained consistent at 4.5 turns as of December 31, 2009 and 4.4 turns
as of June 30, 2010. Inventory increased 40.0% from December 31, 2009 to June 30, 2010. We expect
inventory levels to fluctuate as we attempt to maintain sufficient inventory in response to
seasonal cycles of our business; ensuring competitive lead times while managing the risk of
inventory obsolescence that may occur due to rapidly changing technology and customer demand. Our
investment in inventory increased in the second quarter to support strong customer order levels and
to mitigate component supply constraints broadly affecting the industry as production increased. We
anticipate these constraints will ease over the balance of the year.
Accounts payable increased 71.8% from $25.8 million at December 31, 2009 to $44.3 million at June
30, 2010. Generally, the change in accounts payable is due to variations in the timing of the
receipt of supplies, inventory and services and our subsequent payments for these purchases.
Investing Activities
Capital expenditures totaled approximately $4.8 million and $3.9 million for the six months ended
June 30, 2010 and 2009, respectively. These expenditures were primarily used to purchase
manufacturing and test equipment and computer software and hardware.
Our combined short-term and long-term investments increased $26.1 million from $334.6 million at
December 31, 2009 to $360.8 million at June 30, 2010.
We invest all available cash not required for immediate use in operations primarily in securities
that we believe bear minimal risk of loss. At June 30, 2010 these investments included municipal
variable rate demand notes of $83.6 million, municipal fixed-rate bonds of $113.3 million, and
corporate bonds of $76.7 million. At December 31, 2009, these investments included municipal
variable rate demand notes of $84.4 million, municipal fixed-rate bonds of $141.3 million and
corporate bonds of $20.4 million.
Our municipal variable rate demand notes are classified as available-for-sale short-term
investments. At June 30, 2010, 24% of our municipal variable rate demand notes had a credit rating
of AAA, 64% had a credit rating of AA, 12% had a credit rating of A, and all contained put options
of seven days. Despite the long-term nature of their stated contractual maturities, we believe
that we have the ability to quickly liquidate these securities. Our investments in these
securities are recorded at fair value, and the interest rates reset every seven days. We believe
we have the ability to sell our variable rate demand notes to the remarketing agent, tender agent
or issuer at par value plus accrued interest in the event we decide to liquidate our investment in
a particular variable rate demand note. Approximately 41% of our variable rate demand notes are
supported by letters of credit from banks that we believe to be in good financial condition. The
remaining 59% of our variable rate demand notes are supported by standby purchase agreements. As a
result of these factors, we had no cumulative gross unrealized holding gains (losses) or gross
realized gains (losses) from these investments. All income generated from these investments was
recorded as interest income. We have not been required to record any losses relating to municipal
variable rate demand notes.
At June 30, 2010, approximately 39% of our municipal fixed-rate bond portfolio had a credit rating
of AAA, 52% had a credit rating of AA, and 9% had a credit rating of A. These bonds are classified
as available-for-sale investments and had an average duration of 1.0 years at June 30, 2010.
Because our bond portfolio has a high quality rating and contractual maturities of a short
duration, we are able to obtain prices for these bonds derived from observable market inputs, or
for similar securities traded in an active market, on a daily basis.
At June 30, 2010, we held $76.7 million of corporate bonds. Of this amount, we held $41.2 million
in bonds that have been guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the
Temporary Liquidity Guarantee Program (TLGP). These bonds are classified as available-for-sale and
had an average duration of 2.0 years at June 30, 2010. At June 30, 2010, approximately 54% of our
corporate bond portfolio had a credit rating of AAA, 10% had a credit rating of AA, 21% had a
credit rating of A, and 15% had a credit rating of BBB.
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Our long-term investments increased 29.7% from $162.2 million at December 31, 2009 to $210.4
million at June 30, 2010. The primary reason for the increase in our long-term investments was the
realignment of our investment portfolio. Long-term investments at June 30, 2010 and December 31,
2009 included an investment in a restricted certificate of deposit of $48.3 million which serves as
collateral for our revenue bonds, as discussed below. We have various equity investments included
in long-term investments at a cost of $10.4 million and $9.8 million, and with a fair value of
$32.3 million and $33.5 million, at June 30, 2010 and December 31, 2009, respectively, including a
single equity security, of which we held 1.8 million shares and 2.1 million shares, carried at
$21.6 million and $22.4 million of fair value at June 30, 2010 and December 31, 2009, respectively.
The single security traded approximately 1.3 million shares per day in the first half of 2010 in
an active market on a European stock exchange. Of the gross unrealized gains included in the fair
value of our marketable securities at June 30, 2010, this single security comprised $21.0 million
of the unrealized gain. Long-term investments at June 30, 2010 also include $3.5 million related
to our deferred compensation plan; $2.3 million of other investments carried at cost, consisting of
interests in two private equity funds and an investment in a privately held telecommunications
equipment manufacturer; and $0.7 million of a fixed income bond fund.
We review our investment portfolio for potential “other-than-temporary” declines in value on an
individual investment basis. We assess, on a quarterly basis, significant declines in value which
may be considered other-than-temporary and, if necessary, recognize and record the appropriate
charge to write-down the carrying value of such investments. In making this assessment, we take
into consideration qualitative and quantitative information, including but not limited to the
following: the magnitude and duration of historical declines in market prices, credit rating
activity, assessments of liquidity, public filings, and statements made by the issuer. We
generally begin our identification of potential other-than-temporary impairments by reviewing any
security with a fair value that has declined from its original or adjusted cost basis by 25% or
more for six or more consecutive months. We then evaluate the individual security based on the
previously identified factors to determine the amount of the write-down, if any. As a result of
our review, we recorded an other-than-temporary impairment charge of $42 thousand during the first
six months of 2010 related to three marketable equity securities. For the six months ended June
30, 2009, we recorded an other-than-temporary impairment charge of $2.0 million related to 107
publicly traded equity securities. In addition to the impairment charge we recorded on our
marketable equity securities, we recorded an impairment charge of $0.4 million related to our
investment in a fixed income bond fund and $0.5 million related to our deferred compensation plan
during the first six months of 2009 as a result of similar reviews. There were no impairment
charges related to the fixed income bond fund or deferred compensation plan assets during the six
months ended June 30, 2010.
Financing Activities
Dividends
In July 2003, our Board of Directors elected to begin declaring quarterly dividends on our common
stock considering the favorable tax treatment of dividends and adequate levels of Company
liquidity. During the six months ended June 30, 2010, we paid dividends totaling $11.2 million.
Debt
We have amounts outstanding under loans made pursuant to an Alabama State Industrial
Development Authority revenue bond (the Bond) which totaled $48.3 million at June 30, 2010 and
December 31, 2009. At June 30, 2010, the estimated fair value of the Bond was approximately $45.8
million, based on a debt security with a comparable interest rate and maturity and a Standard &
Poor’s credit rating of A+. Included in long-term investments are restricted funds in the amount
of $48.3 million at June 30, 2010 and December 31, 2009, which is a collateral deposit against the
principal amount of the Bond. We have the right to set-off the balance of the Bond with the
collateral deposit in order to reduce the balance of the indebtedness. The Bond matures on January
1, 2020, and bears interest at the rate of 5% per annum. In conjunction with this program, we
receive certain economic incentives from the State of Alabama that reduce the amount of payroll
withholdings we are required to remit to the state for those employment positions that qualify
under this program.
We are required to make payments in the amounts necessary to pay the principal and interest on the
amounts currently outstanding. Based on positive cash flow from operating activities, we have
decided to continue early partial redemptions of the Bond. It is our intent to make annual
principal payments in addition to the interest amounts that are due. In connection with this
decision, $0.5 million of the Bond debt has been classified as a current liability in the
Consolidated Balance Sheets.
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Stock Repurchase Program
Since 1997, our Board of Directors has approved multiple share repurchase programs that have
authorized open market repurchase transactions of up to 30 million shares of our common stock.
During the six months ended June 30, 2010, we repurchased 0.5 million shares of our common stock at
a weighted average price of $21.62 per share. We have the authority to purchase an additional 2.2
million shares of our common stock under the plan approved by the Board of Directors on April 14,
2008.
We issued 0.5 million shares of treasury stock for $7.4 million during the six months ended June
30, 2010 to accommodate employee stock option exercises. During the six months ended June 30,
2009, we issued 0.5 million shares of treasury stock for $8.4 million.
Off-Balance Sheet Arrangements and Contractual Obligations
We do not have off-balance sheet financing arrangements and have not engaged in any related party
transactions or arrangements with unconsolidated entities or other persons that are reasonably
likely to materially affect liquidity or the availability of or requirements for capital resources.
During the six months ended June 30, 2010, there have been no material changes in contractual
obligations and commercial commitments from those discussed in our most recent Annual Report on
Form 10-K for the year ended December 31, 2009 filed on February 26, 2010 with the SEC.
We have committed to invest up to an aggregate of $7.9 million in two private equity funds, and we
have contributed $8.0 million as of June 30, 2010, of which $7.5 million has been applied to these
commitments. See Note 4 of Notes to Consolidated Financial Statements for additional information.
We intend to finance our operations with cash flow from operations. We have used, and expect to
continue to use, the cash generated from operations for working capital needs, purchases of
treasury stock, dividend payments, and other general corporate purposes, including (i) product
development activities to enhance our existing products and develop new products and (ii) expansion
of sales and marketing activities. We believe our cash and cash equivalents, investments and cash
generated from operations to be adequate to meet our operating and capital needs for the
foreseeable future.
FACTORS THAT COULD AFFECT OUR FUTURE RESULTS
The following are some of the risks that could affect our financial performance or could cause
actual results to differ materially from those expressed or implied in our forward-looking
statements:
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The foregoing list of risks is not exclusive. For a more detailed description of the risk factors
associated with our business, see Item 1A of our Annual Report on Form 10-K for the year ended
December 31, 2009, filed on February 26, 2010 with the SEC.
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We are exposed to financial market risks, including changes in interest rates and prices of
marketable equity and fixed-income securities. The primary objective of the large majority of our
investment activities is to preserve principal while at the same time achieving appropriate yields
without significantly increasing risk. To achieve this objective, a majority of our marketable
securities are investment grade, municipal fixed-rate bonds, municipal variable rate demand notes
and municipal money market instruments denominated in United States dollars. At June 30, 2010, 24%
of our municipal variable rate demand notes had a credit rating of AAA, 64% had a credit rating of
AA, 12% had a credit rating of A, and all contained put options of seven days. At June 30, 2010,
approximately 39% of our municipal fixed-rate bond portfolio had a credit rating of AAA, 52% had a
credit rating of AA, and 9% had a credit rating of A. We also held $76.7 million of corporate
bonds. Of this amount, we held $41.2 million in bonds issued by various banks that have been
guaranteed by the Federal Deposit Insurance Corporation under the Treasury Liquidity Guarantee
Program. At June 30, 2010, approximately 54% of our corporate bond portfolio had a credit rating
of AAA, 10% had a credit rating of AA, 21% had a credit rating of A, and 15% had a credit rating of
BBB.
We maintain depository investments with certain financial institutions. Although these depository
investments may exceed government insured depository limits, we have evaluated the credit
worthiness of these financial institutions, and determined the risk of material financial loss due
to exposure of such credit risk to be minimal. As of June 30, 2010, $26.8 million of our cash and
cash equivalents, primarily certain domestic money market funds and foreign depository accounts,
were in excess of government provided insured depository limits. The Temporary Liquidity Guarantee
Program adopted during 2008 by the Federal Deposit Insurance Corporation provided full coverage of
our domestic depository accounts through December 2009. Although this program was extended through
June 30, 2010, the banks where we maintain our depository accounts opted out of participation in
this program after December 31, 2009.
As of June 30, 2010, approximately $285.0 million of our cash and investments may be directly
affected by changes in interest rates. We have performed a hypothetical sensitivity analysis
assuming market interest rates increase or decrease by 50 basis points (bps), 100 bps and 150 bps
for the entire year, while all other variables remain constant. At June 30, 2010, we held $101.5
million of cash and money market instruments and municipal variable rate demand notes where a
change in interest rates would impact our interest income. Hypothetical 50 bps, 100 bps and 150
bps declines in interest rates as of June 30, 2010 would reduce annualized interest income on our
cash and money market instruments and municipal variable rate demand notes by approximately $0.5
million, $1.0 million and $1.5 million, respectively. In addition, we held $183.6 million of
fixed-rate municipal bonds and corporate bonds whose fair values may be directly affected by a
change in interest rates. Hypothetical 50 bps, 100 bps and 150 bps increases in interest rates as
of June 30, 2010 would reduce the fair value of our municipal fixed-rate bonds and corporate bonds
by approximately $1.2 million, $2.4 million and $3.6 million, respectively.
As of June 30, 2009, interest income on approximately $244.5 million of our cash and investments
was subject to being directly affected by changes in interest rates. We performed a hypothetical
sensitivity analysis assuming market interest rates increase or decrease by 50 basis points (bps),
100 bps and 150 bps, while all other variables remain constant. Hypothetical 50 bps, 100 bps and
150 bps declines in interest rates as of June 30, 2009 would have reduced annualized interest
income on our cash, money market instruments and municipal variable rate demand notes by
approximately $0.5 million, $1.0 million and $1.5 million, respectively. In addition, hypothetical
50 bps, 100 bps and 150 bps increases in interest rates as of June 30, 2009 would have reduced the
fair value of our municipal fixed-rate bonds and corporate bonds by approximately $0.8 million,
$1.6 million and $2.4 million, respectively.
For further information about the fair value of our available-for-sale investments as of June 30,
2010 see Note 4 of Notes to Consolidated Financial Statements.
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(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief
Financial Officer are responsible for establishing and maintaining “disclosure controls and
procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for
ADTRAN. Our Chief Executive Officer and Chief Financial Officer, after evaluating the
effectiveness of our disclosure controls and procedures as of the end of the period covered by this
quarterly report, have concluded that our disclosure controls and procedures are effective.
(b) Changes in internal control over financial reporting. There were no changes in our internal
control over financial reporting that occurred during our most recent fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
PART II. OTHER INFORMATION
A list of factors that could materially affect our business, financial condition or operating
results is included under “Factors That Could Affect Our Future Results” in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 2 of
Part I of this report. There have been no material changes to the risk factors as disclosed in
Item 1A of Part I of our most recent Annual Report on Form 10-K for the year ended December 31,
2009, filed on February 26, 2010 with the SEC.
Exhibits.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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EXHIBIT INDEX
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