ADTRAN, Inc. 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; filed November 5, 2014. The filing is for ADTRAN, Inc. (the company identified in the filing), and its interim financial statements are unaudited. The company provides networking and communications equipment through Carrier Networks and Enterprise Networks.
Financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Sales | $162.9 million | $177.4 million | $486.0 million | $482.7 million |
| Gross profit / margin | $78.3 million / 48.0% | $82.5 million / 46.5% | $242.8 million / 50.0% | $232.0 million / 48.1% |
| Operating income / margin | $12.5 million / 7.7% | $17.2 million / 9.7% | $43.1 million / 8.9% | $37.8 million / 7.8% |
| Net income | $11.3 million | $16.2 million | $35.3 million | $34.0 million |
| Diluted EPS | $0.21 | $0.28 | $0.63 | $0.57 |
| Operating cash flow | Not presented by quarter | $41.0 million | $51.6 million |
Q3 cost of sales was 52.0% of sales, versus 53.5% a year earlier; nine-month cost of sales was 50.0%, versus 51.9%. The filing attributes improved gross margins mainly to international margin improvement, partly offset by domestic customer mix and a higher services mix.
Liquidity, debt and capital allocation
- At September 30, cash and cash equivalents were $58.4 million and short-term investments were $55.6 million, totaling $114.0 million in short-term liquidity, down from $164.1 million at year-end 2013.
- Current assets were $348.8 million and current liabilities $117.0 million; working capital was $231.8 million. The current ratio was 2.98 and quick ratio 1.82, down from 3.71 and 2.44, respectively, at December 31, 2013.
- Total short- and long-term investments were $354.1 million, including $30.0 million of restricted collateral for the revenue bond. The company reported no off-balance-sheet financing arrangements.
- Revenue bond debt was $30.0 million, down from $46.5 million at year-end after a $16.5 million principal payment. The bond bears 2% interest, matures January 2020, and is collateralized by restricted funds.
- Nine-month investing cash flow was positive $51.8 million, including net proceeds from investment sales and maturities; capital expenditures were $8.2 million. Financing cash outflow was $91.3 million, including $62.1 million of treasury-share purchases, $15.1 million of dividends and $16.5 million of debt payments.
- The company repurchased 2.7 million shares during the first nine months at an average $22.68 per share and paid $0.27 per share in dividends. It had authority to repurchase a further 5.7 million shares at September 30.
Material changes and operating trends
- Q3 sales fell 8.2% year over year, while nine-month sales rose 0.7%. Q3 net income declined 30.1%; nine-month net income increased 4.0%.
- Carrier Networks sales decreased 5.9% in Q3 but increased 5.4% year to date. Enterprise Networks sales fell 17.2% in Q3 and 15.5% year to date, reflecting softer internetworking demand and inventory reductions at two distribution partners.
- For the first nine months, Broadband Access sales grew $33.9 million, but HDSL and other legacy products declined $23.8 million. Legacy revenues are expected to continue declining as customers migrate to newer technologies.
- International sales were $197.7 million for the first nine months, up 47.7%, and represented 40.7% of sales versus 27.7% a year earlier. The filing cites increased hiX sales in EMEA and growth in Latin America, partly offset by lower Asia-Pacific sales.
- Q3 operating income was pressured by lower revenue and higher R&D as a share of sales. Nine-month results benefited from higher gross profit and lower interest expense, partly offset by higher SG&A, R&D and taxes.
Outlook, risks and unusual items
- No specific revenue, earnings or margin guidance is provided. Management said cash, investments and expected operating cash generation should cover operating and capital needs for at least the next 12 months.
- Management cautioned that quarterly results can vary with customer orders, backlog, product mix, economic conditions, competition, product launches and the timing of price reductions versus cost savings. Prompt-delivery inventory needs also create obsolescence and expediting-cost risks.
- Other key risks include customer and distributor concentration or credit exposure, dependence on suppliers and contract manufacturers, product quality and warranty costs, foreign-exchange movements, technology changes, and the continued decline of legacy products. The filing reported no material changes to the risk factors from the 2013 Form 10-K.
- Q3 2014 included $2.7 million of net realized investment gains and $1.0 million of other expense, primarily foreign-currency losses. Investment gains supported reported earnings; other comprehensive income was reduced by investment-security and currency losses.
- The company disclosed an immaterial $0.5 million understatement of net income in the first two quarters of 2013 from acquired-business adjustments; it corrected the items in Q3 2013 as an out-of-period adjustment. A $1.5 million warranty-claim settlement reduced both warranty liabilities and other receivables in 2014.
- The effective tax rate for the first nine months rose to 31.5% from 27.0%, mainly because the research tax credit had expired, partly offset by release of a foreign-subsidiary valuation allowance. Management said the new revenue-recognition standard was under evaluation.
- Subsequent to quarter-end, the board declared a $0.09-per-share dividend payable November 13, 2014. Management also reported 0.2 million additional share repurchases through November 5 at an average $20.47 per share.
Important facts for investors to verify
- Whether the Q3 revenue decline and Enterprise Networks weakness persisted, and how distributor inventory levels and customer demand developed.
- Whether the year-to-date Broadband Access and international growth can offset continuing declines in legacy products and weaker Enterprise Networks sales.
- How sustainable gross-margin improvement is given customer mix, services mix, pricing pressure and product cost reductions.
- Whether operating cash flow, working capital, receivable days outstanding and short-term liquidity improved after quarter-end; DSO rose from 50 to 56 days.
- The effects of ongoing buybacks and dividends on cash resources, share count and liquidity, alongside debt repayment and investment-portfolio market risks.
- Whether warranty costs, foreign-exchange losses, investment gains and the higher effective tax rate materially affect future reported earnings.