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DIGI INTERNATIONAL INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
Our management's discussion and analysis should be read in conjunction with our
financial statements and other information in this Annual Report on Form 10-K
for the fiscal year ended September 30, 2012.
OVERVIEW
We are a leading provider of machine to machine (M2M) networking solutions that
enable the connection, monitoring and control of local or remote physical assets
by electronic means. These networking products and solutions can connect
communication hardware to a physical asset and convey information about the
asset's status and performance which can be sent to a computer system and used
to improve or automate one or more processes. As wireless communications become
more and more prevalent, increasingly these products and solutions are deployed
via wireless networks. Our hardware products have been the historical foundation
of our business. In 2009, we introduced a cloud-based internet platform
(iDigi®) which our customers can utilize to monitor and control electronic
devices. Our iDigi® Device Cloud provides customers with a platform to securely
aggregate and to host data transmitted by remote electronic devices and to
connect enterprise applications to these devices. We also assist customers by
providing application development and hosting services as well as consulting and
integration services. These applications and services ease the deployment of M2M
communications solutions. Our wireless product design and development services
offered by our Spectrum Design Services subsidiary provides customers turn-key
wireless networking products that can use a wide range of wireless technology
platforms. Our products are deployed by a wide range of businesses and
institutions as any business that utilizes a significant number of devices in
the conduct of their business may realize benefits from M2M networking.
We have a single operating and reporting segment. Our revenues consist of
products that are in non-embedded and embedded product categories. Non-embedded
products are connected externally to a device or larger system to provide wired
or wireless network connectivity or port expansion. Embedded products are used
by a product developer to build an electronic device in which the product
provides processing power, wired Ethernet, or wireless network connectivity to
that device. The products included in the non-embedded product category include
cellular products, wireless communication adapters, console and serial servers,
USB connected products and serial cards. The products included in the embedded
product category include modules, single-board computers, chips, software and
development tools, iDigi® services, software applications and related services,
custom hardware design services and satellite communication products.
We utilize many financial, operational, and other metrics to evaluate our
financial condition and financial performance. Below we highlight the fiscal
2012 metrics that we feel are most important in these evaluations:
• Net Sales were approximately $191 Million. Our net sales were $190.6
million in fiscal 2012, and decreased by $13.6 million, or 6.7%, compared
to net sales of approximately $204.2 million in fiscal 2011. The majority
of the decrease was attributable to wired product net sales which
decreased by $11.7 million from fiscal 2012 to fiscal 2011.
• Gross Margin was 52.7%. Our gross margin increased as a percentage of net
sales to 52.7% in fiscal 2012 from 52.2% in fiscal 2011. The increase
primarily resulted from a reduction in the amortization of purchased and
core technology as certain intangibles were fully amortized, reduced costs
through the restructuring of European operations and cost reduction
initiatives for the production of our products. These impacts were
partially offset by increased costs to operate the iDigi® Device Cloud and
increased expenses associated with mitigating the effects of flooding in
Thailand in October 2011 which impacted a significant contract
manufacturer.
• Net Income was $7.6 Million and Earnings Per Diluted Share were $0.29. Our
net income was $7.6 million in fiscal 2012, a decrease of $3.4 million, or
30.9%, compared to net income of $11.0 million in fiscal 2011. Earnings
per diluted share were $0.29 in fiscal 2012 compared to $0.43 in fiscal
2011.
•Earnings Before Taxes, Interest, Depreciation and Amortization (EBITDA). We
believe that the presentation of EBITDA as a percentage of net sales, which is a
non-GAAP financial measure, is useful because it provides a reliable and
consistent approach to measuring our performance from year to year and in
assessing our performance against that of other companies. We also believe this
information helps compare operating results and corporate performance exclusive
of the impact of our capital structure and the method by which assets were
acquired. EBITDA is also used as an internal metric for executive compensation,
as well as incentive compensation for the rest of the employee base, and it is
monitored quarterly for these purposes. Our EBITDA were $18.4 million, or 9.7%
of net sales in fiscal 2012 compared to $25.5 million, or 12.5% of net sales in
fiscal 2011. Below is a table reconciling net income to EBITDA (in thousands):
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Year ended September 30,
2012 2011
Net income $ 7,615 $ 11,019
Interest income, net (266 ) (165 )
Income tax provision 3,282 5,496
Depreciation and amortization 7,815 9,177
Earnings before interest, taxes, depreciation and
amortization $ 18,446 $ 25,527
• Our Balance Sheet and Cash from Operations Remained Strong. Our current
ratio was 9.5 to 1 at September 30, 2012 compared to 8.3 to 1 at September
30, 2011. Cash and cash equivalents and marketable securities increased
$12.4 million to $118.6 million at September 30, 2012, from $106.2 million
at September 30, 2011. On July 25, 2012 our Board of Directors authorized
a new program to repurchase up to $20.0 million of our common stock (see
Note 12 to our Consolidated Financial Statements).
We accomplished a number of key initiatives in fiscal 2012 and also faced
significant challenges relative to our business.
Accomplishments
• We continued to generate strong, positive cash flows even as revenues fell
short of expectations. We believe our strong cash position provides a
solid foundation for growing our business.
• We announced important strategic relationships with Freescale and Wind River that we believe will advance our business to become the leading M2M
solutions provider. Each relationship will provide connectivity to our
iDigi® Device Cloud in products that use Freescale, via our relationship
with Wind River, Intel technology, respectively. This will allow
developers and OEMs to build connected products and cloud enabled services
more rapidly. We believe that these types of relationships signal the
beginning of a market strategy that will promote sales of broader M2M
solutions that include hardware, cloud-based software services and
professional services.
• We restructured our sales organization and invested in solution sales
capabilities to more aggressively sell broader-based M2M solutions. As a
result of this restructuring, we eliminated employment positions in our
work force and hired new employees or re-assigned existing employees into
newly created positions (see Note 9 to our Consolidated Financial
Statements).
Challenges
• During fiscal 2011 we completed sales on many significant customer
projects. During fiscal 2012 we were unable to close on a similar level of
project-based sales opportunities. This issue was most pronounced in North
America and Europe.
• The global economic environment, most notably in Europe, continued to be
volatile in fiscal 2012. This also adversely impacted our financial
results.
• We experienced an unexpected decline in sales of our Rabbit products
during fiscal 2012 and now believe this product line is maturing one to
two years earlier than anticipated.
• Flooding at a Thailand based contract manufacturer in October 2011 disrupted our business temporarily. While this did not impact our revenues
or margins materially, it did have some negative impact on our expenses
within cost of goods sold.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from our
Consolidated Statements of Operations, expressed as a percentage of net sales
and as a percentage of change from year-to-year for the years indicated.
($ in thousands) Year ended September 30, % Increase (decrease)
2012 compared 2011 compared
2012 2011 2010 to 2011 to 2010
Net sales $ 190,558 100.0 % $ 204,160 100.0 % $ 182,548 100.0 % (6.7 )% 11.8 %
Cost of sales (exclusive of
amortization of purchased and
core technology shown separately
below) 88,445 46.4 94,702 46.4 86,266 47.3 (6.6 ) 9.8
Amortization of purchased and
core technology 1,776 0.9 2,870 1.4 4,073 2.2 (38.1 ) (29.5 )
Gross profit 100,337 52.7 106,588 52.2 92,209 50.5 (5.9 ) 15.6
Operating expenses:
Sales and marketing 39,242 20.6 39,549 19.4 37,010 20.3 (0.8 ) 6.9
Research and development 30,767 16.2 31,642 15.5 27,825 15.2 (2.8 ) 13.7
General and administrative 18,188 9.5 18,206 8.9 17,889 9.8 (0.1 ) 1.8
Restructuring 1,259 0.7 154 0.1 (468 ) (0.3 ) 717.5 (132.9 )
Total operating expenses 89,456 47.0 89,551 43.9 82,256 45.0 (0.1 ) 8.9
Operating income 10,881 5.7 17,037 8.3 9,953 5.5 (36.1 ) 71.2
Other income (expense), net 16 - (522 ) (0.2 ) 566 0.3 (103.1 ) (192.2 )
Income before income taxes
10,897 5.7 16,515 8.1 10,519 5.8 (34.0 ) 57.0
Income tax provision 3,282 1.7 5,496 2.7 1,578 0.9 (40.3 ) 248.3
Net income $ 7,615 4.0 % $ 11,019 5.4 % $ 8,941 4.9 % (30.9 )% 23.2 %
NET SALES
Net sales were $190.6 million in fiscal 2012 compared to $204.2 million in
fiscal 2011, a decrease of $13.6 million or 6.7%. The decrease primarily was due
to a lower than anticipated closure rate of large new customer projects, most
notably in North America and EMEA, and unfavorable economic conditions, most
notably in Europe. In addition, our Rabbit-branded product line matured and net
sales began to decline one to two years earlier than anticipated. We believe
that our serial servers, Rabbit-branded modules, chips and USB products are
mature products and we expect that net sales of these products will continue to
decrease in the future. We did not experience a material change in revenue due
to pricing during fiscal 2012.
Net sales were $204.2 million in fiscal 2011 compared to $182.5 million in
fiscal 2010, an increase of $21.7 million or 11.8%, primarily due to a $26.6
million increase in the net sales of modules, cellular products, engineering
design services, serial servers, chips and iDigi® services. This was partially
offset by a $4.9 million decrease in net sales of serial cards, USB devices,
wireless communication adapters and satellite-related products. The increase in
net sales in fiscal 2011 compared to fiscal 2010 is primarily driven by
increased unit volume as a result of increased customer sales, many of which
were wireless. We did not experience a material change in revenue due to pricing
during fiscal 2011.
Fluctuation in foreign currency rates compared to the prior year's rates had an
unfavorable impact on net sales of $1.4 million in fiscal 2012. In fiscal 2011
we had a favorable impact on net sales of $0.9 million and in fiscal 2010 we had
an unfavorable impact of $0.3 million.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Net Sales by Non-Embedded and Embedded Product Categories
The following summarizes our net sales by non-embedded and embedded product
categories:
Net Sales % of Net Sales
($ in millions) 2012 2011 2010 2012 2011 2010
Non-embedded $ 95.6 $ 108.5 $ 91.2 50.2 % 53.1 % 55.0 %
Embedded
95.0 95.7 74.7 49.8 % 46.9 % 45.0 %
Total net sales $ 190.6 $ 204.2 $ 165.9 100.0 % 100.0 % 100.0 %
Non-embedded products
Non-embedded products net sales decreased $12.9 million, or 11.8%, in fiscal
2012 compared to fiscal 2011. The decrease was mostly due to a reduction in net
sales of cellular products, serial servers, wireless communication adapters and
USB products. We believe that the serial servers and USB products are in the
mature phase of their product life cycle and we expect the net sales of these
products to continue to decrease in the future.
Non-embedded products net sales increased $8.4 million, or 8.3%, in fiscal 2011
compared to fiscal 2010 due primarily to increases in cellular products and
serial servers. This was partially offset by decreases in sales of serial cards,
wireless communication adapters and USB connected products. USB connected
product net sales decreased due to softening of the retail sector for retail
point-of-sale related USB applications in fiscal 2011. Increased sales to
customers in the medical and fleet industries contributed to the increase in
fiscal 2011 compared to fiscal 2010.
Embedded products
Embedded products net sales decreased $0.7 million, or 0.8%, in fiscal 2012
compared to fiscal 2011. The decrease was primarily due to a reduction in net
sales of Rabbit-branded modules, chips and engineering design services. This was
offset partially by increased net sales of Digi-branded modules, iDigi® services
and satellite-related products. We believe that the Rabbit-branded products and
chips are in the mature phase of their product life cycle and we expect the net
sales of these products to continue to decrease in the future.
Embedded products net sales increased $13.3 million, or 16.2%, in fiscal 2011
compared to fiscal 2010 due mostly to increases of net sales of modules,
engineering design services and chips. Increased sales to customers in the
medical industry contributed to the increase in fiscal 2011 compared to fiscal
2010.
Net Sales by Wireless and Wired Product Categories
The following table presents our revenue by wireless and wired categories:
Net Sales % of Net Sales
($ in millions) 2012 2011 2010 2012 2011 2010
Wireless $ 82.8 $ 84.7 $ 66.4 43.4 % 41.5 % 36.3 %
Wired 107.8 119.5 116.1 56.6 % 58.5 % 63.7 %
Total net sales $ 190.6 $ 204.2 $ 182.5 100.0 % 100.0 % 100.0 %
Wireless product net sales decreased by 2.3% in fiscal 2012 compared to fiscal
2011 and increased 27.6% in fiscal 2011 compared to fiscal 2010. Despite this
decrease, wireless product net sales as a percentage of our total net sales
increased in fiscal 2012. We believe this is because of our continued investment
and focus on wireless M2M products and solutions. As is the trend with respect
to the use of telecommunications generally, we anticipate that our sales of
wireless products will continue to increase as a percentage of net sales.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Net Sales by Geographic Location
Our net sales by geographic location of our customers is as follows:
Net Sales % of Net Sales
($ in millions) 2012 2011 2010 2012 2011 2010
North America $ 112.4 $ 118.7 $ 107.3 59.0 % 58.1 % 58.8 %
Europe, Middle East & Africa 47.0 52.1 47.7 24.7 % 25.5 % 26.2 %
Asian countries 24.9 27.0 22.7 13.0 % 13.2 % 12.4 %
Latin America 6.3 6.4 4.8 3.3 % 3.2 % 2.6 %
Total net sales $ 190.6 $ 204.2 $ 182.5 100.0 % 100.0 % 100.0 %
North America net sales in fiscal 2012 decreased $6.3 million, or 5.3%, due to
lower net sales of non-embedded products of $8.2 million. This was offset
partially by an increase in net sales of embedded products of $1.9 million. The
decrease in net sales in fiscal 2012 compared to the prior year largely was due
to a lower than anticipated closure rate on large projects. North America net
sales in fiscal 2011 increased $11.4 million, or 10.5%, due to an increase of
$6.3 million in net sales of embedded products. The North American sales for
fiscal 2011 increased over the prior fiscal year primarily as a result of large
project based sales, many of which were for wireless products.
EMEA net sales decreased $5.1 million, or 9.8%, in fiscal 2012 from fiscal 2011.
This primarily was due to poor economic conditions in the EMEA market, a lower
than anticipated closure rate on large projects and the weakening of the Euro.
Net sales in EMEA increased $4.4 million, or 9.3%, in fiscal 2011 over fiscal
2010 mostly due to large project-based sales. The strengthening of the Euro and
British Pound contributed $0.7 million to the increase in fiscal 2011 compared
to fiscal 2010.
Asian countries revenue decreased $2.1 million, or 7.8%, in fiscal 2012 from
fiscal 2011 mostly related to net sales of non-embedded products. Net sales in
Asian countries increased by $4.3 million, or 18.5%, in fiscal 2011 compared to
fiscal 2010 mostly related to net sales of RF modules in the embedded product
grouping.
Latin America revenue decreased slightly by $0.1 million, or 2.6%, in fiscal
2012 from fiscal 2011. Latin America revenue increased by $1.6 million, or
35.3%, in fiscal 2011 compared to fiscal 2010 primarily due to non-embedded
cellular products.
Net Sales by Distribution Channel
The following table presents our revenue by distribution channel:
Net Sales % of Net Sales
($ in millions) 2012 2011 2010 2012 2011 2010
Direct/OEM channel $ 73.6 $ 73.3 $ 66.2 38.6 % 35.9 % 36.3 %
Distributors channel 117.0 130.9 116.3 61.4 % 64.1 % 63.7 %
Total net sales $ 190.6 $ 204.2 $ 182.5 100.0 % 100.0 % 100.0 %
During fiscal 2012, net sales by our distributors decreased by $13.9 million, or
10.6% compared to net sales in fiscal 2011. Net sales in fiscal 2012 in our
Direct/OEM channel increased by $0.3 million, or 0.3% compared to the prior
fiscal year. The decrease in net sales in the Distributors channel compared to
the Direct/OEM channels was due to lower net sales of mature non-embedded
products, lower than anticipated closure rate on large projects, and foreign
currency impacts.
Net sales in our Direct/OEM channel increased $7.1 million, or 10.8% compared to
net sales in fiscal 2010. During fiscal 2011, net sales by our distributors
increased by $14.6 million, or 12.4% compared to net sales in fiscal 2010.
Increased customer sales to targeted industries contributed to the increase in
net sales by both our distributors and our Direct/OEM channel. International
sales growth also contributed to the increase by our distributors.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
GROSS PROFIT
2012 Compared to 2011
Gross profit was $100.3 million and $106.6 million in fiscal 2012 and 2011,
respectively, a decrease of $6.3 million, or 5.9%. The gross margin for fiscal
2012 was 52.7% compared to 52.2% in fiscal 2011, an increase of 0.5 percentage
points. The increase primarily resulted from a reduction in the amortization of
purchased and core technology as certain intangibles were fully amortized,
reduced costs through the restructuring of European operations and cost
reduction initiatives for the production of our products. Amortization of
purchased and core technology was $1.8 million or 0.9% of net sales in fiscal
2012 as compared to $2.9 million or 1.4% of net sales in fiscal 2011. These
aggregated impacts were partially offset by increased costs to operate the
iDigi® Device Cloud and increased expenses associated with mitigating the
effects of flooding in Thailand in October 2011 which impacted a significant
contract manufacturer.
2011 Compared to 2010
Gross profit was $106.6 million and $92.2 million in fiscal 2011 and 2010,
respectively, an increase of $14.4 million, or 15.6%. The gross margin for
fiscal 2011 was 52.2% compared to 50.5% in fiscal 2010. Gross margin increased
1.7 percentage points primarily due to product cost reduction initiatives that
allowed us to reduce the cost of our products and increase gross profit through
purchasing and manufacturing efficiencies during the fiscal year. Favorable
customer and product mix, as well as a decrease in the amortization of purchased
and core technology as certain intangibles were fully amortized, also
contributed to the increase in gross profit during fiscal 2011. Amortization of
purchased and core technology was $2.9 million or 1.4% of net sales in fiscal
2011 as compared to $4.1 million or 2.2% of net sales in fiscal 2010.
OPERATING EXPENSES
2012 Compared to 2011
Operating expenses were essentially flat at $89.5 million in fiscal 2012 and
$89.6 million in fiscal 2011. Below is a summary of our operating expenses by
function.
Sales and marketing expenses were $39.2 million in fiscal 2012, a decrease of
$0.4 million or 0.8%, compared to $39.6 million in fiscal 2011. Commission
expense decreased by $0.6 million, partially offset by a $0.2 million increase
in other compensation-related expenses.
Research and development expenses were $30.8 million in fiscal 2012, a decrease
of $0.8 million or 2.8%, compared to $31.6 million in fiscal 2011. Compensation
expenses were reduced by $1.1 million resulting primarily from lower incentive
compensation payouts compared to the prior fiscal year, as well as lower
headcount. In addition, professional services decreased by $0.3 million compared
to the prior fiscal year. This was partially offset by an increase of $0.6
million in other miscellaneous research and development expenses.
General and administrative expenses were $18.2 million in both fiscal 2012 and
2011. General and administrative expenses decreased by $0.6 million in
amortization expense as certain intangible assets are now fully amortized.
Compensation-related expenses decreased by $0.4 million due to a decrease in
headcount and lower incentive compensation payouts. This was offset by increases
of $0.4 million in bad debt expense, $0.3 million in professional fees and $0.3
million in other general and administrative expenses.
Restructuring expenses were $1.3 million in fiscal 2012, an increase of $1.1
million, compared to $0.2 million in fiscal 2011. During fiscal 2012, we
recorded $1.0 million related to our 2012 restructuring that was announced on
April 26, 2012. In addition, we recorded an additional $0.3 million related to
the Breisach, Germany restructuring announced on July 21, 2011. In fiscal 2011
we recorded $0.2 million related to the above mentioned restructuring for
Breisach, Germany. For further information on restructuring, see Note 9 to our
Consolidated Financial Statements.
2011 Compared to 2010
Operating expenses were $89.6 million in fiscal 2011, an increase of $7.3
million or 8.9%, compared to $82.3 million in fiscal 2010. Below is a summary of
our operating expenses by function.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Sales and marketing expenses were $39.6 million in fiscal 2011, an increase of
$2.6 million or 6.9%, compared to $37.0 million in fiscal 2010. Sales and
marketing expenses increased by $2.0 million for compensation-related expenses
due to increased headcount and full reinstatement of our non-sales incentive
program and $0.6 million for outside services, travel and entertainment and
miscellaneous other sales and marketing expenses.
Research and development expenses were $31.6 million in fiscal 2011, an increase
of $3.8 million or 13.7%, compared to $27.8 million in fiscal 2010. Research and
development expenses increased by $2.6 million for compensation-related expenses
due to increased headcount and full reinstatement of our non-sales incentive
program, $0.8 million for other research and development expenses mostly related
to the investment in our iDigi® cloud-based platform and $0.4 million for
professional services and contract labor.
General and administrative expenses were $18.2 million in fiscal 2011, an
increase of $0.3 million or 1.8%, compared to $17.9 million in fiscal 2010. The
increase in general and administrative expenses was due to increases of $1.3
million for compensation-related expenses mostly related to a full reinstatement
of our non-sales incentive program and $0.2 million related to a litigation
settlement discussed in Notes 16 and 18 to our Consolidated Financial
Statements. This partially was offset by a reduction of $1.2 million in
professional fees related to internal investigation and remediation actions we
took related to the U.S. Foreign Corrupt Practices Act incurred in fiscal 2010.
Restructuring expenses were $0.2 million in fiscal 2011, and increase of $0.6
million, compared to a net reversal of restructuring expenses of $0.4 million in
fiscal 2010. During fiscal 2011, we recorded $0.2 million related to the
Breisach, Germany restructuring announced on July 21, 2011. In fiscal 2010 we
reversed $0.5 million of restructuring expenses related to the closing of an
engineering facility in Long Beach, California, and the relocation and
consolidation of the manufacturing facility in Davis, California that was
announced on April 23, 2009, which was partially offset by an additional charge
relating to this restructuring of $0.1 million for an additional six months of
continued medical benefits as a result of new health care legislation passed in
December 2009.
OTHER (EXPENSE) INCOME, NET
2012 Compared to 2011
Total other income, net was minimal in fiscal 2012 and $0.5 million in fiscal
2011, a decrease of $0.5 million. This decrease was mostly due to a reduction of
$0.3 million in foreign currency net transaction losses in fiscal 2012 as
compared to fiscal 2011. Also during fiscal 2012 we recorded a gain on the sale
of an investment of $0.1 million and recorded an additional $0.1 million in
interest income. Our average investment balance increased from $85.9 million in
fiscal 2011 to $94.4 million in fiscal 2012, but our interest income remained
the same as the prior fiscal year since we earned an average interest rate of
0.3% in both fiscal 2012 and fiscal 2011.
2011 Compared to 2010
Other (expense) income, net was $0.5 million of expense in fiscal 2011, a
decrease of $1.1 million compared to $0.6 million of income in fiscal 2010. The
majority of this was due to $0.7 million of foreign currency net transaction
losses in fiscal 2011 compared to foreign currency net transaction gains of $0.3
million in fiscal 2010. We realized interest income on marketable securities and
cash and cash equivalents of $0.3 million in fiscal 2011 compared to $0.4
million in fiscal 2010. Our average investment balance increased from $69.0
million in fiscal 2010 to $85.9 million in fiscal 2011, but our interest income
was less than in the prior fiscal year since we earned an average interest rate
of 0.3% in fiscal 2011 compared to 0.5% in fiscal 2010.
INCOME TAXES
Our effective income tax rate was 30.1%, 33.3% and 15.0% for fiscal years 2012,
2011 and 2010, respectively. Our effective tax rate will vary based on a variety
of factors, including overall profitability, the geographical mix of income
before taxes and related statutory tax rate in each jurisdiction, and discrete
events, such as settlements of audits.
During fiscal 2012, we recorded a discrete tax benefit of $1.5 million, related
to additional research and development tax credits identified for fiscal years
ended September 30, 2009, 2010 and 2011, reversal of tax reserves for closure of
various jurisdictions' tax matters and tax rate reductions in foreign
jurisdictions. These discrete tax benefits reduced our effective tax rate by
14 percentage points for the twelve month period ended September 30, 2012 to
30.1%. During fiscal 2012, the income tax provision before discrete tax benefits
was higher than the statutory rate primarily due to an increase in certain
reserves for unrecognized tax benefits, an adjustment for foreign income taxed
at the U.S. rate, and a reduction in domestic tax benefits
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
compared to a year ago.
During fiscal 2011, we recorded a discrete tax benefit of $0.7 million. This
benefit primarily resulted from the reversal of tax reserves from various
jurisdictions, primarily foreign, related to the expiration of the statutes of
limitations. It also resulted from the enactment of the Tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of 2010 extending the research
and development tax credit that allowed us to record tax credits earned during
the last three quarters of fiscal 2010 in the first quarter of fiscal 2011. This
benefit reduced our effective tax rate by 4 percentage points for the twelve
month period ended September 30, 2011 to 33.3%.
During fiscal 2010, we reversed $2.3 million in income tax reserves associated
primarily with the closing of prior tax years through statute expiration and the
conclusion of a federal tax audit. While the statutes of limitations have not
expired, U.S. federal income tax returns for the periods ended September 30,
2007 and September 30, 2008 have been audited by and settled with the Internal
Revenue Service. The aforementioned income tax benefits resulting from the
reversal of income tax reserves and other discrete tax benefits reduced the
effective tax rate by 22 percentage points in fiscal 2010.
INFLATION
Management believes that during fiscal years 2012, 2011 and 2010, inflation has
not had a material effect on our operations or on our consolidated financial
position.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations principally with funds generated from
operations. We held cash, cash equivalents and short-term marketable securities
of $118.6 million, $106.2 million and $87.6 million at September 30, 2012, 2011
and 2010, respectively. Our working capital was $155.4 million, $142.7 million
and $122.1 million at September 30, 2012, 2011 and 2010, respectively. Absent a
disruption in our business, we expect our working capital to continue to
increase.
Consolidated Statements of Cash Flows Highlights:
Year ended September 30,
($ in thousands) 2012 2011 2010
Operating activities $ 15,127 $ 21,839 $ 16,095
Investing activities (10,954 ) (22,399 ) (15,167 )
Financing activities 2,311 4,639 2,604
Effect of exchange rate changes on cash and cash
equivalents (922 ) (338 ) (1,023 )
Net increase in cash and cash equivalents $ 5,562 $ 3,741 $ 2,509
Net cash provided by operating activities was $15.1 million during fiscal 2012
compared to $21.8 million during fiscal 2011, a net decrease of $6.7 million.
This net decrease is due to the following: a decrease in net income of $3.4
million, deferred income tax benefit of $1.2 million, depreciation and
amortization of $1.4 million and an increase in net working capital of $2.3
million. This was partially offset by net increases related to restructuring of
$1.1 million and other non-cash items of $0.5 million. Changes in working
capital decreased cash flows primarily due to decreases of $5.1 million for
accrued expenses, partially offset by an increase of $2.8 million related to
income taxes.
Net cash provided by operating activities was $21.8 million during fiscal 2011
compared to $16.1 million in fiscal 2010, a net increase of $5.7 million. This
net increase was due to an increase in net income of $2.1 million, deferred
income taxes of $2.4 million, inventory obsolescence of $1.1 million, net
increases in working capital of $1.0 million and other non-cash items of $0.4
million. This was offset by net decreases in amortization expense of $1.3
million. Changes in working capital increased cash flows by $1.0 million due to
a $3.8 million increase in accounts receivable as the increase in accounts
receivable in fiscal 2011 was less than the increase in fiscal 2010 and a $1.5
million increase in inventories as inventories have declined in fiscal 2011.
This was offset by a $2.7 million net decrease in accounts payable and $1.6
million in other assets and accrued expenses.
Net cash used by investing activities was $11.0 million in fiscal 2012 as
compared to $22.4 million in fiscal 2011. Our net purchases of marketable
securities were $9.5 million less in fiscal 2012 as compared to fiscal 2011. We
spent $3.0 million for the final deferred payment related to the Spectrum
acquisition in fiscal 2011. This was partially offset by a decrease of $1.2
million related to additional purchases of capital expenditures in fiscal 2012
compared to fiscal 2011.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Net cash used in investing activities was $22.4 million in fiscal 2011 as
compared to $15.2 million in fiscal 2010, a net increase of $7.2 million. We
used an additional $7.4 million of cash for net purchases of marketable
securities in fiscal 2011 compared to fiscal 2010, partially offset by $0.2
million fewer capital expenditures in fiscal 2011 as compared to fiscal 2010.
Net cash provided by financing activities was $2.3 million in fiscal 2012 as
compared $4.6 million in fiscal 2011, a net decrease of $2.3 million, resulting
primarily from fewer exercises of stock options. Net cash provided by financing
activities was $4.6 million in fiscal 2011 as compared to $2.6 million in fiscal
2010, an increase of $2.0 million, resulting from additional exercises of stock
options and employee stock purchase plan transactions.
We expect positive cash flows from operations and believe that our current cash,
cash equivalents and marketable securities balances, cash generated from
operations and our ability to secure debt and/or equity financing will be
sufficient to fund our business operations and capital expenditures for the next
twelve months and beyond. On July 25, 2012 our Board of Directors authorized a
new program to repurchase up to $20.0 million of our common stock. This
repurchase authorization expires on September 30, 2013.
At September 30, 2012, our total cash and cash equivalents and marketable
securities balance was $118.6 million This balance includes approximately $28.7
million of cash and cash equivalents held by our controlled foreign subsidiaries
of which $22.0 million represents accumulated undistributed foreign earnings.
Although we have no current need to do so, if we change our unremitted assertion
to repatriate additional undistributed foreign earnings for cash requirements in
the United States, we would have to accrue applicable taxes. The amount of any
taxes and the application of any tax credits would be determined based on the
income tax laws at the time of such repatriation. Under current tax laws, we
estimate the unrecognized deferred tax liability to be in the range of $2.5
million to $3.5 million and could have a material impact on our current
consolidated balance sheet, results of operations and cash flows.
The following summarizes our contractual obligations at September 30, 2012:
Payments due by fiscal period
($ in thousands) Total Less than 1 year 1-3 years 3-5 years Thereafter
Operating leases $ 5,844 $
2,390 $ 2,737 $ 716 $ 1
The operating lease agreements included above primarily relate to office space.
The table above does not include possible payments for uncertain tax positions.
Our reserve for uncertain tax positions, including accrued interest and
penalties, was $3.3 million as of September 30, 2012. Due to the nature of the
underlying liabilities and the extended time often needed to resolve income tax
uncertainties, we cannot make reliable estimates of the amount or timing of
future cash payments that may be required to settle these liabilities.
The above table also does not include those obligations for royalties under a
license agreement as these royalties are calculated based on future sales of
licensed products identified in the settlement agreement and we cannot make
reliable estimates of the amount of cash payments.
FOREIGN CURRENCY
We are exposed to foreign currency risk associated with certain sales
transactions being denominated in Euros, British Pounds, Japanese Yen and Indian
Rupees and foreign currency translation risk as the financial position and
operating results of our foreign subsidiaries are translated into U.S. Dollars
for consolidation. We have not implemented a formal hedging strategy to reduce
foreign currency risk.
During 2012, we had approximately $78.2 million of net sales related to foreign
customers including export sales, of which $23.4 million was denominated in
foreign currency, predominantly the Euro and British Pound. During both 2011 and
2010, we had approximately $85.5 million and $75.2 million, respectively, of net
sales to foreign customers including export sales, of which $28.8 million and
$27.6 million, respectively, were denominated in foreign currency, predominantly
the Euro and British Pound. In future periods, we expect a significant portion
of sales will continue to be made in Euros and British Pounds.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
RECENT ACCOUNTING DEVELOPMENTS
In August 2012, the U.S. Securities and Exchange Commission (the "SEC") adopted
a rule mandated by the Dodd-Frank Act to require companies to publicly disclose
their use of conflict minerals that originated in the Democratic Republic of the
Congo or an adjoining country. The final rule applies to a company that uses
minerals including tantalum, tin, gold or tungsten. The final rule requires
companies to provide disclosure on a new form filed with the SEC, with the first
specialized disclosure report due on May 31, 2014, for the 2013 calendar year,
and annually on May 31 each year thereafter. We are currently evaluating the
impact of adoption.
In July 2012, the Financial Accounting Standards Board ("FASB") issued ASU
2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived
Intangible Assets for Impairment." The FASB amended its guidance on testing of
indefinite-lived intangible assets for impairment. Under the amended guidance,
companies may perform a qualitative assessment to determine whether further
impairment testing is necessary, similar to the amended goodwill impairment
testing guidance noted below. The guidance for indefinite-lived intangible
assets is effective for annual and interim tests performed for fiscal years
beginning after September 15, 2012, with an option for early adoption. We will
adopt ASU 2012-02 effective for our fiscal year beginning October 1, 2012 and do
not expect this pronouncement to have a material effect on our consolidated
financial statements.
In September 2011, the FASB issued Accounting Standards Update ("ASU") No.
2011-08, "Intangibles-Goodwill and Other (Topic 350) Testing Goodwill for
Impairment". This guidance provides an update on how an entity tests goodwill
for impairment. This revised guidance allows companies an option to make a
qualitative evaluation about the likelihood of goodwill impairment. Under the
revised guidance, a company is permitted to first assess qualitative factors to
determine whether goodwill impairment exists prior to performing analysis
comparing the fair value of a reporting unit to its carrying amount. If, based
on the qualitative assessment, a company concludes it is more likely than not
that the fair value of the reporting unit exceeds its carrying value, then
quantitative testing for impairment is not necessary. This guidance is effective
for fiscal years, and interim periods within those years, beginning after
December 15, 2011. We, however, adopted this update early so it was effective
for our fiscal year beginning October 1, 2011 (see Note 7 to the Condensed
Consolidated Financial Statements). This guidance had no impact on our
consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income
(Topic 220): Presentation of Comprehensive Income". This guidance eliminates the
option to report other comprehensive income and its components in the
consolidated statement of stockholders' equity. Rather it requires that all
non-owner changes in stockholders' equity be presented in either a single
continuous statement of comprehensive income or in two separate but consecutive
statements. This guidance also requires us to present on the face of the
financial statements any reclassification adjustments for items that are
reclassified from other comprehensive income to net income. The guidance is
effective for fiscal years, and interim periods within those years, beginning
after December 15, 2011. We will adopt this guidance beginning with our fiscal
quarter ending December 31, 2012. The adoption of this guidance is not expected
to have any effect on our consolidated financial position or results of
operations, as it will only impact how certain information related to other
comprehensive income is presented in our consolidated financial statements. In
December 2011, FASB issued ASU No. 2011-12 which amends this guidance and defers
only the presentation of reclassification of items out of accumulated
comprehensive income. No other requirements of ASU No. 2011-05 are affected by
this deferral.
In May 2011, the FASB issued ASU No. 2011-04, "Fair Value Measurements (Topic
820): Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and IFRSs". This guidance updates many of the
requirements in U.S. GAAP for measuring fair value and for disclosing
information about fair value measurements to ensure consistency between
U.S. GAAP and International Financial Reporting Standards ("IFRS"). This
guidance is to be applied prospectively and is effective during interim and
annual periods beginning after December 15, 2011. We adopted this guidance
beginning with our fiscal quarter ending March 31, 2012. This guidance had no
impact on our consolidated financial statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these consolidated financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, the disclosure of contingent assets and
liabilities and the values of purchased assets and assumed liabilities in
acquisitions. We base our estimates on historical experience and various
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates.
We believe the following critical accounting policies impact our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
REVENUE RECOGNITION
Our revenues are derived primarily from the sale of embedded and non-embedded
hardware products to our distributors and Direct/OEM customers, and to a small
extent from the sale of professional and engineering services, fees associated
with technical support, training, software licenses and royalties. We recognize
product revenue when persuasive evidence of an arrangement exists, delivery has
occurred, the sales price is fixed or determinable, collectability is reasonably
assured and there are no post-delivery obligations other than warranty.
Under these criteria, product revenue is generally is recognized upon shipment
of product to customers, including Direct/OEM and distributors. Sales to
authorized domestic distributors and Direct/OEMs are made with certain rights of
return and price adjustment provisions. Estimated reserves for future returns
and pricing adjustments are established by us based on an analysis of historical
patterns of returns and price adjustments as well as an analysis of authorized
returns compared to received returns, current on-hand inventory at distributors,
and distribution sales for the current period. Estimated reserves for future
returns and price adjustments are charged against revenues in the same period as
the corresponding sales are recorded. Material differences between the
historical trends used to determine estimated reserves and actual returns and
pricing adjustments could result in a material change to our consolidated
results of operations or financial position. We have applied consistent
methodologies for estimating reserves for future returns and pricing adjustments
for all years presented. The reserve for future returns and pricing adjustments
was $1.4 million at September 30, 2012 and $1.3 million at September 30, 2011.
Our non-product revenue represented 4.5%, 4.5% and 3.3% of net sales in fiscal
2012, 2011 and 2010, respectively. The majority of the non-product revenue was
from professional and engineering services and represented 4.1%, 4.2% and 2.9%
of net sales in fiscal 2012, 2011 and 2010, respectively. We also had revenue
from cloud-based services, post-contract customer support, fees associated with
technical support, training, royalties and the sale of software licenses. Our
software development tools and development boards often include multiple
elements, including hardware, software licenses, post-contract customer support,
limited training and basic hardware design review. Our customers purchase these
products and services during their product development process in which they use
the tools to build network connectivity into the devices they are manufacturing.
Revenue for professional and engineering services and training is recognized
upon performance. Revenue from software licenses is recognized when earned.
Revenues from contracts with multiple element arrangements are recognized as
each element is earned based on the relative fair value of each element provided
the delivered elements have value to customers on a standalone basis. Amounts
allocated to each element are based on its vendor specific objective evidence,
such as the sales price for the product or service when it is sold separately.
Revenue from cloud-based services is earned in two ways. First, web-based
management fees are considered to be earned on a monthly basis consistent with a
monthly contractual commitment. Second, transaction fees that are billed to the
customer at the larger of the minimum price or the number of transactions times
the stated fee and are considered earned as the transactions occur.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
We regularly monitor and evaluate the realizable value of our marketable
securities. When assessing marketable securities for other-than-temporary
declines in value, we consider several factors. These factors include: how
significant the decline in value is as a percentage of the original cost, how
long the market value of the investment has been less than its original cost,
the underlying factors contributing to a decline in the prices of securities in
a single asset class, the performance of the issuer's stock price in relation to
the stock price of its competitors within the industry, expected market
volatility, analyst recommendations, the views of external investment managers,
any news or financial information that has been released specific to the
investee and the outlook for the overall industry in which the issuer operates.
If events and circumstances indicate that a decline in the value of these
securities has occurred and is other-than-temporary, we would record a charge to
other income (expense).
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts, which reflects the estimate of
losses that may result from the inability of some of our customers to make
required payments. The estimate for the allowance for doubtful accounts is based
on known
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
circumstances regarding collectability of customer accounts and historical
collections experience. If the financial condition of one or more of our
customers were to deteriorate, resulting in an inability to make payments,
additional allowances may be required. Material differences between the
historical trends used to estimate the allowance for doubtful accounts and
actual collection experience could result in a material change to our
consolidated results of operations or financial position. The allowance for
doubtful accounts was $0.3 million at both September 30, 2012 and September 30,
2011.
INVENTORIES
Inventories are stated at the lower of cost or fair market value, with cost
determined using the first-in, first-out method. We reduce the carrying value of
our inventories for estimated excess and obsolete inventories equal to the
difference between the cost of inventory and its estimated realizable value
based upon assumptions about future product demand and market conditions. Once
the new cost basis is established, the value is not increased with any changes
in circumstances that would indicate an increase in value after the
remeasurement. If actual product demand or market conditions are less favorable
than those projected by management, additional inventory write-downs may be
required that could result in a material change to our consolidated results of
operations or financial position. We have applied consistent methodologies for
the net realizable value of inventories.
GOODWILL
Goodwill represents the excess of cost over the fair value of identifiable
assets acquired. Goodwill is tested for impairment on an annual basis as of
June 30, or more frequently if events or circumstances occur which could
indicate impairment. As of June 30, 2012, our market capitalization was $264.3
million compared to our carrying value of $265.7 million. Our market
capitalization plus our estimated control premium of 40% resulted in a fair
value in excess of our carrying value by a margin of 39% and therefore no
impairment was indicated. At September 30, 2012, our market capitalization was
$263.3 million compared to our carrying value of $270.9 million. Since there
were no triggering events through September 30, 2012, and our market
capitalization plus our estimated control premium of 40% resulted in a fair
value in excess of our carrying value by a margin of 36%, no impairment was
indicated.
The control premium used in our annual goodwill assessment at June 30, 2012 and
our further evaluation of goodwill at September 30, 2012 was based on a recent
control premium study as of June 30, 2012, resulting in a range of control
premium of 30% to 45%. We concluded that a 40% control premium best represented
the amount an investor would pay, over and above market capitalization, in order
to obtain a controlling interest given the economic conditions at that time.
INCOME TAXES
We operate in multiple tax jurisdictions both in the U.S. and outside of the
U.S. Accordingly, we must determine the appropriate allocation of income to each
of these jurisdictions. This determination requires us to make several estimates
and assumptions. Tax audits associated with the allocation of this income, and
other complex issues, may require an extended period of time to resolve and
could result in adjustments to our income tax balances that are material to our
consolidated financial position and results of operations and could affect our
cash flows for potential cash outflows.
We have unrecognized tax benefits of $3.3 million classified as a long-term
liability. We expect that it is reasonably possible that the total amounts of
unrecognized tax benefits will decrease approximately between $0.3 million to
$0.4 million over the next 12 months due to the expiration of statue of
limitations. The total amount of unrecognized tax benefits that if recognized
would affect our effective tax rate is $2.7 million. We recognize interest and
penalties related to income tax matters in income tax expense.
WARRANTIES
In general, we warrant our products to be free from defects in material and
workmanship under normal use and service. The warranty periods generally range
from one to five years. We typically have the option to repair or replace
products we deem defective due to material or workmanship. Estimated warranty
costs are accrued in the period that the related revenue is recognized based
upon an estimated average per unit repair or replacement cost applied to the
estimated number of units under warranty. These estimates are based upon
historical warranty incidents and are evaluated on an ongoing basis to ensure
the adequacy of the warranty accrual. The product warranty accrual was $1.0
million and $0.9 million at September 30, 2012 and September 30, 2011,
respectively.
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