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IXIA - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion contains forward-looking statements that involve risks
and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of many factors. The
results of operations for the three and nine months ended September 30, 2012 are
not necessarily indicative of the results that may be expected for the full year
ending December 31, 2012, or for any other future period. The following
discussion should be read in conjunction with the unaudited condensed
consolidated financial statements and the notes thereto included in Item 1 of
this Quarterly Report and in conjunction with our Annual Report on Form 10-K for
the year ended December 31, 2011 ("2011 Form 10-K"), including the "Risk
Factors" section and the consolidated financial statements and notes included
therein.
BUSINESS OVERVIEW
We were incorporated on May 27, 1997 as a California corporation. We are a
leading provider of converged Internet Protocol (IP) network validation and
network visibility solutions. Equipment manufacturers, service providers,
enterprises, and government agencies use our solutions to design, verify, and
monitor a broad range of Ethernet, Wi-Fi, and 3G/LTE equipment and networks. Our
test solutions emulate realistic media-rich traffic and network conditions so
that customers can optimize and validate the design, performance, and security
of their pre-deployment networks. Our intelligent network visibility solutions
provide clarity into physical and virtual production networks for improved
performance, security, resiliency, and application delivery of cloud, data
center, and service provider networks. Our product solutions consist of our
hardware platforms, such as our chassis, interface cards and appliances,
software application tools, and services, including our warranty and maintenance
offerings and professional services.
Acquisition of BreakingPoint Systems, Inc. On August 24, 2012, we completed our
acquisition of all of the outstanding shares of common stock of BreakingPoint
Systems, Inc. ("BreakingPoint"). The aggregate cash consideration paid totaled
$164.1 million, or $150.7 million net of BreakingPoint's existing cash and
investment balances at the time of the acquisition, and is subject to certain
post-closing adjustments, including a potential adjustment based on the final
amount of BreakingPoint's closing net working capital. The acquisition was
funded from our existing cash and investments. BreakingPoint is a leader in
security testing, and its solutions provide global visibility into emerging
threats and applications, along with advance insight into the resiliency of an
organization's information technology infrastructure under operationally
relevant conditions and malicious attacks. With this acquisition, we have
expanded our addressable market, broadened our product portfolio and grown our
customer base. In addition, we expect to leverage BreakingPoint's existing sales
channels and assembled workforce, including its experienced product development
and sales teams. The results of operations of BreakingPoint have been included
in our consolidated statements of operations and cash flows since the date of
the acquisition. See Note 3 to the Consolidated Financial Statements included in
this Form 10-Q.
Acquisition of Anue Systems, Inc. On June 1, 2012, we completed our acquisition
of all of the outstanding shares of common stock of Anue Systems, Inc. ("Anue").
The aggregate consideration paid totaled $151.9 million, or $148.3 million net
of Anue's existing cash and investment balances at the time of the acquisition,
and is subject to certain adjustments including an adjustment based on the final
amount of Anue's net working capital on the closing date. The acquisition was
funded from our existing cash and investments. Anue provides solutions to
monitor and test complicated networks, including Anue's Net Tool Optimizer
solution that efficiently aggregates and filters network traffic to help
optimize network monitoring tool usage. With this acquisition, we have expanded
our addressable market, broadened our product portfolio and grown our customer
base. In addition, we expect to leverage Anue's existing sales channels and
assembled workforce, including its experienced product development team. The
results of operations of Anue have been included in our consolidated statements
of operations and cash flows since the date of the acquisition. See Note 3 to
the Consolidated Financial Statements included in this Form 10-Q.
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Acquisition of VeriWave, Inc. On July 18, 2011, we completed our acquisition of
all of the outstanding stock of VeriWave, Inc. ("VeriWave"). The purchase price
for VeriWave totaled $15.8 million, or $15.6 million net of VeriWave's existing
cash and investment balances at the time of the acquisition. The acquisition was
funded from our existing cash and cash equivalents. VeriWave's test solutions
validate wireless networks, devices, and applications by benchmarking and
measuring speed, quality, interoperability, compliance, and other pivotal
aspects of mobile performance. The results of operations of VeriWave have been
included in our consolidated statements of operations and cash flows since the
date of the acquisition.
Revenues. Our revenues are principally derived from the sale and support of our
test systems. Product revenues primarily consist of sales of our hardware and
software products. Our hardware products primarily relate to our traffic
generation and analysis hardware platform consisting of a multi-slot chassis and
interface cards. Our primary hardware platform is enabled by our operating
system software that is essential to the functionality of the hardware platform.
Our software products consist of a comprehensive suite of technology-specific
test applications. Our software products are typically installed on and work
with our hardware products to further enhance the core functionality of the
overall test system, although some of our software products can be operated
independently from our hardware products.
Our service revenues primarily consist of post contract customer support and
maintenance ("PCS") related to the initial period of service provided with the
purchase of our software or software-related (i.e., our operating system
software) products and separately purchased extended PCS contracts. PCS on our
software and software-related products includes unspecified when and if
available software upgrades and customer technical support services. Service
revenues also include separately purchased extended hardware warranty support,
implied PCS and hardware warranty support, training and other professional
services.
For the nine months ended September 30, 2012, sales of our Ethernet interface
cards, including our 1 Gigabit Ethernet, 10 Gigabit Ethernet and 40/100 Gigabit
Ethernet interface cards represented the majority of our total revenues. Over
the longer term, while we expect the sale of our Ethernet interface cards to
represent a significant amount of our revenues going forward, we expect to see
some decline as a percentage of total revenues as the sales of our network
visibility solutions, and other appliances increase. Sales to our largest
customer, Cisco Systems, accounted for approximately $13.1 million, or 12.0%,
and $42.5 million, or 14.8%, of our total revenues for the three and nine months
ended September 30, 2012, respectively, and $8.6 million, or 11.1%, and $30.3
million, or 13.5%, of our total revenues for the three and nine months ended
September 30, 2011, respectively. Sales to AT&T were approximately $12.3
million, or 11.2%, and $15.2 million, or 5.3%, of our total revenues for the
three and nine months ended September 30, 2012, respectively, and $3.9 million,
or 5.0%, and $8.6 million, or 3.8%, of our total revenues for the three and nine
months ended September 30, 2011, respectively. To date, we have generated the
majority of our revenues from sales to network and telecommunication equipment
manufacturers. While we expect that we will continue to have some customer
concentration with network and telecommunication equipment manufacturers for the
foreseeable future, we expect to see some decline as a percentage of total
revenues as we continue to sell our products to a wider variety and increasing
number of customers. To the extent that we develop a broader and more diverse
customer base, our reliance on any one customer or customer type should
diminish. We also expect that our 2012 acquisitions of Anue and BreakingPoint
(the "2012 Acquisitions") will further diversify our customer base. From a
geographic perspective, we generated revenues from shipments to international
locations of $41.5 million, or 37.9%, and $123.9 million, or 43.1%, of our total
revenues for the three and nine months ended September 30, 2012, respectively,
compared to $37.4 million, or 48.5%, and $113.9 million, or 50.7%, of our total
revenues for the three and nine months ended September 30, 2011, respectively.
The decline in the percentage of our revenue from shipments to international
locations was primarily due to our 2012 Acquisitions, which have a higher
concentration of revenue in the United States as compared to Ixia. Over the next
12 months, we expect to leverage and expand our international sales force to
sell our products related to our 2012 Acquisitions, and as a result, we expect
to increase our percentage of revenue from shipments to international locations.
Total revenues from product shipments to Japan, were $8.6 million, or 7.8%, and
$33.5 million, or 11.7%, for the three and nine months ended September 30, 2012,
respectively, compared with $9.8 million, or 12.7%, and $21.7 million, or 9.7%,
for the three and nine months ended September 30, 2011, respectively.
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Stock-Based Compensation. For the three and nine months ended September 30,
2012, stock-based compensation expense was $4.2 million and $12.0 million,
respectively. Stock-based compensation for the three and nine months ended
September 30, 2011 was $2.9 million and $10.0 million, respectively. The
increase in stock-based compensation expense in the three and nine months ended
September 30, 2012 as compared to the same periods in 2011 was primarily due to
(i) an increase in the number of participants in our employee stock purchase
plan, (ii) the incremental impact of the share-based awards granted to the
employees of Anue following the Anue acquisition, and (iii) the partial
recognition during the 2012 periods of expense for certain performance-based
awards which had no comparable cost in 2011 (i.e., In the comparable 2011
periods, these performance-based awards were previously not expected to be
earned). The aggregate amount of gross unrecognized stock-based compensation to
be expensed in the years 2012 through 2016 related to unvested share-based
awards as of September 30, 2012 was approximately $17.8 million. In October
2012, we granted annual share-based awards to our employees as well as awards to
BreakingPoint employees following the BreakingPoint acquisition, which increased
our aggregate balance of gross unearned stock-based compensation by an estimated
$15.5 million. To the extent that we grant additional share-based awards, future
expense may increase by the additional unearned compensation resulting from
those grants. We anticipate that we will continue to grant additional
share-based awards in the future as part of our long-term incentive compensation
programs. The impact of future grants cannot be estimated at this time because
it will depend on a number of factors, including the amount of share-based
awards granted and the then current fair values of such awards for accounting
purposes.
Cost of Revenues. Our cost of revenues related to the sale of our hardware and
software products includes materials, payments to third-party contract
manufacturers, royalties, and salaries and other expenses related to our
manufacturing and supply operations, technical support and professional service
personnel. We outsource the majority of our manufacturing operations, and we
conduct supply chain management, quality assurance, documentation control,
shipping and some final assembly and testing at our facilities in Calabasas,
California, Austin, Texas and Penang, Malaysia. Accordingly, a significant
portion of our cost of revenues related to our products consists of payments to
our contract manufacturers. Cost of revenues related to the provision of
services includes salaries and other expenses associated with technical support
services, professional services and the warranty cost of hardware that is
replaced or repaired during the warranty coverage period. Cost of revenues does
not include the amortization of purchased technology related to our acquisitions
of certain businesses, product lines and technologies of $7.0 million and $13.3
million for the three and nine months ended September 30, 2012, respectively,
and $2.9 million and $7.9 million for the three and nine months ended September
30, 2011, respectively, which are included within our Amortization of Intangible
Assets line item on our condensed consolidated statements of operations.
Our cost of revenues as a percentage of total revenues is primarily affected by
the following factors:
· our pricing policies and those of our competitors;
· the pricing we are able to obtain from our component suppliers and contract
manufacturers;
· the mix of customers and sales channels through which our products are sold;
· the mix of our products sold, such as the mix of software versus hardware
product sales;
· new product introductions by us and by our competitors;
· demand for and quality of our products; and
· shipment volume.
In the near term, although we anticipate that our cost of revenues as a
percentage of total revenues will remain relatively flat, we expect to continue
to experience pricing pressure on larger transactions and from larger customers
as a result of competition.
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Operating Expenses. Our operating expenses are generally recognized when
incurred and consist of research and development, sales and marketing, general
and administrative, amortization of intangible assets, acquisition and other
related costs and restructuring expenses. In dollar terms, we expect total
operating expenses, excluding stock-based compensation expense discussed above
and amortization of intangible assets, acquisition and other related, and
restructuring costs discussed below, to increase for the remainder of 2012 due
primarily to the recently completed acquisition of BreakingPoint.
· Research and development expenses consist primarily of salaries and other
personnel costs related to the design, development, testing and enhancement of
our products. We expense our research and development costs as they are
incurred. We also capitalize and depreciate over a five-year period costs of
our products used for internal purposes.
· Sales and marketing expenses consist primarily of compensation and related
costs for personnel engaged in direct sales, sales support and marketing
functions, as well as promotional and advertising expenditures. We also
capitalize and depreciate over a two-year period costs of our products used
for sales and marketing activities, including product demonstrations for
potential customers.
· General and administrative expenses consist primarily of salaries and related
expenses for certain executive, finance, legal, human resources, information
technology and administrative personnel, as well as professional fees (e.g.,
legal and accounting), facility costs related to our corporate headquarters,
insurance costs and other general corporate expenses.
· Amortization of intangible assets consists of the purchase price of various
intangible assets over their estimated useful lives. We evaluate our
identifiable definite-lived intangible assets and other long-lived assets for
impairment when events or changes in circumstances indicate that a potential
impairment may exist. An impairment charge would be recorded to the extent
that the carrying value of the intangible asset exceeds its undiscounted cash
flows and its estimated fair value in the period that the impairment
circumstances occurred. We also evaluate the recoverability of our goodwill on
an annual basis or if events or changes in circumstances indicate that an
impairment in the value of goodwill recorded on our balance sheet may exist.
Impairment losses are recorded to the extent that the carrying value of the
goodwill exceeds its estimated fair value. The future amortization expense of
acquired intangible assets depends on a number of factors, including the
extent to which we acquire additional businesses, technologies or product
lines or are required to record impairment charges related to our acquired
intangible assets.
· Acquisition and other related costs are expensed as incurred and consist
primarily of transaction and integration related costs such as success-based
banking fees, professional fees for legal, accounting, tax, due diligence,
valuation and other related services, change in control payments, amortization
of deferred consideration, consulting fees, required regulatory costs, certain
employee, facility and infrastructure transition costs, and other related
expenses. We expect our acquisition and other related expenses to fluctuate
over time based on the timing of our acquisitions and related integration
activities.
· Restructuring expenses consist primarily of employee severance costs and other
related charges. We expect to incur additional restructuring expenses in the
fourth quarter of 2012 primarily consisting of facility-related charges for
the closure of our Melbourne, Australia office. See Note 4 to the Consolidated
Financial Statements included in this Form 10-Q.
Interest Income and Other, Net represents interest on cash and a variety of
securities, including money market funds, U.S. government and government agency
debt securities, corporate debt securities and auction rate securities, realized
gains/losses on the sale of investment securities, certain foreign currency
gains and losses, and other non-operating items.
Interest Expense consists of interest due to the holders of our 3.00%
convertible senior notes issued in December 2010, as well as the amortization of
the associated debt issuance costs. See Note 5 to the Consolidated Financial
Statements included in this Form 10-Q.
Income Tax is determined based on the amount of earnings and enacted federal,
state and foreign tax rates, adjusted for allowable credits and deductions, and
for other effects of equity compensation plans. Our income tax provision may be
significantly affected by changes to our estimates for tax in jurisdictions in
which we operate and other estimates utilized in determining the global
effective tax rate. Actual results may also differ from our estimates based on
changes in economic conditions. Such changes could have a substantial impact on
the income tax provision. Our income tax provision could also be significantly
impacted by estimates surrounding our uncertain tax positions and the recording
of valuation allowances against certain deferred tax assets and changes to these
valuation allowances in future periods. We reevaluate the judgments surrounding
our estimates and make adjustments as appropriate each reporting period.
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During the three months ended September 30, 2012 and June 30, 2012, we released
$12.7 million and $22.6 million, respectively, of our valuation allowance
previously established against our U.S. deferred tax assets. The partial
releases were the result of a net deferred tax liability recorded as part of
both the Anue and BreakingPoint acquisitions. While we continue to maintain a
valuation allowance against our remaining U.S. deferred tax assets, the release
of the remaining valuation allowance, or a portion thereof, will have a
favorable impact on our effective tax rate. We will continue to monitor the need
for a valuation allowance each reporting period, and at this time, it is
uncertain when such a release may occur.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of
operations is based upon our Consolidated Financial Statements included in our
Form 10-Q which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing basis, we
evaluate our estimates and judgments, including those related to revenue
recognition, allowance for doubtful accounts, write-downs for obsolete
inventory, income taxes, acquisition purchase price allocation, impairments of
long-lived assets and marketable securities, stock-based compensation, and
contingencies and litigation. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances. None of these accounting policies and estimates have
significantly changed since our Annual Report on Form 10-K for the year ended
December 31, 2011. Critical accounting policies and estimates are more fully
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in the 2011 Form 10-K. Actual results may differ from
these estimates under different assumptions or conditions.
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--------------------------------------------------------------------------------RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of total revenues for the periods indicated:
Three months ended Nine months ended
September 30, September 30,
2012 2011 2012 2011
Revenues:
Products 80.9 % 80.3 % 81.3 % 81.0 %
Services 19.1 19.7 18.7 19.0
Total revenues 100.0 100.0 100.0 100.0
Costs and operating expenses:(1)
Cost of revenues - products 18.7 18.3 17.2 18.3
Cost of revenues - services 2.5 2.0 2.6 2.1
Research and development 23.5 24.5 24.1 24.9
Sales and marketing 28.0 26.4 27.9 28.8
General and administrative 10.1 12.2 11.7 11.5
Amortization of intangible assets 9.1 5.5 6.7 5.2
Acquisition and other related 3.9 0.5 2.9 0.4
Restructuring 1.9 - 0.7 -
Total costs and operating expenses 97.7 89.4 93.8 91.2
Income from operations 2.3 10.6 6.2 8.8
Interest income and other, net 0.8 1.2 0.6 0.8
Interest expense (1.6 ) (2.3 ) (1.9 ) (2.4 )
Income before income taxes 1.5 9.5 4.9 7.2
Income tax (benefit) expense (8.9 ) 1.2 (9.9 ) 1.0
Net income 10.4 % 8.3 % 14.8 % 6.2 %
(1) Stock-based compensation included in:
Cost of revenues - products 0.1 % 0.1 % 0.1 % 0.1 %
Cost of revenues - services 0.0 0.0 0.0 0.1
Research and development 1.2 1.2 1.2 1.5
Sales and marketing 1.0 0.9 1.0 1.1
General and administrative 1.5 1.5 1.8 1.6
Comparison of Three and Nine Months Ended September 30, 2012 and 2011
As a result of our acquisitions of Anue Systems, Inc. ("Anue") on June 1, 2012
and BreakingPoint Systems, Inc. ("BreakingPoint) on August 24, 2012 (the "2012
Acquisitions"), our 2012 consolidated results of operations include the
financial results of these acquisitions from their respective acquisition dates.
To assist the readers of our financial statements in reviewing our
year-over-year consolidated operating results, we have estimated the impacts of
these acquisitions for the applicable periods in the related statement of
operations sections below.
Revenues. In the third quarter of 2012, total revenues increased 41.8% to $109.6
million from the $77.3 million recorded in the third quarter of 2011. As a
result of our 2012 Acquisitions, the third quarter of 2012 included revenues of
$20.8 million related to the 2012 acquisitions. Excluding the revenues from our
2012 Acquisitions, revenues increased to $88.8 million in the third quarter of
2012 primarily due to a $14.7 million increase in shipments of our hardware
products (primarily our 10 and 40/100 Gigabit Ethernet interface cards and
IxVeriwave products), partially offset by decreases in shipments of our software
products (primarily our IxCatapult software).
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In the first nine months of 2012, total revenues increased 28.0% to $287.5
million from $224.7 million recorded in the same period of 2011. Excluding
revenues of $24.6 million related to the 2012 Acquisitions, revenues increased
to $262.9 million in the first nine months of 2012 primarily due to a $32.0
million increase in shipments of our hardware products (primarily our 10 and
40/100 Gigabit Ethernet interface cards and our IxVeriwave products).
Cost of Revenues. As a percentage of total revenues, our total cost of revenues
increased to 21.2% in the third quarter of 2012 from 20.3% in the third quarter
of 2011. Excluding the impact of our 2012 Acquisitions, our cost of revenues as
a percentage of total revenues in the third quarter of 2012 increased to 22.8%.
This increase was primarily due to increases in personnel-related costs
attributable to professional services and technical support. As a percentage of
total revenues, our total cost of revenues decreased to 19.8% in the first nine
months of 2012 from 20.4% in the first nine months of 2011. Excluding the impact
of our 2012 Acquisitions, our cost of revenues as a percentage of total revenues
for the first nine months of 2012 was also 20.4%.
Research and Development Expenses. In the third quarter of 2012, research and
development expenses increased 36.1% to $25.8 million from $18.9 million in the
third quarter of 2011. As a result of our 2012 Acquisitions, our research and
development expenditures in the third quarter of 2012 included approximately
$4.6 million related to the research and development activities of the acquired
operations. Excluding the incremental research and development costs related to
the 2012 Acquisitions, research and development expenses in the third quarter of
2012 were $21.2 million compared to $18.9 million in the third quarter of 2011.
This increase was primarily due to an increase in compensation and related
employee costs of $1.4 million as a result of additional investments in our
product development teams in the United States and Romania, and higher
stock-based compensation expense of $414,000.
Research and development expenses for the first nine months of 2012 increased
23.5% to $69.2 million from $56.0 million in the same period of 2011. As a
result of our 2012 Acquisitions, our research and development expenditures in
the first nine months of 2012 included approximately $5.5 million related to the
research and development activities of the acquired operations. Excluding the
incremental research and development costs related to the 2012 Acquisitions,
research and development expenses for the first nine months of 2012 were $63.7
million compared to $56.0 million for the first nine months of 2011. This
increase was primarily due to an increase in compensation and related employee
costs of $7.5 million that was primarily a result of (i) additional investments
in our product development teams, including the Wi-Fi development team added as
part of our acquisition of VeriWave in July 2011 and our teams in the United
States, Romania and India, and (ii) higher bonus expense as we expect our 2012
performance to exceed that of 2011 when compared to the applicable annual
company-wide objectives. This increase was partially offset by a one-time charge
of $900,000 incurred in the first quarter of 2011 to terminate and settle a
product development contract.
Sales and Marketing Expenses. In the third quarter of 2012, sales and marketing
expenses increased 50.2% to $30.6 million from $20.4 million in the third
quarter of 2011. As a result of our 2012 Acquisitions, our sales and marketing
expenditures in the third quarter of 2012 included approximately $6.8 million
related to the sales and marketing activities of Anue and
BreakingPoint. Excluding the incremental sales and marketing costs related to
the 2012 Acquisitions, sales and marketing expenses in the third quarter of 2012
were $23.8 million compared to $20.4 million in the third quarter of 2011. This
increase was primarily due to an increase in compensation and related employee
costs, including travel, of $2.1 million and higher stock-based compensation
expense of $363,000. The net increase in compensation and related employee costs
was primarily due to higher sales commissions as revenue levels increased in the
third quarter of 2012 over the same period in the prior year and higher salaries
due, in part, to annual merit increases in 2012.
Sales and marketing expenses for the first nine months of 2012 increased 23.7%
to $79.8 million from $64.5 million in the same period of 2011. As a result of
our 2012 Acquisitions, our sales and marketing expenditures in the first nine
months of 2012 included approximately $8.2 million related to the sales and
marketing activities of Anue and BreakingPoint. Excluding the incremental sales
and marketing costs related to the 2012 Acquisitions, sales and marketing
expenses for the first nine months of 2012 were $71.6 million compared to $64.5
million for the first nine months of 2011. This increase was primarily due to an
increase in compensation and related employee costs, including travel, of $5.3
million, higher depreciation expense of $839,000 primarily related to an
increase in the number of our demonstration units in the field, and higher
stock-based compensation expense of $432,000. The increase in compensation and
related employee costs was primarily due to higher sales commissions as revenue
levels increased in the first nine months of 2012 over the same period in the
prior year, and higher salaries due, in part, to annual merit increases in 2012.
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General and Administrative Expenses. In the third quarter of 2012, general and
administrative expenses increased 17.4% to $11.1 million from $9.4 million in
the third quarter of 2011. As a result of our 2012 Acquisitions, our general and
administrative expenses in the third quarter of 2012 included approximately $1.1
million related to the general and administrative activities of Anue and
BreakingPoint. Excluding the incremental general and administrative costs
related to the 2012 Acquisitions, general and administrative expenses in the
third quarter of 2012 were $10.0 million compared to $9.4 million in the third
quarter of 2011. This increase was primarily due to an increase in compensation
and related employee costs of $575,000 and higher stock-based compensation
expense of $498,000, partially offset by lower litigation and other legal fees.
The net increase in compensation and related employee costs was primarily due to
higher bonus expense as we expect our 2012 performance to exceed that of 2011
when compared to the applicable annual company-wide objectives.
For the first nine months of 2012, general and administrative expenses increased
30.0% to $33.7 million from $25.9 million in the same period of 2011. As a
result of our 2012 Acquisitions, our general and administrative expenses in the
first nine months of 2012 included approximately $1.4 million related to the
general and administrative activities of Anue and BreakingPoint. Our general and
administrative expenditures in the first nine months of 2012 included one-time
charges of $1.7 million incurred in the first quarter of 2012 in connection with
the departure of our former CEO and $401,000 incurred in the second quarter of
2012 to settle a legal matter. Excluding these one-time charges and the
incremental general and administrative costs related to the 2012 Acquisitions,
general and administrative expenses for the first nine months of 2012 were $30.2
million compared to $25.9 million for the first nine months of 2011. This
increase was primarily due to an increase in compensation and related employee
costs of $1.9 million, higher stock-based compensation expense of $1.5 million,
and higher information technology infrastructure and services costs, offset by
lower litigation and other legal fees of $531,000. The net increase in
compensation and related employee costs was due, in part, to higher bonus
expense in the 2012 period as we expect our 2012 performance to exceed that of
2011 when compared to the applicable annual company-wide objectives.
Amortization of Intangible Assets. In the third quarter of 2012, amortization of
intangible assets increased to $10.0 million from $4.2 million in the third
quarter of 2011. In the first nine months of 2012, amortization of intangible
assets increased to $19.4 million from the $11.7 million recorded in the first
nine months of 2011. These increases were primarily due to the incremental
amortization of intangibles related to our acquisitions of VeriWave in July
2011, Anue in June 2012 and BreakingPoint in August 2012.
Acquisition and Other Related Expenses. Acquisition and other related expenses
for the three and nine months ended September 30, 2012 were $4.3 million and
$8.5 million, respectively, and related to our acquisitions of Anue and
BreakingPoint. Acquisition and other related expenses for the three and nine
months ended September 30, 2011 were $377,000 and $851,000, respectively, and
related to our acquisition of VeriWave. Acquisition and other related costs
primarily consisted of transaction and integration related costs such as
success-based banking fees, professional fees for legal, accounting and tax
services, integration related consulting fees, amortization of deferred
consideration payable to certain pre-acquisition employees of BreakingPoint,
certain employee, facility and infrastructure costs, and other
acquisition-related costs.
Restructuring. There were no restructuring expenses incurred in 2011.
Restructuring expenses for each of the three and nine months ended September 30,
2012 were $2.1 million and primarily related to one-time employee termination
benefits consisting of severance and other related costs. During the third
quarter of 2012, our management approved, committed to and initiated a plan to
restructure our operations following our recent acquisition of BreakingPoint.
The BreakingPoint restructuring included a net reduction in force of
approximately 29 positions (primarily impacting our research and development
team in Melbourne, Australia). We expect that the BreakingPoint restructuring
will produce cost savings of $7.0 million to $8.0 million on an annualized
basis. However, we expect that this will be offset as we make additional
investments in certain new or existing initiatives. See Note 4 to the
Consolidated Financial Statements included in this Form 10-Q.
Interest Income and Other, Net. Interest income and other, net decreased to
$928,000 in the third quarter of 2012 from the $1.0 million recorded in the
third quarter of 2011. Interest income and other, net decreased to $1.6 million
in the first nine months of 2012 from the $1.8 million recorded in the first
nine months of 2011.
26--------------------------------------------------------------------------------
Interest Expense. Interest expense, including the amortization of debt issuance
costs, was $1.8 million for the third quarter of each of 2012 and 2011, and $5.4
million for each of the nine months ended September 30, 2012 and the nine months
ended September 30, 2011. Interest expense relates to our convertible senior
notes, which were issued in December 2010. For additional information, see Note
5 to Consolidated Financial Statements included in this Form 10-Q.
Income Tax. Income tax benefit was $9.8 million, or an effective rate of
(605.5%), for the third quarter of 2012 as compared to an income tax expense of
$943,000, or an effective rate of 12.8%, for the third quarter of 2011. The
overall decrease in the effective rate for the third quarter of 2012 as compared
to the same period in 2011 was primarily due to the tax benefit realized from
the $12.7 million partial release of our valuation allowance (previously
established against our U.S. net deferred tax assets) resulting from the net
deferred tax liabilities recorded as part of the BreakingPoint acquisition. See
Note 12 to the Consolidated Financial Statements included in this Form 10-Q.
Income tax benefit was $28.5 million, or an effective rate of (202.0%), for the
first nine months of 2012 as compared to an income tax expense of $2.2 million,
or an effective rate of 13.8%, for the first nine months of 2011. The overall
decrease in the effective rate for the first nine months of 2012 as compared to
the same period in 2011 was primarily due to the income tax benefit realized
from the partial releases of the Company's valuation allowance for the Anue and
BreakingPoint acquisitions. The 2011 effective tax rates differs from (i.e., are
lower than) our federal statutory tax rate primarily due to our foreign earnings
being taxed at lower rates than in the U.S.
Our effective tax rate also differs from the federal statutory rate due to state
taxes, significant permanent differences and adjustments to our valuation
allowance. Significant permanent differences arise due to research and
development credits, foreign tax rate benefits, and stock-based compensation
expense that are not expected to generate a tax deduction, such as stock-based
compensation expenses on grants to foreign employees, offset by tax benefits
from disqualifying dispositions.
Realization of our deferred tax assets is dependent primarily on the generation
of future taxable income. In considering the need for a valuation allowance we
consider our historical, as well as future, projected taxable income along with
other objectively verifiable evidence.
27
--------------------------------------------------------------------------------LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations with our cash balances generated primarily from
operations and proceeds from our initial public offering, our convertible debt
offering and exercises of share-based awards. Our cash, cash equivalents and
short- and long-term investments, when viewed as a whole, decreased to $154.3
million as of September 30, 2012 from $385.0 million as of December 31, 2011
primarily due to the cash and investments used in the acquisitions of Anue in
the second quarter of 2012 of $148.3 million and BreakingPoint in the third
quarter of 2012, which used cash and investments of $150.7 million, and capital
expenditures of $12.9 million. These amounts were partially offset by the $58.3
million in net cash provided by our operating activities and $20.7 million of
cash generated from the exercises of share-based option awards.
Of our total cash, cash equivalents and short- and long-term investments, $21.7
million and $26.9 million was held outside of the United States in various
foreign subsidiaries as of September 30, 2012 and December 31, 2011,
respectively. Under current tax laws and regulations, if our cash, cash
equivalents or investments associated with the subsidiaries' undistributed
earnings were to be repatriated in the form of dividends or deemed
distributions, we would be subject to additional U.S. income taxes and foreign
withholding taxes. However, barring unforeseen circumstances, we consider these
funds permanently invested in our foreign operations and do not intend to
repatriate them. We had no exposure to European sovereign debt as of September
30, 2012.
The following table sets forth our summary cash flows for the nine months ended
September 30, 2012 and 2011 (in thousands):
Nine Months Ended
September 30,
2012 2011
Net cash provided by operating activities $ 58,259 $ 42,303
Net cash used in investing activities (72,427 ) (83,673 )
Net cash provided by financing activities 22,627 13,704
Cash Flows from Operating Activities
Net cash provided by operating activities was $58.3 million in the first nine
months of 2012 and $42.3 million in the same period of 2011. This increase in
cash flow generated from operations was primarily due to an $11.3 million
increase related to net working capital changes in the first nine months of 2012
over the first nine months of 2011. The working capital changes were principally
due to the timing of payments of accounts payable and accrued liabilities, such
as the 2011 year-end bonuses of approximately $5.7 million paid in 2012 compared
to the 2010 year-end bonuses of approximately $9.3 million paid in 2011,
partially offset by the increase in our accounts receivable balances in the
first nine months of 2012 when compared to the same period in 2011 (due
primarily to our higher sales, as well as the higher percentage of our third
quarter sales occurring in the last month of the quarter (i.e., September 2012)
in 2012 as compared to 2011).
Cash Flows from Investing Activities
Net cash used in investing activities was $72.4 million and $83.7 million for
the first nine months of 2012 and 2011, respectively. Excluding marketable
security purchases and proceeds, net cash used in investing activities was
$312.5 million and $27.0 million for the first nine months of 2012 and 2011,
respectively. The increase in net cash used in the first nine months of 2012 was
primarily due to the acquisitions of Anue in the second quarter of 2012 and
BreakingPoint in the third quarter of 2012, which resulted in cash paid, net of
cash acquired, of $148.3 million and $150.7 million, respectively.
28
--------------------------------------------------------------------------------Cash Flows from Financing Activities
Net cash provided by financing activities was $22.6 million and $13.7 million
for the first nine months of 2012 and 2011, respectively. This increase in cash
provided by financing activities was primarily due to a $7.0 million increase in
proceeds from the exercises of share-based awards for the first nine months of
2012 when compared to the first nine months of 2011.
We believe that our existing balances of cash and cash equivalents, investments
and cash flows expected to be generated from our operations will be sufficient
to satisfy our operating requirements for at least the next 12 months.
Nonetheless, we may seek additional sources of capital as necessary or
appropriate to fund acquisitions or to otherwise finance our growth or
operations; however, there can be no assurance that such funds, if needed, will
be available on favorable terms, if at all. Our access to the capital markets to
raise funds, through the sale of equity or debt securities, is subject to
various factors, including the conditions in the U.S. capital markets, our
financial condition, and the timely filing of our periodic reports with the
Commission. In addition, our $200 million convertible senior notes have various
default provisions, which could accelerate repayment and adversely impact our
liquidity.
29--------------------------------------------------------------------------------SAFE HARBOR UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements that are not historical facts in this Management's Discussion and
Analysis of Financial Condition and Results of Operations and other sections of
this Quarterly Report on Form 10-Q may be deemed to be forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), and are subject to the safe harbor
created by that Section. Words such as "may," "will," "should," "could,"
"would," "expect," "plan," "anticipate," "believe," "estimate," "project,"
"predict," "potential," and variations of these words and similar expressions
are intended to identify forward-looking statements. These statements reflect
our current views with respect to future events and are based on assumptions and
are subject to risks and uncertainties. These risks, uncertainties and other
factors may cause our future results, performances or achievements to be
materially different from those expressed or implied by our forward-looking
statements and include, among other things: anticipated benefits and synergies
of our recent acquisitions of Anue Systems, Inc. and BreakingPoint Systems, Inc.
will not be realized, changes in the global economy, competition, consistency of
orders from significant customers, our success in developing and producing new
products, market acceptance of our products, war, terrorism, political unrest,
natural disasters and other circumstances that could, among other consequences,
reduce the demand for our products, disrupt our supply chain and/or impact the
delivery of our products. The factors that may cause future results to differ
materially from our current expectations also include, without limitation, the
risks identified in our Annual Report on Form 10-K for the year ended December
31, 2011, and in our other filings with the Securities and Exchange Commission.
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