American Virtual Cloud Technologies, Inc.
Q4 2007 Earnings Call Transcript

Published: 24 Jan 2008

Operator:

Good day everyone, and welcome to the Avocent Corporation conference call. Today's call is being recorded. At this time I would like to turn the conference over to Mr. Sam Saracino, Executive Vice President of Legal and Corporate Affairs for the opening remarks and introduction. Mr. Saracino, please go ahead.
Sam Saracino:

Thank you. Good morning and welcome to Avocent Corporation's quarterly conference call. I want to remind all participants that this call will contain forward-looking statements. These include statements regarding future business prospects; capital spending and economic conditions in general; statements about the future management and governance of the company; statements relating to Avocent's revenue, sales, expenses, margins, inventory, tax rates and cash flow; and operational earnings per share, including our expectations for the first quarter of 2008. They include statements regarding the integration of the operations, products and technologies of the companies we have acquired, and the future revenue attributable to them, and statements about the development and the introduction of new products and technologies, the size, growth, and leadership of these markets, and the timing of future revenue attributable to them. These forward-looking statements are based on current expectations that involve a number of risks and uncertainties which could cause our actual results to differ materially. These risk factors are described in our periodic SEC filings, including our annual report on Form 10-K. The information discussed today will include certain non-GAAP financial measures. These operational measures are reconciled to the most directly related GAAP financial measures in our earnings press release, which was distributed yesterday. That press release is also available on our website, www.avocent.com, and was furnished to the SEC on a Form 8-K this morning. As we have previously stated, Avocent Corporation intends to comply fully with Regulation FD, and we have adapted our Investor Relations practices and procedures to do so. Any and all guidance given to analysts and investors will be done only during this conference call, either in our prepared statements or during the question-and-answer session that follows. Accordingly, we encourage you to ask any questions you have concerning Avocent or our business or prospects during this conference call, since we will not be providing additional material commentary or guidance during one-on-one conversations with analysts or investors. I would now like to introduce John Cooper, Avocent Corporation's Chief Executive Officer. John?
John Cooper:

Thanks Sam. Let me add my own good morning to everyone. I'll move to my comments or my regular comments on the quarter in just a minute, but I hope at this time you will allow me a brief personal moment to explain my reasons for deciding to retire at the end of the first quarter. I've enjoyed the past seven years at Avocent, and I certainly continue to be optimistic about our prospects as we're well-positioned with a solid balance sheet, excellent products and customers and great people. Over in the last year we clearly have not hit the high points quite like we used to, and I simply began to wonder that it might be time to bring in new leadership to take the company forward. I want to make clear to everyone that I will continue working hard for Avocent. The Board and I have agreed that I will continue as CEO until the end of the current quarter. I'll be joined by Ed Harper, as our new Chairman, who will be active in the management of the company. We will be working together every day to produce the results that our shareholders expect of us. Ed will be a big part of our management effort going forward and he will be able to provide the continuity needed until we find a new CEO. I want to say to everyone that a significant part of my stock psychological well-being, not to mention my net-worth, depends on accomplishing the goal of attaining results that Avocent shareholders expect. So, our shareholders can be rest assured of our commitment to a strong performance in this interim period. As I contemplate this moment, I want to thank Steve Thornton for recommending me for this job. I would not want to let the moment pass without saying that I cannot adequately express to the great folks of Avocent, how much I appreciate the support and cooperation they have provided me. As I mentioned a moment ago, I am pleased that Ed Harper, our new Chairman, is here with us today. Ed has extensive managerial experience at all levels including extensive Board work as well as CEO and other operational roles. He has helped in transition roles, as well as having day-to-day long-term management experience. His experience ranges from start ups to companies as large as Network Associates or McAfee, and encompasses both hardware and software companies. At this point, Ed I would like to invite you to say a few words.
Ed Harper:

Thanks John. And I want to take this opportunity to express my personal thanks and to the entire Board for your service to Avocent over the past years. I am proud to have been asked by the Board to step in and provide continuity in this leadership role for the company. We all strive to deliver shareholder value, even as we search for a new CEO. We have a strong company that delivers great cash flow, an outstanding employee team. and an excellent array of products and services in growth markets. We still have some work to do in developing further our growth potential. That potential is very evident as we examined our product road map and look at the opportunity to integrate the products of our LANDesk and the MSD divisions. We believe Avocent has strong potential to build long-term shareholder value by combining our strengths in hardware and software to build sales across our extensive customer base. I am very pleased to be joining the strong management team here at Avocent and I look forward to talking with investors, customers and employees. Thanks for the opportunity for your few words John, and I will turn the microphone back to you for the call.
John Cooper:

Thank you Ed. Now let's move on to our traditional quarterly discussion. As it is customary on these calls, I will take some time to provide you a few of the highlights from the fourth quarter. Teddy Blankenship will also provide a little color surrounding the results for the quarter, as well as provide an overview for our first quarter 2008 outlook. Let's look at financial highlights for the fourth quarter. Total revenue for the quarter was $155.4 million, compared to $166.1 million in the fourth quarter of 2006. Although our overall sales, did not reach the level we had expected in the fourth quarter of 2007, we did experience strength in several areas of our business. We are pleased with the strength in our European and Asian branded businesses as well as the strength in our Asian OEM business. Continuing to support this regional strength, I would also like to discuss our new regional headquarters in Singapore. This location, coming online this quarter and with full capacity expected in the second quarter, will provide many benefits to our continued expansion in Asia. It will bring benefits similar to the long-term benefits our company has enjoyed with the Shannon regional headquarters in Europe. A few of the expected benefits include improved customer service, decreased product delivery times for regionally-focused operation sales, marketing and customer support. This location will support both the branded and OEM businesses as well as the LANDesk business. The Singapore site, working in concert with our Shannon and Huntsville operations, will primarily serve the needs of our customers and partners in the growing Asian region. Our LANDesk business was strong during the fourth quarter, as this division achieved both record revenues and bookings during the quarter. [All of these] we pointed out on our call in early January, that the strength showing by LANDesk as well was in Europe and Asia or as well as MSD was in Europe and Asia but was not enough to offset the short fall expensed in out North American branded business. We believe the slowness there was the result of lower IT spending in certain sectors of our enterprise customer base, including our financial services business. Despite the lower revenues experienced in the fourth quarter of 2007, our gross margins remained strong and were 65.9%. For the fourth quarter our earnings per share were $0.55 compared to $0.59 for the fourth quarter of 2006. Let me also mention that our cash flows from operations were $41 million for the fourth quarter of 2007, and approximately $140 million for the year. This time I need to extend a special thanks to Gene Mulligan and his operations team for doing a superb job of managing our inventories during the quarter and in fact the entire year. Now let me give you a few highlights regarding the LANDesk division. Overall I'm very pleased with what they accomplished this quarter. Revenue grew to $31.8 million in the fourth quarter of 2007 from $26.8 million in the fourth quarter of 2006. That's a 19% increase in LANDesk revenues. Additionally bookings grew to $37.9 million for the fourth quarter, the strongest bookings achieved by LANDesk in any quarter-to-date. This time, I also would like to mention a recent addition we have made to our executive team, Kay Kienast, our new Executive Vice President and Chief Marketing Officer. Kay is a seasoned technology marketer with strong branded OEM channel and services marketing experience. Prior to joining Avocent, she held senior marketing positions at some of the industry's most innovative product and services companies including [Presidial] Network Solutions, CBW, DELL Computer, Digital Equipment and Verizon. Kay, I hope you are listening and let me welcome you to Avocent, and say that we look forward to working with you as part of our team. Now Teddy will provide additional commentary regarding the quarter and our 2008 outlook. Teddy.
Teddy Blankenship:

Thanks John and good morning everyone. As in previous quarters, we have filed our commentary and our press release for the quarter on an 8-K. The items included in that 8-K should provide a detailed account of the numbers presented on this call as well as other numbers not discussed today. Although I mentioned the detailed information is contained within that release and related commentary, I want to highlight some of the details. Our revenue for the fourth quarter was $155.4 million and within the range provided earlier this month. Our operational EPS was higher than anticipated at that time at $0.55 per share. This increase in EPS was a result of our pre-tax earnings being rated much more towards our international operations based in Ireland than our earlier expectations. Our international effective tax rates are much less than that of our operations within the U.S. and our international performance this quarter was quite strong, while that in the U.S. was disappointing. This unusual rating of pretax income within much lower tax regions of the world, combined with the impact of certain tax selections we made surrounding treatment of goodwill as they shared with a LANDesk acquisition, resulted in an annual effective tax rate of about 18.7% for 2007. Our fourth quarter tax expense included the benefit of reducing the tax rate by 24.4%, which was used for the year-to-date income through the third quarter to 18.7% for the full year. Cash flows from operations for the quarter were also quite strong at $41 million, yielding a total of $140 million in cash flows from operations for the year. Our day sales outstanding and receivables improved to 64.3. This includes LANDesk which typically had longer payment terms in our legacy business and it compares with 69.3 for the fourth quarter of 2006. Our inventory turns remained relatively constant at 6.6 for the quarter versus 6.8 for the prior quarter, the third quarter. But demonstrated a strong improvement compared to 5.1 for the fourth quarter of 2006. And this was a good result considering the fall-off in expected sales we had in December. Of the $155.4 million in revenues, $117 million was provided by our management system's division and $31.8 million was generated by our LANDesk division, where MSD represents a decrease of 7% from the third quarter of '07 and 12% from the fourth quarter of '06. The LANDesk represents an increase of 11% over the third quarter of '07, and 19% over the fourth quarter of '06. Gross profit for the quarter remained relatively constant with [debt] experienced in prior quarters of the year at approximately 66%. Operating expenses were slightly higher, due to our investment in engineering development for new products, targeted at both existing and new market segments as well as an increase in targeted marketing activity around both LANDesk and other core products. Operational net income was $27.4 million, compared to $28.5 million in the third quarter of '07 and $30.6 million in the fourth quarter of '06. As I stated previously, the fourth quarter of '07 benefited due to the significantly lower effective tax-rate than the earlier quarters in 2007. As was also included within our commentary, we provided some forward-looking guidance for the first quarter of 2008 with anticipated revenues at or above those experienced in the first quarter of '07 of about $134 million, and an estimated EPS of $0.21 to $0.25 per share. We expect relatively consistent operating expenses for those experienced in the fourth quarter of '07, including call surroundings and realignment of resources within our operations. This is currently estimated to be around $1 million to $2 million. As the company is still evaluating potential realignments to better match our resources with the needs of the company, this estimate could change, but we do not believe it is material to our overall financial results. We expect an effective tax-rate of 22% to 24% in 2008, as we anticipate our net income split between international and domestic U.S. operations to more approximate than experienced in prior quarters. We expect to experience the same seasonal sequential trends as that of a general technology industry with a decrease in revenue from the fourth quarter of one year to the first quarter of the following year. During Q4, we were able to work with our channel partners to reduce some of the inventory levels they typically hold, and are optimistic that we will see some benefits of that effort during the first quarter of '08. Our estimates are predicated on a stable economy within the U.S. and in other markets where we operate, and could change if significant instability occurs within those markets. We have factored in recently lower forecasts for technology, expanding and a measure of general economic uncertainty in to our expectations. Our Board of Directors has previously approved stock repurchase programs totaling up to 15 million shares. Through the end of last week, we have repurchased approximately 14.3 million shares under this program. Yesterday, our Board approved an additional 4 million shares to be repurchased, through this program, and we anticipate a significant portion of that will be completed during the first quarter 2008, through cash from operations and may be borrowings under our line of credit. And John, on behalf of the all the employees of Avocent around the world, we would like to thank you for your leadership and advice over the past few years and the example that you set for us. And we wish you all the best as you start planning for upcoming retirement
John Cooper:

Well thank you Teddy. Must be careful not to get [chirpy though with]. We need to go ahead and take questions at this point. So, Rob if you are ready. We will go ahead with the questions.
Operator:

Absolutely the question-and-answer session will be conducted electronically today. (Operator Instructions). And we will go first to Mark Kelleher with Canaccord Adams
Mark Kelleher:

Hi guys.
Teddy Blankenship:

Hi Mark.
John Cooper:

Hi Mark.
Mark Kelleher:

Had a couple of questions. The headwinds that you are being running into seem to be from a couple of directions. One's the virtualization effect, and one is the general economic slowdown with maybe a focus on the financials. Could you kind of separate those and tell us what you think those are looking like going forward? Is one overwhelming the other? How does that shape-up?
John Cooper:

Mark, I would have to say that -- well first our half state would be extremely difficult to do any precise division of those two things in the marketplace. I guess I would offer this. I believe in the fourth quarter, we were affected more by economic uncertainty, in the enterprise market in particular, just by the way we saw deal [talk] go, and deals get delayed. We have been very frank to virtualization, there's been a headwind for several quarters, I think we are beginning to see the abatement of that as we move forward. I think we were affected a little more by economic conditions in the fourth quarter. I believe we had virtualization pretty well [baked] into our estimates. As we went into the quarter, I think the shortfall in the quarter was more attributable to problems and segments of the enterprise market.
Mark Kelleher:

Okay and now that you are couple of weeks later from where you held the call on preannouncement. Has the economic visibility improved, or deteriorated or stayed the same?
John Cooper:

Well, you know probably as much or more about the last two weeks on what people have had to say. I think yesterday in the market, it is just a great example of economic news and economic expectations and so forth, and just that yo-yo effect is going on, I think the uncertainty is still there. Just this morning, as I watched, we had good job numbers and housing numbers that, I guess, upset some people and so Mark, I don't know that it would be possible to say whether it is more or less. I guess we would say that our first quarter has started to this point in time, in a pretty normal way. But what the expectations are, since nobody of the firm, CNBC News had put a handle on, and I probably should not try either.
Mark Kelleher:

All right, and my last question, can you talk a little bit about DSView 3 and how the reception with that has been going?
John Cooper:

DSView 3?
Mark Kelleher:

Yes, the new virtualization capability?
John Cooper:

The new virtualization product, we can. Teddy will give you an update on that.
Teddy Blankenship:

Sure. Mark, I think in our earlier call, we mentioned that we had sold about 4,000 licenses of the virtualization management module through that time, really through the end of the fourth quarter. That number has since going up to over 5,000, so in the last couple of weeks, we've had some more uptake of over a 1,000 servers to be managed by that management module. And we continue to have a significant number of customers who are testing it in their data centers and evaluating it and considering when and how they want to deploy it as well.
Mark Kelleher:

Okay, great. Thanks.
John Cooper:

Thank you.
Operator:

Thank you. Next, we'll go to David Duley with Merriman.
David Duley:

Given that you had a difficult time in the fourth quarter, and I think the round numbers, let's say my original estimate was $20 million higher than what you just reported in the fourth quarter. I'm a little surprised that we're guiding down again in the first quarter to the same magnitude that we saw in previous years or another $20 million or so whatever the number is. Could you talk about why you think that is? Yes, I would suspect there would be seasonality, but we just missed the fourth quarter, so we're seeing a fourth quarter miss and then incremental -- seasonality on top of the miss, so it's a little bit confusing. I was wondering if you could talk about that?
Teddy Blankenship:

Sure Dave, the biggest factor in the guidance is the reduced level of expected IT spending and server growth in the first quarter. You may have seen some of the industry experts or analysts come out with their wise forecast in the past few weeks, where some of them are now are expecting server units to be basically flat in the first quarter year-over-year or may be up 1%. Something like that, those are pretty low expectation for the quarter at this point. Now we have counter balanced that against some pretty good feedback from our sales force. And things they are hearing and seeing in the field, including the activity we had overseas in the fourth quarter that continues to be positive in the first quarter. That even in the U.S. things seem to be running slightly ahead of where we were last year. But we are very cautious because we know what happened, late in the month of December and as you know a lot of our sales activity happens late in every quarter. So something like that could happen again in March given ongoing economic uncertainties.
David Duley:

Okay, so -- basically, the forecast for [unit volumes of] servers is looking somewhat flattish in the first quarter. Let me take this to the whole year then. Starting off where you are in Q1 with your guidance, it looks to me like 2008 is going to be flat on the revenue line? I was wondering if you can comment on that?
John Cooper:

Well we are not offering any guidance for the rest of the year. We believe Dave, in the conditions we are in right now. It's appropriate to limit the guidance to the first quarter and let ourselves get on in to the spring time to see how trends are going both economically and in terms of IT spending. To see how budget release is coming along in the big IT organizations at that time, and hopefully we will be able to give a better picture of the rest of the year at that point. But right now, we just think, it probably would not be prudent to go beyond the first quarter in our expectations.
David Duley:

Okay. Well I think we all have like roughly a 10% kind of growth number for 2008. Maybe there is some variation to that. But clearly with server volumes being cut to a flat unit volume forecasts in Q1, I don't think there is anyway we can grow 10%. So I am just trying to fish around on, if your forecasts that you had talked about before on annual basis, or tying it to unit volumes of servers, the baseline number has definitely come in recently. Is there any reason to think that if the baseline has come in that your overall revenues won't match that trend?
John Cooper:

I think Dave what we're telling you is we really don't feel sufficiently certain of what the trends are going to be to offer any guidance beyond the first quarter. Already as Teddy mentioned our sales force actually feels pretty good. We've tried to kind of blend those feelings together with what we are reading and hearing about the general economy, what a number of experts are saying about our uncertainty, particularly in the early part of the year, and just trying to be prudent and limit our guidance to the first quarter and trying to prudently balance all those factors to come up with the best number we could. We are not offering any expectation for the rest of the year. We feel pretty good internally about things, but we have to recognize that there is a lot of uncertainty afoot in the market and I just think it's prudent to kind of take a middle course toward that at this point.
David Duley:

Okay, when you contemplate the revenue guidance for the March quarter, what is the direction of the LANDesk business?
John Cooper:

We expect it to be up again. Year-over-year we expect it to still show growth as it has throughout 2007.
David Duley:

Okay, thank you.
John Cooper:

You are welcome.
Operator:

Next, we got a Reik Read with Robert W. Baird & Co.
Reik Read:

Hey good morning.
John Cooper:

Good morning Reik.
Teddy Blankenship:

Good morning Reik.
Reik Read:

John I didn't want to get served either, but I want to wish you the best in retirement and just getting into questions, can you guys give us a little bit more insight on the weakness with the enterprise and why you are seeing it there and not in the SMB? And then can you also, to the extent you can't break apart the enterprise business, you talked about the financial areas being particularly weak, how are the rest of those vertical markets doing?
John Cooper:

Reik, I would be honest and say that I don't know if any of the vertical markets excelled during the fourth quarter. If we did, the experiences, as we said earlier, are a kind of a general slowness particularly late in the quarter across the enterprise business. Financial was more accentuated and certainly has a broader profile generally than some of the others. I think that we would analyze that internally, that the enterprise business is typically a bigger deal, typically a more complicated approval process. Typically requires the convincing of a list of people as opposed to maybe one or two in the SMB business where both the amounts are smaller and the decision making is quicker. That has typically I think been a trend that we see quicker fluctuations in response to economic conditions in the enterprise business. And you tend to see that kind of going up too. So, I think the reasons are just the structures of the companies and the size of the deal and the fact that the bigger deals get focused on quickly, more quickly, accentuated some by exposure to financial, which tended to have a longer period of time to decide the whole things back.
Reik Read:

Okay, and then can you give us some additional insight as to why the OEM business is down as much today is it really a reflection of what's happening in the branded or is there anything more to that?
Teddy Blankenship:

Yes Reik, as you probably know with OEM's we don't get a tremendous amount of visibility through who they are actually selling to, which end users are selling to, but anecdotally what our accounts team have heard is, that they have experienced similar softness in North America enterprise type purchasing.
Reik Read:

Okay, and then let me just ask more of a big picture question, if I'd give you guys a two-year outlook and try to get away from some of the short-term noise that we're talking about here, can you talk a little bit about the KVM and the serial products specifically, and I understand you have a lot of new products that are coming out. But can you talk about where the penetration rates are today in those segments, and what you'd think the opportunities are for upgrades and things like that?
John Cooper:

I think we can do that. I want to be sure that I'm not giving any kind of guidance, but I think we can talk about what we feel like the markets will look like for those products. I think the markets for those products over the longer period rack, are reasonably good. I believe that some of the headwind that we saw from virtualization will start to abate as people start to really solidify their strategies and know which way they are going. So within the context of the assumption of reasonable economic conditions I think the prospects for the products over the next couple of years are pretty good. Now if economic conditions continue to deteriorate and I guess I fell into the trap, so many do, that it seems they have deteriorated and there are different numbers coming out of that there. But if they were to deteriorate, that obviously will change people's outlooks and if they deteriorate to a certain point it starts to change outlooks up and down the spectrum of bar. We don't know what people's expectations are at this point, but assuming reasonable economic expectations, I think the prospects for the products over the next couple of years are pretty good. Particularly when you combine, how those products will play with other products that we have in the pipeline. And, start to be part of a package of our team management products that we will offer, as a package and tied together. And so when you consider all that, I think the prospects are pretty good. I don't want to do anything that says I am providing guidance beyond the first quarter but because as I said earlier that's how we are really comfortable in doing right now, but philosophically we feel pretty good about things over the next couple of years.
Reik Read:

Yeah, and I am not trying to get you to think of 3 to 5 if that makes you more comfortable. Do you have a sense for what the penetration rates are or if that's the wrong way to look at it, can you tell me how I should think about it?
John Cooper:

Well, I think when you look at penetration rates; you have to consider there are qualitative aspects as well as quantitative aspects of penetration rates. So a product -- a port that is hooked to a KVM device at this point in time, the port with a build or a move or whatever, takes on a different nature and probably becomes hooked to a different kind of KVM device after that occurs. So when you talk about penetration there are two aspects of it. There is the aspect that occurs when moves occur whether that move would be for a new rebuild or whatever reason it would be, and then there is penetration for just what the absolute percentage of ports are. I think the penetration on percentage of ports is reasonably high, but there is no way to know what the total degree of penetration is, but in the enterprise market I think it's pretty high. However, if we get into the build cycle that we all anticipate, and given reasonable economic conditions, penetration rate does not become the controlling factor there. What becomes the controlling factor, there is the package of capability you offer in the KVM device that goes into the new rack. And so on that standpoint, I feel like penetration, if you want to call it that is in pretty good shape because it would bring lots of upgrades that would go along with builds and moves.
Reik Read:

Okay, great and then just one last question, the desktop discontinuance, can you give us, it's a small revenue number, but can you give us a sense for what that would do, if that goes away from an operating loss standpoint. And then maybe even a little bit more broadly can you talk a little bit about the entrepreneurial business, which is $24 million business and I understand that the profitability is getting better but it's still an $8 million loss if you look at it in the ‘07 timeframe. How much of that is, it needs to be revenue driven and how much of that can come from some other sources of improvement?
John Cooper:

Let me first try to address the DSD business, and then, I think Teddy will make and get prepared by that time, to answer some of the numerical questions. The DSD business actually has been broken apart, and a substantial portion of the technology has been moved into either the MSD business, or the CCD business. The two parts of the business here actually expect to sell the products. And there are a couple of exciting products that have come out of the technology investment in that division that we will be introducing, I think, in the second quarter for one and maybe the third quarter for another one. We would be a little more prepared to talk about those on the next call, but that's what's happening to the technology and then there is a third leg of technology there that is still in the development phase. We are going to move into our CTO office simply to maintain it. We don't think the market is quite ready for it yet, and so we are just going to try to maintain that technology and spend a minimal amount of money on it. In terms of the expenditure levels, I think they will be reduced. I don't know that I have the information now that it is within the divisional budgets and Teddy; he might be able to give more color on that.
Teddy Blankenship:

Yes, that division had an operating loss of about $1.6 million in the fourth quarter and there have already been some head count adjustments made in January, which will lower that run rate by at least $400,000 per quarter starting in the second quarter. And there are some more evaluations being made by the divisions that John mentioned who are accepting or bringing in the technology and incorporating into their product lines. So, we'll have more of an update on that probably next quarter.
Reik Read:

Okay great. Thank you, guys.
John Cooper:

Thanks Reik.
Operator:

We will go next to Harsh Kumar with Morgan Keegan
Harsh Kumar:

Hi guys. First of all, best of luck to you in the future, John.
John Cooper:

Thanks Harsh.
Harsh Kumar:

Couple of questions. On the last call that was held, I think there was some business that was, sort of spilled over from fourth quarter supposedly into the first and the second quarter. Did you see any of that or it's not built in, how should we think about that piece?
John Cooper:

Harsh, those deals are still there, checked as recently as yesterday afternoon with our sales folks. By and large the deals are still there. They are in various states. There are some that we think are close. Probably the bigger part of them though, the deals are still active, but we think the stand on those deals will be sometime after the first quarter.
Harsh Kumar:

Okay fair enough, John. And so we should think about your guidance as having not included any of those deals to materialize in other words?
John Cooper:

Well any, is one of those words, I don't know that I want to say that it doesn't include any, but it doesn't include any substantial amount from those deals.
Harsh Kumar:

Got it and kind of a second question, I guess its been asked in a variety of different ways, you know we listen to Intel, IBM and I could go on and on John, and for the most part the server spending, the chip sales, all of that stuff has been coming out okay. So, we're kind of I guess reconciled to what we're hearing from your company in terms of the fourth quarter, and the first quarter relative to what the other companies are saying, some of them substantially large. I am trying to understand, whether you are losing share or what you're seeing in your business that's different from some of the other guys, most of the companies for most part have good numbers.
John Cooper:

Is there a question there that you want to formulate or you want to me respond to that?
Harsh Kumar:

Well, I mean the question there is, are you experiencing share loss, I guess, or is your guidance conservative, just trying to understand what?
John Cooper:

Well, we hope our guidance is conservative.
Harsh Kumar:

Okay.
John Cooper:

We know of no share loss that we're experiencing. That's not to say we don't lose a deal now and then, but on a cumulative basis, we're pretty sure that we're holding our share, if not gaining share. I think part of the disconnect that you are having probably has to do with what companies are saying and when they are saying it, and what period they're talking about, and it probably ties into our hesitancy to go away from what we see, as some of the industry surveys on predictions, on server spending in the first quarter. There are lags and delays between the numbers that you referred to, and server spending and sometimes it operates both ways depending on where we are in channel flows. If you look within some of those numbers there are anomalies within them. We're looking at the forecast for server growth and that's what we're trying to base our forecast off of. And historically we have been, give or take, a quarter or two of fluctuation pretty well tied to those numbers. Typically we have been able to beat those numbers in our growth rate sum, but we have had to acknowledge for a long time, that we are at least in some indirect way tied to those numbers. And I think what we're trying to do, is be conservative in our guidance, but also to reflect the forecast that is there -- the experts that we all look to like Gartner and IDC on server growth.
Harsh Kumar:

That's helpful John. And I guess a question maybe for Teddy. If I am doing the math correctly, it looks like your LANDesk operating margins jumped up substantially 8% versus 4%. Can you tell us if that was a one-time, or is there something going on there, or should we be modeling 8% and increasing going forward, if I am right on the numbers?
Teddy Blankenship:

Harsh, you are right. We did have a significant increase in the operating margin at LANDesk in the fourth quarter, but it's not where we want it to be yet. We and the division have several plans underway to continue to improve that margin over the course of 2008. Of course, one would expect that margin to dip in the first quarter just from the normal seasonal decline in revenues if you go from the fourth quarter to the first quarter, but the operating expenses stay largely level with the fourth quarter. So I would expect the operating margin to dip a little bit in the first quarter and then resume improvement over the course of '08.
Harsh Kumar:

So that's also very helpful, thanks. And then I guess a cultural question, broader question. In a CEO search, are you looking at some of the internal heads or willing to talk about that at all John, or want to stay off the topic?
John Cooper:

Well, of course it's a search that will be done by the Board, as it should be. I think I can outline the general parameters of that search. I believe the Board feels compelled to conduct a broad search. There are internal candidates involved, or will be involved in the search. The search will be started shortly. And so I think the answer to that is there will be a broad and general search. There are internal candidates who will be included in that search.
Operator:

Thank you. We'll go next to Tom Curlin with RBC.
Tom Curlin:

That was basically the nature of my question, the search for a new CEO maybe just for starters has that search begun or not yet initiated?
John Cooper:

Tom, the search is not yet initiated. It will be I think within the next week.
Tom Curlin:

Okay, that's really it. Thanks very much.
John Cooper:

Thank you, Tom.
Operator:

Next we go to Manny Recarey with Kaufman Brothers.
Manny Recarey:

Good morning.
John Cooper:

Good morning Manny.
Manny Recarey:

And good luck in your next endeavor, John.
John Cooper:

Thank you.
Manny Recarey:

A question about the outlook for OpEx, you said on a pro forma basis, it's going to be flat versus the fourth quarter level. If you can help me understand in terms of the thinking behind that with revenue coming down by $20 million, and OpEx has been flat, you know why do the step up in investment there?
Teddy Blankenship:

Well, Manny, we have several R&D programs going on in the new infrastructure management products that we've talked about, and we added people during Q4, we didn't have them for the full fourth quarter, but we will have them for the full first quarter. So we have added R&D efforts. We also have some marketing programs planned around some of the recent product introductions and product refreshes. And then we mentioned some of the realignment of resources that we are going through. And back at our Analyst Day in New York, we talked about the need to go through a detailed analysis of some of our resources and what they are working on, and look at some of the more mature product areas versus the new areas, and look at where we could shift resources from the more mature product lines to the newer activities. So, the first quarter includes some of the costs associated with that, where we had to make some headcount adjustments and maybe do some more of recruiting for some new skills there as well.
Manny Recarey:

Okay, so then kind of looking forward, I know you are not giving guidance, but we have to create models here. Is this new level of $73 million, $74 million kind of a good base rate to use going forward?
Teddy Blankenship:

It would be. We had those extra costs that we factored in to the first quarter but those could be then offset by additional areas like marketing costs, or sales costs related to any potential revenue increases going forward.
Manny Recarey:

Okay, and then staying with the first quarter, the margin hit that you are going to take from this sequentially, is that going to be more -- assume it would be more on the -- Management Systems Division is going to see kind of the margins that have grown more than typical from a seasonality basis because of this added investment?
Teddy Blankenship:

Both operating margins for LANDesk and Management Systems Division will be impacted by the sequential seasonal decline in revenue. And yes, MSD will have probably a broader share of the additional investment in the infrastructure management products in the first quarter. So, we do expect the first quarter to again have that impact, and then as I mentioned and related to LANDesk and it also relates to MSD too, that they will be getting more leverage from the expense base and the headcount adjustments we've made going forward. So, we will see the savings from the headcount adjustments are going forward and work towards getting back in line with our longer term operating margin goal of being more into the lower to mid 20% range.
Manny Recarey:

Okay, and then one last question, the $0.21 to $0.25 EPS guidance, that's on a pro forma basis and if I -- if that's correct then kind of working to the numbers, you are on a GAAP basis you are going to be kind of like break-evenish or maybe even negative?
Teddy Blankenship:

It should still be positive, but yes, there will be an impact from the stock compensation and intangible asset amortization.
Manny Recarey:

Okay. All right, thanks.
John Cooper:

Thanks Manny.
Operator:

Thank you. (Operator Instructions). And we will go next to Scott Zeller with Needham & Co.
Scott Zeller:

Thanks. Could you tell us what number to use approximately for share accounts, and the one you have given the shares you have repurchased, and those you plan to purchase?
Teddy Blankenship:

Sure Scott, just a second. We have repurchased about 1.6 million shares so far in January. We of course won't get a full quarter's impact with that, but we will get a pretty good bet, and then we repurchased 2 million shares through the -- whole of fourth quarter, we will get the full impact from that waiting in the first quarter. There will be, I am thinking that you add -- what fully diluted weighted average share count would be, probably somewhere around 48 million or a little above.
Scott Zeller:

Okay, that's helpful. And is there any additional color, I know this came on the previous call, but if you could help us with any sort of color on how you've managed the advanced buying on the channel, and is there any sort of metrics you can share on, what they were actually down to -- any additional color will be helpful?
John Cooper:

I think what we could say as we pretty much accomplished our goal for this quarter, it's our hope and I complimented Gene Mulligan and his group earlier for their operational efficiencies. Gene's done a really good job of being able to take time out of our supply chain, and one of our goals is to continue to work with our partners to reduce the channel inventories that are there, and take time out of the overall chain, because we do have better turnaround ability at this point. So, we accomplished our goal for the fourth quarter. It is our goal over the longer term to continue to manage inventories downwardly including our own and the channel inventories. So the first quarter, I think will probably see a very small decline in those inventories compared to what they normally would be, because it's not a big quarter to act with. We are going to continue to try to move inventories, and general, down, and since we share that with them, we'll try to help them move that down too as we gain more confidence in our ability to respond more quickly. So all I would be prepared to say as we hit our goal in the fourth quarter. We probably have some more to do over the course of this year that we'll be able to do for them, and we are committed to do that. So, it's going pretty well.
Scott Zeller:

Okay, thanks.
Operator:

Thank you. We'll go next to Aaron Schwartz with JP Morgan.
Aaron Schwartz:

Good morning. I had a follow up on your comments about your core business being tied to server unit growth. And if we think of the server unit growth being seasonally strong in the December period, what gives you confidence of going back and recapturing that or is it more rational to think of that maybe being harder to catch up in capturing the first half of '08?
John Cooper:

Aaron, I thought the general gist of what I conveyed a while ago was that the deals that we could identify, that got deferred, by and large are still active. We think some of those deals, with probably a relatively small portion, will actually close in the first quarter. We'll just have to see how the balance of those deals close over the year, but generally speaking our server growth per se in the absence of an identified deal, you know I wouldn't ever argue that you get that back per se at any point of time. I was trying to answer the question earlier about certain identified deals that got deferred, and whether those deals were holding in place and my answer was the deals by and large were still active. But they are not expected to close early in the year.
Aaron Schwartz:

Okay. And on the last call you had talked about the shape of your pipeline. And I am just wondering normally when you think about maybe the second half being a stronger seasonal period for you when you have confidence in looking at your pipeline build for the second half, I mean does that come more in the June quarter or when would you actually be very comfortable in talking about through the pipeline count you know building up to and delivering for your second half?
John Cooper:

Well let me try to answer that this way. In a normal year here, the first quarter is always slow, always starts very slowly, it picks up the pace in March, and we start to really get a feel for the year at that time initially. Given reasonable economic conditions, that feel normal holds pretty well, I think this will be an interesting year just to see how solid everyone feels about what the condition of the economy is coming into the second quarter. Assuming that some consensus has formed around that by that time, I think we'll start to be reasonably able to anticipate what kind of year it's going to be. But it will depend on getting some degree of consensus about the feeling about the economy and removing some of the uncertainty from the environment.
Aaron Schwartz:

Okay, and I had a question on LANDesk, you've obviously seen a higher mix of revenue that is deferred relative to upfront recognition and I am just wondering if you could comment on that to get your sense of, if that mix shift should continue to occur or if you start to see some stabilization there or if it anniversaries or just some commentary about how you think about the revenue growth going forward in terms of what is upfront and what is getting deferred?
Teddy Blankenship:

Yes, Aaron, we do expect to continue to sell more subscription based products, as well as continue the high renewal rate on maintenance related to their installed base for the LANDesk management [suite]. So we do expect deferred revenue to continue to grow, and the bookings to exceed the revenues that we're recognizing. There are a lot of newer products that we have on our roadmap as well. Envision more of a subscription model because they would involve an ongoing provision of services to the customer.
John Cooper:

We lack the subscription business, we realized it's kind of frustrated folks at times, trying to figure out how it was flowing, but we do lack the subscription model. We think it has a saleability factor that is easier to deal with, and it has been our goal to grow the deferred revenue and increase the sales of those, and we were pleased to see that trend in the fourth quarter.
Aaron Schwartz:

Okay and lastly I had a follow up question on the management change and again best wishes to you, John going forward, but what type of qualities are you looking for in a candidate? I mean should we think of more of a -- you are looking more for a technology background or operational strength, I’m sure it's all of the above, but is there anything specific that you will be looking for?
John Cooper:

I think it would be overly presumptuous of me to try to preempt what the Board Committee is going to give a spec to whoever the headhunter may be. So let me defer on that, I think that will clear itself up over a reasonable period of time.
Ed Harper:

This is Ed, let me amplify on that. The search committee is now being worked on. The one that will actually do the search, and then will go through a process of looking for a recruiter based on what we form as our spec for the new CEO. And certainly it will consist of the traits you mentioned and certainly some of the ones that John has also exhibited throughout his tenure here. So while we are not yet fully formed on that, we certainly want to do this full search to find the best possible candidate for Avocent.
Operator:

Thank you. We’ll go next to Rob Owens, with Pacific Crest Securities.
Rob Owens:

Yes thank you. What is the gross margin for the LANDesk business?
Teddy Blankenship:

For the fourth quarter it was about 89%.
Rob Owens:

89%?
Teddy Blankenship:

And that's been consistent pretty much through the year.
Rob Owens:

Okay and can you give me a sense of what headcount is attributable to the LANDesk business?
Teddy Blankenship:

Just over 700 people are in our LANDesk Division.
Rob Owens:

So if you look at enhancing profitability going forward, do you think it is restructuring within the existing business, or is it really going to come from more leverage, I guess is the top line growth, how should we think about that?
Teddy Blankenship:

There is a combination of factors, but a lot of it is from getting more leverage from the existing sales force and the resellers. Such as, equipping our resellers to handle more of the smaller deals, so that our sales people can focus with them on some of the bigger deals. Also involves tweaking the sales compensation plans to more directly align sales compensation with the people who are contributing to the sales growth.
Rob Owens:

And of the 700, can you give me any sense of how that's broken out between sales or R&D or just general G&A?
Teddy Blankenship:

I can, one second.
John Cooper:

Rob, you have got him shuffling paper.
Rob Owens:

That's a good thing.
John Cooper:

I'm trying to get you an answer.
Rob Owens:

How are you today?
John Cooper:

Good. You've got some percentage guidelines there you could kind of give Teddy.
Teddy Blankenship:

Sure.
Rob Owens:

Anything rough Teddy would be good.
Teddy Blankenship:

Sure. It's roughly half sales and marketing, and then probably about 40% R&D, and then that would leave something less than 10% for administrative and operational type roles.
Rob Owens:

Okay, because as I look at the business overall, your revenue per head is pretty low relative to software standings, if the business in of itself is doing about $110 million, bookings are obviously in excess of that. And I guess I am wondering if you think there is too much capacity in there, or just not enough product at this time, or how you think you are going to drive better efficiency?
John Cooper:

Rob, what you said is one of the things we have identified, the revenue per head, and it is something we are working on. It is influenced fairly significantly by where the people are located in some parts of the company. And so -- but is an area that we have identified that we think we can do better in terms of revenue per head and that is a major part of our objectives for this year is to get that process started in a meaningful way. And if you combine that with the leverage we think we can get out of the core organization from improving the revenue, then those are the two things that go to move us to the kind of operating margins we think would be more inline with what you are to expect.
Rob Owens:

Okay. And last question from me. Actually, I am good, thank you.
John Cooper:

Okay, thank you.
Operator:

Thank you. Next we go back to Harsh Kumar with Morgan Keegan.
Harsh Kumar:

Hi guys, just a quick housekeeping question. Taxes are going to be a mix again international versus U.S. Teddy, could you give us some guidelines of what we should think about taxes for 2008 for the whole year model purposes?
Teddy Blankenship:

Sure Harsh. It will take a little time, let me refer back to my notes that I'd mentioned earlier in the call, we expect the tax rate to be in the region of 22% to 24%. There is the expectation we should get some savings once we are really ramped up in our new Singapore location. So that will probably be more in the back half of the year once we really have the Singapore operation running smoothly, and having more of the Asian orders being fulfilled there. We will unfortunately have a lower tax rate in Singapore than the U.S. certainly, and even a little bit lower than what we have in Ireland, though we expect to see some improvement from that in the back half of the year. But right now, I would say 22% to 24% is what we are working with.
Harsh Kumar:

Okay, fair enough. Thanks guys and best of luck again.
Teddy Blankenship:

Thanks Harsh.
John Cooper:

Bye, bye.
Sam Saracino:

Robbie, at this point we've been going about an hour or so. Let's kind of close off the questions and before we close the call though, I want to emphasize a few points, kind of in my final remarks about Avocent and the market in which we find ourselves. I want everyone to remember that we are a strong company with excellent market position, a broad customer base and many long-standing relationships. As a company, during our history, we have prospered through several transitions and in each case we have emerged as a more integral part of our customer's environment. We expect to emerge from this transition with solid margins, strong profitability, and excellent cash flow. The future is bright with a great base to build upon, including right level of presences in many data centers through our appliance business, strong OEM relationships in the appliance embedded in software parts of our business, a great desktop presence through LANDesk, and excellent strategic partnerships in many parts of the IT market. Add to that some great new products in the pipeline for later this year and I believe it's a very strong combination. In my final closing, I can over emphasize the talent and dedication we have at Avocent. We have great people, who take seriously our obligations to our shareholders. I fully expect that our ongoing execution and success will be recognized by the markets so that our shareholders can enjoy the results they have come to expect from us. I thank you for your continued attention and time and your interest in Avocent and I wish all of you a good day.
Operator:

That concludes today's conference. You may disconnect your lines at this time.

American Virtual Cloud Technologies, Inc. Q4 2007 Earnings Call Transcript

Other American Virtual Cloud Technologies, Inc. earnings call transcripts:

American Virtual Cloud Technologies, Inc.
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