IXIA Q4 2008 Earnings Call Transcript

Executives

Brent Novak – Vice President of Finance

Errol Ginsberg – Chairman of the Board & Chief Innovative Officer

Atul Bhatnagar – President, Chief Executive Officer & Director

Thomas B. Miller – Chief Financial Officer

Analysts

Sam Wilson – JMP Securities

Mathew Robison – Pacific Growth Equities

Analyst for Ajit Pai – Thomas Weisel Partners

[Andy Sopic – Nutmeg Securities]

IXIA (XXIA) Q4 2008 Earnings Call February 5, 2009 5:00 PM ET

Operator

Welcome to the Q4 2008 earnings conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Brent Novak, Vice President of Finance.

Brent Novak

Thank you for joining us on today’s conference call to discuss IXIA’s fourth quarter results. This call is also being broadcast live over the web and can be accessed in the investor relations section of IXIA’s website at www.Ixia.com for 90 days. With me on today’s call are Errol Ginsberg, IXIA’s Chairman and Chief Innovation Officer, Atul Bhatnagar, IXIA’s President and Chief Executive Officer and Tom Miller, IXIA’s Chief Financial Officer.

After the market closed today IXIA released a press release discussing the results for its fourth quarter and year ended December 31, 2008. We would like to remind you that during the course of this conference call IXIA’s management may make forward-looking statements including financial projections, statements as to the plans and objectives of management for future operations and statements as to the company’s future economic performance, financial condition or results of operations.

These forward-looking statements are not historical facts but rather are based on the company’s current expectations and beliefs. Words such as may, will, expects, intends, plans, believes, seeks, estimates and variations of these words are intended to identify forward-looking statements. The company’s actual results may differ materially from those projected in these forward looking statements.

With that said, I’d now like to turn the call over to IXIA’s Chief Financial Officer Tom Miller.

Thomas B. Miller

I should mentioned that unless specifically noted otherwise, we are discussing all numbers on a non-GAAP pro forma basis prior to non-cash charges for the impact of stock-based compensation, amortization of acquisition related intangible assets an impairment charge related primarily to the company’s investment in auction rate securities as well as the related income tax affects of such items.

In the fourth quarter these charges consist of $2.9 million related to stock-based compensation, $1.4 million for the amortization for acquired intangible assets, a $15.9 million investment impairment charge and a net tax benefit of $600,000 related to these items. A full reconciliation of the non-GAAP financial measures covered in this call to the most directly comparable GAAP measures are available in the investor relations section of our website at www.IXIACom.com.

Revenue for fourth quarter of fiscal 2008 was $41 million, below our guidance of $44 to $48 million. This $41 million of revenue compares to $47.3 million in the immediately preceding third quarter of 2008 and $46.4 million in the fourth quarter of 2007. Our GAAP loss for the quarter was $0.29 per share which includes a $15.8 million write down on auction rate securities. Non-GAAP EPS for the fourth quarter of 2008 was $0.02 per diluted share.

In the fourth quarter interface cards accounted for 66% of our revenues, software accounted for 16% of revenues with the remaining 18% representing revenue from chassis, warranties and other products. From a geographic perspective, domestic revenues represented 62% of our total fourth quarter revenues with Canada representing 6%, EMEA 13% and Asia Pac 19% of revenues.

From a customer perspective 56% of our revenues in the fourth quarter came from network equipment manufacturers, 15% from service providers, a combined 12% from enterprise university and government customers and 17% from distributors, communication chip manufacturers and other accounts. Our top five non-distributor customers represented approximately 33% of revenues in Q4 and included CISCO, Juniper, Alcatel Lucent, Hewlett Packard and Hitachi. Sales to CISCO, our largest customer were $7.9 million representing 19% of revenues.

Moving down the income statement, non-GAAP gross margins were 79%, within our target range of 78% to 80%. We expect our non-GAAP gross margins to be in the 78% to 80% range for the first quarter of 2009. Non-GAAP operating expenses were $31.9 million in the fourth quarter, approximately $650,000 higher than the $31.3 million reported in the third quarter. Included in the fourth quarter operating expenses were approximately $2.1 million in non-recurring costs related to severance, due diligence on strategic initiatives and certain other one-time accruals.

Excluding these non-recurring items from the Q4 run rate, non-GAAP operating expenses for the fourth quarter dropped by approximately $1.5 million sequentially from the third quarter primarily due to lower bonus expense. Fourth quarter 2008 non-GAAP net income was $1.4 million or $0.02 per diluted share. This compares to $7.7 million or $0.11 per diluted share for the same period last year.

The non-GAAP effective tax rate was a -28% in the fourth quarter. This low effective rate is due primarily to lower than projected pre-tax income in the fourth quarter and the pickup of a full year’s worth of federal R&D tax credit in Q4. We expect a non-GAAP effective tax rate for the first quarter of 2009 to be in the range of 21% to 27%.

Turning to the balance sheet cash, cash equivalents and investments were approximately $206 million at December 31 which compares to $217 million reported three months earlier. As noted we recorded a $15.8 million impairment charge for auction rate securities in Q4. As we had reduced the carrying value of our auction rates by $6.9 million through other comprehensive income prior to the start of the fourth quarter, the impact on cash and investments due to this impairment in Q4 was a reduction of $8.9 million. After the impairment charge IXIA had auction rate securities for the current value of $3.2 million at year end. Also at yearend over 90% of our cash and investments was invested in T Bills.

Pursuant to our $25 million share repurchase program, during the fourth quarter we repurchased 472,000 shares of IXIA stock at a total cost of $2.8 million or an average of $5.92 per share including commissions. Cash flows from operations for the fourth quarter of 2008 were $1.7 million compared to $5.4 million in the immediately preceding third quarter. Capital expenditures for the fourth quarter of 2008 were $1.4 million compared to $2.3 million in the immediately preceding third quarter.

Accounts receivable decreased from $37.2 million on September 30, 2008 to $34 million as of December 31^st. DSOs for the fourth quarter based on trailing figures was 76 days. Inventory was $15 million at December 31 for an annual turnover rate of 2.3 times. The number of full-time employee equivalents as of December 31, 2008 was 805 as compared to 797 employees at the end of the third quarter.

Looking forward, the continuing economic uncertainty has reduced our visibility. Taking this in to account and based on a review of the sales pipeline and discussion with our sales management team, we expect first quarter revenues in the range of $37 to $42 million and we expect first quarter revenues from CISCO to be $6 to $8 million. We currently expect our non-GAAP EPS to be in a range from a loss of $0.01 per share to earnings per diluted share of $0.03 in the first quarter with comparable GAAP EPS estimates in a range between a net loss of $0.02 to $0.06 per share.

The difference between anticipated GAAP and non-GAAP results relates to the expect non-cash charges and associated tax affects including non-cash charges relating to stock-based compensation. We estimate at this time that out stock-based compensation charges will be between $3.7 and $4.2 million for the first quarter of 2009 on a pre-tax basis.

With that said, I would now like to turn the call over to Atul.

Atul Bhatnagar

The economic turbulence of the last few months has impacted IXIA as long as the industry in general. We expect to see continued uncertainty at least in the near term and possibly longer. Accordingly, we are taking some immediate actions to reduce operating expenses and all expenditures in 2009.

These actions include decreasing compensation costs through the direction of bonuses and raises, further reduction in compensation costs through the impact of normal attrition and the elimination or reduction of numerous other operating and capital expenses. We are committed to lowering operating expenses in 2009 to below 2008 levels.

As of now, we expect non-GAAP operating expenses for 2009 to be approximately $120 million or about $6 million lower than the 2008 level. Q1 is expected to be a higher expense quarter somewhere under $31 million due to payroll taxes and our annual sales meeting. After Q1, quarterly expenses are expected to drop to under $30 million.

But, as we trim cost in preparation for this challenging economic environment, we are laser focused on what is most important to IXIA as a company, namely innovative products and strong customer relationships. The majority of our employees are directly involved in either developing or selling our products. To maintain our product leadership and to keep sales momentum even in tough times, we need to retain our highly skilled engineers engaged on product innovation and we also need to keep our sales force fully staffed, on the street and in constant contact with our customers.

We need to stay close to our customers, understand their needs and be ready to deliver next generation products when their budgets ramp back up. With high gross margins, positive cash flow and over $200 million in the bank, we are committed to maintaining our strong foundation of people, products and processes that will win market share in 2009 and beyond and, we truly care what our customers think of the IXIA products and their interactions with IXIA’s sales and support personnel.

We just completed our second customer satisfaction survey. The results were very positive and reflective of the investment we have made in our customer relationships. We surveyed over 200 customers and found a 12% increase from the prior survey of customers who were delighted with IXIA as a company as well as a 12% increase in our customers’ willingness to recommend IXIA’s products and services. We’ll continue to closely monitor and measure our customer satisfaction levels. It is easier and less expensive to sell to satisfied customers.

We also made significant strides this quarter in improving our manufacturing process and supply chain management. We just signed a new manufacturing agreement with Plexus Services Corporation, a major electronic manufacturing service company. Over the next several months we will transition a substantial portion of our manufacturing and material sourcing to Plexus. By leveraging its’ operational expertise and purchasing power we expect to reduce our product cost over the next several quarters. These savings should start to show up in our costs of good sold in the second half of the year.

Turning to our product development efforts, we enter 2009 with significant product leadership in several key areas. In Q4 IXIA became the first test and measurement company to deliver a 100 gigabyte Ethernet test solution. As the convergence of networking and storage accelerates we are well positioned to fulfill our customers’ needs with our IxYukon 10 gigabyte solution. We also further expanded in to converged datacenter Ethernet by leveraging our IxYukon 10 gig solution.

On the application side Frost & Sullivan has recognized IXIA as a leader in triple play testing with a 38.5% market share in addition to being the leader in 1 gigabyte and 10 gigabyte testing. With increasing concerns over lack of security and exposure to malicious threats in datacenters and communications infrastructures, equipment makers and service providers are looking for new ways to test their systems for robustness. IXIA’s recently introduced IxDefend Solutions is targeted dedicatedly at this area of resiliency and security testing.

With IxDefend and the rest of our product line up, we are poised to further accelerate our leadership in 2009 with continued strong investment and focus on innovative products and customer delight. With the industry’s only 40 and under gigabyte Ethernet test solutions IXIA continues to be at the leading edge of converged communication testing. As equipment manufacturers and service providers work towards the development and deployment of this next major Ethernet technology, IXIA is well positioned as a key partner to many of them.

At this point IXIA offers the only commercially available test solution for 100 gigabyte Ethernet. We continue to work closely with the early adopters as well as with standard IEEE and ITU. We are focused on continuing to lead in 40 gig Ethernet and 100 gig Ethernet on a global basis. By using this technology to get a foothold in many labs across the world, we expect these products to be strong drivers for IXIA’s growth going forward with equipment makers and service providers.

In the 10 gig Ethernet arena, our IxYukon product line continues to offer the highest performance and density in the industry. With 96 [cords] per chassis, IxYukon has four to one density advantage over its nearest competitor. IxYukon was instrumental in driving significant growth in 10 gig sales in 2008 when compared with 2007. IxYukon now drives the bulk of IXIA’s 10 gigabyte sales.

As a company, we are very proud that within six months of introduction IxYukon has also become IXIA’s best selling load module exceeding our expectations and it is earning substance in the market place with unprecedented quality. We expect the 10 gigabyte market to continue to grow over the next several years. The 10 gigabyte Ethernet is finding more applications in the real world. A key driver for 10 gigabyte Ethernet going forward is datacenter Ethernet. Equipment manufacturers are developing innovative solutions based on fiber channel over Ethernet or FCOE.

In Q4 IXIA delivered the industry’s most comprehensive datacenter Ethernet solution for FCOE. This solution is based on the IxYukon hardware and was demonstrated last November at the Super Computing 2008 Trade Show in Austin Texas. IXIA was the only test and measurement vendor in this public demonstration. In 2009 IXIA will continue to partner with key customers to build on this strong datacenter Ethernet solution.

With IxYukon’s superior per density and with strong portable support provided by our network products, IXIA’s datacenter Ethernet solution is well positioned for this key growth market. In the area of converged IT services and applications testing, IXIA continues to lead the market with our multi dimensional IX load product. The market for triple play and advanced service testing has driven significant new revenue and growth for IXIA.

All major service providers are moving quickly to offer IP based communications and entertainment services. This trend continues to drive significant overall investment for product development and network build out. In addition, the [inaudible] intelligence of traffic management has been increasing dramatically. As new converged IT services like IPTV, [inaudible] are deployed and scaled, the focus on testing is now beyond protocol and performance.

Our customers are now looking to truly analysis and [inaudible] a subscribers experience when multiple converged services are deployed. This type of testing requires a new level of testing sophistication in subscriber modeling and emulation that stresses and tests all the underlying network and [inaudible] protocols with realistic traffic and loads. We are confident that we can maintain our leadership in this key area.

Another recent innovative solution is our new security and robustness assessment product called IxDefend. Security threats and malicious attacks are an increasing concern to our customers. IxDefend is a software solution that runs on IXIA hardware to provide customers with comprehensive and preemptive threat assessment across various IP technologies and protocols. The best way to access robustness is to test for various threats in conjunction with high load performance in one chassis.

IXIA solutions have always focused on load performance. IxDefend now allows our customers to further leverage their investment in IXIA load generation equipment by adding significant security and threat test capabilities. This is another example where the total cost of ownership is optimized with a multipurpose IXIA platform.

In spite of the difficult challenges we expect to see during 2009 on a global economic front, we continue to remain very confident about IXIA’s future. We have a strong balance sheet and no debt. We enjoy competitive advantage and technological leadership in many of our key markets and our customer satisfaction levels are at an all time high. In addition, IXIA’s employees are energized and confident in their ability to innovate and deliver new products.

While we are committed to maintaining our profitability during this period of economic uncertainty, we will also continue to make [inaudible] investments in our business to ensure our core technology and market leadership positions remain intact and in fact get stronger for when the economic environment improves because when the economy does rebound and demand increases, customers will be looking for new solutions and not legacy technology. We plan to be there with the solutions they will want.

We would like to thank the entire IXIA team and our partners for their contribution and loyalty during this tough times. With that said, we will now be happy to answer any questions you may have. Operator, you can now open it up for questions

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sam Wilson – JMP Securities.

Sam Wilson – JMP Securities

I have sort of a number of one off questions I hope you’ll forgive me for a few minutes here. First, on carriers and enterprise it looks like quarter-to-quarter they were down the most versus NEMs and I’m wondering here if you’re the NEMs continue to invest throughout this downturn on next generation products and you’re benefitting a little bit from that versus the carriers and enterprises which are pulling in? Or, do you think this is just a lumpiness in the business? I just want to get a sense for what you think is going on among your individual customer segments?

Atul Bhatnagar

NEMs definitely are continuing to invest in the next generation platform. I think we see that across the board because we all know as the markets come back the density and speed increases will be a new number not the legacy platform so we do see that investment continuing. On the carrier front, really in some ways there is some lumpiness because the projects tend to be lumpy. Enterprise for us is again, I don’t see a significant trend right now which tells us very definitively. I think a couple of quarters in a row will give us an idea.

So, on the carrier front there are many projects which we still have in the funnel that we’re working on so I don’t think there’s a specific trend as such I could point to right now. But, NEMs you’re right we are seeing that the next generation products, they’re still buying the right solution to make sure they are there as the markets turn around.

Sam Wilson – JMP Securities

A second question, in the past Nortel’s been a top five customer. I’m wondering if you have any exposure vis-à-vis Nortel’s bankruptcy right now?

Thomas B. Miller

Very minimal. We have right around $100,000 in accounts receivable. Fortunately for us in that respect Nortel’s purchases have been low the last couple of quarters. They were very large in Q1 but the purchase levels came down during the year.

Sam Wilson – JMP Securities

I know there’s sort of a reorganization, are they continuing to buy from you on a cash basis now or is it effectively down to zero?

Thomas B. Miller

Right now there’s not a whole lot of activity going on with them and when we start seeing orders we’ll assess how we want to be paid for that.

Sam Wilson – JMP Securities

I wanted to get a sense also, I know you’re running a program called right now switch to IXIA where you will it looks like from what I understand of the program, either buy or repurchase old equipment from other vendors or your own legacy stuff for upgrades. Can you talk a little bit about that, the program itself? Then also, in the context do you feel like in this environment right now running promotions can stimulate customer demand or is the environment so bad that really it’s sort of buckle the seatbelt, batten down the hatches and survive until the next upturn comes?

Atul Bhatnagar

Sam, switch to IXIA, if I look at last year, I think the first two quarters there was a pent up demand. In terms of the last few quarters it really hasn’t been that huge a program for us. Most of the time the place where we benefit is is if our competition has some old chassis and we can position some of our new chassis, that brings us the real estate and down the line we can sell the blaze in to it. I think overall this is mostly to make sure accounts where IXIA is not present and yet the customer will benefit tremendously by the innovation of our 10 gig high density and our IX load [inaudible] solutions, those are the accounts we target.

So far it has worked well for us and we are very mindful of the margins and as you can see towards the year we maintain our margins. Net/net this has opened up some new accounts where we were not there before.

Sam Wilson – JMP Securities

Can you just give us a sense right now, are customers batten down the hatches and just not buying it? Are they price sensitive so if you ran a promotion you could stimulate a little bit of demand? It kind of doesn’t matter? I’m just trying to get a sense for their propensity to purchase right now?

Atul Bhatnagar

Without naming the NEMs of our customers, I would say that it’s all over the spectrum. I think everyone is definitely spending cap ex dollars very judiciously and very carefully and that is a trend everywhere. I will say that even in this environment there are several NEMs that are doing well, who are actually gaining market share, coming out with new products, expanding their market segments and they are buying and they are buying aggressively. And, there are some NEMs who are really being more conservative.

So, from our vantage point we are growing our business extremely well with some of them, with some of them it’s stable. With some of them its decreased, it’s all over the place.

Sam Wilson – JMP Securities

My last question is for Tom, on the ARS issue, I know there’s been a little bit of a settlement going on, etc., you’ve taken an impairment. Do you expect to be made whole at some point in the future or do you expect this is probably permanently impaired?

Thomas B. Miller

I think from an accounting point of view this would be an impairment. We are pursuing recovery of the funds. I can’t comment on that though, the likelihood of that happening but we are definitely pursuing it. I think most of the settlements so far have been individual investors, corporations and institutions have had less success getting made whole but we’re certainly pursuing that. We’ll keep you posted on that.

Operator

Your next question comes from Mathew Robison – Pacific Growth Equities.