Q1 2008 Earnings Call Transcript
April 24, 2008 5:00 pm ET
Brent Novak – VP of Finance
Atul Bhatnagar – President and CEO
Tom Miller – CFO
Errol Ginsberg – Chairman and Chief Innovation Officer
Sven Eenmaa – Thomas Wiesel Partners
Leo Choi – Ferris Baker Watts
Joanna Makris – Brean Murray Carret
Good afternoon, ladies and gentlemen, and welcome to the Ixia Q1 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, Ixia's Vice President of Finance. Mr. Novak, you may begin.
Good afternoon, and thank you for joining us on today's conference call to discuss Ixia's first 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.ixiacom.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 issued a press release discussing the results for its first quarter ended March 31st, 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 would now like to turn the call over to Ixia's President and CEO, Atul Bhatnagar. Atul?
Thanks, Brent, and thanks everyone for being on the call. As we announced in our press release two weeks ago, we missed the low end of our revenue guidance by approximately $350,000. Our guidance was $42 million to $46 million for the first quarter, and we came in at $41.7 million. For non-GAAP earnings per share, we came in at $0.04, which was at the low end of our earnings guidance. As I will discuss more fully later in the call, our first quarter results were impacted by a combination of seasonality, which we predicted on our last earnings call, and the effects of the economic environment. However, we saw some positive trends in the first quarter with good results in Asia Pacific and with our equipment manufacturer accounts.
Results in Europe and Canada were below expectations for the first quarter. In particular, carriers and service providers were weak in Europe and throughout North America, but we attribute that softness mainly to seasonality. In the second quarter, we expect an improvement in results as we move past the seasonality, seasonally soft first quarter, and we have some exciting new product initiatives to discuss such as our IxRave offering to monitor light converged IP networks, and our new 8-Port 10 gigabit IxYukon card, which will give our customers the highest combination of performance and density on the market.
But, more on those topics later. I'm now going to ask our Chief Financial Officer Tom Miller to go through the first quarter financial results. Tom?
Thank you, Atul. I should mention that, unless specifically noted otherwise, we are discussing all numbers on a non-GAAP or pro forma basis prior to non-cash charges for the impact of stock-based compensation and amortization of acquisition related intangible assets. These non-cash charges in the first quarter consist of $2.9 million related to stock-based compensation, $1.5 million for the amortization of acquired intangible assets, and net tax benefit of $1.7 million related to these items.
A full reconciliation of the non-GAAP financial measures covered in this call to the most directly comparable GAAP measures is available in the Investor Relations section of our Website at www.ixiacom.com.
Total revenues for the first quarter were $41.7 million, compared to $40.7 million in the first quarter of last year. Interface cards accounted for 71% of our revenues. Software accounted for 15% of revenues with the remaining 14% representing revenue from chassis, warranties, and other products.
From a geographic perspective, domestic revenues represented 67% of our total revenues with Canada representing 5%, EMEA 10%, and Asia Pac 18% of revenues. Bookings and shipments in Asia Pac were a record, driven by healthy sales to China, Japan, and India, while sales in Europe and Canada were weaker than expected due in part to the effects of seasonality.
From a customer perspective, 67% of our revenues in the first quarter came from network equipment manufacturers, 12% from carriers and service providers, a combined 8% from enterprise, university, and government customers, and 13% from distributors, communication chip manufacturers, and other accounts.
Our top five non-distributor customers represented approximately 45% of revenues in Q1, and included Cisco, Alcatel-Lucent, Juniper, Nortel, and NTT. Sales to Cisco, our largest customer, were $10.6 million, representing 25% of revenues. Non-GAAP gross margins were 78.3%, down from 81.2% in the fourth quarter of 2007, and within our target range for non-GAAP gross margins of 78% to 80%.
The main drivers behind the lower sequential margins included pricing pressures at some larger accounts and a shift in customer and product mix. We expect that our customer mix will be more normal in the second quarter, and that our non-GAAP gross margins will be in the 78% to 80% range by the second quarter. However, we want to caution investors that the market remains very price competitive, and our gross margins are likely to remain under pressure.
Non-GAAP operating expenses were 74.4% of sales, compared to 65.8% in the immediately preceding fourth quarter. The increase in operating expense percentage is primarily due to the sequential drop in revenue. In dollar terms, first quarter 2008 operating expenses were higher when compared to the fourth quarter of 2007 by approximately $440,000. This increase is primarily due to higher seasonal fringe benefit costs and the cost of our annual sales conference, partially offset by lower commissions and by the one-time severance cost in Q4, which did not recur in Q1. We will continue to focus on controlling the growth of operating expenses in Q2.
R&D expenditures were 26.1% of revenues in the first quarter, up from 22.9% for the immediately preceding fourth quarter of 2007. In dollar terms, R&D expenses increased approximately $240,000 from the immediately preceding quarter, due mainly to higher seasonal fringe benefit costs. Sales and marketing expenses represented 33.1% of revenues in the first quarter, up from 30.7% for the immediately preceding quarter – excuse me, fourth quarter of 2007.
In dollar terms, sales and marketing expenses decreased by $459,000 from the immediately preceding quarter. The cost of our annual sales conference and the higher seasonal fringe benefit costs in Q1 were more than offset by lower commissions in Q1 and the non-recurrence of a Q4 severance cost.
G&A expenses represented 15.1% of revenues in the first quarter, up from 12.2% for the immediately preceding fourth quarter. In dollars terms, G&A expense increased by $659,000 sequentially from the fourth quarter, due in part to higher seasonal fringe benefit costs and an increase in professional fees. Our year-over-year basis, GAAP net income for the first quarter of 2008, which includes stock-based compensation charges and amortization of acquisition related intangible assets, was $106,000, or zero cents per diluted share, compared to a net loss of $759,000 or $0.01 per diluted share for the first quarter of 2007.
For the first quarter of 2008, non-GAAP net income, excluding the effects of non-cash charges and the related tax effects was $2.8 million or $0.04 per diluted share. This compares to $3.3 million or $0.05 per diluted share for the same period last year.
The non-GAAP effective tax rate, which is the ratio of non-GAAP income tax expense to non-GAAP pre-tax income, increased to 36.2% in the first quarter, up from 26.2% in the fourth quarter of 2007, and within our target range for the non-GAAP effective tax rate of 36% to 37%. The fourth quarter of 2007 was lower, due in part to a benefit related to the completion of a California Franchise Tax Board audit in the fourth quarter. We expect the non-GAAP effective tax rate to be in the 35% to 36% range for the second quarter of 2008.
Now turning to the balance sheet, cash and investment were approximately $244.5 million at March 31st, down about $4 million from three months earlier. Under the $50 million share repurchase program that we announced in August of 2007, during the first quarter we repurchased approximately 1.1 million shares of our common stock at an average cost of $7.68 per share or approximately $8.3 million in total. This brings the total amount of shares of our common stock we have repurchased since the start of our repurchase program to the end of the first quarter to approximately 2 million shares at an average cost of $8.75 per share or approximately $17.4 million in total.
Accounts receivable increased from $32.4 million on December 31st, 2007 to $33.9 million as of March 31st. Based on trailing figures, our day sales outstanding increased to 74 days from the 64 days reported three months earlier, but it was the same as the 74 days reported in the first quarter of 2007.
Inventory decreased on a sequential basis from $12.7 million to $10.6 million at March 31st. This trailing inventory balance equates to a turnover of 3.4 times. The number of fulltime employees equivalents as of March 31st was 788 as compared to 785 employees at the end of the fourth quarter.
Looking forward, we expect second quarter revenues in the range of $42 million to $45 million, and we expect second quarter revenues from Cisco to be $8 million to $10 million. We currently expect non-GAAP EPS of $0.04 to $0.06 per diluted share in the second quarter of 2008 with comparable GAAP EPS estimates of breakeven to $0.02 per diluted share.
The difference between anticipated GAAP and non-GAAP results relates to expected non-cash charges and the associated tax effects, including non-cash charges relating to stock-based compensation. We estimate at this time that our stock-based compensation charge will be between $2.5 million and $3 million for the second quarter of 2008, on a pre-tax basis. With that said, I would now like to turn the call over to Atul.
Thanks, Tom. First, before we talk about what lies ahead in terms of products and initiatives to grow the company, I want to comment on our first quarter results. As I mentioned at the top of the call, we missed the low end of our revenue guidance by approximately $350,000. Our revenue guidance was $42 million to $46 million for the first quarter, and we came in at $41.7 million.
So, what happened in Q1? We exited 2007 on the heels of three sequentially up quarters. In fact, the fourth quarter of 2007 set all-time records at Ixia in terms of bookings and shipments. But, in our fourth quarter earnings call in February, as you may recall, we discussed the seasonality of our business and indicated that Q1 could be down, in keeping with trends noted in the first quarters of past few years.
As we said on the call, seasonality is a new trend that we are beginning to understand at Ixia. As we have diversified our business away from our strong equipment manufacturer base, we have seen more seasonal variability in certain customer categories and geographic regions, such as the service provider area and Europe. While we anticipated the seasonality and incorporated it into our revenue guidance, we unfortunately came in slightly below the low end of that guidance range.
There were several factors for our first quarter revenue shortfall. Chief among these factors, our business experienced more seasonal softness than we anticipated in Europe and Canada, and we had a generally weak quarter with carriers and service providers across both Europe and North America. In Asia Pacific, carriers were up slightly from their fourth quarter level, and the Asia Pacific region overall hit a record level in terms of bookings and shipments in the first quarter.
We are continuing to see solid performance in China and India. Also, we had a strong quarter with equipment manufacturers both in the US and Asia Pacific. The equipment manufacturer business was led by a strong performance at Cisco, where sales increased by over 20% from fourth quarter levels. We believe that the softness in the carrier space and in Europe and Canada is more seasonal in nature.
We expect improvements in these areas in the second quarter and for the rest of the year. As we grow and diversify our customer base even more, we will mitigate the effects of seasonality to some extent. However, more was going on in Q1 than just seasonality.
During the first quarter, a most challenging economic environment evolved from the financial market crisis, which we believe led to some customers to delay their purchase decisions. While business activities remain robust, order closure rates in most geographies fell below our expectations. We saw many opportunities remain open for a longer duration.
Clearly, these larger economic forces are beyond our control. In these uncertain times, we will manage our costs prudently while making sure we have the products and sales force to meet any surge in demand that an improved economic environment will provide. We believe the recent investments we have made in our executive staff and throughout the sales organizations have strengthened our capabilities, and together with our strong product portfolio, will have a positive impact on our business this year, particularly as the macroeconomic environment becomes more settled.
Overall, we are optimistic about our prospects for the second quarter. We have seen positive trends develop in many areas, and we are seeing our pipeline fill up. We believe that many factors that led to our lower than expected first quarter results were seasonal in nature. We are experiencing an increasing rate of activity at the carriers, as well as growing interest in 10 gigabit Ethernet everywhere. Barring any unforeseen shocks to the economic environment, we will – we should see an improved second quarter, as our guidance suggests.
Now, I would like to discuss some of the new products and initiatives that will help drive growth at Ixia. Last year, Frost and Sullivan recognized Ixia as the leader in gigabit and 10 gigabit Ethernet test solutions. This week, we announced a dramatic addition to our industry leading 10-gigabit Ethernet product line with our breakthrough IxYukon load module, which features eight ports of 10-gigabit Ethernet traffic on a single card.
The IxYukon card widens Ixia's leadership position as the highest performance and port density solution in the industry. Prior to the introduction of IxYukon, Ixia already had a 50% port density advantage over the nearest competitor, with 36 ports of 10 gigabits on it per chassis versus competition's 24 ports. With this highly scalable IxYukon load module, our 10-gigabit port density goes to a staggering 96 ports per chassis, giving Ixia a four to one port density advantage over the nearest competitor, as well as the most green testing solution available for next generation data centers.
Why is port density so important? For many reasons. The top two reasons are footprint in the customers’ lab and ease of test administration. Our customers do not want their test gear to take up more space in their labs than their own gear. With our extreme 10-gigabit port density, we take up significantly less lab space than any other test vendor, so the customer can focus on testing rather than racking and stacking test gear.
Second, by putting more ports in a chassis, it is easier to configure and administer a large port count test with Ixia. Imagine for a moment a 10-gigabit Ethernet test involving 256 ports. We think this scale of testing will become routine in the future. Ixia can do a 256 port, 10-gigabit test with only three chassis compared to 11 chassis required by the closest competitor. The complexity of the test plan administration skyrockets when the number of chassis increase by so much. So, not only does Ixia's new solution take up dramatically less footprint in the lab than the competition, with Ixia's dense design, it is easier to set up and administer large tests on an ongoing basis.
With the expected ramp of 10-gigabit Ethernet development and deployment, we think the IxYukon widens our leadership position in this area, and will allow us to take more market share as 10 gigabit Ethernet grows everywhere. Another key benefit that our IxYukon card offers is reduced energy consumption. We know that our customers are concerned about energy usage, not just for cost reasons for also for environmental reasons.
With the IxYukon, our design engineers started with a clean sheet of paper and designed in the lowest power consumption components they could find. The end result is a high performance, high density card that uses half the power of other offerings in the market.
Turning to another exciting new product, Ixia has recently started to move its IP test platforms from lab to the live network. With carriers worldwide deploying new IP offerings such as video on demand and voice over IP, there's a growing need to proactively monitor IP over live networks.
Ixia recently announced its IxRave solution, which enables carriers and service providers to test these new IP services upon rollout, and to provide on demand troubleshooting when a customer experiences a problem. Ixia has already deployed this technology at two carriers, and it’s currently rolling out IxRave at a third carrier.
At one major North American carrier, this innovative technology provided a payback on investment in less than one year. The IxRave solution integrates into a service provider's customer support system. When telephone support personnel receive calls from customers, they are able to quickly launch the IxRave solution and diagnosis where the problem is in the network. Without a central office troubleshooting solution such as IxRave, a service provider might have to deploy a service technician or reroute customer traffic to another DSL port.
In many cases, the analysis provided by IxRave will allow a service provider to avoid the cost of a truck roll or the cost of DSL ports that had to be taken out of service. This can result in large and very real savings to the service provider. As carrier compete to offer an increasing selection of advanced IP services to their customers and struggle with increasing operating costs, Ixia's ability to offer solutions that provide – that improve the end user quality of experience and reduce operational costs is critical.
The carrier market is experiencing rapid worldwide subscriber growth for multimedia IP services. With our expertise in IP tests, Ixia is uniquely positioned to help carriers manage this growth successfully. Our outlook for this business is very positive. However, there is a long lead-time on selling and deploying the systems. We expect to announce more wins for IxRave during 2008 with revenue accelerating in 2009.
Finally, I want to close with a few comments about my personal focus on cost controls and earnings growth at Ixia. As you know, I have just recently taken over as Chief Executive at Ixia. While I have met with some of you, there are many investors that I have not yet met. In the coming months, I plan to meet many investors. Let me repeat what I have previously stated in public forums. I'm focused on controlling costs and increasing profitability at Ixia. I believe that Ixia has sufficient resources in place to support significant future growth.
While we may shift our current resources to new growing areas such as IxRave, I do not see any need to make large incremental investments in our core business at this time. Our previous investments position us very well with clear product leadership today. We are optimistic that we will see revenue growth over the next 12 months to 18 months. My focus will remain on tightly controlling costs and letting incremental gross margin dollars drop to the bottom line.
As a proof point, we have staffed our IxRave initiative mainly with headcounts from other departments within Ixia. I intend to take full advantage of the operating leverage that our near 80% gross margins provide us. With that said, Errol, Tom, and I would now be happy to answer any questions that you may have. Operator, you can now open it up for questions. Thank you.
Thank you. (Operator instructions) Our first question comes from Ajit Pai of Thomas Weisel Partners. Please go ahead.
Sven Eenmaa – Thomas Wiesel Partners
Yes, hi. This is Sven Eenmaa calling in for Ajit.
Sven Eenmaa – Thomas Wiesel Partners
Hi. I have a couple of quick questions. First one is, could you talk about the pricing environment? You mentioned is it competitive, but how has it changed from the prior quarter and in the March quarter and how we have seen it developing in April?
Well, I think that we've always had price competition. It continues. It's really no worse than it's been in the past. One difference might have been that because of the customer mix, a much higher percentage of the NIMs, I think that's really a big factor in having our margins go down sequentially from the fourth quarter. But, we've always seen pricing pressure. We think we'll continue to see it. Our costs on the products drop to help us protect the margins a little bit, so I don't think there's going to be an abrupt drop in the margins going forward.
So, Sven, this is Atul. Our strategy is show customers the value, and show customers unique things, unique differentiations Ixia can do. There will always be price pressure in every market, and we see it, too. But, as you can see from the products we have brought, there is a significant value we have, and we will always price for value.
Sven Eenmaa – Thomas Wiesel Partners
Great. In terms of the carriers in the revenue mix, I mean, in last two quarters you saw carriers in like 19% to 22% of revenues range. Where do you see them in the mix for the current calendar year, on average?
Yes, so, Sven, my read is that the carrier business will be lumpy. And that's how they do it. Generally the life cycle is the proof of concept and they test it, then they approve it. So, it just – it goes over, in those cases, either 9 months or 12 months. I think that will continue. And this is a long-range business where you fill up the pipeline, you deliver, and then it starts showing results over a little longer period of time. So, mix-wise, I think a little bit of lumpiness will come because of that. And I don't expect that to change, really. It will just continue. That's the nature of the beast.
Right, right. But, if you look back at the numbers, you'll notice that Q1 of last year was the low point for carriers in '07, and hopefully Q1 is the low point in '08.
Sven Eenmaa – Thomas Wiesel Partners
Great. Thanks very much.
Our next question comes from Matt Robison of Ferris Baker Watts. Please go ahead.
Leo Choi – Ferris Baker Watts
Hi, this is Leo Choi. I'm filling in for Matt. Just got a question about the gross margin and how much of that, if you can comment a little bit on that regarding the trade-in program? How much of the gross margin has to do with that? And just a little bit more flavor regarding the ongoing trade-in program and how big of a part is that – would that be going forward in Q2?
I think in the first quarter, I know some of the analysts made a big deal of the trade-in program. We estimate the impact of that at less than a 0.5% on gross margin, though. So, it wasn't that big of an impact on gross margins. The biggest – the bigger impacts on gross margin were, once again a shift to the equipment makers who are, on average big buyers and get good pricing and have slightly lower margins, say, than some other accounts, and part of that is that because they buy a little bit less software on a percentage basis. And then, the third thing really that impacted our margins in the first quarter was just the drop in volume sequentially that we have certain internal manufacturing costs or operating overhead, and there was a less of a revenue volume to absorb those costs. So, it was really the mix, the customer mix, the product mix, and the drop in volume, and the trade-in program was – had much less impact than you might imagine.
Yes, this is Errol. Sorry, I have a cough so excuse me if I cough into the mike here. Just to add to this about the equipment makers, they tend to buy a larger number of ports in a given buy. And the way our software is licensed, it's typically licensed on a chassis. And so, you may have a equipment maker buying a full chassis worth of ports with a particular software package, and that versus a carrier maybe will buy a smaller number of ports but with the same software package. And so, when you compare the two, the carrier is going to be a higher percentage of software to hardware ratio because of that.
Leo Choi – Ferris Baker Watts
Okay, got you. Thank you very much. Thank you.
Our next question comes from Joanna Makris of Brean Murray Carret. Please go ahead.
Joanna Makris – Brean Murray Carret
Hi, there. Two questions. One regarding Cisco, obviously up sequentially but down year over year. Could you maybe talk about some initiatives or other possible stimulus' to that business? And then, secondly, if you could maybe give us some anecdotal comments on the networking – network monitoring piece, the IxRave and maybe initial customer interest, and what kind of market opportunity that could represent for you?
So, Joanna, this is Atul. I'll let Tom maybe comment on the Cisco side, but let me give you a little bit about the monitoring piece. I think monitoring business is a long-term investment we are making. And the reason for that is that many carriers now are now deploying, whether it's wireless or wired, they're deploying IP based infrastructures. And then, when it comes to IP protocols, IP expertise, Ixia has that as a very key core competence. So, we're leveraging that under the monitoring side so this way we can participate in post-deployment solutions as well along with pre-deployment testing solutions. The life cycle on these programs, as I said earlier, is going to be a little long range. But, I think once the customers start to use our solutions both in the pre-deployment and post-deployment, it becomes reasonably sticky in the sense that your solutions, your GUIs, your border software network, both pre-deployment, post-deployment. So, overall, we are getting good traction with many carriers almost on a global basis. On the other hand, it will be a 9-month, 12-month type of a gestation cycle per deal. And we'll keep you guys posted as we make progress.
If I could just add to that, this is Errol. With the – we talk about monitoring, but I just want to clarify that we're not really doing monitoring per se. It's really more of a proactive troubleshooting on demand rather than a system that's just sitting there passively monitoring the network. So, it's a customer service solution rather than a network operations monitoring solution. It's a pretty unique solution. There's no one else that we are aware of that has something that is directly comparable to what we're offering right now. Sorry, one more point. The other thing that we've seen with the couple customers that have deployed it so far is they tend to deploy it in one area, and then over time they start adding more and more regions to it and tend to keep adding to the system and buying more. So, I think once you sell into a large carrier, that's really just the sort of initial installment and then they add to it over time.
So, Joanna, if you look at the – where the costs are increasing significantly for carriers and service providers, it's the operational costs. And the word, in all of our press releases and our marketing literature we are using, is not monitoring but service verification. That's where Ixia is focusing on making sure that when it comes undefined issues and resolving issues, especially on the service side, there's a very proactive solution provided by Ixia.
Right. And, Joanna, real quickly on Cisco. Yes, Cisco was – did hit its high point last year in the first quarter. And I don't know that – comparing to the first quarter of last year and this year, I'm not sure that's that meaningful. It's – what we're really looking at Cisco – up at Cisco is some trends there, and we're seeing some of the projects ramp down a little bit, and we're waiting for some of the newer ones to ramp up. We think there's a lot of opportunity hopefully with their new data center products, and then with 10 gig. We think the IxYukon solution that we were talking about is going to be a great product for equipment makers like Cisco who are the guys who really need the high port density test solutions. So, we would think that there is a lot of opportunity through the rest of the year up there.
Joanna Makris – Brean Murray Carret
(Operator instructions) We have no further questions at this time.
Well, we would like to thank everyone who joined us on this call. I appreciate your questions, and please feel free to reach us in case there's any clarifying questions down the line. Thank you so much.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.