EXHIBIT 99.11
AVOCENT CORPORATION
COMMENTS BY MANAGEMENT ON FINANCIAL RESULTS
FOR THE QUARTER ENDED JUNE 29, 2007
AND EXPECTATIONS FOR REMAINDER OF 2007
Concurrently with the filing of these comments, Avocent Corporation has issued a
press release containing financial information for the second quarter ended June
29, 2007. The following commentary should be read in conjunction with that press
release including its financial tables and disclosure regarding the use of
non-GAAP measures.
Financial Results for the Second Quarter of 2007
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Operational revenue of $150.7 million for the second quarter represents an
increase of 28% from the second quarter of 2006. The year over year increase is
due primarily to the inclusion of LANDesk in 2007 (which was acquired on August
31, 2006) and increased sales of our KVM products.
We are pleased with our second quarter 2007 revenue, which was above the
mid-range of our expectations. Q2 2007 revenue increased 13% from the first
quarter of 2007 and demonstrates our stated belief that our business would
rebound from the slowness experienced in the first quarter of 2007.
Divisional Revenue
The Management Systems Division recorded revenue of $115.0 million, up 3% from
the second quarter of last year and 9% from the first quarter of this year. For
the second quarter of 2007, revenue from the sale of KVM products was
approximately $87.5 million, revenue from serial products was approximately
$12.8 million and revenue from our embedded software and solutions was
approximately $7.9 million. This compares to revenue from the second quarter of
2006 of $83.5 million for KVM, $13.8 million for serial and $8.8 million for our
embedded software and solutions product revenues. The $1.0 million decline in
serial revenue was primarily attributable to a product transition issue and a
couple of large customers reducing their data center build-out activities. The
$900,000 decline in embedded software and solutions revenue is primarily due to
the declining sales of the Agilent RMB product (acquired in March 2006) as it
nears the end of its product life cycle.
LANDesk revenue increased to $27.6 million in the second quarter of 2007 from
$23.9 million in the second quarter of 2006, on a pro-forma basis. The increases
from 2006 were primarily due to new license sales of the LANDesk Management
Suite and new subscriptions of the LANDesk Security Suite. Security products
were 21.7% of LANDesk revenue this quarter versus 17.4% in the second quarter of
2006. The change in mix had an impact on revenue recognized as license sales
typically are recognized upon delivery of the license keys whereas subscription
revenue is deferred and amortized to revenue over the subscription term.
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As previously mentioned, we began limited cross-selling efforts between our
LANDesk and Management Systems Divisions during the second quarter of 2007. The
process of coordinating our product roadmaps is well underway and we are on
target to complete the integration of our software platforms within the next
year.
Our other, smaller entrepreneurial divisions continue to make progress. Revenue
for the second quarter of 2007 grew to $6.0 million compared to $5.2 million in
the second quarter of 2006. These entrepreneurial business units and our
continued investments in emerging technologies provide Avocent the potential to
diversify our revenue and find new areas for growth.
Sales of new products that were introduced or significantly refreshed during the
past 12 months contributed approximately $15.7 million to revenue in the second
quarter of 2007.
GAAP basis revenue was $150.2 million for the second quarter 2007. Operational
revenue includes $495,000 for the amortization of LANDesk deferred revenue,
which was not recognized on a GAAP basis as it was reduced in the application of
purchase accounting. Had we not acquired LANDesk, the $495,000 represents the
portion of deferred revenue existing at the acquisition date (August 31, 2006)
that LANDesk would have recognized as earned during the second quarter.
Gross Margin
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Total gross profit was $98.6 million for the second quarter compared to $71.6
million for the same quarter last year, representing an increase of 38%. The
increase in gross profit was disproportionately higher than the 28% increase in
operational revenue due to the impact of LANDesk software and maintenance
revenue. LANDesk software and maintenance revenue increases our overall gross
profit as the gross margin for this division was 88% for the quarter. Excluding
LANDesk, Avocent produced $74.5 million in gross profit on $123.2 million in
sales, or 60.5% gross margin, up 2.6 points compared to our 57.9% gross margin
in Q2 2006.
Operating Expenses
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R&D costs during the second quarter of 2007 were $19.8 million and represented
13.1% of sales. This compares to $13.6 million, or 11.5% of sales, for the
second quarter of 2006, with the increase primarily attributable to the impact
of the addition of LANDesk R&D. Our Q2 R&D expenditures remained constant with
the Q1 2007 expenditure level of $19.8 million and were in line with the
guidance provided previously for the quarter.
Selling, General and Administrative expenses were $49.0 million, or 32.5% of
sales during the second quarter of 2007. This compares to $30.8 million, or
26.1% of sales, for Q2 2006, with the increase primarily attributable to the
additional costs resulting from the inclusion of LANDesk as well as the increase
in revenue and the related impact on incentive and commission compensation
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expense, higher legal fees and administrative costs related to integration
activities. Our Q2 SG&A expenses were in line with the guidance provided
previously and compares to $46.3 million for Q1 2007.
Our Q2 2007 operating profit increased $4.9 million compared to the second
quarter of 2006 and $11.2 million from the first quarter of 2007, to $29.8
million, resulting in an operating margin of 19.8% for the second quarter of
2007.
Other Income (Expense) Statement Items
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Other income and expense netted to an expense of $1.3 million for Q2, down
$300,000 compared to that of Q1 2007. This also compares to $1.8 million in net
other income generated in Q2 2006, primarily through investment activities.
Compared to Q2 2006, the increase in net other expense is a result of reduced
cash available for investment combined with interest expense on our line of
credit as we funded the acquisition of Cyclades at the end of the first quarter
of 2006 and LANDesk at the end of August 2006. We used approximately $15.4
million and $2.5 million of cash during the first and second quarters of 2007,
respectively, for our share repurchase program.
Our operational effective tax rate for the quarter was 25.8% compared to 30.0%
and 25.0% for the second quarter of 2006 and the first quarter of 2007,
respectively. The mix of pretax profit among our U.S. and foreign based
companies affects the rate. On a GAAP basis, our tax rate for the quarter was a
benefit of 19.8% and 17.9% for the year to date as a result of our making
certain tax elections related to the purchase of LANDesk and the resulting
treatment of $18.6 million in-process R&D as deductible in the period of
election. This is a one-time tax benefit; however, the elections also allow us
to receive tax deductions for goodwill and other intangible amortization over a
15 year period.
Operational net income (before the effects of intangible asset amortization and
stock-based compensation) was $21.1 mi1lion or 14.0% of sales. This compares to
$18.7 and $12.7 million for the second quarter of 2006 and the first quarter of
2007, respectively.
Operational earnings per share (before the effects of intangible amortization,
acquired in-process research and development and stock-based compensation)
amounted to 41 cents per diluted share for the quarter versus 38 cents for the
second quarter of 2006. Our weighted average diluted shares outstanding
increased year over year by approximately 2.4 million to 51.2 million this
quarter related to the net new shares issued in the LANDesk acquisition (after
offset by shares we repurchased).
Cash Flow and Balance Sheet Items
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At the end of the second quarter we had approximately $109 million in cash and
investments. Cash flow from operations was a record of approximately $40 million
for the second quarter and $57 million for the first six months of 2007.
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Our accounts receivable balance decreased over $16 million from December 31,
2006, despite strong sales in the second quarter of 2007. This was achieved
through improved cash collections during the quarter across locations,
specifically at LANDesk. This resulted in an improvement in our DSO during the
second quarter to 67 from 74 at the end of first quarter of 2007. As mentioned
in the previous quarter, adding LANDesk customer balances to our accounts
receivable, which tend to have longer payment terms than legacy Avocent
balances, has increased our DSO.
Excluding LANDesk, our DSO was 61 for the quarter, just outside our target of
60 for legacy Avocent. Our aging remains strong, with only 5.4% of the
outstanding balances greater than 30 days past due.
Our operations group worked especially hard during the second quarter of 2007 to
reduce inventories, which declined by $7.9 million from the end of our first
quarter 2007. As a result, our inventory turns increased slightly to 6.0 during
the quarter compared to 4.6 in the previous quarter.
We remain focused on our balance sheet. The results of our efforts to better
manage the balance sheet are reflected in the improved results of cash flows
from operations for the second quarter of 2007. Our management team believes
strong balance sheet management should be a priority and we will continue to
keep this as one of our primary focuses throughout the remainder of the year.
During the quarter, we invested approximately $2.3 million for capital
expenditures while depreciation was approximately $2.4 million for the quarter.
The $115 million balance outstanding on our line of credit reflects a net
reduction of $35 million from the end of the first quarter of 2007 and is in
line with management's expectations.
During the second quarter, we purchased 100,000 shares of Avocent stock at a
cost of $2.5 million. These shares plus the shares of Avocent stock bought back
in prior quarters total 10.4 million shares out of the 12 million shares
authorized for repurchase under our repurchase programs. The shares repurchased
during the second quarter were used to offset options exercised during the
quarter and a portion of the restricted stock units vesting during the quarter.
Proceeds from option exercises totaled $740,000 in the second quarter of 2007.
Longer Term Growth Rate Expectations
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During our first quarter conference call, we committed to provide an updated
view of our prospects and additional insight as to how investors should "model"
Avocent in terms of expectations. We will look first at the Management Systems
Division and then at LANDesk.
Of course, no discussion of expected growth and revenue expectations would be
complete without reference to the impact of general economic conditions. The
environment for IT spending is a subset of overall trends in general economic
conditions and capital spending. However, there is significant evidence
indicating that IT spending is critical to business success in today's economy
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and generally receives higher priority than many other categories of spending.
Our own experience is that we do well in fair to good economic conditions
because of the importance of our products to data center operations. We do even
better when the economy is strong and business confidence is high leading to
rapid expansion of IT infrastructure.
We feel reasonably optimistic on this front for the next few years. Avocent is
sufficiently diverse in terms of participation in all parts of the world to
expect to benefit from growth in the world economy. We see reasonable strength
in the markets where we have the largest parts of our business and we expect
strong growth in developing markets in Asia.
Management Systems Division
For most of our history as a public company -- primarily in the KVM space -- our
revenue growth has been generally related to the growth in the number of
servers, which in turn is a subset of the strength of overall IT spending and is
influenced by the confidence businesses have to make capital commitments
overall. While there are numerous factors that can cause our revenue trend to
diverge from the trend in server growth in any given quarter -- changes in
channel inventory levels of our branded products, changes in channel inventory
levels of OEM products, OEM decisions with respect to their own inventory
levels, product backlogs due to component shortages on occasion, the occasional
really big deal that all closes in a single quarter, the concentration of
government business in the third quarter, etc. -- over longer periods we
generally have followed and expect to continue to follow server growth since our
KVM and serial appliances work primarily in conjunction with servers.
Through a number of creative approaches, we generally have been able to grow our
revenue in excess of the growth in either server units or server revenue.
Examples are our early move to the digital product line with faster growth in
the enterprise segment and our products directed to branch environments where
KVM had not been used before. Also, as KVM has come to be regarded as more of a
necessity in some areas, the percentage of servers being attached to KVM
appliances has increased.
Over the last several quarters, the trend to virtualization has been a slight
headwind for server growth and probably has shaved a few points off of our
growth rate. Clearly, fewer servers being shipped than would otherwise be the
case makes us work harder to achieve the same growth rate in the short run. We
have not seen a marked change in this trend in recent quarters and do not expect
to see much change in the remainder of this year.
We think the "braking" effect of virtualization lies more in the pause it
creates in customer IT spending while they contemplate their virtualization
strategy than in the number of virtual servers being deployed. As CIOs and
others become more comfortable with their strategy we expect more activity
since, in our opinion, virtualization of servers makes KVM connectivity and
access even more vital to IT administrators. Therefore, at some point in the
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next year, considering product developments we plan to announce over the
remainder of this year, we expect to see virtualization start to become a
positive factor in our business.
Diverse assets in data centers have always led to growth for Avocent as our
software component serves to mask the diversity and make the administrator's job
easier. Over the longer term, virtualized servers create additional diversity in
the data center. Additionally, there is great concern over access permissions
and security in general in a virtualized environment -- problems made simpler by
the use of Avocent solutions.
LANDESK Division
In recent years, LANDesk was able to grow revenue by 20% or more on a
year-over-year basis. In the first quarter of this year, growth was reduced to
6.4%, a rate that was disappointing but not really surprising in retrospect,
given the organizational changes that took effect at the beginning of the year.
As planned, the incumbent CEO left the Company. More significant, however, was
the realignment of the sales organization, including the planned departure of
the former CEO's wife who was in charge of sales efforts in China. Because of
the earnout that ran through the end of 2006, these changes could not be started
prior to the beginning of 2007 and all took effect then. In addition, the
negative impact on the sales organization of the 2006 revenue revisions that
occurred in the middle of the first quarter was meaningful.
Second quarter results show year-over-year growth in revenue of 15.6% and
year-over-year growth in bookings of 17.5% (to $30.9 million), despite an
additional change in the leadership of the sales force. While still not being at
the level we expect, these results are an initial confirmation that the
structure we have in place at LANDesk is moving the Division in the right
direction.
In our own analysis, we have researched numerous industry trends searching for
one or more that might be indicative of what to expect from LANDesk. However,
due to the stage of LANDesk's development and the large segment of potential
customers in its market who do not have software similar to LANDesk's at this
time, we do not believe LANDesk can be modeled based on any industry index.
Given the relatively under-penetrated middle market and the new products
recently introduced as well as those on our product roadmap, we generally expect
LANDesk revenue to grow at annual rates of 16 to 24% over the next two to three
years.
2007 Expectations
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Many organizations, including the US Chamber of Commerce, The Conference Board,
the CFA Centre for Financial Market Integrity, and the Business Roundtable
Institute for Corporate Ethics, are encouraging US public companies to either
not give guidance at all or to limit guidance to annual periods to focus
companies and investors on longer term business strategies and growth prospects.
We have heard similar recommendations from some of our shareholders and
sell-side analysts who cover Avocent.
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Like many technology companies, our quarterly results are volatile and are
impacted by many factors outside our control, such as the levels of inventories
which our OEM and channel partners choose to carry and the timing of purchase
orders issued by end user customers. Accordingly, beginning in 2008 we plan to
give guidance only on an annual basis with quarterly updates as necessary for
any expected material changes.
In the comments that follow we provide our expectations for our businesses over
the remainder of 2007.
We expect continued improvement and growth in our revenues and earnings during
the second half of 2007. We have heard from industry analysts as well as our
resellers and end customers that they expect IT capital spending will increase
during this time period.
Usually the second half of the year sees higher IT capital spending in general
and higher revenue for us than in the first half of the year. We expect this
seasonal trend will recur in 2007. We expect our revenue for the second half of
2007 will be within a range of $330 to $350 million. This equates to an increase
of 16 to 23% over our revenue of $284.7 million for the first half of 2007 or 7
to 13% over our reported revenue of $308.4 million for the third and fourth
quarters of 2006.
In the past, we experienced significant sequential increases in revenue from the
second quarter to the third quarter and again from the third quarter to the
fourth quarter. However, in recent years our government business has become more
concentrated in the third quarter with our corporate business being stronger in
the fourth quarter. We believe the third to fourth quarter trends of recent
years have been influenced (with the fourth quarter being made larger) by the
impact of strong sales patterns in these months that, in some cases, cause our
channel partners to stock higher levels of inventory exiting the fourth quarter.
Since this trend causes fourth quarter revenue to be greater and reduces first
quarter revenues, we intend to work to reduce our channel inventories in the
fourth quarter to eliminate any inventory overhang similar to what we believe
existed at the end of recent years.
On a divisional basis, for the second half of 2007 we expect our Management
Systems Division to experience slight year over year growth due to the trends
mentioned above and our LANDesk Division to have year over year growth of 18 to
20% as contributions from newer products increase.
Our gross margin should improve slightly with the increased contribution of
revenues from LANDesk to a range of 66 to 67%.
We anticipate R&D spending in Q3 and Q4 to remain relatively consistent with
that of Q2 within a range of $20 to $21 million each quarter.
We expect that SG&A expense will be relatively flat compared to Q2 with the
exception of anticipated increases in certain incentive and sales commission
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compensation as sales increase over that of Q2 which will be offset by lower
legal costs. As a result, we anticipate our SG&A expenses to be within the range
of $50 to $52 million in each of Q3 and Q4.
In general we expect our operating margin to be between 22 to 24% in the second
half of 2007 as we gain more operating leverage in our LANDesk Division and
complete some of our administrative integration activities.
We repaid $35 million on our line of credit from cash generated by our
operations in Q2 and expect to continue paying down the debt in the second half
of the year. Accordingly, we expect net other expenses to be below that of Q2
and result in a net expense of approximately $700,000 in Q3 and $300,000 in Q4.
Although paying down the debt is currently our first priority for using cash, we
may purchase additional treasury shares, depending on circumstances present at
the time.
The effective tax rate for the remainder of 2007 should reflect our estimated
annual rate of 25 to 26%. We made a "section 338 election" in the US in Q2 which
will result in our obtaining tax deductions for the LANDesk intangible assets
and goodwill over a 15 year period.
We expect the fully diluted weighted average shares outstanding for the rest of
2007 to remain relatively constant with that of Q2 2007 within a range of 51 to
52 million.
These estimates equate to an expected operational diluted EPS for the second
half of 2007 of $1.06 to $1.24.
The previous amounts exclude stock-based compensation and intangible asset
amortization. During each of Q3 and Q4, we expect approximately $6 million of
pre-tax stock compensation expense and approximately $11 million in pre-tax
intangible asset amortization.
Forward-Looking Statements
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This commentary contains statements that are forward-looking statements as
defined within the Private Securities Litigation Reform Act of 1995. These
include statements regarding general economic conditions, growth in capital and
IT spending, strength in the markets where we have business and the developing
markets in Asia, server growth and server attach rates, virtualization trends,
the impact of virtualization on us, our product development plans with respect
to virtualization, diversity of assets in data centers, Management Systems
Division growth rates, LANDesk growth rates, the integration and operation of
LANDesk and its operations, product roadmap, and software platforms, our focus
on the emerging technologies in our entrepreneurial business units and our
efforts to diversify our revenue and find new areas for growth, growth of our
government business, the size and growth of the current and future markets for
our products and technologies, our focus on strong balance sheet management, our
effective tax rate in the future, and our projected ranges of revenue, gross
margin, expenses, R&D spending, operating margin, reduction of our channel
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inventories, number of fully diluted weighted average shares outstanding,
pre-tax stock compensation expense, intangible asset amortization and
operational earnings per share for the second half of 2007. These
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from the statements made, including
the risks associated with general economic conditions, risks attributable to
future product demand, sales, and expenses, risks associated with reliance on a
limited number of customers, component suppliers, and single source components,
risks associated with acquisitions and acquisition integration, risks associated
with product design efforts and the introduction of new products and
technologies, and risks associated with obtaining and protecting intellectual
property rights. Other factors that could cause operating and financial results
to differ are described in our annual report on Form 10-K filed with the
Securities and Exchange Commission on March 1, 2007. Other risks may be detailed
from time to time in reports to be filed with the SEC. Avocent does not
undertake any obligation to publicly update its forward-looking statements based
on events or circumstances after the date hereof.
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