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| AVCT > SEC Filings for AVCT > Form 10-K on 27-Feb-2009 | All Recent SEC Filings |
27-Feb-2009
Annual Report
Overview
Avocent Corporation designs, manufactures, licenses, and sells software and hardware products and technologies that provide connectivity and centralized management of information technology (IT) infrastructure. We (meaning Avocent and its wholly-owned subsidiaries) provide connectivity and systems management, endpoint security, and service management products and technologies that centralize control of servers, desktop computers, serial devices, wireless devices, mobile devices, and network appliances, thus increasing the efficiency of IT resources. Server manufacturers resell private-labeled Avocent KVM (keyboard, video, and mouse) switches, LCD trays, and embedded software and hardware technology in their systems, and companies large and small depend on our software and hardware products and technologies for managing their growing IT infrastructure.
Our technological innovations include Internet Protocol (IP) based switching, centralized management, and intuitive software interfaces. With more than two decades of experience, we have grown through product innovations, global expansion, and strategic acquisitions. Formed as a result of the merger in 2000 between Apex Inc. and Cybex Computer Products Corporation, we subsequently acquired Equinox Systems Inc. in 2001, 2C Computing, Inc. in 2002, Soronti, Inc. in 2003, Crystal Link Technologies, OSA Technologies, Inc., and Sonic Mobility, Inc. in 2004, Cyclades Corporation and LANDesk Group Limited in 2006, and Touchpaper Group Limited and certain assets and liabilities of Ergo 2000, Inc. in 2008.
Most of our revenue is derived from sales to a limited number of OEMs (who purchase our products on a private-label or branded basis for integration and sale with their own products), sales through our reseller and distributor network, and sales to a limited number of direct customers. Sales to our OEM customers accounted for 33% of sales in 2008, 35% in 2007, and 40% in 2006. Sales to our branded customers accounted for 67% of sales in 2008, 65% in 2007, and 60% in 2006. We do not have contracts with many of our branded customers, and in general, our OEM and branded business customers are obligated to purchase products from us only pursuant to binding purchase orders. Although we are not substantially dependent on any one OEM customer, the loss of, or material decline in orders from, these customers would have a material adverse effect on our business, financial condition, results of operations, and cash flows. Our top five customers include both OEM and branded distributor customers and accounted for 48% of sales in 2008, 52% in 2007, and 56% in 2006.
We sell products to resellers, distributors, end-users, and OEMs in the United States and foreign markets. Sales within the United States accounted for approximately 52% of sales in 2008, 56% in 2007 and 57% in 2006. Sales outside of the United States accounted for 48% of sales in 2008, 44% in 2007 and 43% in 2006. Outside the United States, no other country accounted for more than 10% of 2008, 2007, or 2006 sales.
With continued industry-wide initiatives to reduce all channel inventories and to shorten lead times, trends with our major customers are, generally, to reduce the number of weeks of forward-committed firm orders. This trend continues to affect our business with certain distributors, OEMs, and other server manufacturers, and we believe that it will continue to make our future sales more difficult to predict and inventory levels more difficult to manage. We monitor inventories of our products owned by our major distribution partners and we strive to maintain a level of inventory in our own facilities to service these customers, and monitor these levels to minimize potential exposure of having excessive inventory on hand. A change in the amount of inventory held by a customer in any one period could adversely affect our revenues through reduced orders in that or a subsequent period which could have a material impact on our business, financial condition, results of operations, and cash flows.
We experience significant price competition in the market for most of our products, and we expect that pricing pressures will continue in the future. In addition, our business and operating results depend to a significant extent on economic conditions in general and on IT spending in particular, and we expect our revenue growth rate to fluctuate in relation to economic conditions and IT related spending trends. Any adverse change in IT spending due to adverse economic conditions, declining capital spending levels, or other factors could have a material adverse effect on our business, financial condition, and results of operations. World-wide efforts to cut capital spending, general economic uncertainty, and a weakening global economy could have a material adverse effect on us. For example, since mid-2007, global credit and other financial markets have suffered substantial stress, volatility, illiquidity, and disruption. This financial crisis and the current global recession could have an impact on our business in a variety of ways, including insolvency of key suppliers resulting in product delays, inability of customers to obtain credit to finance purchases of our products and customer insolvencies. As we evaluate anticipated impacts from the global economic uncertainties, we periodically adjust our spending and related headcount to mitigate the overall impact on our financial results of any anticipated negative changes. We continually monitor the financial health of our key suppliers and customers by constant reviews of our accounts receivable aging and open purchase orders to ensure our customers are paying in a timely fashion and our suppliers are meeting our needs so that we can service our customers.
Many of our executive officers and directors are vested in significant amounts of options to purchase shares of our common stock and restricted stock units (RSUs). These officers and directors have informed us that they have sold, and may sell, additional shares of our common stock to provide liquidity and diversify their portfolios. During 2008 our Board of Directors granted time-based, performance-based and market condition-based RSUs with two and three year vesting periods. During 2008 the Compensation Committee of our Board of Directors modified the market conditions of these awards to better measure relative performance during the year.
During 2008, we had the following business units:
† Management Systems, which includes our branded and OEM KVM, embedded software, serial console, power control, LCD tray, and management appliance businesses;
† LANDesk, which includes systems, security, and service management solutions for desktops, servers, and mobile devices across the enterprise; and
† Connectivity and Control, which focuses on our serial, extension, point of sale, and audio-visual products.
In the first quarter of 2008, we dissolved our Desktop Solutions business unit and transferred some of its personnel and a portion of its technology into Management Systems. We believe our remaining business units allow us to focus on new technology and growth opportunities and to add product and shareholder value in the future. We believe this structure enhances customer service, speeds delivery of products to market and better focuses our research, development, and marketing resources. We recently announced our intention to sell or license the technology of the majority of our emerging Connectivity and Control Business Unit. We have divided this entrepreneurial business unit into its three product lines; the Equinox branded serial business, the Broadcast business and the Pro Audio Visual business. We have folded our Broadcast product line into Management Systems and intend to sell or license the technology of the remaining two parts of this business. All revenues and costs associated with our broadcast business are included within Management Systems and historical results for both Management Systems and our other business units have been adjusted to reflect this change.
Our largest business unit on a revenue basis, Management Systems, contributed 76% of our consolidated net revenue in 2008, 78% in 2007, and 89% in 2006. LANDesk contributed 22% of our consolidated net revenue in 2008, 18% in 2007 and 8% of net revenue to 2006 for the four months it was part of Avocent. The other business units and unallocated revenue comprised the remaining 2% of our consolidated net revenues in 2008, 3% in 2007 and 4% in 2006. See Note 14 in the notes to the consolidated financial statements contained in Item 8 of this document.
Results of Operations
Our consolidated statements of income, stockholders' equity, and cash flows reflect the results of acquired companies from the respective dates of acquisition. The following table sets forth, for the periods indicated, selected statement of income data expressed as a percentage of net sales:
Years Ended December 31,
2008 2007 2006
Net sales 100.0 % 100.0 % 100.0 %
Cost of sales 34.9 35.1 37.3
Cost of sales - amortization of intangibles 2.1 1.8 0.7
Gross profit 63.0 63.1 62.0
Operating expenses:
Research and development expenses 14.7 14.6 12.3
Acquired in-process research and development expense 0.1 - 4.0
Selling, general and administrative expenses 35.7 34.7 28.6
Restructuring, integration and retirement expenses 2.4 - 0.8
Amortization of intangible assets 5.0 5.4 4.4
Total operating expenses 57.9 54.7 50.1
Income from operations 5.1 8.4 11.9
Net investment income 0.3 0.6 1.5
Interest expense (1.3 ) (1.3 ) (0.6 )
Other income (expense), net 0.3 (0.1 ) (0.1 )
Income before provision for income taxes 4.4 7.6 12.7
Provision for income taxes 0.5 - 3.9
Net income 3.9 % 7.6 % 8.8 %
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Years Ended December 31, 2008 and 2007 ($ Data in all tables presented in 000s)
Net sales.
Years ended December 31,
% of % of
2008 Sales 2007 Sales
Net sales, customer distribution:
Branded $ 442,951 67 % $ 393,799 65 %
OEM 214,183 33 % 207,076 35 %
$ 657,134 100 % $ 600,875 100 %
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The 9% growth in our net sales in 2008 from 2007 was the result of increased branded sales across our geographic regions and international OEM sales. The two acquisitions we completed in the third quarter of 2008, Ergo and Touchpaper, contributed over $29 million in revenue during 2008. The Ergo product line contributed $15.5 million in 2008 while Touchpaper contributed $13.9 million in 2008. Branded sales grew 12% in 2008 from 2007, primarily due to the contribution of Touchpaper revenue and an increase in revenue from our secure switch products. Our OEM sales increased approximately 3% in 2008 from 2007 primarily due to the contribution of the Ergo product revenue. Our branded and OEM businesses grew in EMEA and Asia during 2008. We attribute our strength in our foreign markets partly to the revenue from our recent acquisitions and to recent additions to our international sales force.
Years ended December 31,
% of % of
2008 Sales 2007 Sales
Business unit net sales:
Management Systems $ 497,852 76 % $ 470,719 78 %
LANDesk 144,192 22 % 111,906 18 %
Other business units 12,304 2 % 15,523 3 %
Corporate and unallocated 2,786 - 4,601 1 %
Amortization of fair value
adjustment to LANDesk deferred
revenue - - (1,874 ) -
$ 657,134 100 % $ 600,875 100 %
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Our Management Systems business unit includes our traditional KVM products, our serial products, our LCD trays, and our embedded software and solutions products (see Note 14 in the notes to our consolidated financial statements in
this document). Revenue from our Management Systems business increased 6% from 2007 to 2008, primarily as a result of the contribution from our Ergo acquisition (included in "other" in the table below) and increases in the sales of our embedded software and solutions. Revenue by product line for Management Systems for the years ended December 31, 2008 and 2007 was as follows:
Years ended December 31,
2008 2007
Management Systems net revenue:
KVM $ 355,944 $ 359,131
Serial management 51,269 49,603
Embedded software and solutions 35,162 32,983
Other 55,477 29,002
Total MS net revenue $ 497,852 $ 470,719
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LANDesk revenue is comprised of license-based revenue, primarily from the LANDesk Management Suite (LDMS) product, and subscription-based revenue, primarily from the LANDesk Security Suite products and from maintenance and support services related to LANDesk Management Suite. LANDesk revenue also includes revenue from our Touchpaper acquisition. The growth in subscription and maintenance revenue and the addition of Touchpaper also results in an increase to deferred revenue recorded on the balance sheet. Deferred revenue increased to $75.8 million at December 31, 2008 from $66.1 million at December 31, 2007. Revenue by product line for LANDesk for the years ended December 31, 2008 and 2007 was as follows:
Years ended December 31,
2008 2007
LANDesk net revenue:
Licenses and royalties $ 50,686 $ 42,514
Maintenance and services 65,215 45,911
Subscription revenue 28,291 23,481
Total LANDesk net revenue $ 144,192 $ 111,906
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International sales grew 18% in 2008 from 2007, while sales within the United States grew 2% in 2008 from 2007. As mentioned earlier, our OEM and branded business grew in EMEA and Asia, but only our branded business grew in North America.
Years ended December 31,
% of % of
2008 Sales 2007 Sales
Net sales, geographical distribution:
United States $ 340,838 52 % $ 333,915 56 %
International 316,296 48 % 266,960 44 %
$ 657,134 100 % $ 600,875 100 %
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Gross profit. Gross profit is affected by a variety of factors, including the ratio of sales among our distribution channels; absorption of fixed costs as sales levels fluctuate; product mix and component costs; labor costs; new product introductions by us and by our competitors; increasing sales of our software products which tend to have higher gross margins; and our outsourcing of manufacturing and assembly operations.
Years ended December 31,
Gross Gross
2008 Margin % 2007 Margin %
Management Systems $ 296,234 59.5 % $ 283,981 60.3 %
LANDesk 124,296 86.2 % 98,724 88.2 %
Other business units 4,576 37.2 % 4,644 29.9 %
Corporate and unallocated 2,837 4,530
Intangible amortization (14,054 ) (10,985 )
Amortization of fair value
adjustment to LANDesk
deferred revenue - (1,874 )
Gross profit dollars and
margin % $ 413,889 63.0 % $ 379,020 63.1 %
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Gross profit increased approximately 9% from 2007 to 2008, while gross margin declined slightly from 2007 to 2008. The decline in gross margin during 2008 resulted from a change in product mix as a result of the acquisitions within Management Systems and LANDesk and the price reductions on certain older analog products (see Note 14 in the notes to our consolidated financial statements in Part I Item 8 of this document). Sales of certain secure switch products by Management Systems also increased during 2008. These products carry lower margins than our other Management Systems products; and the sales increase therefore had a direct impact on our margins in 2008. In addition, margins on the Ergo products are much lower than margins on our legacy products. Similarly, margins on the Touchpaper product line are lower than the legacy LANDesk product line due to Touchpaper's higher component of professional services. In 2008, Ergo and Touchpaper products contributed $12.4 million to gross profit. As Touchpaper and Ergo become fully integrated into Avocent, we expect margins on these acquired product lines to improve. The increased gross profit was partially offset by the additional costs included in cost of sales from amortization of other intangible assets recorded as a result of the Touchpaper acquisition related to developed technology and internally developed software for resale. We recorded $14.1 million of amortization of intangibles in cost of goods sold in 2008 and $11.0 million in 2007. We recorded six months of intangible amortization in 2008 from Touchpaper, which was acquired in the third quarter of 2008.
Operating expenses.
Years ended December 31,
% of % of
2008 Sales 2007 Sales
Research and development
expense $ 96,723 14.7 % $ 87,888 14.6 %
Acquired in-process
research and development
expense 700 0.1 % - -
Selling, general, and
administrative expense 234,802 35.7 % 208,783 34.7 %
Restructuring, integration
and retirement expenses 15,757 2.4 % - -
Amortization of intangible
assets 33,074 5.0 % 32,162 5.4 %
Total operating expenses $ 381,056 57.9 % $ 328,833 54.7 %
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Research and development expenses. Research and development expenses include compensation for engineers, support personnel, outside contracted services, and materials costs, all of which are expensed as incurred. R&D expenses increased 10% in 2008 from 2007. Costs related to salaries and benefits, including costs for added headcount from the acquisitions of Touchpaper and Ergo, increased approximately $8.0 million in 2008 compared to 2007. We believe that the timely development of innovative products and enhancements to existing products is essential to maintaining our competitive position, and we will continue to make significant investments in research and development. However, we will continue to evaluate and rebalance our R&D efforts to re-align our resources towards products we believe to have higher growth opportunities.
Acquired in-process research and development expense. Acquisition related expenses for 2008 were comprised solely of the non-recurring write-off of $700,000 of in-process research and development expense related to the acquisition of Touchpaper. There were no such charges during 2007.
Selling, general and administrative expenses. Selling, general and administrative expenses include personnel, materials, services and other related costs for administration, finance, information systems, human resources, sales and marketing and general management, rent, utilities, legal and accounting expenses, bad debts, advertising, promotional material, trade show expenses, and related travel costs. Selling, general and administrative expenses increased 12% in 2008 from 2007. Our recent acquisitions, Ergo and Touchpaper, added over $8.3 million in SG&A costs during 2008 and were a significant component of the increased costs. Our integration strategy for Ergo included headcount reductions and reduced facility costs, and we completed the integration of Ergo into our operations during the fourth quarter of 2008. For Touchpaper, our integration strategy includes some headcount reductions and facility consolidations as well. The increase in selling, general and administrative expenses also resulted from increased sales commissions resulting from increased sales for the period. Compared to 2007, salaries, commissions, bonuses and benefits, including costs for added headcount from the acquisitions, increased approximately $13.0 million in 2008. Stock compensation, discussed separately below, increased approximately $2.0 million in 2008. Contracted services increased $1.8 million, primarily in relation to marketing programs to increase brand awareness and other marketing directives. Legal fees increased $1.4 million in 2008 from 2007 as we incurred fees in defense of our intellectual property and to support other claims brought by and against us.
Restructuring, integration and retirement expenses. Restructuring, integration and retirement expenses in 2008 include expenses related to severance charges incurred for certain workforce reductions in association with the reduction in certain research and development investments, the integration of marketing functions, shifting our Asian support operations from Shannon, Ireland to Singapore, the relocation of certain functions from our Redmond, Washington facility to Huntsville, Alabama, and the integration of our acquisitions into our operations. Restructuring, integration and retirement charges for 2008 also includes $2.2 million of retirement costs for our former CEO, who left the company in March 2008.
Amortization of intangible assets. Amortization was $33.1 million in 2008 and $32.2 million in 2007. The increase in amortization for 2008 was due to the amortization of intangible assets related to our acquisitions of Touchpaper and Ergo.
Stock Compensation. We allocate stock-based compensation expense based on the department in which an employee works. Stock compensation expenses by income statement classification for 2008 and 2007 were as follows:
Years ended December 31,
% of % of
2008 Sales 2007 Sales
Stock compensation:
Cost of sales $ 1,218 $ 1,134
Research and development expense 5,634 5,825
Selling, general and administrative expense 14,661 12,682
Restructuring, integration and retirement expenses 3,209 -
$ 24,722 3.8 % $ 19,641 3.3 %
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Stock-based compensation increased 25% during 2008 compared to 2007. The increase is primarily a result of charges associated with the accelerated vesting for certain RSUs and other equity related charges associated with restructuring actions in 2008, listed separately in the table above. Additionally, we recorded charges associated with the accelerated vesting for certain RSUs and other equity related charges for the retirement of our former CEO in the first quarter of 2008.
Net investment income. Net investment income declined from $3.8 million in 2007 to $2.2 million in 2008. This decline was primarily the result of lower interest rates during the year.
Interest expense. Interest expense was $8.6 million in 2008 and $8.1 million in 2007. Interest expense results from borrowings under our $250 million unsecured line of credit obtained in the second quarter of 2006 and our $90 million term loan obtained in the third quarter of 2008. Interest expense increased in 2008 compared to 2007 due to higher borrowings as we borrowed an additional $50 million to partially fund the acquisitions of Touchpaper and Ergo in fiscal July 2008.
Other income (expense), net. Other income (expense), net improved from an expense of $174,000 in 2007 to income of $2.0 million in 2008. We recorded a gain of approximately $3.2 million in the third quarter of 2008 from a foreign currency exchange gain related to the tax free repatriation of capital from a European subsidiary to partially fund the acquisition of Touchpaper.
Provision for income taxes. The provision for income taxes was a provision of $3.1 million in 2008 compared to a benefit of $148,000 in 2007. The effective tax rate in 2008 was approximately 10.7%, compared to an effective tax rate of approximately (0.3)% in 2007. The increase in the effective tax rate was primarily due to the recognition in 2007 of a $6.5 million tax benefit attributable to the LANDesk acquisition for previously expensed in-process R&D of $18.6 million. Additionally there was a change in our mix and amount of pre-tax profit among our U.S. and international companies in 2008 compared to 2007. The tax benefit resulted from elections made in the second quarter of 2007 under Internal Revenue Code Section 338(g) related to previously expensed in-process R&D that, until the elections were made, was nondeductible for U.S. tax purposes.
Net income. Net income in 2008 was $25.5 million compared to $45.9 million in 2007, as a result of the above factors. Net income as a percentage of sales for . . .
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