Avocent 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number: 000-30575
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act
Common Stock, $0.001 par value per share
Securities registered under Section 12(g) of the Exchange Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and disclosure will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of the last business day of the registrants most recently completed second fiscal quarter was approximately $817,773,018.
The number of shares outstanding of the registrants common stock as of February 23, 2009 was 45,785,907.
DOCUMENTS INCORPORATED BY REFERENCE
Information with respect to items 10 to 14 of Part III of this Form 10-K may be found in the definitive proxy statement to be delivered to stockholders in connection with the 2009 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Item 1. Business.
THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. ALL STATEMENTS CONTAINED IN THIS ANNUAL REPORT THAT ARE NOT PURELY HISTORICAL FACTS ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS RELATING TO FUTURE EVENTS, FUTURE RESULTS, AND FUTURE ECONOMIC CONDITIONS IN GENERAL AND STATEMENTS ABOUT:
· OUR FUTURE STRATEGY, STRUCTURE, AND BUSINESS PROSPECTS;
· PLANNED ENGINEERING AND DESIGN ACTIVITIES, DEVELOPMENT AND ENHANCEMENT OF CURRENT PRODUCTS, AND INTRODUCTION OR ACQUISITION OF NEW PRODUCTS AND TECHNOLOGIES;
· THE SIZE, GROWTH, AND LEADERSHIP OF THE POTENTIAL MARKETS FOR OUR PRODUCTS AND TECHNOLOGIES;
· THE ADEQUACY AND EXPANSION OF OUR RELATIONSHIPS WITH CURRENT, AND THE DEVELOPMENT OF NEW, OEM, DISTRIBUTOR, RESELLER, AND SUPPLIER RELATIONSHIPS;
· OUR FUTURE SALES, EARNINGS, INCOME, EXPENSES, OPERATING RESULTS, TAX RATES, OPERATING AND GROSS PROFIT AND MARGINS, INVENTORY LEVELS AND VALUATIONS, RECEIVABLES, RESERVES, AND INVESTMENT INCOME;
· OUR FUTURE LIQUIDITY, THE IMPACT OF CURRENCY RATES, AND OUR PLANS REGARDING EQUITY-BASED COMPENSATION, CAPITAL RESOURCE NEEDS, SHARE REPURCHASES, BORROWINGS, AND REPAYMENTS;
· OUR CUSTOMERS, SEASONALITY, AND COMPETITIVE ENVIRONMENT;
· OUR ABILITY TO OBTAIN AND PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS;
· ANTICIPATED EXPANSION OF INTERNATIONAL SALES AND OPERATIONS; AND
ALL OF THESE FORWARD-LOOKING STATEMENTS ARE BASED ON INFORMATION, EXPECTATIONS, ESTIMATES, FORECASTS, AND PROJECTIONS AVAILABLE TO US ON THE DATE OF THIS ANNUAL REPORT AND THE BELIEFS AND ASSUMPTIONS OF OUR MANAGEMENT. WORDS SUCH AS EXPECTS, ANTICIPATES, TARGETS, GOALS, PROJECTS, INTENDS, PLANS, BELIEVES, SEEKS, ESTIMATES, CONTINUES, MAY, AND VARIATIONS OF THESE WORDS, AS WELL AS SIMILAR EXPRESSIONS, ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION, ANY STATEMENTS THAT REFER TO PROJECTIONS OF OUR FUTURE FINANCIAL PERFORMANCE, OUR ANTICIPATED GROWTH, TRENDS IN OUR BUSINESSES, AND OTHER CHARACTERIZATIONS OF FUTURE EVENTS OR CIRCUMSTANCES ARE FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS ANNUAL REPORT. THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS ANNUAL REPORT, AND OTHER WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS MADE BY US FROM TIME TO TIME, ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES, AND ASSUMPTIONS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN ITEM 1A RISK FACTORS. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON.
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, designed to increase the efficiency of IT personnel by centralizing control of servers, desktop computers, serial devices, wireless devices, mobile devices, network appliances, and process management. 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.
We market our products around the world to a diversified group of original equipment manufacturers (OEMs), dealers, distributors, resellers, and end users, primarily through our sales and customer support staff, advertisements in trade publications, on-line sponsorships, and participation in major industry trade shows. A substantial portion of our sales is to major server OEMs that purchase our switching systems on a private-label or branded basis.
Information technology is critical to most business operations as computers perform multiple and diverse functions throughout many different types of organizations. Many corporations have decentralized computing power while sharing technology resources and providing broad access to enterprise data. This has resulted in the widespread adoption of distributed network computing environments using a network-based architecture of interconnected computers that span from the data center to the corporate office. Businesses are increasingly faced with a growing number of challenges. These challenges include:
Data Center Growth. The typical data center installation consists of a local area network (LAN), with a large number of computers operating as servers dedicated to performing specific functions for the many client computers connected to the LAN and, in many cases, a wide-area network (WAN). With the shift of software applications to a web services model, the demand for servers and storage is growing. Users are accessing more data and resources using intranets and the Internet. This growth causes a proliferation of physical and virtual servers and increases the administration, environmental, power, security, and space challenges of managing data centers containing growing networks of servers, consoles, peripherals, and cables, and other network devices.
Increasingly Mobile Workforce. As the workforce continues to become more mobile, handheld devices and laptop computers are increasingly used outside of the corporate LAN. This proliferation of networked devices and the difficulty in controlling these devices outside of the corporate LAN pose many significant management and security challenges.
Heterogeneous Environment. Corporate IT departments may manage hundreds or thousands of servers, clients, and other networked devices. In managing these network devices, they must identify and access relevant devices, add or delete users, add, change, or upgrade applications, tune systems for better performance, and diagnose and correct network failures. These network devices are generally purchased from multiple vendors and are designed to operate as stand-alone systems, each with its own console. IT professionals must therefore deal with a large number of consoles and workflow processes, whether centrally located or dispersed throughout the organization, when performing administration and management tasks.
Always-On Infrastructure. Information technology resources are critical to organizations. Accordingly, constant availability is crucial to the operation of many businesses. The time that an Internet service provider (ISP), an application service provider (ASP), a data center, a server farm, a corporate network, or a desktop computer, a laptop, or a mobile device is down or degraded can cause significant inconvenience, loss of productivity, and financial loss. Quick and efficient diagnosis and the correction of problems can be difficult, and the ability of a facilities manager or network administrator to quickly and efficiently diagnose and correct the problem may be hampered by the inability to access the software.
Virtualization. Virtualization is the separation of the computer operating system and applications from the hardware - often supporting multiple operating systems and applications on a single hardware platform. As a relatively new technology, virtualization offers significant economic benefits to IT organizations in the form of increased scalability and asset utilization, but this emerging mix of virtual and physical servers and desktops adds a new layer of complexity to IT
management. IT administrators need to manage and control these virtual machines in the same manner as physical machines, and our management software products address many of these needs. Our solutions offer combined access and control of both virtual and physical servers and desktops through a secure platform while reducing the cost and complexity of managing the IT infrastructure.
Products and Technologies
As of January 1, 2009, we have three business units that provide the following software and hardware products and technologies. The products and technologies we provide solve many of the network administration, systems, security, device management, and storage problems faced by facilities managers, network administrators, and IT managers.
· The Management Systems business unit consists of our branded Avocent and OEM branded IT infrastructure management products, which include KVM, LCD console trays, serial console, power control, digital extension, management appliances, management software, and our embedded manageability technologies, such as intelligent platform management infrastructure (IPMI) and embedded KVM systems.
This business unit focuses on IT infrastructure management solutions and technologies for (i) data centers, (ii) remote access and distributed branch office environments, (iii) mid-size server rooms for the small and medium business market, and (iv)desktop switching and universal serial bus (USB) hubs for simplified control of desktops, small offices, and home-based businesses. Many of our hardware products contain software or firmware, and this business unit also provides the technology that links our embedded technologies and our DSView 3 management software.
The products and technologies offered by Management Systems include:
· Our DS Series products, which allow users to access and control both physical and virtual servers from remote locations using an Internet or network connection without the necessity of remote access hardware or software on the computers or servers being accessed. The DS Series KVM products digitize keyboard, video, and mouse information and compress and transport that information in packets over traditional network connections optimizing performance for busy data centers. Our DSR® switching systems feature a digital console connection that allows facilities managers and network administrators access to servers utilizing standard networking infrastructure and our KVM over IP technology. Our DS Series appliances are managed with DSView® centralized management software, providing access and control of servers and serial devices in the network operations center or from almost any location in the world using TCP/IP connectivity. IT administrators can securely manage all connected data center devices and gain point-and-click access and control over these devices using a browser interface.
· Our AutoView® switch family, which offers users a variety of analog and digital KVM switches. Our AutoView switches provide small to medium size businesses with a 1U-high design, saving valuable rack space in the server room. Our AutoView switches offer an on-screen display and a web-based interface, which means that no additional software is required for remote server access.
· Our SwitchView® switching products includes our SwitchView SC family of secure switches, built for the secure environment and designed to restrict the transfer of data between connected computers. Our compact, space-saving SwitchView desktop KVM switches support multiple computers and allow users to control multiple PCs and share access to a digital camera, CD-ROM, PDA, scanner, printer, speakers, and a microphone.
· Our AMX analog matrix switching systems, which provide simpler access and easier manageability of servers in multi-rack, multi-platform environments. Our AMX switches increase the number of users with simultaneous access and offer efficient scalability with an architecture that makes it easy to add and support additional servers.
· Our KVM extension product lines, including our CAT 5 extension products, fiber optic and copper extension products, and wireless extension products. The LongView® extender allows users to extend a keyboard, monitor, mouse, speakers, microphone, and serial port up to 500 feet away from the computer or KVM switch with one CAT 5 UTP cable.
· Our ACS appliances, which deliver secure, serial over IP access to console ports of command line driven operating systems such as LINUX or UNIX servers and other serially-managed devices such as power management systems, storage elements, firewalls, and network switches and routers. These serial appliances and attached devices can be centrally managed using our DSView 3 management software.
· Our Avocent console trays provide out-of-band access to KVM switches for convenient access and control of servers and other devices in the data rack.
· Our PM series of intelligent power control and distribution devices, which can monitor power consumption and provide control over a connected devices AC power source. These devices are critical in certain situations when the connected devices require a full hardware level reset to restore operational service. Our PM devices are connected to DSR or ACS appliances and can be managed by the user interface of these appliances or centrally managed using our DSView 3 management software.
· Our embedded products, which are provided as hardware, software, firmware, or licensed technology. These products include IPMI firmware, SMASH and WS-Man interfaces, DASH firmware, service process drivers, and development utilities. Our remote presence products include KVM switching and video compression technologies, virtual media firmware, and software for graphical user interfaces (GUIs). Our embedded technologies are licensed to our OEM customers for inclusion in their servers, desktops, notebooks, and other devices. Our hardware products consist of remote access, system management, and chassis management cards that are also sold to our OEMs for integration with their systems.
This business unit delivers systems, security, and service management software solutions that simplify how corporate enterprises manage desktops, servers, mobile devices, and IT services and processes. These LANDesk solutions allow an IT staff to increase productivity and protect corporate assets from a single, easy-to-use console while leveraging prior investments in database, application, and directory service technologies and across heterogeneous IT environments (Windows, Mac OS, UNIX, LINUX, handheld, and embedded device operating systems). LANDesk revenue and bookings are comprised of license-based revenue, primarily from the LANDesk Management Suite product, and subscription-based revenue, primarily from the LANDesk Security Suite and LANDesk Patch Manager products and from maintenance and support agreements related to LANDesk products.
The products and technologies offered by LANDesk include:
Systems Management Software
· Our LANDesk® Management Suite (LDMS) software, which allows enterprise IT departments to easily and efficiently automate systems management tasks and see, manage, and update desktops, servers and mobile devices from a single console. LDMS provides intelligent and efficient distribution capabilities, such as functional load balancing, fault tolerance, bandwidth minimizing technologies, and local access to packages previously delivered to a subnet, to minimize the impact to corporate systems. With just an Internet connection, corporate IT teams can identify and securely manage computer assets (including assets outside the firewall and at geographically distributed sites), scan, define, track, and audit applications, and provide compliance and usage reports.
· Our LANDesk Server Manager software, which provides enterprises with the tools to improve server performance, reliability, and availability through operating system (OS) and application provisioning, real-time hardware health monitoring, automated patching, imaging, and updating, historical data collection, predictive failure analysis and prevention, and remote problem resolution, all through a single console.
· Our LANDesk Application Virtualization software, which provides enterprises with the capability to virtualize an application isolated from other applications running on the operating system. This allows IT managers to run older applications on new operating system platforms. The virtualized application can be run on the local device or streamed from a remote server, and does not require local administration rights or a local agent to be present.
· Our LANDesk Handheld and Embedded Device Manager software, which is designed and optimized for managing across the low-speed, intermittent connections characteristic of handheld, embedded, and wireless devices, and allows an IT staff the ability to secure moving resources and the information on them, including the option to clear a devices memory card, delete contacts, address book data, and e-mail, and perform a reset of the mobile device.
· Our LANDesk Asset Lifecycle Manager software, which allows enterprises to track assets through a single console and a structured asset repository that extends the management of a customers hardware and software assets throughout an assets lifecycle to enable better planning decisions, informed business analysis, and improved business capacity.
· Our LANDesk Inventory Manager software, which enables IT staff to discover networked computing devices, automatically maintain detailed hardware and software inventories, and gather and track detailed hardware, software, and OS configuration data for license compliance, plan upgrades, identification of security issues, and determination of purchase needs.
· Our LANDesk Power Manager software delivers a simple-to-use, easy-to-deploy solution to quickly create sophisticated power management policies for networked PCs and to balance power savings and system availability.
Security Management Software
· Our LANDesk Security Suite, which includes software and subscription content that allows enterprises to easily perform and automate patch, anti-spyware, and security threat management from a single console with quarantine, antivirus enforcement, vulnerability detection, threat remediation, computer access restriction tools, and a variety of reporting capabilities (including trend graphs, spyware reports, and an executive dashboard with a graphical view of critical enterprise concerns).
· Our LANDesk Patch Manager software, which allows corporate IT departments to actively scan managed computers across heterogeneous IT environments to identify application and operating system vulnerabilities and quickly download patches with e-mail or pager alerts when a vulnerability or a specific severity level is detected.
· Our LANDesk Antivirus software, which provides enterprises with affordable, real-time virus protection and root kit detection to user endpoints with little or no new infrastructure. LANDesk Antivirus can automatically encrypt and quarantine suspicious files and known infections, and allows IT staffs to customize and control alerts, queries, and reports for full security.
· Our LANDesk Host-based Intrusion Prevention (HIPs) software, which provides enterprises the ability to protect endpoint devices from zero-day attacks and other similar threats. The LANDesk HIPs solution also monitors the behavior of applications and isolates machines on the network that are behaving erratically.
Service Management Software
· Our LANDesk Process Manager, which integrates, optimizes, and automates IT and business processes, workflow, change management, and configuration management, with a graphical process builder, full-featured auditing, customizable reporting capabilities, and support for third-party electronic forms.
· Our LANDesk Service Desk software (including the products we acquired in our recent acquisition of Touchpaper), which provides help desk and IT staff with an Internet-based consolidated service desk solution with process-driven incident management, role-based privilege sets, knowledge base, call logging, assignment, form design, and service level escalation for delivering support services. LANDesk Service Desk includes an Internet-based interface that allows service providers and end users or customers to easily and proactively report problems, log incidents, communicate and track service status, and research the intelligent knowledge base for solutions to facilitate faster resolution.
· Our LANDesk professional services, training, which include maintenance, upgrade protection, and customer support offerings to help customers realize the most value from their LANDesk software investment. The LANDesk Professional Services team can draw from the experience, talents, and abilities of the people who develop award-winning LANDesk solutions, helping customers experience the best implementation possible. In addition, customers can attend LANDesk training courses or complete the Certified LANDesk Engineer or Administrator programs.
This business unit offers managed audio visual (AV) infrastructure solutions for commercial digital signage, presentation, and rental and staging markets. Our Emerge product family allows industry professionals to deliver innovative analog, IP-wired, and wireless solutions for AV extension, switching, distribution, and signal processing needs. Extension products simplify connectivity and control of displays, projectors, and AV source equipment.
The products and technologies offered by Connectivity and Control include:
· Our Emerge family of products, which provide both wired and wireless switching and extension of video, audio, and control data for use in a range of markets. Our Emerge family of multipoint high-definition wired/wireless extenders (MPX) allows AV consultants to design managed audio-video extension networks for commercial signage and presentation markets. Our Emerge Wireless extender is used in boardrooms, classrooms, and commercial digital signage applications, and our Emerge Media Streamer (EMS) extenders offer CAT 5 wired video extension for use in similar markets. Our digital ECMS products provide intra-building extension and switching of digital media across IP networks. Our Emerge family also incorporates a range of video processing products such as scalers and presentation switchers, which allow integrators to provide full audiovisual solutions when combined with our distribution and extension products.
Sales and Marketing
We market, sell, and license our hardware and software products and services through our own sales force and various distribution channels, including OEMs, system integrators, distributors, and reseller arrangements. We market our products primarily through advertisements in trade publications, online sponsorships, participation in major industry trade shows, promotions with distributors and resellers, direct marketing, telemarketing, publicity programs, and through our website. We also devote a substantial portion of our marketing efforts to developing, monitoring, and enhancing our relationships with our network of OEMs, independent dealers, distributors, resellers, and end users. Our sales personnel are supported by our engineers and our customer service representatives who provide technical support and advice to customers. As of December 31, 2008, we employed 851 people in sales, marketing, and customer support. As of December 31, 2008, we were also working with approximately 41 independent contractors on various sales and marketing projects.
We currently sell or license various hardware and software products and technologies to APC, Dell, EMC, Hewlett-Packard, IBM, Intel, Lenovo, Fujitsu Components Limited, Fujitsu Siemens, and other OEMs pursuant to private-label, branded, and other licensing arrangements. These OEM customers integrate and sell our products and technologies with or within their own products, including networked servers and clients. We devote significant sales, engineering, operations, and customer service resources to our OEM accounts. We have significant experience in working with our OEMs and other system manufacturers, and we intend to use that experience to enter into new relationships with other computer manufacturers in the United States, Europe, and Asia. We believe that the architecture, quality, and reliability of our products and technologies, together with our commitment to customer service, are attractive to computer manufacturers and software developers worldwide.
We have relationships with a variety of distributors and resellers, and systems integrators, for the distribution and sale of Avocent, Cybex, Cyclades, Equinox, and LANDesk branded software and hardware products in the United States, and internationally. We devote resources to educating our distributors and resellers about the benefits of our products and training them in the proper sales, marketing, installation and support of our products. We will continue to devote additional resources to increase these branded sales, and we will pursue additional relationships with distributors and resellers, both domestically and internationally, who have the technical capability and market presence to assist end-user customers in developing network space management, access, control, systems management, and security products and technologies to meet customers particular needs. Our future success will depend in part on our ability to attract, train, and motivate additional distributors and resellers.
We provide discounts, other special pricing arrangements, and certain return privileges to our OEMs and our distributors and resellers. Our agreements with our distributors and resellers are generally nonexclusive and may be terminated on short notice by either party without cause. Our OEMs, distributors and resellers are not within our control, are not obligated to purchase products from us, and frequently offer products from several different manufacturers, including products that compete with our products.
International sales accounted for approximately 48% of net sales in 2008, 44% of net sales in 2007, and 43% of net sales in 2006. No foreign country accounted for more than 10% of 2008, 2007, or 2006 sales. We are expanding our international sales efforts within Europe, Latin America, Asia, and the Pacific Rim through the utilization of our sales offices in Sydney, Australia; São Paulo, Brazil; Beijing, Guangzhou, and Shanghai, China; London, England; Paris, France; Munich, Germany; Rotterdam, Holland; Hong Kong; Shannon, Ireland; Tokyo, Japan; Mexico City, Mexico; Taipei, Taiwan; and Singapore.
Our customers include our channel partners, which is a diversified group of dealers, major distributors, resellers, and direct end users who purchase our branded products. These customers represented 67% of net sales in 2008, 65% of net sales in 2007, and 60% of net sales in 2006. We believe that our broad range of products sold at different price points offers us the opportunity to market our products to customers of all sizes, in different industries, and with varying degrees of technical sophistication.
Sales to OEM customers represented 33% of net sales in 2008, 35% of net sales in 2007, and 40% of net sales in 2006. The declining trend in percentage of sales in recent years is due in part to the change in the mix of our business as a result of our acquisitions. While we have agreements with many of our OEM customers, these agreements are generally cancellable at the will of the OEM (generally subject to notice provisions), and none of our OEM customers is obligated to purchase products from us except pursuant to binding purchase orders or licensing agreements. Consequently, any OEM customer could cease doing business with us at any time. Although we are not substantially dependent on any one OEM customer, the loss of, or material decline in orders from, certain of our current OEM customers would have a material adverse effect on our business, financial condition, results of operations, and cash flow.
The following table identifies our customers that exceeded 10% of our net sales for the years 2008, 2007, and 2006:
Sales to these customers are reported primarily through our Management Systems business unit, but also through our LANDesk business unit. No other customer accounted for more than 10% of our net sales in 2008, 2007, or 2006.
Our operating results are affected by seasonal trends and by general conditions in the server market. We have experienced, and expect to continue to experience, some degree of seasonality due to customer buying cycles. We believe that the third and fourth quarters will generally have higher net sales levels due to customer budgeting and procurement cycles, which may depress net sales in other quarters. In addition, we typically see a sequential decline in revenue from the fourth quarter of a year to the first quarter of the following year. While it is difficult to predict revenue in any quarter, we expect that this pattern will continue in the future.
We emphasize customer service by developing high quality products, encouraging customer feedback through contact with our key customers, providing technical support and information on our website, and providing a customer hotline that offers technical support for the life of our hardware products. We also offer annual software upgrade protection and maintenance agreements for licensees of our software products. We strive to respond quickly to our customers requests for technical support and service, and our engineering department often works with individual customers to troubleshoot problems and develop solutions. We offer warranties for parts and service on all of our hardware products, ranging from one to three years (and, in the case of some of our Equinox branded products, five years). We also offer a 30-day money-back
guarantee for our appliance products sold in North America. To date, we have not experienced any significant hardware product returns. For our software products, we generally provide a 90-day limited warranty on the media used to deliver the software, which is not applicable to electronic downloads, and a 90-day limited warranty (except where a longer period is required by local law) that our software products will function in accordance with the end user documentation provided with the software product. We may, as a result of competitive pressures or requirements in certain geographies, change our warranty policies in the future to provide coverage that is greater in scope and duration than the coverage we currently offer. If we were to increase our warranty coverage, our risk of warranty claims, and therefore our warranty expense and reserves, would likely increase.
Development of New Products and Technologies
We believe that the timely development of enhancements to our existing hardware and software products and technologies and of new products and technologies is essential to maintaining and building on our competitive position. The market for our products continues to experience rapid technological advances, frequent new product introductions and enhancements, and significant price competition. The introduction of products incorporating superior or alternative technologies (such as the creation of virtual servers using a combination of hardware and software, which is known as virtualization), the creation or adoption of new technologies, the emergence of new industry standards, or changes in the markets pricing structure could render our existing products and technologies, and the products and technologies we have in development, obsolete or unmarketable.
Our hardware products generally combine components, such as printed circuit boards, semiconductors, memory, connectors, cable assemblies, power supplies, and enclosures, that are manufactured by other companies and are generally available to our competitors and potential competitors. Our software products combine software and content from third parties, such as open source software or technology, drivers, security, application virtualization, or anti-virus information, which may also be generally available to our competitors and potential competitors. Our future success will depend in large part upon continued innovative application of commercially available components and software or technologies, continued enhancements to our proprietary hardware, software, firmware, and other technologies, the expansion and enhancement of our existing products and technologies, and the development and introduction of new products and technologies that address changing industry trends (including virtualization) and customer needs on a cost-effective and timely basis. By emphasizing customer-driven research and development, we have been able to develop innovative, practical, and marketable products that have had immediate application and acceptance. Our failure to respond on a timely basis to technological changes or customer requirements could have a material adverse effect on our business, financial condition, results of operations, and cash flow. In addition, the acquisition of or departure from the market of one or more of these third party technology or component providers could have a material adverse effect on our business, financial condition, products, results of operation and cash flow.
Due to our significant reliance on OEM relationships, some of our product development efforts are focused on developing new hardware and software products or enhancements for OEM customers, which could delay or otherwise negatively affect our planned delivery of non-OEM products. At times, these new products or enhancements may not be available to, or readily marketable to, other customers without significant modifications or delay.
Our engineering and product development efforts focus on anticipating the needs of our customers by providing innovative, practical, and marketable products and technologies that have immediate applications in their markets. By maintaining contact with customers throughout the installation and technical support process, beta-test programs, and customer advisory groups, we are better able to identify and test potential design modifications and improvements as well as new applications and extensions for existing products and technologies. We expect this process will enable us to develop new product categories and applications (including new uses for existing technology) to meet specific customer needs. Many of our products and technologies are designed to accommodate future modifications and additional features, which we believe facilitates the development and integration of future modifications and features if we see a market need.
As of December 31, 2008, we employed 750 people in our engineering departments. In addition, we use independent contractors from time to time. As of December 31, 2008, we were working with approximately 27 independent contractors on various development projects.
A key component of our engineering and product development strategy is the acquisition of new technologies and companies. We intend to continue to evaluate opportunities to acquire technologies and companies, and it is likely that we will complete additional acquisitions in the future. Acquiring new technologies and companies is inherently risky, especially if the technology or the products of the company have not had significant time in the market or exhibit uncertain commercial viability. There can be no assurance that these acquisitions will be successful, will result in the timely development or continuation of commercially viable products or technologies that achieve market acceptance, or will otherwise improve or benefit our financial condition or operating results.
The industry in which we compete is subject to rapid technological developments, evolving standards, changes in customer requirements, and new product introductions and enhancements. Our success depends in part upon our ability to continue to enhance our existing products and to develop and introduce new products that improve performance and reduce total cost of ownership on a cost-effective and timely basis, and to meet these challenges, we expect to make substantial investments in product development in the future. We also expect to continue to make acquisitions and investments where appropriate to provide us with access to new technologies. There can be no assurance, however, that our product development efforts will lead to commercially viable products or technologies, will be completed on a timely basis, or will include the features required to achieve market acceptance.
We do not manufacture any of our hardware products in their entirety. Instead, we manage product planning, purchasing, and shipping, and we perform final assembly, quality assurance, and testing on some of our hardware products while we outsource some or all of these functions on other products. In order to avoid the capital investment required to establish and maintain in-house manufacturing capabilities, we rely on subcontractors throughout the world for the assembly of printed circuit board assemblies, subassemblies, chassis, and equipment enclosures. We believe that our chosen subcontractors can typically perform these functions at a lower cost than we can, while maintaining our high standards for quality and delivery. Outsourcing our manufacturing functions allows us to concentrate our resources on research and development, product design, quality assurance, sales and marketing, and customer service. We (or our subcontractors) subject our most critical components and products to automated testing, equipment burn-in procedures, comprehensive quality audits, functional testing, and regulatory screening to assure quality and reliability. As of December 31, 2008, we employed 147 people in our manufacturing, supply chain management, and logistics department.
We currently rely on several third party manufacturers, including Elcoteq Network Corporation, Plexus Corp., Kontron AG, Likom Computer Products, and Sanmina-SCI for subassembly of our hardware products. These outsourcing arrangements, and any future outsourcing arrangements, involve numerous risks, including reduced control over product quality, delivery schedules, manufacturing yields, and costs. The acquisition or departure from the market of one of these contract manufacturers could have a material adverse effect on our business, financial condition, products, results of operations, and cash flows. In addition, while these third-party manufacturers may have certain warranty obligations, we remain primarily responsible to our customers for warranty obligations. We attempt to diversify our outsourced manufacturing operations and believe we have an adequate supply of alternative subcontractors.
We generally purchase industry-standard parts and components, including power supplies, semiconductors, memory, cable assemblies, line filters, enclosures, and printed circuit boards, for the assembly of our products from multiple vendors and suppliers through a worldwide sourcing program. Custom molded cables and certain turn-key products procured from outside sources have significant delivery times (generally 10 to 12 weeks), and failure to obtain adequate supplies could adversely affect our product deliveries. We buy components under purchase orders and generally do not have long-term agreements with our suppliers. Circuit board assemblies are currently obtained from a number of sources, including Elcoteq Network Corporation, Plexus Corp., Kontron AG, Likom Computer Products, and Sanmina-SCI. We believe that there are adequate alternative sources for our product components. Any termination of, or significant disruption in, the business or affairs of our suppliers or our third-party manufacturers or in our relationship with them may prevent us from filling customer orders in a timely manner since we generally do not maintain large inventories of our components.
In the past, we have experienced delays in the receipt of certain components, which have resulted in delays in related product deliveries. We attempt to manage these risks through developing alternative sources, committing internal resources to supply chain management, and maintaining quality relationships and close personal contact with each of our contract manufacturers and suppliers. There can be no assurance, however, that delays in component and product deliveries will not occur in the future, and the inability to obtain sufficient components or to develop alternative sources, if and as required in the future, could result in delays or reductions in product shipments, which, in turn, could have a material adverse effect on our business, financial condition, results of operations, or cash flow.
The market for our hardware and software products is highly fragmented, competitive, rapidly changing, and we expect these market characteristics to increase in the future. We compete with numerous vendors in each of our product categories. In the market for hardware switching systems, we compete with companies such as Raritan Computer, Rose Electronics, Minicom Advanced Systems, Aten International, Belkin, Digi International, and Lantronix, and in the market for
our systems management products we compete with companies such as Microsoft, Computer Associates, BMC Software, Novell, Tivoli, and Symantec. In addition, certain of our OEM customers, such as Dell, Hewlett-Packard, and IBM, offer technologies and products that are competitive with our products, and we expect these technologies and products to remain competitive in the features they offer. Our products and technologies are also in competition with products and technologies offered by hardware manufacturers and network management companies such as AMI, Cisco, EMC, Intel, and Microsoft. Many of these competitors may have substantially greater financial, marketing, and technical resources than we have.
In the market for our products, we compete primarily on the basis of technological capabilities, performance in relation to price, product features, quality, reliability, return on investment, development capabilities, product availability, and customer service and support. Our future success will be highly dependent upon timely completion, introduction, and distribution of new products, technologies, services, and features at competitive price and performance levels that address changing industry trends and the evolving needs of our customers. We continually experience price competition and expect that pricing pressures could increase in the future. As we continue to grow, especially internationally, we expect that we will encounter new competition in different geographic regions.
Our future success is dependent in part upon our ability to develop and protect our intellectual property and our proprietary rights in our products and technologies. We seek to protect our intellectual property rights by invoking the benefits of the patent, trademark, copyright, trade secret, and unfair competition laws of the United States and certain foreign countries, all of which provide only limited protection. We regularly file applications for and obtain patents, copyrights, and trademarks in the United States and in selected foreign countries where we believe filing for such protection is appropriate. We have been issued over 60 U.S. patents and have over 55 U.S. patent applications pending. We have various corresponding patent applications pending under the provisions of the Patent Cooperation Treaty, which permits the filing of corresponding foreign patent applications in numerous foreign countries within a limited time period. We also have other foreign patent applications pending. There can be no assurance that any additional patents will be issued from any of our pending applications, that any patents will be issued in any additional countries where our products or technologies can be sold or licensed, or that any claims allowed in our patents or in any pending patent applications will be of sufficient scope or strength for, or provide any meaningful protection or any commercial advantage to, us. Moreover, our competitors or other holders of intellectual property rights may challenge the validity of, or be able to design around, these patents or any other patents that may be issued to us. The laws of certain foreign countries in which our products are or may be developed, manufactured, or sold (particularly, countries in Asia) may not protect our products or intellectual property rights to the same extent as do the laws of the United States and thus increase the likelihood of piracy of our products and technologies.
We have in the past filed, and we may in the future file, lawsuits against other companies regarding the alleged infringement of our proprietary rights. Patent litigation, and any other litigation relating to our intellectual property to which we become a party, is expensive and subject to numerous risks and uncertainties, and there can be no assurance that we will be successful in any such litigation. There can be no assurance that the steps we take to protect our intellectual property rights will be adequate to prevent misappropriation of our technologies or that we can use our intellectual property rights to successfully prevent competitors from commercializing technologies that are substantially equivalent or superior to our products and technologies. Additionally, current or future competitors could develop their own proprietary technologies or obtain patents that may prevent us from developing or selling our products and technologies.
We also seek to maintain our trade secrets and confidential information by nondisclosure policies and through the use of appropriate confidentiality and nondisclosure agreements.
As of December 31, 2008, we had 1,099 full-time employees working in the United States. Of our domestic full-time employees, 391 were in marketing, sales, and customer support, 480 were in engineering, research, and development, 90 were in manufacturing and logistical operations, and 138 were in administration. As of December 31, 2008, we had 872 full-time employees working at our facilities outside of the United States. Of our international full-time employees, 460 were in marketing, sales, and customer support, 270 were in engineering, research, and development, 57 were in manufacturing and logistical operations, and 85 were in administration. Our employees in Brazil (approximately 17) and the LANDesk employees in France (approximately 32) are covered by collective bargaining agreements. No other employees are covered by collective bargaining agreements relating to their employment by us. We believe that we have good relations with our employees.
Backlog consists of purchase orders with delivery dates scheduled within the next six months. None of our customers is obligated to purchase products from us except pursuant to binding purchase orders or other legal agreements. Because of the timing of orders and the possibility of customer changes to delivery schedules, our backlog as of any particular date is not representative of actual sales for any succeeding period. Moreover, with recent industry-wide initiatives by OEMs, distributors, and resellers to reduce inventories and shorten lead times, we do not view backlog as an important indicator of our future results, and we do not believe it is a meaningful indicator of actual sales for any succeeding period.
Our corporate Internet address is www.avocent.com. At this website, we make available free of charge our annual report on Form 10-K, our annual proxy statement, our quarterly reports on Form 10-Q, any current reports on Form 8-K, and any amendments to these reports, as soon as reasonably practicable after we electronically file them with, or furnish them to, the Securities and Exchange Commission (SEC). Also available at this website are our Code of Business Conduct and Ethics, our Corporate Governance Guidelines, our Whistleblower Policy, the Nominating and Governance Committees Policies and Procedures for Director Candidates, and the Charters for our Acquisition and Strategy Committee, Audit Committee, Compensation Committee, and Nominating and Governance Committee. If any amendment to our Code of Business Conduct and Ethics or any waiver granted under it is applicable to our principal executive officer, our principal financial officer, our principal accounting officer or controller (or any persons performing similar functions) and relates to the code of ethics definition enumerated in the SECs regulations, we will disclose such amendment or waiver at this website within five business days after the date of such amendment or waiver. The information found on our website is not part of this Form 10-K.
ACS, Apex, AMX, AMWorks, Avocent, the Avocent logo, AutoView, Cybex, Cyclades, DSR, DSView, Emerge, Equinox, KVM over IP, LANDesk, the LANDesk logo, LongView, PM, The Power of Being There, SwitchView, Touchpaper, and the Touchpaper logo are trademarks or registered trademarks owned by us. This annual report also includes trademarks of other companies.
Item 1A. Risk Factors.
THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS ANNUAL REPORT. THESE RISKS AND UNCERTAINTIES INCLUDE THE FOLLOWING:
Difficulties encountered during challenging and changing economic conditions could adversely affect our results of operations.
Our business and operating results depend to a significant extent on economic conditions in general and on IT spending and the server market 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 or in the server market 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. The current financial crisis 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, bank failure or governmental takeover of financial instituitions, and customer insolvencies. In addition, we continue to see industry-wide initiatives by OEMs and by distributors and resellers of our hardware products to reduce their inventories and to shorten their lead times, thereby reducing early commitments to firm orders by our major OEM and distributor and reseller customers. If we are unable to effectively manage during the current challenging and changing economic conditions, our business, financial condition, and results of operations could be materially adversely affected.
We have acquired, and expect to continue to acquire, technologies and companies and these acquisitions could disrupt our business or expose us to other risks.
A key component of our engineering and product development strategy and our future growth is the investment in or the acquisition of technologies and companies. We intend to continue to execute our strategy through the acquisition of technologies or companies or through investments in complementary companies, products, personnel, or technologies, and it
is likely we will complete such acquisitions or investments in the future. These acquisitions and investments involve many risks and factors outside our control, including the following:
· Difficulty integrating the acquired companys personnel, distribution channels, products, product roadmaps, technologies, systems, processes, and operations, including product development, product delivery, order management, and information systems;
· Difficulty in conforming the acquired companys financial policies and practices to our policies and practices and in implementing and maintaining adequate internal systems and controls over the financial reporting and information systems of the acquired company;
· Diversion of managements attention and disruption of our current business and the challenges associated with managing the resulting larger company following any acquisition;
· Difficulty in combining product and technology offerings and entering into new markets or geographical areas in which we have no or limited direct experience and where our competitors may have stronger market positions;
· Loss (at either Avocent or in the acquired company) of management, sales, technical, or other key personnel or the loss of customers, distributors, resellers, vendors, or other business relationships as a result of the acquisition;
· Revenue or deferred revenue from the acquired company not meeting our expectation, and the potential loss of the acquired companys customers, distributors, resellers, suppliers, or other partners;
· Delays or difficulties and the attendant expense in evaluating, coordinating, and combining administrative, manufacturing, research and development, operations, facilities, and relationships with third parties in accordance with local laws and other obligations while maintaining adequate standards, controls and procedures, including financial controls and controls over information systems;
· Difficulty in completing projects associated with acquired in-process research and development;
· Incurring amortization expense related to certain intangible assets and recording goodwill and non-amortizable assets that will be subject to impairment testing and possible impairment charges;
· Dilution of existing stockholders as a result of issuing equity securities, including the assumption of any stock options or other equity issued by the acquired company;
· Overpayment for any acquisition or investment or unanticipated costs or liabilities;
· Assumption of liabilities of the acquired company, including any potential intellectual property infringement or other litigation claims, the liabilities and obligations under the acquired companys existing agreements, and any unrecorded tax obligations; and
· Incurring substantial write-offs, restructuring charges, interest expense, amortization, and transactional expenses.
Our integration plans and indemnification and escrow agreements might fail to adequately mitigate these risks and factors, and our failure to manage these risks and challenges could materially harm our business, financial condition, and results of operations. Further, if we do not successfully address these challenges in a timely manner, we may not fully realize all of the anticipated benefits or synergies on which the value of a transaction was based. Future transactions could cause our financial results to differ materially from expectations of market analysts or investors for any given quarter.
Our impairment testing may indicate we have an impairment of goodwill and require us to take an impairment charge.
As required by generally accepted accounting principles, we have performed an annual impairment test of goodwill in each of the fourth quarter of 2008, 2007, and 2006. Our testing in the fourth quarter of each year concluded that there had been no impairment of goodwill and that no adjustments were required.
While our testing in 2008 indicated that there was no goodwill impairment, we noted certain factors during the 2008 testing that will require monitoring and may require additional testing prior to our next scheduled test in the fourth quarter of 2009. With the broad-based decline in the stock market, our market capitalization has declined to less than the book value of our shareholders equity after year end and through the date of this filing. We believe the reduction in our market capitalization is a short term anomaly and is not indicative of our true value as a whole nor the value of our individual reporting units.
Although our testing indicated there was no impairment for our LANDesk reporting unit in the 2008 test, LANDesk carries a significant amount of goodwill and other intangible assets, including those added in the recent Touchpaper acquisition. The value of these intangible assets resulted in the carrying value of LANDesk being marginally below the indicated fair value calculated through our impairment testing.
As a result of these factors and due to the current recessionary environment and the resulting impact on our business, we are monitoring our stock price, control premium, and other conditions in relation to potential additional goodwill impairment testing, and we intend to perform an additional test for goodwill impairment in the first quarter of 2009. There is a risk that there may be an impairment in the future requiring an adjustment to the carrying value of goodwill and other intangible assets, and we may be required to take an impairment charge. If so, any charge could have material adverse effect on our financial position and the results of our operations.
Intense competition from new and existing competitors or consolidation in the industry could impair our ability to grow our business, to sustain our profitability, and to sell our products and technologies.
The markets for our products and technologies are highly fragmented, rapidly evolving, and intensely competitive, and we expect these characteristics to continue and increase. Aggressive competition from both hardware and software products and technologies could lengthen the customer evaluation process and result in price reductions and loss of sales, which would materially harm our business. Our business is highly sensitive to the introduction of new products and technologies (such as virtualization), price changes, and marketing efforts by numerous and varied competitors. Accordingly, our future success will be highly dependent upon our timely completion and introduction of new products, technologies, and features at competitive prices and performance levels that address changing industry trends and the evolving needs of our customers. We continue to experience aggressive price competition and increased customer sensitivity to product prices, and pricing and margin pressures are likely to increase in the future. Because of this competition, we may have to continue to lower the prices of many of our products and technologies or offer greater functionality within our products without increasing prices to deliver greater value to customers to stay competitive, while at the same time trying to maintain or improve our revenue and gross margin. Because our business model is based on providing innovative and high quality products, we may spend a proportionately greater amount on research and development than some of our competitors. If we cannot proportionately decrease our cost structure on a timely basis in response to competitive price pressures and the loss of revenue, our gross and operating margins and profitability could be adversely affected. In addition, if our pricing, functionality, and other factors are not sufficiently competitive, or if there is an adverse reaction to our product decisions, we may lose market share in certain areas, which could adversely affect our revenue and prospects.
We compete for sales of switching systems and extension products with companies such as Raritan Computer, Rose Electronics, Minicom Advanced Systems, Aten International, Belkin, Digi International, and Lantronix. These products also face competition from software providers (such as Microsoft, Computer Associates, Tivoli, Symantec, Novell, AMI, and BMC Software), who may be able to offer software products competitive with our hardware products at a much lower cost or even bundled for free with their other products, and from server manufacturers (including our OEM customers), who are able to offer their competitive technologies or products at the time of the server sale. These competitive software and hardware products address many of the problems our switching systems and technologies, extension products, and remote access products are designed to address.
We compete for sales of our systems management and security products with companies such as Microsoft, Computer Associates, BMC Software, Novell, and Symantec, many of whom have greater financial, technical, and marketing resources, a larger customer base, a longer operating history, greater name recognition, and more established relationships in the industry than we do, and may offer their own or third-party competitive software products at a lower cost or bundled for free with their other products. Microsoft, in particular, has delivered competitive products and announced its intention to continue to develop competitive software, and if it is successful in delivering software products that are competitive with our products, our ability to grow our software business may be limited.
Our current and potential competitors may be able to respond more quickly to new or emerging technologies or products and to changes in customer requirements or to devote greater resources to the research, development, promotion, sale, and support of their products and technologies than we do. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties that expand or enhance the ability of their products and technologies to address the needs of our current and prospective customers. Some of these competitors can also bundle hardware, software, and services together, and offer a more complete set of products and services than we are able to offer. We may not be able to compete successfully against current and future competitors and competitive pressure may materially harm our business, financial condition, operating results, and cash flows, or impair our ability to achieve our desired results.
Certain of our customers, such as Dell, Hewlett-Packard, IBM, Microsoft, and Symantec presently offer competitive hardware and/or software products and technologies that address many of the problems our products and technologies address. These customers could decide to manufacture or enhance their own switching, IPMI, or other embedded technologies, or systems management, security, and service desk products, or offer products or technologies supplied by competitors. Companies with hardware manufacturing experience or network management products, many of which are substantially larger than we are and have significantly more financial resources than we do, also offer products or technologies that compete with us. Established companies with hardware manufacturing or network management experience (such as Intel, Cisco, or EMC) could also offer new products, new technologies (such as virtualization), or new solutions that compete with, or reduce the demand for, our products and technologies.
There has been consolidation in the markets in which we compete, which we believe will continue and could lead to increased price competition and other forms of competition as companies attempt to maintain or extend their market positions in the rapidly changing IT industry. In addition, we may face competition in the future from large established companies or from emerging companies that have not previously entered the market or that do not currently have products that directly compete with our products. This could lead to more variability in our operating results for a variety of reasons including the lengthening of the customer evaluation process and/or the loss of business to these competitors, which may adversely affect our business, financial condition, and results of operations.
Our gross margins are expected to vary and may decline.
Gross margins may vary or decline from period-to-period and may be adversely affected by a number of factors, including:
· The ratio of OEM sales to branded sales, since OEM sales typically have lower gross margins than branded sales;
· The ratio of sales through indirect channels to direct sales, since indirect sales typically have lower gross margins than direct sales;
· The ratio of sales in established markets to sales in new markets with different pricing and cost structures;
· Sales of lower margin products or other changes in our product mix, because sales of some of our products and technologies will have lower gross margins than sales of other products or technologies (e.g. our software products tend to have higher gross margins);
· Increased price competition;
· Changes in product costs and sales discounts;
· Changes in raw materials, freight, regulatory, certification, import or export expenses, tariffs, and labor costs;
· Introduction of new products, services, business models, and technologies by us and by our competitors;
· The level of and costs for third-party technology and code used in our software products; and
· The level of and costs for outsourcing of our manufacturing and assembly services for our hardware products and the impact this can have on our inventory valuation of older products.
We expect that our gross margins may vary and may decline in the future primarily due to the factors listed above and to increased competition and the introduction of new products and technologies that may affect product prices and demand for our products.
We have limited protection of proprietary rights and face risks of third-party infringements.
Our future success depends in part upon our ability to develop and protect proprietary rights in our products and technologies. We seek to protect our intellectual property rights by invoking the benefits of the patent, trademark, copyright, trade secret, and unfair competition laws of the United States and other countries and the protections provided by confidentiality and nondisclosure agreements and other legal agreements. These laws and practices, however, afford only limited protection. There can be no assurance that the steps we have taken to protect our intellectual property rights, or that the steps we take in the future, will be adequate to prevent or detect misappropriation of our intellectual property or technologies or that our competitors will not independently develop proprietary or other technologies that are substantially equivalent or superior to our products or technologies. In addition, our proprietary information may be misused or improperly disclosed by third parties entrusted with this information. There also can be no assurance that our proprietary rights will not be challenged, invalidated, or avoided.
The U.S. Patent and Trademark Office has issued several patents to us for various aspects of our products. We have various corresponding patent applications pending under the provisions of the Patent Cooperation Treaty, which permits the filing of corresponding foreign patent applications in numerous foreign countries within a limited time period. We also have other United States and foreign patent applications pending. There can be no assurance that any additional patents will be issued from any of those pending applications or that any patents will be issued in any additional countries where our products can be sold. Claims allowed in our patents or in any pending patent applications may not be of sufficient scope or strength for, or provide meaningful protection or any commercial advantage to us or such claims may not be upheld if challenged. Also, competitors may develop their own intellectual property or technologies, obtain their own patents, or challenge the validity of, or be able to design around, our patents. The laws of certain foreign countries in which our products are or may be developed, manufactured, or sold (particularly certain countries in Asia) may not protect our products or intellectual property rights to the same extent as do the laws of the United States and thus increase the likelihood of piracy of our technologies and products.
We may initiate claims or litigation against other third parties for infringement of proprietary rights or to establish the validity of proprietary rights. Similarly, our competitors or other third parties may initiate claims or litigation against us alleging infringement of their proprietary rights or improper use of their intellectual property, and from time to time, third parties notify us that our products may infringe their intellectual property rights, which regardless of merit, requires our time and resources to evaluate and respond. Existing litigation, and any other litigation relating to intellectual property to which we become a party, is subject to numerous risks and uncertainties, including the risk of counterclaims or other litigation against us, and we may not be successful in any such litigation. Dealing with adverse claims and litigation is very expensive, and the existing litigation or any other litigation by or against us could result in significant additional expense, divert the efforts of technical and management personnel, whether or not such litigation results in a favorable determination, harm our relationships with existing customers, and deter future customers from purchasing or licensing our products. In the event of an adverse result in any such litigation, we could be required to pay substantial damages, suspend or cease the development, manufacture, use, marketing, and sale of any infringing products, expend significant resources to redesign products or develop non-infringing technology, discontinue the use of certain processes, or obtain licenses to the infringing technology. There can be no assurance that we would be successful in such development or that such licenses would be available on reasonable terms, or at all, and any such development or license could require us to expend substantial time and other resources. In the event that any third party makes a successful claim against us, or our customers, and a license is not made available on commercially reasonable terms, our business, financial condition, and results of operations could be adversely affected. In addition, any dispute involving our intellectual property could result in our customers, distributors, or resellers becoming involved in the litigation, which could trigger indemnification obligations in certain of our sales, license, or service agreements.
The IT industry is characterized by vigorous pursuit and protection of intellectual property rights or positions, which has resulted in significant and often protracted and expensive litigation. We have in the past been, and we may from time to time in the future be, a party in litigation or other proceedings alleging infringement of intellectual property rights owned by third parties. If necessary or desirable, we may seek licenses under such intellectual property rights. However, licenses may not be offered on terms acceptable to us, or at all. The failure to obtain a license from a third party for technology used by us
could cause us to incur substantial liabilities and to suspend or cease the manufacture of products requiring such technology. In addition, current or future competitors could obtain patents or other intellectual property rights that may prevent us from developing or selling our products. The result of these litigation matters is difficult to predict and an unfavorable resolution could affect our operating results, business, or financial condition. The resolution of litigation may have a negative impact on our operating results or financial condition.
Our recently-announced restructuring may disrupt our operations and adversely affect our operating and financial results.
In fiscal July 2008, and again in January 2009, we announced a series of actions designed to enhance competitiveness, improve our efficiency, and reduce our cost structure. We initiated workforce reduction and consolidation actions designed to intensify our focus on our growth areas and improve our operating efficiency. The restructuring includes actions to increase our organizational efficiency, reduce certain research and development investments in lower growth product areas, integrate our marketing functions, and shift support for our Asian operations from Shannon, Ireland, to our recently-established regional hub in Singapore. We are also relocating certain functions from Redmond, Washington to Huntsville, Alabama. The impact of these organizational improvements will result in a net decrease of approximately 273 positions or approximately 13% of our global workforce. In fiscal July 2008, we also announced that, as part of our continued focus on core markets, we intend to sell the portion of our entrepreneurial Connectivity and Controls business unit dedicated to our Professional Audio Video and our Equinox serial products. The restructuring activities could create uncertainty and confusion among our employees, customers, and suppliers. In addition, the restructuring activities might not result in the cost savings or efficiencies we anticipate and may result in temporary operational inefficiencies. As a result, these restructuring activities could have a material adverse effect on our business, financial condition, and results of operations. The factors described above also could disrupt our product development, manufacturing, and sales, which would affect our financial results.
We are likely to experience fluctuations in operating results.
We have in the past experienced substantial fluctuations in revenue, bookings, and operating results, on a quarterly and an annual basis, and we expect these fluctuations will continue in the future. Our operating results will be affected by a number of factors, including, but not limited to:
· The volume, timing, pricing, and contractual terms of orders, particularly from OEMs, resellers, and other large customers, a significant portion of which tend to occur late in each quarter;
· The timing of shipments;
· The unpredictable nature of the sales cycle for software products and the timing and completion of delivery of software products and any related services;
· The timing of new product introductions, new technologies, and enhancements by us and by our competitors, and the possibility that customers may defer purchases of our products in anticipation of these new products, new technologies, and enhancements;
· Changes in or our failure to accurately predict product or distribution and reseller channel mixes, including changes in the mix of software licenses in which revenue is recognized upfront as opposed to subscription licenses that are deferred over time and changes in the mix of revenue attributable to higher-margin products as opposed to lower-margin sales or services;
· Changes in demand for our products and services;
· Changes in pricing policies, price reductions, and channel programs;
· Changes in laws, regulations, or other government requirements;
· Changes in renewal rates for software upgrade protection or maintenance;
· Competition from new products, technologies, business models, and price reductions by competitors;
· The availability and cost of supplies, components, or third-party code or content on commercially reasonable terms;
· Compatibility or interoperability of our products with third-party systems and applications;
· Sales and marketing expenses related to entering into new markets, introducing new products, new technologies, and retaining current OEMs, resellers, and other large customers;
· Fluctuations in sales of servers and personal computers due to changes in technology (such as virtualization), economic conditions, or capital spending levels;
· The amount and timing of operating expenses and capital expenditures relating to the expansion of our business and operations; and
· Costs associated with legal proceedings, including legal fees and any adverse judgments or settlements.
Our operating results will continue to be affected by seasonal trends, by general conditions in the IT market, and by general economic conditions. Depending on the severity and longevity of the current economic crisis, we may see fluctuations in our operating results. In addition, we have experienced, and we expect to continue to experience, some degree of seasonality due to customer buying cycles and delays in customer orders during unfavorable economic periods. We believe that the third and fourth quarters will generally have higher net sales levels due to customer budgeting and procurement cycles, which may depress net sales in other quarters. In addition, European sales are often weaker during the summer months. In the past, we have typically seen a sequential decline in revenue from the fourth quarter of a year to the first quarter of the following year, and while it is difficult to predict revenue in any quarter, we expect that this pattern will continue in the future. Many of the factors that create and affect seasonal trends are beyond our control.
Our quarterly sales have also reflected a pattern in which a disproportionate percentage of each quarters total sales occur toward the end of the quarter, and this trend has become more pronounced in recent periods. Our increased focus on the software market continues this trend with a greater proportion of our software revenue coming from software license and subscriptions booked in the last weeks or days of each quarter. This uneven sales pattern makes prediction of revenue, earnings, and working capital for each financial period difficult, increases the risk of unanticipated variations in quarterly results and financial condition, and places pressure on our hardware inventory management and logistics systems. If predicted demand for hardware is substantially greater than orders, there will be excess inventory. Alternatively, if hardware orders substantially exceed predicted demand, we may not be able to fulfill all of the orders received in the last few weeks of each quarter. Other developments late in a quarter, such as a systems failure, component pricing movements, actions or announcements from our competitors, global logistics disruptions, or large sales opportunities not being completed when predicted, could adversely impact inventory levels and results of operations in a manner that is disproportionate to the number of days in the quarter affected. In addition, accounting requirements associated with satisfying the various elements necessary to recognize software revenue may result in significant fluctuations in our quarterly results.
In order to remain competitive and provide our increasingly sophisticated customers with more options, we have made and expect to continue to make new products and new software purchasing and licensing options available to our customers. These new products and options may result in an increase in contracts where software revenue is deferred or cash is received over time as opposed to recognition of revenue or payment at or about the time of the purchase or license.
We believe that quarter-to-quarter comparisons of our historical financial results are not meaningful indicators of our future operating results, and you should not rely on them as an indication of our future performance. If our quarterly operating results fail to meet the expectations of equity research analysts, the price of our common stock could be negatively affected.
A large portion of our business consists of sales to a limited number of resellers and distributors that are not obligated to continue doing business with us, and these sales vary considerably from quarter to quarter.
A large portion of our sales consists of sales of our branded products to a limited number of resellers and distributors. Sales to resellers and distributors represented approximately 60% of net sales in 2008, 61% of net sales in 2007, and 56% of net sales in 2006. The loss of significant revenue opportunities with these resellers and distributors could negatively impact our results of operations. In addition, many of these customers also have or distribute competing products. If resellers and distributors elect to increase the marketing of competing products or reduced marketing of our products, our ability to grow our business will be negatively impacted and will impair one of our substantial revenue sources.
Our reseller and distributor business is subject to many risks, including:
· Concentration of business in a limited number of resellers and distributors could result in significant damage to our business upon the termination of a reseller relationship;
· Termination of reseller and distributor agreements or reduced or delayed orders;
· Difficulty in predicting sales to resellers and distributors who do not have long-term commitments to purchase from us, which requires us to maintain sufficient inventory levels to satisfy anticipated demand;
· Lack of visibility of end user customers and revenue recognition and channel inventory issues related to sales by resellers and distributors;
· Resellers and distributors electing to resell or increase their marketing of competing products or technologies or reduced marketing of our products; and
· Changes in corporate ownership, financial condition, credit worthiness, payment patterns, business direction, sales compensation related to our products, or product mix by the resellers and distributors.
Any of these risks could have a material adverse effect on our business, financial condition, and results of operations. We have experienced, and expect to continue to experience, pricing pressures and significant variability in orders from our resellers and distributors, which may in the future have a material adverse effect on our quarterly sales and operating results.
The loss of one or more large resellers or distributors could materially harm our business. While we have reseller and distributor agreements, none of our resellers or distributors are obligated to purchase products from us. Consequently, any reseller or distributor could cease doing business with us at any time. Our dependence upon a few resellers and distributors could result in a significant concentration of credit risk, thus a substantial portion of our trade receivables outstanding from time to time may be concentrated among a limited number of customers. In addition, the inability to accurately forecast the timing and volume of orders for sales of branded products to resellers and distributors during any given quarter could adversely affect operating results for such quarter and, potentially, for future periods. If we underestimate sales, we will not be able to fill orders on a timely basis. This could cause customer dissatisfaction and loss of future business. If we overestimate sales, we will experience increased costs from inventory storage, waste, and obsolescence.
We will need to expand our sales distribution channels in order to develop our business and increase revenue.
We expect to rely increasingly on distributors and resellers, VARs, and systems integrators for the distribution and sale of our branded hardware and software products. Our strategy contemplates the expansion of our distributor and reseller networks both domestically and internationally, particularly in Asia, and an increase in the number of customers licensing our products through these expanded channels. Our future success will depend in part on our ability to attract, train, and motivate new distributors and resellers and expand our sales distribution channels. We may not be successful in expanding our distributor and reseller relationships. We will be required to invest significant additional resources in order to expand these relationships, and the cost of this investment may exceed the margins generated from this investment. Conducting business through indirect sales channels presents a number of risks, including:
· Difficulties in replacing any lost or terminated distributors or resellers;
· Existing or new distributors and resellers may not be able to effectively sell our current or future products or services;
· Potential distributors and resellers deciding not to enter into relationships with us because of our existing relationships with other distributors and resellers with which they compete;
· Our ability to provide proper training and technical support to our distributors and resellers;
· The possibility of damage or impairment to our market position, brands or trademarks as a result of the actions of our distributors and resellers;
· Distributors and resellers electing to place greater emphasis on products or services offered by our competitors; and
· The lack of direct control over the business practices, marketing, sales and services offered by distributors and resellers.
As we expand our distribution and reseller channels, we will also need to expand our sales organization and invest substantial resources toward this expansion. We may experience difficulty in recruiting, training, and retaining qualified sales personnel, and any failure to obtain, train, and keep qualified personnel could limit our ability to sell products.
In addition, distributors and resellers of our hardware products often have rights of return, and in the future, these returns from our existing or any new distributors and resellers may have a material adverse effect on our business, financial condition, and results of operations. Our agreements with our current distributors and resellers are generally nonexclusive and may be terminated on short notice by either party without cause, and any new distributor or reseller agreements are likely to contain similar provisions. Distributors and resellers are not obligated to purchase products from us and frequently offer products from several different companies, including competitors products, and distributors and resellers may give higher priority to the sale of our competitors products. A reduction in sales efforts or efficiency by our distributors or resellers could lead to a reduction in our sales and could materially adversely affect our business, financial condition, and results of operations.
A large portion of our business consists of sales to a limited number of OEM customers that are not obligated to continue doing business with us, and these sales vary considerably from quarter to quarter.
A large portion of our sales is concentrated among a limited number of OEM customers. Aggregate sales to these OEMs represented approximately 33% of our net sales in 2008, 35% of net sales in 2007, and 40% of net sales in 2006. The following table identifies our customers that exceeded 10% of our net sales for the years 2008, 2007, and 2006:
We have experienced, and we expect to continue to experience, period-to-period variability in sales to these OEM customers. Any cancellation, rescheduling, or reduction of orders by OEM customers in the future could materially adversely affect our operating results. Although our OEM customers typically place orders for products up to several months prior to scheduled shipment dates, these orders are subject to cancellation.
Our OEM business is subject to many risks, including:
· Contract termination or reduced or delayed orders;
· Short order cycles and difficulty in predicting sales because our OEM customers do not have long-term commitments to purchase from us;
· Changes in the OEMs internal product life cycles including the delay of planned new product introductions and uncertainty over product end-of-life decisions;
· Adoption of competing products or technologies developed by third parties for the OEMs, acquisition or internal development of competing products or technologies by the OEMs, or changes in the OEMs marketing of competing products or reduced marketing of our products; and
· Changes in corporate ownership, financial condition, credit worthiness, payment patterns, business direction, sales compensation related to our products, or product mix by the OEMs.
Any of these risks could have a material adverse effect on our business, financial condition, and results of operations. We have experienced, and expect to continue to experience, pricing pressures and significant variability in orders from our OEM customers, which may in the future have a material adverse effect on our quarterly sales and operating results.
Although we are not substantially dependent on any one OEM customer, the loss of one or more large OEM customers would materially harm our business. While we have agreements with some of our OEM customers, these agreements are generally cancellable at the will of the OEM (generally subject to notice provisions), and none of our OEM customers is obligated to purchase products from us except pursuant to binding purchase orders or licensing agreements. Consequently, any OEM customer could cease doing business with us at any time. Our volume of sales from just a few OEMs also results in a significant concentration of credit risk, thus a large portion of our trade receivables outstanding from time to time may be concentrated among a limited number of customers. In addition, OEM customers have longer payment cycles that increase the likelihood of aged or problem accounts receivable.
We use multiple warehouses for many of our OEM customers to fulfill their hardware orders under a just-in-time inventory management system, which requires us to maintain sufficient inventory levels of our hardware products at each of these warehouses to satisfy anticipated demand from our OEM customers, and we generally recognize revenue only when these OEM customers take possession of our hardware products. We are required to plan production, order components, and undertake our manufacturing activities prior to the time that these orders become firm or the products are accepted. In addition, our OEM customers have requested, and are likely to continue to request from time to time, that we delay shipment dates or cancel orders for hardware products that are subject to firm orders. As a result, at any time we may be holding a significant amount of OEM-branded hardware products in inventory, and our sales to OEMs for future quarters are difficult to predict. The inability to accurately predict the timing and volume of hardware orders for our OEM customers during any given quarter could adversely affect operating results for that quarter and, potentially, for future quarters. If we underestimate sales, we may not be able to fill orders on a timely basis. This could cause customer dissatisfaction and loss of future business. If we overestimate sales, we may experience increased costs from inventory storage, waste, and obsolescence.
Our failure to respond to rapid technological change or to introduce successful new products and technologies may result in reduced revenue or revenue growth.
The process of developing or acquiring new products, software, and technologies and enhancing existing products, software, and technologies is complex, costly, and uncertain, and any failure by us to anticipate customers changing needs and emerging technological trends accurately could significantly harm our market share and results of operations. Our products and technologies are characterized by rapid technological advances, frequent new product and technological introductions and enhancements, and significant price competition. If we do not keep pace with these changes, we will lose customers, and our business will be adversely affected. The introduction of products or technologies incorporating superior alternatives such as switching software, the emergence of new industry standards such as virtualization, or changes in pricing structure could render our existing products and technologies and those we have under development obsolete or unmarketable. New technologies offered by us or our competitors could compete with our existing products at a lower price, which could reduce our revenue.
Our future success will depend in large part upon continued innovative application of commercially available components and software or technologies, continued enhancements to our proprietary hardware, software, firmware, and other technologies, the expansion and enhancement of existing products and technologies, and our development and introduction of new products and technologies that address changing industry trends (including virtualization) and customer needs on a cost-effective and timely basis. If we fail to respond on a timely basis to technological developments, changes in industry standards, customer requirements, competitive products, product localization, or software innovations, we will lose customers, and our business will be greatly harmed. Similar results could occur if we experience significant delays in the development or introduction of new products or technologies.
We are dependent upon third-party suppliers and outsourced manufacturing for our hardware products. Disruption of our access to these supplies and services, or problems with the quality of supplies or services, could prevent us from filling customer orders and harm our business.
The principal components of our hardware products are electronic components, power supplies, semiconductors, memory, cable assemblies, line filters, enclosures, and printed circuit boards, all of which are purchased from outside vendors. We generally buy components under purchase orders and generally do not have long-term agreements with our suppliers. Also, we generally do not maintain large inventories of components. Any termination of, or significant disruption of, our relationships with the suppliers of our product components may prevent us from filling customer orders in a timely manner which could result in customer dissatisfaction and lost sales.
We have occasionally experienced, and we may in the future experience, shortages or delays in delivery of components. Although alternate suppliers are available for most of the components and services needed to produce our products, the number of suppliers of some components is limited, and qualifying a replacement supplier and receiving components from alternate suppliers could take several months.
We have limited ability to control quality issues (particularly with respect to faulty components manufactured by third parties), and we depend upon suppliers to deliver components that are free from defects, competitive in functionality and cost, and in compliance with specifications and delivery schedules. Disruption in supply, a significant increase in the cost of one or more components, failure of a third-party supplier to remain competitive in functionality or price, or the failure of a supplier to comply with any of our procurement needs could delay or interrupt our ability to manufacture and deliver our products to customers on a timely basis, thereby delaying our revenue recognition and adversely affecting our business, financial condition, and results of operations.
We rely on third-party manufacturers for subassembly of products and for final assembly, quality assurance, and testing of many of our products. These outsourcing arrangements and any future outsourcing arrangements involve numerous risks, including the economic and financial viability of these manufacturers, reduced control over product quality, delivery schedules, manufacturing yields, and costs. Moreover, although arrangements with such manufacturers may contain provisions for warranty obligations on the part of such manufacturers, we are primarily responsible to our customers for warranty obligations.
Our hardware products are subject to warranty claims and returns. Increased warranty claims or returns could harm our business.
We typically offer a 30-day unconditional money-back guarantee on our appliance products sold in North America. We also offer warranties for parts and service on our hardware products, ranging from one to three years (and, in the case of some of our Equinox branded products, five years). Although our historical return experience has not been significant, our returns may increase in the future. An increase in returns would have an adverse effect on our sales and could negatively affect our financial results.
For our software products, sales are final and we do not generally allow any returns. We provide a 90-day limited warranty on the media used to deliver the software, which is not applicable to electronic downloads, and we generally provide a 90-day limited warranty (except where a longer period is required by law) that our products will function in accordance with the user documentation.
In the future, we may, as a result of competitive pressures, requirements in certain geographies, or customer demands, change our warranty policies or our warranty terms to provide coverage that is greater in scope and duration than the coverage we currently offer. If we were to increase our warranty coverage, our risk of warranty claims, and therefore our warranty expense and reserves, would likely increase.
We must meet the increased demands on customer service operations or customer satisfaction and sales could suffer.
Continued growth of our sales is likely to be accompanied by increasing demands on our customer service operations. As a result of our commitment to a high level of customer service, we will need to invest significant resources in the maintenance and improvement of our customer service resources. Any failure to maintain adequate customer service could cause customer dissatisfaction, result in reduced sales of products, reductions in the renewals of software maintenance and support agreements for future periods, and, accordingly, materially adversely affect our business, financial condition, and results of operations.
If we are unable to successfully develop our international distribution and reseller networks and international sales efforts, results of operations may suffer.
We are working to develop, integrate, and expand our international distribution and reseller networks in an effort to increase international sales and availability of our products. We may not be successful in developing or expanding the international distribution and reseller network or in marketing and selling products in foreign markets, particularly Asia. If the revenue generated by our international sales is not adequate to recover the expense of establishing, expanding, and maintaining an international distribution and reseller network, our business, financial condition, and results of operations
could be materially adversely affected. If international sales become a more significant component of net sales, our business could become more vulnerable to the risks inherent in doing business on an international level, including:
· Difficulties in managing foreign distributors and resellers;
· Longer payment cycles and problems in collecting accounts receivable;
· The effects of seasonal customer demand;
· Differing license terms and conditions to meet local requirements;
· Changes in regulatory requirements;
· Difficulties in meeting the requirements of different international product regulations, including import and export requirements, tariffs, and other trade barriers;
· Risks relating to the protection of our intellectual property rights;
· The impact on our marketing expenses and our research and development resources as we localize our product offerings to meet local user requirements such as language translations and hardware compatibility issues;
· Fluctuations in currency exchange rates; and
· Potentially adverse tax consequences and political instability.
The existence or occurrence of any one or more of these factors could have a material adverse effect on our business, financial condition, and results of operations.
Due to the international nature of our business, political or economic changes or other factors could harm our future revenue, increase our costs and expenses, and impair our financial condition.
We are a global company with sales, manufacturing, and research and development efforts around the world. Sales outside the United States generate approximately half of our revenue, over half of our manufacturing takes place outside the United States, and we have research and development centers in several locations outside the United States. Accordingly, our business, operating results, future revenue, gross margin, expenses, and financial condition could suffer due to a variety of international factors, including:
· Ongoing instability or changes in a countrys or regions economic or political conditions, including inflation, recession, interest rate fluctuations, and actual or anticipated military or political conflicts, particularly in areas where we have offices or other facilities;
· Currency fluctuations, which could contribute to variations in sales of products and technologies and could also affect our reported results expressed in U.S. dollars;
· Longer accounts receivable cycles and financial instability among customers;
· Tax or trade regulations, tariffs, duties, and procedures and actions affecting production, pricing, and marketing of or payments for products;
· Local labor conditions and other regulations;
· Differing technology standards or customer requirements;
· Limited or unfavorable intellectual property protection in certain foreign countries including the loss of proprietary information due to piracy or misappropriation;
· Fluctuations in freight costs and disruptions at important geographic points of exit and entry;
· Natural or manmade disasters, such as earthquakes, tsunamis, flooding, hurricanes, typhoons, fires, power shortages, blackouts, telecommunications failures, terrorism, or computer viruses;
· Medical epidemics;
· Seasonal reductions in business activity in certain foreign countries, such as the summer months in Europe;
· Compliance with a wide variety of complex laws, treaties, and regulations that increase the risks of doing business in certain foreign countries;
· Restrictions against repatriation of earnings from our international operations;
· Difficulties in staffing and managing international operations, including the difficulty in managing a geographically dispersed workforce;
· Possible non-compliance with our Code of Conduct or other corporate policies due to inconsistent laws, interpretations, and/or application of corporate standards in foreign countries;
· Increased financial accounting and reporting burdens and complexities; and
· The need to localize our products.
The factors described above also could disrupt our product development and manufacturing, key suppliers, and OEMs and resellers located outside of the United States. For example, we rely on manufacturers in Asia and Europe for the assembly and manufacture of many of our hardware products, and we conduct substantial software development and testing operations in China and Taiwan. Accordingly, we are directly affected by economic, political, and military conditions in the regions where we have operations, including China and Taiwan. In particular, any interruption or curtailment of trade between China and its present trading partners could materially adversely affect our product development, product releases, support, business, operating results, and financial condition.
Continued or increased international political instability, evidenced by the threat or occurrence of terrorist attacks, enhanced national security measures in the United States or other countries, sustained military action or other conflicts, or strained international relations may impair our ability to do business, increase our costs and adversely affect our stock price. Increased international instability may negatively impact our ability to obtain adequate insurance at reasonable rates or require us to take extra security precautions for our domestic and international operations.
Fluctuations in the value of foreign currencies could result in currency exchange losses.
Currently, a majority of our international business is conducted in U.S. dollars. As we expand our international operations, however, it is likely that international business will increasingly be conducted in foreign currencies. Fluctuations in the value of foreign currencies relative to the U.S. dollar have caused, and are expected to increasingly cause, currency transaction gains and losses. In addition, currency fluctuations could also affect our reported results expressed in U.S. dollars. While we attempt to hedge our foreign currency exposure, we cannot predict the effect of exchange rate fluctuations upon future quarterly and annual operating results, and we may experience currency losses in the future.
The sales cycle for our software products is unpredictable, making it difficult to forecast operating results for any given period.
The sales cycle for our software products is typically ninety to one hundred eighty days or longer. This sales cycle is subject to a number of significant risks over which we have little or no control, including:
· Customers budgetary constraints, fluctuations, or uncertainty, internal acceptance requirements, and procurement procedures;
· The actions or announcements of our competitors and their products;
· Customer concerns about the future or performance of our company; and
· Changes in economic conditions generally, in the technology market specifically, and in a customers particular industry.
Moreover, our software license revenue is heavily weighted toward the end of each quarter, with as much as ninety percent of LANDesks license revenue recorded in the third month of a quarter, making it difficult to forecast operating results for any quarter or give accurate guidance. For large opportunities, especially for enterprise-wide sales, the sales cycle is often significantly longer than our average sales cycle. In addition, these large opportunities are more difficult to forecast, and if we do not correctly forecast the timing in a given period, the amount of revenue we recognize in a period could be higher or lower than we expect, which could significantly affect our operating results for the then current period and future periods over which revenue would have been recognized. The terms and conditions of the legal agreements for these large opportunities are often based on our customers purchase agreements and may contain terms that are generally less favorable to us than our standard terms and conditions. As a result, revenue recognition may be delayed or otherwise negatively affected, and if we fail to meet expectations, the price of our common stock could be negatively affected.
A significant percentage of our software revenue is dependent on sales to existing customers or the renewal of annual software upgrade protection or maintenance services by existing customers.
Our LANDesk business unit has historically derived, and plans to continue to derive, a significant portion of our total software revenue from existing customers who purchase additional products or annual maintenance or upgrade protection. As we introduce new software products, our current customers may not require or desire the functionality of our new products and may choose not to license these new products or renew their agreements for maintenance or upgrade protection. If our current customers do not purchase additional products, increase the numbers of our products already in use, or renew annual software upgrade protection or maintenance services, our ability to increase or maintain revenue levels could be limited to only new customers.
Maintenance revenue related to the licensing of our software products is a significant part of our current and future operating revenue. In general, maintenance fees increase with increased use of our software because we receive higher maintenance fees when we enter into new license agreements with new customers and when existing customers license our products for use on additional systems. Due to increased discounting for larger sales opportunities, maintenance fees on a per unit basis for such large deals can be lower than average. In addition, customers are generally provided annual maintenance discounts for entering into long-term maintenance agreements. Declines in our license bookings, increases in long-term maintenance agreements, customers electing to migrate to competitive products or other alternatives to our products, and/or increased discounting could lead to reduced software maintenance revenue and reduced gross margins.
Our software products are designed with interoperability or compatibility with many third-party platforms, systems, and applications, the absence of which may harm our business.
Our software products are designed for use with specific third-party platforms, systems, and applications. We believe the breadth of our integration with such platforms, systems, and applications is a significant competitive advantage. Any significant change in these third-party products could result in the loss of interoperability or compatibility with our products, making our products less attractive, increasing our research and development costs in order to modify our products, license new solutions, or develop new products, and potentially harming our future revenue. Our failure to anticipate, manage and adapt to these risks could result in significant delays in our product releases, changes in our product roadmaps, loss of current customers for whom the lost compatibility is an issue, and damage to our operating results.
Our software products include licensed third-party content or code upon which we rely for the interoperability, integration, development, or updates of our products, and disruption of our access to such code or content could delay product releases, inhibit our compatibility with third-party products, and harm our business.
The principal components of our software products are proprietary code and content. We do, however, rely on some licensed third-party code, content, or other intellectual property, and we expect to use such third-party code, content, or intellectual property in future products. Although we believe that there are usually adequate alternative sources for the third-party technology licensed to us, any significant interruption in the availability of these third-party software products on commercially acceptable terms or any defects in these products could delay development of future products or enhancement of our future products and harm our revenue. Use of such third-party code, content, or other intellectual property presents risks such as:
· Owners or licensees of third-party systems could adopt more restrictive policies or impose unfavorable or unacceptable terms and conditions for access to their products making it more difficult for us to make our products compatible with their products and resulting in higher research and development costs for us for the enhancement or modification of our existing products and the development of new products;
· Functionality provided by third-party code, content, or other intellectual property in our products may become obsolete, defective, or incompatible with future versions of our products, may not be adequately maintained or updated, and we may be unable to find viable alternatives or develop our own proprietary solution;
· Quality, warranty, and support terms vary dramatically when licensing third-party code, content, or other intellectual property and we have limited ability to control quality issues with third-party code, content, or other intellectual property and we must depend on our own research and development personnel to evaluate and select third-party code, content, or other intellectual property that we believe is of the most value to our customers; and
· Technical difficulties in integrating our products and third-party code, content, or other intellectual property to create a combined solution, and the risk that customers will not perceive the need for such integrated solutions.
Any significant termination of a third-party license, change in third-party license provisions, increase in the cost of such third-party code, content or other intellectual property, failure of a code, content or other intellectual property provider to remain competitive in functionality, or defect in or a quality issue could delay or interrupt our ability to develop and deliver software products to customers on a timely basis. This could delay our revenue recognition and adversely affect our business, financial condition, and results of operations and possibly expose us to claims under license agreements with our customers and possibly increased litigation fees and expenses. Our failure to anticipate, manage, and adapt to these risks could result in significant delays in our products releases, changes in our product roadmaps, and damage to our operating results.
Software errors or bugs, and possible product liability claims related to such errors or bugs, could result in increased costs, damage to our reputation, and loss of market share.
Our software products are generally large and intricate programs. As a result, our current software products, updates, upgrades, or future products may contain errors, failures, or bugs, some of which may not become known until after the product has been released by us for use by customers. While we routinely test our products for such errors and identify and correct bugs through our customer support group, these problems are inevitable. Any significant errors may result in, among other things, loss of, or delay in, the market acceptance or our products, lost revenue and sales of our products, reallocation of, or increases in, development and customer support resources, impairment to our reputation, loss of future renewal or maintenance revenue, and increased service and warranty costs. Errors could also result in significant delays in the release of updates, upgrades, or new products while such errors are corrected. Moreover, because our products primarily support other systems and applications, any software errors or bugs in these other systems or applications may affect the performance of our software, and it may be difficult or impossible to determine where the errors reside. As a result, product errors, failures, or bugs could result in significant harm to our business and have a material adverse effect on our results of operations.
We may be subject to legal actions or claims for damages related to product errors which could, whether or not successful, increase costs and distract our management and our development and support teams and could harm our business, result in unexpected expenses and damage our reputation. Our license agreements with our customers typically contain provisions designed to limit exposure to potential product liability claims, and, to the extent permitted by governing law, our standard agreements in many jurisdictions also provide that we will not be liable for indirect or consequential damages caused by the failure of our products. In certain jurisdictions, however, warranty and limitation of liability provisions are not effective.
Use of free or open source software or technology in our products or in the development of our products may reduce our ability to control the quality and support for products and may result in damage to our operating results.
Free or open source software is software that is made widely available by its authors or other third parties and is often licensed on an as is basis for a nominal fee or, in some cases, at no charge. We have incorporated some free and open source software into our products, allowing us to enhance certain solutions without incurring substantial additional research
and development costs. In addition, we may use free or open source tools in the development of our products. While we have not experienced any material problems as a result of our use of free or open source software, use of free or open source software entails significant risks including:
· Free or open source software or technology becoming competitive with our proprietary technology, which could cause sales of our products to decline or force us to reduce the fees we charge for our products, which could have a material adverse impact on our revenue and operating margins;
· Requiring that we make available the source code for any modifications or derivative works we make to or from the free or open source software, and that we license or contribute such modifications or derivative works under the terms of a particular free or open source license or other license granting third parties certain rights of further use;
· Our proprietary software could be combined with open source software in such a way that we would be required to release the source code of our proprietary software; and
· The lack of any warranty, maintenance, or support for most open source software or technology.
We have established processes to help minimize these risks to the extent within our control, including a review process for screening requests from our development organizations for the use of free or open source, but we cannot be sure that all free or open source software, technology, or tools are submitted for approval prior to use in our products or in the development of our products or that all use is in compliance with our corporate policies. These risks, if not eliminated, could negatively affect our ability to sell and license our products and could materially impact our business.
Executive officers and other key personnel may depart, which could adversely affect our results of operations and harm our ability to grow the business.
We are greatly dependent on the ability to retain key management, sales, and technical personnel, and our future success is highly dependent upon the personal efforts of our management, sales, and technical personnel and other key employees. Our Executive Vice President in charge of our Management Systems business unit departed in February 2009, and his loss or the loss of services of other key personnel could have a material adverse effect on our business, financial condition, and results of operations. We have attempted to mitigate these risks by offering key employees retention bonuses (payable only if they continue employment with us for specified periods) and equity awards that vest over time, but there is the risk that we could nevertheless lose key management, sales, and technical employees.
We have historically used stock options and are currently using an Employee Stock Purchase Plan and restricted stock units, including time-based, performance-based, and market conditioned-based shares, as a key component in our executive and employee compensation programs in order to align employees interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. Many of our employee stock options are fully vested, but most of these outstanding and vested options are currently underwater. This could affect our ability to retain present employees. In addition, we are now required to record a charge to earnings for employee stock option grants and other equity incentives. Moreover, applicable stock exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to make equity awards to employees in the future. As a result, we may incur increased compensation costs, change our equity compensation strategy, or find it difficult to attract, retain, and motivate employees, any of which could materially adversely affect our business.
As we expand our international operations, we will be required to recruit and retain experienced management, sales and technical personnel in our international offices, and we expect that the identification, recruitment, training and retention of such personnel will require significant management time and effort and resources. Competition for employees with the skills required, particularly management, engineering and other technical personnel, is intense, and there can be no assurance that we will be able to attract and retain highly skilled employees in sufficient numbers to sustain our current business or to support future growth. We may need to pay recruiting or agency fees and offer additional compensation or incentives to attract and retain these and other employees, resulting in an increase to our operating expenses.
In addition, for the last several years, we have acquired several companies and these acquisitions have resulted in increased responsibilities and placed significant strain on our managerial, operational, and financial resources and resulted in new and increased responsibilities for management personnel. There can be no assurance that our management, personnel, systems, procedures, and controls are, or will be, adequate to support our existing and future operations or that we will continue to grow. If we fail to recruit and retain sufficient and qualified managerial, operational, or financial personnel or to
implement or maintain internal systems that enable us to effectively manage our growing business and operations worldwide, our financial results in any given period may be adversely affected and our business and financial condition could be materially harmed.
Our credit facility could adversely affect us and our operations.
In the second quarter of 2006, we obtained a $250 million unsecured, five-year, revolving, bank line of credit, and we used borrowings under this line of credit to fund a portion of the LANDesk acquisition and the purchase of our shares under our recently-expanded stock repurchase program. In July 2008, we amended the line of credit and borrowed an additional $90 million under a three-year term note. We may increase this bank debt or seek other bank debt in the future. The balance outstanding on our debt agreements was $170 million as of December 31, 2008. Interest expense on borrowings under the term loan and additional future borrowings under the line of credit could adversely affect our future net income, margins, expenses, and financial conditions by:
· Requiring us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, which would reduce the availability of our cash flow to fund internal growth through working capital and capital expenditures and for other general corporate purposes;
· Increasing our vulnerability to economic downturns in our industry;
· Increasing our vulnerability to interest rate increases to the extent any of our variable rate debt is not hedged;
· Placing us at a competitive disadvantage compared to our competitors that have less debt in relation to cash flow;
· Limiting our flexibility in planning for or reacting to changes in our business and our industry;
· Limiting, among other things, our ability to borrow additional funds, refinance the line of credit, or obtain other financing capacity; and
· Subjecting us to a risk of noncompliance with financial and other restrictive covenants in our indebtedness.
The line of credit and term loan contain affirmative and negative covenants, including limitations on our ability to (i) make distributions, investments, and other payments unless we satisfy certain financial tests or other criteria, (ii) incur additional indebtedness, (iii) restructure our subsidiaries, and (iv) make acquisitions and capital expenditures. All of these restrictions could affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. The failure to comply with these covenants could result in an event of default which, if not cured or waived, could have a material adverse effect on us.
Our ability to comply with these provisions of our line of credit and term loan may be affected by changes in the economic or business conditions or other events beyond our control. If we do not comply with these covenants and restrictions, we could be in default under our line of credit and/or the term loan, and our debt, together with accrued interest, could then be declared immediately due and payable. There can be no assurance that we will be able to obtain sufficient funds to enable us to repay or refinance our debt obligations on commercially reasonable terms or at all. We also face interest rate risk on our bank line of credit and term loan which currently bears interest at a variable rate of LIBOR plus 150 basis points. We have hedged this exposure to interest rate risk with interest rate swaps, which have a remaining notional amount of $170 million, through Regions Bank and SunTrust Bank.
Unanticipated changes in our tax rates or exposure to additional income tax liabilities could affect our profitability.
We are subject to income taxes in both the United States and various foreign jurisdictions, and our domestic and international tax liabilities are subject to the allocation of expenses in different jurisdictions. Our effective tax rates could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, in the valuation of deferred tax assets and liabilities, in tax laws and treaties, or by material audit assessments, which could affect our profitability. In addition, the amount of income taxes we pay is subject to audit in various jurisdictions, and a material assessment by a governing tax authority could affect our profitability.
Failure to maintain adequate internal systems and effective internal controls over our financial reporting and information systems could result in our management and auditors being unable to certify the effectiveness of our internal controls over financial reporting and information systems, which could harm our business reputation and cause our stock price to decline.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that we implement and maintain adequate internal systems and effective internal controls over financial reporting and information systems. The absence of such controls could have a material adverse effect on our business, financial condition, and results of operations. In addition, correction of any significant deficiencies or material weaknesses (as defined under PCAOB guidelines) could require additional remedial measures including hiring additional personnel, which could be costly and time-consuming. If a significant deficiency or material weakness exists at any year-end (including a material weakness identified prior to year-end for which there is an insufficient period of time to evaluate and confirm the effectiveness of the corrections or related new procedures), our management and our auditors will be unable to report favorably as to the effectiveness of our control over financial reporting or information systems. This could result in a loss of investor confidence in the accuracy and completeness of our financial reports and our management, which could result in a decline of our stock price, damage to our business reputation, and potential litigation.
Provisions in our charter documents and in Delaware law may discourage potential acquisition bids for us and may prevent changes in management that stockholders may favor.
Provisions in our charter documents could discourage potential acquisition proposals and could delay or prevent a change in control transaction that stockholders may favor. These provisions could have the effect of discouraging others from making tender offers for shares, and as a result, these provisions may prevent the market price of our common stock from reflecting the effects of actual or rumored takeover attempts and may prevent stockholders from reselling their shares at or above the price at which they purchased their shares. These provisions may also prevent changes in management that stockholders may favor. Our charter documents do not permit stockholders to act by written consent, limit the ability of stockholders to call a stockholders meeting, and provide for a classified Board of Directors, which means stockholders can only elect, or remove, a limited number of directors in any given year. Furthermore, our Board of Directors has the authority to issue up to five million shares of preferred stock in one or more series. The Board of Directors can fix the price, rights, preferences, privileges, and restrictions of such preferred stock without any further vote or action by our stockholders. The issuance of shares of preferred stock may delay or prevent a change in control transaction without further action by our stockholders.
In addition, Delaware law may inhibit potential acquisition bids for us. Delaware law prevents certain Delaware corporations, including Avocent, from engaging, under certain circumstances, in a business combination with any interested stockholder for three years following the date that such stockholder became an interested stockholder.
Our stock price may be volatile.
Our stock has experienced significant volatility in price, in particular whenever there has been a difference between our actual financial results and the published expectations of analysts. We have also experienced changes in our stock price as a result of speculation in the press or investment community about our strategic position, financial position, results of operations, business, or significant transactions or acquisitions. The stock market in general has experienced price and volume fluctuations that have negatively affected the market price of many publicly-held companies in ways seemingly unrelated to the actual operating performance of these companies. For instance, in the past several months stock prices in the U.S. have reacted dramatically in connection with recent events in the U.S. and global economy. Our stock price has been similarly volatile, and at times, more volatile that the market as a whole. These factors, as well as general economic and political conditions and the announcement of proposed and completed acquisitions or other significant transactions, or any difficulties associated with such transactions, by us or our current or potential competitors, may materially adversely affect the market price of our common stock in the future.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
Our world-wide headquarters, occupying approximately 181,000 square feet and containing administrative, sales, marketing, research and development, manufacturing, and distribution facilities, is located in Huntsville, Alabama, on a 35-acre tract of land owned by us in Cummings Research Park.
Our LANDesk facility in Salt Lake City, Utah, consists of approximately 84,000 square feet in an office building, and contains administrative, sales, marketing, and research and development operations. The current base rent under the lease is approximately $1,062,000 per year, plus taxes, insurance, and maintenance of approximately $433,000 per year and is leased through July 2014.
Our primary European administrative, sales, marketing, research and development, manufacturing, and distribution operations are located in a 129,000 square foot building owned by us in the free trade zone in Shannon, Ireland.
We also own a 45,000 square foot building on 6.5 acres of land in Sunrise, Florida. Our Sunrise facility contains sales, marketing, research and development operations.
We lease office space in Fremont, California (administrative, sales, marketing, and research and development), Austin, Texas (sales, marketing, and technical), Taipei, Taiwan (administrative, sales, marketing, research and development and operations), Singapore (administrative, sales, marketing, research and development and operations) and Beijing and Shanghai, China (sales, marketing, research and development and operations).
We also lease sales offices in various United States and international locations, none of which is material to our operations.
We believe that these facilities are sufficient to support our current operations.
Item 3. Legal Proceedings.
In January 2007, we filed a complaint for patent infringement in the United States District Court for the Western District of Washington against Aten Technology, Inc., Aten International Co., Ltd, Belkin Corporation, Rose Electronics and its general partners, and Trippe Manufacturing Company. The defendants filed counterclaims alleging non-infringement, unenforceability, and invalidity. In May 2007, we entered into a Settlement and License Agreement with Trippe Manufacturing, and dismissed Trippe from the lawsuit. In October 2007, the District Court stayed the action pending a re-examination of our patents by the Patent and Trademark Office. That re-examination is currently underway.
In January 2008, we filed a complaint for unauthorized use of patented inventions against the United States government in the United States Court of Federal Claims. The complaint alleges that the United States government accepted products manufactured and sold by Rose Electronics that are covered by patents held by us. The United States has answered and Rose Electronics has intervened.
In March 2007, KBM Enterprises, formerly a contract manufacturer for Avocent, filed a complaint against Avocent in the Circuit Court of Madison County, Alabama, seeking $9.5 million for costs allegedly incurred by KBM in its manufacturing efforts on behalf of Avocent. We have filed an answer and counterclaims against KBM and one of its principals, and discovery is currently underway.
In April 2007, we filed a complaint for declaratory judgment against Aten International Co., Ltd. in the United States District Court for the Northern District of Alabama. We are seeking a declaratory judgment that two patents owned by Aten and asserted against Avocent are invalid and that certain products alleged by Aten to infringe do not infringe these patents. In August 2007, Atens motion to dismiss for lack of personal jurisdiction was granted. We appealed the District Courts dismissal order to the Federal Circuit Court of Appeals, and the dismissal was affirmed by the Federal Circuit Court of Appeals. We have petitioned the Federal Circuit Court of Appeals for a rehearing en banc.
In November 2007, Gemini IP, LLC filed a complaint for patent infringement in the United States District Court for the Eastern District of Texas, Sherman Division, against Avocent Corporation and our subsidiary LANDesk Software, Inc. The complaint alleges infringement of a Gemini patent through the sale of a LANDesk product. The complaint seeks injunctive relief, damages, attorneys fees, and costs. Avocent Corporation was dismissed from the lawsuit in January 2008 though LANDesk Software, Inc. remains a party to the matter. The action was stayed in April 2008 pending the Patent and Trademark Offices reassessment of the patentability of the patent-in-suit.
Item 4. Submission of Matters to a Vote of Security Holders.
Item 5. Market For Registrants Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities.
Price Range of Common Stock; Holders of Record
Our common stock is quoted on the NASDAQ National Market System under the symbol AVCT. The following table shows the high and low sales prices of our common stock for each quarterly period within the last two fiscal years as reported by the NASDAQ National Market System.
As of February 23, 2009, Avocent had approximately 13,000 stockholders including approximately 375 stockholders of record and 12,625 stockholders in nominee name.
Stock Performance Graph
The following graph compares the cumulative total stockholder return data for our common stock to the cumulative return of (i) the NASDAQ US Index and (ii) the NASDAQ Computer Index for the period beginning January 1, 2004, and ending on December 31, 2008. The graph assumes that $100 was invested at a per share price of $36.52 on January 1, 2004, the closing price on December 31, 2003, and the reinvestment of any dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
The information contained above under the caption Stock Performance Graph is being furnished to the Securities and Exchange Commission and shall not be deemed to be soliciting material or to be filed with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference into such filing.
We have not declared nor paid any cash dividends in the past. For the foreseeable future, we expect to retain earnings to finance the expansion and development of our business. The payment of dividends is within the discretion of our Board of Directors and will depend on, among other factors, our earnings, capital requirements, and operating and financial condition. Additionally, covenants related to our credit facility may restrict the potential payment of dividends.
Recent Purchases of Treasury Stock
In the fourth quarter of 2004 our Board of Directors approved a stock repurchase program whereby we may, from time to time, purchase our common stock in the open market, in privately negotiated transactions or otherwise, at prices that we deem appropriate. Since the programs initial approval through December 31, 2008, our Board has authorized a total of 19 million shares to be repurchased, including 4 million additional shares approved by our Board in January 2008. The plan has no expiration date. Details of purchases under the plan during 2008 are as follows:
Approximately 198,000 shares were withheld as payment for employee payroll withholding taxes at the release of vested restricted stock units in 2008 (see Note 12 to our consolidated financial statements contained in Part I, Item 8 of this annual report on Form 10-K). The 198,000 shares were considered to be treasury shares; however, these treasury shares were immediately retired and are not considered in the table above.
Item 6. Selected Financial Data.
(Amounts in thousands, except per share data and amounts in note (1) below.)
(1) For the periods presented, we recognized pre-tax charges for acquired in-process research and development expenses for the following acquisitions: $21.7 million for OSA Technologies, Inc. and $1.1 million for Sonic Mobility Inc. in 2004; $2.1 million for Cyclades Corporation and $18.6 million for LANDesk Group Limited in 2006; and $700,000 for Touchpaper Group Limited in 2008 (see Note 3 to the consolidated financial statements).
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 and 2007 ($ Data in all tables presented in 000s)
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.
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 Part I Item 8 of
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:
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:
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.
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.
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 Touchpapers 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.
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:
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 $45.9 million in 2007, as a result of the above factors. Net income as a percentage of sales for 2008 was 3.9%, compared to 7.6% for 2007.
Years Ended December 31, 2007 and 2006 ($ Data in all tables presented in 000s)
The increase in our net sales in 2007 resulted directly from the contribution of revenue from our Cyclades acquisition, completed March 30, 2006, and our LANDesk acquisition, completed August 31, 2006, which was partially offset by a decline in revenue from certain legacy Avocent products. Within our customer distribution channels, our branded sales (including LANDesk branded sales) increased 26% from 2006 to 2007, while our OEM sales remained flat from 2006 to 2007. A significantly smaller portion of LANDesk business comes from OEM customers compared to our historical customer base, which also explains the change in the percentage mix of our sales.
Revenue from Management Systems increased slightly from 2006 to 2007 (see Note 14 in the notes to our consolidated financial statements in Part I Item 8 of this document). The slight increase was primarily due to the inclusion of a full year of Cyclades revenue in 2007 compared with three quarters of Cyclades revenue in 2006, which was offset somewhat by a decline in sales certain legacy Avocent products. Revenue within Management Systems is comprised primarily of our traditional KVM products, our serial management products, and our embedded software and solutions. Within Management Systems, revenues from our traditional KVM business and serial management products were slightly up in 2007, but we experienced lower than expected KVM and serial revenues in the fourth quarter of 2007 as a result of slowness in our North American branded business. Revenue from our embedded software and solutions product line decreased slightly in 2007 from 2006. This was
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. Revenue by product line for Management Systems for the years ended December 31, 2007 and 2006 was as follows:
LANDesks revenue is comprised of license-based revenue, primarily from the LANDesk Management Suite product, and subscription-based revenue, primarily from the LANDesk Security Suite and LANDesk Patch Manager products and from maintenance and support services related to LANDesk Management Suite. LANDesk was acquired in August 2006, which explains the large increase in revenues from 2006 to 2007 as we recorded a full year of revenue in 2007 compared to four months of revenue in 2006. Deferred revenue increased to $66.1 million at December 31, 2007 from $54.5 million at December 31, 2006, primarily due to increased sales of subscription products and maintenance services. Revenue by product line for LANDesk for the years ended December 31, 2007 and 2006 was as follows:
International sales grew 20% in 2007 from 2006, while sales within the United States grew 13% in 2007 from 2006. Having a full year revenue contribution in 2007 from our Cyclades and LANDesk acquisitions, compared to only a partial year in 2006, contributed to our revenue growth in both the U.S. and internationally. However, the decline in North America branded sales experienced in the fourth quarter of 2007 partially offset the growth we experienced in the United States for the prior three quarters of 2007.
Gross profit. Gross profit is affected by a variety of factors, including the ratio of sales among our distribution channels, as OEM sales typically have lower gross margins than our branded sales; 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 services.
The improvement in gross margin resulted primarily from the added sales of software with related service and maintenance revenue from our LANDesk acquisition (see Note 14 in the notes to our consolidated financial statements in Part I Item 8 of this document). The LANDesk contribution to increased gross margin was partially offset by the additional costs included in cost of sales from amortization of other intangible assets recorded as a result of the LANDesk acquisition related to developed technology and internally developed software for resale. We recorded $11.0 million of amortization of intangibles in cost of goods sold in 2007 and $3.6 million in 2006. As a result of the timing of the acquisition in August 2006, we recorded four months of intangible amortization in 2006 and a full year in 2007.
Research and development expenses. The increase in research and development expense is primarily due to having a full year impact of additional costs from the Cyclades and LANDesk acquisitions in 2007 compared to a partial year impact in 2006. LANDesk research and development costs were $26.9 million in 2007 compared to $9.4 million in 2006. Continued investments in target projects to expand and enhance our existing products also contributed to the increase in 2007 from 2006.
Acquired in-process research and development expense. There were no acquired in-process research and development expenses during 2007. Acquired in-process research and development expenses in 2006 were comprised solely of the write-off of in-process research and development expenses related to our acquisitions, including $2.1 million for Cyclades and $18.6 million for LANDesk.
Selling, general and administrative expenses. The increase in selling, general and administrative expenses is primarily related to increased headcount and associated costs as a result of the acquisitions of Cyclades and LANDesk we completed during 2006 as we recorded a full year of these costs in 2007 versus a partial year of these expenses in 2006. LANDesk selling, general and administrative costs were $65.5 million in 2007 compared to $21.7 million in 2006. We also experienced higher costs as a result of increased equity-based compensation costs, which were $3.4 million higher in 2007 than 2006, as detailed in the table below. In addition, we paid disproportionately higher commissions to LANDesk sales
personnel compared to the increase in revenue as a result of higher bookings of new subscription product sales. A substantial portion of the revenue associated with subscription bookings is deferred, while the commissions are paid at the time of booking. We also selectively increased our participation in targeted marketing programs and events during 2007, which added to our increased costs.
Acquisition integration expenses. There were no acquisition integration expenses incurred during 2007. We recorded acquisition integration expenses in 2006 related to costs associated with the integration of Cyclades into Avocent. These costs included severance accruals resulting from the headcount reductions associated with duplicate positions eliminated during the year.
Amortization of intangible assets. Amortization in 2007 includes primarily the amortization of the identifiable intangible assets created as a result of OSA, Sonic Mobility, Cyclades, and LANDesk acquisitions. Amortization in 2006 includes primarily the amortization of the identifiable intangible assets created as a result of Equinox, 2C, Soronti, Crystal Link, OSA, Sonic Mobility, Cyclades, and LANDesk acquisitions. The increase in amortization expense relates primarily to a full year of amortization in 2007 compared to a partial year in 2006 for the identifiable intangible assets recorded in the acquisitions of Cyclades and LANDesk.
Stock Compensation. We record stock compensation expense based on the department in which an employee works. Stock compensation expenses for 2007 and 2006 were as follows:
We began granting restricted stock units (RSUs) in 2006 and granted additional RSUs in 2007. Compensation expense for these grants is recognized over the vesting periods, and these grants typically have two or three year vesting periods. The increase in stock compensation is the result of the additional grants made in 2007. For 2007, we recorded expense for RSUs granted in both 2006 and 2007, while in 2006 we recorded expense for RSUs granted in 2006.
Net investment income. Net investment income declined from $7.6 million in 2006 to $3.8 million in 2007. The decrease in investment income in 2007 was the result of lower cash and investments due to funding the purchase of Cyclades late in the first quarter of 2006 and the cash component of the LANDesk acquisition in the third quarter of 2006, continued purchases of treasury shares, and repayments of our line of credit.
Interest expense. Interest expense was $8.1 million in 2007 and $3.6 million in 2006. Interest expense results from our borrowings under our $250 million unsecured line of credit obtained in 2006, which we used to finance a portion of the LANDesk acquisition and purchase treasury shares. We had a full year of outstanding debt in 2007 versus a partial year in 2006.
Provision for income taxes. The provision for income taxes was a benefit of $148,000 in 2007 compared to a provision of $20.2 million in 2006. The effective tax rate in 2007 was approximately (0.3%), compared to an effective tax rate of approximately 30.7% in 2006. The decrease in the effective tax rate was primarily due to the recognition of a $6.5 million tax benefit attributable to the LANDesk acquisition for previously expensed in-process R&D of $18.6 million and a change in our mix and amount of pre-tax profit among our U.S. and international companies. 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. Deferred tax liabilities recorded in 2006 have also been adjusted as a result of these elections.
Net income. Net income in 2007 was $45.9 million compared to $45.5 million in 2006, as a result of the above factors. Net income as a percentage of sales for 2007 was 7.6%, compared to 8.8% for 2006.
Liquidity and Capital Resources
As of December 31, 2008, our principal sources of liquidity consisted of $127 million in cash and cash equivalents and a $170 million available balance from our $340 million credit facility that is available for general corporate purposes. In the third quarter of 2008, we amended our $250 million unsecured line of credit by adding a $90 million term loan to the existing facility. The balance of the entire facility is due in June 2011. The term loan and line of credit have similar variable interest rates. The addition to our credit facility gives us additional capacity and provides strategic flexibility.
The line of credit and term loan contain affirmative and negative covenants, including limitations on our ability to (i) make distributions, investments, and other payments unless we satisfy certain financial tests or other criteria, (ii) incur additional indebtedness, (iii) restructure our subsidiaries, and (iv) make acquisitions and capital expenditures. The financial tests include an interest coverage ratio and a total leverage ratio. We are currently in compliance with these covenants and related tests as of December 31, 2008. All of these restrictions could affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. The failure to comply with these covenants could result in an event of default which, if not cured or waived, could have a material adverse effect on us.
We used borrowings under the credit facility in July 2008 to partially fund the acquisitions of Touchpaper and Ergo. In the future we may acquire other technologies or companies that we believe will enhance or complement our existing products and technologies and increase our sales. The line of credit and term loan currently bear an interest rate of LIBOR plus 150 basis points. There was $170 million outstanding under the credit facility as of December 31, 2008. We classify these obligations as long-term as they mature in June 2011. We expect to repay the borrowings through future cash flows from operations. A summary of our cash flows is as follows:
The decline in cash flows from operations in 2008 was primarily the result of working capital increases to fund the growth in our business (changes in accounts receivable, inventories, accrued wages and commissions, other accrued expenses and income taxes payable). Cash flows from operations in 2007 benefited by significant improvements in cash collections on accounts receivable and inventory management. During 2008, we paid approximately $8.0 million to the Internal Revenue Service to settle previously accrued federal income tax matters. Our accounts receivable increased $5.0 million from December 31, 2007 to December 31, 2008 as a result of increased sales through December 2008. This increase in accounts receivable was somewhat minimized by continued improved cash collections. We also made significant progress in collecting older balances outstanding at our LANDesk location during 2007 compared to 2006, resulting in a large decrease in receivables outstanding during 2007. Our accrued wages and commissions have increased in 2008 compared to 2007 as a result of increased sales for the comparable periods and accrued severance related to our restructuring programs.
Our days sales outstanding (DSO) remained steady at 63 days at the end of 2008 compared to the end of 2007. DSO remained constant despite higher sales in 2008 compared to 2007 through continued improvement in cash collections during 2008. Inventories decreased $1.7 million from December 31, 2007 to December 31, 2008. Our inventory turns improved significantly to 7.4 at December 31, 2008 compared to 6.6 at December 31, 2007. The improvement in 2008 was due to higher sales volume experienced in 2008 combined with continued improvements in managing our inventory levels as of December 31, 2008.
Our investing activities used over $82 million of cash flow in 2008, primarily to fund the Ergo and Touchpaper acquisitions that closed early in the third quarter of 2008. We also converted matured investments to cash to help fund the repurchase of 4.2 million shares under our stock repurchase program in 2008.
Our financing activities used cash provided by operations, as well as additional borrowings, to repurchase approximately 4.2 million shares of our common stock during 2008 at a cost totaling $67 million. These treasury shares were purchased through various brokers under the stock repurchase program approved by our Board of Directors. As of December 31, 2008, we have approximately 2.1 million shares available for purchase under the program.
During the second quarter of 2008, we approved a series of restructuring activities. As of December 31, 2008, we had accrued approximately $3.6 million related to restructuring costs and do not expect to record a material amount of restructuring expenses under the 2008 program in future periods. Most of these remaining costs will be paid during the first quarter of 2009.
During January 2009, we approved another series of restructuring activities. As of December 31, 2008, there were no costs accrued related to this second restructuring program. We expect to record $2.5 million to $3 million of restructuring expenses in the first quarter of 2009 and an additional $1.5 to $2.0 million in the second quarter of 2009. We expect most of these costs will be paid during the first and second quarters of 2009.
We may also use a portion of our cash and cash equivalents and our line of credit for strategic acquisitions of technologies and companies that we believe will enhance and/or complement our existing products and technologies and increase our sales.
Off-Balance Sheet Arrangements and Contractual Obligations
In the ordinary course of our business, we may at any point in time have a significant amount of contractual commitments not yet recognized in our financial statements. These commitments relate primarily to our need to schedule the purchase of inventories in advance of the related forecasted sales to customers. Our actual contractual commitments are typically limited to products needed for one to three months of forecasted sales. The liabilities for these inventory purchases, along with the related inventory assets, are typically recognized upon our receipt of the products. We also have, at any point in time, a variety of short-term contractual commitments for services such as advertising, marketing, accounting, legal, and research and development activities. The liabilities for these services and the related expenses are typically recognized upon our receipt of the related services. None of our purchase commitments requires payment beyond the next year.
Other than operating leases for offices and warehouse space, we do not engage in off-balance sheet financing arrangements nor have any variable-interest entities. As of December 31, 2008 we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
The following table sets forth annual payments we are required to make under contractual obligations and other commercial commitments for operating leases and purchases of inventory and services, in thousands, as of December 31, 2008.