A Respite From the Big Picture: Task Gets Granular

SAN FRANCISCO -- Once as high as 9882.80, the Dow Jones Industrial Average stumbled to as low as 9687.61 before closing with a flourish to finish up 0.1% at 9799.06. The S&P 500 closed off 0.5% at 1147.95 after trading as high as 1161.58 and as low as 1136.34. Meanwhile, the Nasdaq Composite fell 1.8% to 1820.57.

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So what is more important: The Dow's comeback despite warnings and cutbacks at "nontech" companies such as Coca-Cola Enterprises CCE, Delphi Automotive DPH and International Paper IP? Or the fact the Comp set a new multiyear closing low? Or that the tech-beleaguered index managed to stay above its March 22 intraday low around 1794?

Given end-of-quarter considerations and the fact many readers complain we try to read too much into one day of trading, I'm not going to attempt to answer that now. I've been pretty clear (haven't I?) about my current worldview and nothing today changed that, although the European Central Bank's failure to cut rates is a disturbing development. One wonders what those who believe the Federal Reserve remains too restrictive and overly concerned about inflation -- despite 150 basis points of easing since Jan. 1 -- think about the ECB, which has yet to cut rates in the current cycle.

Evincing the market's disappointment with the ECB's decision, the euro -- which theoretically should benefit from relatively higher interest rates -- today fell to its lowest level vs. the dollar in 3 1/2 months.

The other reason I'm not addressing the "macro" issues tonight is that having presented a "top down" approach, I'm going to start with some "bottoms up" work, as with the following.

(Still) Something About Ixia

Back in mid-December I wrote about Ixia XXIA, a developer of equipment used to test and analyze a variety of optical networking equipment such as Packet Over SONET networks, LAN and WAN switches, Ethernet, and cable TV Internet products.

Around the time of that report, Ixia's shares were in the midst of a rally that took them from the midteens to a closing best of $29.875 on Dec. 14. Thereafter, the stock traded as high as $38.375 intraday on Feb. 2 and closed as high as $35.25 on Feb. 7. But lately, Ixia has suffered the same slings and arrows as nearly every other tech stock; today, it closed down 7.4% to $12.56, below its Oct. 17 IPO price of $13.

Last week, I drove north from the Milken Conference in Los Angeles to Ixia's headquarters in Calabasas, where I visited with Tom Miller, the firm's CFO.

Miller confirmed that Ixia is "on track" to meet the guidance it has given the Street for first-quarter net revenue of just over $28 million, gross margins near 80% and earnings per share of 14 cents (the latter according to the three-analyst consensus at Thomson Financial/First Call).

But critically, Miller acknowledged the slowdown in the overall networking telecom equipment space is affecting Ixia, a different tune than he and CEO Errol Ginsberg sang when I first met them in mid-December.

Back then, the executives claimed Ixia could sidestep the spending slowdown/inventory backlog concerns dogging major customers such as Cisco Systems CSCO, Nortel Networks NT, Juniper Networks JNPR, Extreme Networks EXTR and Broadcom BRCM, because Ixia is levered to those company's research and development, not their end markets.

Last week, Miller conceded the "malaise in the marketplace" had hit home -- particularly the slowdown at Cisco, which is Ixia's largest customer, accounting for about 30% of its revenues.

In a follow-up interview today, Miller reaffirmed the first-quarter guidance, but noted that since my visit, Nortel has rewarned and Cisco CEO John Chambers has made some additional comments about the U.S. slowdown lasting at least three quarters and spreading overseas.

The "turmoil at Cisco" -- which has announced layoffs of more than 10% of its staff and is believed to be reviewing essentially all of its product lines -- has been particularly jarring to Ixia, the CFO said, although he reiterated Cisco is expected to remain Ixia's top customer. "They're being cautious with spending until they figure out what they want to do," he said. Like so many others, Ixia is dealing with the uncertainty of "when does Cisco start saying good things?"

Miller conceded Ixia didn't see the extent of the coming slowdown last December but reiterated a view "we're a little bit insulated from [Cisco's] sales volume directly." However, "if Cisco were to cut back R&D, that would have an impact," he said. Same with Nortel or Extreme Networks, et al.

The CFO claimed no specific knowledge of R&D cutbacks at Cisco, whose spokesman did not return phone calls seeking comment.

"What's generally being read into the Ixia story is if Cisco and these guys are having trouble, it's going to affect Ixia," said Thomas Coler, analyst at Dain Rauscher Wessels in Dallas. "I tend not to disagree."

Yet Coler maintains a strong buy rating on Ixia, noting that companies such as Cisco are still pursuing development of "next generation platforms."

Miller expressed a similar optimism: "Our feeling is [companies such as Cisco] have got to continue to develop new products if they want to grow in the future."

He noted there has been "no fundamental shift" in Ixia's business model, which has thus far produced high margins and 12 consecutive quarters of profitability (including the current quarter), with no end to that streak expected.

Dain Rauscher's Coler also noted that Miller and Ginsberg "did a very good job of setting guidance" for the current quarter and that their "realistic approach" should enhance investors' faith in Ixia.

Additionally, the analyst said that because of Ixia's market position and sound balance sheet (featuring $96 million in cash and short-term investments as of Dec. 31), it is potentially an attractive acquisition target for larger competitors such as Agilent A, or could "do a roll-up and get bigger themselves."

In classic CFO style, Miller said the company would assess the "right opportunities at the right price" but didn't offer much additional insight on the M&A issue, other than to say Ixia would acquire only companies that could add something new to their product mix.

Meanwhile, Ixia continues to expand its product offering through internal efforts, the latest being an OC-192C Bit Error Rate tester for analysis of Layer 1 performance of SONET and optical networks. Eran Karoly, Ixia's vice president of marketing, also noted the company is now offering "triple-speed" equipment where one card can test Ethernet-over-copper interface at 10-, 100- and/or 1000-megabits per second, which is where "major demand" from original equipment manufacturers is occurring.

Lockup, Lock Down

Coler, whose firm was one of the underwriters of Ixia's IPO, said another issue currently dragging Ixia's stock is the approximately 48 million-share lockup expiration occurring in mid-April.

But Miller noted that of those 48 million shares (out of a total float of about 54.3 million), more than 25 million are owned by Stephane Ratel, principal owner of Technology Capital Group in Luxembourg. As I previously reported, Ixia's principal shareholder agreed to a 360-day lockup at the time of the IPO. Another 15 million are owned either by Ginsberg or Joel Weissberger, the firm's director of hardware engineering. Both executives are subject to the Securities & Exchange Commission's Rule 144 restrictions. Neither has filed to sell at this point.

Given that Ixia's public float is currently only 6.3 million shares, any sale of a significant portion of the remaining 8 million shares will certainly be dilutive. But the amount likely to be sold isn't anywhere near 48 million.

So the situation with Ixia is the same as with many tech firms -- a lot of near-term risks and no visibility. With the issue of the lockup and the question of what Ixia will say about the second quarter and beyond when it reports first-quarter earnings, there's no need to rush in.

But those currently underweight technology, and who believe in the continued expansion of broadband and Internet rollout, might want to consider at least monitoring this mid-cap. At 21.3 times its projected 2001 earnings per share of 59 cents and 17.2 times projected 2002 earnings of 73 cents, the company seems at least reasonably valued, assuming those estimates remain intact.

Bottom line is the biggest risk to Ixia's future is a draconian scenario in which major telecom and Internet equipment manufacturers stop trying to innovate. As bad as things look now, we're not at that juncture. If we get there, the current market will look downright friendly.