Digi International Inc (DGII) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Digi International third quarter earnings conference call.

During the presentation, all participants will be in a listen-only mode. Afterwards, you'll be invited to participate in the question-and-answer session.

At that time, if you have a question, you'll need to press the one followed by the four on your telephone.

As a reminder, this conference is being recorded, Wednesday, July 17th, 2002.

I would now like to turn the conference over to Mr. S. Krishnan, CFO. Please go ahead.

Thank you and good afternoon.

Before I start, I need to go over a couple of housekeeping details. First, if you do not have a copy of our earnings release, please visit the press release section of Digi Web site at www.digi.com.

Second, I would like to remind our listeners that our remarks might contain forward-looking statements that involve risks and uncertainties. These forward-looking statements are not a guarantee of the company's future performance. Important factors that cause actual results to differ materially include, and are not limited to, the following: rapid changes in product and technology that may displace products sold by Digi; the industry in which Digi operates; Digi's reliance on distributors; declining prices on network; and products and changes in the company's level of profitability.

I will turn the call over to Joe Dunsmore, our Chairman and CEO, for his comments about the quarter, and then I'll spend a few moments highlighting our financial performance.

Thank you, Kris, and good afternoon, everyone.

Before I get into the discussion of performance this quarter, a word about trust. The integrity behind how we operate and manage Digi International has always been very important to us, our employees and, of course, our shareholders.

This orientation takes on a new significance given the recent, highly-publicized accounting indiscretions in the business community.

Digi is a company whose financials have been built upon conservative accounting standards. We take pride in the honesty and integrity in our business practices, and it's our pledge to remain true to these values.

Now let's talk about the business in fiscal Q3.

We were pleased with our top-line performance in the quarter, which was within the range of our revenue guidance, and up modestly on a sequential basis over our second fiscal quarter results.

We accomplished that in an economic environment that remains very challenging. Our NetSilicon division contributed more than $6 million in revenue for the third quarter. Our gross margins were also better than expected, and net earnings on a pro forma basis totaled $388,000, or two cents a share.

Less satisfying was the fact that we fell short of our goal of $9 to $9.3 million in sales from our growth products, namely our Connectware family of multi-port terminal and device servers and USB products. The total revenue contribution from this product range was $8.1 million, or about 10 percent short of expectations.

This shortfall was driven primarily by project delays in the point-of-sale segment that are expected to return to normal demand levels in the next couple of quarters. We remain deeply committed to these products, and confident that with stronger business conditions, revenue trends will improve in the coming quarters.

During the quarter we took important steps at NetSilicon, which is our first full quarter since closing the deal. And we continued the integration process and gained a much better understanding of the business.

As a result, we gathered new data about the business, its customers and market conditions. Unfortunately, this will negatively impact NetSilicon's revenue trajectory.

We have found that, while we have a rich set of customers that are designing NetSilicon chips and software into their products, many of those customers are experiencing delays or cancellation of their programs, thus materially impacting our projected revenues.

While we are still completing the analysis, we believe that the revenue ramp in the business will be delayed at least one year from earlier projections. As a result, we are in the process of aligning our costs with the projected revenues.

Accordingly, the board of directors has authorized management to develop plans to restructure NetSilicon subject to final board approval. The process of developing the plan is expected to be completed within 30 days. While the details of the restructuring are undetermined at this point, the effect is expected to be material.

Our balance sheet continued to improve during the quarter. We ended the quarter with almost 58 million in cash. This continues the positive trend that Digi has maintained over the past three years.

We are continuing our focus on reducing receivables and managing credit, resulting in DSO of less than 40 days, and we've made strides in improving our use of assets. Kris will be providing you with more detail in a few minutes.

Among the quarter's highlights, Digi introduced new server management features for its PortServer CM line of console management products. This line is targeted to improve server uptime and increase the efficiency of IT departments.

Our PortServer CM-32 that continuously monitors the console ports of servers, routers and other network equipment now features an auto-alert system that instantly notifies network managements of system errors or failures, automatically generating detailed alerts directly to a network manager's cell phone, pager or PDA for immediate response.

This kind of functionality can be a key factor in maximizing network uptime, and is a good example of the kind of value-added feature that we plan to bring to our entire product line.

The company also secured significant contracts and design wins of customers in several of its targeted vertical markets, which include point-of-sale, industrial automation, hospitality, finance and medical industries, addressing applications for auto -parts retailing, semiconductor testing, office automation, product manufacturing and ATM deployment.

In summary, I believe that we turned in a solid quarter in very challenging times. The main reason that we've been able to meet the guidance number is because we believe that we are generally gaining market share in an otherwise down market.

We look forward to realigning the NetSilicon business, and believe that it's a very important element of Digi's long-term success strategy.

Now, I will turn it back over to Kris to discuss our financial results in more detail.

Thank you, Joe.

As Joe mentioned earlier, our revenue for the quarter was up slightly on a sequential basis to $26.1 million, which we view very positively, given the current economic conditions. This quarter's revenue included $20 million from Digi products and $6.1 million from NetSilicon.

The Digi Connectware product, growth products, accounted for $8.1 million, or 31 percent of Digi revenue, compared with 8.9 or 35 percent of Digi's revenue the second fiscal quarter.

Because of the higher percentage of legacy products, our gross margin in the quarter improved to 57 percent, up from 52.3 percent in the second quarter.

Expenses for the quarter, excluding amortization, the one-time acquisition divestiture-related expenses, and the forgiveness of the European investment grant totaled 15.4 million, compared to 15.1 million in the prior quarter.

During the quarter, as indicated , we recorded a credit of approximately 1.1 million for the forgiveness of an investment grant, goodwill and intangible amortization of 2.2 million, and total acquisition and divestiture-related charges pertaining to NetSilicon of approximately $795,000.

Excluding our NetSilicon business, operating expenses, excluding the amortization and the forgiveness of the grant, was 10.2 million for the third quarter of fiscal 2002, compared to 10.1 million in the prior quarter.

On a pro forma basis, our net income for the third fiscal quarter was $388,000, or two cents per diluted share compared to $707,000, or four cents per diluted share the second quarter.

The pro forma number excludes the effect of the goodwill and intangible amortization of $1.6 million, net of taxes, acquisition and divestiture-related expenses of $500,000, net of taxes, as well as the forgiveness of the investment grant of $1.1 million.

Turning to the balance sheet, our cash position at the end of the quarter was $57.6 million, up from $52.8 million at the beginning of the quarter. The cash increase is primarily attributable to cash from operations, up $1.6 million, and an income tax refund of $5.2 million, offset by net cash outlay for working capital of $1.7 million, and capital spending of $400,000.

During the quarter, EBTDA - earnings before taxes, depreciation and amortization - was $1.6 million versus a negative $1.2 million in the second fiscal quarter. Our DSO was 32 days, a significant improvement over last quarter's level of 43 days.

Our current ratio is 3.6 to one. And our net tangible assets totaled 3.6 - $3.67 per share. Further, we anticipate in keeping with our long-term strategies to improve manufacturing efficiency, Digi will soon consolidate its manufacturing operation into its current headquarters building, which is expected to generate annual savings of approximately $500,000.

Now let me take a few moments to give you some guidance. As indicated on the press release, we expect fourth quarter revenues to be in the range of 25.5 and 26.5 million, and pro forma loss per diluted share of two to four cents.

For the year, we expect revenue to be between 101 and 103 million, and pro forma earnings per diluted share five to seven cents.

The growth product component will be in the range of 33 to 34 million.

As mentioned in the press release, effective October 1st, 2002, we must adopt Statement of Financial Accounting Standards Number 142 - Goodwill and Other Intangible Assets. SFAS 142 provides a new methodology for evaluating goodwill impairment.

While we have not performed the necessary calculation, we anticipate that the methodology prescribed by SFAS 142 for evaluating and measuring the impairment of goodwill will result in a goodwill impairment charge from NetSilicon, and the amount of such charge may be material.

Once determined, any charge will be reported as a cumulative effect, as a change in accounting principle in the first quarter of fiscal 2003.

We will be required by SFAS 142 to assess, on at least an annual basis, whether our goodwill carrying value is impaired. In the event that the fair value of our businesses declines in the future, we may incur additional charges for impairment.

Now, I would like to open it up for questions.

Thank you. Ladies and gentlemen, if you wish to register a question for today's question-and-answer session, you'll need to press the one, followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request.

If your question has been answered and you wish to withdraw your polling request, you may do so by pressing the one followed by the three.

If you are on a speakerphone, please pick up your handset before entering your request.

Once again, if you would like to ask a question, press the one followed by the four.

William from Commerce Capital Market, please go ahead.

Hi, Joe and Kris.

Hi, Bill.

Walk me through what's going to happen in the fourth quarter to give us a loss on revenues that are about the same as they were in the third quarter.

The difference, Bill, is three things. One, if you recall in the current quarter, we have that investment grant, which is a benefit that we receive that we will not have, which is $1.1 million.

The second thing is the other income. We generated some additional interest income towards the grant that we didn't have to pay. And we're not going to have that. That was about 300 and some thousand dollars.

And finally, we made it, because the grant, we did not tax-effect the grant, on an annualized basis, our effective tax rate was 36 percent. So during the third quarter, our effective tax rate was 64 percent, which we will - as a benefit - which we will not have in the fourth quarter.

So those three elements does make the difference, so everything else is .

What's the tax - what's the amount of the tax benefit?

The effective tax rate for the quarter was about ...

Sixty-four percent, yeah.

... was 64 percent. The reason for the quarter was 64 percent is primarily because, during the quarter we got the forgiveness of the grant, which is not being tax-affected.

So on an annualized basis, you have to determine your effective tax rates, which is 36 percent. So the impact of the difference between the year-to-date and the third quarter flows through the quarter.

All falls in the fourth quarter.

The third quarter. That's why your effective benefit is 64 percent.

OK. OK, fine. Because that's when you got the forgiveness.

That's correct.

OK. I guess I understand that.

Now, tell me. We're looking at a material impairment charge in NetSilicon. And we are looking at a, you know, delayed rollout of revenues there of about a year.

Can you tell me in particular, or a little more specifically, about what part of NetSilicon's future business has basically drifted further into the future?

Bill, what we did was, over the last five months we've done a real intense analysis of all of NetSilicon's customers, all of the design wins.

And we now have a very detailed understanding of all of those customers.

And, in general what we're seeing is that those customers are being impacted by the economy. There are some project delays. There are some project cancellations.

So, as a result of that very detailed analysis, we now have a much better view for the revenue for the next few quarters. And what we see is a revenue basis that's, you know, roughly flat in the 5.5 million kind of range.

And so, the effect is across each of the vertical market segments that NetSilicon serves, and not necessarily focused on any one.

OK. OK, what's happening to the print server part of that business?

Well, you know, obviously the print server part of the business is a more mature part of that business, and that's where we have significant customers over in Japan. And orders are down.

Orders are depressed coming out of that part of the business, and that's contributing to the revenue being light, again, in the $5.5 million kind of ballpark, quarter over quarter.

OK. I'll defer to the next question.

OK. Thanks, Bill.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press the one followed by the four at this time.

I'm . William , please go ahead with your follow-up.

Hi, guys. If no one else is going to ask you a question, I'll ask the next one. And that is, let's go back to Digi's core business and talk about what sectors of the core where you're seeing some strength.

In fact, one you suggested was semiconductor test. Can you talk about, you know, the strength that you're seeing, and some, I guess, retail as well?

Yeah. What we saw was, the heritage business performed pretty strong in the last quarter. It was - it did not decline. In fact, it was pretty flat quarter over quarter. So that Async business was strong.

The , for instance, that semiconductor manufacture design win was a design win for our device server business. And that's a significant - that was a significant opportunity for us.

So what we're seeing generally is Async has flattened out a bit in the last two quarters, so it's not declining quite as aggressively. The device server and terminal server businesses have been relatively flat.

And the USB business, we experience - we've been experiencing in the last two quarters some push-outs in major projects. That tends to be driven by major projects. And what we've seen is, a push-out in those programs.

The good news is that we feel a lot more comfortable this quarter, that we're going to be returning to normal levels on those major programs for the USB business.

How soon?

Right now, the visibility that we have right now is that we expect a return to normal level this quarter.

There's some risk with that, but it looks pretty good for this quarter.

OK. OK.

Thanks, Bill.

I'm showing that there are no further questions. Please continue with your presentation or any closing remarks.

Yeah, I'd just like to say that it was a - it's a challenging market environment out there. And we're pleased with the effort that the team here has made to maintain the revenue levels in that tough market environment.

And we certainly learned a lot about the Net Silicon business going forward. And while we have some short-term challenges with that business, we still feel very strongly that it's a key strategic element for Digi's long-term growth strategy, and feel very strongly that one of the positive aspects of that NetSilicon acquisition is, we really are seeing a lot of synergies between the two businesses - the device server business at Digi and the NetSilicon business.

And very pleased with the progress we're seeing in that arena.

So, thanks a lot for attending the call, and we look forward to talking to you in the next call.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.