Digi International Inc (DGII) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Digi International Second Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we’ll conduct a question-and-answer session. At that time, if you have a question, please press the one, followed by the four, on your telephone. As a reminder, this conference is being recorded Wednesday, April 16, 2003.

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

Well, thank you. Good afternoon, and thank you for joining us today. Before we start, I need to go over a few details.

First, if you do not have a copy of our earnings release, you may access it through the press release section of the Digi website at www.digi.com.

Second, I would like to remind our listeners that our remarks may 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 may cause actual results to differ materially include, but are not limited to, the following: rapid changes to the products and technologies that may displace products sold by Digi, the definitive industry in which Digi operates, Digi’s reliance on distributors, declining prices of networking products, and changes in the Company’s level of profitability.

Finally, as a result of the SEC’s recently adopted rules governing the use of non-GAAP financial measures, we will not provide any non-GAAP financial measures during this conference call. We will not provide any non-GAAP financial measures in our earnings release. However, in our earnings release, we provided a balance sheet, a statement of operations and a statement of cash flow from which you can calculate those measures. We will also not provide any non-GAAP financial measures in response to questions at the end of this conference call, but, rather, we will refer you to the information in the financial statements.

I would now like to introduce Mr. Joe Dunsmore, Chairman, President and CEO.

Thank you, Kris. Welcome to the call, everyone.

The challenging market environment in the communications technology sector did not subside in fiscal Q2. All indications are that the market was once again flat to down. Despite these market challenges, I’m very pleased with our continued improvement and execution and performance. Our revenues of $25.5m, compared to $25.5m in the prior quarter, have demonstrated our continued strength in a down market. Revenue for the quarter was at the high end of our guidance range.

As previously announced, last quarter we achieved our goal of attaining equilibrium between Digi’s Connectware growth and mature products. As a result, it is no longer necessary for us to continue breaking down our results along those lines. Instead, our forward-looking focus will be on reporting the device networking and connectivity solutions results.

Revenue from our device networking business, which includes our Digi Device Server and NETSilicon-embedded microprocessor product lines, was $8.2 million. Revenue from our Connectivity Solutions business, which includes our terminal server, USB, and heritage product lines, was $17.3m.

Gross margins held strong at 59.6 percent, a slight variation from the previous quarter’s results. Most importantly, once again we exceeded our profitability target, coming in at $0.12 EPS versus the $0.02 to $0.04 guidance.

Next, I’ll cover a few of the quarter’s key highlights.

NETSilicon gained traction with several design wins for its new 7520 chip and generated a total of over 20 new design wins in the quarter. Inside Out Networks has made significant progress in the quarter, penetrating several new large customers. I will not elaborate further due to competitive concerns.

Digi launched its Digi One EM, a high-performance embedded module for device networking that has already closed several design wins for the product. Digi received a 2002 Control Engineering magazine “Editor’s Choice” award for our Digi One IA RealPort product. Digi improved its cash position by $2.1m from $54.4m at the beginning of the quarter to $56.5m at the end. Now, I will hand it back to Kris to discuss our financial results in more detail.

Thank you, Joe.

As Joe stated, our revenue for the quarter was $25.5m, similar to prior quarter’s figure of $25.5 and compared to $25.2m in the fiscal second quarter of 2002. Our results were in the high end of the range of our previously disclosed guidance of $24.5m to $25.5m. This quarter’s revenues included $17.3m from the Digi Connectware product and $8.2m from the Device Networking products, which includes NETSilicon and the Device Server product lines.

The gross margin for the quarter was 59.6 percent, compared to 60.1 percent in the previous quarter and 52.3 percent in the fiscal second quarter of 2002. The slight variation of gross margin over the past two quarters is primarily a result of product mix. The increase in 2003 gross margin resulted primarily from placing lower-margin LAN products with higher-margin embedded networking connectivity products. As previously stated, we still believe that our gross margin for the rest of the year will be in the range of 58- to 59-percent range.

Our operating expenses for the quarter totaled $13.7m, compared to $13.9m in the previous quarter. We continued to focus on controlling our expenses.

Net income for the quarter was $2.5m, or $0.12 per diluted share, compared to a net loss of $7.3m, or $0.39 per diluted share, in the fiscal second quarter of 2002. These results compared to a net loss of $42.8m in the fiscal first quarter of 2003, or $1.94 per diluted share. Excluding the impact of the cumulative effect of FAS 142 charge, in the accounting principle that resulted in a non-cash goodwill impairment charge of $43.9m, Digi recorded net income of $1.1m, or $0.05 per diluted share, in the fiscal first quarter of 2003. The earnings per share for the quarter exceeded management’s previously disclosed guidance of $0.02 to $0.04.

During the fiscal second quarter of 2003, the Company recognized the beneficial impact of reversing an income tax valuation reserve to its German net operating loss carry-forwards. The reversal resulted in an effective tax rate for the year of 6 percent versus a previously stated annual tax rate of 27 percent. The impact on the quarter is a tax rate benefit of $1.4m, or $0.07 per diluted share, in the second quarter. The effective tax rate for the fiscal third and fourth quarters of 2003 will be at 25 percent.

Turning to the balance sheet, we increased our cash position by $2.1m to $56.5m at the end of the quarter, compared to $54.4m in the previous fiscal quarter. The cash value per share increased to $2.66 from $2.57 in the previous quarter.

During the quarter, our accounts receivable and inventory dollars combined remained flat from the beginning of the quarter. Our DSO for the quarter was at 34 days, an increase of a day, when compared to the beginning of the quarter.

Now, I would like to take a few moments to provide you with some guidance.

For the third fiscal quarter of 2003, we expect revenues to be in the range of $24.5m to $25.5m. For the year, our revenue guidance remains the same as previously reported at $101m to $103m. For the third fiscal quarter, we expect the range of earnings per share to be in the range of $0.03 to $0.05. We’re increasing our guidance of our earnings per share range for the year to $0.23 to $0.27, up from $0.13 to $0.17. Excluding the impairment charges relating to the adoption of FAS 142, for the full fiscal year, the earnings per share will be reduced to a range of a loss of $1.76 to $1.79, from a previous range of $1.82 to $1.86.

Now, I would like to open the call to questions. Operator?

Thank you. Ladies and gentlemen, if you’d like to register for a question, please press the one, followed by the four, on your telephone. You’ll hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one, followed by the three. If you are using a speakerphone, please lift your handset before entering your request. One moment, please, for your first question.

Your first question will come from the line of Troy Jensen with Dougherty & Company. Your line is now open. Please proceed with your question.

Gentlemen, first of all, congrats on a nice quarter.

Thank you, Troy.

Thank you.

I’m very impressed with that. Kris, I was wondering if you could break out maybe the gross margins per the two different business units?

I don’t have that handy at this point, but I think basically what we have indicated between the two groups were pretty even, so they’re approximately in the range of anywhere from 57 to 59 percent.

Okay. That’s fine then. How about – could you maybe touch base a little bit on how linearity shaped up? Specifically, I’m just kind of wondering how business was during the month of March.

The month was, you know, pretty much as expected. I’d say that March, the third month in the quarter, typically a little bit stronger than the other two, and March was a fairly strong month.

How about, Kris, another quick question for you. Op ex savings – you guys have done a phenomenal job of kind of taking the expense base down. Can we expect that to continue in the next quarter, or are you getting kind of all done with the savings?

Yeah, I’ll answer that one, Troy. You know, we did a lot of work last year at the end of the year to – and the assumption that we used was that the market was going to be flat to down for the foreseeable future. And so we were pretty aggressive in taking expense out of the business model and putting us in a good position to drive profitability throughout 2003. So, you know, certainly the lion’s share of expense reduction, you know, we took care of, anticipating, you know, the market conditions that we’re seeing. And, obviously, we’ll keep our eyes on things and try to continue to reduce expenses as we go forward, but a lion’s share of that reduction we took care of last year.

Okay. I’ve got one last question, I promise, for Kris. Could you tell us what you [will] start modeling for amortization of goodwill going forward?

Well, our amortization expense for the quarter, as reflected in the financial statements, is about $1.7m. It would be $1.7m during the third quarter. In the fourth quarter we had indicated earlier that we will drop to $1.2m, and so that’s what we had given earlier guidance.

Great. And then one point, too, for all of ’04?

At this point, that’s what we anticipate, yes.

Great. Thanks, guys, and congrats again.

Thanks, Troy.

Your next question will come from the line of [Jay Meier][ph] with [ASK Equity Research][ph]. Your line is now open. Please proceed with your question.

Yeah, this is Jay Meier. Great quarter, guys. Congratulations. I have one question following on about the operating expenses going forward. Would you expect for the remainder of the year that operating expenses would stay relatively flat as a percentage of revenues?

Yeah, Jay, I’d say that that’s probably a safe assumption. And, you know, the other thing I’d add is the long-term model that we’re trying to achieve, you know, over the next couple years is to get to a [EOR][ph] of 40 percent would be the goal, and maintain our gross margins in the high 50s. So we’re continuing to try to drive the business model in that direction.

The only [clarification] – the 40 percent excludes amortization.

Right, right.

I understand. Okay. Can you – is there any way that you can give us an idea of where you’re going with some of your products going forward? I mean there seems to be this constant inkling of light at the end of the tunnel, and then when we get there, it seems like it’s not much really happened. But you must be having some thoughts about where you’re going with your products. Can you shed any light that way?

Well, I’m not sure I’d characterize it the same way that you’re characterizing it, Jay. We’ve been, you know, aggressively introducing new products in all areas of our business over the last year, and that’s why we’ve been able to perform as well as we’re performing.

You know, we introduced the very innovative AnywhereUSB product out of the I O Networks business, as well as the Watchport camera and the Watchport series products.

In the device networking arena, we introduced several different versions of our Digi One product line, the Digi One IA, Digi One IA RealPort, the Digi One EM, which I just talked about.

In the NETSilicon part of the business, we introduced a new chipset, the 7520.

So all these things are – have been introduced and are being received very well in the marketplace. And that’s why we’ve been able to perform as well as we’re performing. Remember, there’s still a significant part of this business that’s a part of a market, the heritage business that’s a part of a market that’s declining at 20 percent. So in order for us to be flat or growing, we have to overcome that declining market, and we’re doing that with all these new product introductions. So I want to make that point first.

Going forward, as a result of our engineering approach, which is a very modular approach where we’re very careful about making sure that the software development is done in a modular way, hardware development is done in a modular way, so that we’ve got piece parts that – where we can easily add on to existing platforms and come to market quickly with products, that’s the approach we’ve taken in the last year, and that’s the approach we’re taking going forward. So you’ll continue to see new product introductions in the device server arena coming up. There’ll be several new products and introductions. You’ll continue to see progress in the I O networks arena, and we’ll continue to drive growth in that part of the business. So, you know, I take exception with the promise. I think we’ve done a lot, and we’re going to continue to do a lot in the way of introducing new products.

I appreciate that, and let me qualify my statement. I wasn’t speaking about Digi necessarily; I was speaking about more macroeconomic things.

Oh, okay.

So –

I’m sorry. In terms of the macroeconomic arena, you know, our assumption right now -- in terms of visibility, Jay, our assumption is flat. And to the extent that we get an economic updraft, that’s good news, and that’ll be a benefit to us. But we feel like -- as I said last quarter, we feel like we’re in a really strong operating leveraged position where if we get that updraft, you know, we feel like we’ve got the business model in place to take advantage of it and drive more profitability.

I agree. Thanks a lot.

Thanks, Jay.

[Caller instructions.]

Your next question will come from the line of [Ross Strawell][ph] with RBC. Your line is now open. Please go ahead.

Yeah, hi, guys.

Hey, Ross.

How did – what kind of revenue did NETSilicon specifically do?

You know, Ross, we don’t get into breaking out NETSilicon, but the combined NETSilicon and device server business was $8.2m, and that grew about $1.6m quarter over quarter. So, you know, within the device networking business, there was significant growth, and certainly NETSilicon was a significant part of that.

Okay. When did you start not breaking – you know, I thought that always broken out in the past?

We combined the NETSilicon business with the Digi Device Server business, and that’s how we’ve been reporting.

When did you do that?

We did that last quarter, Ross. If you look at our press release, we said that we’re going to be combining those two businesses.

Okay. So you’ve basically operationally done that, so it’s pretty difficult to break it out; is that correct?

Yeah, it’s one business that’s managed and run by Bruce Berger.

Okay. When you look at another 20 design wins coming out of NETSilicon, when do you – you know, you’ve talked in the past about NETSilicon eventually really turning profitable. Do you have any more guidance, you know, specifically with that area? Or maybe a better way to ask the question is, when are the design wins expected to really show some revenue growth for that operation?

The lead-time that you typically see with design wins can be anywhere from six months to two years down the road, and that varies by the design win. And so, you know, that’s the timeframe we’re looking at. You know, in the market segments that we play in, it tends to be, you know, more in the 18- to 24-month range, but there’s some that are fairly quick and happen within six months. So that’s the typical lead-time that you see. We’ve been working now for over a year with NETSilicon, and we’ve been driving some pretty good design win activity, and so as I, you know, have said in the past, I expect to see significant growth out of NETSilicon’s business in 2004. And the positive results that we’re seeing this quarter, you know, are a result of design wins and activity and [pull-ends][ph] and revenue opportunities that happened a year, year-and-a-half, two years ago.

Right. And I’m not trying to be, you know, critical. I understand, as Jay mentioned, too, the macroeconomic situation out there has been very difficult. So that’s good to hear that you’re still expecting growth in 2004.

And the other good news, Ross, that you should understand is that, you know, the $1.6m quarter-over-quarter growth in that device networking business is pretty significant.

That’s what it was from the previous quarter? You’re up $1.6m?

Right. From $6.6m to $8.2m.

Okay. Very good, very good. Now, the German situation, I guess I don’t quite understand that. If you could just clarify really where that extra $0.07 came from?

Okay –

I’m trying – the way it reads, is it true that the German operation is turning profitable now? You talk about anticipated taxable income -- [inaudible] just explain that some more, please?

Sure. What has happened is, yes, the German operation has been profitable the last few quarters and will continue to be profitable as well we’re projecting. It’s a judgmental decision working with our auditors. So what happens is when you know that a subsidiary is turning profitable and has net operating loss, you have to recognize on your balance sheet an asset for that net operating loss. So basically we evaluated it, we looked at where we think Germany would be delivering from a taxable income perspective, and based on that judgment, we felt that it was appropriate to set up an asset for the net operating loss that is there in Germany, and the impact is a tax benefit on that net operating loss of $1.4m. So what happens is as we – now that we have set up an asset in the future, when the profitability is offset against net operating loss, you don’t get future benefit because you recognize it under accounting rules right away.

Okay. So in other words, it’s an asset based upon the fact that you now believe you’re – I mean you’ll have income to take advantage of that asset; is that right?

Correct.

Okay. And then I had a question handed to me from the crowd here. What percentage of design wins will eventually generate revenue?

That’s a great question, and that varies a lot based on economic conditions. In really difficult economic times, there tends to be more fallout from the time you get a design win until, you know, it’s actually on the marketplace because you go through a process of, you know, the customer going through their development process and bringing a product to market and then introducing it, and so during difficult economic times, obviously, budgets get cut and programs get cut. So that – it tends to be a much higher percentage. I don’t have a precise number for you, Ross, but the fallout during tough times can be over 50 percent.

Okay. Okay, very good. I guess that’s it for me. Thanks very much. Nice quarter, guys, in a difficult environment.

Thanks, Ross.

Thank you, Ross.

[Caller instructions.]

Your next question will come from the line of Clint Morrison with Piper Jaffray. Your line is now open. Please proceed with your question.

Hey, Joe, one last question on design wins, and I’m sorry to beat it to death. But I think you said 20. Can you give – put that in context a little bit? What have you been winning on a quarterly basis? Maybe what have you done since the beginning – or since the year or so that you’ve owned NETSilicon? And maybe – you’re obviously generating some revenue. How much of your revenue has come out of design wins since you acquired them versus ones that kind of came along with the deal?

The last question I can’t answer for you here because I don’t have the specific data, so we’d have to go get that data.

But we are generating some revenue out of the more recent design wins already?

Yeah, yeah, absolutely.

Okay.

Yeah, so in terms of perspective, we have in our design win database well over 300 active design wins. We’ve been winning, you know, 20-plus per quarter. Some quarters, it’s been over 30. And the activity that we see this quarter, you know, I think is very positive because not only do we have over 20 design wins, but many of those design wins are large high-volume – we expect to be high-volume design wins with very high-quality customers, meaning, you know, you can get a design win.

The quality of design wins can vary significantly in terms of how you assess it. You might have a design win with a start-up company, or you might have a design win with a huge multi-billion-dollar multinational company. In one case, it may be very risky that it’s ever going to get to production. In the other case, it may be almost a slam-dunk if it’s a next-generation product that is definitely going to go to market, where you have great visibility and that you’re going to have high expected volumes and revenues. So I characterize – you know, many of our design wins this quarter have been very high quality and high volume.

Okay. Perfect. Thank you.

Gentlemen, I am showing no further questions at this time. Please continue with your presentation.

Thanks a lot for attending the presentation. I look forward to talking to you guys again next quarter. Thank you.

Thank you.

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