Executives
Ron Clifton – President & CEO
Susan Parsons - CFO
Analysts
Greg Reid - Wellington West Capital Markets Inc.
Eyal Ofir - Canaccord Adams
International Datacasting Corporation (IDC) Q2 2008 Earnings Call September 8, 2008 5:00 PM ET
Operator
Good afternoon ladies and gentlemen. Welcome to the International Datacasting Corporation second quarter results conference call. (Operator Instructions)
International Datacasting Corporation would like to remind all listeners that this call contains forward-looking statements related to expected future events and financial and operating results of IDC that involve risks and uncertainties. Actual results may differ materially from management expectations as projected in such forward-looking statements for a variety of reasons including market and general economic conditions and the risks and uncertainties detailed from time to time in the company’s SEDAR filing.
I would now like to turn the call over to Mr. Ron Clifton, President and Chief Executive Officer; please go ahead.
Ron Clifton
Good afternoon everyone and welcome to International Datacasting Corporation’s investor conference call for the second quarter of fiscal 2009. I am Ron Clifton, President and Chief Executive Officer of IDC and I am joined today by Susan Parsons, our Chief Financial Officer.
Hopefully everyone has had a chance to review the press release that we issued approximately an hour ago. Overall we are pleased to report continued growth in our business with a positive second quarter that delivered both strong revenues and bottom line performance.
In fact, this is the best revenue quarter in our company’s history and on a year-to-date basis we are well ahead of our performance compared to the same point last year.
While our gross margins fell short of our target levels, we effectively managed our operating expenses which resulted in increased earnings. At the same time we succeeded in growing the business and introducing innovative new products into the market.
In our press release today we reported $8.9 million of revenue in the second quarter, up from $5.6 million a year ago, an increase of 60%. Overall revenues for the first half of the year increased by 28% from $11.4 million to $14.6 million. We also reported approximately $1 million in net income, almost double the net income of $0.50 million reported for the second quarter of last year.
Moving on to gross margins, our Q2 margins were 42% compared to 58% for the same period last year. The decrease is somewhat less pronounced when looked at as a year-to-date where margins were 44% compared to 53% for the first half of fiscal 2008.
The pressure on our margins was largely the result of higher then expected start-up and manufacturing costs associated with the introduction of a new product used to fulfill the $6 million order that we announced earlier this year.
We have taken measures to address this issue and have adjusted pricing of the product for new customers going forward. Based on the new pricing we do not expect that our recent gross margin performance will be representative in any overall negative trend going forward.
All of our growth in recent periods has been organic and we are very pleased with the continued progress made in each of our three vertical market segments during the first half of this year. In our first quarter we were very active with new product announcements corresponding to major trade shows held during the spring.
We are relatively quiet on the press release front during Q2 but continue to book and fill orders for existing as well as new customers. As many of you know our strategy to grow the business is to focus on three vertical markets; broadcast radio, data and video.
So let’s take a moment to review our progress in each in a little more detail. Our priority for broadcast radio has been to expand applications and capture the replacement equipment market as radio networks around the world including many of our existing customers modernize their outdated platforms with the latest bandwidth efficient technology and new internet protocol or IP based delivery systems.
Leading the way in this has been CBS Westwood 1, the largest radio network in the US who proceeded with their rollout of IDC SuperFlex technology this year. This market is also strong for us internationally and second quarter we received orders for new radio networks in Asia, as well as Europe where our PROFline products continue to be in demand.
The broadcast data vertical also performed well for IDC during the quarter. I have already spoken about the $6 million order. This order was our new SuperFlex dual tuner receiver, an ultra high speed product that is ideal for mission critical heavyweight applications. We were also pleased to open up a new front for this technology with a sizable initial order from a large aerospace and defense contractor for the US Department of Defense, a customer we believe offers significant long-term business potential.
The third and final vertical market broadcast video, offers the highest potential growth rates as new and emerging media applications build momentum. This is our newest vertical market and we are excited about it. We have a competitive advantage in key niches within this market such as IPTV, professional video and digital cinema.
During the second quarter we continued to ship products for our major IPTV networks in the US and continued development on our next generation IPTV product line which we expect will lead us deeper into this market particularly for high definition television delivery and for higher volume sites such as multiple [inaudible] units.
Turning to pro video, we expanded our product line during the quarter to add the ability to receive terrestrial feeds in addition to our existing satellite functionality. Presently the product is under evaluation by a number of international customers for some significant new applications and opportunities.
We were also very pleased with the progress and indeed the success of our digital cinema product line. We have been working to add live high definition 3D broadcast functionality to our SuperFlex pro cinema product line using leading edge technology from Sensio.
In second quarter we strengthened our relationship with Sensio Technologies by signing exclusive worldwide license agreements with them. This technology is used in the [Senio] Live 3D product we have developed for our longstanding digital cinema customer AccessIT, and I am pleased to report that we have now shipped the first significant quantity of [Senio] Live units. AccessIT has announced their plans to deliver live 3D alternate content at theaters across the US with this product line this year.
IDC technology also continues to be under evaluation by a number of digital cinema service providers in Europe and Asia. We have received initial orders from two new customers in Europe in second quarter and our product was at the heart of a special event live broadcast of the Buena Vista Social Club to theaters across Italy.
Next week we’ll be showcasing this live 3D technology at the industry’s International Broadcasting Convention in Amsterdam.
In summary IDC is continuing to build exciting momentum. We are executing on our long-term strategy by producing innovative technologies and securing key strategic partnerships. I believe that IDC is well positioned for continued success. I will discuss our outlook in a few minutes but first I’d like to turn it over to Susan to discuss our financial results in a little more detail.
Susan Parsons
Thanks Ron, our complete statements with notes and MD&A will be filed tomorrow. I would like to provide some additional details besides those disclosed in this afternoon’s press release. Ron has discussed our total revenue, looking at our two operating segments, recorded a 68% increase in the satellite equipment business largely due to the $6 million order discussed earlier in the call.
Broadcast services segment revenue declined slightly by 2% due to the previously disclosed reduction in the number of geographical areas that served under our contract with the Canadian government.
Turning to expenses IDC budgets operating expenses according to what is needed to grow the business and achieve the annual revenues expected in implementing our strategic plans. During the second quarter while we increased spending to support our higher volume of business we are pleased to report that we reduced operating expenses as a percentage of total revenue for the quarter.
Our overall operating expenses were $2.9 million during the second quarter compared to $2.7 million a year earlier representing an increase of 8%. Our selling, general and administrative expenses or SG&A, increased from $1.7 million in second quarter of last to $1.8 million in Q2 of this year.
This increase was primarily due to added staff and commission expenses associated with higher revenue as we continued to grow the business. We were happy to report that our research and development, R&D, costs have followed a similar pattern.
We have historically planned for our R&D investment to be approximately 10% of annual revenues in order to develop the new technologies and products needed to support our growth. Strong revenue performance in Q2 enabled us to exceed this target. During the quarter R&D spending rose 10% to $0.8 million from $0.7 million, representing 9% of total revenues.
Previous calls we have explained that our internal investment strategy for maintaining organic growth follows a step function with the step needed up front to drive the annual growth meaning that in previous quarters we have budgeted to invest heavily in SG&A and R&D in order to ensure that we would be able to grow the business aggressively.
While those resources now are in place, we are able now to limit growth in our expenses during the second quarter, an indication of where we are positioned on the step function. On the strength of our revenue for the quarter we increased net earnings to $1 million, or $0.02 per share, up from $0.5 million or $0.01 per share a year earlier.
For the year-to-date we have generated a net income of $782,171, up $505,823 last year; earnings per share remaining constant at $0.01. The balance sheet remains strong. We generated operating cash flow of $2.7 million in Q2 which enabled the company the increase its cash balance to $8.6 million as of July 31, 2008 compared to $6 million at April 30, 2008.
IDC remains free of term debt. I’ll turn the call back to Ron now who will discuss our outlook.
Ron Clifton
Thanks Susan. In previous investor communications we have mentioned that the overall industry in which we compete is forecasted to grow at 10% per year and that our strategy is to budget for revenue growth in this range, with the objective is we’ve demonstrated in past years of growing faster then that, by focusing on high growth verticals such as IPTV and digital cinema.
While our results have proven to vary from quarter to quarter and there is still some uncertainty in the economic outlook, we are pleased that at the halfway point of fiscal 2009, we have already achieved over 60% of our total annual revenues for last year.
In previous quarters we have also mentioned we expect to see some variability in our quarterly revenues and gross margins. We said that after slow periods and we’re saying it again after a very strong quarter. Fluctuations are largely due to the nature of our business with the variability caused by product mix and the timing of orders and customer budget cycles.
This is particularly evident as we grow the business increase the quantity of large projects we execute in parallel. Although we expect to continue to see these quarterly variations as we grow the business we expect to continue to improve our margins on an annualized basis as we have over the past few years.
Overall we remain focused on execution. Demand for applications and products continues to be strong and we are experiencing favorable results in all our target vertical markets. We have several large projects in the pipeline and we continue to see strong repeat business as well as new orders.
Sales in Asia are starting to grow this year. We have recently hired two new experienced sales people; one for the Asia Pacific region and one for the western United States. We are bidding on new projects and have products under evaluation and have good prospects in place for future growth.
While with our investment infrastructure and product development, this puts IDC in a solid position to continue to execute on our growth strategy going forward. In addition to organic growth acquisitions remain a part of our overall strategy. While market conditions have changed the type of acquisition we would consider, we continue to look for opportunities that would be accretive to our shareholders as we work towards growing the business.
In the context of all these factors I have described, I remain cautiously optimistic about our future prospects as we enter our third quarter. This concludes our prepared remarks and we are now ready to take any questions you may have.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Greg Reid - Wellington West Capital Markets Inc.
Greg Reid - Wellington West Capital Markets Inc.
I missed the comment when you were giving the segmented breakdown, can you give me the hard numbers for services business and the satellite equipment business?
Susan Parsons
What I said is that the satellite equipment business increased by 68% and the broadcast services decreased by 2%.
Greg Reid - Wellington West Capital Markets Inc.
In terms of the gross margins there’s some commentary in the release that talked about you’ll adjust the pricing in the future. You don’t mean that you’re able to re make up margins with the current large customer, do you? You’re just saying that you’re going to charge more for it in the future because the costs turned out to be higher?
Ron Clifton
The core technology has gone into another new product we mentioned which is for another customer. When we originally set this pricing it was about a year ago for the large order and it’s also before we had the finalized designs so there were some surprises. We went into production, we managed to control those and we now know and we set our pricing going forward and we always give volume discounts for large orders. That is sometime a flexible item but going forward we set our prices so we get the margins we prefer to have.
Greg Reid - Wellington West Capital Markets Inc.
Is it reasonable to expect that we can see margins back north of 45% within a quarter or two?
Ron Clifton
Well we’ve said every year we’re trying to improve our overall gross margins on an annual basis. We’ve done it for the last three or four years improving by at least 1% every year, and we were down a little bit in the second quarter. We had a good first quarter and looking forward we hope to return back to our annual plan. There’s always variability in every quarter but we are optimistic we will improve and get back on our annual objective plan.
Greg Reid - Wellington West Capital Markets Inc.
The defense contractor win, is the first time I’ve heard you mention a customer like that, can you talk about what the type of application is that they’re using it for?
Ron Clifton
It’s a heavy route high speed data application with lots of encryption and it’s the kind of thing we couldn’t put a press release out on because the timing and also because of the nature of the project.
Greg Reid - Wellington West Capital Markets Inc.
So both [head end] and terminal equipment?
Ron Clifton
No it’s all terminal equipment.
Greg Reid - Wellington West Capital Markets Inc.
In terms of that existing customer is it a case where you’ve penetrated 5% or 10% or is this—I guess I’m trying to sense is there a larger near-term opportunity there?
Ron Clifton
There is an ongoing opportunity and we don’t want to give more information then that because it is competitive sensitive.
Greg Reid - Wellington West Capital Markets Inc.
Can you characterize your backlog in terms of either flat or up or down and just curious as to what feedback you’re getting from your customers in terms of are they trying to push for shorter lead times because there’s more uncertainty out there; what are your customers saying?
Ron Clifton
Customers in general, there is some economic turmoil in Europe and in the US. People are being a little more cautious and stretching out their buying decisions. This is a capital equipment business as you know but we’re primarily in the broadcast industry so we’re talking to customers and we have customers as you know that are in the broadcast market which tends to be not as sensitive to some of the economic turmoil you would see on the consumer end for example.
Again that’s why we say we’re cautiously optimistic. We have some large projects in the pipeline. We’re tracking them. We’re working with our customers. They’re being careful about their timing obviously as everybody is.
Greg Reid - Wellington West Capital Markets Inc.
Are there any large ones that have fallen away just because of economic concerns?
Ron Clifton
Nope, nothing large that we had in—none of our existing customers like that have fallen away.
Greg Reid - Wellington West Capital Markets Inc.
On the M&A side, almost a year ago now when you raised some money part of it was you had hoped to do some M&A and I was just wondering if you can update us on what you’re seeing? You made a comment about things, parameters might have changed and I assume you just meant that you don’t have the same stock currency to do it. Have you seen a change in pricing on targets, have expectations of potential targets come down?
Ron Clifton
We have been tracking a number of opportunities. We are looking for that right deal that’s a right mix, a strategic fit both culturally and technology and market wise. We believe that valuations on the targets are coming down for some of those candidates. We are waiting for the right timing, the right opportunity. We do have a couple of opportunities that we’re sniffing at right now that we’re looking around for but we’re not going to move until we find the right time and the right price and it’s the right strategic fit.
Operator
Your final question comes from the line of Eyal Ofir - Canaccord Adams
Eyal Ofir - Canaccord Adams
You talked about initial two orders from—in Europe and the digital cinema space, can you just elaborate on that and tell us what we should be expecting going forward from those two projects?
Ron Clifton
Europe is behind the US in some ways. The US launched a couple of years ago when the program called the virtual print fee was introduced. It allowed people to make the investments necessary to put the digital projectors in place. Our customer AccessIT was the first one that put in a satellite delivery network using our technology and so the US is ahead.
In Europe they’re moving a little slower, about a year behind. But now we’re starting to see the first steps of that. We were involved with—in a program a couple of years ago for the Europe digital cinema forum and our technology was evaluated because it was the leading one we believe in the US and that created visibility for us at two digital cinema service providers and actually a third one recently just this—since we put out the press release is interested and these other two have acquired initial systems and they’re launching with the live demonstration projects.
That market is dependent on investments necessary to put the digital projectors in place and to put in place satellite delivery networks. You can deliver movies with hard drives for the projectors, but when you start doing live events which develop more, additional revenue streams, and then you definitely need satellite because of the quality of service and the ability to get it to all theaters at one fixed cost.
Not giving more details, this is competitive sensitive information but we’re pretty pleased that our technology was chosen for these trials and the initial orders and we’ll be tracking that. We’ll be a feature at IBC this week in Amsterdam doing a live 3D [Sensio] demo on the spot and we’ll be featuring the technology.
Eyal Ofir - Canaccord Adams
Regarding the defense contractor you won, have you shipped that in the quarter, or is this just the initial, you’re still shipping in the third quarter?
Ron Clifton
That was shipped in the quarter.
Eyal Ofir - Canaccord Adams
On the customer concentration side, can you just provide us with information on that, what was the largest customer size from a revenue standpoint in the second quarter?
Ron Clifton
I believe its four customers that make up—this will all be on the SEDAR tomorrow. It may even be on tonight.
Eyal Ofir - Canaccord Adams
In general maybe you could talk about your market expectations going forward, obviously you said in Europe you’ve seen some slowdowns, but you are targeting the broadcast market and you’re not seeing it decline as quickly as the consumer market. Can you give a little more details what you’re seeing there? Are you seeing some opportunities in the Asia Pacific region and emerging markets?
Ron Clifton
The Asia Pacific is up for us. It’s fairly large compared to last year as you may have seen in our results or later when they get posted on SEDAR. Asia is picking up. Projects we announced, the radio projects were in New Zealand. We have other activities going on in that region. Europe, the euro exchange rate which is slowing some things down but that’s starting to balance out a little bit. US exchange rate is also turning in our favor now which is good news. We had a foreign exchange [inaudible] turn around in the last quarter.
The markets are, we’ve got some major trade show activity going on in third and fourth quarter. We’re at IBC this week. We’re at IPTV in Eastern Europe in third quarter and we’re at the industry’s major satellite convention in New York in October.
So we’re busy. We’re promoting and it’s all down to capital equipment budgets and whether people are going to deliver on what they’ve been planning for awhile.
Eyal Ofir - Canaccord Adams
Do you have the breakdown between Asia Pacific, Europe and North America?
Susan Parsons
To answer your previous question, four customers accounted for 59% of our revenue; three customers were in the satellite equipment segment and one customer was in the broadcast services segment. The full financial statements are going to be filed on line.
So for the three months ended, the US was at $2.1 million, versus the prior period it was at $2.9 million. Europe was at $4.4 million for the three months versus $1.5 million. So the significant growth in revenues was in Europe. Second part where we had growth was Pacific Rim; $1.6 million for the three months versus $355,000 for the other three months. Canada was flat. Latin America is such a small amount, it’s not worth discussing.
Eyal Ofir - Canaccord Adams
The $6 million order, that was split between EMEA and Asia Pac, right?
Susan Parsons
That’s correct.
Operator
There are no additional questions at this time; I would like to turn it back over the Mr. Ron Clifton.
Ron Clifton
Thanks to all of you who participated for your interest in International Datacasting Corporation. We look forward to speaking with you again in approximately three months if not sooner. Bye.
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