Digi International Inc (DGII) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Digi International fourth quarter and year-end conference call. During the presentation, all participants will be in a listen-only mode, and afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. As a reminder, this conference is being recorded.

Thursday, November 7th of 2002. And I would now like to turn the conference over to Mr. Kris -- Krishnan, Chief Financial Officer. 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 the Digi website at www.digi.com.

Second, I'd 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, but are not limited, to the following: rapid changes in product and technology that might displace products sold by Digi, the development of 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.

Now I'll turn the call over to Mr. Joe Dunsmore, Chairman and CEO.

Thank you, Kris. Good afternoon, everyone. The topic for discussion in today's call is Digi's 2002 results. I will also say a few words about our 2003 plan, our acquisition strategy, and the current valuation of Digi's stock. As everyone knows, the market environment was somewhat challenging in fiscal 2002. However, despite the market turbulence, Digi has managed to continue to build its cash position, improve its share position, and maintain revenues throughout 2002.

Additionally, this quarter for the first time since I've been at Digi, the revenues from growth products are very near 50% of the total of Digi and IO branded products. With the addition of NetSilicon and the divestiture of Milan Technologies, we improved our gross margins to the 56 to 57 percent range, over the last two quarters. With all of Digi's energy now focused on one strategy, driving our leadership position in Connectware, we believe this focus has allowed us to improve our competitive position. We belief that we have either maintained or improved our share position in all of the growth markets that we address, and we believe that we have maintained our strong leadership position in the mature Async business.

2002 was an important year for Digi in gaining focus on the Connectware strategy. In addition to fiscal measures, Digi accomplished the following highlights during fiscal 2002. Digi further focused its Connectware strategy by divesting its data fire and Milan business units and acquiring NetSilicon, a leading provider of Ethernet microprocessing solutions for intelligent network devices. On the products front, Digi introduced the first USB over IP concentrator called "Anywhere USB" which allows USB enabled devices to be connected anywhere on a wired or wireless LAN. Digi launched its Portserver CM product line which enables data center managers and systems administrators to connect to and efficiently monitor and control IT equipment. Digi also introduced the Digi 1IA real port, a product that can network enable virtually any serial device in the industrial automation environment and was acknowledged by Veritas Testing to be significantly better than competing products by generating the lowest latency of all products tested.

On the litigation front, Digi recently reached a settlement with Lantronix. The settlement provides for dismissal of the lawsuits between the companies, and a cross licensing of some existing patents between the companies. While the details of the agreement are confidential, the agreement allows both parties to avoid the significant costs of litigation in 2003.

Next, I will discuss our 2003 plans that were highlighted in the September press release. As a result of the strong balance sheet and the restructure that we've completed, Digi has strong operating leverage entering fiscal 2003. We have a strong cash position and have reduced our operating expenses by over 10 million on an annualized basis. Our gross margins are expected to be in the 55 to 57% range, while we expect our operating expenses to be in the 46 to 49% range on flat revenue guidance of 101 to 103 million.

Additionally, in 2003, we are extending our strategy. Over the past three years we have executed on a plan to leverage the strong Digi brand into key vertical markets such as point of sale and industrial automation. Our strategy has been to organically and through acquisition add key Connectware growth products and technologies that also play into these verticals. In 2003, we are extending this strategy by driving a marketing strategy and message to make device networking easy. We believe that this is a key differentiating value proposition that Digi provides today, and will become a mantra throughout the organization that will provide more value to our customers in the future. It embraces all of our products from Async to Device Server to terminal servers to USB to NetSilicon-embedded networking. In fact, making device networking easy is at the very core of the NetSilicon value proposition to deliver a turnkey embedded hardware and software solution to its customers. Our marketing message, our product strategy, our engineering strategy, our technical support strategy, and our sales strategy will all embrace making device networking easy at the core.

Next, I would like to address Digi's acquisition strategy. As I stated a minute ago, we have been aggressively working to change the mix of products addressing growth markets versus mature markets. Our acquisition strategy has been a key to driving this effort to date. Our strategy is to continue that effort in our primary currency for execution is cash. It continues to be an opportunity-rich environment, as the technology sector continues to suffer, putting cash pressure on many, many companies. There are several areas that we are monitoring for acquisition opportunities.

However, the areas that we are working strategically are as follows. One, extending our console management capabilities in the data center. Two, broadening our NetSilicon product offering and three, extending our offering into point of sale to provide more application content: These are three areas that we are addressing. However, that does not necessarily mean that we'll execute in any of these. It does mean that we are focusing most of our resources evaluating opportunities in these segments. Due to competitive considerations, I will not elaborate any further than this level of detail on our acquisition strategy.

Next, I would like to briefly touch on a topic that is important to all of us, the Digi stock price and market cap. Digi is $100 million-plus company that has been consistently generating positive cash flow while going through a very aggressive turnaround effort over the past three years. We've been executing this turnaround in the midst of some very interesting times in the high-tech sector.

We have divested the ITK business in Germany, the high density Raz business and the MiLAN technology business and have added through acquisition IO networks, Decision Europe and NetSilicon. These acquisitions have put us in a position where today almost 50% of Digi and IO branded products address both markets versus approximately 21% three years ago.

We have improved our cash position from 26 million to 58 million over that period, while spending 22 million on acquisitions. We are now 100% focused on our Connectware strategy with a business that has a very healthy and vibrant culture. We are much more well positioned in the market than at any time in the past three years, yet our stock has recently been trading under cash value.

We believe that Digi is currently undervalued. In fact, many of the senior management team at Digi are currently buying Digi stock through the Digi employee stock purchase plan, underscoring that belief.

Now I will hand it back to Kris for a more detailed discussion of 2002 results.

Thank you, Joe.

Digi's revenue for the quarter was 25.1 million compared to 26.1 million in the prior quarter and 26.4 million in the fourth quarter of fiscal 2001, excluding impact of SAP 101. Our results are within the range of our guidance. This quarter's revenue included 19.7 million from Digi products and 5.4 million from NetSilicon.

Digi's Connectware growth products accounted for 9.3 million, or about 47.4% of Digi product revenue, compared with 8.1 million, or 40.9% of Digi's product revenue during the third fiscal quarter. Revenues from our growth products increased sequentially 14.2% in the fourth quarter compared to the third quarter. For the year, our growth products accounted for 34.7 million or 43.4% of Digi product revenue compared with 33.3 million, excluding the impact of SAP 101 or 32.7 million in fiscal 2001. A year over year increase of 4.3%.

Gross margin for the quarter was 56.1%. Excluding the effects of NetSilicon restructuring charge, that were included in the cost of goods sold, the margin would have been 57.3%. Up from the previous quarter of 57%. Gross margin for the full fiscal year excluding the one-time charges associated with the restructuring and the acquisition-related cost was 55.8% as compared to 54.2% a year ago, excluding the SAP 101 adjustment and write-down of inventory related to the sale of the Raz product line. The increase in margin is primarily attributable to the sale of the lower margin MiLAN business and acquisition of the higher margin NetSilicon business. Expenses for the quarter totaled $15.4 million, consistent with the prior quarter. These figures exclude amortization expense, the restructuring expenses, and the one-time acquisition-related expenses.

On a year-to-year basis, excluding the above charges, expenses were 58.9 million, compared to 59.9 million in the prior year. As previously reported, the cost saving measures undertaken by the company at the end of fiscal year 2002 will further reduce our 2003 operating expenses by 10 to $11 million.

Excluding our NetSilicon business, operating expenses, excluding the amortization and the restructuring charge, were 10.3 million for the fourth quarter of fiscal 2002, compared to 10.2 million in the prior quarter. On a pro forma basis, net loss for the fourth fiscal quarter was $379,000, or 2 cents per diluted share compared to net income of 388,000, or 2 cents per diluted share.

The change in net income is primarily due to lower revenues in the fourth fiscal quarter compared to the third fiscal quarter and the foreign tax benefit in the third quarter attributable to the gain on the forgiveness of the investment grant. The pro forma number excludes the effect of the goodwill and intangible amortization of 1.6 million, net of tax, acquisition-related expense of 200,000 net of tax, as well as the restructure charge of 2.5 million net of tax. As we have previously reported, in the future we will only be reporting on GAAP basis.

Turning to our balance sheet, our cash position at the end of the quarter was 58.2 million, up from 57.6 million at the beginning of the quarter, an increase of 600,000. Cash during the fiscal year increased by 2 million, net of acquisitions and divestiture and in tax refunds received. Accounts receivable at the end of the year was 10.5 million, a 5.6 million decrease -- dollar decrease from the beginning of the fiscal year. Our DSO was 33 days compared to a year ago of 57 days.

Inventory levels at the end of the fiscal year were at 12.5 million, compared to 16.7 million at the beginning of the year, a decrease of $4.2 million. The company continues to aggressively manage its current assets to maximize cash flow. Account ratio was 3.5 to 1, similar to the prior quarter, and down from the beginning of the year primarily due to the reduction in receivables and inventory. A net tangible book value per share totaled $3.52 per share and cash volume per share is at $2.62 per share.

Now I would like to open it up for questions. Operator?

Yes, thank you. Ladies and gentlemen, if you have a question for today's conference, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt acknowledging your request. If your question has been answered and you would like to withdraw your registration, priest press please press the 1 followed by the 3 on your telephone. If you are utilizing a speakerphone today, please lift your hand set before entering your request. One moment, please, for the first question.

And our first question will come from the line of William Beckline with Commerce Capital markets. Please go ahead.

Hi Joe and Kris.

Hi, Bill.

Hi, Bill.

I'd like to talk a little bit about the, you know, build-up to the top line number. Have you gotten to the point where there's any sort of consistency going forward among the, you know, the Digi -- the growth products, the Digi mature products and the NetSilicon products just in terms of trends? There was a nice pick-up in the Digi growth markets, the mature markets kind of, you know, fell off after they were a little higher than you expected the last quarter, and NetSilicons were down a little from the third quarter, you know, going forward, does it look like the growth markets can consistently deliver growth and, in fact, are the mature markets going to continue to decline?

Thanks, Bill. Generally speaking, we're looking at a flat market going forward. As we look at each of the product areas in the growth markets, we expect to continue to drive growth over time in the USB device server and terminal server area, and in the mature part of the business, we expect to continue to see a market trend similar to what we've seen in the past. Kind of a consistent decline in the Async market. And our strategy for addressing that is to continue to drive our channel strategy aggressively at our competitors to take share. So in the Async piece, what we want to do is offset any declines that we see on a market perspective, markets declining around 20% per year, and try to drive share gain in that to minimize the decrease, and in the other areas, obviously we're looking at, we believe, markets that in terms of their market life cycle have growth, but obviously in the short term with the economic conditions, that's flattened out a bit. So we expect when the market picks up, that that will provide a significant opportunity for us in the growth segment and increased opportunity for growth in those parts of the business.

Does that answer your question, bill?

Yeah, no, thanks. That's good guidance. In the NetSilicon business, which tends to be driven by design wins, can you talk at all about what design -- the pattern of design wins and I'm sure that over the course of the last six months or so, you've scrubbed that out pretty hard.

Yeah, I think on the last call, we talked, Bill, about --

-- what new design wins look like?

We talked about the fact that we had roughly 300 design wins, and we had a plan to deliver 15 design wins last quarter, and Bruce overachieved his plan last quarter and I believe he achieved 19 design wins against the plan of 15. So I think Bruce had a good quarter. They've done a good job of continuing to augment that sales effort in NetSilicon. We've added three reps in North America and we've added a couple of reps outside of North America in Europe, and the team is doing a good job of ramping up and trying to crank new design wins out.

Okay. Thanks, Joe.

Uh-huh. Thanks, Bill.

Thank you. Our next question will come from the line of John Taylor with Taylor Research. Please go ahead.

Joe, Kris, congratulations. You advertise and you produce, and that's always very good.

Thanks, John.

A couple of things on you didn't change the guidance for 2003, yet you say the Lantronix will, you know, possibly reduce legal expenses and so I guess, you know, you're saying that that doesn't change that guidance by implication, just to confirm that. Secondly, you said that the -- I believe you said, Kris, that the guidance for 2003 is on a GAAP basis? And lastly, could you make any comments just about how the embedded computing or NetSilicon market is looking?

Okay. The first question, the Lantronix legal expense question, related question, when we built our plan, I had an expectation that we were going to settle that. We had already made progress and we had expectations, so we boiled that into the plan.

Fair enough.

There's no expectation for incremental cost reduction. As you'll note, in our press release that we issued on 2003 guidance, we said that we were reducing our expense levels by, you know, $10 million year over year roughly. And the legal savings that we expected to get from settling that were boiled into that. So I think that answers that question.

In terms of the embedded opportunity of NetSilicon, basically what we see in the marketplace is a market that's flat. It's about what it's been. There are some signs, I think there are some signs out there that are positive from, you know, some of the players in the semiconductor market that maybe things have bottomed out, and so I don't see anything inconsistent with that view.

John, to answer your question on the GAAP, basically we’re going to shy away from the – if you look at the tables, we do the actual GAAP reporting and then we add back the one-time or acquisition of goodwill amortization net of tax to come up with the pro forma number. But the guidance that was issued earlier for the year of 2003, we have factored in goodwill amortization and we will -- what was communicated on an EPS level and the cash flow does take everything into account.

Okay.

Thank you very much.

Does that answer your questions, John?

Yeah, just on the embedded thing, I assume that what the issue there is just really trying to get a new technology up and running that is obviously running counter to the market right now?

Yeah, the market's been really tough. You know, I've talked in the past about, you know, in general how some of the players have performed, and, you know, and so the semiconductor market over the last several quarters has been -- had been trending down. I think the message out there in the industry is that many players out there believe that it's bottomed out and they're expecting it to begin to come back, and so I don't have anything that tells me that I should disagree with that view of things.

In terms of our experience specifically, we had a plan to do 15 design wins last quarter and we exceeded that. We did 19. And we continue to execute on our strategy over at NetSilicon, and I'm happy with the progress that we've made in terms of integrating that business, and in terms of really driving the sales and marketing effort.

Very good. Thank you.

Thank you, John.

Thanks, John.

Our next question will come from the line of Jay Meyer with MJS Case Securities. Please go ahead.

Thanks. Good afternoon. And a good quarter. My question relates a little bit to your comments on the stock price and the market cap, you know, and I recognize that your intentions for your cash, the substantial cash that you're building up, is primarily for acquisitions. But there also is the issue of Sorrento Networks in that possible overhang, and I wonder if you could take a moment and try and address that a little bit.

Okay. Thanks, Jay. On the stock price and market cap comments, one of the things that I'll add to that is specifically relative to the fact that the price of the stock has been trading under cash value, so we feel at those levels, the stock is undervalued.

In terms of Sorrento, they continue to be significant player, they have roughly 2.3 million shares, and we have as a part of the agreement during the acquisition, they can sell out of that stock up to certain cap levels on a quarterly basis. And beyond that, there's nothing else that I can tell you about Sorrento.

Okay. Thank you.

Thanks, Jay.

Once again, ladies and gentlemen, if you do have any questions today, please press the 1 followed by the 4 at this time. We have a follow-up question from the line of William Beckline. Please go ahead.

Let me just ask a little bit about the operating expenses.

Sure.

I think the guidance you've given us is that they're going to come down a little bit from the fourth quarter, and is your plan to sort of stabilize those in the first quarter and maintain them flat next quarter? You talked about operating leverage in the business. I presume that's what you're talking about.

Yeah. Bill, that's exactly what we're doing. We brought -- took a lot of expense out of the business year over year. We mentioned how much before. And that puts us on a track to generate an E to R, at the current guidance level of 101 to 103 in revenue, an E to R in the range of 46 to 49%. And hat's on a track that's an improvement that gets us on a track where if we are able to, you know, beyond 2003 grow like we expect to, that will get into our long-term E to R range which would be under 40%. So our long-term target is to have a business model that gets us under 40% E to R, and we expect to this year to be in the 46 to 49% range at those 101 to $103 million levels.

It does, Bill, it does exclude the amortization expense. This is more operating expense.

Right.

Just that one amortization, and goodwill and intangibles, just that one line item is excluded, all the other stuff under GAAP is included?

Yes, that's correct. In that range that Joe mentioned, 46 to 49.

Okay. Fine. Thanks.

Our next question will come from the line of Ross Shurlow of RBC Dane Rauscher. Please go ahead.

Yeah, hi Joe and Kris.

Hello?

Yes?

Can you hear me now?

Yeah, I can hear you now.

Yeah.

Okay. I just want to talk a little bit about the NetSilicon. These design wins that you guys have, how many of those design wins are actually in the process of producing revenues?

We've got many, many customers out there producing revenues. Off the top of my head, I don't have a number, but, you know, just to give you, you know, an idea, over in Japan, we've got many large customers, players like Ricoh and Sharp and Toshiba Tech and a host of, you know, large office networking customers. In the U.S., we've got a host of, you know, significant customers in the IA arena, in the building controls arena and in other vertical markets that are producing revenue.

Well, okay, so of the 300 or so design wins, that's an accurate number, about 300 design wins, correct?

Yeah, it's over 300 now.

Okay.

That was as of last quarter.

Of those, is it – is it 50% of them or 25% of them or a third of them that are producing or more than that or just -- just a ballpark would be nice to know.

Yeah, I I'd say that the number is -- you know, it's over 100.

Okay. It's over -- so it's around a third?

Yeah, in that ballpark.

Okay. Now --

And Ross, at least a third.

At least? Okay.

Yeah.

All right. So maybe -- call it maybe 40%. Of the other ones that are out there, what type of potential actually exists? I mean, and when is that -- when do you think that with the design wins of the rest of them are really going to start to turn into revenue?

Well, what we've said when we talked about the restructuring of NetSilicon was that we expected the ramp to push out a year based on the downturn that happened in the semi -- communications/semiconductor space over the last, you know, six quarters or so.

Sure. Right.

And so the expectation was that on the intelligent devices part of that business where we expected to see the growth, that we wouldn't see any growth out of that. Things would be flat for 2003, and we begin to see growth in 2004, and that the growth that we see wouldn't be as aggressive a ramp as we had originally predicted. So we're going to be flat in -- at NetSilicon this year quarter over quarter, and we're expecting to begin to see ramp in 2004.

Okay. So now let's just take these last 15 or 16 design wins that you just received now. Is it the same type of a cycle, does it take a couple of years before they kick in and start producing revenue?

It varies a lot by design win. There’s actually -- if you look at that group, there's actually design wins in there that are going to produce revenue fairly quickly because the design cycle is so short.

Okay.

So we'll start to see revenues, you know, early next calendar year for -- actually for design wins that we closed this last quarter. And that's for relatively simple design-in effort with companies that really understand networking and can move fairly quickly, and then there are some that are much longer that tend to be in industrial automation or building controls that have a longer design cycle that have a lot of certification elements to them, once the product's complete, they've got to go through certification, and so their design cycle is longer and those might be as long as a year and a half, two years.

Okay. Okay. Now let's just – now let’s just, think a little bit about two years down the road, when you’re -- and let's just assume that you're going to get no more design wins. What is the revenue type of potential of NetSilicon when you got all your design wins kicking in? What type of revenue can you guys generate from that?

Yeah Ross, right now we're looking at 2004 revenue growth, we're expecting 2003 to be -- and we're expecting growth in the neighborhood of about 25%

year over year from 2003 to 2004. Those are expectations to today.

Okay. Now, so when you're talking about 25% growth, you're also taking into account that you may -- that you’re -- you trust that you're going to continue to get more design wins as you go that are going to kick in too?

Yeah, we do. We expect to continue up the number of design wins on a quarterly basis, so -- and the other thing that we're working on doing is upping -- continuing to work on upping the quality of the design wins.

Okay. All right. That's all I've got.

Thanks.

Thanks.

Thank you.

Gentlemen, I'm showing no further questions at this time. Please continue with closing comments.

Thank you, everyone one, for listening to today's call. As we said, we think we're well positioned to capitalize on improvements in the industry as they come. We think we have a wide variety of acquisition opportunities out there that we're exploring. And we think that we have plenty of room to add shareholder value as the market recognizes the inherent value of our stock. Thank you very much.

Thank you.

Thank you, ladies and gentlemen.

That does conclude the conference for today. Thank you for participating, and we ask that you disconnect your line at this time.