Digi International Inc (DGII) 2003 Q3 法說會逐字稿

Welcome to the Digi International third quarter earnings conference call. (CALLER INSTRUCTIONS). I would now like to turn the conference over to Chris (ph) Krishnan, Senior Vice President, Chief Financial Officer and Treasurer. Please go ahead, sir.

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 and 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 in products and technologies that may displace products sold by Digi; the definitive (ph) 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 the SEC's recently adopted rules governing the use of non-GAAP financial measures, 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 operation, a statement of cash flows, 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 the conference call. But rather, we will refer you to the information in the financial statements.

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

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

All indications are that the communication technology sector was once again flat in Digi's Q3. Despite these market challenges, I am very pleased with our improved execution and performance for the quarter.

Our revenues of 25.6 million compared to 25.5 million in the prior quarter showed continued strength in a flat market. Revenue for the quarter was $100,000 greater than the high end of our guidance range. Revenue from our device networking business, which includes our Digi Device Server, and NetSilicon embedded microprocessor product lines, was $8.1 million. Revenue from our connectivity solutions business, which includes our terminal server, USB, and Heritage product lines, was $17.5 million.

Gross margins held strong at 59.7 percent, slightly higher than the 59.6 percent achieved in fiscal Q2, and a significant increase over the 57 percent achieved in fiscal Q3, 2002. Most importantly, once again, we exceeded our profitability target, coming in at 6 cents EPS versus the 3 to 5 cents guidance.

Now, for some key highlights for the quarter. Digi repurchased 1.2 of its common shares from Sorrento Networks Corp. This resulted in the acquisition of all of Sorrento's remaining equity interest in Digi. In total, Digi bought back approximately 12 percent of its outstanding stock at an average share price of $3.68 over the two transactions with Sorrento. Digi released the Digi Connect ME. It is the most powerful and customizable embedded networking solution available, as well as one of the smallest.

NetSilicon expanded its relationship with Sharp Electronics Corp. to include the integration of NetSilicon's device networking platforms into Sharps Super G3 (ph) document communication system. Digi began stripping its newly released Digi TS W family of one, two and four ports serial to wireless device servers. These are the first in a series of products to ship with 802.11B wireless connectivity. Digi began commercial shipments of its new NetStream network printer controller to Hitachi Printing Solutions Ltd.

Digi's balance sheet remains strong. Fueled by cash from operations of 4.39 million, Digi maintained a cash balance of 54.5 million despite cash outlays for stock buyback, and Dortman's (ph) facility debt payment totaling slightly over 6 million in the quarter.

Now, I will hand it back to Chris to discuss our financial results in more detail.

Thank you, Joe. Our revenue for the quarter was 25.6 million, ahead of both our prior quarter figure of 25.5 million, and our guidance of 24.5 to 25.5. Sales of our device networking products have grown nicely. In fact, this quarter's revenue included 17.5 million for the Digi Connectivity solutions and 8.1 million from device networking products, which includes both NetSilicon and Device Server product lines.

The device networking products grew 21 percent during this quarter compared to the third quarter of fiscal 2002. The gross margin for the quarter stayed relatively static at a healthy 59.7 percent compared to 59.6 percent in the previous quarter, and 57 percent in the fiscal third quarter of 2002. We're striving to increase our 2003 gross margin, primarily by replacing the lower margin MiLAN products with higher margin embedded networking connectivity products, and continuing strength in certain Legacy products.

Our operating expenses for the quarter stayed steady at 13.7 million for (inaudible) on last quarter, as we continue to focus on controlling our expenses.

Earnings per share for the third quarter surpassed management's previously disclosed guidance of 3 to 5 cents. Net income for the quarter was 1.2 million, or 6 cents per diluted share compared to a loss of the 600,000, or 3 cents per diluted share in the fiscal third quarter of 2002.

As you may remember, net income of 2.5 million was reported in the fiscal second quarter of 2003, or 12 cents per diluted share, due to the recognizing the beneficial impact of reversing an income tax valuation reserve related to a German net operating loss carryforward. This resulted in a tax benefit of 1.4 million or 7 cents per diluted share.

Turning to our balance sheet, our cash position decreased by $2 million to 54.5 million at the end the quarter. We utilized $5 million to purchase the remaining Digi common shares owned by Sorrento Networks, and also paid out $1 million in our mortgage payment.

The cash value per share increased to $2.71 from $2.66 in the previous quarter. At the end of the quarter, our shares outstanding are at 20,140,062. Accounts Receivable and inventory dollars were up slightly this quarter combined by a total of 1.2 million. DSO was at 34 days, even with the previous quarter.

Now, I'd like to take a few moments to provide you with some guidance. For the fourth fiscal quarter of 2003, we expect revenues to be in the range of 24.5 to 25.5. This brings our full fiscal year revenue guidance forecasted to the range of 1.01 (ph) to 1.02. For the fourth fiscal quarter, we expect the range of earnings per share to be in the 4 to 6 cents. For the full fiscal year, we are now forecasting our earnings per share in the range of 26 to 28 cents, up from 23 to 27 cents, excluding the impairment charge relating to the adoption of SFAS 142. For the full fiscal year, the earnings per share are now forecasted in the range of -- in the range of $1.80 to $1.82 loss, including the impact of the impairment charge relating to the adoption of SFAS 142.

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

(CALLER INSTRUCTIONS). Troy Jensen with Dougherty & Company.

Congratulations on the nice results. A couple of questions on the NetSilicon side. Can you maybe give us some insight into a number of design wins during the quarter?

Yeah, the number of design wins is over 20; and several of those design wins were very high-quality, expected to be high-volume design wins.

Can you maybe talk about which verticals you've seen the most design win activity in?

We've seen a lot of design win activity in industrial automation, in building controls and in office automation.

And then, just to follow up on NetSilicon. If you guys look back historically, I think NetSilicon's annual revenues went from 7 million in '97 to about 37 million in 2001. Could you give us any type of gauge -- what the number looked like in 2002? And when we start to see this 30 to $40 million annual contribution from NetSilicon again?

Well, when we were looking at NetSilicon, the quarterly revenue was in the 7 to 8 million range. And then the communication semiconductor market tanked, and the revenues fell into the, you know, mid-fives. And so, I hope that answers your question for 2002.

For next year, and, as we said, we expect to see growth out of the NetSilicon business, year-over-year. We have talked about, you know, growth in the neighborhood of 10 percent. And while I'm not giving guidance on that, because we are in our planning process, we do expect growth; and when we are done with our planning process, we will give more specific guidance on that.

And just one follow-up. If you look at the 2000 number, I think they did about 17 cents of earnings off 31, 32 million in sales. Gut sense, have you guys restructured that company enough to get maybe better types of margins once you hit that revenue level again?

Well our long-term model at Digi, I think as I've discussed in the past, is to get to, over the next couple of years, to get to an ER (ph) of about 40 percent -- with margins remaining in the 55 to 60 cent range. And certainly, what we're planning on doing with NetSilicon is driving revenue growth in order to help achieve that overall company target.

And the (indiscernible) excludes amortization expense.

Jane Myers with MJSK (ph) Equity Research.

Nice quarter. I'm a little curious about the comment in the press release about strength in some of the Legacy products. Can you add any color there?

Yeah. What we are seeing is for the last couple of quarters, the Async (ph) product line has not been declining at quite the same rate as we have seen in the prior several quarters. So, what we are seeing is a little bit of flattening out in that Async product line, which, you know, is a good thing, and we hope that that continues. Although market forces would say that, you know, you expect continued decline. Over the last three years, the average had been about, you know, 20 percent decline per year in the overall market. But what we are seeing is a little bit less decline in the last couple of quarters. And while we hope that continues, you know, there is still, you know, the strong trend that we've seen over the long-term, is this, you know, 20 percent per year market decline.

The resurgence you are seeing and, well, the flattening of the business in Async, is that sort of patched, piecemeal kind of contract work? Or has it been sort of across the board? Can you pinpoint where that is coming from?

Well, you know, as has been the case for the last several quarters, with that business, much of that business is run rate business, where we have been designed into deals and, those deals just move ahead. And that is the vast majority of the business, because there are not that many new deals with the Async product line. Now, we have seen, you know, in the last few quarters, we have seen some new business, some new deals, and that's a good thing. Whether that continues, you know, we are not really planning that, because, you know, kind of the way that that technology has moved in the marketplace, has been that it has been replaced in the point-of-sale arena by USB connectivity solutions, like the I/O Networks products, and it's being replaced in other arenas by Ethernet infrastructure that requires device server and terminal server technology. So, while we would like to see that, and while we are driving to, you know -- drive revenue to flatten out in that arena, the market forces, overall, would say that, you know, we would not expect that to continue.

Just to look at it, you know, in a broader sense. If you look at all the players that play in that market, that market -- the Async market -- was probably in the neighborhood of a 4 to $500 million market back when it peaked in about '95 or '96. And today, if you look at the collective revenues from all the players, it is probably about $80 million market, roughly. So, that gives you an idea of how that market has moved.

Fortunately, we've got a strong position, and, over time, you know, we gain share. So, we don't decline quite at the same rate as the market does.

I understand. I know, in your qualifications at the beginning of the call, you said you are not going to talk about pro forma estimates. But, can you touch on, a little bit, add any color at all what is going on with the acquisition-related amortization expense, going into Q4?

Well, I think if you look at our cash flow, Jay, we had, you know, for the three months, amortization shows up about 1 million 921, is what I think the number is showing up on the cash flow for the three months. We had indicated early on in the year that there will be a decline in the amortization expense until (ph) going into the fourth quarter.

I think that was to about 1.2 or 1.3 million; is that --

About 1.3 million; that is correct. We did indicate that.

That is still in the range then, or --

Yes.

(CALLER INSTRUCTIONS). Troy Jensen with Dougherty & Co.

Just a quick follow-up. A lot of buzz this quarter on point-of-sale. Could you maybe give us some insight on how that business performed for you? And remind us who you partnered with?

Yeah, the point-of-sale vertical is our largest segment. It is probably in the neighborhood of about 25 plus percent of the business. What we are seeing in point-of-sale is existing customers are beginning to -- I don't want to say ramp up, but are beginning to recover from some down quarters. So we are seeing a bit more health, I would say, overall in this segment from existing customers. And, with our I/O (ph) Networks business, especially, we continue to aggressively execute in the marketplace. So, we are identifying new opportunities. And, we are aggressively working those opportunities. And, the expectation is that we will continue to see that segment, you know, come back and recover. So, you know, in general, what I would say is that, you know, six months ago, the momentum was flat to down, and today, the momentum is more flat to up.

Just a follow, Joe. RFID -- is that in any way a competitive threat to your POS (ph) business?

No, we see that as kind of a separate application in retail, that we may have an opportunity to participate in at some level. And we see that opportunity not really being a revenue opportunity today; but probably two to three years down the road that will turn into more of a revenue opportunity in the overall marketplace.

Jared Berlin (ph) with Campillion (ph).

A very nice quarter. I wanted to see if you give me a sense for your view on the pace of any recovery that we may see, whether it's in the back half of this year or next year, in 2004, in terms of, you know, what type of growth rate do you think it will equate to? And also, if you can speak to, on a vertical basis, which vertical industries, you think, for your business at least, will show the most strength coming into a recovery?

Starting with the second part, I would say that based on what we are seeing right now, retail point-of-sale would probably be the one that I would expect to begin to see recovery first. I am not sure I can give you a lot of good reasons for that. But, you know, from a micro perspective, looking at our business and our customers, that is kind of the sense and the feel that we get.

Overall in the marketplace, I would say, generally, what we see is flat. We don't see any signs of significant recovery. You know, we just saw recently, in the technology sector, we just saw Motorola and Lucent come out with what I would characterize as pretty negative news -- Intel with a little bit more positive news. So, you know, it is pretty mixed out there right now. And it is really hard to be too optimistic at this point. So, my characterization would be that I think we have hit the bottom, and from a technology sector perspective; and I am optimistic that we will see a slow recovery. But, when it starts -- when that recovery has a positive impact on Digi or any other business, is really hard to predict.

Okay. Congratulations, again on a good quarter and thanks for the time.

Jim Tutenney (ph) with Delphi (ph) Management.

Great job, anyways, considering the state of the economy out there. What did you see for pricing declines in the quarter, and how is pricing holding up?

In general, our business is very inelastic, and pricing holds up extremely well, and that's reflected in our gross margins, close to 60 percent. So, we tend to play in smaller market segments, you know, 100 million, $200 million market segments. We tend to provide pretty unique connectivity solutions for customers. We get designed in, so the switching costs are high. And our brand provides a lot of equity in terms of reputation for high-quality product and good technical support. So, it tends to be a relatively inelastic -- if you look at technology markets, and I have seen a lot of different technology markets, this happens to be one that seems to be relatively inelastic.

Great. One other question. How is Anywhere (ph) USB -- can you give an update on that?

Yeah, Anywhere USB is shipping and it's being trialed (ph) with a number of customers that are very interested. We would expect to see material revenues coming from Anywhere USB in fiscal 2004. So, but we are real happy with the progress the we are seeing with the customers that are trialing the product.

So, basically you are in beta tests within these sites?

No, we are beyond beta. This is a new technology, and nobody else has it. And so, when you're dealing with -- a couple of factors. One, our business requires, with a new product whether it's a brand-new technology in the market or just a new product, it requires customers to integrate it into their systems. And, now you couple that with brand-new technology to be integrated into their systems, untested technology -- to be integrated into their systems -- there's just an upfront sales cycle and process in terms of the customer taking the product, understanding it, integrating it, testing it. The product is shipping. It is not beta-quality product; it is shipping product. But they still have to go through their process. And so, we would expect a fairly long kind of sales cycle, upfront, and then we will see, you know, customers adopting and integrating and deploying. And, as we see that happen with a few customers, I think we will start to see it happen more broadly beyond that.

Okay. And would (indiscernible) -- how is the feedback thing from the customers that are trialing the product?

The feedback's been good.

(CALLER INSTRUCTIONS). I am showing no further questions at this time. Please continue with your presentation or any closing remarks.

Well, I would like to thank everybody, and I look forward to talking with you again about fourth quarter results. Thank you.

Thank you.

Ladies and gentlemen, that does conclude your conference call for today. You may all disconnect, and thank you for participating.

(CONFERENCE CALL CONCLUDED)