Digi International Inc (DGII) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Digi International First Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS]. I would now like to turn the conference over to Mr. Kris Krishnan, Senior Vice President and Chief Financial Officer. 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 our press release section of Digi's Web site 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. The important factors that may cause actual results to differ materially include, but are not limited to, the following: Rapid changes in 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 the changes in the company's level of profitability.

Finally, as a result of the SEC 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, and a statement of cash flow from which you can calculate those measures. We'll also not provide any non-GAAP financial measures in response to questions at the end of the conference call but rather will refer to the information in the financial statements. Now, I would like to introduce Mr. Joe Dunsmore, Chairman, President and CEO.

Thank you, Kris. Welcome to the call, everyone. I'm very pleased with our results for the quarter. Our revenues of 26.3 million compared to 25.5 million in Q1 in 2003 and 26.3 million last quarter showed continued strong performance.

Revenue for the quarter was $300,000 greater than the high end of our guidance range. Revenue from our Device Networking business, which includes our Digi Device Server and Net Silicon product lines, was 8.8 million, an increase of 10% over the previous quarter's figure of 8 million and a 33% increase over fiscal first quarter of 2003, which was 6.6 million.

Revenue from our Connectivity Solutions business, which includes our terminal server, USB and Heritage product lines was 17.5 million. The gross margin for the quarter was 61.2% compared to 60.1% in the fiscal first quarter of 2003. Most importantly, once again, we exceeded our profitability target coming in at 8 cents EPS versus the 4 to 6 cents guidance.

Now, for some key highlights for the quarter. Digi launched its new USB Plus series, a complete line of powered USB solutions designed to simplify retail operations by allowing powered USB peripherals to be used with a standard low cost PC. We displayed this new line at powered USB solutions at Comdex in November.

Digi expanded its Digi CM console server line to include the new Digi CM 48 console server, a secure 48-port console server designed for use in large scale deployments of data center equipment. We entered into an agreement with Rackable Systems to provide the CM 48 for use Rackable systems large scale data center rack systems and have begun shipments.

Once again, NetSilicon closed over 20 new design wins for the quarter. Many of which were considered high-volume opportunities. Digi's balance sheet remains strong, fueled by EBIDTA of 4.5 million, Digi grew its balance - its cash balance -- to 60.7 million. Now I will hand it back to Kris to discuss our financial results in more detail.

Thank you Joe. As indicated, the revenue for the quarter was 26.3 million, an increase of 800,000 over the first quarter revenue a year ago and exceeding our guidance of 25 to 26. Sales of our Device Networking products which includes both NetSilicon and Device Server products were 8.8 million an increase of 800,000 or 10% over prior quarter and increase of 2.2 million or 33% over first quarter of fiscal 2003. Our sales of our Connectivity Solution products were 70.5 million in the first quarter of fiscal year 2004.

Gross margin for the quarter was 61.2% compared to 59.1% in the prior quarter and compared to 60.1% in the first quarter of fiscal 2003. The increase in 2004 is due primarily to higher margins from engineering services, software maintenance fees, as well as o emphasis on cost reductions in certain product lines and favorable product mix. During the quarter we received non product revenue based on meeting development from Mile stones for cut some OEM opportunity which had a benefit of 1.5% on the gross margin.

Our operating expenses for the quarter were at 13.8 million, compared to 14 million in the prior quarter, and in the first quarter fiscal 2003. Amortization of intangibles was lower than a year ago, quarter by approximately 400,000. But it was offset by an increased investment in research and development, primarily in the Device Networking segment.

Net income for the quarter was 1.6 million or 8 cents per diluted share, compared to a net loss of 42.8 million or 1.94 dollar per diluted share in the first quarter of fiscal 2003. Earnings per share exceeded the upper management -- upper end of the management guidance of 4 to 6 cents.

In the first quarter fiscal 2003, Digi adopted the statement of financial accounting standards No. 142, goodwill and other intangible assets and recorded a non-cash goodwill impairment charge of 43.9 million as a change in accounting principle. Income before the cumulative effect of this accounting change was 1.1 million or 5 cents per diluted share in the first fiscal quarter of 2003.

Turning to our balance sheet our cash position increased by 3.1 million from the prior quarter. As reported in our cash flow statement, the increase is primarily a result of cash generated from net operations of approximately 2.8 million, earn out payments on prior acquisitions of approximately 1.9 million, included in that investing activities were offset by cash provided by option exercises and employee stock purchase plan transactions, of approximately 2.2 million, included in our financing activities.

Accounts receivable at the end of the quarter was 10.2 million, compared to 10.8 at the end of the prior quarter. DSO was at 30 days compared to DSO of 32 days reported in the prior fiscal quarter. Inventory levels at the end of the quarter was 11.1 million compared to 10.4 million at the end of prior quarter. The current ratio for the first quarter was 3.3 to 1 compared to 3.2 to 1 in the prior quarter. Tangible book value per share was $4.18 compared to $4.06 per share in the quarter. Cash value per share was $2.93 compared to $2.85 in the prior quarter.

Now I would like to take a few moments to provide you with some updated guidance of fiscal 2004. For the second quarter of fiscal 2004, we expect revenues to be in the range of 25.5 million to 26.5 million, with earnings per diluted share in the range of six to 8 cents. We continue to forecast an increase in revenue over fiscal year 2003 by 2 to 7%. We are increasing our guidance for earnings per share for fiscal 2004 to a range of 30 to 34 cents, from a previously forecasted range of 26 to 32 cents. Hence on an apples to apples basis excluding last year's 9 cent increase in earnings per share, related to the valuation of the tax benefit of the net operating loss carry-forwards we now expect our earnings per share to increase 36 to 55% for the year, before the cumulative effect of the accounting change related to the adoption of SFS 142. Now I would like to open the call to questions. Operator.

Thank you. [OPERATOR INSTRUCTIONS]. One moment please, for the first question. Our first question comes from the line of Troy Jenson from Synch Equity Partners. Please go ahead with your question.

Hey, nice quarter guys. I got two quick questions here. Joe, could you give me maybe your guess on what percent of your revenues legacy versus kind of the growth product lines?

Well, we break it up, looking at Connectivity Solutions versus Device Networking. So, we talked about that as being 17.5 million in Connectivity solutions and 8.9 million in the Networking area. In terms of the Mex., growth versus mature, we stopped reported that about a year ago, because, at that point, we felt we had 50-50 equilibrium and we have certainly been continuing to drive to be past that equilibrium or better going forward. But that's not something we've continued to report.

OK. One for Kris. Kris, could you go over the one, excuse me, the 1.5% gross margin impact you had, I missed part of that

I said we received non product revenue based on meeting developmental milestone for customer OEM opportunity. So, that had an impact of 1.5% on the gross margin during the quarter.

Got it. Nice job, guys.

Thanks Troy.

Our next question comes from the line of David Hawk from Dougherty and Company. Please go ahead with your questions.

A very solid quarter as well, gentleman. Had a question on the Device Networking business side. I see that was up very strong, nice uptick from prior quarters. Could you give us some sense on whether this upside is being driven by much earlier design wins or is this coming from some traction from your 7520 and 9750 network process processors?

Good question, David. And it's coming from both the Device Server product line and the NetSilicon product line. With the NetSilicon product line, it's coming from earlier design wins. You know, we're getting design wins today. We introduced the 7520 and the 9750, and those design wins, you know, are happening on a quarterly basis. But, in terms of translating those design wins into revenue, that takes some time. And we just introduced the 7520 I think it was in Q1 or Q2 of 2003, so we would just be starting to derive some revenue from that 7520. So, that's not a major source of the uptick. It's more from earlier design wins, momentum with those customers, and an uptick also on the Device Server side of the product line.

OK, thank you.

Our next question comes from the line of William Becklean from Oppenheimer. Please proceed with your question.

Hello, thanks. Hello guys.

Hi Will.

Help me out on this. The Device Networking side of the business is showing nice growth and the December quarter isn't normally the quarter when you have strong results. What, in particular, caused the, you know, the big bump in the, in the first quarter, the December quarter? And going forward, when we think about modeling, you know, results of the two sectors of the business, you know, to get to the numbers that you've given for guidance, you either have to, you know, look at very modest growth in both sectors of that business, or if you have continued strong growth in device networking you've got to model the Connectivity business basically declining, which would suggest that the legacy business is declining faster than it historically has or the growth part of that business isn't growing. Help me understand what the mechanics are going in there?

OK, Bill, there's a lot there. I'll start with the second part of your question, relative to the Connectivity Solutions business, 17.5 million this quarter. If you'll look at that versus the previous quarter, the previous quarter was 18.3 million, a year ago was 18.8 million. So if you look at it year over year, it's down about 6.9%. That's a little bit deceiving in that if you look at a year ago, the 18.8 million had a one-time revenue period of benefit of about 1.3 million from a major customer in that quarter. So if you bring that down, then a year ago was about 17.5. So the trend then would be, normalized, 17.5 million a year ago, and then the subsequent quarters were 17.2, 17.6, 18.3 and 17.5. So that describes a very -- a relatively flat trend in the Connectivity Solutions part of the business. And generally speaking, looking forward with that business, the expectation is that what we'd like to do is, we'd like for that to remain flat, if we can drive upward momentum that would be great. But the expectation would be that we would drive growth in the USB element of that business to offset, to try to offset the decline coming from the Async serial port expansion part of that business. So that's my characterization of the Connectivity Solutions business. I think the early part of your commentary was with regard to the Device Networking business, and why is that up? If you look at the long-term trend, you know, over the last several quarters for that business, it's been trending upwards. It's been trending from, you know, last year it was in the 6s and it's trended up around 8 million the last couple quarters and now up to 8.8 million. That's part of what we consider for NetSilicon and Device Server business a long-term growth trend. We are going to see possibly a little bit of bumpiness, you might see a quarter up and other one might be a little down, but what you're going to see is a consistent long term growth trend in that part of the business. Bill, does that answer your question?

It does except for one thing. If you maintain the Connectivity business relatively flat in the model, then the kind of growth you've had in Device Networking over the last year doesn't show up. To get to your -- to get to your guidance numbers.

I'm not sure -- I'm not sure what you're saying, Bill. Could you be a little bit more specific?

Yes, what I'm saying is if the Device Networking business continues to grow on the same basis than about the same rate as it has for the last year, and you model that into the model against the revenue guidance you've given for the year, fundamentally you've got to model the Connectivity business down and your objective is to keep it flat.

Yes I -

I am saying if you keep connectivity flat and grow the Device Networking business look at somewhere near what looks to be its potential, you end up with a higher number in the guidance you are giving for the year which is 2 to 7% revenue growth.

What I mean we're giving a range of 2 to 7%. At the high end of that range, you know, I think we're in the ballpark of, if we're able to maintain Connectivity Solutions flat which is what we would like to do, you know, that would place us toward the higher end of that range. So that's what we want to do. We want to drive, you know, that part of the business to be flat, and we want USB to offset the decline in a sync, and that's what we're striving to do.

OK. Thanks, Joe.

Thank you.

Our next question comes from the line of Clint Morrison from Piper Jaffray. Please proceed with your question.

Hello guys, good quarter. Can you just kind of break out Net Silicon, if I remembered, we bought it a big pipe lie, lots of good potential, sounds like we're continuing to buy -- get lots of design wins. Can we get a handle of sort of how many design wins or kind of are on the pipeline, how many of these are actually revenuing for us, and I just kind of, you know, how much of that 8.8 million is coming out of that NetSilicon?

Well, we don't break out NetSilicon in the 8.8 million. NetSilicon and the Device Server element of that have both been growing over the last several quarters. In terms of design wins, design wins have been healthy. If you look at 2003 over 2002, we had a 65% increase year over year in design wins, which was very positive. And this quarter, we had, you know, well over 20 design wins, many of which were high volume, and we exceeded our internal targets on that. So that was a very positive development. In terms of the number of design wins in our design win database that continues to grow. As we -- as we had design wins we're certainly adding design wins a lot faster than any are dropping out. So that database continues to grow, and I think a few quarters ago, I -- you know, without committing to a specific number, I gave a ballpark that it was well over 300.

OK. And sort of how many programs are actually generating the revenue if you've got 300 design wins do you have a couple dozen they're generating this revenue or a couple hundred?

It's more than a couple dozen and I think less than a couple hundred, and that's about as specific as I can get right now.

OK, fair enough. And Kris, the special development revenue that boost your gross margins, can you talk a little bit, how unique is that? Are you getting more -- are these fairly frequent and sort of why are you getting paid for this one as opposed to it being just kind of another design win?

Well, it's - Yes, Clint, there are, you know, significant design win opportunities, where a customer might have some really unique customer requirements. And in those cases, where they're very unique customer requirements, you know, we certainly go back to the customer and say hey, you know, the engineering expense to do this is X. And we expect some payment for that. So where we have significant design win, that has significant customization, you know, there's a strong likelihood that there's going to be some NRE attached to it. It's not a majority of the deals. It's a minority of the deals. But there are some of those types of deals out there for us.

So it's not this atypical?

It's -- I'd say -- I'd say it probably is atypical. It certainly is not typical. So yeah, I'd say it's unusual but there are some of them.

That's fine, thank you.

Yeah.

Our next question comes from the line of Jay Meier from MJSK Equity Research. Please proceed.

Hi guys, nice quarter. I just have a couple quick ones. First the tax provision is up at 30% again. Is that going to be consistent throughout the year, do you think?

Yes.

OK.

At this point.

And the share count bumped up by what looks like about 750,000. I know you did mention option exercises, is that what we're talking about?

That and you figure out the fully diluted shares, we factor in the effect of the option is the primary -- primary increase.

OK. As far as your revenue and growth forecasts, can't complain about the way you've cut costs and enhanced the bottom line here. It's really wonderful. But you're still maintaining a 2% to 7% growth for the year. You know, things seem to be ramping up out there, and yet it doesn't seem to be appearing on your horizon. Is that because you just lack visibility, or because you see -- have you visibility but just aren't seeing it yet?

You know, what we've seen is, a small upturn, I think, a growing upturn in the overall economy, that I think we probably started to get visibility to maybe three to five months ago. And so we believe that there is a real overall economic upturn. We believe that it's a positive impact on the technology sector, and we're starting to see that with some of the other technology companies' results. And we're starting to see that in terms of, you know, pipeline opportunity. For our business, what we see, when you see an overall economic upturn, what we would expect to see then is pipeline opportunity. What that means is more deals, more large deals in process. And however, for our business, on the Digi side where we're integrating products into vertical solutions, you know, the sale cycle is still typically, especially for a large deal, is -- it can be a couple years. Most deals it's probably 6- to 12- months. So we're not going to see the positive revenue impact from an upturn for at least a 6-to 12-month lag. And so you know, given the times that we've been through, we feel like we are they realistically assessing the opportunity in front of us, and at the same time, I believe that there is, you know, reason for optimism, that you kind of continue to come back and there may be some upside opportunity down the road. But we feel real comfortable that our forecast, our guidance are realistic.

I understand. Well, we've seen -- we know that the design time and the lead cycle for these projects can be quite long. And yet we've seen you, we've heard you talk about design wins every quarter, and you've announced some nice contracts over the last 6 to 9 months and yet that doesn't seem to be showing up, even in the end of the year guidance. That would suggest that either there is not a whole lot going on, or maybe you're just not willing to put it in the number yet.

Well, you know, if you'll look at it, what we said was we did, I think, 102.9 million last year, and we said 2 to 7% increase. So you know, 7% increase on that would, you know, would be pretty significant number. That would be in the neighborhood of 109, 110 million. So, at the high end of that range, to get to 110 million, we would need to be generating quarters in the, you know, 27, 28 million dollar range, which would be, you know, pretty reasonable growth quarter over quarter.

OK. All right, thank you.

Thank you.

[OPERATOR INSTRUCTIONS]. Our next question comes from the line of William Becklean from Oppenheimer. Please go ahead sir.

I'll take a different bite on a different question. Other than the modest pickup you've seen on the economy, is there anything in particular going on out there that's driving design wins in the NetSilicon business, or broadly the Device Server business also, and I'm thinking, also, are you giving a kick out of voice over IP, or any particular vertical markets where you're seeing traction, and in connection with that what, in fact, is going on in your major vertical markets which might be what the printer copier market, the point of sale market, the industrial automation market? Could you kind of bring us up to date on those?

Yes. If you look at the design wins for the quarter, number one in terms of design wins per vertical, office automation would be second after that, and we had additional design wins in control and building automation, but leader was industrial automation. We are seeing significant opportunity across the verticals. IA has been traditionally been a very strong vertical for us, continues to be a strong vertical for us, at NetSilicon, office automation the same. Traditionally has been strong, continues to be strong, and we continue to drive our efforts into the point of sale and building controls arena.

Any plan in DOIP?

Yes, we do. We do play. We have one major design win that's generating significant revenue for us.

OK.

Our next question comes from the line of Richard Friery from Delfi Management. Please Go ahead sir.

Good afternoon. I missed a few questions here. I just looking at a note I made on the bottom of the first page of the release you rolled out, you launched a new USB Plus series.

Yes.

Maybe I am little confused here. Are you booking any revenue from that yet?

Yes, we are. We're just starting to. We just launched the products. We're seeing a lot of opportunities working with some our OEM partners, and we're just starting to see revenue.

All right. And also anywhere in your business, are you starting to get some revenues and business from areas that some of your competitors may be exiting or they no longer you know, feel are profitable? Are you picking up any business from that?

That's hard to say. My expectation would be that in the, for instance, in the serial port expansion arena, kind of the heritage product line arena, Copytone left that market a little over a year ago. Others of our competitors have had some challenges financially. And my expectation is that with our broad product line, broad Ls coverage and broad channel coverage that we would be gaining share and we believe that we are. So -- yeah, so I believe that we're gaining share at the expense of some of our competitors.

All right, thank you.

Our next question comes from the line of William Becklean from Oppenheimer. Please proceed with your question.

I forgot the question I was going to ask, Joe. It was a good one. I'm sorry.

Hopefully another few, and you can get back at us.

Our next question comes from the line of David Hawk from Dougherty and Company.

Earlier this week in retailing conference that Microsoft announced a number of initiatives based on Windows XP-some powerful solution based on Windows NT. Where do you stand relative to integrations with Microsoft XP and are you work pretty actively with them?

Yes, we've always had a good working relationship with Microsoft, especially on our USB arena, certainly had to have a close relationship in order to write the USB stack for NT. And across all of our product lines, we have - we have to have a strong relationship with Microsoft, because we have to be able to write the drivers for all of their operating systems. So we've got to support, you know, XP, 2000, NT, CE, etc. And we've got a strong engineering team that understands each one of those that lasts and has capability to write the drivers for those. And we have that working relationship with Microsoft at times to be able to work through technical issues and gain better understandings of the interface with their O Ss.

So do you have solutions that are actually deployed in production that are running on XP or are those pending?

Yes, we have -- we have products, you know, across the board in our USB product line, other product lines that support XP.

OK, thank you.

Our next question comes from the line of William Becklean from Oppenheimer. Please proceed with your question.

Joe, you made some pretty interesting announcements of wireless products over the last six months. Could you tell us how that initiative is going and are you getting revenues out of that business now?

Again, the way I'd like to characterize wireless at Digi is we view wireless, whether it be WI-FI or Bluetooth or some other future standards like - and others as interfaces that you know need to be a part of our, you know, road map for each of our product lines. So within the terminal server product line, we've, you know, got some wireless products with our, you know, 2 and 4-port terminal server products. And within our Digi 1 product line we've got WI-FI capability. We've got a serial to Bluetooth product, and so wireless is a key part of, you know, each one of our product lines. And basically, we go out and work with customers to the extent that they have requirements for wire line connectivity, we provide it. Whether it be on the device side, you know, RS 232, 422, 485, on the network side, whether the requirements are Ethernet, WI-FI, Bluetooth, whatever, you know, it's our objective to make device networking easy and be able to provide you know, any of those interfaces and whatever you know, quantity combinations of ports on either the device or network side. So you know, that's -- that's what we do well. It doesn't matter whether it's wire line or wireless connectivity. And in general, the marketplace, we're starting to see the wireless opportunity, you know, pick up. It's not a significant part of our business right now. It's not -- it's not growing aggressively. But we're starting to see more and more opportunities.

Thanks. And can I follow that up with another question?

Sure.

The competitive environment, are you starting to see any new small companies showing up out there? I mean, how do you define the competitive environment that you're in?

Well, we look at competitors by product segment. And you know, we've talked about that in the past. You know, in the Async arena people like Comptro,, Equinox, Maxa and others in the Device server and people like Maxa, indigenous players like you know, in region like WT over in Germany and various other players in the NetSilicon arena it's players like Motorola, Hitachi and others. We haven't seen any recent, I can't think in the last 3 to 6 months, you know, any new competitors. You know, the landscape looks, you know, pretty much the same, and I'd say the competitive intensity is, you know, is very similar to what it's been. I don't see any major changes.

And price pressure, price competitive, price pressures anywhere?

From a price pressure perspective, I'd say in the near term, the price pressures have been about what it's been. It hasn't changed dramatically. My expectation, however, would be, you know, especially in the NetSilicon business, as long term as we drive more and more growth and move out aggressively, you know, with our new products into other markets, to broaden our addressable market in that space, I would expect to see, over time, as we grow, a bit more price pressure. And that's why when I talk about our business model long term, I talk about a business model of a 40% expense to revenue ratio, including amortization, and a gross margin model long term of 55 to 60%. That's why I give that range, because I would anticipate with growth, venturing into these markets, especially with the NetSilicon business, that we would see more price competitiveness, and that would give us a little bit of margin pressure long term.

OK. Thanks, Joe.

Thanks, Bill.

Our next question comes from the line of Jay Meier from MJSK Equity Research. Please proceed with your question.

Thanks. This is a real quick one. The R&D expense bumped up under special and unusual circumstances. Do you expect that to continue at these levels, and is that in real dollars or a percentage of revenue?

We expect R&D to continue at current levels.

Beyond the next quarter? Are we talking about indefinitely?

We expect it to continue next quarter, and for the foreseeable future, I don't see anything for the foreseeable future that's going to bump that up. If we do, we'll certainly, you know, come out and explain, you know, what we see and why we're doing it..

OK. But my impression was the R&D bumped up because you had some special work that you were doing. Is that, am I misinterpreting that?

Yes, many you are. I basically said there were increased spending in R&D Device Networking segment.

All right, thanks.

Next question from William Becklean Oppenheimer.

Last question, I promise. The one-time gain, 1.5% gross margin from the non product revenue, is that a one-time in fact impact, that we're going to see the gross margins kind of come back down, take that 1.5% off going out?

Yes, I would expect that to be a one-time impact.

OK, thanks.

Gentlemen, there are no further questions at this time, and we'll now turn the call back to you. Please continue with your presentation or your closing remarks.

Thank you everybody, look forward to driving positive results again this quarter, and talking to you again in a few months. Thank you.