Digi International Inc (DGII) 2004 Q2 法說會逐字稿

Welcome to the Digi International second quarter 2004 earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded Thursday, April 15, 2004. I would now like to turn the conference over to Mr. Kris Krishnan, Vice President and Chief Financial Officer.

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 the Digi website at www.digi.com. Second, I would like to remind our listeners that our remarks may contain forward-looking statements that involve risks and uncertainties. These forward-looking statements are not a guarantee of the Company's future performance. 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 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 the earnings release we provided a balance sheet, a statement of operations, statement of cash flow, from which you can calculate those measures. We will also not provide any non-GAAP financial measures in response to questions at the end of the conference call, but rather we refer to the information in the financial statement.

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 27.3 million compared to 25.5 million in Q2 of 2003, and 26.3 million last quarter showed continued strong performance. Revenue from our device networking business, which includes our Digi Device Server and NetSilicon embedded microprocessor product lines, was 9.1 million, an 11 percent increase over fiscal second quarter of 2003, which was 8.2 million.

Revenue from our Connectivity Solutions business, which includes our terminal server, USB and heritage product lines, was 18.2 million. The gross margin for the quarter was 60.5 percent compared to 59.5 percent in fiscal second quarter of 2003. Most importantly, we hit the high end of our profitability target, coming in at 8 cents EPS versus the 6 to 8 cents guidance.

Now for some key highlights for the quarter. Digi introduced the DigiConnect WI-ME to provide the industry's first WiFi and wired interchangeable 32 bit embedded modules to support wired and wireless networking. NetSilicon released its NS 9775 and NS 9750 microprocessors to full production, supported by the NET+Works development tools and software suite. Digi launched the RealPort COM port redirectional licensing program. Of particular note is the fact that we paid down the balance of the mortgage on our German facility this quarter, which makes Digi totally debt free. Additionally, we increased our cash and marketable securities position by 7.4 million during the quarter to 68.1 million. This highlights the continuing progress that Digi has made to strengthen its balance sheet.

Next I would like to briefly discuss stock buyback. As I'm sure you noted in the press release, the Digi Board authorized stock buyback of up to 2 million shares. I would like to emphasize, however, that our primary focus for the use of cash continues to be acquisition. The Board has approved the buyback as a tool to add to the toolkit to enhance shareholder value.

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

Thank you, Joe. As Joe indicated, our revenues for the quarter were 27.3 million, an increase of 1 million over last quarter, or 3.9 percent, and an increase of 1.8 million, or 7.2 percent, over the second quarter revenue a year ago. Revenue for the quarter exceeded management's guidance of 25.5 to 26.5 million. We experienced sequential and (indiscernible) versus prior quarterly revenue growth in both our Device Networking Solutions and Connectivity Solutions segment.

Sales of our Device Networking products, which include the NetSilicon device set of product lines, were 9.1 million, an increase of 300,000, or 3.2 percent over the prior quarter, and an increase of 900,000, or 11 percent over the second quarter of fiscal 2003. Sales of our Connectivity Solution products were 18.2 million in the second quarter of fiscal 2004, an increase of 800,000, or 4.3 percent from our first quarter fiscal 2004, and an increase of a million, or 5.7 percent over the second quarter of fiscal 2003.

For the six months ending March 31, 2004, Device Networking products exceeded the same period a year ago by 3 million, or 20.3 percent. Sales of the Connectivity Solution products were at 35.8 million during the first six months of fiscal 2004, compared to 36.2 million in the comparable period a year ago.

Gross margins for the quarter were 60.5 percent compared to 61.2 percent in the prior quarter and compared to 59.6 percent in the second quarter of fiscal 2003. As indicated in the last conference call, during the prior quarter we recorded non product revenue from a onetime customer requirement which had a benefit of 1.5 percent on the gross margin. For the first six months of fiscal 2004, gross margin was 60.8 percent compared to 59.8 percent during the same period in the prior year. We continued to emphasize the growth -- the gross margin growth in all our product lines.

Operating expenses for the quarter were at 14.1 million compared to 13.8 million in the prior quarter and compared to 13.7 million in the second quarter of fiscal 2003. The increase in expenses is due to increase in variable selling and other variable operating expenses due to higher revenues during the quarter. As indicated in the last conference call, amortization expense was lower than the year ago quarter by approximately 400,000 and was offset by an increased investment in research and development, primarily the Device Networking segment.

On a year-to-date basis, our operating expenses were 27.9 million compared to 27.6 million in the same period a year ago. Operating expenses for the first six months of fiscal 2004 are flat compared to prior year operating expenses for the six months, excluding the change in the estimate of 300,000 relating to the restructuring charge that was recorded in the first six months of fiscal 2003.

Net income for the quarter was 1.7 million, or 8 cents per diluted share, compared to 2.5 million, or 12 cents per diluted share, in the second quarter of fiscal 2003. During the second quarter of fiscal 2003, the Company recognized the beneficial impact of reversing an income tax valuation reserve related to the German net operating loss carryforward. The reversal resulted in a favorable impact of 7 cents per diluted share. Excluding the impact of the reversing of the valuation reserve, earnings per diluted share would have been 5 cents. The current quarter earnings per diluted share represents a 60 percent increase over the second quarter earnings per diluted share, as adjusted for the reversal of the valuation allowance. Earnings per diluted share met the upper end of the management guidance of 6 to 8 cents.

On a year-to-date basis, the Company reported earnings per diluted share of 16 cents compared to a loss of $1.86 per diluted share for the same period a year ago. Excluding the impact of the cumulative effect of the accounting change related to the adoption of FAS 142 -- goodwill and other intangible assets -- and a tax benefit of the net operating loss carryforward, earnings per share would have been 9 cents, or a 78 percent increase during the first six months of fiscal 2003. Diluted weighted average shares outstanding at the end of the quarter were 21,999,881 shares, compared to the previous quarter of 21,276,303 shares, an increase of 723,578 shares. This increase in shares was primarily a result of employees options exercised.

Turning to our balance sheet, which remained strong, our cash position increased by 7.4 million from the prior quarter. As reported in our cash flow statement, the increase is primarily a result of cash generated from operations of approximately $5 million. Net cash provided by financing activities was 2.2 million, resulting from stock option and employee purchase plan transactions of 4.3 million, partially offset by the payment of the remaining debt of 2.1 million in Germany. Now the Company is debt free with a cash and marketable security balance of 68.1 million.

Accounts receivable at the end of the quarter was 10 million compared to 10.2 million at the end of the prior quarter, in spite of higher revenues. DSO of 31 days compared to 30 days reported in the prior fiscal quarter. Inventory levels at the end of the quarter were 10.2 million compared to 11.1 million at the end of the prior quarter, a decrease of $900,000. Our account ratio increased for the second quarter to 4.1 to 1 compared to 3.3 to 1 in the prior quarter. Tangible book value per share increased to $4.47 compared to $4.18 per share in the prior quarter. Our cash value per share increased to $3.19 compared to $2.93 in the prior quarter.

Now I would like to take a few moments to provide you with some updated guidance for fiscal year 2004. For the third quarter of fiscal 2004, we expect revenues to be in the range of 27 to 28 million with earnings per diluted share in the range of 7 to 9 cents. For the full year 2004, Digi forecasts an increase in revenue over the fiscal year 2003 revenue of 5 to 7 percent. We are increasing our guidance for earnings per share for fiscal 2004 to a range of 32 to 36 cents, from a previously forecasted range of 30 to 34 cents.

Fiscal 2003 earnings per diluted share, before the cumulative effect of accounting change, was 31 cents. This includes a tax benefit of 9 cents for the reversal of the income tax valuation reserve related to the (indiscernible) net operating loss carryforward. The updated guidance and anticipated earnings per diluted share for fiscal 2004 would result in an increase of 45 percent to 64 percent over fiscal 2003 earnings per diluted share, before the cumulative effect of the accounting change related to the adoption of FAS 142 and a tax benefit of net operating loss carryforward.

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

(OPERATOR INSTRUCTIONS). William Becklean.

Congratulations to the Board on deciding to buy back some stock. How often have you heard that? Could you give us a little color on the growth of the Heritage business? Based on the channel checks I have done there, some suggested that the decline in that Heritage business has slowed down. In fact, is that correct? Can we expect that to continue? Is it possible that we could start to see that growing at all? And also, while you're talking about the breakdowns, talk a little bit about, could you please, about the growth in the Device Networking business? Thanks.

Thanks, Bill. You characterize it as the Heritage business; I think you're probably talking about the Connectivity Solutions piece. And if within the Connectivity Solutions business, we have that Heritage element, which is -- our Async product line is the primary piece of that. The other parts of that Connectivity Solutions business is our terminal server business and USB. So within that dynamic, if you look at the overall Connectivity Solutions business, for the last eight quarters it's been relatively flat, in the low 18 million to mid 17, back up to the low 18 million range. So it's been relatively flat over eight quarters. Underneath that, the Heritage business, the Async piece, has flattened out. So it's been flat to very, very slightly down. The terminal server business has been flat to slightly up, and the USB business which we consider a growth part of the Digi business has been on an upward trend.

Now on the Device Networking side of the business, what you have seen over the last couple of years is kind of a migration from the high 6's to the 8's, to now were over 9 million. And we have several drivers behind that business; certainly with NetSilicon driving design wins and design win improvement in the last year, 2003 over 2002, we increased our design wins by about 65 percent. So that provides some fuel. We -- the wireless TS family, the WI-ME, the DigiConnect WI-ME, the DigiConnect YEM; the DigiConnect ME, and several other products. New products is fueling growth in that business, and certainly over the last couple of quarters we're starting to see the general economy providing some level of uplift or wind behind the sales in both businesses.

Troy Jensen, ThinkEquity.

Nice quarter. A couple of questions. Could you give us the number of design wins this quarter on the NetSilicon side?

Once again we were well over 20 design wins, a lot of high-volume design wins. And in addition to that, the other, I guess, key point I should make is that we are now over 400 active design wins in our design win database that we are tracking. So we have been, as I mentioned in the earlier question, we ramped up our design win capability 2003 over 2002. We are continuing that trend towards higher and higher design win activity and closure. The reasons behind that include the fact that -- again, the economy is providing a benefit. We've got a few new products -- we've got the 7520, the 9750, the 9775. And we're also marketing the Connect ME and the WI-ME to the NetSilicon channel. We have got improved focus and coverage in North America over the past year. So we're getting -- where we were getting very good traction in Japan and Europe and less traction in North America a couple of years ago, the traction has improved substantially in North America in the past couple of quarters. And we continue to improve our vertical focus for that business.

Joe, I know you've spoken over the past couple of quarters about a just larger production opportunity with some of these design wins. When -- what is the normal leadtime between design wins and actual volume shipments?

It varies dramatically, from six months to two or three years. It depends on the design win. Verticals that tend to be a little bit faster are point-of-sale; some point-of-sale design wins tend to be faster. Office networking design wins tend to be a bit faster, so they tend to be in the probably six months to a year and a half kind of leadtime. And industrial automation, building controls, telecom or datacom -- those would tend to be a little bit longer leadtimes before we would see production.

Since you touched on verticals, could you let us know if one vertical is stronger than the other, or did you guys see pretty much broad-based increase in all the verticals?

We saw broad-based. The number one was industrial automation, and behind that, office networking and point-of-sale were real active. And we saw good design win activity in the medical vertical also.

Last question for me and I'll pass it on. Could you give us maybe an update or some insight into the litigation settlement that you guys announced with Tactical?

Yes. We had that licensing settlement with Tactical, basically on the RealPort. As Joe mentioned, we have a licensing program in place that we introduced on that.

They were in violation of the prior patent and we resolved it with licensing.

(indiscernible) any insight on what that could contribute as far as royalties or licensing revenues?

No. It's not material at this point.

Jay Meier, MJSK Equity Research.

Great quarter, guys. Just a couple of questions that haven't been touched on yet. I know you normally don't do this, but would you be willing to ballpark a backlog for us? Some of my checks out there suggest that the backlog may actually be getting stronger.

We have not been disclosing numbers in terms of backlog. What I will say, Jay, is that the backlog for this quarter, going into the quarter was higher than the backlog going into last quarter.

That's positive. Next question, and this is the last one. Can you talk a little bit about the Embrace acquisition? What exactly did you buy, and give us some target markets and maybe some comps if you have that kind of visibility?

Okay. We bought the assets of a company called Embrace out of Naperville, Illinois. The reason that we bought those assets, the main reason was because they had software in the remote device management arena, and we felt -- we feel like over the long-term there's going to be significant opportunity in that space, and that Digi, with our customer relationships -- our broad-based relationships in the connectivity space -- could be a significant player in the extended Internet kind of space. The software that we acquired from Embrace plays in the remote control monitoring and maintenance of devices. We have not deployed a strategy; we're currently continuing to work on that strategy. We believe there's a significant long-term opportunity. However, we believe it's the right thing to do to operate in stealth mode on that strategy until we're real comfortable with launching a broad-based strategy for that product. So that's about as much as I'm going to say about Embrace.

I don't want you to give way any secrets or anything. Thanks a lot; good quarter.

(OPERATOR INSTRUCTIONS). Jeff Stevenson (ph), Vargas (ph) Inc.

Congratulations on the quarter. A couple of questions here. By my back of the envelope calcs, it looks like USB likely might have been very strong. And I know you don't like to comment specifically on those product line items, but if you could give us some color -- a little bit more color on the strength in Connectivity Solutions, I'd appreciate it.

As I mentioned earlier, USB has been on a -- over the last many quarters has been on a growth trend, a general upward growth trend. And we had a good quarter with USB last quarter. And Terminal Server was -- we're seeing flat to up. So that's on an upturn. And Async continues to maintain itself extremely well. So I'm not going to go beyond that level of coloring on the elements, other than USB was strong, it's been growing, continues to grow. The underlying market opportunity for USB is strong, the pipeline is strong; still very much a play into point-of-sale and retail. There's also opportunities to pursue the mobility segment also in this space. An example of mobility would be providing connectivity in police cars, or military units, or buses, or trucks. So that's another kind of target application for our USB product line.

So you'll be a beneficiary of this first responder federal spending opportunity?

I guess I will leave that to you to conclude whatever you conclude on that. That's not something that we've talked about.

Could you talk a little bit about how you intend to pursue the buyback? Would it be opportunistic or systematic? What's your thinking there?

The primary focus of our cash is -- continues to be what it's been, which is to look at acquisition opportunities that would provide additional product platforms to help enhance long-term growth. So that's our primary focus. And the Board has authorized stock buyback as an additional tool to be used in our toolkit when we believe it's appropriate in order to enhance shareholder value. And that's about as far as I'm going to go coloring our strategy on stock buyback.

And last question. You've had in the past some launches with the 7520 and the 9750 NetSilicon processors. Did you see any revenue coming from design wins for those chipsets this quarter?

Yes. We are starting to see revenues coming from the 3520 and 9750. So that flow has started.

Thanks a lot guys.

William Becklean, Oppenheimer.

Second bite of the apple here. The business model going forward, is the current gross margin level, 60.5 percent, sustainable going forward? And how about operating expenses? What do you plan to do with those?

Operating expenses we intend to keep roughly flat. Where we would see variability, obviously, would be as revenues increase, we've got sales, variable sales expense that would move up. But in general, we're very focused on maintaining our expenses at current levels. Beyond that, gross margins -- we continue to focus -- if you look at the background of gross margins over the last few years, we've driven it from 49 percent to mid 50s, to the last five or six quarters now above 59 percent, in the 59 to 61 percent range. And we continue to tactically focus on how to continue to drive really strong gross margins. So we're going to continue that focus, and I would like to continue to maintain gross margins in the 60 to 61 percent level, and believe that at least over the next couple of quarters that that's sustainable. Over the long-term that's harder to forecast. You would expect, especially as we see more and more growth in the marketplace pursuing device connectivity, especially in the NetSilicon business, you would expect more competitive pressures. And you would expect that to have an impact on gross margins, but we're working like crazy to counter that. So I guess to summarize, in the short-term, I feel pretty good about, roughly, where we are and our ability to sustain it. In the long-term, expect competitive pressures and we will continue to fight the battle. But we would expect in the long-term to have some negative impact from competitive pressures..

Thanks. Any of the verticals represent 10 percent of revenues for NetSilicon?

Office networking is over 10 percent. Beyond that, I think industrial automation is probably over 10 percent. And the others, couldn't be specific.

Mr. Krishnan, we have no further questions at this time. I would now turn the call back to you.

Thank you for attending the call, and I look forward to speaking with you again in three months.

Thank you, all.

Thank you ladies and gentlemen. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.