Digi International Inc (DGII) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Digi International fiscal third-quarter 2004 earnings conference call. (OPERATOR INSTRUCTIONS). As reminder, this conference is being recorded Thursday, July 15th, 2004. I would now like to turn the conference over to Mr. Kris Krishnan, Senior VP 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 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. 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 different (indiscernible) industries where 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 our earnings release, we provide a balance sheet and statement of operation and (indiscernible) cash (indiscernible) from which you can calculate these measures. We will also not provide any non-GAAP financial measures in response to questions at the end of the conference call. 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, Kris. Welcome to the call, everyone. I am very pleased with our results for the quarter, which were highlighted by double-digit revenue growth, double-digit EPS performance and a 97.4 percent increase in net income year-over-year. Our revenues of 28.3 million compared to 25.6 million in Q2 of 2003 showed continued strong performance. We achieved year-over-year revenue growth of 10.7 percent on the heels of 7 percent growth in Q2 and 4 percent growth in Q1. Revenue from our Device Networking business, which includes our Digi Device Server and NetSilicon embedded MICRO processor product lines, was 9.5 million, an increase of 17.3 percent over the fiscal second quarter of 2003. Revenue from our Connectivity Solution business, which includes our terminal server, USB and heritage product lines, was 18.8 million, an increase of 7.7 percent. The gross margin for the quarter was 61 percent compared to 59.7 percent in fiscal second quarter of 2003. Most importantly, we exceeded the high end of our profitability target coming in at 11 cents EPS versus the 7 to 9 cent guidance.

Now for some Digi highlights for the quarter. Digi added power management capabilities to its USB+ series of powered USB solutions. Digi signed an agreement with ScanSource to distribute Digi Connectivity products, including USB products, multi-port serial cards, device servers and wireless serial adapters. Digi improved its cash and marketable securities position by 7.2 million to 75.3 million. Digi Device Networking business once again generated well over 20 design wins. Now I will hand it back to Kris to handle our financial results in more detail.

Our revenue for the quarter was 28.3 million, an increase of $1 million or 3.5 percent over last quarter and an increase of 2.7 million or 10.7 percent over the third-quarter revenue a year ago. Revenue for the quarter surpassed management's guidance of 27 to 28 million. We continue our sequential revenue growth in the last three quarters. We experienced both sequential and year-over-year quarterly revenue growth in both our Device Networking and Connectivity Solution segments. Sales of our Device Networking products, which include both the NetSilicon and (indiscernible) other product lines, were 9.5 million, an increase of 400,000 or 4.9 percent over the prior quarter and an increase of 1.4 million or 17.3 percent over the third quarter of fiscal 2003.

Sales for Connectivity Solution products were 18.8 million in the third quarter of fiscal 2004, an increase of 500,000 or 2.8 percent for the second quarter of fiscal 2004 and an increase of 1.3 million or 7.7 percent over the third quarter of fiscal 2003. For the nine months ended June 30th, 2004, Device Networking products exceeded the same period a year ago by 4.4 million or 19.3 percent. Sales in the Connectivity Solution products are 54.7 million during the first nine months while fiscal 2004 compared to 53.7 million in the comparable period a year ago, an increase of 1 million or 1.7 percent.

Gross margin for the quarter was 61 percent compared to 60.5 percent in the prior quarter and 59.7 percent in the third quarter of fiscal 2003. For the first nine months of fiscal 2004, gross margin was 60.9 percent compared to 59.8 percent during the same period in the prior year. We continue to focus on maintaining our gross margins.

Operating expenses for the quarter were at 14 million compared to 14.1 million in the prior quarter and 13.9 million in the third quarter of fiscal 2003. As indicated in our last conference call, amortization expense was lower than a year-ago quarter by approximately 400,000, which was offset by an increase in variable selling expenses and other variable expenses associated with increasing revenue over the same quarter in the prior year. On a year-to-date basis, operating expenses were 41.9 million compared to 41.6 million in the same period a year ago. Operating expenses for the first nine months of fiscal 2004 were flat compared to the prior year's operating expenses for the first nine months, excluding the change in the estimate of 400,000 related to the restructuring recorded during the first nine months of fiscal 2003. Net income for the quarter was 2.4 million or 11 cents per diluted share compared to 1.2 million or 6 cents per diluted share in the third quarter of fiscal 2003, an increase of 97 percent. Earnings per diluted share exceeded the upper end of management's guidance of 7 to 9 cents.

On a year-to-date basis, the Company reported earnings per share of 26 cents compared to a loss of $1.81 per diluted share for the same period a year ago. Excluding the impact of the cumulative effect of accounting change related to the adoption of FAS 142, goodwill and other intangible assets, and the tax benefit of the net operating loss carryforwards, earnings per diluted share would have been 15 cents, an increase of 73 percent compared to the first nine months of fiscal 2003. Diluted weighted average shares outstanding at the end of the quarter were 22,223,623 shares compared to the previous quarter of 21,999,881 shares, an increase of 223,742 shares. This increase was primarily a result of employee stock exercises.

We continue to closely monitor and work to maintain our strong working capital position. Our cash position increased by 7.2 million from the prior quarter. As reported in our cash flow statement, the increase is primarily as a result of cash generated from operations of approximately 6 million and net cash provided by financing activities of 1.4 million resulting from stock option and employee purchase plan transactions. Accounts receivable at the end of the quarter was 10.3 million compared to 10 million at the end of the prior quarter. DSO was 32 days compared to a DSO of 31 days reported in the prior fiscal quarter.

Inventory levels at the end of the quarter were 11.3 million compared to 10.2 million at the end of the prior quarter, an increase of 1.1 million. Inventories have increased due to increased lead times of certain materials as well as the timing of the build plan for the early part of fiscal fourth quarter. The current ratio for the third quarter was 4.0 to 1 compared to 4.1 to 1 in the prior quarter. Tangible book value per share increased to $4.67 compared to $4.47 in the same period. Cash value per share increased to $3.49 compared to $3.19 in the prior quarter.

Now I would like to take a few moments and provide you with some updated guidance for the rest of fiscal year 2004. For the fourth quarter of fiscal 2004, we expect revenues to be in the range of 28 to 29 million with earnings per diluted share in the range of 11 to 13 cents. For the full year 2004, Digi forecasts an increase in revenue over fiscal year 2003 revenue of 7 to 8 percent. We're increasing our guidance for earnings per share for the full year of fiscal 2004 to a range of 37 to 39 cents from the previously forecasted range of 32 to 36 cents. Fiscal year 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 income tax valuation reserve related to the foreign net operating loss carryforwards. The updated guidance and anticipated earnings per diluted share for fiscal 2004 would result in an increase of 64 to 73 percent over fiscal 2003 earnings per diluted share before the cumulative effect of the accounting change related to the adoption of FAS 142 and the tax benefit of the net operating loss carryforwards. Now I would like to open the call to questions. Operator?

(OPERATOR INSTRUCTIONS). William Becklean, Oppenheimer.

Nice quarter. A couple of questions, the R&D is down by about a half $1 million. Any particular reason for that? And what would you expect that to be going forward? Will it come back up or are you going to hold it at about 4 million?

Yes, we last quarter, we spent a little bit more than we had planned and we're back down to the level where we would like to be in R&D spending. And we would like to hold that in that general ballpark. So yes, R&D is, on a need-R (ph) basis is where we would expect it to be today and over time as we drive the topline, we would like to continue to drive the expense-to-revenue ratio as a percent of total down.

Okay. So you are going to continue to try and manage operating expenses? We are not going to see them grow significantly above that $14 million level?

I would not say -- no. I would say significantly no, we would not. There's going to be -- in terms of operating expenses as we drive the topline, obviously, we are going to have some sales expense that's going to be a little bit higher and there may be other investments that we make. We are in our planning process for next year and we have not made our final decisions on our plans for next year. So there is the potential for some additional investment, but that would be more than supported by any planned growth that we have.

Okay, do you think you can maintain gross margins at the 61 percent level?

That's a good question. The background on that is that I think two or three years ago, I was telling you that the -- and everybody -- that our business model was to drive gross margins to the 55 to 60 percent range and to drive our expense to revenue down to 40 percent. If you look at what we have done, we've driven our gross margins over the last three years from 49 to 61 percent, so we have overshot that financial model goal. And then if you look at the expense-to-revenue, excluding amortization, we have driven that down from 58 percent two years ago to 46 percent or 48 percent last year and actually this quarter to under 45 percent and year-to-date under 46 percent. So we are moving in the right direction, certainly, in all areas. I think long-term, it will be -- that's a real interesting question, long-term, you know how well we can maintain gross margins. We certainly tactically are not satisfied with a 55 to 60 percent. We would love to drive that better, but we certainly have overshot initial expectations on gross margins today.

Okay. Between the two businesses, could you tell us any particular areas of strength in the Connectivity and the Device Networking businesses, if there are any?

Well, the Device Networking businesses, once again we grew that I think over 17 percent year-over-year. So if you look at this quarter versus the quarter a year ago, we did 9.5 million versus 8.1, and so that would indicate some strength in certain areas. I would say the lion's share of that growth is coming from the NetSilicon side of the business and you know we have introduced some new chipsets and we have been driving over the last couple of years an increased rate of design wins. If you remember, we did 65 percent more design wins in 2003 than 2002, and we are now in that time frame, that lead time, where some of those are starting to come to fruition and generate incremental revenue. So you know, I think the increased design win activity, as well as some strength that we are seeing in the office automation side of that business in Japan is certainly helping to fuel that growth. If you look over the last two years, we've driven from Q3 '02 at 6.8 million Q3 '03, 8.1 million in revenue and Q3, '04, 9.5 million in revenue.

Could you give us some metric for some indication of the percentage of design wins that have actually been converted into production runs?

No, I can't. That is something that we have not shared and we did not plan on sharing today, so I don't have that information in front of me right now.

Okay last two questions. In the Connectivity business, any particular areas of strength?

Yes, I would say USB continues to be strong and growing and Async continues to surprise us in terms of the strength in that business, and our ability not only to maintain flat revenues but actually driving a little bit of growth in that space.

I was thinking of vertical markets, Joe.

In terms of vertical markets point-of-sale, obviously, with the USB strength, point-of-sale is very strong. Also, another area that has been very strong is in the OEM relationship area. We have got some key OEM relationships with people like IBM and NCR and a host of large customers, and so the OEM space has been pretty strong for us. In terms of other verticals, I would say that other verticals are generally kind of tracking to the overall economy and generally things have been positive.

Okay last question, any seasonality in either one of those businesses, Connectivity or Device Networking?

The only seasonality that we've talked about is fiscal -- where our concern is fiscal Q1 with the holidays, with Thanksgiving and Christmas, and just fewer shipping days and the risk that we might have. That tends to be counterbalanced a little bit by end of the year shipments into OEM customers. But that is the main concern that I have with regard to seasonality.

Great. Nice quarter. Thanks.

Troy Jensen, ThinkEquity Partners.

This is Dan Berkstrom (ph) for Troy Jensen. Really good quarter and a lot of good questions by William there. If we take a look at the 10-Q, the Connectivity business is getting about 30 percent operating margins and the Device Networking has negative operating margins. At what revenue level will that turn an operating profit for that business? And then longer-term, maybe you could talk about what you see margins for that side of the business at?

Well we are going through our planning process right now for next year. And so a lot depends, as you look at the breakeven point in that business, a lot depends on the level of investment that we put into that business. We obviously have been investing fairly aggressively over the last couple of years, and what you have seen is, over time, is that the overall profitability for that picture for that business over the last two years has been improving pretty much on a quarterly basis. And so I hesitate to, at this point, since we are in the middle of our planning process for next year, I hesitate to project what that breakeven point would look like. But you can do some of your own math to look at current levels of investment what it might be. And we will be doing planning for next year to define that a little bit more precisely.

Sure, fair enough. Thanks. And then any activity on the buyback?

No. We have not done any buybacks. We continue to -- our primary strategy for cash has been an acquisition. We continue to look at acquisitions and we continue to have the authorization from the Board to do up to a million shares, and certainly are open to strategic buyback opportunities. But in general, we have not done any general buyback.

Great. Thanks, guys, great quarter.

(OPERATOR INSTRUCTIONS). Jay Meier, MJSK Equity Research.

Nice quarter, guys. Just a couple sort of macro-type questions. It seems like the landscape is kind of ugly out there for somebody at least in the software space and some of these other companies. You guys seem to be performing well. How does your economic landscape look going forward?

It continues to look positive. Our pipeline continues to be strong; and as you see, the performance has, topline and bottom line, we've continued to gain momentum. And we continue to see positive prospects going forward. As you saw with our guidance, we were once again increasing twenty to twenty (ph) million in revenue and increasing EPS to a range of 11 to 13 cents. So we would not be providing that kind of guidance if we did not see positive economic picture for Digi out there.

Understood. And last quarter, Joe, you broke from tradition and give us a little bit of hint of what your backlog might looked like. Can you give us a little flavor there this quarter?

No, what I remember doing last quarter was suggesting that we provide backlog information once a year in our annual report and giving you an idea of what that was. And generally I think what I said was it was around 7 million, which was in the neighborhood of 25 percent of what we might do in a quarter. And I don't think I spoke -- I may be wrong, but I do not remember speaking specifically about our backlog going into the quarter last quarter, and nor do we plan to break tradition and talk specifically about backlog numbers going into this quarter. I think that I have given adequate guidance though, in terms of believing you know in the 28 to 29 million overall revenue and that we are in a good position from both a backlog perspective and pipeline perspective to execute on that.

Okay, fair enough. Thanks a lot. Good quarter.

There are no further questions at this time. I will turn the call back over to you.

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

Thank you.

Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation and ask that you please disconnect your lines.