Digi International Inc (DGII) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Digi International fiscal first quarter 2005 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, January 13, 2005.

I would now like to turn the conference over to Mr. Kris Krishnan, Senior Vice President and Chief Financial Officer of Digi International. Please go ahead, sir.

Thank you. 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 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 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.

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

Thank you, Kris. Welcome to the call, everyone. Needless to say, I am very pleased with our results for the quarter. They were highlighted by 13.9 percent operating income and 10 percent net income, high watermarks in the past five years at Digi. Excluding the impact of intangibles amortization, which decreased operating income by 4.5 percent, our operating income would have been 18.4 percent. Our revenues of 29.5 million in the first quarter of 2005, compared to 26.3 million in the first quarter of 2004, showed 12 percent year-over-year growth. Revenue from our Device Networking business was 10.1 million, an increase of 15.5 percent year over year. Revenue from our Connectivity Solutions business was 19.4 billion, an increase of 10.3 percent year over year. The gross margin for the quarter was 62.1 percent, compared to 61.2 percent in fiscal first quarter of 2004. We achieved the high end of our profitability target, breaking the 10 percent net income barrier, coming in at 13 cents EPS and growing net income 80 percent year over year.

Now, for some key highlights for the quarter. Microsoft selected the Digi CM console server with patented RealPort software to provide remote out-of-band access via serial port to the servers that power Microsoft's recently introduced MSN Search Engine. Digi introduced an enhanced Digi One IAP industrial device server, the industry's first truly interoperable device server featuring the industrial protocol bridging.

Digi added four new products to its USB Plus series of powered USB connectivity solutions. Standard & Poor's made semiannual changes to its various entities, including the S&P small cap 600 BARRA Value Index, where Digi was reclassified from a value company to a growth company. We continue to grow our cash position to 83 million in cash and marketable securities at the quarter's end.

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

Thank you, Joe. Our revenue for the quarter was 29.5 million, an increase of 3.2 million or 12 percent over first-quarter revenue a year ago, and at the upper end of our guidance of 28.5 to 29.5 million. First-quarter revenue from Device Networking Products, which include both NetSilicon and Device Server product lines, was 10.1 million, an increase of 1.4 million or 15.5 percent over the year-ago quarter. Revenue from Connectivity Solutions products increased to 19.4 million in the first quarter of fiscal 2005, compared to 17.5 million in the first quarter of fiscal 2004, or an increase of 10.3 percent.

Our gross profit margin for the quarter was 62.1 percent, compared to 61.2 percent in the first quarter of fiscal 2004. Gross profit margin increased as a result of customer and product mix, as well as continued improvement in manufacturing efficiencies. Operating expense for the quarter was 15.2 million, compared to 13.8 million in the first quarter of fiscal 2004.

Selling, general and administrative expense increased due to primarily increased variables selling and other variable operating expenses, related to the increase in revenue. Research and development expenses were less than the year-ago quarter, due to the timing of development costs related to chip fabrication and testing.

The effective tax rate in Q1 of 2005 was at 31 percent, compared to an annual effective tax rate of 28.7 percent recorded in fiscal 2004 first quarter. The increase in the effective rate is primarily as a result of increased annualized pretax income.

Net income for the first quarter of fiscal 2005 was 3 million or 13 cents per diluted share, compared to net income of 1.6 million or 8 cents per diluted share. This is an 80 percent increase, despite the higher effective tax rate and higher share count.

Earnings per share are at the high end of the range of previously announced guidance of 11 to 13 cents.

Diluted weighted average shares outstanding at the end of the quarter were 23,308,998 shares, compared to the previous quarter of 22,538,917 shares, an increase of 770,000 shares. The increase was primarily a result of employee stock option exercise.

Turning to the balance sheet and cash flow statements, our combined cash and cash equivalents and marketable security balance increased by 1.3 million from the prior quarter. Net cash used in operating activities for the quarter resulted from the settlement payment of the recent IRS audit that was noted during the last conference call and other working capital increases that created a use of funds, including increased levels of inventory and receivables. Cash provided by the financing activity resulted primarily from stock option and employee stock purchase plan transactions.

Accounts receivable at December 31st was 12 million, compared to 10.6 million at the end of the prior fiscal year. Our DSO for the first quarter of 2005 was 32 days, compared to 33 days for the fourth quarter of fiscal 2004.

Inventory levels at December 31st were 12.6 million, compared to 11.2 million at the end of the prior quarter. Inventories have increased primarily due to strategic inventory purchases and timings of inventories used by subcontract manufacturers. Our current ratio is 6.0 to 1, compared to current ratio of 4.5 to 1 at the end of the prior fiscal year.

Tangible book value per share for the first fiscal quarter of 2005 is $5.25, compared to $4.90 at the end of the prior quarter. Cash value per share for the first fiscal quarter of 2005 is $3.71, compared to $3.74 at the end of the prior quarter. Cash value per share has been slightly reduced, due to the increase in outstanding shares at December 31st, compared to September 30th of 2004.

Now, I would like to take a few moments to provide you with some guidance of fiscal year 2005. For the second quarter of 2005, we expect revenues to be in the range of 29 to 30 million. Digi expects second fiscal quarter 2005 earnings per share to be in the range of 12 to 14 cents. For the full fiscal year, we forecast fiscal 2005 revenues to increase in excess of 10 percent over fiscal year 2004. As a result of a settlement of the Internal Revenue Service and an audit of prior fiscal years, subject to final approval by the joint committee of taxation, Digi anticipates that 2005 earnings per share may include a reversal of approximately 5.5 million of previously established income tax reserves, equating to approximately 24 cents per share positive impact. Excluding this one-time tax item described above (ph), we expect earnings per diluted share for fiscal 2005 to increase in excess of 33 percent, compared to fiscal 2004. In addition, Digi will adapt a statement of Final Accounting Standards No. 123R, share-based payment, effective July 1, 2005. The Company is currently analyzing the impact of the adoption of FAS 123R. Our earnings guidance on this call excludes the impact of the one-time tax item, as well as the impact of adoption of FAS 123R.

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

(OPERATOR INSTRUCTIONS). William Becklean, Oppenheimer.

Looking at the revenue line from the Device Networking business, revenues were down slightly in the first quarter. And in fact, if you go back and look at the sequential revenue growth, it sort of bounces around. Can you talk a little bit about as we progress through the quarters, does that sort of settle out and become a steadier progression? And if not, what is going on there that makes that sort of lumpy?

Good question, Bill. You hit on the reason why we try not to provide guidance at the segment level, because at the segment level, it does tend to be kind of lumpy with both businesses. And as a result of that, at that level, at the company level, it tends to even out, but at that level it tends to provide a little bit less predictability. So we keep it at the high level. As we look at the business going forward -- and, you know, the reason for that tends to be that we have large customers and some lumpy demand, and so that creates a certain degree of variability that, again, at the high level, at the company level, tends to kind of cancel it out.

Over the long run, we believe that the Device Networking business is positioned well in the long-term growth market. And so, over the long run, we believe that there's a significant growth opportunity. But certainly, in the short run, we do tend to see some variability.

Joe, can you talk a little bit about how large might a single order be in any particular quarter?

We really haven't gotten into that in the past, Bill. I think we have talked about the relative size of some customers, so I think you already have a pretty good general idea of that. Our largest customers might be in the neighborhood of 4 or 5 percent of revenue. But we really haven't gotten into a discussion of orders in the past.

Could you talk a little bit about, for NetSilicon, the whole design win metric? I think the last number we had was that they were up something like 68 percent in fiscal '04. Could you give some guidance on kind of what they were like in the first quarter, and kind of how many total design wins you have in-house now?

Well, again, the design win database is well over 400. We had a very good quarter, in terms of design wins. We exceeded our internal plan, and our internal plan drives aggressive growth year over year. In terms of the verticals where we had the design wins, the most significant vertical was building controls, where we had a significant number of design wins -- things like access control systems, those types of applications. We had strong design wins in point-of-sale and retail and industrial automation. Kind of a new area where we saw a pretty good number of design wins this quarter was in the datacom/telecom arena -- so very strong design win activity in the quarter.

Troy Jensen, ThinkEquity.

Just a couple questions for Kris. Kris, can you talk about maybe linearity in the quarter? I saw receivables were up a little bit sequentially.

Yes. I think if you look at it historically, our receivables tend to be in the 32 days days sales outstanding -- average it around between 11 to 12, 12.5 million. But as revenue also tends to increase, we try to maintain the 32 days DSO. So in relations to that, you'll see slight increases in receivables also.

How about going forward? Should we model a 31 percent tax rate?

Yes, because as we look forward at pretax income as the pretax income had gone up from prior year, our defective rate was at 31 percent for the current year, versus 28.7 percent last year.

Last question -- the comment about moving to the expensing of the options -- could you remind us maybe what the dilutive impact would have been if you look at last year's numbers, or maybe just the September quarter numbers?

Like I said, as I mentioned earlier, we are still evaluating that. But what we reported in our K is the impact was 10 cents for fiscal year 2004, in one of the footnote disclosures that we have in the K.

Keep up the good work, guys.

Jay Meier, MJSK Equity Research.

Another spectacular quarter, guys. Good job. I'm kind of interested in your comments initially, Joe, about the operating metrics. Clearly, the Company continues to improve its profitability numbers here. How would you expect them to behave going forward? Is this kind of a one-time spike, or can we even consider modeling some more aggressive numbers?

Good question, Jay. The guidance that I've given in the past -- you know, we talked about the long-term operating model, and getting to 55 to 60 percent gross margins. And we are obviously overachieving that right now, in that we wanted to get down to 40 percent over time, to a 40 percent or better E to R (ph). And I think we talked about the progress that we've made over the last few years, and expectation that we'd move from operating income excluding amortization moving from about 15 percent to about 17 percent. We though we had a couple -- 2, 3 points, maybe -- improvement that we could make this year. And obviously, in first quarter at 18.4 percent, we are very pleased.

In terms of how that looks going forward, in the short run, I'll hold to the previous guidance that I gave. We really felt like we could, for the year, get to 15 to 17 plus. And we'll hold to that, because I think gross margins, the realistic gross margin level is probably more in the 61 to 62 percent range. And we are hitting our expense targets.

Long-term, beyond this year, we expect to continue to drive improved operating margins. So we believe that there is opportunity to continue to find ways to be more efficient. We believe that there's opportunity, potentially even at the gross margin level; we'll continue to look at that and see, long-term, if we can improve that. But generally speaking, we are very pleased with the quarter. And for the year, I'm going to hold to the previous guidance that we'd be very happy with something for the year in the 17 to 18 percent operating income excluding amortization kind of range.

Okay, good. And you know, we've talked about this every quarter for the last year or so -- you guys are still amassing quite a chunk of cash. You're probably going to have to start looking into FDIC insurance, or something like that. But the acquisition strategy comes up. Any highlights there? How is that progressing? Are you seeing any candidates or anything like that?

Well, I continue to spend a significant portion of my time looking at that. I'm always seeing candidates out there, and we are always evaluating that. We are not only looking at it from an acquisition standpoint, but we are building relationships out there with companies that might be acquisition candidates today or in the future. So that's an ongoing relationship-building process for us.

In terms of the criteria, I think we've talked about that. The criteria for an acquisition is it has to be accretive to our growth rate, and we have to be able to see a higher growth rate. It needs to be earnings-accretive right away, or in the very near-term unless it's disruptive technology, which might be a longer-term play. But certainly, if it's an ongoing type of thing, we would hope that it would be accretive fairly soon. And a hard rule is it's got to drive higher growth rate and has to be a good strategic fit to the core strategy of the business, leveraging the Digi brand into next-generation commercial grade Device Networking products, and it needs to be a good cultural fit.

So those are the criteria, and there are candidates out there that meet that criteria. Sometimes, in environments like this, the most challenging thing isn't to find those opportunities, but you have to have two willing parties and agreement on valuation to make them happen, and that's a very difficult thing to do.

So we are always looking, and I spend a lot of my time on it, and we've certainly built a cash position to continue to be in a good position to take advantage of those opportunities as they come up.

One final kind of lob (ph) out there. Is there anything on the horizon -- we've talked about the economy, kind of -- you know, it's fits and start here. Are you feeling more confident about your visibility and your economic horizons? Can you comment on that at all?

I'd say that the guidance that I've given you on that in the last couple of quarters is still true, that last year the GDP was a little bit healthier, a little bit more aggressive in the US. This year, it's slowed down a bit. And I'd say the market is somewhat reflective of that, but we continue to really drive aggressively execution and try to drive share growth, and that's how we try to combat that. So the market, we don't think, is quite a strong as it was maybe a year ago. But it's still healthy, so we are still very optimistic about the economy and the markets, and other reasons for optimism include our product roadmap and new products that we expect to bring out in the next couple quarters. So we are very excited about some things that we have on the horizon, in terms of new products.

Andy Schopick, Nutmeg Securities.

I'd like to ask management to just clarify the tax rate guidance. If you are reversing about 5.5 million of previously deferred taxes, wouldn't that result in a corresponding increase in the effective tax rate going forward?

No. What would happen is that the reversal will take place in that one quarter, and that quarter where it reverses out, we will see a dip, because it's called a single-event type of activity. But then we have to normalize it the following quarter.

Yes, that's what I'm getting at. I'm getting at the future effective tax rate once this reversal is in fact taken. Usually, it results in a corresponding increase in the effective tax rate going forward.

Yes. Right now, we are at 31 percent effective rate, and the quarter that the reversal takes place, you'll see a dip. And then we'll be back to 31, because part of the effective tax rate is driven by we do have, you know, intangible amortizations and R&D credits and the export sales benefits. So those will all come into play in determining the effective tax rate.

What is the total amount of the deferred tax asset that's on the books?

The net deferred tax asset is 3.4 million, as we see on the balance sheet. The net deferred tax liability is 83,000, as you see it on the balance sheet.

83,000?

Yes.

But you are reversing 5.5 million?

That's coming out of the income tax payable line, where you are seeing $6.1 million sitting on the liability section.

Mr. Dunsmore, I am showing no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks, sir.

Thank you all for joining us on the call. We are real happy with the quarter this quarter, and look forward to talking to you again in three months.

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. Thank you.