Digi International Inc (DGII) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Digi International third quarter earnings results conference call. During the presentation, all participants will be in listen-only mode. Afterwards, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). Also, as a reminder, this conference is being recorded Monday, July 17, 2006. I would now like to turn the conference over to Kris Krishnan, Chief Financial Officer with Digi International. 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 don't 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 of 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 the 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, certain other financial information disclosed on this call include non-GAAP measures. The information required to be disclosed about these measures, including reconciliation to the most comparable GAAP measures, are included in the earnings release or in the Form 8-K that we filed before this call. The Form 8-K can also be accessed through the SEC filing section of our investor relations website at www.digi.com. Now, I would like to introduce Mr. Joe Dunsmore, Chairman, President and CEO.

Thank you. Welcome to the call everyone. We're very happy with our results for the quarter, which were highlighted by 18.7% year-over-year revenue growth, an EBITDA of 19.3% and net income of 9.3% which all signify sequential upswing from last quarter. Our revenues of 35.9 million compared to 30.2 million in Q3 of 2005 were supported by another solid contribution by the Rabbit product line.

Revenues from our growth products, device server, terminal server, chips and software, and cellular, were up 3% sequentially and 21.6% year-over-year. Revenues from our mature products, which include Async, RAS, sync, SNIC product lines, were up 2% sequentially and down 28.6% year-over-year. Gross margin for the quarter was 57.6% compared to 60.3% in the fiscal third quarter of 2005.

We met our profitability target, coming in at $0.16 EPS excluding the impact of stock-based compensation expense. We made significant progress pursuing our business development initiatives in the cellular product line this quarter. Digi continued to make progress on carrier certifications for the Connect WAN family of wireless cellular products, with 12 certifications added during the quarter including Verizon Wireless.

The Connect WAN is now certified on 19 carrier networks spanning GSM and CDMA technology in United States, Canada, Asia, and Latin America. We expanded our Wireless cellular router family with the introduction of the ConnectPort WAN, the industry's first upgradeable commercial grade 3G wireless WAN router. 3G technologies bring faster speeds for remote Wireless communications, with downloads today averaging 400-700 kbps and the promise of even faster speeds in the future. The ConnectPort WAN is already certified on the Cingular Wireless and Sprint networks.

Our sequential revenue growth in the cellular this quarter was 72%. Our sales pipeline remained very robust and we expect our revenue growth to continue to ramp. During Q3, ConnectPort Display began production rollout into a major fast food restaurant franchise, the production rollout continuing for the balance of '06 and beyond existing and new locations.

Typical installations have between and 11 and 14 ConnectPort displays per site. This franchise has over 3000 locations today and is expanding. Production versions of ConnectPort Display have been sold or sampled into approximately 90 accounts year to date. We expect to see revenues ramp for this product line in fiscal 2007.

Digi International is now listed on the NASDAQ Global Select Market, a new market classification within the NASDAQ stock market. It is the highest tier of companies within NASDAQ. Only 1200 of 3200 NASDAQ companies meet the Global Select liquidity, financial performance, and market cap tests. With the introduction of the NASDAQ Global Select Market, NASDAQ says that it is proactively calling attention to and driving recognition of its world-class NASDAQ-listed companies and their commitment to high standards and good governance.

Lastly, I would like to comment on the trends we are seeing within the business. This Florida NIC product line was only approximately 2% of our total revenue. We don't expect significant sequential impacts from the Nick business going forward. We expect the Async product line to continue its general trend of slow decline on a quarterly basis. However, we are projecting a slight increase for next quarter.

We expect continued growth from our growth products going forward, with the cellular ConnectPort Display and new Rabbit products providing some exciting upside opportunity. Backlog continues to build at an accelerated rate and we're starting Q4 at a much higher backlog level than previous quarters. As a result, our revenue guidance for Q4 will be 34.5 to 39.5 million.

On the gross margin front, we're expecting to maintain gross margins in the 56 to 58% range over the next several quarters. Now, I'll hand it back to Kris for a more detailed discussion of our financial performance.

Thank you, Joe. Our revenue for the quarter was 35.9 million, an increase of 5.7 or 18.7% over third quarter revenue year ago and within management's guidance of 32.5 to 37.5. The increase in revenue third quarter of 2006 was primarily attributable to the revenue from growth products and acquired products, offset primarily by decline in the mature product line.

Our growth products, excluding the acquired products, grew 21.6% compared with third quarter of 2005. And our sales of our mature products declined 28.6 compared to the third quarter of the prior year.

Gross profit margin for the quarter was 57.6% compared to 60.3% in the third quarter of 2005. The decline in gross profit margin were caused by product mix changes between the mature product lines and growth product lines, higher manufacturing expenses and Rabbit product sales which carry a lower gross profit margin. We anticipate our gross profit margin will be approximately 56 to 58% range in the next couple of quarters.

Operating expense for the quarter were 16.9 million compared to 14.5 million in the third quarter of 2005. The increase in operating expense in the third quarter of 2006 was primarily attributable to the acquisitions that were completed in the third quarter of 2005. Digi also recorded a pre-tax charge of $600,000 for stock-based compensation expense in the quarter as a result of the adoption of Financial Accounting Standards Number 123R share-based payment in the first quarter of 2006.

A charge of 300,000 for acquired and process R&D, research and development, due to the acquisition of Rabbit is included in the operating expenses for the third quarter of 2005. Digi's quarterly effective tax rate was 22.6% compared with 37.7 in the third quarter of 2005. The effective tax rate has declined from previous quarter as a result of recovery of additional discrete tax benefit in the third quarter of 2006. We anticipate our annual effective tax rate for 2006 will be approximately 27 to 32%.

Net income for the third quarter of 2006 was 3.3 million or $0.14 per diluted share compared to a net income of 2.5 million, or $0.11 per diluted share in the third quarter of 2005. Stock-based compensation expense reduced earnings per diluted share by $0.02 for the third quarter of 2006. Earnings per diluted share excluding the impact of the stock-based compensation were at $0.16 for the third quarter of 2006 and at the upper end of the range of the management guidance of $0.10 to $0.16.

Digi reported revenue of $103.6 million for the first nine months of 2006 compared to revenue of $89 million for the comparable period in fiscal 2005, or an increase of 16.4%. Net income for the first nine months was $8.1 million or $0.34 per diluted share compared to $14.2 million or $0.61 per diluted share for the first nine months of 2005. Stock-based comp expense of 1.7 million reduced earnings per diluted share by $0.05 for the first nine months.

Earnings per diluted share excluding the impact of stock-based compensation expense were at $0.39 for the first nine months of 2006.

As a result of a settlement with the Internal Revenue Service in the audit of prior fiscal years, Digi recorded a reversal of $5.7 million of previously established income tax reserves equating to $0.24 per diluted share positive impact in the second quarter of 2005. Earnings per diluted share would have been $0.37 for the first nine months of 2005 excluding the impact of a favorable tax settlement. Diluted weighted average shares outstanding at the end of the quarter were 23,903,903 shares compared to a previous quarter of 23,687,367 shares, an increase of 216,536 shares.

Turning to the balance sheet and cash flow statement, our combined cash and cash equivalents and marketable securities increased by 5.9 million from the prior quarter and has increased 15.7 million from the end of the prior fiscal year. Net cash provided by operating activities for the quarter was $5.7 million. Cash provided by financing activities was $500,000 resulting primarily from stock option and employee stock purchase plan transactions.

Digi invested approximately $200,000 in purchases of property equipment and other assets in the quarter.

Net accounts receivable at June 30th was $19.2 million compared to $18 million at the end of the prior quarter. Our DSO still remains at 34 days. Inventory levels at June 30th were $19.1 million or $300,000 higher compared to prior quarter. Our current ratio is 4.9 to 1 compared to a current ratio of 4.4 to 1 at the end of prior fiscal year. Our cash value per share for the third fiscal quarter of 2006 is at $2.85 compared to $2.60 at the end of the prior quarter.

Now, I would like to take a few moments to provide you with some guidance for the fourth quarter and the full fiscal year 2006. For the fourth quarter of fiscal 2006, we expect revenue to be in the range of $34.5 million to $39.5 million. Digi expects fourth fiscal quarter 2006 earnings per diluted share to be in the range of $0.11 to $0.18 excluding the impact of stock-based compensation expense. We expect stock-based compensation expense to have an impact of $0.02 for the quarter.

For the full fiscal year, Digi forecasts revenue to be in the range of $138 million to $143 million, or an increase over 2005 revenues of 10 to 14%. We expect earnings per diluted share for 2006 to be in the range of $0.50 to $0.57 excluding the impact of the stock-based compensation. We estimate stock-based compensation expense will impact the financial statement by approximately $0.07 per diluted share for the full fiscal 2006. Digi estimates reported earnings per diluted share, including impact of the stock-based comp, to be in the range of $0.43 to $0.50 for the full fiscal year.

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

(OPERATOR INSTRUCTIONS). Clint Morrison, Feltl & Co.

Good quarter. Question on the tax rate that kind of jumps out. It sounds like you got a benefit and what I heard was it benefited you, and I heard what you said for the year. Is the fourth quarter going to be back at that sort of 32% rate that we were at before? Is that how we get to whatever guidance you gave us for the full year?

Well it's hard to predict the tax rates now, because when tax benefits are recovered, we need to get through the quarter that the event occurs. So that's why we give the range of 27 to 32 to be the rate for the full year coming into the fourth quarter.

Okay, so assuming no other -- assuming no tax rate recoveries, kind of that 32% number you have been running for the last couple of quarters is okay looking forward?

Yes, because our annualized rate for this quarter ended up being at 30%.

I got you. And I don't know if you're in a position to do it yet, you were talking about kind of your cellular products and certified what, I think you said 12 new -- 12 certifications added in the quarter and now you are on 19 carriers?

That is right.

Can you -- so I am thinking of trying to -- and you said 72% cellular growth in the quarter? Can you give us at all kind of a dollar figure? Those are obviously big growth numbers; we're trying to get our arms around how big this deal really is at the moment.

As we said in the past, we don't get into revenue dollars by product line, but it's actually starting to get into some pretty significant numbers and we're anticipating a strong ramp going forward. Some of the carriers that we have certified include Cingular, Sprint, Verizon, Rogers in Canada, Midwest Wireless, Alltel, T-Mobile, Cellular One, [Cellular Self], Centennial Wireless in Puerto Rico, Movistar in Colombia, Mexico and Chile, Telecel in Mexico, Intel in Chile, Claro in Peru, Vodafone in New Zealand, Comcel in Colombia.

Okay, so we're -- it sounds like we pretty well got the U.S. ramped up and now we are kind of doing the rest of world stuff.

Yes.

Okay. That's all I needed at the moment. Thanks.

Jay Meier, MJSK Equity Research.

Thanks for having me. I have a few questions for you. Joe, can you provide your sense of the macro environment for your businesses right now?

Yes, it seems pretty healthy from a micro prospective for us in terms of backlog generation. We are seeing very strong backlog not only for the upcoming quarter, but actually beyond next quarter, more so than we have seen in the past, a Very strong backlog position. So in general, for the micro business, it looks very healthy.

The overall environment that we're playing in, the signals are pretty mixed in terms of the overall economy and how other companies are coming in with their results. So it appears that we're feeling some pretty strong backlog strength that's probably in a sense outperforming what we're seeing in the broader environment.

Okay. Assuming that Q4 is the first quarter that should show organic growth after acquiring Rabbit in Q3 of '05, your guidance doesn't appear to demonstrate a lot of confidence in year-over-year growth. Have you rationalized that and when would you expect to see some more robust organic growth on a year-over-year basis?

Yes, when you break that down and look at year-over-year, we anticipate that the growth products will continue to show the robust growth along the lines of what we saw this quarter. If you look at the last few quarters, you've seen the growth products have increased in the last three quarters from Q1 being kind of a tough quarter for us where there is only 1% growth, then Q2 was 4.4%, then this quarter was 21.6. I would expect our growth products to be pretty robust again this quarter, up in that ballpark that we saw this quarter.

The -- and so the offset to that on a year-over-year basis is primarily that NIC business, which is going to be on a -- while sequentially quarter over quarter not having a big impact, when you look at the year-over-year, NIC next quarter will have a significant impact. So the mature products will have an impact from the NIC business which will be negative.

So what we've done is, looking at the guidance and the strong backlog, we've increased our guidance over the last few quarters by 2 million on the low end/high end, and believe we have a strong backlog and believe that we have a good opportunity to hit the midrange or better on this guidance number that we gave.

Okay. As you're building backlog into the fourth quarter and even beyond, when would you expect -- is there something going on with the bookings that they're coming in that you're able to run them as revenue at a later date relative to when you book them? Or is it -- when would you expect to see that business start to really show up and offset the decline in the NIC business and other mature products?

Well, if you look at it on a year-over-year basis, we're going to continue to see that NIC business have a negative impact. The backlog is showing up this quarter on the growth products side with the 21% growth and we expect it to show up again next quarter, and we would hope that it would continue to remain robust given the backlog trends that we're seeing.

We will continue to keep a close eye on this over the next two or three months while we're in the process right now, in the middle of the process of defining our 2007 plan. So the combination of working through that 2007 plan and keeping an eye on this backlog momentum, driving it and hoping for it to continue to be as robust as it is right now, we'll be able to tell you a lot more in a couple months -- in a few months.

Okay. Let me ask it a little differently. When do you expect the NIC business to be gone?

Well, it was about 2% -- approximately 2% of our revenue this quarter, and we're expecting it to decline to -- in the ballpark of maybe 1% or so next quarter and remain at that level for a few quarters. So then, if you look at it on a quarter over quarter basis, just to give you a sense for the size of that business, Q1 '06 was in the 1.7, 1.8 million range. So I think you'll start to see on a quarter over quarter basis, the Q2 to Q2 for next year, you're looking at kind of a 2% of revenue Q2 '06 going to 1% or less Q2 '07. Does that help you?

What would help me more is if you could give me a ballpark what NIC's revenue was in Q3 of '05.

Q3 of '05, it was right around 3 million, ballpark.

All right. And, Kris, you mentioned that the gross margin, you expect it to be in the 57, 58% range for the next couple of quarters.

56 to 58.

56 to 58, excuse me. And what would you -- what would you target beyond the next couple quarters? How should we expect that to change as we get beyond six months or so?

I would not expect any big changes from that range because as I said, the Rabbit product lines continue to carry low gross margin. But as the ramp up against of this product mix shift, there will be variances towards the higher end of the range and the lower end of the range. We'll continue to give guidance as we go along.

Okay. Very good. Thanks.

(OPERATOR INSTRUCTIONS). Christian Schwab, Craig Hallum Capital.

This is Christian. The North American distribution channel, I am sorry, I dropped on the call late, has that environment improved yet?

I would say through most of the quarter it was pretty flat, and then towards the end of the quarter showed some life and was starting to improve. And our natural expectation kind of seasonally for this quarter would be to expect that to continue to improve and to see a little bit more life out of the North America channel than we've seen in the past couple quarters.

So last quarter, we talked about that channel kind of starting out strong. So is that kind of -- started off strong for couple weeks and then just kind of was stagnant through the remainder of the quarter? I don't want to put words in your mouth.

No, not for the rest of the quarter. It ended up strong in the last couple of weeks.

Okay. Would you classify that as more -- is this company-specific to your products or do you just think that there is -- or kind of like what you suggested last quarter, kind of network sector in general for everybody?

We maintained or grew our share position, so I would say it was more of a broader network sector statement where it was a little bit slow in kind of a broad sense for the networking sector, and also for our sector, more precise sector, commercial grade device networking. And like I said, we believe that we maintained or grew our share position in the channel throughout that time period.

Great. And then, two quarters ago we kind of talked about the cellular push outs as an explanation of guidance at that time, and suggested that we would expect a measurable ramp to start in some of those pushed out product lines this September quarter. Are you seeing that?

Yes. It's meeting our expectations. It's almost precisely a six-month push out as we said. So we said we thought we would see the ramp curve that we had predicted move out six months, and that's exactly what's happened. And it's ramping exactly how we expected and hoped it would when we gave you that guidance.

Fabulous. Given that the sequential growth is kind of flattish to slightly up, is there other businesses that are offsetting that strength?

Well, the sequential growth on a quarter over quarter basis isn't bad. I think it was sequentially 4.3%. So on a quarterly basis, that's not bad. And as I said, the NIC business wasn't -- it wasn't a huge impact quarter over quarter. Our other growth products did very well. On a sequential basis, the one product line that was relatively flat on a quarter over quarter basis was USB.

Okay. And then, just two housekeeping questions, gross margins expected to remain around the 57% level or are they expected to increase or decrease?

Yes, 56 to 58% is the longer-term perspective on that. And yes, we would expect to be in the 57% kind of range plus or minus.

Okay. Fabulous. Thank you.

Thank you. Mr. Dunsmore, I'm showing no further questions at this time. I will now turn the conference back over to you.

Thank you. Thanks everybody for joining us this quarter. And I look forward to talking to you again in three months.

Thank you.

Thank you. Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.