Digi International Inc (DGII) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Digi International first quarter 2007 earnings results conference call. (OPERATOR INSTRUCTIONS). As a reminder, today's conference is being recorded, Thursday, January 18, 2007. It is now my pleasure to turn the conference over to Mr. Kris Krishnan, 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 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.

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 business environment 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 of the financial information disclosed on this call includes non-GAAP measures. The information required to be disclosed about these measures, including reconciliations of the most comparable GAAP measures, are included in the earnings release on 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.

Welcome to the call everyone. I'm happy with our results for the quarter, which were highlighted by 25.3% year-over-year revenue growth, and EBITDA of 18.3%, net income of 9%, and a GAAP EPS of $0.15 a share, which is up $0.06 a share from Q1 '06.

Our revenue of $41.8 million compared to $33.4 million in Q1 of 2006 included year-over-year organic growth of 11.5%, with the balance coming from the MaxStream acquisition.

Of particular note is that our revenue of $41.8 million is the highest in the past seven years. And the EBITDA, net income, and EPS are all high watermarks for the first fiscal quarter in the past seven years since I have been at Digi.

Embedded product revenue was $16.6 million, which is up 18.5% year-over-year. Non-embedded product revenue was $25.2 million, which is up 30.1% year-over-year.

We saw particularly strong performance from our cellular and terminal server productlines this quarter. In fact, the cellular productline increased 54% sequentially and 440% year-over-year, as it continues to ramp very aggressively. Our GAAP EPS at $0.15 came in toward the high-end of our $0.10 to $0.16 guidance range.

Now for some highlights of the quarter. In October we announced the availability of the XBee XTender wireless bridge, that extends the range of Zigbee and 802.15.4 networks up to 40 miles. Because the Zigbee and 802.15.4 standards focus on low-cost, low-power, wireless monitoring and control of electronic devices, Zigbee modems typically must be located within 100 to 300 feet to communicate.

In November we introduced a Rev A version of our ConnectPort WAN VPN, the industry's first commercial grade EVDO Rev A Wireless WAN router. With broadband download and upload speeds it is the first commercial grade solution to take advantage of enhanced Rev A EVDO wireless networks to enable wireless connections to remote sites and devices at the DSL speeds.

In December our MaxStream-branded XBee product family was ZigBee Certified by the ZigBee Alliance. The XBee and XBee-PRO OEM RF modules passed rigorous independent testing to become the first wireless module in one of only four products to receive Zigbee certification.

The Company strengthened its Board of Directors with the election of Ahmed Nawaz. Mr. Nawaz brings to the Digi Board extensive general management, as well as global sales and marketing experience in the communications technology arena.

Lastly, I would like to comment on the revenue trends that we are seeing within the business. We expect the Async productline to continues its general trend of slow decline on a quarterly basis. We expect continued year-over-year growth from our embedded product going forward, with the Rabbit and MaxStream productlines leading the way.

We expect continued year-over-year growth from our non-embedded products, with the cellular and USB productlines showing very high growth opportunity. As a result, our revenue guidance for Q4 and Q2 will be in the $39 million to $44 million range, with a GAAP EPS range of $0.11 to $0.17.

Now I will hand it back to Kris for a more detailed discussion of our financial performance.

Our revenue for the quarter was $41.8 million, an increase of a $8.4 million, or 25.3%, over first quarter revenue a year ago. Revenue for the first quarter also increased sequentially from the fourth quarter of 2006 by $800,000, or 1.9%, despite a traditionally weaker first fiscal quarter.

First quarter revenue includes organic growth of 11.5% compared to the first quarter of 2006. MaxStream, acquired on July 27, 2006, contributed $4.6 million in revenue for the first quarter. Revenue from embedded products in the first quarter of 2007 was $16.6 million, an increase of $2.6 million, or 18.5%, compared to the first quarter of 2006.

Revenue from embedded product -- non-embedded products, was $25.2 million in the first quarter of 2007, an increase of $5.8 million, or 30.2%, compared to the first quarter of 2006.

Our gross profit margin for the quarter was 52.6% compared to 54.5% in the first quarter of 2006. Gross profit margin was lower in the first quarter of 2007 compared to the first quarter of 2006 due to lower sales of mature products with higher gross profit margins, as well as higher manufacturing expenses. The amortization of purchased and core technology reduced gross profit margin in the first quarter of 2007 and 2006 by 2.8% and 3.5%, respectively.

Total operating expenses for the first quarter of 2007 was $17.7 million compared to $15.3 million in the first quarter of 2006. The increase in operating expenses in the first quarter of 2006 was attributable to the inclusion of operating expenses pertaining to MaxStream, as well as the variable compensation expenses related to the increase in revenue compared to the prior year.

Digi continues to focus on controlling expenses while increasing revenue. Operating income improved by 49.6% to $4.3 million, or 10.3% of net sales in the first quarter of 2007, compared with $2.9 million, or 8.6% of net sales in that first quarter of 2006.

Net income for the first quarter of 2007 increased 74.2% to $3.8 million, or $0.15 per diluted share, compared to net income of $2.2 million, or $0.09 per diluted share in the first quarter of 2006.

As a result of the extension of research and development credit for two additional years beyond calendar 2005, a benefit for research and development credit earned during the last three quarters of fiscal 2006 was recorded in the first quarter of 2007, resulting in additional tax benefit of $500,000, or $0.02 per diluted share.

Digi's effective tax rate for the first quarter of 2007 was 25.1% as a result of the benefit discussed previously for research and development credit, compared to 32% in the first quarter of 2006. We anticipate that our annualized affective tax rate will be approximately 33 to 33.5%.

Diluted weighted average shares outstanding at the end of the quarter was $25,983,390 shares compared to the previous quarter of 25,275,716 shares, an increase of 707,674 shares. Weighted -- diluted weighted average shares outstanding increased by 2,497,761 shares from the first quarter of 2006, primarily as a result of shares issued pursuant to the acquisition of MaxStream.

Turning to the balance sheet and cash flows statements, our combined cash and cash equivalents and marketable security balance increased by $2.6 million from prior quarter.

Net cash provided by operating activities for the quarter was $3.2 million. A contingent consideration of $800,000 was paid to the previous owners of FS Forth based on achievement of achievement of certain milestones defined at the time of the acquisition of FS Forth.

Cash provided by financing activities was $700,000, and resulted primarily from stock option, employee stock purchase plan transactions. Digi spent $700,000 on the purchase of property, equipment improvements in the first quarter of 2007.

Net Accounts Receivable at December 31, 2006 were $19.8 million compared to $20.3 million at the end of the prior fiscal year. Our DSO remains at 33 days. Our inventory levels at December 31 were $24.6 million compared by $21.9 million at the end of prior fiscal year.

Our current ratio is 5.2 to 1 compared to a current ratio of 4.6 to 1 WAN at the end of the prior fiscal year. Cash value per share for the fourth fiscal quarter of 2006 is $2.45 compared to $2.35 at the end of prior fiscal year.

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

(OPERATOR INSTRUCTIONS). Jeff Evanson, Dougherty & Company.

Congratulations on the quarter. The growth is quite impressive here. In particular, I note MaxStream is up I think 44% sequentially. Could you tell us a little bit about what is going on there?

That is as expected. The MaxStream growth -- the reason we did the MaxStream acquisition was because it was a great strategic fit, and we felt like it was a great cultural fit. And we felt like it would have the effect, as a primary factor in acquisitions, of improving our topline growth rate.

So MaxStream has been a strong growth business. We acquired them and expected it to continue to grow. And so if you look on a normalized year-over-year basis, it is up about -- like you said -- it is up about 44% year-over-year compared to MaxStream's performance this fiscal quarter last year. It has had a strong quarter, strong growth, and growth as expected.

Does their business conform to the same types of seasonal patterns that your regular business does?

Good question. I don't necessarily -- it should. They are in the same space, so you would expect it to have the same seasonality patterns. If you will look at some of the seasonality that is in that business, it does tend to vary a bit. We're still learning some of the factors that affect that business. But generally speaking, I think over the long run, my expectation would be we're in the same commercial grade device networking space, and I would expect to see the same kinds of seasonality impacts.

Sure. Joe, you always talked about November and December being tough months to predict. You have clearly come through that well. Could you talk about where you see inventory positioned at the end of the quarter here, both in the channel, and maybe even comment on backlog, if you would please.

Yes. Typically, like you said, last quarter is always a challenging quarter, and we had a strong quarter. We started the quarter strong. And October is typically stronger than November, and December are typically not as strong.

We have seen -- we saw strength throughout the quarter. We typically see January -- typically is very down in terms of backlog, and it is a very slow month. So on a relative basis, we're seeing the same relative strength continue with the business, considering seasonality impacts that we have seen in the past. We're still bullish about the backlog and sales pipeline trends that we are seeing. And so we're very positive about that looking ahead.

On the inventory side of things, you were asking the question on inventory level or channel inventory?

Channel inventory.

We continue to maintain the same channel inventory policy that we always have, to maintain between six and eight weeks on hand and on order in the channel. And we continue to manage to that parameter.

Then my last question. Could you talk a little bit about where you see gross margins trending?

We are seeing the same trends that we have seen within the business. As we see the Async -- the mature Async productline, which is a high margin productline, decline, we see growth and high growth from some of the MaxStream products, the XBee productline and other productlines which tend to be not as high margin. So some of that high margin productline is being replaced by some lower margin product revenues.

You have that general trend happening, and then underneath that we do a lot of work in terms of driving cost reductions within engineering, and a lot of things to offset any negative impact of that. We will continue to drive that, and we will continue to drive to our operating model, which is to try to maintain gross margins in the mid-50s.

This level is a low level, you think? You be able to digest these new manufacturing costs, do you think?

No, I wouldn't characterize it that way. I would characterize where we're at as kind of typical for where we would expect to be today, post MaxStream acquisition. With the Rabbit and MaxStream acquisitions we have acquired a couple of businesses that -- whose gross margins were in the low-50s, which has a natural effect of bringing down margins to the -- weighting down the margins to the point where they are now, in the mid-50s. And my expectation would be that we would expect to hold at level. We could see some decline. We could see some slight increase.

If we're effective in our cost reduction efforts, if we are effective in our product customization efforts, we would hope to see it remain flat or slightly up. If we're not as effective, or if we see higher growth rates in the market and more competitive intensity, it could have an effect to drive it slightly down. Those are some of the factors that we're working with on that, and it is hard to predict.

Michael Ciarmoli, Boenning & Scattergood.

Congratulations on the quarter. A couple of things. And I heard this -- looking at the release and looking at the tax credit related to the R&D, I think one source is reporting the GAAP EPS is $0.13. How should I look at that? Is that including your GAAP number there of $0.15, or should we strip that out as a onetime -- not charge, or just a onetime occurrence?

You know, we're just focused on providing GAAP. So we are now in an apples-to-apples arena where everything is on a quarter-over-quarter basis. Everything is equal essentially now. You don't have the problem we had last year with the stock option expensing issue.

Sure. Okay, I think I just saw a report out there saying $0.13 and that kind of threw me. And I know some of our sales guys were looking at it and that threw them. Okay, but that is good enough.

In terms of the outlook for MaxStream, I think you guys have said the guidance for revenue there was between $20 million and $24 million, still confident in those numbers?

Yes, we are.

Okay. So could I interpret it as a $4.6 million dollar a good quarter for MaxStream, but can we expect that to trend higher here as we continue through the year?

Well, our annual range is $20 million to $24 million, and that is what we are targeting.

Got you. The other thing, as far as operating expenses, you're still targeting to get to the sub 40% level. Do you think as the integration proceeds with MaxStream, do you think those expenses will come down?

This quarter that number is taking out intangible amortization. The number, when you take that out for this quarter is 39%.

Okay.

So that is a very strong number for us. And, yes, we continue to try to drive that number. Kind of an interesting statistic, if you look at our revenue growth, our revenue increase year-over-year was over 25%, [Hint's] increase year-over-year was 15.6%.

What about in terms of -- to the organic growth rate, 11.5%, a great number. Where do you see that number going forward? Do you think you'll get the strength from the other productlines to keep that going? Any direction that you can give us in terms of where you're looking in organic growth?

A good question. The perspective on that was four quarters ago we said that we were dealing with some negative percentage organic growth. And we said that once we got rid of the decline from the NIC products that we would start to see positive organic growth. The last quarter it was -- I think it was about 4.7% -- where it is about 11.5%.

And we don't -- while we don't try to provide guidance or forecast that number specifically, it is our goal and our desire to continue to drive year-over-year improvement in organic growth. That is what we're trying to do.

We certainly have, from an organic perspective, we have got some really exciting products that are driving growth. Our cellular productline is on an extremely high-growth ramp right now. Our terminal server productline performed extremely well last quarter, and we expect to have another strong quarter with that productline. And we have strong growth trends with the Rabbit productline in general -- with the Rabbit productline on a year-over-year basis and with our device server productline and USB productline.

So we think we've got strong organic growth opportunity. Certainly not having the negative impact of the NIC card is a positive for us. And the challenge of continuing to maintain the Async decline at moderate levels will allow us to continue to drive strong performance there.

Okay. Can you give us any details, numbers or percentages on the cellular revenue?

I think we gave percentages on that. I think (multiple speakers).

Just the cellular line. I know you gave percentages with the embedded and non-embedded, but as far as just (multiple speakers).

I think what I gave is what I can give at this --. I think I gave -- the sequential number was just something in the neighborhood of 54%, and the year-over-year was 440%.

But in terms of dollars. You won't give us any dollar numbers there?

No.

Okay. Last question and then I would jump off. I saw the quarterly guidance. Any update on the full year guidance, keeping that the same?

Keeping that the same.

Clint Morrison, Feltl.

Good quarter. A couple of questions. The big jump in SG&A, what is going on there? I assume last quarter had the full impact of MaxStream in there. Are we seeing something unique, or what is going on?

First of all, let me pull back on the overall expenses and drive the point home that on a year-over-year basis our revenues were up 25%. And our total expenses, [E2 R] was up only 15.6%, so you are seeing a lot of improved efficiencies there.

Now within SG&A, I think Kris can comment.

Yes, I think if you recall last quarter we had the sale of a domain name, which was for about $250,000 was a reduction of our G&A expense. Of course we didn't have that positive impact, and it is just normal business accruals, along with compensation expense with the growth in revenue.

Okay. Let's see, then the tax rate, the number you gave us is what you expect for the full year, so over the next three quarters it will actually be a little bit higher than that, correct?

Yes, that's right. Because a full year annualized basis, 33 to 33.5%. So to annualize it, on a quarterly basis it will be closer to 35%.

Okay. And the FAS 123 expense you recognized this quarter, is that representative of what you think it will be ongoing this year?

Yes, that's correct.

I noticed that your interest income had a -- like a 30% sequential increase, a whole lot more than your cash balance. Did some stuff rollover, or is that sort of realistic as to what it is going to be on a quarterly basis moving forward?

I think part of it, as a year ago our effective rate of return on the investments was around 3.5%. Currently we're generating about 5%. And we are at a higher cash balance this year versus last year, so you will see some (multiple speakers).

You will see something sequentially. Sequentially you are up roughly 30% and your cash is only up a couple of million.

Yes, it would be down slightly. Again, there are some things that are rolling around, long maturities at lower interest rates, so it is slightly lower than what we are projecting.

But it will tend to -- it will tend to be more at that level than the previous level.

Correct.

Okay, so that is reasonable going forward. And then finally on MaxStream, are we essentially kind of done with integration expense cutting and so forth? It is a pretty representative quarter we just saw?

Yes, it is.

Yes.

(OPERATOR INSTRUCTIONS). [Ross Spearlow], RBC/Dain Rauscher.

Guys, I'm not going to tell you good or a great quarter, because I don't want it to go to your head. A couple of mine have been answered, but just talk a little bit about how big is this market potential in this non-embedded area? And what is your competition there?

We think there's a lot of potential, and we think we've got a really strong value proposition. The market space that we're playing in is, we think, very high-growth over the long-term certainly. And it is driven by the fact that more and more devices, many more devices in the future are going to be connected to networks in order to provide value-added capabilities. And we've got a value proposition -- that is to make it very easy for our customers to integrate and network their devices, whether it bit with the Rabbit productline and the Rabbit kits, and the ease of integration with those kits, or the Digi-branded products, or the MaxStream products now.

It is a common value proposition to really drive ease of integration, primarily focusing on selling modules into these customers. We think we've got unique value proposition and unique positioning in this space.

From a competitive standpoint, we tend to go in there and compete against the customer deciding to do kind of a full chip-based integration effort themselves, where they go out and decide on a chip and then do a full integration on the motherboard kind of effort versus a modular effort which might be faster and easier.

There are a lot of chip vendors out there that provide chips that might compete with us. People like Freescale and Samsung and others. But our value proposition is very different than that. It is providing the module, providing ease of integration. We think that that is going to be a high-growth market opportunity for the future.

Joe, if you could put -- if you could put a number on the size of the market, like where it is today, or where it could be in three to five years, could you put a number on it?

We've got our internal view of total addressable market for the entire business, and we look at that by productline. When we talked about our total addressable market today being somewhere in the $600 million to $700 million range, which would put our overall market share across all productlines above 20%.

And we believe by 2010 it is likely that the overall market for our products will be up in the $900 million to $1 billion range, possibly a little more, possibly not that much. But we think it is going to be somewhere up in that vicinity.

We're playing in a very exciting market opportunity here. Before I was at Digi I was at USRobotics, and I had the opportunity to be right in the middle of driving a high-growth opportunity at USRobotics where we were connecting -- in the first phase of Internet expansion, we were connecting people to the Internet. And we drove that business and grew that USRobotics business over three years from $400 million to $2 billion.

And the excitement at Digi is we're now working in the second phase of that big Internet expansion, which is connecting everything else, all other devices to the network to provide value-added capability. So it is connecting devices and machines to a network for value-added capability.

It is a very exciting market opportunity. We think it's got a lot of learn term growth. And we just don't know when we're going to hit that knee in the curve where it really takes off. But certainly on a kind of conservative basis, a market going from $600 million to $700 million up to close to $1 billion over the next three or four years is certainly a very realistic view.

Brian Cawolchick, WestPark Capital.

As opposed to the prior caller, I will take the opportunity to express my congratulations on your return to a double-digit organic growth environment, something we have long looked for and certainly applaud its arrival. So a nice job there.

Just to follow-up, maybe clarify some of the prior questions regarding expense levels, the MaxStream acquisition closed kind of end of July, is that correct?

Yes, July 26.

So the prior quarter would have had two plus months worth of expenses, whereas this quarter was fully loaded, is that correct?

That is correct.

Yes.

I just wanted to make sure I had that correct. Thanks so much.

Any other questions, operator?

There are no more questions at this time, sir. You may continue with your closing remarks.

Well, thank everybody for attending the call. And I 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.