Digi International Inc (DGII) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the DIGI International Inc 2nd Quarter Fiscal 2007 Earnings Fiscal Results Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the "1," followed by the "4," on you telephone. If at any time during the conference you need to reach an operator, please press *-zero. As a reminder, this conference is being recorded Wednesday, April 25th, 2007.

I would now like to turn the conference over to Kris Krishnan -- Chief Financial Officer, 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 do not have a copy of our earnings release, you may access it through Press Release Action 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 and are not limited to the following.

Rapid change in the 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 reconciliation to the most-comparable GAAP measures -- are included in the earnings release or the Form 8K that we filed before this call. The Form 8K can also be accessed through the SEC filing section of our investor relations website -- www.Digi.com.

Now, I would like to introduce Mr. Joe Dunsmore, our chairman, president and CEO.

Thank you, Kris. Welcome to the call, everyone.

I'm very happy with our results of the quarter, which were highlighted by 24.7% year-over-year revenue growth, and EBITDA of 18.7%, and a GAAP EPS of $0.14 a share, which is up from $0.11 a share from Q2 '06. Our operating income and net income were up 46.8%, and 40.1%, respectively, on a year-over-year basis. Our revenue of 42.9 million compared to 34.4 million in Q2 of 2006 includes year-over-year organic growth of 10%, with the balance coming from the MaxStream acquisition.

Embedded product revenue was 18.4 million, which is up 40.7% year-over-year -- non-embedded product revenue was 24.5 million -- which is up 14.8%, year-over-year. We saw particularly strong year-over-year growth from our cellular and MaxStream product lines, this quarter. In fact, the cellular product line increased 293%, and the Max Stream line grew 60%, in comparison to the 2nd quarter of 2006, as they continued to ramp very aggressively.

Now, for some highlights of the quarter.

Digi extended its family of cellular routers with a UMTS HSVPA version of its ConnectPort WAN VTN. This product leverages the latest high-speed enhancements in carrier networks, based on GSN technology. It is already certified by AT&T Cingular.

Also in the quarter, a CDMA technology version of the product was certified by Sprint.

Digi increased its access to embedded markets by rolling out a new approach to ARM-embedded development. Digi jumpstart kits are subbed $500 development kits that get design engineers started very quickly in developing complex NET OS, Linux and WinCE-based embedded products.

Digi launched a Rabbit wireless control application kit for remote monitoring and control -- continuing a strong push into wireless solutions. This is the 2nd Rabbit-branded application kit containing both MaxStream and Rabbit technology.

Digi introduced the RCM4200 Rabbit core module. This announcement expanded to 7 the family of Rabbit core modules, based on the Rabbit 4000 -- the newest Rabbit microprocessor.

Lastly, I'd like to comment on the revenue trends that we're seeing within the business. We expect the Async product line to continue its general trend of slow decline. However, we're expecting an upward bounce in the current quarter as an offset to the atypical decline that we saw in Q2.

We expect continued year-over-year growth from our embedded products going forward, with the Rabbit and MaxStream product lines leaning the way. We expect continued year-over-year growth from our non-embedded products with cellular and USB product lines showing significant growth opportunity. As a result, our revenue guidance for Q3 2007 will be 41 million to 46 million, with a GAAP EPS range of $0.13 to $0.19.

We are increasing our guidance for the full fiscal year 2007 to a 170 to 180 million revenue range, and a GAAP EPS range of $0.56 to $0.68. Now I will hand it back to Chris for a more detailed discussion of our financial performance.

Thank you, Joe.

Revenue for the 2nd quarter of 2007 was 42.9 million -- an increase of 8.5 million, or 24.7% over 2nd quarter a year ago. In addition to the revenue data already provided by Joe, MaxStream contributed 5 million in revenue for the 2nd quarter.

Gross profit margin for the quarter was 52.5% compared to 53.3% in the 2nd quarter of 2006. Gross profit margin was lower in the 2nd quarter of 2007 compared to the 2nd quarter of 2006 due to lower sales of mature products with higher gross profit margins, as well as other product mix changes within both the embedded and the non-embedded product categories.

Gross profit margin includes the amortization of purchased and core technology, shown separately on our condensed consolidated statement of operations. The amortization of purchased and core technology accounted for 2.6% and 3.4% respectively.

Operating expenses as a percent of net sales decreased 2.5 percentage points in the 2nd quarter of 2007, compared to the 2nd quarter of 2006, as Digi continues to focus on controlling expenses, while increasing revenue.

Total operating expenses for the 2nd quarter of 2007 were 17.8 million, or 41.5% of revenue, compared to 15.1 million or 44% of revenue in the 2nd quarter of 2006.

The increase in operating expense in the 2nd quarter of 2007 was attributable to the inclusion of operating expenses pertaining to MaxStream, as well as variable compensation expenses related to the increase in revenue compared to prior year.

Operating income improved 46.8%, to 4.7 million -- or 11% of net sales in the 2nd quarter of 2007, compared with 3.2 million or 9.3% of net sales in the 2nd quarter of Fiscal 2006.

Net income for the 2nd quarter of 2007 increased 40.1% , to 3.6 million, or $0.14 per diluted share -- compared to net income of 2.6 million or $0.11 per diluted share in the 2nd quarter of 2006. This reflects an EPS growth of 27.3% year-over-year during the second quarter.

Digi's effective tax rate for the 2nd quarter of 2007 was 34.3%. We anticipate that our annualized effective tax rate for 2007 will be approximately 33 to33.5%. The expected annualized effective tax rate is lower than our effective tax rate for the 2nd quarter, as a result of additional benefits for research and development credits earned during the last 3 quarters of Fiscal 2006 -- and was recorded in the 1st quarter of Fiscal 2007, due to the extension of the R&D credit.

This has an impact of lowering our effective tax rate for the year. We expect the effective tax rate to be approximately 35%, in both the 3rd and 4th quarters of Fiscal 2007.

For the first 6 months of 2007, Digi reported revenue of 84.7 million, compared to a revenue of 67.8 million for the first 6 months of 2006. An increase of 16.9 million, or 25%.

For the first 6 months of 2007, Digi reported net income of 7.4 million -- or $0.28 per diluted share compared to a net income for the first 6 months of 2006, of 4.8 million, or $0.20 per diluted share. An increase of 56%.

Earnings per diluted share for the first 6 months of 2007 include the $0.02 attributable to the additional benefit recorded in the 1st quarter, as a result of the extension of research and development credit.

Diluted weighted average shares outstanding at the end of the quarter were 25,958,518 shares -- compared to a previous quarter of 25,983,390 shares. A decrease of 24,872 shares.

Diluted weighted average shares outstanding increased by 2,271,151 shares from the 2nd quarter of 2006 -- and by 2,366,886 shares compared to the first 6 months of Fiscal 2006. Primarily as a result of shares issued pursuant to the acquisition of MaxStream.

Turning to the balance sheet and cash flow statement. Our combined cash and cash equivalent of marketable securities balance increased by 8.4 million from the end of the prior quarter, and increased by 11 million from the end of the prior fiscal year. The cash increase of 8.4 million is net of payments of 1.7 million that was made during the quarter for estimated income taxes.

Net cash provided by operating activities for the quarter was 8.1 million. Cash provided by financing activities was 1 million, and resulted primarily from stock option and employee stock purchase plan transactions.

Digi spent 800,000 on the purchases of property and equipment improvement in the 2nd quarter of fiscal 2007.

Net accounts receivable at March 31st 2007 were 20.8 million, compared to 19.8 million at the end of prior fiscal quarter -- an increase of $1 million. Our DSO still remains at 32 days.

Inventory levels at March 31st were at 23.5 million, compared to 24.6 million at the end of prior fiscal quarter. A reduction of $1.2 million.

Our current ratio is 5.5 to 1, compared to a current ratio of 4.6 to 1 at the end of the prior fiscal year. Cash value per share for the 2nd fiscal quarter of 2006 is $2.77, compared to $2.45 at the end of the prior fiscal quarter.

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

Thank you. Ladies and gentlemen, if you would like to register a question, please press the 1, followed by the 4 on your telephone. You will hear a 3-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1, followed by the 3. If you are using a speakerphone, please lift your handset before entering your request. One moment please for the first question.

And our first question comes from the line of Jeff Evanson, from Dougherty & Company. Please proceed.

Good afternoon, guys. Thanks for taking my questions.

Joe, you mentioned that Async was going to be up slightly in Q3, I think you said. But just temporarily. What's driving that?

Well, this quarter Async was down more than we expected. What I was saying was that we're expecting a bounce back next quarter. Last quarter, I think Async was down 9.4%. This quarter, year-over-year, it was down about 30%. And we're expecting a bounce back next quarter.

We've said in the past, and we continue to reiterate that on a year-over-year basis, we expect a decline of about 15-20%. So we continue to believe that we're on that rate. And that the quarterly changes have to do with some lumpy demand with OEMs, et cetera. But yes, we're expecting to see a bounce back next quarter.

So your confidence in that is based upon -- I guess -- the fact that some OEM orders pushed out a quarter.

We typically see this quarter is typically a weak quarter with the OEMs. The last fiscal quarter was typically a stronger one. The first fiscal quarter of the year -- end of the calendar year. And then second fiscal quarter's typically weak. And it came in a little bit weaker from the OEMs than we had expected. And then we typically see a bounce back the next quarter -- so we would expect to see that.

So you're seeing this as typical seasonality.

Yes. We're seeing it as typical seasonality with Async, with this quarter being a little bit more significant dip than we had expected. The OEMs gave us a forecast. They came in under our forecast for the quarter. And so that was a little bit of a surprise this quarter.

But it is a seasonality impact, compounded by OEMs coming in a little bit less than we expected. We expect to bounce back as we always seem to see on an annual basis next quarter. Or the current quarter that we're in.

I have a couple questions on some of your business highlights from the quarter. First, on the cellular routers. Could you give us a sense now of I guess how many skews or products you actually have in that area? And how much more you maybe need to add this year, to build out that portfolio.

Yes. We've got many, many skews covering 1g -- 2 to 2.5 g -- and 3rd-generation networks. We have these 3 generations of multiple skews. Bi-carrier. So we've got skews that address the opportunity with AT&T Cingular. We have skews that address the Sprint opportunity and the Verizon opportunity and other carrier opportunities.

So there are many skews deployed, and this opportunity will continue to evolve. So we'll continue to invest heavily in R&D. We will continue to support the various carrier networks. Not only in the US, but around the world.

We're seeing real aggressive ramp in the US, and we're starting to see traction outside of the US and Canada -- in Latin America and Europe. And we expect that trend to continue. We'll continue to drive certifications with carriers around the world. We're up to 25 individual carriers around the world that we're certified with.

And from a feature perspective, we've got some very, very exciting new features that we're going to be deploying in the near-term with our next-generation cellular products. So keep an eye open for announcements, because we have some very exciting things happening in the very near term in that arena.

And then my last question. Could you give us some sample applications or verticals where you're seeing good traction for that product?

Jeff -- very exciting vertical that we're seeing getting a lot of traction for that product -- and we believe that there's going to be a lot of opportunity for feature enhancement -- is remote monitoring and control applications.

There are many applications out there. There are backup applications. There are primary connectivity applications. There's a whole host of them. But one that is a significant application for us, where we're seeing a lot of revenue opportunity -- a lot of large-deal opportunity -- is in remote monitoring and control applications. Where we literally are able to now drop in a wireless network and in places that you couldn't do it before, in order to remotely monitor or manage assets.

And so one example of a very large deal that we've been deploying is remote management and monitoring of cell tower lights -- as an example. And there's just a wide variety of these remote monitoring and control applications where the wireless drop-in network opportunity is emerging as a very exciting opportunity.

Great. Thank you for that.

Ladies and gentlemen, as a reminder -- to register for a question, press the 1 followed by the 4.

And our next question comes from the line of Michael Ciarmoli, from Boenning & Scattergood. Please proceed.

Hey, guys. Nice quarter. Thanks for taking my call.

Thanks, Michael.

Thanks, Michael.

Just to piggyback on that last question. When you guys acquired MaxStream, I guess you expected revenues of 20-24 million. And I've seen a lot of the press releases and products coming out. Whether it's Rabbit leveraging some of the MaxStream technology. So a lot of it, I guess, is kind of cross selling.

When you issued or accounted for that 20-24 million in revenue, was that kind of MaxStream on its own? Or how do I view these products that are coming out that are combining your existing product lines with the new MaxStream technology? Is that sort of organic growth or acquired growth? How are you viewing that?

Well, first of all, in the 20-24 million -- that's MaxStream on its own. So as you see us announcing products with the Rabbit brand or Digi brand that incorporate MaxStream technology, that's not figured in the 20-24 million. So that would be upside opportunity. And we expect to drive that.

Then just shifting gears to the gross margin. Now I think on past calls, you've said the goal is to get that up to the 55-60% range. What else are you guys planning to do to lift that margin? It seems like the lower-priced product lines are continuing to dominate here. What's in the plans to kind of prevent some further price erosion?

Yes. I think, Michael, in the last couple quarters, I think my words have been more along the lines of trying to maintain our margins in the 55% arena. And last call, what I said was that we had some challenges where we had the high-margin Async product line in decline, and we had high growth on the embedded side -- which are under more price pressure than we typically would see on the Async side.

So the challenge we have is you have this natural downward pressure as a result of that fundamental dynamic. And the way that we counterbalance that pressure is with aggressive R&D cost-reduction programs, with manufacturing efficiency programs. And then especially on the non-embedded side of the business, really driving differentiation and customization into our products. All factors that tend to counterbalance that natural momentum that we see in the marketplace.

So this question's come up a couple times in the last couple quarters. My answer's been the same. We're trying to hold at that 55% level. We have that natural momentum. We've got good programs in place to counterbalance that, and we'll continue to drive those programs.

My expectation for next quarter would be that we would see a quarter, in terms of gross margins, that would be flat to slightly up.

Great. In terms of these product releases, you were mentioning the carriers that you now have certified. Is it more Digi driving product introductions? Is it a combination of working with your customers? Who's -- where are the new initiatives really coming from? Is it what you guys are seeing out in the marketplace that's leading you down a certain path of what products to fully develop and introduce?

We work very closely with the carriers in this space. We have a lot of experience. A lot of tribal knowledge and technical expertise in these vertical markets, where the carriers want to play in this space. And so we bring a lot of that expertise to the table.

And so when you combine that expertise with partnership with the carrier -- product-management teams and marketing teams and sales teams -- we get their data sales teams out there driving essentially lead generation for us. They know that we're the technical experts out there. They share those leads with us. And then we jointly work the opportunities. So we've got a very strong co-marketing relationship with the carrier, identifying opportunities. They look at Digi as very knowledgeable in this space. Having a strong history and a great reputation for reliable products and great support.

So it's a strong co-marketing -- strategic relationship that we have out there in the marketplace.

Then a last question, and then I'll jump off. I've been following you guys for a little bit now, and I know you are definitely very conservative. The guidance for Q3 -- it kind of, again, opens up the possibility that there could be a lighter revenue quarter and even bottom line.

It just looks like over the course of the history, you guys have never really put up a lighter Q3 than Q2. How do I view that, going forward? Just to expect these wide guidance ranges?

Well, they've been at this level for many quarters now, Michael. And I think if you look at the range that we gave for this quarter, it was a $5 million range. Last quarter it was a $5 million range. And the previous several quarters it was a $5 million range.

And last quarter's range was 39-44 million. We came in at 42.9. We think given the kind of market -- potential market -- variability that you see out there that a $5 million range is a reasonable range.

But if you look at it from the standpoint of range movement, we have moved the range from last quarter. We gave 39 to 44 million. This quarter we're giving 41 to46 million. So that's, on the low end and the high end, a $2 million move.

Sure. Okay. Fair enough. Thank you for answering my questions. I will jump off. Thanks, guys.

Thanks, Mike.

Thanks, Mike.

Our next question comes from the line of Brian Cawolchick, from WestPark Capital. Please proceed.

Good afternoon, gentlemen.

Hey, Brian.

Hey, Brian.

Hey, guys. Following up on a couple of the past questions, in terms of where Michael was headed -- the recent increase in guidance this quarter is kind of a step out of your recent history. Maybe talking a little bit. In fact, I can't remember last time you guys raised that, and I'm so very happy to see that.

What's given you that increased confidence this quarter to raise numbers, in light of your traditionally historically conservative artwork?

We have a very detailed, tops-down, bottoms-up process that we use in order to define the quarterly and annual guidance that we give. So this isn't me sitting around and thinking, "Okay. What should the guidance be?" We've got to build that process where we ask all of our product managers or we ask all of our sales managers to come in weekly before the quarter, and then on a weekly basis throughout the quarter. With their worst-case, most-likely and best-case numbers for the quarter.

And this -- every quarter -- it comes right out of that. It comes right out of that process. So this is a process-driven build-up that's based on that. And that alone. It's reflective of a move.

Our last quarter, we said 39 to 44. This quarter, we're saying 41 to 46. Because that's what we see. In terms of worst-case, best case, most likely.

So the pipeline has apparently improved?

Yes.

The pipeline's improved -- visibility's up. That's fantastic to hear.

And then importantly, also, Brian -- we don't want to lose the fact that we made a pretty significant increase in our annual EPS guidance of $0.03 on the low end.

Yes. And I was going to talk to you about that. Because if I do the math, $0.03 on the share count -- that's $700,000 or $800,000 on a $2 million increase effectively in your revenue. That implies almost a 39% drop-through on incremental revenue.

So as I look at going forward, if there is continued revenue upside, is that the kind of drop-through rate that you see?

You know, I'd have to go back and look at those numbers with Kris.

Sure.

So I don't know if I could kind of validate the 39% numbers sitting here right now. But we are comfortable. I can say we are very comfortable with 170 to 180 million revenue range and the new EPS range.

Sure. Fantastic.

But a little bit of discussion about the Async product and some impact, there. I don't want to draw attention to it, but could you just frame it for those of us that might not be familiar? If I remember right, that product represents a fairly small piece of your revenue base. And it's excepted to kind of become diminimus at some point, isn't it?

Yes. It's still the most significant part of our mature product line. So, when you look at it [inaudible]

What approximately is the mature mix, right now?

Pardon?

What was the approximate percentage of the mature products versus total rev at this point?

It's become a much smaller percentage. We had talked about it being 70/30, but in fact, that continues to migrate. And now it's much, much better than even 80/20, in terms of growth versus mature.

So you're right. It's migrating pretty significantly, and over time, that Async piece becomes a much less significant impact. And over time, what happens is it just puts us in a much better position, as we continue to drive strong numbers on the growth side of our business.

The growth product lines puts us in a better position over time to drive improved organic growth. So I think that's the dynamic that you're concerned about.

And so our growth products this quarter -- if you look at all of the products that we think are in growing markets, every one of them grew sequentially, and year-over-year. And on a year-over-year basis, the total grew over 20%. So we're still seeing very robust growth from the products that we consider residing in growth markets.

Could you go over those numbers again? I think you gave the year-over-year growth rates on the growth products in cellular and MaxStream at 290 year-over-year and MaxStream at 60. Is that right?

Yes.

Can you remind us of what those year-over-year growth rates were in Q1, and maybe what the sequential growth rates were even for those product lines?

Yes. I don't have the sequential in front of me. But in Q1, MaxStream, if I remember right, was about 45%. And cellular was up in the 300-some percent range. So it was higher than 293%. It was 300 and change.

Okay. So the MaxStream product seems to be accelerating, as well.

Yes. It was a good quarter for us with MaxStream, and we're real bullish, moving forward, that we'll continue to see strong growth from MaxStream.

Can you remind us as to where you are or if you're already there, or what your plans might be? Do you see any great MaxStream products with the Digi/Rabbit products so that you'll be able to deliver that complete drop-in local-to-wide-area delivery via [inaudible]? You got that product line fully integrated at this point? Or what's that development path look like?

It looks good. We've been working on it. We've had products in development now for months. You're starting to see announcements with the Rabbit kits that we've announced, where we've integrated. Recently put out a new Rabbit kit. Actually, in the current quarter where we have a Zigbee module. So you're seeing more and more Rabbit products.

And then beyond that, one of the natural things that you're going to be seeing is more and more combinations of MaxStream technology with Digi-branded products. And we're well down that path. And I think we're going to have some very exciting things to announce in the very near future. But obviously, we haven't made those announcements. So I can't talk about them, yet.

Sure. I understand. But maybe once those products are out and once you have that complete kind of end-to-end solution from an in-house perspective, even though we've seen tremendous growth rates so far, once you have that solution, would you expect that to be kind of a catalyst for the next leg up in growth?

Yes. I would. We think there are going to be some very exciting incremental growth opportunities with the new products that we're coming out with that integrate MaxStream technology with Digi products. We think it's going to be very exciting. And we will have a lot more to talk about with regard to the products and the market category that we're looking at, and the kind of growth that we would expect in future quarters.

All right. I look forward to those announcements. Nice job on the quarter, and I'll talk to you at the end of the next one.

Great. Thanks, Brian.

Thanks, Brian.

And our next question is a follow-up question from the line of Michael Ciarmoli from Boenning & Scattergood. Please proceed.

Hey guys. In terms of the climate out there, I've seen a lot recently about automated metering technology getting deployed. How is that impacting your business, if at all?

We have several opportunities in this space. We have large opportunities in this space. So it is a very positive impact on our business. MaxStream has done very well in that vertical market.

Okay. Are those domestic? Abroad?

We've got very large opportunities domestically. We are with the MaxStream product line, in the process of really educating the channel. We've done a lot of training. A lot of education. And in the process of developing products that meet the requirements of some of the international markets.

For instance, whereas the 900 MHz standard is applicable in the US, the standard is different in Europe. It's an 868 MHz standard. And so we're adapting products for these markets outside of the US.

Great. Great. And then in terms of future wireless technology. I've seen [Ruby]'s been one that's mentioned. [Ension]. Are you guys looking at other future technologies that you might want to roll into your products?

Yes. We have an innovation team that spends a lot of time. I'm on the team and Joel Young is on the team. We've got a host of other people on the team that spend a lot of time looking at the next-generation future technologies. And looking at innovative ideas and innovative ways of bringing those technologies to market.

So yes, there are several wireless technologies that we're taking a look at that we think are going to be important in the future. The most important one today and that's going to really help us drive aggressive growth for the near and medium term are in the cellular and mesh networking arenas.

But there are certainly next-generation WiMax and ultra-wide band and other wireless technologies that we're keeping our eyes on, and making sure that we understand as those opportunities emerge.

Great. Thanks, guys.

Thank you, Michael.

There are no further questions, at this time. I will now turn it back to management.

Okay. Well, thanks, guys. We feel like it was a very good quarter. Operating income was up 47%. Net income up 40%. Year-over-year, strong cash-generating quarter for us. And real strong performance out of our growth products.

I look forward to talking to you guys again next quarter. Thank you.

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.

[session end]