Digi International Inc (DGII) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Digi International earnings conference call. My name is Katie, and I will be your coordinator for today. At this time all participants will be in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I will now turn the call over to your host for today, Mr. Kris Krishnan, Senior Vice President. Sir, you may proceed.

Good afternoon and thank you for joining us today. Before we start I need to go over a few details. First, if you do not have a copy of our earnings release, you may access it through our press release section of the Digi website at www.dgii.com. Second, I would like to remind our listeners that our remarks may contain forward-looking statements and involves 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. Rabid 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, changes in the economic conditions in the U.S. or other key markets or geographic areas, the ability to achieve the anticipated benefits and synergies associated with this area and acquisition. And the risks that the combined businesses will now be integrated successfully. As you are aware, we are holding this conference call only a short time after the issuance of a press release which announced these transactions.

Therefore, in accordance with Regulation FD the information provided on this call must not include material information that is not included within the text of the press release. Thank you for your understanding. Finally, certain of the financial information disclosed on this call includes nonGAAP 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 8K that we filed before this call. The form 8K can also be accessed through the SEC filing section of our investor relations website at www.dgii.com. Now, I would like to introduce Mr. Joe Dunsmore, our Chairman, President and CEO.

Thank you, Kris. Welcome to the call everyone. During my opening comments of the conference call I will focus on the financial and performance highlights of fiscal Q2, key takeaway's from the quarter and update on why we are bullish about long term growth projections for the company, a discussion of the Syrian acquisition and our guidance for the balance of fiscal 2008. We achieved revenue of $43.1 million of the second fiscal quarter of 2008 compared to $42.9 million to the second quarter of the 2007. an increase of $.2 million or .5%. Revenue in Europe was $12.6 million or 29.3% of the total for the quarter. An increase 17.1% year-over-year. Revenue in the Asia Pacific region was $4 million or 9.3% of the total for the quarter an increase of 23% year-over-year. Revenue on the Americas was $26.5 million or 61.2% of the total for the quarter and decreased year-over-year by 8.2%.

While I'm not satisfied with Q2 results, I believe the very robust international growth is indicative of a core growth strategy that continues to gain momentum despite the softness that we are currently seeing in the U.S. Gross profit was 53.8% of sales, and increased by $.7 million year-over-year. Net income was $1.3 million in the second fiscal quarter of 2008 or $0.12 per diluted share and we increased our cash and marketable securities position by $13.2 million to just over $100 million by the end of the quarter. As has been the case in a few time in the past eight years, whenever we see an issue that seems to impact our business momentum we carefully and introspectively assess it, use it as an opportunity for accelerated improvement and move forward to achieve even stronger business momentum and results. This will be the case once again.

Plus there are a couple of key takeaways that I would like to emphasize about the Digi business model after analyzing the Q2 performance and future plans. First key takeaway is that the underlying fundamentals of the Digi business remains strong while overall year over year growth was substantially muted by the economic environment in the U.S. it is important to keep in mind that Q2 '08 was still the highest Q2 revenue performance in the past eight years in the company. We believe we have maintained or grown our share position in the market place, we grew our cash by $13.2 million to over $100 million this quarter despite the increased expense level investment and international growth and then we continue to maintain our EBITDA margins in the 15% to 20% range and we continue to be very profitable. As importantly the wireless drop in networking sales pipeline continues to grow aggressively, so we remain very bullish that we will see some revenue ramp in the second half of fiscal 2008 and a significant boost when the US economy returns to normal GDP growth levels.

The second key takeaway is that while the fundamentals and product portfolio are strong, this quarter's results point to an opportunity that we are working to improve our business model. The Digi business in Q2 continues to be heavily weighted on Americas performance versus International, about 61% Americas and 30% International. As you have likely noted, those companies that have the majority of the business weighted towards International have tended to fare much better in the second quarter than those that are significantly dependent on the North American market. Thus, the impact of a downed U.S. economy has impacted Digi and Q2 more than others will drive a majority of their business outside of the U.S. As a result we intend to continue to drive International growth more aggressively more forward.

As I've stated in past calls, part of our increased expense load this year is investment in international sales head count and marketing expense. I continue to be very bullish about that investment, we expect to drive the business from approximately 60/40 Americas to international to the inverse over the next five years. The acquisition of Sarian will help to drive the balance immediately, since today Sarian is 100% International. I am excited to announce the acquisition of Sarian systems, a European based leader in wireless commercial grade device networking. The acquisition is a cash transaction for approximately $30.5 million for all of the outstanding ordinary shares of Sarian. A purchase price of $30.5 million includes cash on Sarian's balance sheet as of the acquisition date estimated to be approximately $2.5 million. Sarian is based in the (inaudible) United Kingdom, a suburb of [Leeds], employees 34 people and generated $10.4 million in revenue and 8.9% net income in their fiscal year 2007 ending June 30, 2007. It has been a high growth company over the past few years with a focus on wireless routers for commercial grade device networking applications. While Digi has been focused on wire and wireless device networking, we've had an increasing emphasis on wireless products and capabilities, especially focused on cellular, Wi-Fi and [mesh] technologies.

As the world continues to migrate from wired to wireless Sarian cellular wireless and routing technologies and products greatly augment Digi's position in the cellular arena. In fact Sarian's leadership position in Europe compliments Digi's leadership position in the Americas to greatly enhance Digi's global position immediately. Sarian's value proposition is to develop and manufacture advanced cellular IP routing equipment from mission critical applications. Having developed it's own comprehensive IP operating system and software, Sarian delivers customers technical excellence, flexibility and rapid customization. The vertical market focused in deep protocol knowledge Sarian has developed a strong customer base in ATM connectivity, retail and payment systems connectivity, remote monitoring or [telemetry], lottery terminal connectivity and wireless backup of wired broadband connections. This vertical focus is highly complimentary to Digi's market approach and positions Digi as the global market share leader in the cellular gateway and router arena. We expect revenue from Sarian products to grow in excess of 20% per year.

We believe this acquisition is a terrific strategic cultural and financial fit for Digi and its shareholders. I will now go into detail on each of these the three areas. First, strategically, the acquisition of Sarian is a perfect fit. Sarian has been a high growth company growing from revenues of $2.6 million in 2003 to $4.4 million in 2004 to $6.5 million in 2005 to $7.6 million in 2005 to $10.4 million in 2007. Based on the Sarian's fiscal year-ended June 30th. While we focused on many similar commercial grade device networking vertical applications to those Digi addresses, they have been exclusively focused on the European market and have demonstrated success in key vertical markets that are complimentary to Digi's focus today. Combined we provide an even more formidable global product line up in the commercial grade device networking arena enabling us to target a broader set of applications worldwide.

Key synergies will include: strong tribal knowledge in wireless and routing and gateway arena. Strength and focus in the UK and Europe and leverage of the broader Digi channel in Europe. We will bring Sarian products into the Americas and Asia Pacific, leveraging Digi's channels to pursue ATM, point of sale, lottery, gaming and backup applications. Product synergies with our product mesh and Wi-Fi product lines, customization and differentiation strategic orientation and that global leadership position in the cellular gateway and router arena.

There are a couple of additional reasons why Sarian is a good strategic fit for Digi. The Sarian brand in Europe delivers the same value proposition as the Digi brand. Reliability. Differentiated products. Great support and ease of integration. Sarian has an extensive base of customers and we believe we will be able to drive incremental sales by selling other Digi products into the existing Sarian customer base. Culturally, we believe we have an excellent match. We have found Sarian to be an open, high integrity culture where great listening and teaming are highly valued and where innovation is engrained. We found the management team to be entrepreneurial and yet very mature, allowing them to leave the company to high revenue growth while maintaining the discipline to be consistently profitable. These values are very compatible with the Digi culture.

Next, the financial sect. Sarian has demonstrated high revenue growth and strong financial performance in the past. Its 2007 revenue growth rate was 7.8%. We expect the acquisition to be $0.06 to $0.08 EPS accretive to the company in fiscal 2009, in fact Sarian will not be dilutive in the current quarter excluding the acquisition-related expenses. We expect Sarian to contribute in excess of $2.5 million in revenue from the date of acquisition in the third fiscal quarter of 2008, and in a range of approximately $3.5 million to $5.5 million in revenue for the fourth fiscal quarter of 2008. And $23 million to $27 million in fiscal 2009.

Next, I would like to say a few words about the integration of the Sarian business into Digi. Andy Hood, Sarian's CEO, is planning on staying with the company for one year to lead the integration efforts and serve in a Vice President role reporting directly to me. The functional leaders currently at Sarian will be immediately integrated and reporting to the functional executives at Digi. We don't expect to achieve any immediate expense energy synergies and will further evaluate expense synergy possibilities over the next three to six months or so. The primary emphasis for this acquisition is revenue growth, so we intend to take full advantage of product and channel related synergies to drive that growth and the product arena. We are in the process of constructing product development road map that contemplates leveraging Sarian product platforms on a global basis.

I have said many times in past calls that we are looking for acquisitions that will enhance our positioning in the commercial grade device networking space, accelerate our top line revenue growth rate and be EPS accretive in a reasonable time period. This acquisition clearly meets all the above noted requirements and provides us with some outstanding wireless products and competencies. We are tremendously excited to move forward on a combined basis.

Next, I would like to discuss our guidance for the year. Generally, I expect Digi to drive 10% to 20% organic growth in normal economic conditions. We expect to return to these levels of growth when the US economy returns to a normal level of GDP growth. Digi execution and the rate of adoption of our wireless drop-in networking products will have the most significant impact on where we fall within those ranges. With these expectations as a precept we are revising our guidance for fiscal year 2008. For the full fiscal year Digi forecasts 2008 revenue to be in the range of $180 million to $192 million or an increase over fiscal 2007 revenue of 4% to 11%. Projected fiscal 2008 revenue includes estimated revenue from Sarian systems from the date of acquisition of approximately $6 million to $8 million. Digi expects earnings per diluted share for fiscal 2008 to be in the range of $0.38 to $0.52 which includes estimated in process research and development and other expenses totaling $0.08 to $0.10 associated with the acquisition of Sarian systems as of April 20, 2008. This full 2008 earnings per diluted share are expected to be within the range of $0.46 to $0.62 excluded estimated in process research and development and other acquisition related expenses.

In conclusion, there is a key point I would like to reemphasize about the Digi business and culture. Digi is a highly adaptive business and culture. In the past each time the company has encountered market transitions or temporary setbacks we have emerged much stronger and fully expect to do the same this time. We remain very committed to our core strategy to be the best in the world in commercial grade device networking and our vision of being a leader in the Next Generation of internet expansion. Times like these provide a silver lining opportunity to accelerate improvement of our overall marketing position.

We will do this by continuing to invest in key high leverage investments like International sales and wireless drop in networking. We will augment this with increased focus on acquisitions. Digi is in a very strong cash position and in this highly fragmented market, acquisitions will be pursued aggressively. Sarian is a good example of an acquisition that clearly fits that model. I said previously that we expect the addressable market will double over the next five years, additionally by 2012, I fully expect that we will be able to drive business to over $500 million through organic growth and acquisition while maintaining high growth and profitability. We will target at least 60% of the business to be derived outside of the U.S. Now I will hand it off to Kris for a more detailed discussion of our financial performance for the quarter.

Thank you, Joe. Revenue for the second quarter of 2008 was $43.1 million, an increase of $200,000 or .5% over the second quarter revenue a year ago. Revenues in the Americas was $26.5 million in the second quarter of 2008 compared to $28.8 million in the comparable period last year, a decrease of $2.3 million or 8.2%. Reflecting the current weakness in the U.S. economy. Revenue in Europe was $12.6 million in the second quarter of 2008, compared to $10.8 million in the comparable quarter a year ago, an increase of $1.8 million or 17.1%. Revenue in the Asia Pacific region was $4 million in the second quarter of 2008 compared to $3.3 million in the second quarter of 2007, an increase of $700,000 or 22.8%. Revenue from the embedded products in the second quarter of 2008 was $21.7 million compared to $18.4 million in the second quarter of 2007. An increase of $3.3 million or 17.9%. Revenues from the nonembedded products was $21.4 million in the second quarter of 2008 compared to $24.5 million in the second quarter of 2007, a decrease of $1.1 million or 12.6%. Revenue from the embedded products increased by $2.4 million or 36.1% in Europe and Asia Pacific region and by $900,000 or 7.6% in the Americas for the second quarter 2008 compared to the same period a year ago. Revenues from the nonembedded products increased by $200,000 or 2.5% in the Europe Asia Pacific region and decreased by $3.3 million or 19.2% in the Americas for the quarter quarter of 2008 compared to the second quarter 2007. The strengthening of the Euro had a favorable impact on revenue of $700,000 in the second quarter of 2008, compared to the second quarter of 2007.

Gross profit increased 3% or $700,000 for the second quarter of 2008. Gross profit margin for the quarter was 53.8% compared to 52.5% in the second quarter 2007. Gross profit margin was higher in the second quarter of 2008 compared to the second quarter 2007 primarily due to product mixed changes within both the embedded and nonembedded product groups and the decrease in the amortization of purchased and core technologies. The amortizing of purchased and core technologies decreased by $200,000 in the second quarter of 2008 compared to the same quarter a year ago and accounted for .5 percentage point increase in the gross profit margin. We anticipate that our gross profit margin will be in the range of 50% to 54% for fiscal 2008.

Total operating expenses for the second quarter of 2008 were $19.5 million or 45.3% of revenue, compared to $17.8 million or 41.5% of revenue in the second quarter of 2007. The increase in operating expenses in the second quarter of 2008 reflects compensation related expenses associated with incremental head count as well as Digi's continued investments in drop in networking initiative and international expansion. In addition, our operating expenses were unfairly impacted by $400,000 in the second quarter of 2008 compared to the prior year of comparable quarter as the result of the strengthening of the Euro. We anticipate that the operating expenses including stock based comp and amortization expense to net sales ratio will be approximately 44% to 46% on an annual basis which includes, estimated expense of $2.5 million for in process research and development and other expenses associated with the acquisition of Sarian Systems. In March 2008, we closed on a transaction for the sale of our building in Dortmund, Germany, and subsequent partial lease back for a five year term. The building was sold for EUR4. 5 million or $7 million with a corresponding gain of EUR1 million or $1.6 million. As a result of the lease back $1.5 million of the $1.6 million gain on the sale was deferred and will be recognized ratably over the lease term as an off set to lease expense.

The gain on sale of $100,000 that was recognized the second quarter of 2008 was recorded as a component of the general G&A expenses. Operating income was $3.7 million or 8.5% of net sales in the second quarter of 2008. Compared with $4.7 million or 11% of net sales in the second quarter of 2007. Net income for the second quarter of 2008 was $3.1 million or $0.12 per diluted share compared to net income of $3.6 million or $0.14 per diluted share in the second quarter of 2007. Digi's effective tax rate for the second quarter 2008 was 33.6%. We anticipate that our annualized effective tax rate for 2008 will be approximately 37% to 39% which includes estimated in process research and involvement expenses of approximately $2.1 million associated with the acquisition of Sarian System which is nondeductible. And for the first six months of 2008 Digi reported revenues of $87.6 million compared to $84.7 million for the first six months of 2007, an increase of $2.9 million or 3.5%. Revenues in the Americas was $55.3 million in the first six months of 2008 compared to $58.4 million in the same period a year ago. A decrease of $3.1 million or 5.2%. Revenue in Europe was $23.8 million for the first six months of fiscal 2008 compared to $19.6 million in the comparable period a year ago. An increase of $4.2 million or 21.1%. Revenue in the Asia Pacific region was $8.5 million in the first six months of fiscal 2008 compared to $6.7 million in the first six months of fiscal 2007. An increase of $1.8 million or 28.3%.

Revenue from the embedded products in the first six months of the fiscal 2008 was $42.4 million compared to $35.1 million in the first six months of fiscal 2007 an increase of $7.4 million or 21%. Revenue from the nonembedded products was $45.2 million in the first six months of 2008 compared to $49.6 million in the comparable period in 2007. A decrease of $4.4 million or 8.9%. Revenue from the embedded products increased by $5.6 million or 46.2% in Europe and Asia Pacific region and by $1.7 million or 7.6% in the Americas for the first six months of fiscal 2008 compared to the same period a year ago.

Revenue from the nonembedded products increased by $400,000 or 2.7% in Euro Asia Pacific region and decreased by $4.8 million or 13.5% in the Americas for the first six months of fiscal 2008 compared to the first six months of fiscal 2007. Revenue was favorably impacted by a $1.4 million for the first six months of 2008 compared to the first six months of 2007 primarily as a result of the strengthening of the Euro. For the first six months of 2008 Digi reported net income of $6.8 million or $0.26 per diluted share compared to net income of the first six months of 2007 of $7.4 million or $0.28 per diluted share. Earnings per diluted share for the first six months of 2007 included $0.02 attributable to the additional benefit recorded as a result of the extension of research and development credit. Diluted weighted average shares outstanding at the end of the quarter was 26,311,606 shares compared to the previous quarter of it 26,592,933 shares, a decrease of 281,327 shares.

Turning to the balance sheet and cash flow statements. Our combined cash and cash equivalents and marketable security balances including long term marketable securities were $100.8 million as of March 31, 2008. Increasing by $10 million from the end of the prior quarter and by $13.2 million from the end of the prior fiscal year. Net cash provided by operating activities was $5.2 million, net cash provided by investment for the quarter $4.9 million which includes the proceeds from the sale of Dortmund, Germany, building of $7 million. Digi spent $700,000 on the purchase of property, equipment and improvements in the second quarter of 2008. And cash that was provided by financing activities was $400,000 and resulted primarily from stock option plan transactions.

I would like to provide you with a brief update of Digi's marketable securities due to recent current market and liquidity events. As stated in our significant accounting policy footnote in our 10K filing for fiscal 2007, all marketable securities are classified as held to maturity and are carried at amortized costs. Marketable security consists of high grade commercial paper and corporate bonds. Our current policy specifies the types of eligible investments and minimum credit quality of our investments as well as diversification and concentration limits which mitigate our risk. Our portfolio contains no auction rate securities. We intend to hold all marketable securities currently in our portfolio to maturity. And we believe that realization of any unrealized holding losses are not unlikely at this time and therefore, not recorded. Net accounts receivable.

Net accounts receivable at March 31, 2008, was $25.3 million compared to $21 million at the end of the prior fiscal year. Our DSO is at 37 days. DSO has increased to the timing of shipments as well as some slow down in the customer payments. We anticipate that our DSO will improve to a range a 34 to 35 days in the future quarters. Inventory levels as March 31, 2008, were $26.8 million. Compared to $26.1 million at the end of prior fiscal year. Our current ratio is 7.3:1. Compared to prior ratio of 6.3:1 at the end of prior fiscal year. Cash value per share for the second fiscal quarter is $3.92 compared to $3.43 at the end of the prior fiscal year. As we noted in our comments during the last conference call we are in the process of implementing an upgrade to our system for financial reporting and operations. We do not believe that these implementation would adversely effect our internal control or financial reporting and have not adversely effected our the financial results for the three and six months ended March 31st, 2008.

I would like to provide you with some guidance pertaining to the acquisition of Sarian System. We expect Sarian to contribute in excess of $2.5 million the revenue for the third fiscal quarter of 2008 from the date of acquisition and in the range of $3.5 million to $5.5 million in revenue for the full fiscal quarter of 2008. We anticipate that Sarian will contribute revenue in the range of $23 million to $27 million for the fiscal year 2009. We anticipate that the estimated in process research and development and other acquisition related expenses will reduce earnings per diluted share by $0.08 to $0.10 for the third fiscal quarter of 2008. We expect Sarian acquisition will be $0.06 to $0.08 accretive per diluted share for fiscal 2009. And that Sarian earnings per diluted share will be break even or slightly accretive beginning in the fourth quarter of fiscal 2008. Now, I would like to open the call to questions. Operator.

(OPERATOR INSTRUCTIONS) And please hold while we compile the list of questions.

Hello. Any questions?

Yes, sir, one second. Your first call question from the line of Jeff Evanson from Dougherty & Company. Please proceed.

Good afternoon, gentlemen. Thanks for taking my questions.

Hi, Jeff.

Congratulations on the acquisition. It sounds like a very compelling fit. Could you guys talk a little bit about where Sarian's GMs will be this year and what your thoughts are on the GMs going into 2009?

Yes. We believe that the gross margin range for Sarian will be somewhere in the 45% to 50% ballpark and in the short term and long run, as we are able to get some purchasing power behind the volume will be able to drive that probably up above 50%, and so, my expectation would be and potentially drive it up over the mid-50%s. But from a planned perspective I'd say we are looking at right now 45% to 50%.

Okay. And Joe, you mentioned your areas that will turn around -- your areas of sale that will turn around when the economies will turn around were wireless and drop in networking, I think you said. Was that the reason for the revenue short fall this quarter?

No. What I was saying was once we get know that time period where the economy gets back to normal GDP levels in the 3% to 4% range, that I would expect overall revenue to organically, not including Sarian, but organically to be in the 10% to 20% ballpark. And that the real big swinger in terms of whether at the lower end of that range or the high end of that range is going to be the take rate on the wireless drop in networking initiative and how quickly that deploys. And so -- but my expectation would be that once we get back to normal levels we will see organic growth rates in the 10% to 20% range. And for your purposes, Jeff, as you think about how you kind of look at the business, the way I would guide on that is generally speaking, if we see the economy remaining kind of the recession that it is in today, if you listen to the economists and the Bush administration and even Warren Buffet today, they are saying the expectation in this kind of situation would be that our growth rates would probably be somewhere in the zero to 5% range, plus or minus. And then once as we return we will see it bump up to 10% to 20% with in general Digi execution determining at whether at the low end or the high end of the range and certainly the wireless drop in networking piece being the most significant variable.

Okay. And a little bit more on the quarter. You are clearly indicating that nonembedded in the Americas was the weakness in the quarter. Correct?

That's right.

Is there anything specific you can point to, any verticals or product lines?

Yes. What we saw was those product lines and nonembedded that are highly U.S. leveraged got hit the hardest. So, as an example we saw that the terminal server product line, the USB product line, and the cellular product line all highly leveraged in terms of the US versus international mix. And as a result of that they got hit pretty hard. And in addition to that on the terminal server product line we had one big customer that moved away. Our customer's customer actually moved away from them. So that we had a one customer hit there. And then in the USB arena, it's even more severe because I would say the segment of the U.S. that I think has been hit the hardest probably by the recession is the retail point of sale segment. And that's a segment that we focus on with our USB product line.

Okay. And Joe, just a couple of quick -- or, I'm sorry, Kris, just a couple housekeeping questions. I missed the embedded increase in the EU in the quarter.

In the EU, we said that on the embedded side, it increased by $2.4 million or 36.1%.

And then APAC was really -- how did that filter in there?

It was combined EU and APAC so we didn't break it out from an embedded/nonembedded break out. And they were $2.4 million.

APAC was up $2.4 million

No, no, I said Europe and APAC was up $2.4 million or 36.1%.

Got it.

Significant component of that would have been Europe.

Overall, when you look at International versus the Americas overall grew about 18.4% and the the Americas was down about 8.2%.

Okay. And then last on the effective tax rate. Did you say it was going to go to 37% to 39% for the remainder of the year?

Yes. That's what on an annualized basis it would end up being, Jeff, because we have this in process R&D and when you have that and it's a nondeductible item, it tends to drive your effective tax rate for the quarter that you have that to a high number, but on an annualized basis for the year of 2008 will end up between 37% to 39%.

So that's for the full year. Then, are you going to have a charge related to this acquisition?

Yes, we said that the in process R&D is approximately $2.5 -- $2.1 million that would be the charge that we would take during Q3. There is some acquisition related expense so the total charge will be about $2.5 million for this quarter.

Alright. Great. And then I just have to ask the question, because of the way you described your marketable equity -- your marketable securities. Should we be concerned that there might be some unrecorded loss and I know this is an accounting error and not cash. But what have you found in your analysis there?

As I said we intend to hold all our marketable securities in our portfolio to maturity. And we believe that realization of any holding losses are not likely at this time and therefore not recorded. So clearly we believe it is not likely.

One must assume though, that there are some mark to market losses, if you were to account for it that way.

No.

Okay. All right. Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Michael Ciarmoli from Boenning & Scattergood. Please proceed.

Hey, guys. Just on the -- can you give us a break down in terms of what MaxStream related products did in the quarter?

Yes. MaxStream grew at about 17.9% year-over-year. MaxStream was another one where it is highly leveraged in the U.S. If you look at the US versus international breakdown it has improved actually over the last year, but it is still about 85% U.S. and 15% International. So highly leveraged on the US side and therefore we think impacted by the recession. We feel pretty good about the fact that we expect that growth rate to improve and -- over the next couple of quarters.

Okay. And just on -- Joe, we talked at the end of the last conference call, you guys seemed like you weren't experiencing any major headwinds. Didn't change your guidance. So did this all come, I assume -- was it -- since the, February, March, time frame. I mean, what really changed? The economy at that point on your last call was pretty much in the tank then. I would imagine you saw some weakening at that point. Were you thinking there would be a rebound? And then you'd adjust your guidance at that point, or can you give us any real major headwinds that cropped up?

Yes. If you remember in the call did last quarter when you asked this question, the point I made was that one the reasons we didn't have great internal visibility at that point was that we had just gone through an ERP transition. So one of the challenges that we had was that we just didn't have as much information as we would typically have at that point. And so I would say that, in general, we saw was just a real softness throughout the quarter. From a backlog perspective we started the quarter pretty strong and then we just saw softness occur throughout the quarter. As we inspect that, we see that the North America two tier distribution channel was real soft, as we inspect that further and talk to them about what they saw from the broader networking category, the feedback we got from the channel, the major players in the channel that we deal with was that they saw broad-based softness. We track our share position on a weekly basis through the channel. And we saw that our share position was holding firm. So clearly what we saw was softness in the channel.

The other think we saw in the quarter was especially led by as I said earlier retail point of sale vertical segment, we saw several customer pushing out orders. And so, the retail point of sale, probably the most significant, but we saw that in other vertical markets as well. And so obviously generally speaking we saw International going gangbusters at 18.4% and then Americas pulling back. And obviously a result of the overall recession and the impact on our business. Generally speaking, our business this quarter was 61% Americas, 39% International. As I mentioned, those companies that have the inverse of that, if it's 60/40 or better, obviously fared much better. And we see that as a challenge on us to create the inverse situation where it is 60/40 and where we insulate ourselves from regional dynamics like that, if we had done that coming into this quarter and if you apply the same growth rates we would have had double digit growth. So if we're 60/40 international, applying that 18.4% would be a whole different dynamic. And that's what other -- some other companies saw. So that's the big challenge we have. We've done a good job, I think, of driving towards a majority of our revenue coming from what we call growth products over the last several years, which has put us in a position to grow, and what we need to do a little bit better job of going forward is really driving that International mix.

Right. And what has been your exposure to the automated metering market? How is the opportunities in that space looking?

Very good for us. We sell tens of thousands of units into that market and have several key customers that we are shipping to today. And have some very large prospects out there that we're working, and it is a very attractive segment for us, not only for the mesh networking end point product, but we have gateway opportunities, we have other opportunities in that space. So we see that as a very attractive opportunity going forward.

It's just the retail point of sale, one vertical, that's really dominating the revenue mix right now.

No, I'd say that is certainly the one that is most impacted. I would say in general, most verticals are impacted in North America by this dynamic. I would say, in the drop in networking space, where we have customers that are doing things that are more revolutionary, I think it does tend to delay things a little bit, it does tend to push out trials and pilots a little bit. And so it does have a bit of an impact on that sales cycle. So we have to be realistic about that. But we feel pretty good that the -- we have gotten now visibility to what it is happening. We've analyzed it. We feel pretty good about the guidance that we put out there for the rest of the year. And the general -- more general guidance, that while we are in this situation, we are going to be looking at lower growth rates zero to 5% plus or minus a point or two. And then when get back to more normal times that we should be able to bounce back organically to the 10% to 20% kind of ballpark. And then later Sarian on top of that, that's the organic Digi piece.

Right. Okay. Great. Thanks, guys.

Your next question comes from the line of Jay Meier from Feltl & Company. Sir, you may proceed.

Thank you. Would you please, Kris or Joe, would you please go over your operating metric targets once again? You continue to introduce acquisitions that seem to have lower and lower gross margins and trying to get a sense of how this model is going to leverage over time. Would you give us an idea of where you anticipate your gross and operating margins going?

Yes. We mentioned that our gross margins were 53.8%. If you look at what's happened with that over the last year that's actually up about a point so it's been trading slightly up. What's I've said however is that over the three to five year time horizon, I would expect to see higher top line growth opportunity in the market and I would expect to see more competitive intensity and some pressure on gross margins, a little bit more price elasticity. So I would expect slight degradation in that over the long run. To the point on Sarian, what I was saying earlier is that while the gross margins are on the 40% to 50% kind of ball park today we think there is it opportunity to drive that up to at least 50% and likely into the mid 50%s, so that would be a big focus for us. In terms of the other operating metrics, it really hasn't changed. The expectation is that over the next three to five years we will be able to drive our EBITDA, right now which is in the 15% to 20% ballpark up into the 20%, 25% range, and what I said earlier in previous calls, is the goal would be to get to 25% EBITDA. The way we'll do that is by driving, again into higher growth market opportunities and driving down our [EBITDAR] over time faster than any gross margin degradation that we might see. So my perspective on the three to five year time frame on the overall operating model really hasn't changed.

And what is your view of the trajectories of some of the historically over recent years the historical legacy products? Are you anticipating those are going to dry up at around 20% -- a 20% reduction per year, or has that accelerated now or has that maybe even stalled out as customers trying to refresh their existing infrastructure rather than upgrade?

Yes. Our expectation is it is going to be in that 20% decline plus or minus about 5% ballpark. This last quarter, I think it was right in the wheelhouse right around -- if I recall right, right around 19% to 20% decline. So my expectation is that we will continue on that kinds of trajectory.

Okay. And you mentioned that you anticipate your margins -- gross margins for 2008 will, I think you said, 50% to 54% for the year. And that is a GAAP number, correct? And historically you have also said that you anticipate 50% to 55% gross margin. Is that still in the ballpark for you?

Yes. I think we said for this year 52% to 54%, yes, so that's still in the ballpark.

That is a GAAP number, right.

Yes, that's after the tangible amortization. That's about 1.5% or they about to. If you take that out that shows a higher percentage on the gross margin without the amortization

Right. Okay. Thank you.

Thanks, Jay.

Your next question comes from the line of John Vinh from Collins Stewart. Please proceed.

Hi, John. Hello?

Hey, sorry about that. I hopped on a little bit late. So I apologize if the question has already been asked. But, Joe, you'd always talked about previously kind of a strong kind of back half ramp of MaxStream drop in networking based on the pipeline. Obviously the slowness of the economy has pushed some of this out. How should we be thinking about this pipeline that you've been talking about? Does this just get pushed out several quarters? And if so, what's the timing of that, or does it become more of a subdued ramp? And do you have any sort of visibility on when you'd expect things to start recovering in terms of MaxStream drop in networking?

Good question, John. We have in that wireless drop in networking pipeline. We continue to see growth. We continue to see growth in significant customers and we continue to -- we have got tracking in place in terms of identified large customers that we call $650,000 and above in terms of revenue. We track them through pilots, through deployment. And we have got metrics that we are tracking. In terms of large customers identified we are doing very well. And what we are seeing is some of those customers are actually moving through pilot into production. And we are seeing a couple moving. And others are moving I think a bit slower than we would otherwise have expected in a normal economic situation. And when we put the plan together and looked at that ramp back in last July, I think our GDP was about 4.9% that quarter so we were feeling some good wind behind our sails at that point. And so the expectation would be that customers are sticking with it. We are not seeing people back away. They are just not moving quite as aggressively in that space and expectation would be that that sales cycle will be longer and the ramp will delay a bit. We are seeing ramp, we just won't see it as aggressive this year. We'll see more -- hopefully, if we see the market come back in fiscal '09, we will see that. And to the extent that the market comes back and we execute well, then we will start to see once again double-digit growth rates and hopefully higher double digit. But that's about as much as I can give you right now, John. We still feel very good, very enthusiastic about the customers we're lining up and the level of differentiation that we have within this customer base and the fact that they will be deploying. It is just a timing question.

Got it. You talked about large and small customers. Can you quantify what percentage of your revenues does the $650,000 and above customers make up? And are you able to identify differences in ordering trends between the large and small customers? I guess what I am trying to get at were the smaller customers more heavily impacted by the slow down do you think based on what you are seeing?

Good question. Where we tend to see the small to medium sized customers is through one of the places we see them through the two tiered channel. And certainly we've seen softness there, so I believe that they have been -- certainly have been impacted by the recession. And I think I commented on the large customers and drop in networking arena and I think that holds to other product areas where the sales cycles are just a little bit longer and pushing out. And we are not seeing customers dropping the program. But we are seeing them push out, it is taking longer.

And roughly, what is the split between your larger customers and your small-medium sized?

I don't have the number in front of me right now. We don't break it out. We haven't broken it out.

Okay. And a last question for you is, you seem to continue to be pretty optimistic about your growth aspects in Europe. We have been hearing about some indications of slowness impacting Europe as well, not as much as North America. Is there any risk there, you think that some of that slow down could impact you or are you starting to see any of that in your Europe numbers or are you still pretty confident with your European exposure at this point?

There's always risk. We're not seeing any slow down at of yet. But obviously there's always, with what we saw in this quarter, it was a bit of a surprise the level of impact, so there's always risk, but we are not seeing it in Europe. We are seeing robust growth opportunity in Europe as well as Asia Pacific.

Alright. [European backlog] this quarter compared to last, was it up or down?

I can't break out European, but I can say that overall the backlog coming into the quarter was up.

Great. Okay. Thanks a lot guys.

Thank you.

Your final question comes from the line of Ali Motamed from Boston Partners. Sir, you may proceed.

Hi. On the Sarian acquisition, I think you said $0.06 to $0.08 in '09. Is that -- that is GAAP EPS. I assume there's probably a good amount of amortization there. So what is the cash EPS impact?

Yes. That is GAAP UPS and there is a fair amount of amortization, and while Kris is looking for the number, off the top of my head it was another $0.08 to $0.10. Yes.

Wow. And then, you were expecting $30 million in revenues. That seems a little aggressive. Can you talk about that? Can you talk about what may be different about their business and your current business that is allowing them to triple revenues -- I know they are a lot smaller obviously, but over the course of a two or three year period?

Yes. I am not sure. The $30 million -- what we said for fiscal 2009, we guided to $23 million to $27 million.

Excuse me. $23 million to $27 million. But that is off of what, $10 million trailing or less than that even. How does that grow so fast? What leads to that?

So the piece we didn't give you was how they are tracking this year.

The last 12 months as of December, '07, they are about $12.5 million run rate.

So you basically expect them to double going into next year. And now looking at also -- I think you spoke of a $500 million number, I don't know what year you put on that. What was that?

Five years out..

Five years out from now. Okay. Thank you very much.

Thank you. Any other questions?

Actually you have a follow up from Jay Meier. Sir, you may proceed.

The -- regarding the acquisition, did you compete against them at all? Is there any cannibalization of business?

We did compete against them. However, for the most part they were focused on vertical segments and they had optimized their product strategy to be effective in vertical segments where we had not focused. So they were focused on the ATM arena, on lotteries, on gaming, on wireless back up, and we were focused on remote device networking and telemetry kinds of applications. So there was some overlap there where we competed with them in Europe and we don't expect to see -- we see -- we expect to see a lot of incremental growth opportunity. And we expect to take their products, bring them into the U.S., get them certified on the U.S. carriers, and aggressively go after the same verticals in the U.S. So we see upside synergies. We don't see any real problem.

Well, if you guys had similar products to theirs, but you were targeting different verticals and now you're going to bring their product here and get them certified on the carriers, I was under the impression your product were already certified on the carriers. So how does that become additive?

Well, in pursuing those vertical markets what they have is, first of all, they have got really, really strong routing protocols and routing competencies, in fact they've got one of their -- they have got a patent in that arena that is very strong. And they have a very strong set of heritage protocols that they support that are well optimized. For instance [syncronist] protocols in the banking and ATM environment like [Bisync] and others are really important. And those are things that we just didn't do. And so they compete and they target those segments with a similar product to the product that we have that with a very, unique feature set that effectively competes in that segment.

Okay. All right. So, let's assume for a minute hypothetically that this economic headwind ends at the -- on September 30, 2008. Should we assume that -- and best case scenario, your core business will grow 10% to 20% organically, and then we can start throwing on the Sarian revenue target on top of that?

If that he is what occurs, then that's what you should assume.

Okay.

Thank you. Jay, I wanted to give you a guidance in a way that you guys can make your own assumptions on the -- everyone has different assumptions on your economy. I wanted to give you some guidance that helped you with that part.

That was helpful. Thanks.

At this time I am showing you have no further questions. I would like to now turn the call back over to management for closing remarks.

Thank you very much for attending the call. I look forward to talking to you again in three months.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Have a wonderful day.