Digi International Inc (DGII) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2009 Digi International Inc. earnings conference call. My name is Jeremy, and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions). At this time, I would like to turn the presentation over to your host for today's call, Mr. Kris Krishnan. 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 don't have a copy of our earnings release, you may access it through the press release section of the Digi website at www.Digi.com.

Second, I would like to remind our listeners that some of the statements that we make in this presentation may constitute forward-looking statements. These statements reflect management's expectation about future events and operating plans and performance, and speak only as of today's date. These forward-looking statements involve a number of risks and uncertainties. A list of the factors that could cause actual results to be materially different from those expressed or implied by any of these forward-looking statements is detailed under the heading "Forward-Looking Statements" in our earnings release today, and under the heading "Risk Factors" in our 2008 annual report on the Form 10-K already on file with the SEC. We undertake no obligation to update publicly or revise these forward-looking statements for any reason.

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 in the Form 8-K that we filed before this call. The Form 8-K can also be accessed through the SEC filing section of our investor-relations website at www.Digi.com. Now I would like to introduce Mr. Joe Dunsmore, our Chairman, President, and CEO.

Thank you, Kris, and welcome to the call, everyone. This is the 27th consecutive quarter of profitability for Digi in an environment that remains challenging yet seems to be stabilizing. While we met our guidance for Q4, our results were toward the low end of the revenue and profitability guidance ranges that we provided at the beginning of the quarter.

Revenue for the quarter of $40 million was down 20.6% year-over-year, and down 10% sequentially. However, when normalized for lumpy demand, excluding the Fujitsu revenue from Q3, the NET+50 last-time buy revenue for both Q3 and Q4, we trended up 7% and saw improved booking rates in Q3 over the prior two quarters. Revenue for fiscal 2009 was $165.9 million, down 10.3% year-over-year. Wireless product revenue for fiscal 2009 was 34% of our total revenue, up from 25% in fiscal 2008, and an increase of 20% year-over-year.

The economic environment and markets that Digi serves seem to be stabilizing. We have seen our daily bookings rate improve significantly in June and July, stabilize in August, and resume growth in September and October. In fact, October bookings to date have been extremely robust. We believe that this was indicative of increasing inventory replenishment needs of our customers in June and July, and likely indicative of underlying demand improvements in October. Market share indicators show we are continuing to gain market traction in share versus our competitors. At the end of our first fiscal quarter, I introduced the fundamental principles that we focused on in 2009. They are aggressive share gain, profitability, positive operating cash flow, aggressive supply chain management, and acquisition.

Now let's review our progress for the quarter and for the year. First, aggressive share gains through continued investment in wireless M2M. We are continuing to increase investment in wireless M2M while others have been pulling back. As a result, we continue to see strong growth from our wireless products. As we compare Digi's revenue performance to others in our sector, we believe we are continuing to gain market share. Additionally, our recent introduction of the iDigi Platform and iDigi Energy are adding significant momentum to our strategic shift from providing point products to providing wireless M2M solutions to our customers. This increases our competitive differentiation and will drive increases in our share position over time.

In fiscal 2009, we introduced the iDigi Platform, executed on 21 new product launches, and targeted key vertical markets like energy management and fleet management to fuel the continued growth that will allow us to meet or exceed our targets. Our wireless product offering grew 20% in 2009 over 2008. We believe this positive trend will continue and we have targeted wireless products to be 40% of revenue for fiscal 2010, and at least 60% of revenues annually within three to five years.

Second, profitability. Fiscal fourth quarter of 2009 was Digi's 27th consecutive quarter of profitability. We recorded EPS of $0.16 in fiscal 2009, compared to EPS of $0.47 in fiscal 2008, remaining profitable in an extremely volatile external environment. Digi, like most technology companies, saw a severe decline of business in fiscal Q1 of 2009. We were able to maintain a profitable posture in the market, partly because we had already established very strong operating margin momentum entering the crisis. Additionally we implemented aggressive margin improvement programs that minimized gross margin degradation, and implemented a restructuring program that aggressively reduced investment in lower-growth product lines while increasing investment in higher-growth wireless product lines. This positions us for significant growth in profitability in fiscal 2010, as the economy continues its recovery.

Third, positive operating cash flow. Digi's free cash flow was $9.3 million for fiscal 2009. Additionally our focus throughout the year on tighter inventory management, as well as maintaining DSOs at 39 days, coupled with positive EBITDA results, have enabled us to improve our cash position year-over-year. Digi's EBITDA for fiscal 2009 was 8.6% of revenue, compared to 16.4% of revenue in fiscal 2008. Digi executed on a $6.6 million stock repurchase program during the year, and still finished the year with $75.8 million in cash, which is up $2.1 million year-over-year. Our balance sheet ratios remain very strong with a current ratio of 7.4, leverage ratio of 0.13, and cash per share of 3.07.

Fourth, aggressive supply chain management. The credit crisis necessitated immediate action to secure our supply and distribution lines in order to continue to meet customer obligations and financial objectives. The immediate concern was the heavy strain the crisis was placing on smaller suppliers and distributors, or those under financial stress. The executive team commenced in October with weekly meetings to assess all key players, classify the degree of stress, and put in place alternative sourcing and distribution strategies to mitigate risk. We continue to proactively manage our supply chain to ensure our key sources of supply are intact and that we have contingency plans in place.

Additionally, increased focus on inventory turns has reduced inventory levels by $2.6 million this quarter, and we have maintained a very strong receivables and payables strategy and position. Finally, continued focus on acquisition. MobiApps is a great example of the type of acquisition that can be completed in this environment, leveraging our strong financial position. We are increasing our focus and energy on identification and evaluation of these opportunities going forward, and are well positioned to execute.

In conclusion, German philosopher Nietzsche said, for a tree to become tall it must grow tough roots among rocks. Fiscal 2009, while very challenging, has made Digi much stronger. While focusing on execution of the five principles noted above, Digi continued to make progress on its vision to be a leader in the next generation of Internet expansion. In 2009 we pivoted the organization to focus on providing wireless solutions to our customers. We introduced iDigi Energy and other iDigi offerings to accelerate this initiative, and as a result we saw high growth of our wireless product offering.

Therefore, in fiscal first quarter of 2010, we expect to see some sequential and year-over-year top-line growth. In fiscal 2010 we anticipate a return to top-line organic revenue and bottom-line profit growth. Kris will provide additional details in his discussion, talking about guidance. I've said in previous calls that our goal is to be a $500 million company by 2013. Additionally I have said that we expect revenues to be at least 60% wireless, 60% international and at least 10% services. I continue to believe that these goals are achievable and that Digi has an actionable plan in place to achieve them.

So to summarize, first, Digi posted its 27th consecutive quarter of profitability. Second, we continued executing our strategy and pivoting more aggressively towards wireless and solutions. And MobiApps and iDigi will only augment our momentum. Third, 2009 is a year where Digi has significantly improved its root structure as a company. Fourth, I'm still bullish on our ability to achieve our 2013 goal to be a $500 million company with a very exciting growth/revenue mix. Next I will hand it back to Kris.

Thank you, Joe. Revenue for the fourth fiscal quarter of 2009 was $40 million, a decrease of $10.4 million or 20.6% over the fourth fiscal quarter revenue a year ago. Excluding one time revenue from Fujitsu and the last time buy for the NET+50 chip, revenue increased from the third fiscal quarter of 2009 to the forth fiscal 2009 by $2.5 million or 7%.

Revenue in EMEA, which is Europe, Middle East and Africa, was $10.6 million in the fourth fiscal quarter of 2009, compared to $14.5 million in the comparable quarter a year ago. A decrease of $3.9 million, or 26.6%. Revenue in EMEA includes Sarian-branded revenue of $2 million and $3.3 million for the fourth quarter of fiscal 2009 and 2008 respectively. Revenue in Latin America was $1.2 million in the fourth fiscal quarter, 2009, compared to $1.3 million in the comparable quarter last year, a decrease of $100,000 or 12%.

Revenue in North America was $24.2 million in the fourth fiscal quarter of 2009, including Spectrum revenue of $1.4 million, and MobiApps revenue of $100,000 compared to $29.1 million in the comparable quarter last year, a decrease of $4.9 million or 16.9%. Spectrum revenue in the fourth quarter of the fiscal 2008 were $800,000 from the date of acquisition.

Revenue in the Asia-Pacific region was $4 million in the fourth quarter of 2009, including MobiApps revenue of $200,000, compared to $5.4 million in the fourth fiscal quarter of 2008, a decrease of $1.4 million or 27%. Revenue from our embedded products in the fourth fiscal quarter of 2009 was $18.8 million, including Spectrum revenue of $1.4 million and MobiApps revenue of $300,000, compared to $23.5 million in the fourth fiscal quarter of 2008, a decrease of $4.7 million or 19.9%.

Revenue from non-embedded products was $21.2 million in the fourth fiscal quarter of 2009, compared to $26.9 million in the fourth fiscal quarter of 2008, a decrease of $5.7 million or 21.3%. Non-embedded products revenue include Sarian-branded product revenue of $2 million and $3.3 million for the fourth quarters of 2009 and 2008 respectively. International revenue was $15.8 million or 39.5% of the total revenue in the fourth quarter of fiscal 2009, compared to $21.3 million or 42.2% of the total revenue in the year-ago comparable quarter.

Our wireless revenue was $13.1 million or 32.7% of our total revenue in the fourth fiscal quarter of 2009, compared to $15.7 million or 35.2% of total revenue in the third fiscal quarter of 2009, and compared to $14.6 million or 29% of revenue in the fourth fiscal quarter of 2008. The strengthening of the US dollar, compared to the euro and the UK pound sterling, had an unfavorable impact on the revenue of $300,000 in the fourth fiscal quarter of 2009, compared to the fourth fiscal quarter of 2008. Our gross margin was 48.5% in the fourth fiscal quarter of 2009, compared to 51.5% in the fourth fiscal quarter of 2008.

The gross margin was lower in the fourth fiscal quarter of 2009 than in the comparable period a year ago, due to unfavorable customer product mix within both the embedded and the non-embedded products. The strengthening of the US dollar, compared to the euro and the pound sterling, had a $200,000 or 0.2% favorable impact on gross margin in the fourth fiscal quarter of 2009, compared to the fourth fiscal quarter of 2008. Our total operating expenses for the fourth fiscal quarter of 2009 was $18.3 million, or 45.8% of revenue, compared to $20.8 million or 41.3% of revenue in the fourth fiscal quarter of 2008.

The decrease in operating expenses in the fourth fiscal quarter of 2009 compared to prior-year comparable quarter is primarily due to savings resulting from the restructuring plan announced in the third fiscal quarter of 2009 and the elimination of incentive compensation program for fiscal 2009, partially offset by ongoing incremental operating expenses for Spectrum and MobiApps. The strengthening of the US dollar, compared to the UK and euro, had a favorable impact on operating expenses of $200,000 in the fourth quarter of fiscal 2009, compared to year-ago comparable quarter. Our total other expense, net was $200,000 for both fourth fiscal quarter 2009 and 2008.

In the fourth fiscal quarter of 2009, interest income on marketable securities and cash and cash equivalents was approximately $100,000 offset by unrealized foreign currency losses of approximately $300,000. In the fourth quarter of fiscal 2008, Digi recorded a pre-tax other than temporary impairment of $1 million on its Lehman Brothers bond, reflecting the estimated permanent decline in value of the security precipitated by the bankruptcy of the security's issuer. This was offset by $600,000 in interest income on marketable securities and cash and cash equivalents, and $200,000 in foreign currency gains.

Net income for the fourth fiscal quarter of 2009 was $1 million or $0.04 per diluted share, compared to net income of $3.6 million or $0.14 per diluted share in the fourth fiscal quarter of 2008. Non-GAAP net income and net income per diluted share for the fourth fiscal quarter of 2009 was $700,000 or $0.03 per diluted share which excludes a tax benefit of $300,000 for the reversal of tax reserves due to the closure of certain domestic and foreign tax years, or $0.01 per diluted share. Non-GAAP net income and net income per diluted share for the fourth fiscal quarter of 2008 was $4 million, or $0.16 per diluted share, which excludes a write-down of impaired investment of $700,000 net of tax, or $0.03 per diluted share, and a tax benefit of $300,000 for the reversal of tax reserves associated with the closure of prior year, or $0.01 per diluted share.

Please refer to the reconciliation table in the earnings release which reconciles our net income and our net income per diluted share from a GAAP basis to a non-GAAP basis. Digi's effective tax rate for the fourth fiscal quarter of 2009 was a negative 7.3%, including a discrete benefit realized as a result of a reversal of $300,000 in tax reserve, due to the closure of certain domestic and foreign tax years, compared to an effective tax rate of 26.8% in the fourth fiscal quarter of 2008.

For a full fiscal year, Digi's effective tax rate was 4.6%, compared to an effective tax rate of 34.7% for fiscal 2008. The effective tax rate for fiscal 2009 includes $1.2 million in discrete tax benefit. The effective tax rate for fiscal 2008 includes $500,000 in discrete tax benefit offset by the tax impact for the charge and in-process R&D associated with the acquisition of Sarian, which is non-deductible. For the full fiscal year of 2009, Digi reported revenue of $165.9 million, compared to $185.1 million for the full year fiscal 2008, a decrease of $19.2 million or 10.3%.

Other specific financial information for fiscal 2009 compared to fiscal 2008 include the following. Revenue from the embedded products for fiscal 2009 was $74.7 million, compared to $86.6 million in fiscal 2008, a decrease of $11.9 million or 13.8%. Revenue from non-embedded products for fiscal 2009 was $91.2 million, compared to $98.5 million in fiscal 2008, a decrease of $7.3 million, or 7.3%. International revenue was $75.2 million, or 45.4% of our total revenue for fiscal 2009, compared to $77.7 million or 42% of our total revenue in fiscal 2008. Wireless revenue was $56.2 million in fiscal 2009, or 33.9% of total revenue, compared to $46.7 million in fiscal 2008, or 25.2% of total revenue, a year-over-year increase of 20.3%.

The strengthening of the US dollar, compared to the euro and the UK pound sterling, had an unfavorable impact on revenue of $6.1 million in fiscal 2009. For fiscal 2009, Digi reported net income of $4.1 million, or $0.16 per diluted share, compared to net income for fiscal 2008 of $12.4 million, or $0.47 per diluted share. Non-GAAP net income for fiscal 2009 was $4.8 million, or $0.19 per diluted share, compared to $14.6 million, or $0.56 per diluted share in fiscal 2008. During fiscal 2009 we repurchased 893,162 shares of our stock under our previously announced stock-repurchase program for $6.6 million, at an average price per share of $7.36. Our diluted weighted average shares outstanding at the end of the quarter were 24,981,381 shares, compared to a previous quarter of 24,875,104 shares, an increase of 106,277 shares.

Turning to our balance sheet and cash flow statements, our combined cash, cash equivalents and marketable security balance, including long-term marketable securities, was $75.8 million, as of September 30, 2009, increasing by $8.9 million from the end of the prior quarter, and by $2.1 million from the end of prior fiscal year. We spent $3 million on the acquisition of assets of MobiApps and $6.6 million on repurchasing our stock in fiscal 2009. Net cash provided by operating activities for the quarter was $11.4 million. Our current ratio is 7.4 to 1, compared to a current ratio of 6.4 to 1 at the end of the prior fiscal year.

Our DSO is at 39 days compared to 40 days in the previous quarter. Now I would like to provide some guidance for fiscal 2010. Digi projects revenue to be in the range of 40 to $44 million for the first fiscal quarter of 2010, and a net income per diluted share in the range of $0.02 to $0.08. For the full fiscal year, Digi projects revenue to be in the range of $165 million to $190 million, or an increase of being flat to 14.5% over fiscal year 2009. Gross margin as a percent of revenue is expected to be approximately 50%, including the amortization of purchased and core technology of approximately 2.5%. We are projecting operating expenses to be approximately 43% to 47% of revenue. Operating expenses including our expectation for a partial incentive care payout in fiscal year 2010. Operating income as a percent of revenue is projected to be in the range of 3% to 8%. Our effective tax rate is projected to be approximately 33% to 35%. Digi projects GAAP earnings per diluted share to be in the range of $0.16 to $0.42. At this time, I would like to open the call to questions. Operator?

Thank you, sir. (Operator instructions) and we'll pause for just a moment as questions are compiled. And your first question will be from the line of Jay Meier with Feltl (inaudible). Go ahead.

Oh, yes, thanks. Kind of curious to get some more color, Joe, on you -- excuse me -- from you, on the Smart Grid and your positioning there. You have talked a lot about it in writing. I didn't hear you really discuss it in depth in the call. When would you anticipate to start seeing your customers giving you orders? What products do you expect to ship for Smart Grid? And how effectively do you think you have penetrated the major integrator base for those -- for that vertical?

Okay. Jay, we have made good progress on the Smart Energy initiative. We saw in 2009 about a 7X ramp in unit volume. So as I have talked about in the last call we're seeing ramp begin. We're seeing customers moving from pilot to production, and the revenue levels are in the millions of dollars now. We expect that unit volume to continue to increase probably another 5 to 10X in 2010 over 2009. The key drivers will be our focus on demand response as a key application, partnering with Comverge and other key integrators in that space. And we are making really good progress. We are ramping up unit volumes in that space, and we have multiple pilots that have moved to production in that arena. We continue to focus -- and the major opportunity for us in the demand-response arena is the gateway opportunity, and then we're also selling with gateways. We're selling XBee modules into devices like thermostats, and hope to be able to drive beyond thermostats into other devices. And certainly iDigi is a key play in that space.

We continue to partner with Itron and others in the AMI arena, providing gateways for connectivity to meters, and connectivity to other distribution grid equipment in their network. They have got the OpenWay network where we can provide gateway connectivity within that play. And then certainly doing the same type of thing with other players in that space. Itron is the one partner that is announced publicly.

And then in alternative energy we are seeing significant opportunity for both solar and wind power installations, for remote monitoring and data logging. That's beginning to ramp up and move from pilot to production. And in that arena we are providing gateway connectivity, unique gateways that are customized for data logging and remote monitoring for that key application area. We're seeing this government stimulus funding beginning to come through. We're seeing several of the companies that we're working with that are evaluating Digi products or have Digi as a part of their offering, are starting to get money from the funding, which actually began -- the grants began yesterday. This funding, we believe, really helps to continue to legitimize the space and the opportunity, and we expect that to continue. We have, from a product perspective -- we have with our gateways and our XBee modules, we have integrated the Smart Energy profile. So these products are Smart Energy certified, and that means that for a broad class of devices that are Smart Energy certified in the Smart Grid, you have interoperability. We have developed the products, we have submitted them to the labs, they have been certified, and now they are available. And it enables our gateways to communicate with thermostats, meters, in-home displays, range extenders, et cetera. And so that is a key thing where we think we're ahead of the curve making our products Smart Energy-profile compatible. So we feel like we have got a lot of traction and momentum. The Smart Energy drive that we have is a key initiative for us that will help underpin the growth that we project for next year. It will help underpin the growth in wireless revenue, where we expect wireless to become 40%, over 35% of our revenue in 2009.

So as you look out over the next year or two or three, when do you anticipate -- I mean, when would you say is the period of time when we should start to see things really ramp up?

Well, we're seeing unit volume ramp and revenue ramp pretty aggressively right now. So I think what I told you last quarter is about right, Jay, that we're going to -- we're seeing in the millions of dollars. We'll see that ramp up significantly. I would expect that our revenue should, in 2010, ramp up maybe 80% to 100% in this space, and I would expect us to continue to see aggressive ramp going forward towards the objective of driving, again, the -- we have the $500 million revenue target -- the Smart Energy piece to -- being somewhere in the neighborhood of 10% to 20% of that, $50 million to $100 million. So we're starting to see that ramp-up occur aggressively. We're seeing multiple customers ramping up unit volume, and certainly this is one area that is less broader-economy dependent than other areas, so I expect this to -- this particular area regardless of the broader economy, I expect us to be able to continue to drive significant growth in this arena.

Okay. So here's a little tougher question for you. Your -- the bottom end of your guidance range for 2010 shows zero growth. So if this is such a big opportunity for you, and you are driving triple digit growth in that area, where is the offset, and how is it possible that you could be flat year-over-year?

Well, our guidance range is based on real simple assumptions. At the low end of the guidance is an assumption that the economy doesn't come back, that this is a false recovery, and we see a lot of problems, and we don't get any benefit. In fact, the economy continues to languish. The high end, 15%, the expectation is that we're going to see the recovery that we're beginning to see continue. And that recovery, all of the signals you are seeing out there on a broader basis, we are seeing in our bookings rates. We saw the beginning occur in June, it extended to July as I mentioned. August, which is typically kind of a tough month anyway, was kind of flat. And then September, bookings were very robust, and October have -- bookings have been more robust even than September, which is unusual. So, bottom line, we feel like -- we feel pretty good about next year. We feel like the midpoint is kind of the most likely scenario, where the economy comes back, but not very strong, maybe -- an average maybe 1% to 2%, where we get maybe 7% growth. The high end, we have a stronger economy.

Now in terms of the mix within whatever the number is, whether it's at the midpoint $178 million or higher, we expect the wireless products and the Smart Energy arena to be a very strong growth element of our business, and we expect the other areas, depending on what the economy does. If you kind of look at the mix of products, there are certain products and solutions that are -- that tend to be focused on new opportunities, large opportunities that are less economy-dependent, and then you have other products whose risk profiles are very economy dependent. So, if we see a tough economy, we're certainly going to see difficult results in the mature and lower-growth products that we have.

Well, I'm -- no offense, but I'm not exactly sure what you said there, and in all honesty, I think -- if you don't mind me giving you a little advice on the call, I think you guys need to start talking a little bit more specifically about who you are working with, and your backlog statistics, and your booking statistics. We need to be able to quantify this stuff. I happen to believe that you are working with a lot of companies, integrators and end users, in this Smart Grid deal, and I think it's a pretty big opportunity for you, but you don't sound all that excited right now, so I'm a little bit skeptical. Can you give us anything to sink our teeth into on that?

Well, Jay, I'm real excited about it. I don't know where you are getting that from. I told you that we saw 7X unit volume increase year-over-year last year we're expecting same kind of unit volume increase in the space. I have told you -- I have named, basically, many of the customers that we can name. Obviously, we have to get approval from our customers and partners to be able to name them publicly. So, I'm giving you as much information as I can from a customer and partner perspective.

All right. Well why don't you do me one little favor. You have named Itron, Comverge. We know you are working with Texas Utilities, we know you are working with Florida Power and Light in certain capacities. We can sort of read into where those companies are going, and Itron is demonstrating a pretty huge backlog in this type of stuff. Right? They are breaking out numbers. In fact, they are categorizing that this is Smart Grid and this isn't. Right? So do me a favor and tell me how many customers have you signed that you haven't been able to announce?

Well we have got -- in this arena, we have got about 10 customers in production overall. 10, 11 customers in production, and then we have got many other customers -- I don't have the exact number in front of me right now -- many, many other customers that are in pilot mode.

Okay. I'll back out of the queue. Thanks.

(Operator Instructions). Your next question will be from the line of [Steven Ray] with Quality Growth Management. You may proceed.

Hi, following the questions by Jay, which pretty much hit the issues, what is your involvement with Comverge's iThermostat, number 1, and number 2, the end users. And Baltimore Gas and Electric received a pretty nice grant. What involvement do you have there?

With iThermostat, we provide the wireless module in the iThermostat. With TXU, as they deploy by residential customer, the customers get one or two iThermostats and a gateway, and then connectivity back to Comverge, which includes the iDigi Platform. We are at multiple points in that opportunity, partnering with Comverge. And the Baltimore question, that's something I can't get into.

Okay. Are you involved in San Diego Gas and Electric's beach grid.

If I haven't named the customer, I can't get into it.

Okay. Okay. When you make a wireless module, what does that device sell for?

Well, it depends on the module. We make a lot of modules. The range is anywhere from $10 or $15 up to $30 or $40.

Okay. Per module?

Yeah.

Okay. Okay. Okay. Well, they are going to need a lot of modules. Well, okay. I'll just look forward to seeing what more you have to tell us in the future. Thank you.

(multiple speakers)Steven.

And your next question will be from the line of [Dan Brunquist] with RBC Wealth Management. You may proceed.

Hi, Joe and Kris, this is Dan Brunquist.

Hi, Dan.

Hi, Dan.

I think the challenge that we're all having is, just looking from a profitability standpoint, can you give me a little thought and some ideas on just the profit margins? When and -- we can kind of expect these revenue dollars to start showing up in the bottom line? I know it's been a really difficult environment that we're in, and so on, but if you look out and extrapolate out to be at $500 million in '13, and you are looking at net income percentages in that 3% to 8% range, it becomes kind of a difficult thing to say, okay, where is the growth going to come from. And then when you look at your stock, trading at a 43 multiple on next year's numbers, it just kind of comes -- we're paying up right now for earnings -- or future earnings. Can you kind of tell me a little bit about where we might be expecting that to come from, and then also why the -- you say the margins were weak this quarter because of product mix. When will that kind of change? Do you have any idea on that?

Yeah, gross margins were up again this quarter sequentially. They have been up for the last two quarters sequentially, Dan, and we expect that to continue. And we expect to have gross margins per Kris's guidance of about 50%. In terms of the profitability, we are expecting our profitability to be up in the neighborhood of, if you look at the midpoint of the range, about 60% this year. And we expect to drive the high growth part of our business, the wireless solutions part from where it is, 35% of the revenue, to 40% next year, and then over time to 60%. And we expect that to be able to leverage top-line growth, which will then be able to drive better bottom-line profitability over time.

As you saw with Digi leading up to the credit crisis, up to that point, we were able to leverage the business and drive improved profitability over time. We were able to drive our EDR down, and we were able to drive operating margins over a 24-quarter time period, EBITDA, between 15% to 22%. And the expectation is as we move out of this difficult environment and drive into the wireless solutions business and drive top-line growth that we'll be able to do the same thing.

Okay. You know, I guess -- and you had mentioned there about having some organic growth. Is the focus there? Because I would think that that becomes your more profitable bottom-line growth. If you are able to grow things organically as opposed to going out and having to make acquisitions. And maybe I'm wrong in this environment. I don't know. But as you mentioned, is that going to be a key focus just to try to drive those sales dollars in the iDigi and the wireless side?

Yeah, I think -- I talked about we expect to get to the $500 million. We expect half of that to drive up to -- from where we are at -- up to about $300 million through organic means, and then acquisition to help us get the rest of the way. So it is going to be a mix. Again, if you look historically, Dan, prior to the credit crisis, the way we grew the business, I think we were able to drive the organic growth as well as the growth through acquisition to the bottom line. I think that's why you saw the consistent high margin, high EBITDA position that we had, and the improved profitability over a six-year time period was a combination of organic growth and growth through acquisition.

And don't get me wrong. I mean, I think you guys are doing a great job. I -- one of the things that I would say -- I know Jay had made some comments about how to look at things, but I think in your space, and maybe in everybody's space today, making a year forecast becomes kind of like a no-win situation for you guys. When you say -- I mean, and maybe you feel like you have to do that, but my feeling, having known you guys from in the past, you show a flat revenue number for the year-over-year, and my feeling obviously is that's kind of like a -- very much a worse-case scenario.

Dan, we are not showing a flat revenue number. The midpoint of the range is 7% growth.

No, I understand that. That's the midpoint, but I'm showing your bottom line as basically flat, right? Saying you are going to do roughly the same amount, if the worst case -- because you just made the comment.

If you want to go to the worst case, if you want to assume that the economy languishes, then yeah, but --

But my only point in saying this, Joe, is that you are looking at $160 million next year as your bottom number, and maybe if you are not able to say with any conviction that you might get a middle range of 7%, why even put it out there. And just say, hey, we're expecting some really good growth coming from the wireless side, and we have got some really exciting things going with the Smart Grid, and then just let people extrapolate from there.

No, it's a good point. If it hasn't come across, let me make sure that it does. The expectation that I have is that we will drive to the midpoint or better of $178 million, and the midpoint of profitability, which is around $0.28, $0.29.

Yeah, and that's perfect. And I think that could be an expectation, and then just leave it at that. It sounds better than just looking at it from a flat, bottom up --

Yes. I'm sorry. One of the things that I assumed and I shouldn't have assumed, I think because of -- I have historically always given ranges, and I think I have tried to explain that our focus in our plan is to drive to the midpoint. I assumed that. And I shouldn't have assumed that. I mean, we expect to drive to $178 million and $0.28, $0.29. (multiple speakers ). It wouldn't be the low end.

Okay.

The perspective that we provide on the range, however, is if the economy goes into a double dip --

Yep.

-- I have a range, so that people understand that there are consequences to various scenarios.

I absolutely understand. I'm just making a comment when I saw and read this, that I'm saying, wow, I would have expected better top line growth, and you are telling me now that is what your expectations are.

Our expectation is $178 million in revenue, and whatever the midpoint is. I thought it was $0.28, but it may be $0.29.

All right. Thanks, guys. I'll get off.

And your next question will be from the line of Craig Irwin with Wedbush Securities. You may proceed.

Thank you. I just wanted to dig in a little bit more on your expectations of growth towards being a $500 million company. On the wireless side, where does the growth really come from? Is this organic growth driven by participation in end markets where you are already doing business, and it's really just rapid growth in the end market, or do you plan on introducing a whole slate of new products that you don't currently offer that would address new opportunities and potentially take share in this market?

It's primarily coming from addressing vertical markets that we have entered with new products. Those vertical markets that are going to drive the most organic growth with our wireless solutions are energy management, medical, fleet management, tank monitoring is another application area. Those are areas where we have current products. The primary drive for growth over the five-year period will be to continue to drive deeper, broader and deeper into those vertical markets, extending our products, going after those markets. There will likely be other verticals that will naturally be addressed as an easy outgrowth of what we are doing in these key targeted markets, but the R&D effort -- the assumption is the R&D effort is going to be focused on deeply penetrating these target markets.

Okay, excellent. And just another question along the lines of the Smart Grid. How far along are you on your development plans? I mean, do you have a full slate of products available today to participate on the 100 or so projects that are moving forward almost immediately? I mean, do you have the products to meet what customers are asking for?

Well, we have a slate of gateway products that have the Smart Energy profile. We have a slate of our ZigBee modules that are enabled with our Smart Energy-compatible products. And we will continue to -- and we are in development on additional gateways, additional end points, extending the iDigi Platform. So we're -- the market, the overall Smart Grid initiative is really at the beginning of a long cycle. I think we're moving from -- likely the big IT growth cycle is now evolving into another high-growth cycle in energy technology, and I think we're at the beginning of that. And I think Digi has hit that with a set of products to be there at the start, and we'll be aggressively investing to extend that. So we certainly don't have as broad a set of products and offerings as we'll have six months, a year, two years, three years from now. But we think we have a set that has gotten us out there, participating in key opportunities in areas that we think are high growth. The demand-response arena, the AMI arena, and alternative energy. So this is going to be a big investment area for us.

Excellent. That's a great segue into my last question. Obviously you are pretty serious about investing for the future growth of your markets. Spending over $25 million a year on R&D. Can you give us a little color on the specific breakdown in there, as far as end markets that you are targeting within your R&D product development programs?

Yes, I don't have specific number breakdowns for you, but I can characterize that even in the past year, we executed on a pretty aggressive pivot of investment within the R&D organization, away from any investment in slow-growth product lines, and investing much more in the wireless solutions product lines, our gateways, our wireless end-point products, and shifting our Rabbit product line to be focused on this arena with wireless solutions. And so we have executed on a significant shift towards wireless solutions. Those wireless solutions are focused on Smart Energy, fleet management, medical, tank monitoring, and vertical markets where asset-tracking,vertical markets where these wireless, wide-area network, and personal-area network, drop-in networking capabilities are important.

Okay. Excellent. And then one more question, if I may. Your margin guidance suggested that you didn't really expect much of a recovery in gross margins, even though there has been modest sequential progress over the last couple of quarters. You are obviously going through a product refresh cycle. But two years ago you were in the mid-50s. I was hoping you could give us a little color on what gets you back to the mid-50s, and the relative contribution of new products. Or if there's anything on the manufacturing side that's going on, or materials cost that factor into where we stand now, and how you get to your guidance?

Yes, so mid-50s. The primary areas where we levered down from mid-50s was with acquisitions where we -- acquiring businesses that, while they had a real strong EBITDA and profitability profile, the gross margin model was a little bit different than the heritage products. So their gross margins, when we acquired MaxStream, and MobiApps and others, were in the high 40s. So focusing on those acquisitions, has levered us down from the mid-50s, down to where we are. The expectation is that we'll continue to drive gross margin in that -- at this point, in that 50% ballpark arena going forward, and we'll continue to drive cost reduction to try to drive above the 50%.

My expectation is that we won't see driving up to the mid-50s, but we'll probably remain in that 50% arena, plus or minus a point or two, especially as we get into these arenas that have very high top-line growth opportunity, like Smart Energy. And so the model going forward over the next 5 years to drive to continued improvement in operating margins and EBITDA will be maintaining those gross margins in the 48%, 49%, to 51%, 52% kind of ballpark, and then with the top-line growth, driving our EDRs down significantly over time. Driving us back into those -- from an EBITDA today that is in the 8% to 9% range, to EBITDAs in the future that get back up into the 15% to 20% range. And then hopefully over time better than that, if we can position ourselves solidly with differentiated solutions in these high-growth markets. So that would be the model.

Craig, the other thing, the mid-50s that we were -- we didn't -- those numbers excluded intangible amortization, so we have 2.5 points of intangibles, so when I gave guidance of 50% for next year, that was after intangible amortization. So to compare apples to apples, a couple of years ago mid-50s would be about 52.5 for next year.

There is another point that doesn't address this question, but I want to address, while I have got the mike here and I'm thinking about it, Dan's point on the guidance for next year. I mentioned $178 million and $0.29. The other key point that I didn't mention that really reinforces the likelihood of that target or better is that we really are seeing in October very, very robust backlog and bookings generation, more than expected. So if that's indicative, as we think of an underlying demand dynamic that is positive in the broader economy, that certainly is a positive sign aiming towards reaching that target or better.

And actually if I could ask a question along that line, could you quantify for us the relative increase in monthly bookings off the trough value? Really what you are seeing today versus what you saw at the bottom of the market?

The bottom of the market? Pretty significant. I would have to do that off the top of my head. Daily bookings since the trough are probably up 50% to 60%. If you look at bookings quarter-over-quarter, fourth quarter versus third quarter, up about 11% to 12%.

Thank you very much. That's all of my questions.

And you have a follow-up question from the line of Jay Meier.

Yeah, thanks. You mentioned earlier, Joe, that the modules, the ZigBee modules cost anywhere from $10 to $35 apiece, and those modules would go primarily in appliances, I assume, like GE would make or somebody else. Or maybe you can explain where they go? And also there's another couple of components. We talk about gateways. How much do you get for a gateway? And how many gateways do we need per home?

You need one gateway per home. Residential gateways are going to be in the neighborhood of $100 per unit. Higher-end gateways, whether it be for the home -- not as likely for the home, but for other applications, within the Smart Grid, where you need cellular capability and Wi-Fi and mesh networking and other capabilities, might have an average sell price of $400, $500, $600. Sometimes higher than that in other parts of the Smart Grid, and in other applications. Certainly in fleet management, they are going to be oftentimes higher. In terms of the XBee question, Jay, thermostats over time going forward, yes, certainly we'll see other appliances in the home. In other applications, you'll see XBee modules in -- within communication devices with various types of sensors that are going to be deployed. Whether it be in a fleet management application, where you are going to have temperature sensors or humidity sensors or accelerometers or whatever it might be. Or tank monitoring, tank level capabilities. There's a wide variety of places where these modules go. When I was answering the question of modules, I wasn't just restricting it to ZigBee. It was more -- a broader answer, answering the question about our wireless modules generically.

Okay. So let's -- since you only talk about stuff that is public, let's talk about Texas Utilities, just to get some color, and some perspective on the opportunity that's in front of you, relative to your guidance. At -- you just said that you need -- that you get about $100 for a gateway per home. Texas Utilities has 2.1 million customers. Electricity customers. Should I -- can I imply that that's potentially 2.1 million locations through which Comverge and Texas Utilities will deliver a $100 Digi gateway?

That's going to -- the way you are going to get to that answer is by spending time with TXU to understand what they -- what their deployment looks like, and what their actual penetration would be of those 2.1 million. (multiple speakers)

We're talking about a market opportunity, Joe. We're not talking -- I understand that TXU has to go out and sell this to their customers, but we also know the pilot program that they ran was pretty successful. And the customers like it. So it may take a few years, but am I incorrect in assuming that this is a total addressable market of something like $200 million at TXU alone?

It's 2.1 million homes.

At $100 apiece, plus potentially a ZigBee module or two.

It's $100 apiece. If that was to drive to the high end, if they were to drive significant penetration, I would expect the average sell price to drive down from $100 probably to, maybe $60 or $70.

Okay.

If we were to see real high penetration that average sell price could drive down into the $60, $70 range.

Okay. Now, President Obama just gave a speech the other day and announced grants worth $3.9 billion to utilities. Texas Utilities wasn't listed there, but Florida Power and Light was. You must have glanced through that list. How many of those utilities -- and don't even consider the list -- how many utility companies are you aware of that your customers intend to deploy to?

There's a number of them. I don't know the number, Jay. In fact, my guy who is responsible -- my director who is responsible for this initiative is off looking at that right now, but there is a number of them.

Okay. Thank you very much.

Thanks, Jay.

Thanks, Jay.

And your next question is from the line of [Henry Glassen] with Wedbush Securities. Go ahead.

Joe, asked and answered. Thanks.

And next you have from the line of Greg Weaver with Invicta Capital.

Hi, I'm just trying to understand the opportunity a little better on the Smart Grid. Do you need a Digi gateway in a smart-meter-equipped home?

Yes, smart-meter-equipped home, an AMI implementation, you may not need our gateway. It may go in -- if you have got ZigBee communications in the meter itself, it may then go in from the meter into the home and communicate with other ZigBee devices within the home.

So of the very -- I think you said there was 10 different engagements you had currently. How many of those 10 have smart meters today?

Well of the 10, I don't have that in front of me, but there's -- we have been deploying our wireless module to metered customers, but I don't have that answer for your right now. I'll have to get that for you later.

Okay. I'll probably see (inaudible). Thanks.

Okay.

And with no further questions, I would like to turn the call back to Mr. Joe Dunsmore.

Okay. Well thank you very much. I look forward to talking to you again in three months.

Thank you.