Digi International Inc (DGII) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Fiscal Year 2010 Digi International, Inc. earnings conference call. My name is Marcella and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Brenda Mueller, Digi's Corporate Controller. Please proceed.

Thank you, Marcella. Good afternoon and thank you all for joining us today.

Before we start, I need to go over a few details. First, if you do not have a copy of our earnings release, you may access it through the Financial Releases section of our Investor Relations 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 expectations 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 2009 Annual Report on the Form 10-K 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 reconciliations to the most comparable GAAP measures, are included in the earnings release or in Form 8-K that we filed before this call. The Form 8-K can also be accessed through the SEC filing section of our Investor Relations website at www.digi.com.

Now, I would like to introduce Mr. Joe Dunsmore, Chairman, President and CEO.

Thank you, Brenda, and welcome to the call, everyone. I am pleased with our results for the quarter and the fiscal year. This is the 31st consecutive quarter of profitability for Digi.

Revenue for the quarter of $47.3 million was up 18.1% compared to the same quarter in the prior year. We were within our guidance ranges and met the street consensus for profitability at $0.09 per share, on net income of $2.2 million for the quarter.

Revenue for the year was $182.5 million, compared to $165.9 million in the prior fiscal year, an increase of 10%. Net income for the year was $8.9 million, or $0.36 per share, compared to the net income of $4.1 million or $0.16 per share in the prior fiscal year.

Wireless product revenue for fiscal 2010 increased by $10.1 million, or 18%, over fiscal 2009 and finished the year at 36.3% of total revenue.

The important news again this quarter is that we continue to see large lead customers deploying our wireless M2M solutions across our targeted vertical markets, which include the Smart Grid, fleet management and medical. And for the year, we saw a step function increase in the traction and momentum in these verticals with several key alliances and new product introductions. I will highlight a few.

Comverge announced an extension of their contract with TXU to deploy their demand response solution to 100,000 more houses. The vast majority of these deployments will be with the Digi gateway and iDigi.

In addition to the market traction we're getting with Comverge, we announced a partnership with Cooper Power Systems to provide an IP-based demand response solution, creating the next generation of demand response with the integration of the Yukon Energy Services software and iDigi.

Digi announced partnerships with energy management system providers, EcoFactor and GroundedPower, to use the Digi X-Grid solution to easily connect customers to home energy devices to their EMS applications. Digi X-Grid is an extended grid that enables real-time, IP-based monitoring and control of home energy devices beyond the electric meter.

Digi extended its partnership with Itron to provide extended grid capabilities in the form of our X2 Smart Energy gateway, our ERT-to-Ethernet Gateway, our ERT-to-Smart Energy bridge that will provide energy management services capabilities to Itron's customers.

Demonstrating the value of Digi solutions in alternative energy applications, Digi and SolarEdge Technologies announced collaboration on full connectivity solutions for PV systems, including data harvesting from revenue-grade power meters, PV inverter mesh networking and future interaction with the Smart Grid.

On the products side, Digi introduced the ConnectPort X2 for Smart Energy gateways. It is the industry's first gateway that connects, controls or gathers data from ZigBee Smart Energy devices with Smart Meter deployments. We introduced and launched the ERT-to-Ethernet Gateway and ERT-to-ZigBee bridge products, targeting Smart Grid applications for Itron customers with existing ERT meters.

This is significant in that it leverages the installed base of meters and provides an incremental migration path to the Smart Grid without immediately requiring a new Smart Meter.

We introduced the ConnectPort X Wireless M-Bus Gateway family, targeting Smart Grid applications in Europe. Targeting mobile applications like fleet management, we introduced the ConnectPort X5 family of compact, ruggedized telematics devices. This product family is the industry's first family of telematics devices to incorporate cellular, satellite, GPS, Wi-Fi and vehicle area network wireless technology in one device.

We introduced the Digi ConnectPort X3, a low-cost programmable cellular gateway for monitoring and tracking remote assets. ConnectPort X3 and all other aforementioned gateway devices, integrated with the iDigi platform, a cloud-computing service that makes it easy to remotely manage devices and integrate device information into a company's back-end systems and machine-to-machine applications.

We introduced the Digi m130, an embedded module that allows OEMs to enable their products with cellular, GPS and ORBCOMM satellite connectivity in a single solution. Ideal for fleet management and asset tracking applications, the compact Digi m130 enables remote connectivity to mobile assets via cellular or satellite networks and is the fastest way for device manufacturers to have cellular, GPS and satellite in one design.

This is all very exciting stuff. The momentum created by these alliances and new product introductions has placed us in a strong position entering fiscal 2011. We expect continued strength driven primarily by large customer opportunities for our wireless solutions. We are tracking these 2011 opportunities closely and are ushering them effectively through our sales cycle.

So in 2011, we expect to see continued high growth from our wireless products led by a focus on our key targeted verticals, Smart Grid, fleet management and medical.

As a result, we fully expect to see the first $200 million-plus year in company history in fiscal 2011. We are assuming an external environment similar to that of today of approximately 0% to 1% GDP growth in the U.S. economy. As I've mentioned in the past, we believe that our targeted verticals will be growth markets regardless of the external environment.

Our revenue guidance for fiscal 2011 is $205 million or 12% growth, with a possibility to achieve up to 18% growth, if the external environment turns more robust.

So our revenue guidance for fiscal 2011 is a range of $195 million to $215 million. These growth projections are organic and any acquisitions are assumed to be incremental. Brenda will provide more detailed financial guidance for the year and for the quarter in her portion of the comments.

Next, I'll provide a quick update on our CFO search process. We continue to make very good progress and are happy with our candidate pool. We fully expect to find an A-plus candidate for this position in a very timely manner.

So to summarize, first, Digi posted its 31st consecutive quarter profitability and posted double-digit revenue growth for both the quarter and the year. Second, we gained significant strategic partnering and new product launch momentum in fiscal 2010, and are well positioned for fiscal 2011.

Third, we continue to have significant growth momentum with our wireless products, especially in our targeted verticals. Fourth, we have provided strong organic growth guidance for fiscal 2011, despite the sluggish external environment. And fifth, the CFO search process is going very well.

Next, I'll hand it back to Brenda for her prepared remarks.

Thank you, Joe. Revenue for the fourth fiscal quarter of 2010 was $47.3 million, an increase of $7.3 million or 18.1% over fourth fiscal quarter revenue a year ago. Other highlights for the fourth fiscal quarter of 2010, all in comparison to the fourth fiscal quarter of 2009, are as follows.

Revenue in North America was $26.8 million, compared to $24.2 million a year ago, an increase of $2.6 million or 10.8%. Revenue in EMEA which is Europe, Middle East and Africa was $12.7 million, compared to $10.7 million a year ago, an increase of $2 million or 19%. Revenue in the Asia Pacific region was $6.3 million, compared to $4 million a year ago, an increase of $2.3 million or 57.5%. Revenue in Latin America was $1.5 million, compared to $1.1 million a year ago, an increase of $400,000 or 27.3%.

Revenue from embedded products was $21.9 million, compared to $18.8 million a year ago, an increase of $3.1 million or 16.2%. Revenue from non-embedded products was $25.4 million, compared to $21.2 million a year ago, an increase of $4.2 million or 19.9%.

Wireless revenue increased by $3.4 million, when compared to the same quarter in the prior year, or a 26.3% increase. Wireless revenue was $16.5 million, or 35% of total revenue, compared to $13.1 million or 32.7% of total revenue a year ago.

The gross margin was 50.8%, compared to 48.5% in the same period a year ago. The gross margin was higher in the current quarter compared to the same period a year ago, primarily due to lower manufacturing expenses and product cost reductions offsetting unfavorable product mix.

Total operating expenses were $20.6 million or 43.7% of revenue, compared to $18.3 million or 44.8% of revenue in the fourth quarter a year ago. Total operating expenses in the fourth fiscal quarter of 2010 include $300,000 of residual expenses resulting from the investigation. And a benefit of $100,000 resulting from a reversal of the restructuring reserve, since expenses associated with the plan were less than expected.

Total operating expenses increased by $2.1 million, excluding the aforementioned items primarily due to a partial reinstatement for fiscal 2010 of the incentive compensation program, which had been eliminated in fiscal 2009, increased commission expenses relating to the increase in revenue, and consulting and professional services fees.

Net income increased by $1.2 million compared to the same quarter in the prior year. Net income was $2.2 million, or $0.09 per diluted share, compared to net income of $1 million, or $0.04 per diluted share, in the same quarter a year ago.

Non-GAAP net income and non-GAAP net income per diluted share were $2.4 million, or $0.09 per diluted share, which excludes residual investigation expenses of $200,000 net of taxes, or $0.01 per diluted share, and a reversal of restructuring expenses and a discrete tax benefit from reversals of tax reserves which together totaled $100,000 and had no earnings per share impact.

Non-GAAP net income and non-GAAP net income per diluted share for the fourth quarter of fiscal 2009 was $700,000, or $0.03 per diluted share, which excludes the reversal of tax reserve of $300,000 or $0.01 per share. Please refer to the reconciliation table in the earnings release which reconciles our operating income and net income and 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 2010 was 36.5%, compared to an effective tax rate of negative 7.3% in the year ago comparable quarter. The effective tax rate for the fourth quarter of fiscal 2009 included a discrete benefit realized as a result of the reversal of $300,000 in tax reserves due to the closure of certain domestic and foreign tax years.

For the full fiscal year 2010, Digi's effective tax rate was 15%, compared to an effective tax rate of 4.6% for fiscal 2009. The effective tax rate was higher in fiscal 2010 than fiscal 2009 due to a higher U.S. statutory tax rate and less R&D credits, due to the expiration of the U.S. R&D credit as of December 31, 2009, partially offset by higher discrete tax benefits compared to the prior fiscal year.

Moving to our annual fiscal 2010 performance, all in comparison to our annual numbers for fiscal 2009, Digi reported revenue of $182.5 million, compared to $165.9 million, an increase of $16.6 million or 10%. Other highlights for fiscal 2010, compared to fiscal 2009, include the following. Revenue from imbedded products was $82.4 million, compared to $74.7 million in fiscal 2009, an increase of $7.7 million or 10.4%.

Revenue from non-embedded products was $100.1 million, compared to $91.2 million in fiscal 2009, an increase of $8.9 million or 9.7%. Wireless revenues increased by $10.1 million, or 18%, compared to fiscal 2009. Wireless revenue was $66.4 million or 36.3% of total revenue, compared to $56.2 million during fiscal 2009 or 33.9% of total revenue.

Net income increased by $4.9 million in 2010, compared to a year ago. For fiscal 2010, Digi reported net income of $8.9 million, or $0.36 per diluted share, compared to a net income for the prior year of $4.1 million, or $0.16 per diluted share.

Non-GAAP net income increased by $2.4 million for fiscal 2010, compared to fiscal 2009. Non-GAAP net income was $7.2 million, or $0.29 per diluted share, compared to $4.8 million, or $0.19 per diluted share, in the prior year.

For fiscal 2010, net income was reduced by $900,000 net of taxes, or $0.04 per diluted share, as a result of the investigation expenses.net income benefited by $300,000 net of taxes or $0.01 per share due to a reduction of the restructuring reserve. Net income benefited by $2.3 million or $0.09 per diluted share as a result of reversal of tax reserves and other discrete tax benefits.

For fiscal 2009, net income was reduced by a charge for the restructuring reserve of $1.9million, or $0.07 per diluted share, and benefited by $1.2 million, or $0.05 per diluted share, as a result of the reversal of tax reserve and other discrete tax benefits.

Diluted weighted average shares outstanding at the end of the quarter were 25,248,001 shares compared to the previous quarter of 25,271,893 shares, a decrease of 23,892 shares.

Turning to the balance sheet and cash flow statements, our combined cash and cash equivalents in marketable securities balance was $87.6 million as of September 30, 2010, increasing by $5.1 million over the cash and cash equivalent and marketable securities balance including long-term marketable securities at the end of the prior quarter, and by $11.8 million from the end of the prior fiscal year.

Net cash provided by operating activities was $16.1 million and $15.7 million for fiscal years 2010 and 2009 respectively. Our current ratio is 6.7-to-1 and we have no long-term debt. Our DSO is at 37 days compared to 38 days in the previous quarter.

Now, I would like to provide some guidance for fiscal 2011. Digi projects revenue to be in a range of $46 million to $49 million for the first fiscal quarter of 2011 and net income per diluted share in a range of $0.04 to $0.08.

For the full fiscal year 2011, Digi projects revenue in a range of $195 million to $215 million or an increase of 6.8% to 17.8% over fiscal year 2010. We expect most likely revenue of $205 million, an increase of 12.3% over fiscal 2010 revenue.

Gross margin as a percent of revenue is expected to be approximately 50%, including the amortization of purchased and core technology of approximately 2.1%.

We are projecting operating expenses to be approximately 41% to 45% of revenue. Operating expenses include our expectation for a full incentive compensation payout in fiscal 2011.

Operating income as a percent of revenue is projected to be in a range of 5% to 9%. Our effective tax rate is projected to be approximately 33% to 37%. We anticipate that earnings per diluted share will be in a range of $0.28 to $0.52.

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

(Operator Instructions) And your first question comes from the line of Tavis McCourt with Morgan Keegan. Please proceed.

Hi, Joe and Brenda, and congratulations on a good quarter and a good year. A couple of questions on the details. It looked like, in this quarter specifically, the wireless revenues were down a little bit sequentially and the North America revenues were down sequentially. Was there anything kind of unique happening in either of those two numbers, or is that just kind of the rhythm of the business?

Well, I guess it's probably a little bit of the rhythm of the business. Fundamentally, we had good year-over-year growth and really good sequential growth from a good part of our wireless product line.

MaxStream, we had a strong year-over-year growth. But sequentially, MaxStream was down a bit. And what we saw there -- we've seen consistent growth for MaxStream over the last eight quarters. And last quarter, we had a little bit of positive lumpy demand that helped us, and actually we saw, in Q3, positive lumpy demand. And then in Q4, we saw a few of our larger customers delaying a little bit. And we fully expect that to bounce back this quarter.

So if you look at the trend line, the trend line will continue to be positive, impacted at times by lumpy demand that may be like what we saw in Q3.

And then in terms of North America being down sequentially, was there anything unique there, although I recognize that year-over-year was still up quite nicely?

No, nothing unique there. I think what we saw was -- maybe one dynamic was things have been very, very robust over the last few quarters. And I'd say in mid-quarter, especially in North America, with the GDP pause that we saw, I'd say that there were probably a few customers that felt like they maybe over-ordered a little bit, and we saw a few of our customers push out a little bit.

But I just see that as kind of a minor tweaking of demand with them. And with me, those customers were seeing that pickup again this quarter.

What are you seeing in your kind of the two-tiered distribution channel for some of your products? Have you seen that demand continue to be robust, or have you seen that start to pause at all?

Generally speaking, we're seeing what I mentioned last quarter. While overall we were up sequentially and significantly up year-over-year, I'd say that the dynamic that we saw with a few customers was a pause and maybe a little bit of a push-out that instead of taking the number that we thought that they're going to take maybe they would take half of what we thought that they were going to take.

So we saw a number of customers in North America that tweaked down a little bit, but then like I said, this quarter we're starting to see that come back. At this point, I would just characterize it as a minor pause and minor inventory adjustment, and things at this point look really robust.

Okay. And then you mentioned the gross margin, although it was good overall, I think you said it was negatively impacted by mix. What was the -- what kind of mix has a negative gross margin for you -- negative gross margin impact?

Well, as we continue to see the migration towards wireless, the wireless gross margins are, as a group, slightly less than what we see from the wireline side. So I think the mix dynamic that we are dealing with is as we drive growth on the wireless side, you're going to see a little bit of pressure on that gross margin line, that we're going to come back with driving cost reductions, driving the solutions focus, which we think over time with iDigi and the solutions approach we'll be able to drive value and drive gross margin improvement, and then certainly driving manufacturing efficiencies, et cetera.

So the product mix dynamic is back.

Got you. And then last question kind of related to the cash balance. It was another good quarter of cash generation. First a question. Is there any amount of that cash that's offshore and somewhat encumbered or is all of it usable? And then if you could talk about the M&A strategy, is that on hold until a CFO is hired, and do you still have an appetite for doing acquisitions like you have in the past?

Okay. So I'll answer the M&A and then I'll pass to Brenda. M&A strategy is not on hold. We haven't seen a pause or any reduced energy there whatsoever. We've continued to keep the fire lit under that. We continue to drive and look for acquisitions very aggressively.

So that momentum has certainly continued and it will continue into the future, really focusing in on how we can drive into market adjacencies to drive more significant value proposition in some of these vertical markets that we're going after. So we'll continue that focus going forward.

And to answer your question regarding the cash balances, the cash balances are primarily here in the U.S. We do have a little bit of cash internationally that are used by the businesses there in their operations. But the vast majority of the cash is here in the U.S.

Right. Thanks a lot.

(Operator Instructions) And your next question comes from the line of Jeff Evanson with Dougherty.

Good afternoon, everybody.

Hey, Jeff.

Joe, I was wondering if you or Brenda could speak to the EPS range on the guidance. It's really, actually, maybe not as dramatic as it appears on the surface, and you've done this before and done well. But I guess what I'd like you to do is speak to some of the variability that you're planning there, outside of revenue impact. Is it mix shift or is there some flexibility on the expense side or what would you attribute that to?

Yes, so I'd say 80% of it has to do with our compensation strategy. We've got a lot of variable compensation, Jeff. As you know, half of my total compensation is variable, and it's that way with most of the executives. And we drive a performance-based variable compensation strategy throughout the organization.

So on the low end of the guidance, there is an assumption that you won't pay out much or you'll pay out a little bit, and at the high end, you'll pay out quite a bit. So the variability there on the compensation piece is huge. It's a really significant piece, and that accounts for probably 80% to 90% of it.

I mean that's quite dramatic. I guess what you're telling me is you did the bottom end of your revenue, but you also hit all of your non-income and revenue-related benchmarks, got your near max bonus, that would account for 80% of the differential in the operating income. Is that right?

What I'm saying is it creates a whole lot of variability. And really it's a good thing, Jeff, because we have the opportunity, if we come in under our target numbers, to save on the expense side as a result of that strategy.

Okay. Thank you.

Your next question comes from the line of Ross Strehlow with RBC Wealth Management. Please proceed.

Hello, How are you?

Hey, Ross.

When I go back a couple of years and before the economy basically stopped, I recall at that point, you guys were really doing quite well. Your bookings were strong. You had a wonderful quarter. And this -- you wrote about how this machine-to-machine networking area was really now starting to come into its own. And I just wanted to ask you if you could take a look at that big picture for that M2M space.

I mean I know that that slowed it down. But how is -- where are we right now, because you've got -- and is there any other vertical markets that are starting to open up other than the three that you mentioned. If you could just talk a little bit about that big picture for M2M and where that's really at, that'd be great.

Yes, so we think the big picture is really a robust opportunity for us. Like I think I wrote probably about a year-and-a-half ago or so, I thought we were at the tipping point and that we're really going to begin to see that market begin to grow. We've since had to fight through the 2009 debacle with the credit crisis, et cetera.

However, through that downturn, what you saw with us was our wireless products were growing at 20% to 30%. And I think that that's reflective of a very strong market opportunity.

I think we're at the -- in the first inning of a nine-inning ball game. This is a long-term growth opportunity, and it's -- in order to comment more specifically about it, it's really a bunch of vertical markets that, across those verticals, you have this wireless M2M opportunity. So there is a significant wireless M2M opportunity in the Smart Grid space. I've talked in length about the demand response in EMS applications.

Again, we're in the first inning there. We're seeing the federal government push with regulatory changes and investment to drive that. And we're now in pilot mode as an industry, and we'll start to see that move more into production mode within the next couple of years. So we think that's a great opportunity, and we're seeing really, really high growth within that market.

We're seeing opportunity -- significant opportunity within fleet management, with our innovative products that I talked about, the X3 and X5. We're seeing really strong opportunity for our wireless LAN-enabling medical equipment, diagnostic equipment. We think we're in the beginning stages of that.

Other verticals that we're seeing begin to develop, one that's a really interesting one for us is in the quick-serve restaurant arena where we're seeing a lot more interest in automating. There are some interesting applications to make the quick-serve restaurant environment more efficient. And so we're seeing some opportunity there. And we're seeing opportunity in other micro-verticals.

So I'd say that as I've talked about the last two quarters seeing the robust bookings, I'd say that this market is well on its way. It is the first inning. So it's early. But we're beginning to see that momentum.

Okay. That's great. Thanks, Joe.

Thanks, Ross.

At this time, we have no more questions, and I would like to turn the conference back over to Mr. Joe Dunsmore for closing remarks. Please proceed, sir.

Well, as you can tell by my comments on the strategic alliances and the new products that we put in place in 2010, we are real excited about the future and about 2011. And we think it's a great time to be in this market, in this wireless M2M space, and we think we're very well positioned and looking forward to a great year in 2011. So I look forward to talking to you again in three months.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.