Digi International Inc (DGII) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter Digi International Inc. earnings conference call. My name is Laura 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 today's conference. (Operator Instructions).

As a reminder, this call is being recorded for replay purposes. I will now turn the presentation over to your host for today, Steve Snyder, Chief Financial Officer. Please proceed.

Thank you, Laura. Good afternoon and thank you for joining us today. Before we start, I need to go over a few details.

First, if you do not have a copy of our earnings release, you may access it through the 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 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 2010 Annual Report Form 10K 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 reconciliations to the most comparable GAAP measures, are included in the earnings release or in 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.Digi.com.

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

Thank you, Steve, and welcome to the call, everyone.

I am very pleased with our results for the quarter. This is the 32nd consecutive quarter of profitability for Digi. Revenue for the quarter of $48.3 million was up 12.5% compared to the same quarter in the prior year, and 2.3% sequentially. Wireless product revenue for fiscal Q1 was $20.2 million, increasing 33.5% compared to the same quarter in the prior year, and was 41.8% of our total revenue.

Net income was $2.3 million or $0.09 per diluted share for the quarter compared to $1.2 million or $0.05 per diluted share in the year ago comparable quarter, an increase of $1.1 million. Steve will provide a non-GAAP breakdown of this in a few minutes.

Revenue and profitability increases are very positive trends. The profitability increase is especially significant since we are absorbing a much higher compensation expense this year.

In fiscal 2011, we have set our bonus targets to pay out 100% for [plan] achievement, up from a 50% payout target in fiscal 2010. Bookings were strong in the quarter, up slightly sequentially over bookings in 4Q, 2010.

The important use this quarter is that we continue to see large lead customers accelerating their deployment of our wireless M2M solutions across our targeted vertical markets. In fact, wireless growth in our targeted verticals is a key internal metric and we significantly exceeded our objective for the quarter. Large customers are ramping revenue and we are seeing sales pipeline increase across several segments.

In the Fleet management arena, we continued shipments to XATA and we expect revenue to continue to grow nicely over the coming quarters. Additionally, we received and shipped a very large order from another Fleet customer in the quarter.

Our momentum in medical applications continued, especially with major customers in bedside connectivity and Embedded medical device connectivity applications. In particular, a major customer recently added in the bedside connectivity space is ramping strongly.

In the Embedded space, we are providing wireless connectivity devices such as infusion pumps, fetal heart rate monitors and patient monitoring devices, to name a few. In fact, this quarter we received one of our largest purchase orders ever from one of our customers in this space for a multi-year deployment. We expect to begin shipments on this order in fiscal fourth quarter of this year.

Tank monitoring customers continue to ramp their deployments this quarter. Additionally we are seeing sales pipeline growth in several other application areas, including irrigation control systems and quick service restaurants, to name a couple.

The Smart Grid opportunity is the vertical of the greatest focus and investment for Digi. We continue to believe that Digi is a natural partner for key players in the demand response, AMR, AMI, energy management systems and alternative energy markets. I have spoken in the past about our partnering with a number of key players, including Comverge, Cooper Power, Eco Factor, Itron, and others. We had a very eventful quarter with the introduction of our ERT Gateway and ERT/Smart Energy Bridge at the Itron Users Conference in October.

ERTs are a form of radio module deployed today in tens of millions of the Itron electric, gas, and water meters in the US. ERTs are widely in use in AMR applications where someone typically drives around a community in a vehicle with ERT meter reading capabilities. Our ERT Gateways provide immediate any-time access to meter information, allowing these meters to instantly enable a smarter grid.

We have seen a lot of excitement around these announcements from the Itron sales team and many of their customers. These products continue to enhance Digi's credibility as a partner that is aggressively driving implementation of solutions that provide Smart Grid capabilities now. This strategy is really resonating with our natural partners in this space. In fact, if you want to get a clear view of our solutions in partnering traction in this space, I encourage you to attend the DistribuTECH Conference in San Diego in early February, where we will be highlighting our solutions that provide Smart Grid now capability.

Steve will provide a more detailed guidance, but needless to say, I am encouraged with the clarity that we are gaining in the remainder of 2011. The anticipated ramp is supported by several large deals that have planned ramps in the second half of the year as well as an expected continued strengthening of small and medium-sized deals through the channel.

As importantly, I believe that our long-term trajectory is strong and getting stronger.

So to summarize, first, Digi posted its 32nd consecutive quarter of profitability. Second, we have significant growth momentum with our wireless products and especially in our targeted verticals. And third, we remain bullish about our annual guidance and long-term future.

Next, I will hand it back to Steve for his prepared remarks.

Thank you, Joe.

Revenue for the first fiscal quarter of 2011 was $48.3 million, an increase of $5.3 million or 12.5% over first fiscal quarter revenue a year ago. Revenue increased sequentially from the fourth fiscal quarter of 2010 to the first fiscal quarter of 2011 by $1.1 million or 2.3%. Revenue in North America was $27.7 million in the first quarter of 2011 compared to $25.5 million in the comparable quarter last year, an increase of $2.2 million or 8.7%.

International revenue was $20.6 million or 42.6% of total revenue in the first fiscal quarter of fiscal 2011 compared to $17.4 million or 40.6% of total revenue in the year ago comparable quarter. International revenue increased by $3.2 million or 18% during these comparable quarters.

Revenue in EMEA, which is Europe, Middle East and Africa, was $12.7 million in the first fiscal quarter 2011 compared to $11 million in the comparable quarter a year ago, an increase of $1.7 million or 15%. Revenue in Latin America was $1.8 million in the first fiscal quarter of 2011, compared to $1.1 million in the comparable quarter last year, an increase of $0.7 million or 62.6%.

Revenue in the Asia region was $6.1 million in the first fiscal quarter of 2011, compared to $5.4 million in the first fiscal quarter of 2010, an increase of $0.7 million or 15.1%.

Revenue from embedded products in the first fiscal quarter of 2011 was $21.1 million compared to $18.1 million in the first fiscal quarter of 2010, an increase of $3 million or 16.8%. Revenue from non-embedded products was $27.2 million in the first fiscal quarter of 2011 compared to $24.9 million in the first fiscal quarter 2010, an increase of $2.3 million or 9.3%.

Wireless revenue was $20.2 million or 41.8% of total revenue in the first fiscal quarter of 2011, compared to $15.1 million or 35.2% of total revenue in the first fiscal quarter of 2010. Wireless revenue increased by $5.1 million or 33.5% during these comparable quarters.

Net sales in the first fiscal quarter of 2011 were unfavorably impacted by foreign currency translation of $0.5 million when compared to the same period in the prior fiscal year, resulting from the strengthening of the US dollar compared to the euro and UK pound.

The gross margin was 51.0% in the first fiscal quarter of 2011 compared to 50.5% in the first fiscal quarter of 2010. The gross margin was higher in the first fiscal quarter of 2011 than in the comparable period a year ago, primarily due to customer mix as well as product cost reductions and manufacturing efficiencies.

Total operating expenses for the first fiscal quarter of 2011 were $22 million or 45.5% of revenue compared to $19.9 million or 46.2% of revenue in the first fiscal quarter of 2010. Operating expenses increased $2.1 million in the first fiscal quarter of 2011 compared to the prior year comparable quarter from primarily due to increased investment in the iDigi Platform, increased headcount and the reinstatement of the full incentive compensation program that had only been partially reinstated in the prior fiscal year.

Total operating expenses increased sequentially $1.4 million in the first fiscal quarter of fiscal '11 compared to the fourth quarter of fiscal 2010. Slightly over 60% of the increase relates to the full restoration of the incentive compensation plan in fiscal 2011. The remaining increase in operating expenses results from additional investment in R&D and higher expenses in sales and marketing.

Net income for the first fiscal quarter of 2011 was $2.3 million or $0.09 per diluted share compared to net income of $1.2 million or $0.05 per diluted share in the first fiscal quarter of 2010. Earnings per diluted share in the first fiscal quarter of 2011 include a discrete tax benefit of $0.6 million or $0.02 per diluted share, resulting from the reversal of tax reserves for various jurisdictions, tax matters as well as the discrete tax benefit resulting from the enactment of legislation extending in the research and development tax credit that allowed Digi to record tax credits earned during the last three quarters of fiscal 2010 in the first fiscal quarter of 2011.

Digi's effective tax rate for the first fiscal quarter of 2011 was 13.7% compared to an effective tax rate of 34.6% in the first fiscal quarter of 2010. The effective tax rate for the first fiscal quarter of 2011 included the aforementioned discrete tax benefit of $0.6 million which reduced the effective rate by 21.4 percentage points.

Diluted weighted average shares outstanding at the end of the quarter were 25,445,139 compared to the previous quarter of 25,248,001 shares, an increase of 197,138 shares.

Turning to the balance sheet and cash flow statements, our combined cash and cash equivalents and marketable securities balance was $91.6 million as of December 1, 2010, increasing by $4 million from the end of the prior fiscal year.

Net cash provided by operating activities for the quarter was $4.7 million. Our current ratio is 6.5 to 1 compared to a current ratio of 6.7 to 1 at the end of the prior fiscal year. Our DSO is at 38 days compared to 37 days in the previous quarter.

Now, I'd like to provide some guidance for the second fiscal quarter of 2011.

Digi projects revenue to be in a range of $47.5 million to $50.5 million for the second fiscal quarter of 2011. We expect the total operating expenses for the second fiscal quarter of 2011 will be approximately flat the first fiscal quarter of 2011. We expect net income per fully diluted shares in a range of $0.06 to $0.10.

For the full fiscal year 2011, we expect that gross margin will be approximately 50.0% to 51.0%. We anticipate operating expenses will be approximately 41.5% to 45.5% of revenue. Digi expects its effective tax rate for the full fiscal year 2011 to be in a range of 30% to 33%. We are maintaining our previously announced annual guidance for revenue in a range of $195 million to $215 million and fully diluted earnings per share in a range of $0.28 to $0.52.

At this time, I would like to open the call to questions. Operator?

(Operator Instructions). Travis McCourt.

Hi, this is Tavis. So, I guess -- Steven, I wonder if you could give us kind of your quick background and kind of what excited you about the Digi opportunity. That would be pretty helpful.

And then, Joe, I think my major question is obviously the wireless part of the business seems to be doing real well. What can you tell us about the wireline part of the business? Is that something that you would still expect to be able to hold relatively flat? Or how are you managing that side of the business? That would be helpful. Thanks.

Sure. I'll go ahead and start, Tavis. Thanks.

My background is I started in public accounting with KPMG. I spent the majority of my career in computer hardware companies, largely big iron shops. Also did a stint with Ancor Communications where we worked with some of your colleagues, which was a storage networking company. We made fiber channel switches for the storage networking industry. So I've been around computer hardware most of my career.

What really interested me in Digi was seeing the transformation that Joe had taken with the Company where he took it from a serial card, serial port-oriented company into a wireless arena and done that very successfully and maintained profitability while doing it, which I found pretty impressive. What I liked also about the Company is the recognition that we need to go beyond just being a hardware supplier and layer on additional service and platform offerings like he is doing with the iDigi Platform.

So I see an opportunity here for a lot of growth and I think we are on a pretty good path to make that happen.

So, on your question on the wireline side of the business, we have got two buckets. One bucket is the [ASIC] and terminal server bucket which is product lines that are on the mature side; and what we've said about that is that the ASIC will continue its decline somewhere in the probably 10% to 20% kind of ballpark on an annual basis.

Terminal server is probably in the same kind of ballpark, maybe a little bit less, maybe 5% to 10%. But could vary from that upward and downward on a quarterly basis, based on lumpy demand and that kind of thing.

Then the other category would be group of wireline products that are still growth market. So the device server fees, the Rabbit module fees, some of the Digi modules would fit into that category, where I would say that in a normal market, you would typically see them in kind of a 5% to 10% kind of growth category.

Now, if you look at the entire mix and how those ballots out, you could probably conclude that it's going to be flat to slightly up on an annual basis, if you look at the combination of all of the ASIC and terminal server products and the growth products that we have with device servers, etc.

What we expect to do is to continue to drive that growth side of the curve with our wireless products and our growth wireline products. So that continues to become a higher and higher percentage. The mix is [probably] for all growth versus matures in the neighborhood of 70/30 right now.

That's very helpful. Thanks a lot.

Matthew Kempler.

The first question on the wireless side, 34% growth and broke through the $20 million barrier for the first time. Is this more about the m10 deployments breaking through to that next level? Or was there some one-time large orders that influenced this quarter?

It's a combination. We saw a couple of good one-time orders, so we saw some real positive lumpy demand that were one-time. And we saw good progression with our existing customers that we have, that are ramping up in the targeted verticals and smart energy fleet. You know, medical and tank monitoring. So we actually saw both.

We do have a pipeline that's building both for the big solutions play that might be a multi-year deployment, and we do have a number of customers out there that might be deploying over a quarter or two. So we expect over time to see more of those so maybe they don't appear as lumpy as we have seen in the past.

And then on the Itron Comverge news, could you give us a little more specifics about what -- how this deal -- how this announcement proceeds? Is this now a matter of going to each of the utilities and then they agree to deployments and then you get commitments for deployments? Or does Itron and Comverge already have a schedule of what is expected?

So what we did was we went to the Itron sales conference, and I think we were the highest activity booth there in terms of interest with our program, extending their capabilities with our ERT gateways. There was a lot of excitement.

There was especially a lot of excitement with the Itron sales team who we trained at that conference. So we saw a lot of energy, a lot of excitement. We're in a mode right now where that sales team is now out calling on their customers, driving this solution. We are doing joint calls with their customers.

And beyond that, we're working on deepening the relationship beyond a co-marketing relationship. We've got several bids already out there, proposals with customers already out there as a result of this activity. So we are really excited about the momentum that we are seeing here.

And the key aspect of this is, this is really helping to deploy Smart Grid capability now in the AMR world. So if you think about it for the most part, the world deployment of meters is the 95% plus AMR and not AMI. And AMI is being deployed very slowly. What we do at the gateway is we now enable a suite of Smart Grid kinds of capabilities to be enabled with our ERT gateway, taking information from the meter, taking information from Smart Thermostat, other devices, publishing it to applications like our partner Google with Google Power Meter, other applications like our iPhone app and other partners.

So it's a very compelling value proposition.

Okay. And then on the international front, it seems like that has been leading growth in the past couple of quarters. Is this headway with some specific larger customers overseas? Or something we just -- North America, I know we talked about on the last call on the inventory buildup that had to be worked through. Can you just elaborate there?

Yes, I'd say that where we are seeing some really good growth recently is in Latin America. And I would say that Latin America is a result of some really strong focus from Digi bolstering the sales team and really driving activity down there. So I would say that's execution-related.

Japan, we are seeing a lot of growth. So historically, Japan wasn't a high-growth market. We are seeing that come back and that's a result of some changes we made over there, distribution partner changes that we made over there and then some strategic changes in terms of the types of customers that we are targeting. And we are getting traction with that.

And beyond that, we are seeing, I would say pretty typical, positive activity in EMEA and in APAC. If you look across all regions, Latin America, EMEA, APAC, Japan, and North America, all regions grew year over year.

Okay and is it typically the same end markets? You know, when you talk about the four key markets you are targeting, are they the same overseas as they are in North America?

In general, we are targeting the same vertical market. So if you look at the wireline point product business internationally, which is a big part of what we do internationally. We are targeting all of the same verticals that we have traditionally targeted in the US. And then as you look at the wireless opportunity and the wireless solutions, we are targeting the same kinds of solutions there with a big focus on Smart Energy.

In particular, one of the areas -- emerging market areas where we are seeing a lot of opportunity with Smart Energy, a big part of it is a result of the presence we now have there is in India, as a result of the acquisition of MobiApps and the presence we have. We are seeing some real strong, early momentum, pipeline momentum, customer momentum in the Smart Energy space.

Okay. Thank you very much.

(Operator Instructions). Ross Strehlow.

You mentioned in your opening comments about your sales pipeline is starting to grow. And then you didn't talk too much about that in detail. Could you provide a little bit more color on that?

Well, I would say overall if you look at six months ago to now, our overall sales pipeline is up for the Company. You know, we track our -- what we have in our CRM in terms of deals that are 25%, which are qualified deals or not. That is up fairly significantly over the last six months. And then if you look at the Wireless Solutions fees, that is up significantly. And if you look at bookings last quarter, bookings are up over the previous quarter.

And so in general, what we are seeing is a positive momentum. Beyond that, I would say that one of the nice things that is starting to happen is with a lot of these large deals, what we are getting -- they are, first of all they are big deals.

Secondly, we are getting big purchase orders that we are able to get visibility to the scheduled ramp over time. So that is providing us with a little bit more visibility now over time, extending out for two or three quarters with these large customers than we've had in the past before we went down this Wireless Solutions path.

So that is one of the nice benefits of some of these large opportunities, is the increased visibility.

Is that why you made the comment that you are anticipating a ramp in the second half of the year?

Two reasons, Ross. One is, I'm feeling like today, and at least for the rest of the fiscal year, that the economy is feeling better. It is feeling like we have got some good positive momentum. And whenever we see that kind of broader economic activity and behavior, what that means is positive momentum for our small and medium-sized deals that flow through the channel. So we would expect if that continues, if that momentum continues, we will see a base level of activity that will ramp naturally through the fiscal year.

On top of that, that is exactly what I am saying. We have got a number of large deals where we have the purchase order in. We have got the orders schedule and we see, with a number of large customers, what their ramp is going to be.

Okay. That's great, Joe. Thanks very much. That's all for me.

Tavis McCourt.

Just a quick follow-up. It looks like the cash position is now back up to its highest level. I think at least since 2007. How should we think about your appetite for M&A in terms of technology or geographic needs that you would have and your willingness to do deals? Or do you think you have enough on your plate executing, especially with looks like some of the Smart Grid stuff is starting to come to fruition?

Good question. Our attitude towards acquisition hasn't changed. We continue to look and analyze the market place. We continue to scan the marketplace for opportunities that are maybe adjacent to where we are. Where if we can pick up an adjacent technology, combine it with what we're doing, we might be able to drive into additional addressable market and much more significant share. So if we can find especially in the Smart Energy space, those kinds of opportunities, we are going to pursue them.

Great. Thanks a lot.

Matthew Kempler.

I also have a couple of follow-ups. First on the incentive comp. Did you say that was 60% of the year-over-year increase in total OpEx?

It is about 60% of the sequential quarter increase.

And then are you accruing for incentive comp steadily on a quarter-by-quarter basis or will that actually climb as the year progresses if you are hitting your targets?

We accrue on a quarterly basis.

And then on the gross margins, it looks like we're moving back towards historic levels. Part of that was customer mix, you said. What is the mix that's affecting business favorably?

Okay. So, let me give some perspective on a background perspective on gross margin and then we can talk about going forward. If you look at what has happened over the last couple of years from early '09, our gross margins were 47.8%. And we have grown it up into the mid-50, 50.5%, 50.8% and now 51%.

This last quarter, we benefited from a significant large deal that was high gross margin which provided a nice little bump above, let's say the 50.7%, 50.8% position that we were in.

Going forward, we are going to be affected as we have historically but on a quarterly basis by how that mix comes out. And so that makes -- that provides a little bit of variability as far as what we see in a particular quarter.

In general, however, we are going to continue to do what we have been doing. We are going to continue to drive hard on looking at opportunities to reduce costs with products. We are going to look at operational efficiencies. We are going to look at a whole host of things in order to do everything we can to continue to drive that positive historic trend that we have driven over the last couple of years.

Having said that, we gave you a range of 50% to 51% and midpoint of 50.5%. I think that's a reasonable conservative range. But we are going to continue to see what we can do to drive towards the high end of that.

Okay. Thank you very much.

There are no further questions at this time. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.