Digi International Inc (DGII) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2012 Digi International Incorporated earnings conference call. My name is Melanie and I'll be your coordinator today. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, today's call will be recorded. I would now like to turn the call over to Mr Steven Snyder, Chief Financial Officer. Please proceed.

Good afternoon and thank you for joining us today. Before we start, I need to go over a few details. First, if you do not have a copy of our earnings release, you may access it through the Financial Releases section of our Investor 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 earning release today, and under the heading, Risk Factors in our 2011 annual report on 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 other financial information disclosed on this call includes non-GAAP measures. The information requires 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, Steve, and welcome to the call, everyone. I am very pleased with our efforts this quarter to deal with the impact of the Thailand flooding on our operations. The flooding impact began early in the quarter and shut down one of our contract manufacturers where we had expected almost 0.25 of our production for the quarter. Our contract manufacturer and the Digi team proactively recovered test equipment and inventory from the second floor of the flooded facilities, and worked very expeditiously to restart manufacturing at another location. This literally included the use of small boats to be able to get in, recover and transport these items out of the flooded facility. Digi was the first customer of this contract manufacturer to restart operations producing product volumes at the recovery location. Additionally, we were able to mitigate the financial impact by aggressively moving some of our lost capacity to other contract manufacturers in Digi's Minnesota facility. This took an incredible effort by the Digi team. The ultimate result is that we have been able to achieve our 36th consecutive quarter of profitability despite this major adversity.

Revenue for quarter of $46.7 million was within the guidance range that we provided, since we expected $2 million to $6 million negative impact in the quarter due to Thailand flooding. We believe that the actual negative impact of the flooding was about $3 million. Our profitability for the quarter was $0.03 per share which was within our guidance range of $0 to $0.05 per share and bolstered by a better than expected 52.4% gross margin. We achieved this gross margin level while absorbing added costs of moving inventory, test equipment and moving production out of the flooded facilities. Wireless revenue was 42.5% for the quarter and was disproportionately impacted by the flooding. We believe that most of the negative impact of the flooding has been absorbed in fiscal Q1.

Overall demand during the quarter was good, but slightly weaker than expected due to general European market weakness and some vertical market weakness. It appears that most European economies have fallen into a recession and we expect weakness and uncertainty to continue throughout the fiscal year. We've seen a pause in some of our targeted verticals, but expect them to strengthen next quarter, the current quarter and in the second half, but not quite to the ramp levels expected at the beginning of the year. So, we expect a strong sequential growth in fiscal Q2 fueled by recovery from the flooding event, and continued growth in the second half of the year. Steve will provide those details in his prepared comments.

Next, I would like to make a few comments on the overall market opportunity for Digi. First, I'm going to forcefully reiterate, the Company has never been better positioned in the marketplace than we are today. As we ramp the wireless M2M space, I have frequently commented that we will encounter lumpiness where some quarters will benefit and others will not. This lumpiness will continue; however, the overall annual trend of growth and especially strong wireless growth will continue. I have spoken at length over the past several quarters about the wireless vertical focus that we've had on smart energy, fleet, tank and medical. I've talked about the traction that we are getting in these verticals and the strong market position that we've established and the momentum that we are creating. In fact, we believe that we've established a leadership position with our solutions approach leveraging our broad array of wireless products and services.

At the core of this strategy is the iDigi device cloud. I've talked about the coming inflection point and what we at Digi are now calling the Internet of Anything. This reflects our solution strategy focus on connecting anything, anywhere, to any application anywhere. The really cool thing is that we have seen a significant increase in partnership activities with key ecosystem players in the past few months. This has strongly reinforced my beliefs on the coming inflection points and Digi's strong position in this ecosystem. While I still cannot predict the precise timing of the inflection point and when that curve starts to bend upwards, but I am more convinced than ever that the Internet of Anything inflection point is rapidly approaching. So to summarize, first Digi posted it's 36th consecutive quarter of profitability despite the impacts from Thailand's flooding and operations. Second, we expect good sequential recovery in second fiscal quarter. Third, we continue to have significant growth momentum with our wireless solutions and we feel that we are very well positioned as we approach the Internet of Anything inflection point. Next, I'll hand it back to Steve for his prepared comments.

Thank you, Joe. Revenue for the first fiscal quarter of 2012 was $46.7 million, a decrease of $1.6 million or 3.5% over first fiscal quarter revenue a year ago. Revenue was reduced by approximately $3 million as a result of the flooding in Thailand and the resulting impact to our contract manufacturer in Bangkok, resulting in a reduction of earnings per diluted share of approximately $0.05. Revenue in North America was $27.8 million in both the first fiscal quarters of 2012 and 2011. International revenue was $18.9 million, or 40.5% of total revenue in the first fiscal quarter of 2012 compared to $20.5 million or 42.6% of total revenue in the year ago comparable quarter. Revenue from embedded products in the first fiscal quarter 2012 was $21.8 million compared to $21.1 million in the first fiscal quarter of 2011, an increase of $700,000 or 3.4%. Revenue from non-embedded products was $24.9 million in the first fiscal quarter of 2012, compared to $27.2 million in the first fiscal quarter of 2011, a decrease of $2.3 million or 8.8%. Wireless revenue was $19.8 million, or 42.5% of total revenue in the first fiscal quarter of 2012, compared to $20.2 million or 41.8% of total revenue in the first fiscal quarter of 2011.

Gross profit was $24.4 million in the first fiscal quarter of 2012, compared to $24.7 million in the same period a year ago. Gross profit was reduced in the first fiscal quarter of 2012 by approximately $1.9 million as a result of the Thailand flooding, of which approximately $300,000 was for out-of-pocket expenses incurred. The gross margin was 52.4% in the first fiscal quarter of 2012 compared to 51.0% in the first fiscal quarter of 2011, and was higher than in the comparable period a year ago, primarily due to product cost reductions, manufacturing efficiencies and reduced amortization of purchased and core technology. The gross margin reflects an impact of less than 1 percentage point as a result of the Thailand flooding.

Total operating expenses for the first fiscal quarter of 2012 were $23.6 million compared to $22.0 million in the first fiscal quarter of 2011. Operating expenses increased $1.6 million in the first fiscal quarter of 2012 compared to the prior year comparable quarter, primarily due to increased head count in the sales, marketing, and research and development function and other expenses in advancement of the IDG platform and other strategic initiatives. Total operating expenses in the first fiscal quarter of 2012 also included a charge of $200,000 related to the restructuring of the Breisach, Germany manufacturing operations which resulted in a work force reduction of 25 positions.

Net income for the first fiscal quarter of 2012 was $700,000, or $0.03 per diluted share compared to $2.3 million or $0.09 per diluted share in the first fiscal quarter of 2011. Net income in the first fiscal quarter of 2012 included a restructuring charge of $200,000 net of taxes, or $0.01 per diluted share offset by a tax benefit of $100,000 or $0.01 per diluted share resulting from the reversal of tax reserves for closure of various jurisdictions, tax matters and a gain on sale of an investment of $100,000 net of taxes with no earnings per diluted share impact. Net income in the first fiscal quarter of 2011 included a benefit of $600,000 or $0.02 per diluted share, resulting from the reversal of tax reserves for closure of various jurisdictions' tax matters, and for the extension of the research and development tax credit recorded in the first fiscal quarter of 2011. Diluted weighted average shares outstanding at the end of the quarter were 26,142,562 compared to the previous quarter of 26,271,597 shares, a decrease of 129,035 shares.

Turning to balance sheet, our combined cash and cash equivalents and marketable securities balance was $106.2 million as of December 31, 2011, decreasing by $1.6 million from the end of the prior fiscal year. Approximately 0.5 of the $1.6 million cash decrease was due to foreign currency losses experienced on cash balance of sales and local currencies due to the strengthening of the dollar during the first fiscal quarter of 2012. Our current ratio is 8.7 to 1 compared to a current ratio of 8.3 to 1 at the end of the prior fiscal year. Our DSO is at 37 days, consistent with the previous quarter.

Now I would like to provide some guidance for the second fiscal quarter of 2012. Digi projects revenue to be in a range of $50 million to $55 million for the second fiscal quarter of 2012, with a most likely revenue of approximately $52.5 million. We expect that total operating expenses for the second fiscal quarter of 2012 will be approximately flat with the previous quarter. We expect net income per fully diluted share in the range of $0.08 to $0.13. We previously had projected revenue for the full fiscal year 2012 in a range of $210 million to $235 million and a net income per diluted share in the range of $0.38 to $0.64. In light of the first quarter 2012 results, Digi expects the most likely revenue and net income per diluted share to be in the bottom half of these previously announced ranges. This acknowledges the current uncertainty about general economic conditions for the remainder of the fiscal year, which make it difficult to provide more precise guidance at this time. At this time I would like to open the call to questions. Operator?

(Operator Instructions) Tavis McCourt, Morgan Keegan.

Thanks for taking my questions, I have got a couple of them. First, on the gross margins, obviously very strong. You mentioned largely due to product cost reductions. In your mind, how sustainable are those, especially given some of the weakness you are seeing? Then, secondly, I wonder if you could describe some of the weakness in the verticals. I think the geographic weakness is pretty obvious, it's economic, but I think you also mentioned some weakness in your core verticals. How much of that do you think is also tied to economic versus just decision cycles?

So, on the gross margin side, my view of gross margin hasn't changed at all. We have been very focused on driving the operational efficiencies. We have, I think been successful over the last -- if you look at the last few years, driving from 49% up to in the 53% range. Obviously this quarter, we had a negative impact as a result of Thailand with some of these additional costs associated with recovery, but we were able to minimize those and still achieve a 52.4% level. We will continue driving that operational program that has allowed us to drive from 49% to where we are today. We will continue to drive the engineering cost reduction programs that have also facilitated that and we'll gain the benefit of manufacturing footprint efficiencies that we've recently driven, while -- just to give you a note, Tavis -- while bringing down Breisach, we had to deal with this Thailand situation. So we dealt with the Thailand situation. We actually brought down in order to drive more efficiency, a small manufacturing facility in Germany, brought that into Minneapolis this quarter, and as we said in the last call, we expect to get about a $500,000 a year benefit from that. So, our view right now hasn't changed. That we should be able to continue to drive gross margins where we are at, or on a trend that may be slightly better. So, 53% is a good number. We would like to improve from there. I don't see major movement one way or the other from that kind of level. What we're going to see is the cost reductions obviously are going to help us to offset any price elasticity issues in the marketplace over time.

And I guess, a follow-up on the vertical market weakness that you're seeing, we need specific verticals and how much of that do you think is related to economic versus specific decision cycles?

Yes. So, the major external force that is kind of working against us and I think everybody right now is Europe. Europe is in the neighborhood of 25% or so of our total revenue. So, Europe certainly, much more than North America. North America seems like it really hasn't changed significantly. But Europe, I would say we are feeling some pressure. In terms of -- and so, that affects the verticals. But in terms specifically on the vertical piece, there is a very specific dynamic that's affected that. And that is, we have had a couple of major customers that had a strong run rate. They have gone not away, but they have gone into kind of a pause mode last quarter, and then we expect it in the current quarter. And they are very significant customers where they are going into kind of a pause. They have got inventory that they are kind of working through and we have PO's for them to pick back up in the second half of the year. So, I think there are very specific reasons. It is really driven by two major customers. Then, the third piece from a vertical standpoint is the smart energy vertical. While we still see strong demand in a lot of the application areas in solar and other areas, distribution automation, across all the areas that we play, we are seeing good demand.

The one area that I talked about last quarter that is being negatively affected by the market situation is more the residential demand response and energy management piece, where we have just seen much more market slowness and slowness in adoption than we expected. And I think than most people expected. So, those are the main things. Now, kind of bringing it back up to the high level, we still believe that in the smart energy space across all the applications that we play in, that we're going to see a double digit growth this year over last year. We had a very strong medical quarter -- the medical vertical, and we feel very strongly about our growth opportunity there this year. We saw fleet was strong, and we feel like we're going to see a very strong year-over-year growth there. In tank, we saw a bit of a pause. That is where we saw a bit of a pause from one of our major customers. So, that's going to be flattish year-over-year. But the good news is, is with that major customer, we not only expect that to rebound, but we expect to rebound with incremental opportunity geographically outside of the US and with additional design wins.

Matthew Kempler, Sidoti.

So, I was hoping you could elaborate. We've had two quarters of softness now, but your enthusiasm hasn't waned at all. In fact it sounds like you're more enthusiastic about the outlook. Can you -- one, you said did use better position than ever, review from your sense what makes Digi better positioned than ever, and what you are seeing that suggests that, and then where the confidence is coming from that -- the M2M market or the Internet of Everything is approaching an inflection point?

Okay. So, you are absolutely right, Matt. I am more enthusiastic than ever. The reason I am enthusiastic is because our strategy -- our execution strategy is very effective. We looked at the broader ecosystem over the last couple years. Our strategy was to go after the early adopters in these vertical markets that we are targeting and develop momentum and a reputation as a thought leader in the space. And we've done that. So, the two ecosystem elements that we focused on were driving the verticals and driving a position with the major carriers. So, we did that. We established co-sell relationships, lead-sharing relationships. Not only did we drive product introduction with a broad set of products, including iDigi Cloud, iDigi application services, wireless design services and our gateway and end point play. So the broader solutions play, but we established a leadership position in the ecosystem, focusing on those two elements of the ecosystem. Now, if you look beyond that and if you look at what is happening, there are other major elements of the ecosystem that we believe are a very high leverage. From a competitive standpoint, I am not going to get into the specifics, but the major areas are systems integrators, the major Cloud players, and major core technology players. We've mapped it out. We are out there really driving our position with who we think are the high leverage players in this ecosystem. We feel like we are getting a lot of momentum, a lot of traction. We have tremendous amount of credibility in this space. So, that is the reason for the ecosystem and the market kind of based enthusiasm and why I feel really very good about our market position.

Now, on the other question, why do I think the inflection point is coming? I touched on this last call. I talked about the fact that every link in this value chain, this Internet of Anything, connecting anything, anywhere at any application, anywhere has dramatically changed over the last three to five years. Every link, the cost has come down at least an order of magnitude. What I used as an example, last quarter, was talking about the cellar module piece going from 200 kilobit kind of bandwidth for $100 for a module to 40 megabytes and the couple orders of magnitude change there. If you take that a little bit further and talk about other links in the chain -- in that same realm, the cellular connectivity piece, the services piece. Coming from AT&T, Sprint, Verizon and others, four or five years ago, you could barely get gateway certified on their networks. It was very expensive, very time consuming, let alone service plans for these kinds of opportunities. And then once they were developed, it was maybe $10, $12 per device per month. Just in the last six months to a year, the carriers are segmenting. Looking at M2M, looking at this as a hot market opportunity. They are segmenting markets and they're providing specific data plans for specific markets. So we are seeing that $10 per device per month going down to under $0.50 per device per month in some applications. So, another order of magnitude kind of change. That same dynamic is happening within the telecom infrastructure. People like Ericsson with their thought leadership position, they are driving those kinds of the same 10x kinds of dynamics. And it is happening at the end point, also. So, every link in the chain has this reduction in cost, improvement in future functionality, and the barriers to deployment are coming way down so that our customers, the people that are building our pipeline, are now seeing a return on investments that they never saw before. So, the dynamic that I am talking about, Matt, in each one of these elements of the value chain, most of those dramatic changes have been occurring in the last year or two. That is why you see the Ericsson's, the AT&Ts, Verizon, Sprint, Qualcomm, all these guys getting so excited about this -- the Internet -- what they call the Internet of Things, or M2M. What we call the Internet of Anything.

Okay, I appreciate that explanation. Then I just wanted to ask to clarify on the expectation that growth starts to accelerate again in the second quarter. If we look at the low end of the guidance, we're pretty much flat year-over-year. Is there still some caution around certain areas that you are seeing?

We are saying, if we look at what Steve said, we are saying the bottom half would be $210 million to $222 million, which would be about 3% to 9% growth. So, we feel like each one of these -- the key areas for us are wireless and really driving these verticals and driving the ecosystem. The wireless piece, Matt, we still believe is going to drive from where it was to be around 47% or so of our revenue for the year. If you look at that over time, we have driven that from 4.6% in 2006 to 16% to 25.2% in 2008, to 33% in 2009, 36% in 2010, 41% and change last year and we are expecting 47% based on our current projections this year. So, wireless we think will continue to be strong growth. Like I said, in each one of these verticals, with the exception of tank, because of the major customer pause that we are seeing there, we expect growth.

Okay. Then, last thing for Steve. The G&A jumped sequentially in the quarter. Did you say there were some unusual items in there and should that come back down in the second fiscal quarter?

Yes, Matt. There were a couple of unusual items. We did have one -- we run bad debt reserve through G&A. There was one discreet transaction. An account that we reserved. We are concerned about collectability. Then we did have a little over -- a little increase in some of our audit and legal fees, so I would expect that to moderate a little bit going forward.

Ty Lilja, Feltl.

First question, just with this weaker economic environment you are seeing, wondering how did that progress through the quarter? Was it even throughout or did it really pick up towards the end?

Well, one of the challenges we had this quarter was more than any other quarter, we had kind of a visibility challenge. Dealing with the Thailand flooding and dealing with all those issues, there was a little bit less pure visibility on the demand side when you are dealing with all these supply side challenges. So, my gut level -- I don't have an analysis on that question in front of me, but my gut level on that is that we took kind of a -- the more significant economic impact was Europe. And we -- you had some visibility. Europe was down this quarter, partly because of the flooding situation in Thailand, partly because of the currency exchange rate, and then the slow demand piece we are thinking was maybe $0.5 million to $1 million kind of impact. And I wouldn't say that we had tremendous visibility to that until towards the end of the quarter.

Okay. Sure. And also just with your wireless business, kind of a slow down in the growth rate which was partially expected with the flood in Thailand, I was wondering given that three of your four verticals grew, if you think a bit about what that business might have done, how much of -- with kind of this flat year-over-year decline, how much of that is coming from the tank vertical and how much of that is come from the flood? Is there kind of a way to allocate that between the two?

That is tough to do. The one thing I'll do to try to characterize the wireless piece. I think we came -- we said we came in around 42% or so this quarter. Expected to come in around this quarter in the 44%, 45% range and the impact of the flood disproportionately impacted wireless. So we believe if that had not happened, that the wireless would have been up in that 44%, 45% ballpark.

Okay, sure. Just one last question. I think you mentioned last quarter that in your wired business, your USB product line had slowed down. You were expecting that to bounce back. Did you see a bounce back in that business?

Yes. So, on the wire line stuff, what we -- generally what we saw -- was we saw, again, this flooding impact kind of cut across everything. So, with USB, we did see a healthy USB business, but it was impacted by SVI. But more generally on the wire line part of the business, we saw that our terminal server business was actually very strong. It was -- did better than we expected. I would say the Rabbit core processor business did worse than we expected. I would say USB did about what we expected.

Ahmar Zaman, Piper Jaffray.

This is [Sean] for Ahmar. I was wondering if we could take a step back and look at margins. I know that you guys outlined earlier the operational progress you guys have made, sort of working costs out of the system. But you obviously had very good margins this quarter. Could you comment a little bit about competitive -- sort of the competitive environment and how you expect to continue to protect such strong margins going forward? It seems that at some point that you are going to see some challenges to that in the industry that will kind of challenge your ability to maintain those margins just on pricing or whatever. But if you could talk a bit to that.

Yes. That has always been the concern, the feeling, that we're going to be feeling that kind of pressure in the market and it's going to impact our margins. So, we've had a strategy to really address that aggressively. It is both on the cost side as I think I already talked about -- a very focused program. To focus on engineering, cost reduction and on manufacturing efficiency and on the cost reduction, focused on those high leverage kinds of products where we can pull cost out and on the manufacturing side, driving our manufacturing footprint so it can be low cost and most efficient, and driving lean techniques, lean processes to pull cost out. On the market side of this thing, the way that we fight that margin battle, I think has been pretty clear and obvious. That we have -- historically, we've been a hardware Company. We've had a strategy to move from wire line point products to wireless solutions. So, we believe there's a lot of unique capabilities that we bring to the table with a broader wireless solutions approach, a lot of IT with our iDigi device Cloud and a lot of capability with our services approach with iDigi applications and our wireless design services that, when you look at any one of those individually, it is kind of a gross margin insulator over time, but when you combine it, it is pretty powerful. So we believe, we are working both on the cost side pretty aggressively. We also believe that we have a strategy approaching this Internet of Anything opportunity with a solutions approach that provides gross margin defensibility from a solutions perspective.

Great, thanks. And if we could just -- I know that in your press release you talk a little bit about the Thai flooding that continues to impact one of your contract manufacturers over there. You guys are not looking, at least at this point for an impact on your revenue. Can you just tell us -- give us some insight as to what you are seeing over there currently and what gives you the confidence that, that really is behind you just in terms of your financials?

Yes. So, during the quarter, we were able to work with them. And we worked with them very closely. We were the first customer to be up and running in their new facility. They went through -- I talked about moving all the stuff. They had a bare bones facility that they ramped up very quickly with power and lights and everything else. 100% MRP rebuild and got up and running to the tune of producing over 100,000 units for us last quarter. So, that was a key part of it. The other key part of it is that we segmented basically the problem, and said, okay, we're going to keep these SKUs there in order to meet demand and then we're going to move some SKUs to other contract manufacturers. And we're going to move some SKUs to Minnesota, to our own facility. We're going to have a strategy to continue in those locations as long as we needed to, while our contract manufacturer was fully getting back up to speed. So we have completely executed on that strategy. So we are up and running with this strategy. And fundamentally, believe that there shouldn't be any impact on revenue this quarter. Now, some of that depends on just how significant the ramp is. For instance, we gave a guidance from $50 million to $55 million. If we are bumping up above the high end of that, we could potentially get into an impact where we could become supply constrained. But outside of that scenario, we feel real good about where we are. We feel very good about where they are. Not only that they have tactically got up and running, but we certainly have been looking at them and working with them to understand their broader business plans. We feel pretty darn strong about what they are doing and where they are heading.

Great. And if we could -- just one final one. As we think about the smart energy segment, which it appears to be one of your strongest growing segments. I mean with the weakness in Europe, I mean is the potential sort of muted there just in terms of growth, or is that more sort of a -- are you guys thinking more smart energy right now as -- and more of a North America opportunity at this point?

Well, great question. We have extended our strategy beyond North America into Europe, working with our partners in North America that are driving into Europe. We have got specific products that are addressing the European market. We have got a wireless M-Bus product, gateway product that is focused on that market. Beyond Europe, we certainly believe that there are other key markets in Asia Pacific that we are targeting, India and China. So, yes, those are focus markets. I think the smart energy play is going to be impacted in Europe over the next couple quarters. The level -- there is just a high level of uncertainty over there right now. And we are not sure where this is going to go. The good news for us is that we do tend to have very strong positions in vertical opportunities in Europe that tend not to be as impacted by significant economic downturns than others. For instance, one area of significant strength for us over in Europe is medical. Where we've got a number of key customers that we're driving. So, there is a little bit of insulation there. But we are all just going to be watching that whole situation very closely to see what happens.

Dick Ryan, Dougherty.

Joe, you mentioned wireless getting to 47% of total revenues. I might have missed it. Did you say for the fiscal year as a whole or as you exit the year going into fiscal 2013?

Our target and our expectation is that we get to 47% for the year.

Okay, how should we look at that even for next year from a margin perspective if you would dare to look that far out the road? I mean, is that where wireless can peak out as maybe somewhere in the upper 40%s, low 50%, or does it have the potential to go above that?

What I've said, rather than focusing in on next year, what I've said about gross margins if you're talking about gross margins by product category, what I've said is that we have seen for years and years and years, and it is still true at Digi, we've got a phenomenon where we have got long application lifecycles. That continues to be true with the wireless solutions play. We've got long sales cycles, high switching costs. What tends to happen is products that are at the beginning of their market lifecycle or product lifecycle tend to be a little bit lower in our gross margin range. As they move through that lifecycle, we are good at cost reduction and we're good at driving improvement over time. So, that is what -- Number One, that's what I expect to continue to see in wireless. Then, the other important piece is, when you look at the wireless solutions play, as we drive more adoption for the iDigi device Cloud and more adoption in a higher services percentage, I expect the services piece to be higher gross margin over time and to see the opportunity for more leverage over time than you might see in a typical hardware program.

Okay. In your commentary you mentioned partnerships, but I was looking at -- if you have to look at the medical, the fleet verticals and maybe even the tank. Can you talk about any new customers showing up in any of those verticals or any new partnerships that have emerged over the last quarter or so?

Most of the stuff that we are working on is not public. Most of the progress that we are making is not public in some of these verticals. Really, a lot of the work that we are doing in the ecosystem is beyond the vertical focus, and we think is very high leverage in the ecosystem in the categories that I talked about earlier. But, for instance, in the smart energy space, we feel like we have made good progress and there are public announcements out there recently with people like Siemens and Honeywell trend over in Europe and e2AMERICA, A Better Place, others that I don't think that we've put out there yet in a press release but we are comfortable discussing. Sensus, a major player in the space, for instance. We are working on a program with them that is not unlike the relationship with have with Itron. So, we are going down a path working with customers like that and certainly there's many, many more that are not public and there are a lot of good reasons why people don't want to go public with some of this stuff.

Sure. Steve, I forgot, the cash, where is most of that sitting?

Most of it is in the US.

Okay. Any updated thoughts on use of the cash, if you are looking at strategies? Either more M&A or dividend buy back opportunities?

No, I think our strategy stays the same. We are focused on holding cash for the right M&A transactions. We continue to have an active business development effort. We maintain a pipeline of deals that we're looking at. We're just looking for the right one at the right price.

(Operator Instructions) Tavis McCourt, Morgan Keegan.

Just a couple of follow-ups. Steve, you mentioned some currency impact on the cash in the balance sheet. But was there any currency impact of note on the income statement and how are you thinking about that -- this year in terms of your hedging activities?

Well, yes, we did have a cash balance impact of about $0.5 million. And relative to the outlook for the year, we maintain about half our business in Europe is done in dollars, half in local currency.

Okay.

So, we don't really pursue an aggressive hedging strategy. But -- and at this point that served us pretty well.

Okay, then a follow-up on the balance sheet. I would have thought with the Thailand issues this quarter, you would have burned through some finished good inventories. But I see your inventories are actually up a little bit. Was that just a reflection of fixing a lot of the Thailand problems earlier in the quarter than you would have thought, or is there something else driving that?

The big driver we had, as we talked about last quarter in this Thailand situation, was -- and a huge goal of ours, was to make sure that we created no impact for any of our customers, that none of our customers have line down situations. So, with that goal, and understanding that there was a major transition over in Thailand where inventory was being moved, as I mentioned before, they had to do 100% MRP rebuild. So, you have got inventory movement and you basically don't know what you have until they do the rebuild. We did a parallel path buy to make sure we could get up and running as fast as we could so we could meet that goal of not impacting customers.

Got you. So, from an inventory turns perspective, we should probably expect that to get back to more normalized levels or the levels you were at towards the end of last year as the year progresses?

Yes.

Ladies and gentlemen, I am showing no further questions. I would like to turn the call over to Mr. Dunsmore for any closing remarks. Please proceed, sir.

Thank you. I am -- as you can tell, I am very excited about this opportunity. We are very well positioned and we're very excited, making great progress. I look forward to talking to you again in three months.

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.