Digi International Inc (DGII) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter and fiscal-year 2014 Digi International earnings conference call. My name is Kim and I will be your operator for today. (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, Mr. Steve Snyder, Chief Financial Officer. Please proceed.

Good afternoon and thank you for joining us today. Before Joe gives you our business update, I would like to remind you about a few administrative items.

First, we issued a press release regarding our quarter and full-year results earlier today. If you do not have a copy of our earnings release, you may access it through our investor website at digi.com.

Second, I would like to remind you that some of the statements that we will make on this call are forward looking. These statements reflect our 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 our 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 2013 annual report on Form 10-K and subsequent quarterly reports and other filings 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 or in our earnings release 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. The earnings release is also an exhibit to a Form 8-K that was filed earlier and can be accessed through our website.

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

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

Now for a report on our business. We are very pleased that our fourth-quarter revenue of $51.6 million beat the midpoint of our guidance of $50 million that we provided on our call at the end of last quarter. Earnings of $0.02 per share were toward the low end of our GAAP guidance range.

Hardware sales exceeded our expectations and services revenues were flat sequentially, but close to our expectations for the quarter. Hardware sales were led by all-time high quarterly sales of gross hardware products and also bolstered by sales from our mature product lines that surpassed our expectations for the third straight quarter. Our cellular product line led the growth, up 15% sequentially and 31% from last year's fourth quarter.

Additionally, we had the strongest RF product sales quarter since Q2 2012. Mature product sales in Q4 were down 0.4% sequentially, but increased 1% year over year.

Sales of our services offerings remained flat, primarily due to the softness in our CRM consulting business. The underutilization of consulting labor that had been retained for higher expected sales from our CRM business was the main driver that led to lower-than-anticipated overall gross margins in the fourth quarter.

We continue to expect a modest revenue ramp to occur in our services business through fiscal 2015. This is fueled by a more robust sales pipeline, driven by a group of new sales account managers that were hired earlier this year and are now fully on boarded.

In Q4, we landed notable deals across multiple industries, including transportation, medical, retail, and industrial. For example, a very large public transit system in North America plans to deploy our cell routers for cell connectivity in new passenger payment systems.

Also, a leader in timers and temperature controls for the food service industry plans to deploy an estimated 50,000 RF modules to enable connected solutions for its food service customers.

The full fiscal year had a challenging start, impacted negatively by a pause in orders from our three largest customers. However, I am very encouraged by the strong second-half recovery in the business. We ramped our quarterly revenue from a low of $45.9 million in fiscal Q2 to $47.9 million in fiscal Q3 to $51.6 million in fiscal Q4.

The ramp is fueled by new customer deployments in our target markets, centered around wireless M2M and Internet of Things projects and our cellular and RF product lines, which, coupled with their built-in cloud management capabilities, drove exceptional growth in the quarter. This positions us very well for this long-term, high-growth market opportunity.

We have a number of new wireless product introductions underway that we feel will serve the market well in key verticals that we are targeting. We will announce more details in the coming months.

As Steve will discuss, we anticipate that in FY 2015 Digi will return to overall topline revenue growth and increasing profitability. For Q1, I have high confidence that we will meet or exceed the midpoint of the revenue guidance we announce today, which would yield the highest revenue for fiscal Q1 in the Company's 29-year history. We are especially encouraged by our sales backlog and pipeline going into Q1 and the balance of 2015.

So in summary, first, our Q4 revenue results were in the upper end of the revenue guidance range, driven by a strong performance from our hardware product lines.

Second, margins were slightly lower and operating expenses higher, resulting in slightly lower-than-expected Q4 bottom line. The operating margins will improve as we see the expected recovery in the services topline growth.

And third, looking at the fiscal year, we realized stronger revenue in the second half, which we will see continue into 2015. As a result, we expect a resumption of topline Company growth and higher profitability in the new fiscal year.

So I will hand it back to Steve.

Thank you, Joe.

I will start with my comments on our fourth-quarter financial performance. As Joe indicated, we are pleased with how we ended the year and the traction we saw in our topline during the fourth quarter.

Our revenue for the fourth fiscal quarter of 2014 was $51.6 million. This was a slight increase from last year's fourth quarter. It also was the highest quarterly revenue number we have reported since 2011 and a sequential increase of 7.8% from the third quarter of 2014. These are very good metrics.

As a group, the growth hardware products were up 9.4% in the quarter from the prior year. This growth was driven primarily by cellular gateway products. Mature product sales were very stable and registered an increase of 1% on a year-over-year basis.

As Joe mentioned, our service business was challenged throughout the year. While service revenue was flat sequentially and we came in about where we had anticipated, we experienced a 31.8% decrease from the year-ago quarter, mostly attributable to challenges within our CRM business.

Geographically, we saw strength in North America. Total revenue in North America was up 3.6% year over year. Product sales were up 13% in the quarter from a year ago, partially offset by the decline in services.

Internationally, all geographies except Europe were up on a year-over-year basis. Europe had its best quarter of the year this quarter, but was down on a year-over-year basis due to our particularly strong fiscal 2013 fourth quarter.

Gross profit was $23.6 million or 45.8% of revenue in the fourth quarter of 2014, compared to $26 million or 50.5% of revenue a year ago.

Our gross profit decrease is primarily a result of two factors. Service margins were up slightly on a sequential basis, but continued to weigh down on overall gross margin. The primary driver of the weak service margin is our decision to maintain consulting labor levels at the same levels as we have done in the past, even though service activity was reduced.

We did this because we have invested in the recruiting, training, and onboarding of our service consultants and we're still optimistic that service revenue will rebound. That said, we're monitoring this on a quarterly basis and have plans to increase service gross margin in fiscal 2015.

The other factor to note is product gross profit was flat at $23.1 million in both the fourth-quarter 2014 and the fourth-quarter 2013, with gross margin declining 2.7 percentage points from 51.9% in the year-ago quarter to 49.2% in the fourth quarter of 2014. This is largely due to customer and product mix.

This quarter, we did incur higher costs associated with the initial production run of a new product. We expect that particular impact to be mitigated going forward. While we expect to see ongoing pressure on product margin, we expect stabilization and modest recovery from Q4 levels in future periods.

Operating expenses in the fourth quarter of 2014 were $800,000 higher than the year-ago comparable quarter.

We reported CEO transition expenses of $500,000, which were included in our G&A expenses for the quarter. Net income for the quarter was $500,000 or $0.02 per diluted share, compared to net income of $2 million or $0.08 per diluted share in Q4 2013.

Now we will provide a few highlights of our fiscal-year financial performance. Total revenue was $192.7 million in fiscal 2014 compared to $195.4 million in fiscal 2013, a decrease of $2.7 million or 1.4%.

These three factors drove our 2014 performance. First, growth hardware products revenue increased by $1.9 million or 2.1% compared to the prior fiscal year. Our cellular products growth was strong, while RF and embedded modules product lines did not grow as expected.

Second, mature hardware product revenue decreased by $2.1 million or 2.5% from the prior fiscal year. This decline was less than expected and is a result of demand for products being greater than expected and some benefit from our announcing end-of-life dates on certain products and fulfilling final orders for those products.

Third, service revenue decreased by $2.5 million or 11% as customers canceled or deferred projects that were not replaced in fiscal 2014.

Gross profit decreased by $9.6 million or 9.6% in fiscal 2014 compared to the prior fiscal year. Like we saw in the fourth quarter, this gross profit pressure was driven by two factors. Gross profit on service revenue decreased by $5.9 million. Service gross margin for fiscal 2014 was 17% compared to 41.8% in the prior fiscal year.

Hardware products gross profit decreased by $3.7 million and gross margin was 50.4% of fiscal 2014 compared to 52.5% in fiscal 2013. This was driven by product and customer mix, as previously noted in my comments on the quarter, although I will note that, on average, mature products carry a higher gross margin than growth products, but as the mix of our business moves to more growth products, pressure on margins will be experienced.

Operating expenses decreased by $2.2 million during fiscal 2014 compared to the prior fiscal year. In fiscal 2013, we recorded approximately $2.3 million in one-time charges. Fiscal 2014 operating expenses included approximately $1 million of expenses related to our CEO transition. This was mostly offset by cost-containment efforts throughout the organization.

Net income was $1.8 million in fiscal 2014 or $0.07 per diluted share compared to $5.8 million or $0.22 per diluted share in fiscal 2013. Fiscal 2014 results do include discrete tax benefits of $0.06 per share.

Moving to the balance sheet, cash and investments totaled $91.9 million at September 30, 2014. This is a decrease sequentially from the end of third-quarter 2014, as well as a decrease of $13.8 million from the end of fiscal 2013.

Both decreases are driven by our share repurchase activity. We continue to be active in buying back our shares as a strong sign that we believe we are undervalued.

Here are some quick data points. In the fourth quarter of 2014, we repurchased 732,800 shares for $6.1 million at an average purchase price of $8.39. For the year, we repurchased 1.734 million shares for $15.8 million at an average purchase price of $9.11.

As a reminder, we purchased 1.481 million shares for $14.1 million in fiscal 2013 at an average price of $9.49. The combined total shares repurchased in the past two years were 3.216 million shares for $29.9 million.

Earlier this week, our Board approved a new program to repurchase up to an additional $15 million of our common stock. This purchase authorization expires on October 31, 2015, and replaces the program that expires tomorrow.

Our balance sheet continues to be robust at a current ratio of 6.7 to 1 at September 30, 2014, compared to 7.0 to 1 at September 30, 2013. Digi remains debt free.

Finally, I would like to provide you details of our outlook for the first fiscal quarter and full fiscal year 2015. Digi projects revenue for the first fiscal quarter of 2015 to be in a range of $47.5 million to $50.5 million. Net income per diluted share to be in a range of $0.00 to $0.02. For the full fiscal year, Digi projects revenue in a range of $193 million to $213 million. Digi projects annual net income per diluted share to be in a range of $0.02 to $0.22.

For context, the annual revenue guidance is built on the following elements. Growth product categories are projected to increase at a 10% to 20% rate. Services are expected to grow at a 5% to 15% rate and mature products are expected to decline at a 5% to 15% annual rate.

Before going to Q&A, I like to reiterate some things Joe mentioned. 2014 was a challenging year for our Company financially. However, we ended the year with a reason for optimism and remain excited about our sales pipeline, product portfolio, and our prospects for 2015.

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

(Operator Instructions). Mike Walkley, Canaccord Genuity.

Steve, maybe just building on the guidance for the full year, can you help us with how to think about maybe the gross margins for the three divisions and how they might trend for the year?

Sure, I will give you -- generally, we expect to see stabilization and a modest uptick on the product side. We expect to see a more substantial gross margin percentage increase on the services side. So on the whole, I would say a stable to modest uptick.

Okay (multiple speakers)

But not -- just to be clear, Mike, not returning to fiscal 2013 levels.

Okay. With that type of outlook, would that back into maybe flattish year-over-year absolute OpEx levels?

That actually would -- a modest increase.

Modest increase? Okay, great. That's helpful.

Then just on some of the new announcements during the quarter, the transport deal, that seems like a nice deal. How big do you see that market potential and can you maybe size that deal for us, and was it an impact to the current quarter or is it more in the bookings for future growth?

That deal is a nice deal for us in general. What we are seeing is -- with the transport product line, we are seeing real robust growth, I think in the neighborhood of 30% when you look at the entire cellular product line, including transport and our cell gateways, year over year. So, real robust growth, really strong momentum with the gateway and router business.

Transport, specifically the cell routers, we are targeting key markets -- the utility space, transportation, retail, and in transportation specifically, there is a lot of interesting deals that we are working on.

This one, to give you a sense of deal size, it's a good-sized deal. It's over $1 million in revenue and we will begin to see that revenue this year.

It is a real interesting application. We see a lot of these types of applications for cell routers in buses, in subways, in these types of systems. So we've won many, many deals in this particular segment and these deals tend to be pretty good sized.

Great, and just building that, are these upgrade sales of new technologies to current customers or are these competitive deals that you're winning from, like, a Novatel or somebody else in the market?

A lot of these tend to be new deals, new customers.

Okay, great, thank you. Then maybe just one last, on the services, and I will pass it on. Just can you update us there just on -- I know you have some things in the works and you're keeping the people there for utilization, but any color on some projects and how they are coming together, just given that has been a little light on gross margin?

Thanks for that question, Mike. I wanted to spend a little bit more time talking about this.

To give you a sense why we're in a flat time period here with the services business, 20/20 hindsight is always a wonderful thing. As we look at it, what we have seen is that we had a big focus on trying to drive building the sales organization at the same time that we are building the ability to provide fulfillment with the technical consultants, the business analysts, et cetera, that we need for these types of deals.

What we found was the sales ramp-up, getting the sales team on board and getting them fully onboarded and effective took longer than what we expected. So we have been in a time period where we have more fulfillment resources than we need at the moment as we are ramping up the sales capability.

The good news is we're starting to see the benefit of having these salespeople fully onboarded and we are now seeing the beginning of a sales pipeline ramp in that business. So, feel like as we look at the next quarter, it's looking flat to up, and as we look out further, it is looking -- the pipeline is looking more optimistic that we can expect a ramp-up in sales and better utilization of those resources.

When you look at the color underneath that, what are the kinds of deals that we are seeing? We are seeing some significant deals. I would say it's exactly the way we would like it to be.

Most of the deals, the majority of the deals, are Service Cloud where we've got a very -- Etherios has a very strong brand. We are a platinum partner with Salesforce. At Dreamforce, we won the Innovation Partner of the Year for our Service Cloud implementation with Walgreens, and we're the first to achieve Service Cloud master certified status of any partner.

The way I would color it is it tends to be Service Cloud customers that are ramping. It tends to be -- it's, right now, 80/20 existing follow-on deals, 20% new deals, and we are feeling that pipeline begin to ramp.

Okay, sounds great. Thank you.

(Operator Instructions). Howard Smith, First Analysis.

I just wanted to follow up on the discussion on the services side and having the people on the bench, so to speak. If you are looking for 5% to 15% growth, which I think is what I heard, on the services line and we think about how that layers in, is the -- do you get the utilization with the people you have at those type of levels or is there some further adjustment that might need to be done?

Yes, we believe that if we maintain at this level and we get 5% to 15% growth, that we will begin to see gross margins averaging up into the 30% and above kind of range, and then continuing from that point. We think we can get there fairly quickly.

Okay, that was really my only question. Thank you.

(Operator Instructions). Thank you, ladies and gentlemen. That concludes our question-and-answer session. I will now turn the conference back to Joe for closing remarks.

Great, thank you. This is my last quarterly call with all of you. I want you to know that I have thoroughly enjoyed working with all of you throughout the years. This is, I think, my 60th call, and I will see you on the golf course. Thanks.

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