Digi International Inc (DGII) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the first-quarter 2015 Digi International Inc. earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Steve 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 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 2014 Annual Report on Form 10-K and subsequent Quarterly Reports and other filings 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. The earnings release is also an exhibit to a Form 8-K that can be accessed through the SEC filings section of our Investor Relations website at www.digi.com. Now I would like to introduce Mr. Ron Konezny, President and CEO.

Thanks, Steve. I am really excited to represent Digi and to introduce myself to the investment community. I look forward to earning your trust. As you get to know me, you will learn that I'm a fierce competitor with a track record of winning and I expect Digi to win. To be sure, it won't be without challenges. I will likely face many of the same challenges I experienced in the 20 years of cofounding and leading PeopleNet in the telematics space. Like the telematics space, the M2M networking industry is a large market ripe with opportunity. As PeopleNet did successfully in telematics, Digi will crisply define our role in the M2M market and be laser-focused on helping our customers reap the benefits of adopting our technology.

When it comes to business planning and forecasting, we plan on doing what we say. I'm working with our team to properly define and assign specific goals and objectives that we will relentlessly pursue and accomplish. As I immerse myself in Digi, I look forward to sharing more specifics about the objectives we will deliver.

So why did I join Digi? First, Digi provides reliable, enterprise-grade networking products that have enabled mission-critical applications for 30 years. Digi is a nearly $200 million provider in the M2M market, which is a multi-billion dollar market with enormous growth rates as customers experience tremendous returns on their investments. With greater focus, combined with a crisp identity, Digi can participate in a larger share of that market and accelerate our growth rate.

Third, the Digi team is incredibly talented and dedicated to our customers. Already I've visited several field offices in addition to our local offices. The level of knowledge and the degree of idea generation I've seen today across the Company has exceeded my expectations.

Fourth, the Board and leadership team's commitment to build on our product success and offer value-added services focused on our customers' outcomes is very encouraging.

Fifth, we have an incredible base of tens of thousands of customers that we can offer higher level solutions and press them with easier ways to do business and help them realize their visions. This bodes well for expanding business with existing customers in addition to attracting new ones.

Last is my ability to make an impact. As I collaborate with the Digi Board, I visualize leading Digi and accelerating its performance. I began my career as a management consultant. In that business, you have weeks to quickly understand complex businesses, identify critical improvements and develop implementation plans. I've resurrected these skills to hit the ground running. I've two big objectives to improve Digi's performance. First and foremost, we are taking immediate actions to improve our profitability. We're sharpening the Company's identity, which will lead to better focus and execution. In particular, our Etherios services businesses are already turning their attention away from the primary pursuit of the Internet of Things, or IoT, end-to-end solutions, which we unfortunately have not been rewarded with in the marketplace. We are refocusing on their core strengths of wireless design services, cloud software implementation and remote device management.

We are also carefully examining the products business units to ensure we have the appropriate resources allocated to our broad range of networking gear. We expect these actions to significantly improve the profitability of the Company. Sustained levels of higher profitability provide the stage for our next objective of increased growth. Critical to this stage is capturing, aligning and communicating Digi's vision. This is coming into focus, but due to the history, size and complexity of Digi, I want to be deliberate and considerate to ensure success.

However, our vision will undoubtedly contain these key elements, a crisp value proposition, leveraging our vast expertise in providing enterprise-grade, mission-critical M2M solutions, a laser focus on the success of our customers grounded in our expert service and trust, demonstrated teamwork based on a culture of caring and strong financial performance that builds shareholder value.

Now a few key observations on Digi's first fiscal quarter. Considering the unfortunate Thailand subcontractor fire that severely impacted our operations, Digi had a nice start to the fiscal year as we achieved our revenue plan. I was particularly impressed with the collaboration efforts of our manufacturing and customer-facing teams to work together to limit the impact from the fire. Our product sales were strong enough to offset underperformance in our services businesses. As I mentioned earlier, getting our services businesses back on track is a top priority and will contribute to greater levels of profitability. Our strong balance sheet provides us with great flexibility.

I'd like to highlight just a few of our recent wins for the Digi team. We released our XLR PRO product to the marketplace. This long-range RF solution enables up to three megabits wireless transmissions over distances that can exceed 100 miles. This enables our energy, agriculture and critical infrastructure customers to quickly and cost-effectively connect and manage their remote assets with nine patents pending, including our unique Punch2 technology. The XLR PRO outperforms any product in this category by a wide margin.

We've completely updated Digi's cloud-based remote management software, which enables Digi's gateway router and sensor customers to configure, update and manage Digi's productline without having to physically connect to the hardware. We expanded our DigiKey and Mouser channel agreements to be global, which will more fully leverage our relationship and presence with these key distributors. And last, our Etherios cloud services business unit received its third annual Partner of the Year award at salesforce's annual Dreamforce event. This award recognizes in particular the work Etherios provided Walgreens in their implementation of the service cloud.

As I close my prepared remarks, I again express my excitement at the opportunity to lead Digi. Digi can be a much stronger leader in the M2M space. I look forward to working with my team to make that happen. With that, I will now turn it over to Steve to provide you with a comprehensive look at the financial performance for the quarter. Steve?

Thank you, Ron. We were pleased with our revenue of $48.7 million for the first fiscal quarter of 2015. This is the highest first fiscal quarter revenue we've experienced in the last 15 years. Product revenue was up 7% from the previous year. As we indicated in our earnings release, revenue was negatively impacted by about $1.5 million as a result of the fire. Productlines not impacted by the fire performed well. We're excited about the revenue momentum that we're seeing in the product side of the business.

Similar to last quarter, our product growth was driven primarily by our cellular router and gateway products, which increased by more than 47% over Q1 2014. RF and embedded products were slightly down in Q1 2015 mainly as a result of production constraints associated with the fire. In the aggregate, growth products were up 18% year-over-year. Our core mature products decreased by $1.1 million, or 5.5% compared to the year-ago quarter, which was in line with expectations. Our service business revenue was down by $1.5 million versus Q1 2014. We continue to address execution issues and we are in the process of examining the positioning of our services and our go-to-market tactics.

Geographically, all regions performed well and exceeded Q1 2014 revenue performance with the exception of EMEA. North American revenue continues to be strong and increased 4.3% over the year-ago quarter. Revenue in EMEA was down 3.2% from the prior year due to foreign exchange rates and economic sluggishness. With about half of our European business sold in local currency, the strengthening US dollar had about a 4% negative impact on European sales.

Gross profit decreased by $1 million in Q1 2015 compared to Q1 2014, almost all of which was a result of the shortfall in the services business. Our gross margin was 45% compared to 48.4% in Q1 2014, a decrease of 3.4 percentage points. I mentioned last quarter that we expected to see ongoing pressure on product margins. Our gross margins continue to be an area of focus by management. There were some challenges this quarter in particular that impacted our margins. First, product mix. As I mentioned earlier, revenue from cellular products was higher than the year-ago quarter while revenue from embedded products and RF products were lower at least partially due to the fire and production capacity and availability. Our gross margins on cellular products were lower than embedded modules and RF, which created the most significant downward pull on gross margin.

Second, we incurred out-of-pocket expenses as a result of the fire, including travel and freight costs, which negatively impacted gross margin. Third, as we redirected production needs following the fire, we incurred modestly higher product costs as SVI has been a low-cost producer for us. Fourth, the shortfall in service revenue drove low utilization rates of our service consultants.

Operating expenses in the first quarter of 2015 were $1.2 million higher than the year-ago comparable quarter. We recorded the final CEO transition expenses for our former CEO of $300,000, which were included in our general and administrative expenses for the quarter.

Ron mentioned looking for gaining operational efficiency in the business. To that end, we informed the (technical difficulty) today that we will be closing that facility. This facility was primarily an engineering center and in an effort to simplify the business, we are closing it. Annual expense savings are estimated to be up to $1 million. Restructuring charges are expected to be $200,000 to $250,000 and will be recorded in the March quarter. We recorded an income tax benefit of $900,000 for the first fiscal quarter of 2015, which includes $500,000, or $0.02 per share of discrete income tax benefits. These discrete benefits resulted from the reinstatement of the research and development tax credit for calendar 2014 and the reversal of tax reserves for the expiration of the statutes of limitation for various US and foreign jurisdictions.

Net income in Q1 2014 also included a discrete tax benefit of $200,000, or $0.01 per diluted share for the reversal of tax reserves. We expect that our effective income tax rate before discrete tax items will be approximately 40% in future periods. Net loss for the quarter was $300,000, or $0.01 per diluted share compared to net income of $700,000, or $0.03 per diluted share in Q1 2014.

Moving to the balance sheet, cash and investments totaled $92.3 million, effectively flat with the prior quarter. In the first quarter of 2015, we repurchased 288,000 shares of stock for $2.3 million. We repurchased a total of 2,022,000 shares for $18.1 million under this plan before it expired at the end of October 2014. As announced in October, 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. Our balance sheet continues to be robust with a current ratio of 6.2 to 1 at December 31, 2014 compared to 6.8 to 1 at September 30, 2014. Digi remains debt free.

Next, I'll provide guidance for the second fiscal quarter of 2015. Digi projects revenue for the second fiscal quarter 2015 to be in the range of $50 million to $53 million and net income per share to be in the range of a $0.02 loss to a $0.02 profit. Our guidance does not include any consideration for insurance proceeds we expect to receive for capital equipment destroyed in the fire. When received, the proceeds will be recorded as nonoperating income.

Here are some insights related to how we built the guidance. The revenue range includes consideration of the $1.5 million of orders in our December quarter, which could not be fulfilled. We anticipate gross margins to show only modest improvement from Q1 levels as we continue to work through manufacturing challenges in Q2. Operating expenses are expected to approximate Q1 2015 levels and include consideration of the restructured expenses previously mentioned. That concludes my prepared remarks. At this time, I would like to open the call to questions. Operator?

(Operator Instructions). Mike Walkley, Canaccord Genuity.

Great, thank you. Congratulations on a good quarter given the issues you had to deal with. Maybe a high-level question, just, Ron, look forward to working with you and congratulations on the CEO job. I was just wondering maybe if you could dive into some of the things you said in the call. You talked about crisply define Digi's role in the M2M market. Given your telematics background and your strong SaaS background and with Digi more hardware-oriented, should we anticipate maybe a shift in Digi's focus over time or maybe you could elaborate a little more on how you're going to crisply define the role in the M2M market.

Yes, Mike, thanks for your kind words and it's a very good question. The first observation here in about 30 days on the job is that Digi is overly complex. We need to simplify what we do, how we do it and how we go about the marketplace. What we're risking is really too many spinning plates and having one of them drop. So there's a simplification trend that we're on. I'll be honest, on the IoT solutions piece or being a solution-oriented SaaS provider, the Company has been chasing a bunch of IoT solution opportunities in a bunch of different verticals and we have not been rewarded for those efforts.

As you know, a lot of IoT solution providers are vertically-oriented. They focus on either fleet management or building automation or other areas and I found that Digi was trying to chase too many things at once and clearly not able to get benefit for those actions. So we are really, instead of IoT solutions being the first slide in our deck, it is now, if you will, the last slide in our deck as we talk about our Etherios businesses. We're going back to what we're good at, which in the Etherios CRM business is helping customers implement their cloud services. So I'm not overly biased, Mike, to rushing to a PeopleNet type model. That's for sure.

Great, that's helpful. You kind of answered already what I was going to ask next, but are there any particular verticals you think Digi is going to focus on first? I guess we'll give you time to go through that, but with your short time there and seeing too many spinning plates, also Digi has a pretty strong balance sheet too, so do you think there's anything that you might need to add to go after certain verticals over time?

Yes, one of the things we're going through, Mike, is we're looking at those verticals that we have a particular strength and domain, both in our products business, as well as our service businesses. Where we have good intersection I think we then can talk about how much of a mandate we have to concentrate on those verticals. So there's a lot of work going on in target marketing and understanding where we win, how we win and quite frankly where we lose and we need to deemphasize our efforts. So that's a key initiative that's going on right now.

In regards to the balance sheet, listen, we really value having some flexibility there. As Steve mentioned, we've got a nice cash balance. We have no debt. It's early right now for I think the Company to be pursuing a lot of activity there. We really want to set that identity, get a real firm focus on who we are and who we have success with and then complement that with the M&A strategy.

So listen, it's great to have the flexibility. It was quite frankly a key asset of Digi and it's attracting us to me becoming a leader, but we're going to be very deliberate.

Okay, that sounds great. You mentioned also just a focus on the software business and recovering that and maybe for you and Steve, just given the consultants you guys have been working with and in place in the low gross margin, is it fair to assume you're going to keep that group in place as you expect to grow this revenue or do you think that's an area that needs to be reduced to get those gross margins to your -- I think your target at one point was 40% to 50% for that business.

Yes and just so you kind of have a feel, the services business has three major components. The largest component traditionally has been, in recent years, has been our CRM implementation team. We've also got wireless design services and we also have a cloud management -- a SaaS-based cloud management solution. The wireless design services, they've got a real strong value proposition and they are doing well and if anything, it's reinforcing the work that they're doing and encouraging additional work that's related to Digi product.

In the traditional Etherios CRM business, I've had a chance to visit all three of our offices here in the US and meet with our leaders and there's just really strong consensus and buy-in that we need to go back to our strengths. We're one of a few platinum providers. As I mentioned, we -- partners -- excuse me. What I mentioned earlier with our recognition of implementing Walgreens, that's the type of business that we know and we're good at. We like to show customers a vision that over time how they can realize and unlock IoT opportunities, but in many cases, we're far too early to that stage.

And then, lastly, the cloud piece, which was in conjunction with our IoT solution efforts, was really going after these end-to-end applications that were just -- we don't have the mandate in verticals, we don't have the domain, so that piece of the business is really being focused on device management. So again, much more closely aligned with Digi's core products.

Okay, great. Thank you. I'll pass on from there. Thank you very much.

Howard Smith, First Analysis.

Yes, good afternoon and let me echo the prior sentiments and welcome you to your new position and let you know I'm looking forward to working with you. A couple questions for you. The first is a follow-up just on the professional services business. I'm not sure I fully understood the answer in terms of just the personnel. As we exited last year going into this quarter, there was some discussion about your predecessor of keeping personnel on staff, kind of keeping an overly large bench underutilized in the anticipation of some of these solutions types of projects coming on in the near future. As you deemphasize that, I know you've got changes in India and things that probably impact how work will get done, but do you anticipate a change in the staffing levels on the professional services side in order to bring it in line or making it up in volume?

Listen, I came from a management consulting background early in my career and we're going to manage that team, Howard, like you would manage a professional services team. You're going to staff or pull back as business dictates. Now in some cases, you do hire into a curve when you see the pipeline building and you see the backlogs and we're not afraid to do those kind of things. But what was happening, Howard, was we had a lot of aspirational IoT opportunities that we'd be in a lot of discussions, but we couldn't progress them to realization. So with that more crisp identity of implementing cloud services, in particular an emphasis on our salesforce relationship with the service cloud and salesforce automation, this is a business that the Etherios has been involved in since inception. So we have much greater command and authority over that pipeline, over the likelihood we can win, deal sizes, implementations. So we expect to really manage this business much more closely with what we can accomplish as compared to, Howard, I think your earlier statement of hiring into some more aspirational projects that we don't have quite as good a visibility on.

Understood. Thank you. And then a question on the product gross margin side. With Thailand really off-line and that being one of your low-cost producers, how long do you think it is you feel the impact of that before you can get back to what I'll call more normal gross profit for product where we're not thinking about the fire as a reason for lower margins?

It's a very good question. It's one of the first things that we really tackled as a team when I got here. To kind of give you a little bit of flavor, we had an unfortunate incident in SVI and we had just recently actually expanded capacity there. So we got hit with some unfortunate timing. So we were off-line for a certain period of time, but our local facilities were able to provide some additional capacity. As we're bringing that back up to normal capacity, we're actually overshooting. We're going to be having much more capacity and we're also going to have some redundancy and so we expect really by the end of this fiscal quarter to have our normal operations in place, have our backlog back down to traditional levels and going into the fiscal Q3 having more traditional levels of gross margins.

Great, well, thank you. I will let the next in line, but I look forward to working with you Ron. Bye-bye.

(Operator Instructions). There are no further questions in the queue at the moment. I would like to turn it back over to Mr. Ron Konezny for closing remarks.

Thank you. In closing, I am very excited to be leading Digi. The Company is well-positioned to be a leader in the large and expanding M2M marketplace. By reducing complexity and focusing on execution, we expect to lead Digi to higher levels of both performance and profitability. Thank you.

Ladies and gentlemen, thank you so much for your participation in today's conference call. You may now disconnect. Everyone, have a great day.