Q2 2022 Digi International Inc Earnings Call

May 4, 2022

Good day and thank you for standing by welcome to the fiscal second quarter 2020 to Digi International Inc. Earnings Conference call.

At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question during the session you'll need to press star one on your telephone. Please be advised today's conference may be recorded if you require any further assistance. Please press Star then zero I would now like to hand, the conference over to your host today, Jamie Loch.

Please go ahead.

Thanks, Michelle good afternoon, everyone. It's great to talk to you again and thank you for joining us today to discuss the fiscal 2022 second quarter results of Digi International.

Joining me on today's call is Ron <unk>, our president and CEO , Ron will provide his thoughts on our business and I will follow with the highlights of our financial performance.

We provided a supplemental presentation of our earnings details for your benefit following our prepared remarks, we'll take your questions.

We issued our earnings release shortly after the market closed today, we also prepared a supplemental investor presentation, highlighting our performance through our second fiscal quarter, you may obtain a copy of both the press release and the supplemental presentation through the financial releases section of our Investor Relations website at <unk> Dot com.

Some of the statements that we make during this call are considered forward looking and are subject to significant risks and uncertainties.

These statements reflect our expectations about future operating and financial performance and speak only as of today's date, we undertake no obligation to update publicly or revise these forward looking statements.

While we believe the expectations reflected in our forward looking statements are reasonable we give no assurance such expectations will be met or that any of our forward looking statements will prove to be correct.

For additional information please refer to the forward looking statements section in our earnings release today and the risks risk factors section of our 2021 Form 10-K, and subsequent reports on file with the SEC.

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 measure 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 filing section of our Investor Relations website.

Now I will turn the call over to Ron.

Thank you, Jamie and welcome everyone to <unk> 2022 second fiscal quarter earnings call.

New this quarter is a supplemental presentation posted on the Investor relations portion of <unk> website.

Our team delivered outstanding performance in an incredibly challenging environment, resulting in several all time record that digi.

The ongoing Covid pandemic war in Ukraine ongoing inflation recent rises in interest rates and the battle for talent has not prevented us from reaching our objectives, but are limiting our full potential.

We had the highest revenue for any quarter in the company's history of nearly $95 million, an increase of 23% from last year.

We are laser focused on delivering enhanced customer value through our hardware enabled software services and subscription offerings. Our progress is best measured by high margin annualized recurring revenue.

Which reached an all time high of nearly $90 million.

Through a careful balance of pricing optimization, and smart supply chain management, we delivered year over year gross margin growth and.

In an environment, where macro headwinds challenged margin preservation.

We also set new quarterly records for profitability, that's measured in adjusted EBITDA and adjusted EPS.

Our results were broad based.

Strong revenue growth and profitability expansion occurred in both our products and services segment and our solutions segment.

And our Iot products and services segment growth was driven by strength in open gears console server business, which is seeing record demand in both data center and edge deployments, we are investing in device and cloud software to further automate key IP requirements. In addition, we've seen growth in our cellular solutions business driven by the return of Smart City and mass transit.

Opportunities as well as retail and point of sale connectivity.

Improved gross margin showed a great teamwork and execution of our business leaders as we carefully manage cost and price increases while meeting customer delivery dates.

Annualized recurring revenue growth was driven by increased adoption of device management and service offerings.

In our Iot solutions segment, we doubled the size of this group from last year, driven primarily by the addition of Ventas.

We added nearly 10000 sites in the quarter, driven by healthcare lottery and gaming and retail point of sale verticals.

Improved gross margins and solutions was materially.

<unk> from last year, driven by the addition of Ventas and their annualized recurring revenue contribution.

We are making a targeted investment in this segment to accelerate the transition and growth of IRR.

There remains a multibillion dollar market opportunity with the vast majority of that Underpenetrated in our offering and team is well positioned to extend our leadership.

Demand for industrial Iot remains strong and robust and Digi is a market leader given our business model and mission critical combination of reliability security scalability and ease of use and management.

Demand is growing rapidly notwithstanding the global supply chain constraints.

Driven by record bookings, we now have a record backlog.

I want to briefly cover opportunity strategy and how we've been able to execute as a team.

We see opportunities in niche markets within the immense industrial Iot market, most of which is greenfield.

We're leveraging decades of product excellence to drive higher profit sales and software and service based Iot applications. The digital transformation in the industrial World has been accelerated by the Covid pandemic in a challenging labor environment.

Ultimately this means better value and lasting relationships with our customers stickier revenue and an improved financial model.

<unk> offerings are easy to deploy manage and deliver results in the most harsh and demanding environments.

We started on this journey seven years ago.

With almost no annualized recurring revenue.

Through great work by our team complemented by thoughtful acquisitions.

Our annualized recurring revenue model delivers more predictable results each quarter and offers higher gross and operating margins than one time sales of products.

Shareholders have been rewarded and we believe that will continue.

Did your new model is intact and sustainable we see double digit annualized recurring revenue and top line growth.

Expanding gross and adjusted EBIT margins, we plan to Delever, the balance sheet with free cash flow after prioritizing business and inventory needs to support our customers.

And the integration of Ventas is progressing our acquisition thesis is being reinforced both internally and externally.

We will prudently invest in our people systems and processes to become more efficient in order to deliver an optimal customer experience.

Our confidence is growing to reach our targets of $100 million.

And quarterly revenue of $100 million in annualized recurring revenue and $100 million in annualized adjusted EBITDA.

I will now turn the call over to Jamie for more detail on our financial performance.

Thanks, Ron and good afternoon again, everyone as Ron said digit continues to break records and sets the bar higher each quarter. Both in terms of the value we deliver to our customers as well as in the value. We believe we continue to provide to our shareholders.

Today, I will provide key financial highlights that contributed to the results of our record second fiscal quarter.

Our new model has pushed our annualized recurring revenue to nearly $90 million as of the end of the quarter, which is up nearly 165% year over year.

Our recurring revenue during the quarter accounted for nearly 25% of <unk> total quarterly revenue as we delivered $94 7 million in total revenue, which is up 23% year over year.

Page five of our supplemental investor presentation provides an overview on our margin performance.

Gross margins were 54, 9% and led to an adjusted EBITDA of $19 5 million or 26% of our revenue.

Gross margins, excluding amortization were 56, 3% for the quarter, we continue to see stable strong margins in the face of global macroeconomic challenges our supply chain team is executing extremely well in this challenging environment.

On a per diluted share basis, our GAAP EPS was <unk> and our non-GAAP adjusted EPS for the quarter was 41.

Revenue adjusted EBITDA and adjusted EPS, all exceeded the high end of the ranges we provided in our Q2 guidance as well as exceeding overall consensus expectations.

Page six of the presentation provides certain balance sheet highlights during the quarter, we made an $11 4 million payment against our credit facility, which places our debt position at the end of Q2 at $288 $8 million we.

We are currently levered less than 325 times, our run rate adjusted EBITDA.

These figures do not consider the treatment of leases, which based on the accounting standards will add $25 million of what is now classified as debt on the books was $17 $6 million of that classified as long term.

During our second fiscal quarter of 2022, we returned to generating positive cash flow from operations.

From a GAAP perspective, we generated $5 9 million in cash from operations in Q2.

Our ending cash position for the quarter was $41 4 million.

Our NDA, our possession is $56 7 million up $7 3 million sequentially from our last fiscal quarter end with no material changes to our reserves.

Our ending inventory balance was $51 7 million roughly flat sequentially and year over year as stated last quarter, we have leveraged our cash position to better manage our inventory in this constrained but rapidly changing environment.

It is a strong testament of our supply chain team to maintain inventory levels, while delivering consistent gross margin performance.

Current inventory in the channel was $21 $3 million up $600 and sequentially from the prior quarter, we monitor those levels closely and regularly.

For our segment performance will move to pages, seven and eight of the supplemental investor presentation.

Iot products and services revenue increased 9% year over year in the second fiscal quarter of 2022 to $71 4 million and gross margins increased 140 basis points to 53, 9%.

Year over year revenue improvement was driven primarily by strength in sales of console servers. The.

The increase in margin rate was driven by product and customer mix the.

The digital supply chain team is doing a fabulous job managing increased production and distribution costs.

Operating income increased $4 $5 million year over year to $9 million for the second fiscal quarter, primarily driven by the revenue growth from the console server business.

On slide eight Youll see Iot solutions revenue increased 100% year over year in the second fiscal quarter of 2022 to $23 3 million and gross margins increased nearly 650 basis points to 57, 9% the.

The increase in revenue because revenue is attributable primarily to the Ventas acquisition and reflects our commitment to investing in the growth objectives of our Iot solutions segment.

Operating income decreased $300000 year over year to a $1 $5 million loss for the second fiscal quarter driven by the installation of large projects in the prior year that are not repeating this year.

Now as it relates to forward looking guidance. This is included on slide nine of the supplemental investor presentation.

With consideration to the supply chain and the other challenging macroeconomic conditions, we are providing the following guidance for our third fiscal quarter of 2022.

We expect revenues of.

Between $94 million to $98 million, providing growth year over year of 19% to 24%.

Using a fully diluted share count of $36 2 million shares we expect our GAAP EPS to be between $3 <unk> per diluted share. We expect our adjusted EPS to be between 37, and <unk> 40 per diluted share with adjusted EBITDA to be between 18 and $19 $5 million.

For the fiscal year previously we had indicated that we expect revenues to grow between 16, 5% and 23% in fiscal year 'twenty two.

We expected profitability at adjusted EBITDA, and adjusted EPS would grow even faster between 35% and 55%.

While not providing specific annual guidance, we would expect to be over the mid point on both of those ranges for the fiscal year.

Additionally, we presently expect our gross margins to continue to hold firm through the ongoing macro challenges. Finally, we expect to have annual recurring revenue is greater than $90 million by the end of the fiscal year.

We expect it to continue to Delever, our balance sheet through the year the quality of our revenue is improving with each passing quarter, which is driving profitability higher we believe our ability to generate cash and grow top line double digits in the Iot industry is a legitimate differentiator.

That concludes our prepared remarks, we're now available to take your questions. Michelle Please provide the instructions to our callers.

Thank you if you have a question at this time. Please press Star then one on your Touchtone telephone answer. Your question has been answered or you wish to remove yourself from the queue. Please press the pound key.

And our first question comes from the line of Sam Sheldon with Punch <unk> Associates. Your line is open. Please go ahead.

Hey, good afternoon, guys. Thanks for taking my questions nice quarter here.

Maybe you could just start by talking more about the early days of integration with Ventas are going and maybe what surprised you most with the deal so far.

Hey, Sam good to hear your voice.

It's gone really well the good news, we knew Ventas for several years prior to the acquisition and we share a lot of the same DNA and so a lot of the collaboration has been really growth oriented of course, there is the behind the scenes work, we need to do to integrate and that's essentially our processes and systems of course life as a public company, but we're pretty excited about.

The growth synergies in particular with our cellular solutions business.

Okay.

That's helpful and maybe you could give us a sense for if we backed ventas and C tech out in the quarter can you just talk about what what organic growth looks like in the quarter for you guys.

Yes, thanks for the question, saying, we can't back out.

Ventas for SEC reporting rules on the segment reporting we do reports year over year growth.

Services <unk>.

Segment contribution was pretty nominal so that organic growth rate.

Gives you a deal.

Prime services group has been doing.

Okay. Okay.

Maybe Ron you can just address the supply chain, maybe talk more detail about what youre seeing there and kind of how the availability of components has trended recently for you guys.

Yes at the beginning of our fiscal year, Sam we really anticipated an easing of the supply chain to start occurring in the second half of our fiscal year.

Unfortunately, while we see some pockets of easing it's still a very difficult market out there I think you've got exacerbated by certainly the warrant Ukraine Ukraine.

And some of the things going on in China with the Covid Lockdowns.

<unk> able to still fight through those things and the team deserves just been incredible.

Thank you for refining scratching and clawing for individual components for keeping our third party manufacturing.

Partners up and running and helping us hit our objectives, we are still far short of our potential.

We left millions of dollars of revenue.

That quarter on the table, because we couldnt get enough parts.

We're optimistic that the supply chain will improve but it's going to take more time than we originally projected.

Okay, maybe you could dig into that just with the demand that you guys are seeing right now it sounds pretty strong can you just talk about what kind of growth you think is possible as the supply chain improves or at least it becomes less of a bottleneck over time.

Yes.

Mentioned this in the.

In the opening comments, we had another record in bookings, which increased our backlog and that's a good sign having that book to ship ratio will be over one and there is at least $10 million higher closer to $20 million of revenue, we were not able to ship last quarter that got deferred into future quarters.

That gives you a feel for what our potential could have been in the quarter.

And it's a tricky balance between making sure we deliver our customer needs.

And also work hard on the supply chain. There is a lot of cost right now in the supply chain between.

The price you need to pay for components getting things trans preceded sorry.

Sorry transport it gives me around the world and so we're really doing a good job balancing those those really difficult variables.

Okay.

And you guys said the backlog was at a record level did you have a number for what the backlog was in the quarter.

No we didn't disclose that but last quarter, we said was $250 million and we built on that pretty significantly.

Okay. Okay my.

And my last question would just be around Opex. It looks like it's up about 20% year over year and presumably a fair amount of that is the inclusion of ventas, but maybe you can just talk about what areas in the organization, you're investing into right now and what hiring plans look like as you guys changed some of the strong demand that youre seeing in your markets.

Yes, Sam this is Jamie.

Yes.

I do think a lot of the Opex is driven by the acquisition, but we've also we've been.

Diligent in how we want to expand in our opex to really position ourselves for future growth and I think that comes from a combination of people and it comes from a combination.

Tradeshows are starting to open back up you're starting to see more traveling youre starting to see some of those things that are really sales.

We call it profit generating activities so.

And on that investment side.

So really taking a.

A keen eye towards the mix between feed on the street between product and software expansion and support so.

The largest part of that increases acquisition will be very much have an eye on on the proper investments that continue to drive growth rates similar to what we've seen and what we talk about in terms of strategic planning.

Thank you and again if you have a question at this time. Please press Star then one.

And Im showing no further questions at this time I would like to turn the conference back over to Brian Coyne Lindsay for any further remarks.

Okay.

Thank you for everyone's time on the call today, our enthusiasm continues to grow for days future. Our thoughts are with the people of Ukraine, and our Digi team members partners and customers impacted by the war, we ultra piece.

Thank you to the entire Digi team and our global partners for their dedication and performance in the face of so many different market challenges.

This concludes today's conference call. Thank you for participating you may now disconnect everyone have a great day.

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Good day and thank you for standing by welcome to the fiscal second quarter 2020 to Digi International Inc. Earnings Conference call. At this time, all participants are in a listen only mode.

After the speaker's presentation, there will be a question and answer session to ask a question. During this session you like to press Star one on your telephone please be advised today's conference maybe recorded.

Require any further assistance. Please press Star then zero I would now like to hand, the conference over to your host today, Jamie Loch. Please go ahead.

Thanks, Michelle good afternoon, everyone. It's great to talk to you again and thank you for joining us today to discuss the fiscal 2022 second quarter results of Digi International.

Joining me on today's call is Ron <unk>, our president and CEO , Ron will provide his thoughts on our business and I will follow with the highlights of our financial performance.

We've provided a supplemental presentation of our earnings details for your benefit following our prepared remarks, we'll take your questions.

Some of the statements that we make during this call are considered forward looking and are subject to significant risks and uncertainties. These.

The earnings release is also an exhibit to a form 8-K that can be accessed through the SEC filing section of our Investor Relations website.

Now I will turn the call over to Ron.

Thank you, Jamie and welcome everyone to <unk> 2022 second fiscal quarter earnings call.

New this quarter is a supplemental presentation posted on the Investor relations portion of <unk> website.

Our team delivered outstanding performance in an incredibly challenging environment, resulting in several all time records that digi.

The ongoing Covid pandemic war in Ukraine ongoing inflation recent rises in interest rates and the battle for talent have not prevented us from reaching our objectives, but are limiting our full potential.

We had the highest revenue for any quarter in the company's history of nearly $95 million, an increase of 23% from last year.

Which reached an all time high of nearly $90 million.

Through a careful balance of pricing optimization and smart supply chain management, we delivered year over year gross margin growth in an environment, where macro headwinds challenged margin preservation.

We also set new quarterly records for profitability back.

<unk> adjusted EBITDA and adjusted EPS.

Our results were broad based.

Strong revenue growth and profitability expansion occurred in both our products and services segment and our solutions segment.

Is it opportunities as well as retail and point of sale connectivity.

Improved gross margin showed a great teamwork and execution of our business leaders as we carefully manage cost and price increases while meeting customer delivery dates.

Annualized recurring revenue growth was driven by increased adoption of device management and service offerings.

And our Iot solutions segment, we doubled the size of this group from last year.

Primarily by the addition of Ventas.

We added nearly 10000 sites in the quarter, driven by healthcare lottery and gaming and retail point of sale verticals.

Improved gross margins and solutions with the materially.

The increase from last year, driven by the addition of Ventas and their annualized recurring revenue contribution.

We are making a targeted investment in this segment to accelerate the transition and growth of IRR.

It remains a multibillion dollar market opportunity with the vast majority of that Underpenetrated and our offering and team is well positioned to extend our leadership.

Demand is growing rapidly notwithstanding the global supply chain constraints.

Driven by record bookings, we now have a record backlog.

I want to briefly cover our opportunity strategy and how we've been able to execute as a team.

We see opportunities in niche markets within the immense industrial Iot market, most of which is greenfield.

Ultimately this means better value and lasting relationships with our customers stickier revenue and an improved financial model.

<unk> offerings are easy to deploy manage and deliver results in the most harsh and demanding environments.

We started on this journey seven years ago.

With almost no annualized recurring revenue.

Through great work by our team complemented by thoughtful acquisitions.

Our annualized recurring revenue model delivers more predictable results each quarter and offers higher gross and operating margins than one time sales of products.

Shareholders have been rewarded and we believe that will continue.

Does your new model is intact and sustainable we see double digit annualized recurring revenue and top line growth.

Expanding gross and adjusted EBIT margins, we plan to Delever, the balance sheet with free cash flow after prioritizing business and inventory needs to support our customers.

And the integration of <unk> is progressing our acquisition thesis is being reinforced both internally and externally.

We will prudently invest in our people systems and processes to become more efficient in order to deliver an optimal customer experience.

Our confidence is growing to reach our targets of $100 million.

And quarterly revenue of $100 million in annualized recurring revenue and $100 million in annualized adjusted EBITDA.

I will now turn the call over to Jamie for more detail on our financial performance.

Thanks, Ron and good afternoon again, everyone as Ron said Digi continues to break records and sets the bar higher each quarter. Both in terms of the value we deliver to our customers as well as in the value. We believe we continue to provide to our shareholders.