Q4 2022 Digi International Inc Earnings Call

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The conference will begin shortly to raise your hand during Q.

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Good day, and thank you for standing by and welcome to Digi International fourth fiscal quarter 2022 conference call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question during the session.

I'll need to press Star one on your telephone you will then hear an automated message advisor in your hand. It's raised please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Jamie Loch Chief Financial Officer. Please go ahead Sir.

Right.

Good day, everyone. It's great to talk to you again and thanks for joining us today to discuss the earnings results of Digi International.

Joining me on today's call is Ron <unk>, our president and CEO .

We issued our earnings release before the market opened this morning, we posted a shareholder letter. This morning as well you may obtain a copy of the press release and shareholder letter through the financial releases section of our Investor Relations website at Digi Dot com.

This morning, Ron will provide a comment on our performance and then 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 statements reflect our expectations about future operating and financial performance and speak only as of today's date and 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.

The risk factors section of our most recent 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 measures are included in the earnings release.

The earnings release is also furnished as an exhibit to form 8-K that can be accessed through the SEC filings section of our Investor Relations Web site.

Now I'll turn the call over to Ron.

Thank you Jamie good morning, everyone I hope you've had a chance to review our fiscal fourth quarter and full year 2022 shareholder letter.

Before we jump into Q&A, just a few highlights.

Did you delivered a remarkable fiscal year.

We set new records for revenue.

<unk>.

Adjusted EBITDA and adjusted EPS.

We hit the first of our three 100 goals.

With consecutive quarters of over $100 million in revenues.

We remain committed to our remaining goals of a $100 million in IRR.

And $100 million in annualized adjusted EBITDA.

I'm, so proud of our teammates for their resilience determination and customer focus in the face of dynamically challenging business conditions.

As we look forward to the current year.

We continue to see strong demand, coupled with gradually easing, but still constrained supply and challenging macroeconomic conditions.

With over $300 million in backlog.

Up from $250 million at the end of the 2021 calendar year, we are poised for growth.

At this time I'd like to turn the call back to the operator for our question and answer session. Thank you operator.

Thank you.

As a reminder to ask a question you will need to press star one one on your telephone. Please wait for your name to be announced please standby, while we compile the Q&A roster.

Our first question comes from the line of harsh Kumar with Piper Sandler Your line is now open.

Yeah, Hey, Ron Jamie in the <unk>.

Digi team congratulations not just for the current quarter, but I think for the whole of last year, it's been a pretty tough environment between supply and macro and you guys have just done very well over the last several quarters I just wanted to note that and congratulate you guys.

Having said that the question is around those lines.

At one level of restaurants are doing extremely well.

At the other level, we're seeing the economy start to crumble with pressure on the consumer you talked about supply getting better can you give us can you like to sum it up for US what does this mean for Digi, we put all this together and try to peer into the future for you guys.

Yeah, Hey, harsh thank you for the comments and the question.

I wanted to just reemphasize.

He has got a really diverse set of customers. We our customers are in medical devices and industrial application agriculture, certainly fluid services, you mentioned with our smart sense group were in financial services and retail and that diversity I think has proven to be a really nice asset for us because as.

I mentioned in my opening comments, our backlog has increased.

Since the last time, we updated shareholders and so you can see that demand has not been the challenge for us that it's been more supply constrained.

We're seeing that customers.

The real value in the ROI from their industrial Iot initiatives, it's helping them save on labor.

Energy costs and in a rising inflationary environment those are pretty powerful tool that become much more urgent than discretionary. So we're seeing continued demand, we certainly don't want to ignore the macroeconomic conditions.

And so we're being very very careful about how we.

Look at our pipeline, our backlog and making sure our inventory is flowing.

<unk> been using our balance sheet too.

Make some part purchases to ensure that our customers have those parts available, but I'd say the theme for us as we speak today is much more of trying to get more supply than worrying about the demand side.

Thanks, Ron and then ill.

Just ask two questions then one and then I'll cede the floor.

Is this a good gross margin level for us to think about as we as we look into the future Ron Youre in the high <unk> somewhere in that 47% range is this a good level and then part two are separate question is you've typically.

<unk> been leaving.

Bit of revenue behind and sometimes a lot of revenue behind I believe last quarter. It was up as a kind of a big number I was curious if you can give us some insight into <unk>.

Two into how much you have left behind and how that will come back to you.

Yeah, we're still at that point where were supply constrained.

As we mentioned in prior quarters that were leaving tens of millions of dollars on the table just in the quarter and were working very very closely with our customers to make sure that their businesses are kept running we don't have enough parts to meet all the demands as you can see from that growing backlog number as well.

In the same same theme is incorporated in the current quarter guidance and quite frankly, the entire fiscal 'twenty three Jamie I'll, let you comment on gross margins, yes harsh. It's good to talk to you I think thank you kind of hit the nail on the head as our shareholder letter indicated we're very cognizant of pricing action.

And not wanting to take advantage of of supply challenges.

Collaborating with our customers to make sure that that all of US are are accomplishing our goals and missions I think as <unk> continues to grow faster than our revenue base that positive mix will have an uptick on margins as time passes but I think based on what we've seen.

Youre seeing a level of consistency with basis point improvement quarter after quarter and that feels like that.

In that range is where we will we will most likely continue to stay for a while.

Hey, guys. Thank you so much and congratulations again I will get back in line.

Yes, thanks harsh.

Thank you one moment for our next question.

And our next question comes from Tommy Moll with Stephens. Your line is now open.

Good morning, and thanks for taking my questions.

Good morning, Jonathan.

Brian I wanted to start on IRR for products and services.

For instance in your letter.

<unk> currently low attach rate for software, particularly around cellular and console servers.

But those are also.

Areas of opportunity going forward. So my questions are is there anything you can do to size or dimensionalize those opportunities.

And is there anything youre doing in terms of sales force incentive structure or any kind of internal initiatives to really drive those attach rates higher as we move forward.

Yes, Tommy Thanks for the question <unk> is a tremendous focus so.

Of the company and most importantly, because it adds more value to the customer solution. We of course benefit from hopefully their success. So I wanted to be clear that it's a real customer focus metric. It's just it's a good way for us to measure a complete solution, we are providing and that leads to opioid longer term relationship as well we've got.

Several initiatives underway, both on the process and the system side, but also to your point on the incentive side to ensure for management down to the individual salesperson that we're leading in highlighting the complete solution.

Backing out.

It's not appropriate for the customer's application.

So we do anticipate if we're able to get those take rates up that we would see much much higher growth rates, especially from product services on the <unk>, which would have a much bigger contribution to the company's <unk> levels.

Thanks, I appreciate the insight I did want to shift gears.

To cash flow and capital allocation it looks like you repaid some debt.

Fiscal fourth quarter that you just concluded and if I'm if I'm reading between the lines here on what you said around inventory and the materials you published this morning.

Plus your guidance.

It would imply that there will be.

Meaningful cash flow in the next fiscal year, and so I'm just curious what the relative priorities there would be in terms of.

<unk> debt reduction M&A anything else that you would want to highlight for us. Thanks.

This is Jamie I think of the cash flow side.

We are.

First of all we're being very mindful of inventory.

And ensuring that we're able to meet our customers' needs. So we're and as <unk> seen throughout fiscal 'twenty two.

We've deployed our capital in a way that we've acquired component inventory when available so.

As you are waiting for that proverbial Golden screw, we're kind of ready to go and make sure that we can meet customer needs and deliver on their needs and drive that revenue.

I think secondly, we look at paying that debt down, especially in an environment, where interest rates are rising you saw that we took a very aggressive posture in fiscal 'twenty two to lower that principal payment.

To really make sure that we're minimizing those that interest cash that's going out the door and I think you would continue to see that in 'twenty three.

I do think that we are confident of.

What our outlook is we're confident in the demand that we're seeing and so we're also evaluating on a regular basis, how we deploy that capital in terms of investment.

To secure growth in the periods beyond 'twenty three.

Across digi.

And then I do think.

We.

We've stated that we're heads down on our acquisition work, we're continuing to integrate ventures, which has been a fantastic.

The acquisition for Digi I think the teams have really collaborated well.

We're really proceeding.

Against our integration plan and that's going to continue to be the case.

But of course, we're always trying to be opportunistic in terms of what makes sense as it sits right now I would tell you those are our top three priorities.

If M&A became opportunistic we would address that as it came up but right now we're really focused on making sure. We've got the inventory on hand to deliver for our customers.

We're going to minimize that principal debt and really focus on trying to minimize that interest expense that goes out the door and evaluating what the right investments are for digi to secure future growth.

Thanks, Jamie I appreciate it and I'll turn it back thanks.

Thanks Tommy.

A moment for our next question please.

And our next question comes from Anthony Stoss with Craig Hallum. Your line is now open.

Hi, guys my congrats as well on the execution, Jimmy just answered a lot of my questions that Ron maybe throw on once you on the $300 million in backlog, how far out does that stretch and is it.

Maybe it gives a sense of the breakout on.

The components in the backlog is it similar to what you have on products and solutions right now.

And then also on the cellular gateway side of the business Im curious for an update just what youre seeing <unk> if things are kicking in.

Hey, Thanks, Tony.

Questions.

Backlog does spread out for the most part over the next four quarters. There are some there are some backlog that actually goes into FY 'twenty four.

It's a credit to our customers. In addition to our team collaborating on the lead times and the importance of getting those orders and giving us the confidence as Jamie mentioned to the purchased those long lead parts as we as we wait for the final kit to be to be completed.

Sure.

And if you look at.

The cellular router cellular solutions group.

We're seeing a real interesting dynamic and that there is the traditional market, which is still alive and well have the solutions that have been deployed over time either to backup wired based solutions or to be primary communications and a lot of connections to mass transit public safety to retailers, but.

But we're also seeing some exciting opportunities in private networks. There is a number of companies now that are starting to really deploy private network opportunities recently here in Minnesota, They announced aksel energies as licensing some private spectrum for for us to monitor their their assets. So there are some exciting things.

That are going on in cellular beyond just the traditional.

Public carriers into private as well as even into Iot type applications that cat M and NB Iot to a lesser extent as well as of course fixed wireless access assets, which is really displacing wires for.

Our more traditional Internet service.

Got it thanks for the update.

Thank you one moment for our next question.

And our next question comes from Derek Soderberg with Cantor. Your line is now open.

Yes, Hey, guys. Thanks for taking my questions and my congrats as well on the quarter.

As it relates to the $100 million adjusted EBITDA goal for you guys. I mean, just given the strength here more if you can put sort of a timeline on when you think you can maybe hit that.

Certainly driving subscription growth is a great way to get there.

So I guess related to that Ron are you seeing customers more willing to attach software than maybe they were a year ago on what are some of the initiatives that you might have for 2023 and beyond.

We're really driving those attach rates.

Yeah, Hey, Derik thanks for the.

The note in the comments here on the question as well, so maybe just kind of phrase.

Categorize a couple of things one as well.

We're seeing a real opportunity based on some pretty intense survey work in collaboration with our channel partners that a bundle of software and service is very very compelling and it's the combination of the two it's not just software its not just service, but that combination is very compelling and that's really what we're driving to increase attach rate.

That's a combination of expert support it's a limited lifetime warranty. In addition to our device and system management capabilities through our software applications. We do think that those attach rates will increase and those attach rates are going to have a much higher margin than what we are displaying at the consolidated level and so we do think that margin expansion.

<unk> to Jamie's point earlier will progress over time.

And the careful thing we're balancing as we feel there is an opportunity to go on offense, we're not talking about a crazy level of investment, we're making some modest investments to take advantage of some opportunities where we can further our leadership. So that's the only thing that balances the progression of EBITDA, We do think EBITDA adjusted EBIT will progress throughout the year, but.

We are tempering that a bit by making some really targeted investments in our sales and marketing team as well as our R&D team in particular on the software side to make sure that we're really pacing with the opportunity in front of us, but the compelling vision is really providing a more complete Iot solution. It's no longer set it and forget it is about <unk>.

Managing the lifecycle of that deployment and and we've got some really good feedback and survey data that really validates that opportunity.

Got it got it that's helpful and as my follow up I wanted to touch on international markets.

Ron maybe if you could talk about some trends going on internationally I'm curious if you're benefiting from.

Any of those whether it would be a.

Shift these.

These companies using western based providers.

Dentists adoption internationally just curious if you can comment on how youre feeling about international growth going forward and anything in terms of trends that youre seeing internationally. Thanks.

Yes, it's a very good question there is a nationalization thats going on without a doubt and youre seeing that protectionism.

We implemented in the U S here in.

So probably a little bit lesser extent Europe , but yes, there is a more concerted effort I think to buy either within countries that share similar values or even within countries and so we think that.

That positions us well because.

Because we aren't going to be competing quite as much as we would in the past with people from certain geographies and in particular, China.

Their expectations for gross margin are quite different and they're more I'd say hardware centric than complete solution centric and that's another thing that really validates. This tremendous opportunity. We believe we have an offering this combination of service and software to help further distinguish edgy, but first and foremost add more value to them.

Customer solution.

Great. Thanks, guys.

Thank you as a reminder to ask a question you will need to press star one one.

I have a follow up one moment please.

Harsh Kumar from Piper Sandler Your line is now open.

Yeah, Hey, Ron a quick question I know you.

I don't want to get into numbers on specific penetration rate, but I know you have a pretty substantial console installed base.

And I know when you acquired opened year, but one of the parts in your mind was to take that software and be able to penetrate that software into your current installed base. If I can ask you just not specific numbers, but just color wise, where do you stand and where do you think the optimal.

Penetration is down the line as you.

Given your goal.

Yes, it's a really good question and we've.

We've got hundreds of thousands of devices that we've shipped out there so that both the new unit opportunity of course to improve the attach rate and there is the ability to go back into the installed base.

Both both offer more software and services to that installed base.

In addition to potentially refreshing even their underlying hardware. So theres a tremendous opportunity I think our focus first and foremost is on the new because it's for us, it's a little bit easier to get that attach on new and going back to install bases budgets and the priorities that may have moved on but.

But we do think that as we add new especially if you're an existing customer. There is an opportunity then to say well why do we protect and manage all of your devices not just this incremental new device because they've got an add on order they've got a refresh of their hardware so to your point harsh.

Tax rate on new is our focus right now, but there's a broader opportunity to go to that base.

Great. Thanks, Ron.

Thank you.

And Im showing no further questions at this time I'd like to hand, the conference back over to management for any closing remarks.

Thank you, it's a very exciting time for digi.

Look forward to connecting with you throughout the quarter here, we've got a couple of conferences, we'll be attending we have our first tenants at Stephens annual investment conference on November 16th and 17th in Nashville were also attending Roth 11th Annual Technology Conference November 16th in New York City, as well as Craig Hallum, 13th annual Alpha select.

Conference on November 17th in New York City. Please contact.

Your representatives to schedule time with us.

In the meantime, stay safe and we look forward to connecting with you.

This concludes today's conference call. Thank you for your participation you may now disconnect everyone have a wonderful day.

Yes.

So we dismiss walkley and then the cantor.

The conference will begin shortly to raise Johan during Q&A you can dial one one.

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