Q1 2023 Digi International Inc Earnings Call
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Lower Johan during Q&A, you can dial star one one.
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Good day, ladies and gentlemen, and thank you for standing by walking through the first fiscal quarter of 2023 Digi International incorporated 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 will need to press star one one on your telephone keypad.
At this time I would like to turn the conference over to Mr. Jamie Loch Sir you may begin.
Thank you 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.
Turning me on today's call is Ron can Anthony 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 and 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.
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 website.
Now I'll turn the call over to Ron.
Thank you Jamie.
Morning, everyone before we jump into Q&A, just a few highlights.
I sound like a broken record.
We set new quarterly records for revenue annualized recurring revenues or <unk> and adjusted EBITDA.
We sustained first the first of our three 100 goals with another quarter of over $100 million in revenues.
We climb closer to our remaining goals of $100 million and <unk> hundred million of annualized adjusted EBITDA.
We're excited to play a leading role in our customers' digital transformation, which has become increasingly important.
In unpredictable macro environment.
We continue to see elevated demand as evidenced by our strong backlog.
Gradually improving supply chain has helped us exceed our expectations.
We expect those dynamics to continue throughout the balance of our fiscal year.
Lastly, we are making tremendous progress with our processes systems and services to enable superior customer experiences and accelerate the delivery of differentiated solutions driving increased AOR growth.
At this time.
Like to turn the call back to the operator for our question and answer session. Thank you operator.
Ladies and gentlemen, if you have a question or comment at this time. Please press star one on your telephone keypad.
Again, if you have a question or comment at this time. Please press star one one if your question has been answered or you wish to remove yourself from the queue simply press star one one again, please standby, while we compile the Q&A roster.
Okay.
Our first question or comment comes from the line of Tommy Moll from Stephens. Mr. Moore. Your line is open.
Good morning, Thanks for taking my questions.
Yes, good morning Tommy.
So I wanted to start off Ron I think I saw some of the language in your letter about having stronger confidence in the 'twenty three outlook and I was curious is that primarily related to the fact that you just beat the first quarter or if you look at the demand and supply chain dynamics.
Better versus when we spoke a quarter ago and if they have any context would be appreciated.
Yes, it's on a very good question, we really feel like demand continues to be robust. So our performance has been more dictated by the availability of supply and you saw that happen in the first fiscal quarter, we had more supply that enable us to exceed some expectations there.
We do still have supply chain challenges, we're seeing less of them.
That we saw in a period or a year ago, but theyre not theyre not alleviated yet so the extent that we get.
Additional supply, we can meet and potentially exceed expectations.
That's helpful. Thank you.
And then.
Zooming in on the next quarter outlook, you've given for the second fiscal quarter.
With that.
Backdrop, you just outlined which sounds fairly constructive can you walk us through why you would expect revenue to be down quarter over quarter or is there some conservatism in there or any assumptions yes.
Really our visibility to supply chain, it's not a demand issue. We've got a robust backlog. So it's really getting access to key components that we can turn into finished goods. So we like to make sure that we've got expectations that are consistent with our supply chain visibility if that improves.
We would be communicating that.
And the associated compression in EBITDA margin quarter over quarter or is that simply a function of lower volumes on that supply chain constraint or is there any other noise you would want to call out.
No we continue to make investments in the business and we don't want to slow down those investments, especially those associated with improving the customer experience and again to the extent that we can get access to components. We do have some I think some.
Im very considerate assumptions, we've put in there for costs. There are still some components that are coming out increased costs.
And although we work to Mark those down we don't want to make sure we get too far ahead of ourselves.
I appreciate the context and I'll get back in line. Thank you.
Tommy.
Thank you. Our next question or comment comes from the line of harsh Kumar from Piper Sandler Mr. Kumar. Your line is now open hey, guys. Congratulations on yet another solid quarter, Ron Let me, let me start off with something simple are you guys still leaving revenues on.
The table could you characterize for us how much that might be.
Yes, we absolutely are it's still in the double digits millions of dollars that we're not able to ship in any given period, we do think as the supply chain eases there could be some.
Normalization that occurs but right now were still not able to meet all of our customer demand.
Okay, Great and then I had a question on <unk>.
Cold chain business, so everybody's out eating out people are out moving around and that should be a tremendous tailwind for your cold chain business I was curious if you could.
Frame for us how you see the growth in that business and I know there was an angle on international expansion, particularly maybe in the European side.
So if you can talk to that.
Yes, we were really happy with this quarter harsh and that we've got balanced contributions from really all of our offerings across all of our geos. So it was a rewarding quarter and that included of course, smart sensor and Youre absolutely right harsh food has been a big part of that of that businesses success, not just the restaurant side, but grocery continues to be a.
Strong vertical for us as well on international expansion, we want to be very considerate, we have plenty of opportunity domestically.
We still look towards international expansion in Europe would be the most likely scenario, especially as we land multinational customers that want us to have a broader presence, but we are being very considerate and calculated about geographic expansion.
And then I had a very similar question Ron.
Integration of Ventas.
I was just curious if it's all done at this point in time or how far along are you.
And then.
Do you think David there wasn't internationally angle to that as well and then if you think maybe.
Maybe one just under control and shut off.
Taken care off from an integration angle if.
If it's time for you to start thinking about adding something else in your portfolio.
Other uses of cash at this time.
Again, good questions harsh.
We are largely complete with the Ventas integration, we do have one big milestone, which is converting their ERP and CRM to the companies.
Systems, which will improve which will conclude about the middle of this calendar year.
But that's in good shape, there is a great team.
Well underway in implementing that.
The international expansion is very similar to smart sensing that we have some larger customers that are asking us in particular for European presence and that's a great way for us to enter those markets part of the experience of being a that this customer is making sure that you have that excellent uptime, which includes making sure we have the people the inventory.
The processes and systems and so we want to pace that really with the implementation of our ERP and CRM integration middle of this year. So that's definitely an opportunity lastly.
We are always looking for opportunities to grow Inorganically, we have a robust pipeline out there we are.
As you know we are focused on integration execution, reducing our leverage and so that remains the priority, especially.
So may be slowing down, but rising interest rate environment. We think it's important to us to delever and prepare ourselves we are biased towards potentially fewer bigger deals and smaller deals and so those can take a little longer to curate and get the confidence that we are the best owner and operator of those businesses.
Fair enough guys. Thank you so much thanks harsh.
Thank you.
Our next question or comment comes from the line of Mike Walkley from Canaccord Genuity. Your line is open Mr. Walkley.
Alright, Thanks, Rhonda congratulations to you and the team on the progress towards your three 100 schools.
Eric I wanted to focus on can you update us just on the business model transition.
Away from one time hardware sales to the stronger mix of recurring revenue how should we think about the pace of this journey and impact if any to near term growth rates and product sales such as the cellular routers and gateways from a more recurring revenue mix.
Yes, good morning, Mike Good question.
Tremendous imperative for the business, we are being very very I think considerate and thoughtful in making sure that we generate a an incredible customer experience and that starts with our processes with our systems. We are going through a very deliberate stages of piloting with our channel partners, who are a critical part of the success of these programs.
And there is some system enablement that we're doing and we're going through if you will a crawl walk and run phase that will gain momentum as we pace through this fiscal year. We expect really began fiscal 'twenty four at that run stage, where in particular at routers, but other parts of our businesses as well being really fully committed to that.
That experience and that solution that has the strong attach rates.
Great.
Good luck on the transition and Jamie just a question for you with the strong backlog you built up a lot of inventory this quarter any thoughts and kind of working capital and how this might impact stronger free cash flow as the year progresses, we're going to keep inventory at these levels do you think that kind of burns down over time as you.
Ship against the backlog.
Good morning, Mike I do think the inventory will burn down, but I think we're also trying to be opportunistic where.
While while were seeing improvement there are still some constraint out there and so.
When opportunities too, especially in the component side present themselves.
For us to be able to deploy our capital that way and really secure.
That forward looking revenue that's coming out of the backlog, we're going to take advantage of that so.
I would tell you that over the course of time inventory clearly will come back to normalized levels does that happen in say one quarter or two quarters.
That's hard to it's hard to tell because.
Youre still a little bit blind on certain areas and so when all of a sudden and opportunity arises we will.
Go through an evaluation period to decide and sometimes you're buying components. Knowing that you still don't have that proverbial golden screw and so you know that it's going to sit in inventory for.
A quarter or even two quarters. So I do think it comes down, but I think inventory inventory will will.
While most likely.
It could it could Bob and weave a little bit as those opportunities present themselves, but we evaluate that as they come forward.
Okay. It makes sense and one last question and I'll pass the line.
Brian .
You've talked in the past about strong demand trends in revenue left on the table or are you seeing anything in terms of demand patterns from your customers, where whereas demand still just as strong and that's really just supply that's that's.
Thats keeping your guidance.
Kind of in that low teen or just over 10% range.
Yes, it's really it's really the burberry supply that's been governing our performance much more so than demand. We've got strong demand the backlog stretches up mainly the next four quarters, but in some cases actually goes well into fiscal 'twenty four for those that really want to ensure their delivery of products and.
As nice as we're seeing not just good contributions geographically, but across different verticals, whether it be us as we talked about earlier the food vertical for smart sense.
EV charging renewables has been a strong segment medical device has been a strong segment data center.
Retail so it's nice to see.
<unk> tack if you will.
Great. Thanks.
Thanks for taking my questions and congrats on the strong start to the fiscal year.
Thank you thanks, Mike.
Thank you. Our next question or comment comes from the line of Anthony Stoss from Craig Hallum. Mr. Stauff. Your line is now open.
Congrats as well a lot of my questions have been asked but maybe if I could just hone in a little bit more on the backlog run was it up sequentially from last quarter end.
Can you share with us maybe the bulk of where that might be or how it splits amongst the three divisions and then follow up would be if youre seeing any kind of weakness either geographically or within any of the three business segments.
Yes, it's a really good question, it's something we look at very carefully it remains at historically elevated levels. We are struggling to get all of the parts to meet our customer needs. Although as we said earlier, we are seeing some easing there which are clear last quarter drove our outperformance that backlog is mainly in the next four quarters. It does spill into 'twenty four we have been.
Really watching Europe in particular with the warranty train with inflation rising energy costs.
We've been really pleased that Europe has held up that was the area. We've I think we've been most concerned about.
But with these rising input costs, if anything really accelerate the urgency on digital transformation to save on labor to save on truck rolls and that ROI is really compelling even in times that could appear dyer. So we're pleased with better performance than we expected, especially out of the European theater.
Okay. Thanks, guys.
Thank you.
Our next question or comment comes from the line of Scott Searle from Roth Mr. Sara Your line is now open.
My questions nice job on the quarter guys.
Maybe just to quickly jump in Ron it sounds like Youre continuing to be supply constrained, but things are improving you guys have guided conservatively I'm wondering if you could give us some color in terms of what visibility do you have to the current level of guidance, particularly at the lower end of the range I would imagine at this point, it's probably pretty good and then I had a couple of follow ups.
Thanks, Scott Good morning, Yeah, as I mentioned demand has not been an issue for us. So it's really our line of sight on key components, and we're making some assumptions that our partners will deliver to our contract manufacturers and we are taking at what I think is a reasonable approach as to how people are performed in the past and will they perform we're not trying to be true.
<unk> that we're assuming too many enhanced improvements and their ability to deliver those components are manufacturers are healthy and ready to turn that into finished goods. So we think we've got a reasonable approach given the information we have we.
We still see some sticking points there are some components, especially those that are used by automotive industry that we're in.
In contention with to get our allocation.
But we think we've got a sort of a reasonable level of assumptions we've put into that.
Got you and if I could on the product front you had good results.
Quarter up sequentially gross margins look good I wonder if you could provide a little bit more color in terms of how things are progressing from September to December and the outlook from a gateway perspective from an open gear perspective being the two elements of that business there what youre seeing on that front, how that pipeline shaping up and maybe some color in terms of the end markets.
Yes, I think we're seeing which again really rewarding to see every one of our offerings grow year over year and contribute to the company's success. One of the things that we're excited about is <unk> is starting to gain a little more momentum than it has in the past and in particular for our retail segments.
We're excited to see that <unk> promised start to kick in and that affects of course, our cellular router and gateway business, but also.
Businesses like open year to a lesser extent.
Great and lastly, if I could on.
On the Iot solutions front revenues were a little bit flattish there grew but it hadn't grown at a particularly accelerating pace I'm wondering if there's anything to be read into that how is that pipeline and book of business starting to shape up. Thanks. So much yes, it's a good question.
And we are targeting growth that's in excess of our revenue growth for IRR and we do feel confident we've got the pipeline. We've got the opportunities. There is if you will a real deliberate approach to make sure that that ROI is there, especially with larger rollouts that really start to move the needle. So you see our our book of business. If you will kind of.
Of your small medium sized opportunities continues to progress, but the larger opportunities I think are getting a little bit more scrutiny, but we do expect those two to really help push that <unk> growth further as we go throughout the fiscal year.
Maybe Ron just to quickly follow up.
As you start to look at the gateway business and managing some of that transition to more of a ventas model should.
Should we be expecting an acceleration on the IRR front, particularly in and around <unk> as we look into the back half of the calendar year, yes.
Yes, that's a very good question. It's one of the key growth synergies, we had between Ventas and Digi and cellular routers in particular that those teams are working closely together. So for example at the <unk> Tradeshow held.
Recently in New York City. Those teams were really in the same exhibit area working with those customers to make sure we're providing the best solution and we're certainly bias towards a managed service model.
And we think we can convert those opportunities.
Great. Thank you.
Thank you.
Next question or comment comes from the line of Derek Soderberg from Cantor Fitzgerald. Mr. Steinberg. Your line is now open Hey, guys. Yeah. Thanks for taking my questions and my congrats as well on the results.
Ron I was curious if you can talk about sort of which areas of the business. You think you can drive subscriptions.
My understanding is that some hardware products, maybe it's embedded solutions.
Makes sense for subscription agreement.
Should you take sort of a cradle point business model.
What portion of your product portfolio do you think you can successfully drive subscriptions I mean is it half the business.
Did the routers and gateways.
How should we think about what portion of the product portfolio. You think you can go to sort of a 100% attach rate.
Yes, we feel strongly that with the exception of our OEM embedded solution that we can really push our.
Our business in our offering towards a solution offering embedded will not be 100% that those companies are typically working with us at the engineering level. We're a part of their Iot solution, but not necessarily all of it that doesn't mean, we can improve our <unk> in that business, but it's not going to be 100% like we would expect out of our business.
<unk> of course and solutions that are already there, but even our our box businesses like infrastructure management cellular and open gear and where we think we're going to have really compelling offerings.
Got it got it and then Jamie on the gross margin front I think they were slightly.
Slightly down year over year can you just kind of talk about or maybe quantify the puts and takes.
On what's having an effect on gross margins.
If you can where do you think gross margins will move from here sort of as we move throughout the year. Thanks.
Yes.
Thanks, Derrick I think there's really a couple of things that drive that and purchase price variance as one of the biggest impacts that you see in that constrained environments.
Youre seeing pricing on certain components.
Going up and above what we've got our standard pricing in App and our accounting policies have been to take those purchase price variance out at the time.
Seeing the inventory so one of the challenges that we do get is as inventory goes up we see a little bit more purchase price variance flow through the P&L.
We are seeing that to some degree.
On a large scale kind of the theme is that it's coming down.
You still see pockets of it and again, it's kind of back to that timing issue, where depending on the components that you buy that depending on the opportunities of how youre deploying the working capital that is another part of the equation in terms of where is the pricing on those components, where do we think that pricing is trending and so that's.
That's probably one of the biggest impacts that we've seen on the gross margin side, we've talked in the past about our pricing strategies and how in some cases youre able to get that reflected in price in other cases, we've made determinations that it's appropriate for us to make that investment into the relationship with our with our customer.
<unk>.
I think you've seen us as the supply challenges have really navigated their way through.
Really watching those gross margins at a sequential level and youre seeing that just a regular pretty consistent ticking up and I think youll continue to see that as the supply chain stabilizes as recurring revenue becomes a greater mix of the total revenue portfolio, which.
Provides strong mix into that so I think youll continue to see that.
That gradual improvement, making its way through as those as those two elements.
As time allows those to flow through the P&L.
Got it that's helpful. Thanks, guys.
<unk>.
Thank you. Our next question or comment is a follow up from Mr. Tommy Moll from Stephens. Mr. <unk>. Your line is now open.
Just a couple more to to wrap us up maybe for the day.
Ron one comment you made.
The materials this morning was around.
<unk> was maybe not as the growth was maybe not what you had hoped for first quarter, but you're still confident.
And exceeding overall revenue growth for the year, you called out some internal investment and process and systems. There can you give any more detail around that.
Yes, so what we are spending a lot of time as a team is making sure that especially in a business that goes through a channel Tommy that when we ship inventory to that channel and it eventually gets to the end user we get that point of sale data back in that point of sale data has to contain the serial numbers. So we create the customer account or if it's in.
The existing countless projects go into that account. So it's a seamless zero touch activation for the customer and the first contact they get is a pretty proactive one for us making sure. The channel partners have the systems the tools and give us the data on a timely basis is incredibly important and of course, then we've got to make sure we ingest that data.
Into our ERP CRM system and into any host systems like the best device management system. So that gives you. An example of some of the plumbing that we're putting in place to make sure that that customer experience is an.
Standing one.
That's helpful. Thanks.
Jamie This will be my last question of the day and.
I wanted to ask.
Follow up on working capital, which has been discussed a couple of times or at least inventory.
Hear you loud and clear that making a call on inventory in any given quarter is difficult just because you've got the plant.
By Opportunistically.
I think I hear you say, but just as a working assumption for working capital comprehensively for the year.
Are we thinking a source of cash or use of cash neutral or no way to know.
Yes, I do think when you look at it over the year I think digi has always been a good strong generator of cash I think that will continue I don't think you end up in a use of cash position I do think you may not have cash flow from operations as high as maybe.
What we've seen in the past.
But I definitely right now I'm not projecting that it would flip into a use of cash position as much as just less positive than normal course and speed.
That's great I appreciate it I'll turn it back.
Thanks Tommy.
Thank you. Our next question or comment is a follow up from Mr. Harsh Kumar from Piper Sandler Your line is open Sir.
The follow up guys first of all just a quick comment I love the format of this call all the information is in the latter.
It's pretty quick and we can get to the topics that are on our minds. So I. Appreciate you. Following this and then Ron for the question you've got a couple of different software you've got lighthouse, you've got smart channel software.
The question is really on <unk>.
Journey towards.
Better.
<unk> could you maybe help us understand.
How much of that software Ken how much of that software is penetrated for example into your existing hardware.
And therefore as you move towards a greater penetration what would that impact roughly beyond the hours.
Yes, yes, thanks for the follow up partially.
As probably most people know our solutions segment, it's 100% attach rate you cannot do business.
You cannot consume their offerings without a subscription that's part and parcel within our product and services businesses.
The attach rate if you will has been well under 30% were moving towards 100% attach rate with.
Both systems processes offerings, and as well as increased software content.
We announced containers are available now for our cellular gateway. So as an example, the OEM business recently announced their connect core cloud connect core security services, which allow our customers to have more of this solution provided and gets them to market more quickly. So you're seeing very demonstrative efforts on the product side.
As well.
And with these opportunities with exception of embedded we think we can raise towards 100% attach rate, but we want to be very considerate very thoughtful in the process. The systems the service and the experience that this bundle that we're offering is going to be comprised of 24 seven support limited lifetime warranty.
And of course, all of our device management capabilities in software. So we think it's a compelling offering that the market will see well.
So Ron from a process angle I suppose when you make a sale now from a product angle you is it mandatory because the customer can get the software with it or do you really push them, but its not mandatory.
Yes, it's not mandatory we're moving from opt in opt out and then eventually into.
Product lines, having that part and parcel of the experience that and Thats, a courageous moment for us harsh where we telecast summer that doesn't want the full offering that we may not be the best fit for them.
And Thats, what we are building up towards.
Got it okay I appreciate it Ron Congratulations again, Jamie Ron and the team.
Thanks, Alright, thanks harsh.
Thank you I'm showing no additional questions in the queue at this time I would like to turn the conference back over to management for any closing remarks.
Thank you for attending <unk>, earning call earnings call and for your continued support for.
For investors, we will be attending Roth Capital's 30, <unk> annual conference March 12 to the 14th in Dana point, California have a great day and thanks again.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day speakers standby.
No.
The conference will begin shortly to raise and lower Johan during Q&A, you can dial star one one.
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Okay.
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