Digi International Inc. Q2 2023 Earnings Call

Good day and thank you for standing by welcome to the Digi International second fiscal quarter earnings call. At this time participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session.

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Withdraw your question. Please press star one one again.

Be advised that today's conference is being recorded I would now like to hand, the conference over to our speaker today, Jamie Loch Chief Financial Officer. Please.

Please go ahead.

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.

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.

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.

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

We are excited to deliver our ninth consecutive record quarter.

It is especially gratifying in a volatile and seemingly ever changing macro environment.

With $100 million in quarterly revenue sustained.

We are confident we will capture the remaining of our $100 million objectives.

Annualized recurring revenue and annualized adjusted EBITDA.

With a large and growing industrial internet of things market Digi has the potential to build and extend our leadership role as a premier solution provider for business and mission critical applications.

At this time I would like to turn the call back to the operator for our questions and answer session. Thank you operator.

Thank you at this time, we will conduct a question and answer session. As a reminder to ask a question you will need to press star one on your telephone and wait for your name to be announced to withdraw. Your question. Please press star one again, please standby, while we compile the Q&A roster.

Okay.

Our first question comes from Tommy Moll of Stephens, Inc. Tommy Your line is now live.

Good morning, and thanks for taking my questions.

Good morning, Tommy.

Brian I wanted to start on recurring revenue maybe.

Maybe a two parter here one on each segment it sounds like the progress on PFS with strong.

You can do to update us there on the initiative to drive higher subscription attach rates would be helpful and.

And then the flip side on solutions it sounds like it took a little longer than anticipated to close some deals, but it feels like second half might be better what gives you that confidence notwithstanding as you referenced some of the concerning macro backdrop. Thank you.

Yes. Thanks, we're really pleased with the performance in product and services and we are still nowhere close to our potential we had some great new contracts as well as renewals of existing so we're pleased with those results on the solutions side. We did have some larger enterprise deals that have taken more time to close we're confident we're going to see those.

Improvements.

And then the back half of the year, but but but we're really excited to see that result on the P&L side.

Okay.

And moving to the guidance you provided for the third quarter.

I'll call it flat to down from a revenue standpoint sequentially can you unpack that for us in terms of what you have versus having assumed for supply chain headwinds.

Is there any impact or read through here from a demand perspective.

Any seasonality trends you would call out would be helpful. As well. Thank you.

Yes, no seasonality trends similar to previous quarters, we are still supply constrained it is getting slowly better, but we still have some challenges I think part of it is.

The surge in demand in.

The strong backlog that we have but we are still having some trouble getting access to certain parts of our guidance does incorporate continued headwinds on the supply chain, albeit slowly improving.

So is there anything to read just in terms of an underlying demand.

Outlook on the sequential trend there.

Still seeing incredible pipeline.

I've heard a lot of synergies so we continue to not be demands.

Constrained as much as we are supply constrained, we're happy with I think our position as well as our customers' businesses. We're very diversified so even if one particular segment has challenges we can more than offset that with strength in other areas. So we're happy with the demand profile.

You have to convert some of these larger <unk> and our solutions segment as we previously commented, but it's not that we don't have a pipeline.

Got it thank you and I'll turn it back.

Thank you one moment for our next question.

Okay.

Our next question comes from Scott Searle of Rock N K M. Scott Your line is now open.

Hey, good morning, nice job on the quarter. Thanks for taking my questions.

Ron maybe to start in terms of the outlook for the year raising that to 12% if I if I take the midpoint of the June guidance. It implies a softer September that's traditionally our stronger seasonal quarter.

Based on your prior comments it sounds like the pipeline is pretty healthy is there anything to read into that or you guys just being conservative I know, it's 12%, but it sounds like the overall supply chain is improving albeit still constrained and the pipeline is pretty robust.

Yes, as I mentioned earlier, Scott the seasonality has really become more and more muted within digi certainly we've been growing sequentially as the business expands its supply chain improves but.

Now with approximately a quarter of our revenue recurring in nature, that's really helping us be a more consistent performer than say in the past, where we had maybe a little bit more seasonality. Our guidance does I think include supply chain constraints listen we've got some crazy things going on from a macro perspective. The fed is still determined yes. It is.

Slow things down and get inflation under control. So we're incorporating these macro headwinds into our guidance to give investors and shareholders. A good sense of what we're capable of which is the specific language of at least 12%.

And we still believe that we will grow <unk> and profits faster than that.

Great helpful and if I could to dive in on couple of the segments on the open gear front.

Data center from a macro standpoint has been softer in digestion. There you guys have been relatively insulated.

Im wondering if you could give us an update on that front, particularly given some of the end markets I think are into financial services, which has seen some disruption and similarly on the gateway front.

Can you give us an update in terms of how demand is going on that front, what youre seeing in the channel and is there any concerns as youre looking at a next couple of quarters by some of the different vertical end markets.

Yes, Scott I'll try to make sure I tackle each of your questions. The first one on console server.

If you recall we had.

Hated earlier that can also serve has really seen a shifted their business.

From a majority of any data center to now majority being edge deployments what is edge deployments can be in small branch offices can be in retail stores.

We're increasingly IP is using that as a tool to manage that equipment remotely and data centers become less important for console server. So it still remains a strong and important part of our business, but we are seeing much more edge business there on the financial services fronts.

<unk> has a real diverse set of end markets Ventas certainly has some some bias towards financial services.

Good news is that Digi services business and mission critical applications, and so keeping bank branches Atms quiet sales up and running is really an essential service. So even though banks are having some challenges in certain cases.

It's really something we continue to expect to service even beyond.

Any particular challenges that are say a regional bank may be facing.

Great and two more quickly and they will get back into queue, but on the open gear front I think that there were some additional opportunities to drive recurring revenues and attach rates on that front Im wondering how youre doing from that perspective, and then maybe just some quick updated thoughts in terms of the pipeline on smart sensor in the recovery of the cold chain product.

<unk> are a potential remains.

Yes.

A tremendous opportunity.

We still have really sub 30% take rates across the business. So theres still remains this this.

The potential to increase that take rate and two and to see that result in annualized recurring revenue, we're making some really good progress.

The open gear side in particular with extended Warrantee 24 by seven in some cases types of your plans. So I think openly here is going to have a lot of potential that we can realize over the next few quarters.

Great. Thank you.

One moment for our next question.

Okay.

The next question comes from Anthony Stoss of Craig Hallum. Your line is now open.

Hi, guys nice execution again.

Ron talked to me about.

<unk> got really really solid growth rates do you think youre, taking share from competitors and maybe a follow up for Jamie occasionally when you guys talk about some supply constraints and missing X amount of revenue how much was it that you probably could have hit.

For the last quarter revenues, if you werent supply constrained.

So it's a really good question on <unk>.

<unk> landscape, we do some really nice win loss analysis.

Perfect and our visibility, but we do think we've got pretty good visibility I think the competitive actors haven't changed but there have been some changes from an M&A perspective with <unk> acquired Sierra we have a smaller competitor in smart sensor was recently acquired as well. So we do think we are in a great position to have taken some share in <unk>.

We can take additional share.

We like the fact that we have been and then we had a company now for well over three decades, we've been a consistent performer both from our product solution, but also as a as a company so I think that.

That flight to safety, if you will.

Positive impact.

On busy so I don't have specific measures I can share with you Tony but I do think we're in a great position to have taken share and also to continue to have that happen.

Yes, Tony it's Jamie.

On the supply chain, we do see it improving and easing you still get.

Wedged in with that Golden screw right. So in the past you might be missing two or three components per device.

<unk> down to one but you still can't get the device when its just one so we do see it getting better, but we still see some constraints.

As far as revenue that gets left on the table what I would say is it's really in line with what we've seen over the past several quarters that it hasnt really changed from that dynamic units.

It's pretty consistent over what we've seen for a period of time now.

Got it thanks for that and if I can sneak in one last one for Ron again.

Love to hear more about the router side of the business you commented about some tech acquiring Sierra.

I'm curious if you've seen any kind of change or pick up in orders again as some uncertainty about that business from Sierra underneath some tech.

Yes, I think it's early to say we've had specific gains on that but I do think there's more and more opportunities, where we're going to be a strong consideration where in the past maybe it's business as usual.

I think the.

The story is yet to be told on those on those dynamics.

Perfect Nice job guys. Thank you. Thanks, Thanks, Brian .

One moment for our next question.

Okay.

Our next question comes from Derek Soderberg of Cantor Fitzgerald. Your line is now open.

Yeah, Hey, guys. Thanks for taking my questions and congrats on another solid quarter here.

So building on an earlier question on the open gear business. Ron I think you had mentioned theres sort of sub 30% take rates.

Theres, a product refresh cycle kind of going on in there.

And I'm wondering if you're using that to sort of shift the conversation to selling the more hardware software bundle.

I'm just trying to figure out if open gear as an example of.

Are you guys, starting those conversations and starting that shift where you can really start to see those those attach rates grow from here.

Derek Good morning, it's an excellent question I think it provides a couple of different avenues as we work with our customers to consider a transition to the next generation. There certainly are some customers that want to hold tight for whatever reason and there's an opportunity to go back to those customers to talk about product longevity extended warranty.

Service packages that include 20, <unk> support and then Theres also to your point the opportunity as they get into OEM, they've got a lot more tools at their disposal that are software oriented which actually increases.

The need for lighthouse device management and to have that service package. There is a lot more capability in the new product line. So derik, it's opening a nice opportunity for us either if you don't want to make the transition because it's just not right timeframe or when you do want to make the transition.

Got it got it and then as my follow up Jamie just on inventory.

It sounds like the supply chain continues to prove improve inventory is up slightly.

Are we sort of cresting at these inventory levels.

Or do you think inventory should go up from here, Yes, I think it's a good question Derik I think the inventory we are seeing improvement we're still.

Taking opportunities, where we can to secure at least on the components side to.

Do our best at securing that future revenue flows. So I think theres a possibility that we could continue to see some increases in inventory here the rest of our fiscal year, we've kind of internally.

As we've discussed in the past, we really probably are planning on the inventory starting to reduce.

In fiscal 'twenty, four rather than fiscal 'twenty, three now thats, obviously going to be dependent upon what actually becomes available.

Components, we're really looking at.

So I don't think we can say specifically, but.

We're kind of looking at opportunities to continue to secure our components and so there is a reasonable possibility that inventory could tick up here in the next two quarters.

Got it that's helpful. Thanks, guys, thanks to Eric.

One moment for our next question.

Your next question comes from Mike Walkley.

Corn Genuity your line is now open.

Great. Thanks, and congrats on the solid results in a tough macro.

I guess question first for you Ron as you look at the Iot industry.

About strong win rate.

And share gains.

How do you look at further consolidation in the industry given digi has been successful and consolidating several companies over the past several years, we are seeing any change in terms of like valuations from privates, given the macro or any new opportunities or areas that did you might take advantage of over the next year or two.

Hey, good morning, Mike excellent question.

As we've discussed before Iot is this massive markets, even industrial Iot is a just a huge market.

Really plagued by.

Many many smaller private companies. So it's ripe for consolidation and then Digi has and I think we'll continue to be.

A consolidator.

We're seeing a bifurcation there is certainly properties with either fatigue investors or maybe performance have met expectations that I think gets here of the rite mindset, you can pursue those things with.

The lower valuation expectations for price of debt has increased so financial sponsors are not able to reach as high as they would in the past.

Really good properties that have really good performance, we're seeing quite frankly more than defer their processes and so the macro conditions improve there are some coming to market, but I'd say buyers, including digi are being probably a tick more.

Disciplined in how we approach those.

So we're going to continue to to.

To work, our pipeline and to be in a good position win.

Our desires match those of.

The company wants to join Digi.

I think youre going to continue to see that'd be a theme within digi.

Great. Thanks, and then follow up for Jamie on that front, given the higher interest rates. How do you feel about your current debt levels as the plant is still maybe.

Inventory levels start to generate cash next year, and you're continuing to generate strong free cash flow you plan to use cash to pay down debt or do you think thats kind of at a level youre comfortable keeping for now yes.

Mike I think the strategy is still the same and we talked about it in our shareholder letter we will deploy capital.

To capture inventory that we need in order to meet demand and deliver for our customers.

I think.

As that settles down I would very much be looking to continue our history of aggressively paying down our debt minimizing that interest expense we're comfortable.

What's that level. It is not ideal in the rising interest rate environment, but digi has demonstrated free.

Our strong cash flow over the last well really in its history and so we like the way that we generate cash operationally.

We will continue to deploy that in the best manner and to the effect that that has on reducing debt loads, we'll absolutely take that Jamie I think as we see.

See the supply chain gradually improve we've got this.

Strong position to meet our customer demand, we should see increased cash generation and be able to apply that towards that we're going to first and foremost take care of our customers and our company.

And now we're in look to retire debt.

I think it's fair to say.

To visualize us generate more cash that we can apply it to pay down the debt totally agree.

Okay, and just one last question and building up that kind of going back to inventory.

A year and partner distributors are they lowering their inventory at all yet or given you've been supply constrained it's pretty stable in terms of channel inventory and do you think they will lower their is also at some point if you hit a better supply demand balance for the industry.

Good it's a good question, Mike what were seeing really in the channel right now as inventory levels are moving back towards sort of pre COVID-19 levels.

And so I would say we've seen a normalization of the channel inventory side.

Think theres been such a groundswell of demand that.

They are interested in kind of getting back to more normalized levels as well. So right now we're seeing a normalized spot we keep a pretty close eye for obvious reasons on where those balances are up but we're right now it's migrating towards a more normalized position.

Okay. That's helpful given numbers, you're putting up so good thanks for taking my questions. Thanks, Mike.

Okay.

One moment for our next question.

Our next question comes from harsh Kumar of Piper Sandler Your line is now open.

Yes, hi.

Curious if you guys left any revenue behind in this quarter because of supply shortages.

And if you could just size that for us if possible.

Yes, it really are similar to recent quarters, we've been supply supply constrained and I know, it's frustrating for all of us to hear that that repeated statement.

We do we do bump into automotive more so than other companies in terms of competing for parts and so we've been constrained in revenue on the table similar to <unk>.

Recent quarters.

And you said.

And magnitude that 5 million is that a fair number for us to think about yes, yes.

Yes exactly.

And Ron I wanted to ask this because I get this a lot from our clients you've got a couple of different software businesses, you've got the lighthouse piece.

And then you've got like what I would call as the jobs of the works module that goes into the cold chain.

I'm just curious.

But they are only <unk> based revenues I was curious how.

First of all you mentioned that the take rate on the lighthouse software rich.

And the open beta software is less than 30% is this where you expected to be in this life cycle. At this time or is this a trend back in some way.

Secondly, what do you think this number can go in and then which category of revenue does it fall into it as the following the solutions or the other product site.

Yeah. So on the private services the two premier software offerings are lighthouse and did your remote manager.

And collectively those have take rates of less than 30%, albeit youre actually slightly exceeds that and we do think there is great potential we're putting systems processes.

In place not only to.

So we'd make sure our customers are joining us capabilities, but that our channel partners are better able to fulfill on our customer experience.

It's by no means not a setback we had signaled that hey, we are going to be taking this fiscal year to get that customer experience nailed before we really make the stronger push so so really meeting expectations today on the on the solutions side really that which is a combination of ventas and smart.

Ventas as Theyre set of software.

Genesis in particular, and then and then smart sense has their application Thats of course, both for condition monitoring as well as workforce management. So so those are the those are the premier software offerings within private services as well as solutions.

Okay got it and then Andy as you mentioned that the console server pieces moving from the data center edge, which has got to be great for you because the edge.

<unk> are a lot more than they would kind of diversify it and spread out across banking and retail.

Is there opportunity for.

Opening your software and those range application scale or is that just more of a hardware sale.

No absolutely is as big if not a bigger opportunity edge than it is in the datacenter datacenter youre more likely to be using a variety of different applications like splunk and other things, whereas on the edge youre, even more likely to want to have lighthouse software to both manage.

Your console server and containers and other software you have on that council server as well courses interfacing with the nodes that are attached to that console server, whether it be routers or storage area networks firewalls et cetera.

Got it Okay fair enough guys. That's it that's it from me. Thank you and congratulations excellent execution, just basically what is a tough market.

Thanks Al Thanks harsh.

Thank you and as a reminder.

If you would like to ask a question you will need to press star one on your telephone.

Last call for questions.

Okay.

Great.

Thank you Alright, I would now like to turn it back to Ron could net CE connect.

Chief Executive Officer.

Thank you Karen and thank you all for joining <unk> earnings call and for your continued support of Digi.

For investors, we will be attending Craig Hallum, 20th annual institutional Investor Conference on May 31 in Minneapolis.

Have a great day.

Thank you for your participation in today's conference. This does conclude the program you may now disconnect.

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