Q3 2023 Digi International Inc Earnings Call
Good day, and thank you for standing by.
Welcome to the Q3 2023 Digi International incorporated earnings Conference call. At this time, all participants are in a listen only mode.
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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.
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 <unk> 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, 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 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 Web site.
Now I'll turn the call over to Ron.
Thank you Jamie good morning, everyone.
Before we jump into Q&A a few comments.
We're excited to deliver our 10th consecutive record revenue quarter, which is especially pleasing in this constantly evolving macro environment.
We're thrilled to announce we achieved the second of our three 100 million goals.
Annualized recurring revenue.
We continue to sustain $100 million in quarterly revenue.
And we are gaining more confidence in capturing our final goal of $100 million in annualized adjusted EBITDA.
Did you provide connectivity and management of the world's assets in most assets are not connected today.
<unk> is well positioned to capture this opportunity with our secure reliable scalable and easy to manage solutions.
At this time I'd like to turn the call back to the operator for a question and answer session. Thank you operator.
Thank you we will now conduct the question and answer session. As a reminder to ask a question. Please 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.
Our first question comes from the line of Tommy Moll Stephens incorporated. Please proceed with your question.
Good morning, and thank you for taking my questions.
Good morning, Tommy.
Well I've got two on IRR. So, we'll we'll start on the P&L.
PNM side, where there was a big step up and I know that driving that penetration rate higher has been a priority for some time. So what can you tell us is behind the trend we've seen how much more is to come.
Yes, it's a really good question, we were obviously very excited to.
See the improvement both year over year and quarter over quarter, There's really two things going on one is is really pleasing and that we have seen year over year growth in really all of our product lines and it's certainly the results a lot of work that preceded this and making sure that our employees our partners and of course, most importantly, our cluster.
<unk>.
I understand the value of a complete solution and so we're seeing increased take rates there.
Also nice renewals, we were benefited as well with one larger enterprise deal that came to close there that helped really.
Catapult that number we do have other enterprise deals we work on those are harder to predict but it was it was nice to secure that one last quarter.
And then Ron on the solution side you.
Hold out I believe in the shareholder letter some of those enterprise deals are taking longer to close than you. Originally would have expected what can you tell us about the trends on that side of the IRR story, yes equally good question.
The good news is the pipeline is increasing and we aren't losing deals. We are two of the points and the shareholder is taking longer customers are being more inspecting and really making sure that the testing process goes well before they rollout.
So we are we're excited that the pipeline is still there and we've got to work hard to convert that of course into ore.
Thank you Ron I will turn it back.
Okay.
One moment for our next question.
Our next question comes from the line of Mike Walkley of Canaccord Genuity.
Proceed with your question.
Great Thanks, and congrats on the 10th.
In the quarter.
Ron or Jamie just for the September quarter guidance of flat to slightly down sequentially at the midpoint.
How much of an impact is that to the <unk>.
Timber quarter still being faced with hard to get components.
And when do you think supply demand might come into balance you said during fiscal 'twenty for us, it's still multi quarters or is that start to come into balance.
Get the early fiscal 'twenty four.
Yes, Mike Good morning, really good question as you know we've been battling supply chain challenges, we have a variety of products with.
Thousands of parts that are needed to put these together to finished goods some of those parts are.
Sure.
A little bit older in terms of their birth dates and harder to secure so we are still facing some supply chain headwinds those are improving gradually.
We don't have an exact quarter, we can we can call out, but we're seeing the trends, where we expect fiscal 'twenty four.
See some degree of normalization.
But we're still facing near term headwinds and I think as you've seen in the last couple of quarters.
We like to give guidance with the confidence that we can secure the parts, we need and we've been fortunate enough to.
Get some hard work that paid off that has enabled us to go beyond.
The guidance in most recent quarters, but we're sticking with that philosophy in the September quarter guidance that.
We know we can secure we're embedding that into our outlook and there is certainly some opportunity to chase some additional parts as well.
That's helpful and as a follow up question for Jamie.
How should we think about seasonality in the December quarter, you might have better supply, but that tends to be an area, where your distribution partners tend to cleanup.
Their inventory a little bit lower and then also for Jamie.
That supply and demand come more imbalanced.
Should we think about the right levels of inventory longer term and how that might free up some working capital that you would continue to pay down your debt.
Thanks, Mike I think.
On the inventory side I do think that as the supply chain normalizes.
The two elements of the inventory balances components will definitely start using their way down as those components are converted into finished goods.
Finished goods inventory balance is up it's up a tick.
And if you look over our historical numbers I think digit kind of normalizes in that kind of pinpoint to rone.
Three times turn on finished goods so.
I think theres a period of time there.
And I don't think youre not going to see inventory just kind of drop off a cliff. So I think it will be.
Over a period of time, but to your point, that's really going to.
A good impact on our operating cash and that's going to enable probably.
More aggressive posture on debt Paydowns as that inventory balance comes down so it will come down, but I don't think it will fall off a cliff.
In terms of seasonality.
Undoubtedly our first fiscal quarter does have at least some element of seasonality to it for issues that you pointed to it. It's typically year end for a lot of our partners. They will traditionally work on lowering their inventory balances.
You will have certain customers that.
Or maybe a little bit more.
Budget dependent and they may be coming up at the end of their budgets you do have some different cycles. So that FQ1 traditionally it has a ticket seasonality.
<unk> say, it's again similar to the to the inventory story, it's not off a cliff, but there is probably a little bit of a tick to it in the first quarter and then it just kind of gradually works its way through for the rest of the fiscal year.
<unk>, which is approaching a quarter of our total revenue definitely there is.
As a buffer against.
That seasonality so it's less so Mike.
Years gone by.
Still a little bit element of that is in there as well.
Okay. That's helpful. One last one I guess, Ron and I'll pass the line.
Just you had some comments this shareholder letter just about M&A can you talk about maybe.
<unk> in this environment and.
Given your three one hundreds and the cash flow that you're generating.
What is kind of your appetite for M&A right now for <unk> given.
<unk> track record, so far consolidating Iot industry.
Yes. Its another good question, we remain assertive in our posture on acquisitions as you know we've been really wanting to focus on fewer larger opportunities those opportunities that have significant IRR to continue our solution strategy and build up that muscle as a.
As a part of our overall financial picture I would say that deal flow is increasing.
Compared to first half of the year as well as there's a bit of a dichotomy I think and expectations on valuation of those properties that are stronger.
Our I think either waiting until better times or insisting on maybe more robust treatment.
And that but Theres also a lot of things where the investors have maybe gone tired or had some fatigue, there and are looking to refresh their portfolio.
Are we not going to be as active in the ladder will probably more active than the former there but in the meantime, as Jamie mentioned, we want to realize this inventory cash dividends pay down our debt certainly more aggressively than we've done in FY2023 to date and prepare us for that opportunity that we don't always of course control the timing of it.
More quickly were available the more capacity, we have the better positioned we're going to do to compete.
Great. Thanks for taking my questions look forward to seeing you next week.
One moment for our next question.
Yeah.
Thank you.
Our next question comes from the line of harsh Kumar of Piper Sandler. Please proceed with your question.
Thank you, Hey, Ron and team great job again guys.
I think the street's coming around to appreciating your software business.
And the profitability that it generates Ron but if I could ask you to maybe clarify or give us some color on the profitability of your software business had a gross margin or op margin level versus your hardware business and what it can do as you get start getting penetration is higher and your hardware.
Like what can the business.
To see down the line mid term long term any color would be appreciated.
Good morning, harsh and thanks for the question.
We've been really focused on this solution mindset.
Bringing more of the value proposition to our customers or our customers can then focus on the data that's brought to their doorstep and really add much more value in the inside of how their remote assets are performing.
Sure they have the highest uptime as well as then feeding those learnings into their engineering cycles, and we think that message is really resonating and that's being shown in really <unk>, which is arguably the most important measure that we're focused on here at <unk>.
Value how much progress, we're making in <unk> comes at a higher margin than our company's overall gross margins so as <unk> grows.
You see that really start to contribute to the gross margin line and you can see that in our sequential performance. Our IRR has is lifted that gross margin up and were obviously almost 37%.
And I want to see that continue to improve and then it's up.
That's up to us as good operators to make sure that we've got.
The opex profile that allows that profitability of flow down to adjusted EBITDA line, and Youre seeing that progress as well and.
Certainly we think it's going to progress over time as <unk> continues to build and then if we can jumpstart that at some point with acquisitions were to look at that as well, but I think it's really important that we continue this as progress on IRR and see it impact gross margin and adjusted EBIT margin as well.
Brian if I can push you on that last sentence that you used is it fair to assume that any software you can look at will be I'm, sorry, any acquisition you would look at would be now in the software side as opposed to hardware side or if you look at maybe some complete solution does.
Yes, I think we're probably most squarely focused on hardware enabled recurring.
An area. We think we have expertise we think its consistent with what we're doing are performing so we can add value.
And quite frankly, it's got a different set of of our growth.
Growth profiles of mechanics than say, a pure software business that can have extreme polarizations in valuations.
A lot of software businesses, especially when they are smaller are investing pretty heavily to fund their growth and so the profitability of the software companies may not be at the profile that would be helpful for digi.
Hardware enabled recurring we think is our sweet spot.
Oftentimes as you can see from some of our performance it can be harder sometimes to close those deals. But then once you get them you perform it can be very long lasting relationship because it was just quite an effort to deploy.
In some cases hundreds of thousands of remote activity assets and keep that up and running so if there is any takeaways with hardware enabled recurring.
Which is a little bit different than say pure software.
Okay.
Absolutely if I can ask one more.
Ron I think you have some presence in Europe , and you've got some tremendous opportunity.
And what's your solutions business and also ranked us in Europe could.
Could you highlight for us could be choppy for us where you stand and maybe what that opportunity could be for you down the line.
Yes, it's a good question most of our solutions business is really focused on the North American theater.
Europe presents a wonderful opportunity we've had the good fortune of not having.
A lack of market to go after North America to hit our growth expectations and as you know when you're going into Europe . It quickly.
Evolves into well, Germany, France, Spain, the U K, because although you a lot of them have local regulations.
Local cultures of language and other things so.
We were careful when we think about Europe to be more country specific than just the entire theater, but.
But thats certainly reserve represents a future opportunity for us and I think when the time is right, we're going to probably be dragged into there by our customers rather than say, establishing a base camp and opening up storefronts.
Got it. Thank you thanks guys.
One moment for our next question.
Thank you.
The next question comes from the line of Scott Searle of Roth. Please proceed with your question.
Hey, good morning, Thanks for taking the questions Hey, Ron maybe to dive in on some of the end markets, particularly around the routers and cellular gateways.
And open gear with without a band I'm wondering if you could give us kind of an update of where youre seeing demand how the channel inventory is working particularly on the gateway front as we look into the back half of the calendar year.
Good morning, Scott.
We were pleased to really see strong results across our product lines. So that was.
You look at our portfolio, that's really good to see each of our product lines has a little different focus area in terms of the verticals that they are exposed to an and.
And that is I think a real benefit for digi and that we're not say overweighted in one vertical where you can have maybe higher gyrations of performance. So typically example, if you look at.
Our open gear console server product line, they're getting quite frankly more opportunities on the edge and the data center, where that was really slipped.
Say three years ago, where the data centers, who are driving the growth so the extension of that.
More presence has extended into storefront retail offices banks insurance companies. So that's really that's really good to see you look at our OEM solutions business continued strength in medical devices continued strengthen in renewables solar EV charging.
In our cellular router product line, we're seeing.
Thankfully renewed strength in smart city in public transit, which as you know during Covid was essentially shut down in addition to utility segments, which are looking at both public and private networks to to upgrade the monitoring of their grids to ensure uptime and performance. So so we were pleased to see.
The performance, but also the distribution of that performance across verticals.
Thanks very helpful. If I could follow up on that are there any pockets of inventory that youre seeing by vertical around the debt or concerns at the current time.
No not really.
We.
For our channel partners. They are typically going to be multi vertical and not over weighted to one. So we don't have any particular concentration by vertical.
Got you and if I could just one last one.
Looking at the traditional gateway business.
How are those channels receiving that message how is that progressing and where the high level thoughts there as we look out into fiscal 'twenty four thanks.
So a really good question Scott is I think the audience knows the cellular router.
Well, obviously actively working with end users works very closely with.
<unk> as well as as well as channel partners Thats, a critical part of their cadence, whereas on the managed solutions side.
There may be a partner involved but you tend to be directly working with end user much more so than going through a channel and so it's going to be an evolution not a revolution as we introduce that model into the channel and start educating them, it's not as intuitive.
For them, but we think we can be successful it will take some time, because it's a pretty it's a pretty.
Different thing that they've been doing to date.
A lot of the work we're doing on take rates really software really applies to the managed network service offering as well.
Great. Thank you.
One moment for our next question.
Thank you.
Our next question comes from Derek <unk> of Cantor Fitzgerald. Please proceed with your question.
Yeah, Hey, guys I appreciate you taking my questions and congrats on the continued execution here Ron.
Ron you mentioned the importance of kind of building these strong customer relationships I think you mentioned.
You are having these conversations with customers, saying, Hey, we really think you guys would benefit from.
This recurring model.
I'm curious if what to what degree are those conversations happening.
Sort of turning down a onetime sales with customers in the past our new customers.
They won't subscribe.
Are those conversations happening with a handful of product lines.
Most of your product lines today.
Can you talk about that a bit and when do you think youre going to take that step to really move towards that recurring model.
Yes. Thanks for the question good morning Derek.
We're not we're not at the point, where we're turning to our business. If it does not include a <unk>.
Solutions element to it.
Certainly leading with solutions and Thats, an important step for us in the past it was leading with product and then offering solutions as a secondary offering now we're really leading in starting those conversations often I'll emphasize its to both end users, but also with the channel and educating channel on the benefit of solutions.
The channels happy.
To hear the message they benefit as well as Digi and also.
We're not the first.
To go about this type of approach. So so that's the good news as well this isn't a foreign concept to our partners.
It affects.
A lot of our product line I would say all of it in particular OEM solutions group, where we're selling an embedded product to two customers designing our solution our product into their larger ecosystem. That's an area, where we're much more careful those are long design cycles, we're not going to upset existing solutions that the customers enjoying because of.
Artificial policy, if you will so that part of our business in particular.
It has a much more discerning implementation of solution that starts right Wednesday order that hits as they start to work on their design and then it takes them some time to actually get into production.
But we're excited about the box business part of our business and product services, where that's really where the supply is more thoroughly.
Got it got it and then as my follow up you mentioned some strength in the clean tech sort of end market solar and electric vehicle charging.
One of your big customers in solar tracking other solution relies pretty heavily on.
<unk> connectivity seems to me like the EV charging network will require something similar.
I'm curious what kind of attach rates, you're seeing in those markets are they have higher than average.
Also curious if you could maybe lay out like what what sort of the opportunity per charging station for electric vehicle.
Chargers it seems like there's a ton of funding.
Space and curious if you can kind of lay out whats the opportunity there yes.
Yes, you mentioned, there's really at least two different vectors. One of course is in renewables, where there is this.
Really important rush to balance our energy sources between more traditional energy sources and renewables and Theres continued funding certainly.
The warm summer, we're experiencing it doesn't hurt that.
That said deployments and those areas were an important provider and theres a great opportunity to help us think about worthy solar farms are located they're very remote and making sure you manage this those facilities as effectively as possible is critical EV charging.
In a relatively speaking a newer phase getting tons of funding there is a rush to put charters out.
And I think that rush that the management of that charging platform has been a little bit of a secondary thought so it's providing a great opportunity for us to have conversations with EV charger providers, but also the operators as to how they manage the uptime availability, it's not just as the charging port available, but many of these have point of sale terminals.
And it was supposed to point of sale terminals need to be up as much as the charging itself theres nothing more disappointments showing up in EV charging with low battery and then you can't get access to a charter so it.
It's more than just deploying it managing that promote assets. So there is I think going to be a great opportunity for us to help that ecosystem not just deploy that manage this critical set of assets.
Awesome I appreciate it.
One moment for our next question.
Thank you.
Our next question is from Tommy Moll Stephens incorporated. Please proceed with your question.
Ron just a follow up on on the macro as we approach.
Fiscal 'twenty for.
You talked about the debate around an imminent recession in your release, but you also talked about.
Now your end market exposures helped in the past whether some challenging market conditions. So are you seeing any incremental pockets of weakness in the business is there any thing on the.
Getting stronger or getting weaker side of the equation you would want to mentioned just to frame everyone's expectations for the next year.
Yeah, Tommy we've been we've been pretty vocal on that we've got this balanced portfolio and that this portfolio has exposure to different verticals. So youre absolutely right in any given point in time, there can be strength and weakness in certain verticals and we like this portfolio because it provides a resilience we think in <unk>.
Especially in maybe more stressful times, we've also acknowledged that because we're not overly weighted in a vertical that we don't necessarily out sized gain if a vertical has particular strength because that's only a portion of our business. So we had this discussion a little bit early even earlier on this call that renewables EV charging medical device.
<unk>.
The utility segment remained very strong for us.
There are certainly pockets.
Of all the things that I think a lot of our.
<unk> would understand so for example, there's a lot of activity going on in banking right now right with <unk>.
Overexposure to.
Two maybe.
Certain deposits or interest rates tied with those and how that affects the financial services industry.
We think on a whole the market is growing at this double digit rates in the although there may be pockets of strength and weakness that we can.
Really sustain that double digit growth rates over time that there might be times like this year, where we're doing I think better than that type of performance and there may be times in the future, where we're not quite there, but we think on balance we have got that strengthen our offerings and our exposures that allows for more consistent performance.
Thank you Ron I will turn it back.
Thank you.
I am showing no further questions at this time I would now like to turn the conference back to Brian Kennedy.
Thank you for joining <unk> earnings call and for your continued support.
For investors, we will be attending Canaccord Genuity <unk> 40, <unk> annual growth conference in Boston on August 9th.
And Piper Sandler growth Frontiers Conference September 11th to 13th in Nashville.
Have a great day.
This.
Today's conference call. Thank you for participating you may now disconnect.
Okay.
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