Q2 2024 Digi International Inc Earnings Call

Okay.

Operator: Good day, and thank you for standing by. Welcome to the Q2 2024 Digi International Incorporated Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. You will then hear an automated message advising that your hand is raised. To withdraw your question, please press star 1-1. Please be advised that today's conference call is being recorded. I would now like to hand the conference over to your first speaker today, Jamie Loch, Chief Financial Officer. Thank you. Good day, everyone.

Yeah.

Good day, and thank you for standing by and welcome to the Q2 2024 Digi International incorporated earnings Conference call.

Operator: At this time all participants are in listen only mode. After the speaker's presentation, there will be a question and answer session.

Operator: Ask a question during this session you will need to press star one on your telephone you will then hear an automated message.

Operator: It was raised to withdraw your question. Please press star one again.

Operator: Please be advised that today's conference call is being recorded.

James J. Loch: I would now like to hand, the conference over to your first speaker today.

Operator: Jamie Loch Chief Financial Officer.

James J. Loch: 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 Konezny, our president and CEO. Reassure issued an earnings release after the market closed yesterday. You may obtain a copy of the press release through the financial releases section of our investor relations website at digi.com. This morning, Ron will provide a comment on our performance, and then we'll take your questions.

James J. Loch: Thank you. Good day, everyone.

James J. Loch: Thank you and 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.

Ronald E. Konezny: Joining me on today's call is Ron can ask me are president and CEO.

James J. Loch: We issued our earnings release after the market closed yesterday.

James J. Loch: You may obtain a copy of the press release through the financial releases section of our Investor Relations website at <unk> Dot com.

Ronald E. Konezny: This morning, Ron will provide a comment on our performance and then we'll take your questions.

James J. Loch: Some of the statements that we make during this call are considered forward-looking and are subject to significant risks and uncertainty. 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. However, we believe the expectations reflected in our forward-looking statements are reasonable. We give no assurance that such expectations will be met or that any of our forward-looking statements will prove to be correct.

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

James J. Loch: 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.

James J. Loch: 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.

James J. Loch: For additional information, please refer to the forward-looking statement section in our earnings release and the risk factor section of our most recent form 10-K and subsequent reports on file with the SBA. 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 gap measures, is included in the earnings release. The earnings release is also furnished as an exhibit to Form 8K, which can be accessed through the SEC filing section of our Investor Relations website. Now, I'll turn the call over to Ron.

James J. Loch: For additional information please refer to the forward looking statements section in our earnings release and the risk factors section of our most recent Form 10-K and subsequent reports on file with the SEC.

James J. Loch: 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.

Ron: Earnings release is also furnished as an exhibit to form 8-K that can be accessed through the SEC filing section of our Investor Relations website.

James J. Loch: Now I will turn the call over to Ron.

Ron: Thank you Jamie good.

Ronald E. Konezny: Before we jump into Q&A, just a few comments. Digi delivered record annualized recurring revenue. Record Gross Margin, Strong Cash Generation, and Lowered Inventory.

Ron: Good morning, everyone.

Ron: Before we jump into Q&A, just a few comments.

Ron: <unk> delivered record annualized recurring revenue.

Ron: Record gross margins.

Ronald E. Konezny: Strong cash generation.

Ronald E. Konezny: Decreased debt balances and strong profitability. Our IoT solutions segment is seeing results of closing enterprise opportunities, helping grow ARR. ARR remains our top priority at Digi, benefiting visibility and profitability. We welcome two new members to Digi's Leadership Team. Jim Freeland joined as Senior Vice President and Chief Information Officer in February.

Ron: Lower inventory.

Ron: Greece debt balances and strong profitability.

Ronald E. Konezny: Our Iot solutions segment as a result of closing enterprise opportunities.

Ronald E. Konezny: <unk> grow.

Ronald E. Konezny: <unk> remains our top priority at Digi.

Ronald E. Konezny: In visibility and profitability.

Ronald E. Konezny: Jim joins us from a nearly 18-year career at Medtronic. Jim's security, IT, and applications experience are a perfect fit for Digi's critical needs. Separately, as announced yesterday, we're thrilled to have Tony Coppolo join Digi as Senior Vice President and General Manager of our Managed Solutions business. Tony joins Digi from a 13-year career at Cradle Point, where he demonstrated outstanding success in sales and product management leadership positions. Don't he has the right combination of technical knowledge, product strategy, and go-to-market expertise?

Ronald E. Konezny: We welcome two new members to <unk> leadership team.

Ronald E. Konezny: Jim Freeland joined as senior Vice President and Chief Information Officer in February.

Ronald E. Konezny: Jim joined Us from a new 18 year career at Medtronic.

Ronald E. Konezny: Jim Security IP and applications experience are perfect fit for <unk> critical needs.

Ronald E. Konezny: Separately as announced yesterday, we're thrilled to have Tony swap below joined <unk>.

Ronald E. Konezny: As senior Vice President and General manager of our managed solutions business.

Ronald E. Konezny: Tony joined <unk> from a 13 year career at a point where.

Ronald E. Konezny: He demonstrated outstanding success in sales and product management leadership positions.

Ronald E. Konezny: Tony is the right combination of technical knowledge product strategy and go to market expertise.

Ronald E. Konezny: While pleased with our first half results, we are staying more cautious. Customers in second half demand. We remain confident in our AR growth projections, however, we have softened top-line expectations. To offset top-line expectations, we have implemented tighter expense controls, resulting in only slightly dimming our annual profit expectation.

Ronald E. Konezny: While pleased with our first half results.

Ronald E. Konezny: <unk> seen more cautious.

Ronald E. Konezny: Customers in second half demand.

Ronald E. Konezny: We remain confident in area of our growth projections. However, we have softened top line expectations.

Ronald E. Konezny: To offset top line expectations, we have implemented tighter expense controls.

Ronald E. Konezny: Resulting in only slightly dampening our annual profit expectations.

Ronald E. Konezny: In the second of our 20-quarter journey to reach $200 million in ARR and $200 million in adjusted EBITDA, we are confident we can reach these targets. The industrial IoT market is positioned for long-term growth. Digi will continuously innovate and service its customers in an environment of accelerating change, and security, regulations, and technological requirements. Our solutions are helping our customers adapt and thrive. At this time, I'd like to turn the call back to the operator for a question and answer session. Thank you, Operator.

Ronald E. Konezny: And the second of our 2000 quarter to quarter.

Ronald E. Konezny: On our journey to reach $200 million in <unk> and $200 million and adjusted EBITDA. We are confident we can reach these targets.

Ronald E. Konezny: The industrial Iot market is positioned for long term growth.

Ronald E. Konezny: Did you will continuously innovate and services customers in an environment of accelerating change.

Ronald E. Konezny: And security.

Ronald E. Konezny: Regulation.

Ronald E. Konezny: And technology requirements.

Ronald E. Konezny: Our solutions are helping our customers adapt and thrive.

Ronald E. Konezny: At this time I'd like to turn the call back to the operator for a question and answer session. Thank you operator.

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 one on your telephone, and your name will be announced. Wait for your name to be called now. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from Mike Walkley with Canaccord Genuity. Your line is open.

Ronald E. Konezny: Okay.

Speaker Change: 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 one on your telephone and your name will.

Operator: Wait for your name to be announced.

Operator: To withdraw your question. Please press star one again.

Operator: Please stand by while we compile the Q&A roster.

Operator: Our first question comes from Mike Walkley with Canaccord Genuity. Your line is open.

Michael Walkley: I think my question, you know, Ron, last night, Qualcomm highlighted their industrial IoT market, and they expect inventory to clear and business to turn in the September quarter, which, you know, consistent with your cautious second half outlook. Is it too early? Are you seeing any signs of maybe September being the bottom? And, you know, any indication that you're either gaining or losing share just given the softer demand outlook for the second half?

Michael Walkley: Great. Thanks for taking my question.

Michael Walkley: Ron last night Qualcomm highlighted.

Michael Walkley: Their industrial Iot market, they expect inventory clearing business to turn exiting the September quarter, which.

Michael Walkley: Consistent with your cautious second half outlook is it too early or are you seeing any signs of maybe September being the bottom end.

Michael Walkley: Also any indication that youre, either gaining or losing share just given the softer demand outlook for the second half.

Ronald E. Konezny: Hey Mike, a couple good questions. You know we monitor our opportunity sets and our ability to convert that opportunity set and and how long it's taking it to convert and we don't have a lack of opportunities so that's that's the good news but we're seeing that the time to close those opportunities extend so in a short answer don't know whether or not September is a return to more We're seeing from customers before they make those decisions that the caution does increase a bit, aka the days get longer, the bigger the deals are.

Mike: Hey, Mike.

Ronald E. Konezny: A couple of good questions.

Ronald E. Konezny: <unk>, our opportunity set and our ability to convert that opportunity set.

Ronald E. Konezny: And how long it's taking share.

Ronald E. Konezny: So it converts and we.

Ronald E. Konezny: We don't have any lack of opportunities. So that's the good news, but we're seeing the time to close those opportunities extend so short answer don't know whether or not September as it returns to a more robust growth levels, but the good news is the demand is there the bad news is era auction.

Ronald E. Konezny: Seeing from customers before they before they make those decisions at the caution does increase a bit.

Ronald E. Konezny: Ladies get longer the bigger the deals.

Ronald E. Konezny: That makes sense. I guess for my follow-up question, just on the litigation accrual, can you remind us what that's for, and is it something that you think this covers, or should we have some more litigation expense as you head into whatever trials are coming up?

Mike: Yes makes sense.

Ronald E. Konezny: For my follow up question, just analytic litigation accrual can you remind us what that's for and is it something that you think.

Mike: This covers there because we have some more litigation expense as you head into <unk>.

Ronald E. Konezny: Yeah, this isn't something that, you know, we've had it in our K's and Q's, it's not something we've discussed on our calls here. It's a contract dispute with a former reseller, and both parties remain in litigation as we work to..., to get it resolved, and that's our best estimate at the moment. Okay, great.

Speaker Change: Whatever trials upcoming.

Speaker Change: Yes, this isn't something that we've had it in our Ks and Qs is patents that we've discussed on our calls here, it's a contract dispute with a former.

Ronald E. Konezny: Our reseller.

Ronald E. Konezny: Both parties remain in litigation as we worked.

Ronald E. Konezny: Two to get it resolved.

Ronald E. Konezny: Our best estimate at the moment.

Michael Walkley: Okay, great. I'll pass the line and jump in the queue.

Ronald E. Konezny: Okay great.

Speaker Change: I'll pass line and jump in the queue.

Operator: One moment for our next question. Our next question comes from Cole Cousins with Stevens Incorporated.

Speaker Change: One moment for our next question.

Cole Cousins: Our next question comes from coal cousins with Stephens incorporated.

Cole Cousins: Hey guys, thanks for taking my questions. Hey, good morning, Cole. Hey, so just, zooming in on the customer caution, is there any specific product type or in-market that is being most impacted? And then also on Ventus, I know last quarter we thought the regional bank

Cole Cousins: Hey, guys. Thanks for taking my questions.

Cole Cousins: Hey, good morning, Paul.

Cole Cousins: Hey, so.

Ronald E. Konezny: Yeah, I think that the caution is a little bit more dispersed, and to be sure, there are areas of strength still where we're seeing certain parts of the market. Michael Walkley, James Loch, Ronald Konezny, Thomas Walkley, Gregory Mesniaeff, Robert Aguanno, And then, on the second side of things, alone.

Cole Cousins: Just.

Cole Cousins: Then again on the customer caution is there any specific product type or end market that.

Ronald E. Konezny: That is being most impacted and then also on dentists I know last quarter, we thought the regional bank overhang was largely done coming out of that quarter, but since then things have changed a little bit. So any updates you can provide on that business would be helpful.

Ronald E. Konezny: Yes.

Ronald E. Konezny: Caution is.

Ronald E. Konezny: A little bit more dispersed.

Ronald E. Konezny: And to be sure there are areas of strength still where were seeing certain parts of the market.

Ronald E. Konezny: Move with more confidence, but then there are other parts in these verticals as you know, we're pretty diverse and our exposure and so we have multiple product lines in service multiple verticals. So I'd say, it's more dispersed in terms of this this caution that we're seeing.

Ronald E. Konezny: And then on the second side of things.

Speaker Change: Can you repeat that question Martin please.

Cole Cousins: Yeah, it was just at the regional bank in Northgate and Vinton. Yeah, so, you know, we think

Ronald E. Konezny: Yes. It was just on the regional bank and mortgage and Ventas. Yes. So we think that's largely behind US there is still some wind down of some existing ATM networks, but there hasnt been any any new concerns that have come out.

Ronald E. Konezny: Yeah, so, you know, we think that that's largely behind us. There is still some winding down of some existing ATM networks, but there haven't been any new concerns that have arisen.

Cole Cousins: Okay, perfect. And then, I think implied by the guidance, there's some margin step-up in the back half of the year. If you could kind of talk through what's the driver of that sequential improvement? I think you mentioned some expense control, but any, any additional color you can provide there would be helpful. Hey, Cole, this is Jamie.

Ronald E. Konezny: For our customer base.

Speaker Change: Okay perfect.

Jamie: And then.

Jamie: I think implied by the guidance there is some margin step up.

Jamie: The back half of the year if.

Jamie: If you could kind of talk through what's the driver of that sequential improvement I think you mentioned some expense control, but any any.

Cole Cousins: Any additional color you can provide there would be helpful. Hey, Paul. This is this is Jamie I think there's really two drivers I think the continued growth of ALR provides positive mix into that gross margin and it's one of the reasons why we continue to say that it is a top priority for us because you see the impact that that has as it flows its way down through the P&L.

James J. Loch: I think there are really two drivers. I think, you know, the continued growth of ARR provides positive mix into that gross margin. And it's one of the reasons why we, you know, continue to say that it's a top priority for us, because you see the impact that that has as it flows its way down through the P&L. I think, secondarily, to your point, we continue to be focused on controlling costs, and that's both at an operating level and at a cost of goods sold level.

James J. Loch: Kundera lead to your points, we continue to be focused on controlling cost and thats. Both at an opex level, but it's also add at a cost of goods sold level at our operations teams drove a really nice job as we're navigating our way out of really the.

James J. Loch: The.

James J. Loch: And our operations teams are doing a really nice job as we're navigating our way out of, you know, really the, the, the semiconductor challenges that we're sitting out there. They're doing a really nice job of helping us navigate through that cost side. So it's kind of a two-folded thing, but I'd really point to the growth in ARR providing that profit, that positive. Perfect, helpful. And if I could squeeze one last one in,

James J. Loch: There are challenges that were sitting out there they are doing a really nice job of helping us navigate through that cost side. So it's kind of a twofold, it but I'd really point to the growth in IRR at providing that that positive mix.

Cole Cousins: I thought it was a good quarter for ARR growth and solutions. I think some of that was on or most of that was on SmartSense wins. But are there any drivers that you're or any changes you're seeing in that business that's kind of driving some of those wins? Any color that would be helpful.

James J. Loch: Perfect helpful and if I could squeeze one last one in.

Cole Cousins: I thought it was a good quarter on <unk>.

Cole Cousins: Our growth in solutions.

Cole Cousins: I think some of that was on most of that was on smart sensor wins, but is there any drivers that you or any changes youre seeing in that business and that business thats kind of driving some of those wins.

Ronald E. Konezny: Thanks. Yeah, you know, in the previous course, we talked about this. We've again had a nice opportunity set there, and we've been just struggling to get the customers to have the confidence to move forward. And, and, you know, we're seeing that finally occur. You saw that in last quarter's results.

Cole Cousins: <unk>.

Speaker Change: Any color there would be helpful. Thanks, yes on previous quarters, we've talked about this again.

Ronald E. Konezny: Nice opportunity set there.

Ronald E. Konezny: We've been just struggling to get the customers to have the confidence to move forward.

Ronald E. Konezny: And we're seeing that finally recur you saw that in last quarter results. We anticipate continued success there and some of it call as these opportunities have been really well vetted by the customer very extensive POC is very extensive ROI mapping.

Cole Cousins: We anticipate continued success there. And some of it calls these opportunities have been really well vetted by the customer. You know, very extensive POCs, very extensive ROI mapping, implementation discussions, and we're starting to see the fruits of that patience and that and that dedication to helping the customer gain that confidence. Perfect. I'll turn it back. Thanks, guys.

Cole Cousins: Implementation discussions and we're starting to see the fruits of that patients in that and that dedication to helping our customers get that confidence.

Cole Cousins: Perfect I'll turn it back thanks, guys.

Operator: One moment for our next question, and our next question comes from Josh Nichols with B. Reilly.

Speaker Change: One moment for our next question.

Operator: And our next question comes from Josh Nichols with B Riley.

Josh Nichols: Yeah, thanks for taking my question. Great to see the AR and the margin flow through to the cash flow generation for the quarter. Just touching on that from a working capital perspective, you know, inventory is being right-sized, as you mentioned. Maybe there's some more work to do. I'm just kind of curious, based on the outlook you have here for the second half, what do you consider a fair amount of inventory or the right-size inventory level that the company is looking to work to over the next couple quarters?

Michael Joshua Nichols: Yes, thanks for taking my question.

Josh Nichols: Good to see.

Josh Nichols: The margin flow through to the cash flow generation for the quarter, just touching on that from a working capital perspective.

Josh Nichols: Inventory has been right sized that you mentioned, maybe there is some more work to do I'm just kind of curious based on the outlook you have here for the second half.

Josh Nichols: What do you consider a fair amount of inventory or right size inventory level that the company is looking to work too over the next couple of quarters.

James J. Loch: You know, if you look historically, I'd say that $40 to $50 million range is probably where we would be on a more normalized basis. The difference between that and our net inventory position is mainly components. So we're seeing those components consumed and winding down, and that'll happen over the next several quarters. So, over time, you know, I think you'll see us get down to that, let's say, $40 to $50 million range. I'd say, you know, $40 to $50 million in more normal times.

Josh Nichols: If you look historically, I would say that 40% to $50 million range.

James J. Loch: Where we'd be on more.

James J. Loch: More normalized basis, the difference between that and our net inventory position is mainly components. So what we're seeing those components be consumed and winding down and that will happen over the next several quarters. So over time, I think you'll see us getting out of that let's say, 40% to $50 million range would be I would say.

James J. Loch: In more normal times.

Josh Nichols: And then, just as a follow-up question, good to see that there will probably be some healthy cash flow generation from those working capital lovers over the coming quarters. But I think previously when you talked about a little softness, you were speaking specifically about what you saw on some console servers. It appears that that was a little bit of a headwind in this quarter. I'm just curious, any update on that specifically for demand? Is that what's causing it? I know you said it's a little bit broad-based, but I'm curious where we stand on the terms of the console server side. Yeah, Josh, just to kind of rewind.

Speaker Change: Great and then just as a.

Josh Nichols: Follow up question.

Josh Nichols: Good to see that there's probably some healthy cash flow generation from those working capital levers over the coming quarters, but.

Josh Nichols: I think previously when you talked about a little softness you were speaking specifically that you saw some console servers.

Josh Nichols: It appears that that was a little bit of a headwind in this quarter I'm just curious any update.

Josh Nichols: On that specifically if the demand is that what's causing any I know you said that it's a little bit broad based but I'm curious, where we stand in terms of the console server side, yes, Josh just to kind of rewind the tape a little bit as we entered FY 'twenty four we clearly signaled that the first half was going to be in our.

Ronald E. Konezny: Yeah, Josh, just to kind of rewind the tapes a little bit, as we entered FY24, you know, we clearly signaled that the first half was going to be, in our best estimate, not as strong as the second half, and it was going to be driven by some delays on the strategic side. So, obviously, that has played out as we expected. We are seeing some of our strategics and our data center now starting to come back as we enter the second half, but I'd say it's a much more deliberate pace at which they're coming back. But we are seeing it, which is positive.

Ronald E. Konezny: Our best estimate.

Ronald E. Konezny: Not as strong as the second half and it can be driven by some delays on the strategic side. So obviously.

Ronald E. Konezny: That has played out as we expected we are seeing some of our strategic data center now starting to come back.

Ronald E. Konezny: As we enter the second half.

Ronald E. Konezny: But I'd say, it's a much more deliberate.

Ronald E. Konezny: The pace at which they are coming back so what we are seeing which is positive.

Josh Nichols: Thanks; I'll hop back in the queue.

Speaker Change: Thanks, I'll hop back in the queue.

Josh Nichols: Yes.

Operator: One moment for our next question, and our next question comes from Scott Searle with Roth MKM.

Josh Nichols: One moment for our next question.

Operator: And our next question comes from Scott Searle with Roth <unk> am.

Scott Wallace Searle: Hey, good morning. Thanks for taking the questions. Hey, Ron, just to clarify, in terms of some of the demand outlook, it sounds like customers are certainly turning a bit more cautious, but is inventory, excess channel inventory, playing at all into that current buying pattern? And then to follow up on a couple of the earlier questions, Open Gear, it sounds like things are starting to move in the right direction. I think last quarter, though, you indicated that there were some larger customers that were expected to return. Have they?

Scott Wallace Searle: Hey, good morning, Thanks for taking the questions Hey, Ron just to clarify in terms of some of the demand outlook. It sounds like customers are certainly turning a bit more cautious but as inventory.

Scott Wallace Searle: <unk> channel inventory playing at all into that.

Scott Wallace Searle: Current buying pattern and then to follow up on a couple of the earlier questions open gear.

Scott Wallace Searle: It sounds like things are starting to move in the right direction I think last quarter, though you indicated that there were some larger customers that were expected to return.

Scott Wallace Searle: They returned or are they still kind of kicking out their decision making process.

Ronald E. Konezny: Hey, good morning, Scott. Yeah, on the channel inventory side, it's higher than I would say normal times. It's exclusively been driven by a few customers with allocated inventory. So yeah, if they didn't have as much inventory, that probably would help on the sales side. But I want to emphasize it's just a few select customers. It's not broad-based. And in terms of the console server side, yeah, we had indicated in the first half of our fiscal year that we've got to be slow on that data center side, which is one of the reasons we thought that the first half may not be as strong as the second half.

Ron: Hey, Good morning, Scott, Yes on the channel inventory side, it's higher than then I would say normal times, it's exclusively but driven by a few customers with allocated inventory.

Ronald E. Konezny: So yes, if they didn't have as much inventory that probably would help on the sales side, but I want to emphasize it's a few select customers, it's not broad based.

Ronald E. Konezny: And in terms of the console server side, yes, we are in.

Ronald E. Konezny: The first half of our fiscal year that we've got to be slow on the datacenter side, which is one of the reasons. We thought that the first half may not be a stronger second half we are starting to see that return here in this current quarter. It's we're a month into it but we are seeing some buying time, they are being very deliberate and we're not getting.

Ronald E. Konezny: We are starting to see that return here in this current quarter; it's, we're a month into it, but we are seeing some buying signs. They are being very deliberate, you know; we're not getting, you know, a large appeal for the quarter for the next six months.

Ronald E. Konezny: Our larger payoffs for the quarter for the next six months, it's much more granular in terms of how they're coming back.

Scott Wallace Searle: It's much more granular in terms of how they're coming back. Got you.

Scott Wallace Searle: So Ron, just to clarify, so we should be thinking about open gear, increasing sequentially into June and then into the back half of the calendar year, and then maybe switching over to the cellular gateway side. That's been weak as well. Share shifts, particular verticals, or any other color that you could provide in terms of what's going on with the demand profile there?

Speaker Change: Got you so Ron just to clarify so we should be thinking about open gear.

Scott Wallace Searle: Increasing sequentially into June and then into the back half of the calendar year, and then maybe switching over to the cellular gateway side thats been weak as well.

Scott Wallace Searle: Share shifts particular verticals or any other color that you could provide in terms of what's going on with the demand profile there.

Ronald E. Konezny: Any of your assumptions are correct in the OpenGear console server business. On the router side, I think there's a couple of interesting dynamics going on. I think industrial IoT is still a strong market, but the carriers have turned their attention, as you probably know, to FWA. There's a little bit more energy that they have on FWA in replacing wired internet connections with wireless internet connections. We think we're in a good spot from a competitive standpoint with some of the things going on with some of our major competitors in North America. Bringing Tony in with his experience at Cradlepoint, we think, is going to be a real strong lift for us as we look to build on some of our competitive positioning.

Scott Wallace Searle: Yes.

Ronald E. Konezny: I think your assumption is correct on the <unk>.

Ronald E. Konezny: Year console server business on the router side I think Theres a couple of interesting dynamics going on I think industrial Iot is still a strong market as the carriers have turned their attention as you probably know <unk>, there's a little bit more energy that they have and FWS, replacing wired internet connections with wireless interconnections.

Ronald E. Konezny: We think very good spot from a competitive side with some of the things going on with some of our major competitors in North America, bringing Tony.

Ronald E. Konezny: His experience.

Ronald E. Konezny: What do you think is going to be a real strong lift for us as well as we look to build on some of our competitive positioning.

Ronald E. Konezny: And lastly, if I could, just from a high level, you know, there's certainly a focus on ARR, growing that from 100 million to 200 million over the next several years. But when I think about the product or hardware-based side of the equation, a lot of transitions ongoing, what gets us back into growth mode? And what does that growth mode look like as we're looking to fiscal 25? Thanks. Yeah, the good news is that AR has been a real bright spot for us.

Speaker Change: Great and lastly, if I could just from a high level.

Ronald E. Konezny: There is certainly a focus on growing that from $100 million to $200 million over the next several years, but when you think about the product or hardware based side of the equation a lot of transition is ongoing what gets us back into growth mode, and what does that growth mode. It looked like as we're looking to fiscal 'twenty five.

Ronald E. Konezny: Yeah, the good news is that recurring revenue has been a real bright spot for us, you know; we're up double digits year-over-year again this current quarter, and we expect, you know, recurring revenue to continue to grow. And, while private services is going to be a big contributor to that, quite frankly, landing these enterprise deals on the solution side of our business is going to have, you know, as much, if not So we're really encouraged by solutions like SmartSense, in particular, starting to contribute to the AR growth. We do expect that we'll continue to see some success there and help propel the AR industry moving forward.

Ronald E. Konezny: Yes, but the good news is <unk> been a real bright spot for us and we're up double digits year over year again, this current quarter and we expect.

Ronald E. Konezny: So continue to grow in.

Ronald E. Konezny: Well private services is going to be a big contributor to that.

Ronald E. Konezny: Quite frankly landing these enterprise deals on the solution side of our business is going to have as much if not more of an impact. So we're really encouraged by.

Ronald E. Konezny: Solutions and smart in particular.

Ronald E. Konezny: To contribute to the growth we do expect that we will continue to see some success there.

Ronald E. Konezny: And helped propel the IRR moving forward.

Speaker Change: One moment for our next question.

Ronald E. Konezny: Yes.

Operator: One moment for our next question, and our next question comes from Harsh Kumar with Piper Sandler.

Ronald E. Konezny: And our next question comes from harsh Kumar with Piper Sandler.

Harsh V. Kumar: Yeah, guys. Just a couple of quick questions. So Ron, I wanted to circle back on your comment about second app pickup in console servers. We're seeing tremendous activity on the semiconductor side with the compute, particularly in data centers, and this talk of not just large but mega data centers being built. So I was curious, A, if you're saying that you're still

Harsh V. Kumar: Yeah, Hey, guys. Just a couple of quick questions Suraj I wanted to circle up on your comments about second half pickup in console Chavez.

Harsh V. Kumar: We're seeing tremendous activity in the semiconductor side, but the compute particularly in data centers and this talk of kind of not just large or mega data centers building. So I was curious youre, saying that youre starting to see some some opening up of wallets in the console server side, but as you talk to the customers.

Harsh V. Kumar: Particularly on the data center side, I guess I'd be curious to hear what their outlook is or what they say or what they think they're going to be spending on things like console server is as we look out and then also I'd love to get a quick update on console server is that retail environment places like home depot, and and bank branches and things like that.

Harsh V. Kumar: Theres, a pretty good application for those as well.

Ronald E. Konezny: Hey, good morning, Harsh. Good question. When we started working with OpenGear and they became a part of the Digi team back in 2019, Datacenter was actually over 50% of their revenue, and Edge was under that. And that has slipped. Edge is now actually the leading application, with Datacenter still being very strong, but not the majority or over 50% of sales as it was back then, and we're

Speaker Change: Hey, good morning harsh good good question.

Ronald E. Konezny: When we started working with opening here and they became a part of the Digi team back in 2019 datacenter was actually over 50% of their revenue and edge was under that.

Ronald E. Konezny: And that has slipped edge is now.

Ronald E. Konezny: Actually the leading application with data center still being very strong, but not the majority of <unk> sales was back then.

Ronald E. Konezny: And there's a lot of energy around it.

Ronald E. Konezny: And one of the biggest constraints is access to power. In particular, affordable power. And this current generation of AI chips, you know, they do require quite a bit of...

Ronald E. Konezny: No pun intended around AI data center build out and one of the biggest constraint is access to power in particular affordable power and this current generation chip.

Ronald E. Konezny: Hips, it does require quite a bit of a.

Ronald E. Konezny: Energy <unk>.

Ronald E. Konezny: I know are working on improving that situation, but as they expand into new locations access to affordable power is one of the biggest constraints and so there is great excitement I think that our ability as we get into the physical world building These things out more.

Ronald E. Konezny: And so there's great excitement. I think that our ability, as we get into the physical world, building these things out is more slowed down. Now, you can have an existing data center, which has traditional compute power, and add AI capability to that if you've got space there. But building out new data centers is like hitting some robots. Okay, okay, got it. And then, as you look at your business, Ron, maybe give us an idea of what segments or subsegments you are most excited about, not just for the rest of the year but maybe next year, two years out, just kind of a little bit longer-term oriented picture. Yeah,

Ron: More pace now you can have an existing data center, which has traditional compute and add AI capability to that you've got space, there, but building out new data centers is hitting some roadblocks.

Speaker Change: Okay, Okay got it.

Ronald E. Konezny: And then as you look at your best Nash, Ron maybe give us an idea of what segments or sub segments. You are most excited about and are not just the rest of the year, but maybe next year or two years or just kind of a little bit longer term oriented picture yes.

Ronald E. Konezny: Yeah. Harsha, if you recall, we have a very diverse set of customers, and we service a number of different verticals. And so, you know, we enjoy that diversification, and I think that shows in some of the strength of our performance over time. So some verticals that are doing well right now, that we anticipate continuing to do well, are more utility-grade solar, for example, which is doing well, where residential solar, you know, is not as robust as it was. EV charging remains very strong.

Ron: Yes Harsha.

Ronald E. Konezny: Harsh if you recall, we have a very diverse set of customers and we service a number of different verticals and so we enjoy that diversification and I think that shows some of the strength of our performance over time.

Ronald E. Konezny: So some verticals that are doing well right now that we anticipate continuing to do well.

Ronald E. Konezny: As more <unk>.

Ronald E. Konezny: Utility grade solar for example, which is doing well where residential solar is not.

Ronald E. Konezny: Not as robust as it was EV charging remains very strong we've always been strong in medical device, you mentioned datacenter retail point of sale type applications. So so we've got a number of applications that we feel we feel pretty darn good about what one of the others thats been a traditional strength of ours that obviously, you got really Walt.

Ronald E. Konezny: We've always been strong in medical devices. You mentioned data center, retail, and point-of-sale type applications. So we've got a number of applications that, you know, we feel pretty good about. One of the others that's been a traditional strength of ours that obviously got really walloped during COVID is the mass transit and smart city segment, and we're seeing that come back, which is nice. Those applications are now considering moving from 4G to 5G, so we've got some nice existing customers that we are going to help them transition, and that's new opportunities that have come up.

Ronald E. Konezny: During Covid is that mass transit and Smart City segment, and we're seeing that come back which is nice.

Ronald E. Konezny: Applications now are considering moving from <unk> to <unk>. So we've got some nice existing customers that we are going to help them transition and thats new opportunities that come up.

Harsh V. Kumar: Got it. And then the last one, I wanted to get back to your comment in the press release and then earlier about wallets kind of getting a little tighter on the IT spend. So the question really is, are they taking longer to close, or are they kind of not wanting to initiate new projects, and then when they look, let's just say past the election, maybe towards the end of the year, what can I do?

Speaker Change: Got it and then and then the last one I wanted to get back to your comment in the press release, and then earlier about wallet scanner getting a little tight in the it spend.

Harsh V. Kumar: So the question really is are they are they taking longer to close or are they.

Harsh V. Kumar: Kind of not wanting to initiate new projects and then Monday look, let's just say past election, maybe towards the end of the year, what kind of outlook or your customers, providing when you talk to them.

Ronald E. Konezny: Yeah, so when we look at the data, the opportunity set is as robust as it's ever been. So the demand is there, the conversion timeline is taking longer, so it's taking longer for customers to make decisions. And if you look at our average dual order size, that's actually down by about 5% as well. So you've got customers that are being more cautious, issuing smaller POs. And you've seen this with a number of public companies.

Ronald E. Konezny: So when we look at the data the opportunity set is as robust as it's ever been so the demand is there.

Ronald E. Konezny: The conversion timeline is taking longer.

Ronald E. Konezny: Taken longer for customers make decisions. If you look at our average order size, that's actually down by about 5% as well so you've got customers that are being more cautious issuing smaller pose.

Ronald E. Konezny: And you've seen this with a number of public companies profitability and cost cutting right now is very trendy right.

Ronald E. Konezny: Profitability and cost-cutting right now are very trendy, right? You know, obviously, it starts with the huge companies, but how many companies are you seeing nowadays where revenue may not be exactly where they want, but you're seeing profitability really strong? And that's, I think, some of the exposure that I'm talking about, which is customers being very cautious. They know they need the stuff. They're being more exacting on what they're looking for and the terms of that arrangement, which is elongating the sales cycle. Very well, Ron. Thank you.

Ronald E. Konezny: Obviously it starts with the huge companies, but how many companies are you seeing nowadays where revenue may not be exactly where they want but youre seeing profitability really strong and thats I think some of the exposure to that.

Ronald E. Konezny: Im talking to which is customers being very cautious they know they need the stuff.

Ronald E. Konezny: They're being more exacting on what Theyre looking for in the terms of that arrangement, which is elongated sales cycles.

Harsh V. Kumar: Very well, Ron. Thank you so much again.

Ronald E. Konezny: Very well Ron Thank you so much again.

Operator: As a reminder, if you want to ask a question, please press star one one on your telephone to get into the queue. Our next question comes from Mike Walkley with Canaccord Genuity.

Speaker Change: As a reminder, if you want to ask a question. Please press star one on your telephone to get into the queue.

Operator: Our next question comes from Mike Walkley with Canaccord Genuity.

Michael Walkley: Great, thank you. Just a quick follow-up question for Jamie. If you take kind of the midpoints of your guidance for Q3, it kind of speaks to FLAT-ISH Q4, but an uptick in adjusted EBITDA, is that just a better mix of console servers, so more of a gross margin uptick, or or is there something else like increased cost controls expected in the September quarter?

Michael Walkley: Great. Thanks, just a quick follow up question for.

Michael Walkley: Jamie.

Michael Walkley: If you take kind of the mid points of the year full year guidance in Q3, it kind of speaks to flattish Q4, but an uptick in adjusted EBIT is that just.

Michael Walkley: Better mix of console server somewhat our gross margin uptick or is there something else like increased cost control is expected in the September quarter.

James J. Loch: Mike, I think the biggest driver that we see that's picking that up is that continued mix of ARR. As we project ARR to continue to hold, I think we will continue to see that increase. There are cost controls that we're looking at that, you know, some we put into play, some get put into play in the quarter, and then you'll get a full quarter effect of that in Q4 versus a partial effect in Q3, so it's a little bit of a combination, but I'd say the biggest driver is going to end up being a more positive mix and an impact on gross margin largely led by ARR continuing

Speaker Change: But I think the biggest driver that we see thats ticking that up is that continued mix of IRR as.

James J. Loch: As we project IRR to continue to hold I think we continue to see that out there there are cost controls that we're looking at that.

James J. Loch: Some we put into play some get put into play in the quarter and then you'll get a full quarter effect of that in Q4 versus a partial in Q3. So it's a little bit of a combination, but I would say the biggest driver is going to end up being more positive mix.

James J. Loch: And the impact on gross margin largely led by <unk> continuing to grow.

Michael Walkley: And just a follow-up question, you know, we're on the script again, the press release you talked about, you know, focus on M&A to grow the business over time, and you guys have done a good job, you know, deleveraging with the strong cash flows. Can you just maybe update us on what you're seeing in the M&A market and opportunities? Yeah, there still is, you know, a really good set out there

Speaker Change: And just a follow up question Ron in the script again in the press release, you talked about focus on on M&A to grow the business over time and you guys have done a good job.

Michael Walkley: Leveraging with the strong cash flows can you just maybe update us on what youre seeing in the M&A market opportunities.

Ronald E. Konezny: Yeah, there still is, you know, a really good set out there. As you know, interest rates have climbed, although, you know, in a broader lens, they're not that high. But in the last 20 years, they're high, and that's helped fuel a lot of financial buyers. So we're seeing financial buyers maybe be more disciplined or less participatory.

Speaker Change: Yes, there is still is.

Ronald E. Konezny: Really good set out there as you know interest rates have climbed although at a broader lens.

Ronald E. Konezny: Hi, Ben last 20 years, they are high and that has helped fuel a lot of financial buyers, who are seeing financial buyers, maybe be more disciplined or less participatory by strategics are still are still pretty active and.

Ronald E. Konezny: But strategics are still pretty active. And, you know, the good news on industrial IoT is it's a massive market. There are thousands, if not tens of thousands, of IoT privately held companies out there.

Ronald E. Konezny: The good news on industrial Iot, it's a massive market there are thousands if not tens of thousands of Iot privately held companies out there and so we.

Ronald E. Konezny: And so we think we have a good opportunity set. As you mentioned, we are very patient and disciplined. We want to find companies of scale that have good ARR attributes, and we have a right to work with them and alongside them. And we want them to be growing and profitable. And so, in the meantime, we're trending towards really fewer, larger opportunities, and deleveraging is an important part of that. We do our best to really prevent dilution, so we use that as a way of helping fund the acquisitions. And so delevering is very important for us to improve our ability to chase larger opportunities should they become available.

Ronald E. Konezny: We think we have a good opportunity set as you mentioned, we are very patient and disciplined.

Ronald E. Konezny: Want to fine companies of scale that have good attributes, we have a right to work with and alongside them and we want them to be growing and profitable.

Ronald E. Konezny: And so in the meantime, we're we're trending towards with a fewer larger opportunities in deleveraging and important part of that.

Ronald E. Konezny: We do our best to try to really prevent dilution. So we use that as well.

Ronald E. Konezny: They are helping fund.

Ronald E. Konezny: The acquisitions and so delevering is very important for us to improve our ability to chase larger opportunity should it become available.

Speaker Change: Makes sense. Thank you.

Operator: I'm showing no further questions at this time. I would now like to turn it back to Ron for closing remarks.

Ronald E. Konezny: I'm showing no further questions at this time I would now like to turn it back to Ron for closing remarks.

Ronald E. Konezny: Thank you and I really appreciate everybody joining our discussion today and for your continued support. Digi will be in attendance at B. Reilly's conference this quarter as well as Craig Hallam, so if you're an investor, please contact those organizations for meetings. A giant thank you to our customers, our distributors, suppliers, and our incredible Digi team. Have a great day.

Ron: Thank you and really appreciate everybody joining our earnings discussion today and for your continued support DG will be in attendance at B Riley conference this quarter as well as Craig Hallum.

Ronald E. Konezny: So if you are an investor please contact those organizations for meetings a giant thank you to our customers our distributors suppliers and our incredible digi team and have a great day.

Operator: And thank you for your participation in today's conference. This does conclude the program. You may now disconnect.

Speaker Change: And thank you for your participation in today's conference. This does conclude the program you may now disconnect.

Operator: Okay.

Operator: [music].

Operator: Okay.