Q4 2024 Digi International Inc Earnings Call
Good day and thank you for standing by. Welcome to Q4 2024 Digi-International Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session.
To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again.
Speaker Change: Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jamie Loch, Chief Financial Officer. Please go ahead.
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.
Jamie Loch: Joining me on today's call is Ron Konezny, our president and CEO.
Jamie Loch: We issued our earnings release after the market closed today. You may obtain a copy of the press release through the financial releases section of our investor relations website at digi.com.
Jamie Loch: This afternoon, Ron will provide a comment on our performance, and then we'll take your questions.
Jamie Loch: 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.
Jamie 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.
Jamie Loch: For additional information, please refer to the forward-looking statement section in our earnings release today and the risk factor section of our most recent Form 10-K and subsequent reports on file with the SEC.
Jamie 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.
Speaker Change: The earnings release is also furnished as an exhibit to Form 8K that can be accessed through the SEC filing sections of our Investor Relations website. Now I'll turn the call over to Ron.
Thank you, Jamie. Good afternoon, everyone.
Before we take questions...
Speaker Change: A few comments on last fiscal year while looking forward to fiscal 2025.
J.J. is committed.
Speaker Change: to be a leader in the industrial Internet of Things market.
we believe a significant share of the market.
Speaker Change: wants a solution provider rather than building a solution to various vendors.
Our solution provider approach reduces risk.
Improves outcomes. Allows customers to focus on their core competencies.
accelerates time to value.
The single metric demonstrating our relative success
is Annual Recurring Revenue, or ARR.
ARR, Consolidated Across Our Product Lines
represents our transition.
From one-time sales to solutions.
Speaker Change: Increasingly, Digi will forego one-time transactional sales and favor a multi-year solutions agreement.
Speaker Change: Over time, this dynamic will dampen overall revenue but increase ARR.
Speaker Change: As ARR grows, our results will become more consistent, provide greater visibility,
and improve our model.
You can see this in our fiscal 2024 results.
Speaker Change: ARR grew 9% year-over-year to reach a record 116 million, which now represents more than 27%.
of our total revenue.
Speaker Change: ARR grew in both our products and services business segment, where we complement our award-winning products with solution packages.
ARR also grew in our solutions business segment.
Speaker Change: where we offer turnkey solutions combining product, connectivity, service, and software.
Speaker Change: ARR increased as we both onboarded new customers and solutions, while retaining and extending existing customers with increased value added to our offerings, such as our recently launched Digi360.
Offering and Achieving SOC 2, Type 2 Compliance.
Speaker Change: Our strengthening model achieves 60% gross margins for the first time in the company's history, driven by this solution strategy.
A disciplined and scalable organization demonstrated flat operating expenses year-over-year.
which resulted in a record-adjusted EBITDA margin.
Speaker Change: were able to reduce her inventory throughout the year as supply chain normalized.
We've restructured our depth facility.
which reduced our interest payments.
Speaker Change: Cash generated from these combined efforts resulted in a net debt to adjusted EBITDA level of less than one.
Speaker Change: Turn the page to fiscal 2025. We are experiencing both uncertainty as well as reasons to be optimistic.
Speaker Change: Supply chain and inventory levels have normalized, but COVID-induced scars create caution resulting in elongated sales cycles and smaller or frequent order patterns.
Speaker Change: The industrial economy's health, measured in part by PMI, has been in contraction for quarters.
Speaker Change: But there is strength in AI, data centers, utilities, and renewables.
Speaker Change: Nationalism persists with talks of increased tariffs, but DIGI has diversified its supply chain to help buffer potential changes.
Speaker Change: With that macroeconomic backdrop we take a consistent but pragmatic approach to setting expectations for fiscal 2025
Speaker Change: We expect continued growth in ARR with contributions from both business segments.
Speaker Change: As we move to more solution packages, one-time revenue is expected to temper. In addition, we are improving our offering portfolio by retiring legacy product lines that have been in decline, such as Rabbit.
combined as a result in an expectation of flat revenue
Speaker Change: Select Operating Expenses, Expense Investments Required to Sustain Launch and Growth Result in Flat Adjusted EBITDA.
Speaker Change: and we expect to generate cash and to be net debt free by the end of calendar 2025.
Speaker Change: We continue to explore potential acquisitions that benefit our customers and are consistent with our focus on ARR and profitable growth.
macroeconomic improvement throughout the fiscal year could improve our outlook.
Speaker Change: Lastly, JT remains confident in reaching its five-year targets of 200 million dollars in ARR and 200 million dollars in adjusted EBITDA established last year.
Speaker Change: In October, we celebrated the 35th anniversary of our listing on NASDAQ.
Next year we celebrate our 40th birthday.
Digi's story is highlighted by customer focus.
Resilience, relentless innovation, and continuous improvement.
Speaker Change: Very few companies that went public in 1989 exist, let alone remain independent.
Amation, 3Com, WorldCom, Symantec
Speaker Change: and Cambridge Technology Partners were some of the companies that went public in 1989 and are no longer independent.
Over the decades, DIGI has adapted to change.
Speaker Change: And that core competence is vital to success in an ever-changing world.
Speaker Change: Operator, that concludes my remarks. I would like to open the call to questions.
Speaker Change: Thank you. As a reminder, to ask a question, please press star 1 1 on your telephone and wait for your name to be announced.
To withdraw your question, please press star 11 again.
Please stand by while we compile the Q&A roster.
Speaker Change: Our first question comes from the line of Tommy Moll from Stevens, Inc.
Good afternoon and thanks for taking my questions.
Hey, good afternoon, Tommy.
Speaker Change: Ron, you mentioned the dynamic where there's a relationship between reported revenue and recurring revenue. I guess I should I could call it a trade-off even.
Speaker Change: and so as you constructed your outlook for fiscal 2025 how much is that in play just looking at the spread and you know double-digit ARR flat rev
Speaker Change: or are there other factors you want to make sure to highlight? You mentioned discontinuing some old product lines could be one. Just help us with that bridge.
Speaker Change: Yeah, it's really it's really a combination of those factors Tommy and I thought you were very keen to pick up on that There's certainly going to be some product that we're going to end of life The supply chain is honestly not holding up for some of these components are getting much more difficult to source and
Speaker Change: and that we can provide quality products. So that certainly is going to be a stunt. And then there's another piece of it, which is also the trade-off of moving towards recurring revenue. So it's really a combination of the two.
Speaker Change: And then, I think I heard you say the expectation on the balance sheet would be net debt free by the end of the year? Yeah, by the end of the calendar year.
Oh, by the end of calendar year 25. Correct.
Speaker Change: All right, that might change the math a bit. Does that imply...
Speaker Change: relatively and a relatively unchanged pace of that quarterly cash flow generation you know are you taking in
Speaker Change: Yeah, I think we're going to see, you know, another inventory dividend, if you will, that kicks in at FY25, which you saw that in 24.
Speaker Change: interest payments are now a fraction of what they were a year ago, those will continue to go down as we pay down debt. And so cash inches even closer to EBITDA with those two factors.
Okay.
Speaker Change: Those were the only two I had prepared, so I'll step back in line. Thank you. All right. Thank you, Tony.
Thank you. One moment for our next question.
Speaker Change: Our next question comes from the line of James Fish from Piper Sandler.
Speaker Change: Hey guys, this is Quinton. I'm for Jim Fish. Thanks for taking our questions.
Speaker Change: You know, maybe first of all, it was really good to see both the reiteration of 2028 targets and kind of the implied re-acceleration, if you call it that, of ARR for next year.
Speaker Change: You know, as we think about specifically for that ARR growth next year, what segments or solutions are going to drive that re-acceleration? And then as we think about your visibility relative to that year.
Speaker Change: Is there anything underneath that makes you more confident that you're seeing all of demand drivers for the full year?
Speaker Change: Yeah, listen, we grew ARR 9% year-over-year in fiscal 24, so to call out, you know, double-digit growth or 10% growth, you know, isn't really much of a stretch.
Speaker Change: in my humble opinion. So there is the potential for things to go even better. We do think we'll see contributions, as we did in 24, from both business segments.
Speaker Change: And that's really good to see and hear, right? That you're not only dependent on one product line, one vertical, one customer. And we think that'll play out as well in Fiscal 25.
Speaker Change: No, that makes a ton of sense. And, you know, maybe touching on the M&A landscape, you know, you mentioned you're still active in the market. Is there anything to call out in terms of the number or type of companies that you're seeing coming up for sale? Is the landscape improving as we kind of seem to have a little bit more confidence in a improving macro and rates coming down?
Speaker Change: It's a really good question. I think things improved maybe modestly throughout 24 to date. You know, interest rates really didn't start coming down until recently and that's a factor I think in people's decisions to market their companies or to hold on to them for maybe better conditions.
Speaker Change: I think some banks have come out with optimistic points of view that M&A will accelerate going into 2025.
Speaker Change: Maybe a combination of macro, interest rates, and maybe a different approach from at least the federal government. And so I think there's reason to be optimistic that M&A will increase in 2025 compared to 2024.
Speaker Change: Got it. And then just last one from us is, you know, as we look at the ARR underneath.
Speaker Change: We were kind of surprised and pleasantly surprised with kind of outperformance of each of our numbers coming from your actual kind of
product and services line.
Is there anything one time or specific in driving?
Speaker Change: that upside, or was this kind of widespread across that segment? Thank you. No, again, the good news, it was a broad-based contribution. You know, each of our product lines has a bit of their own journey that they're going across, going about to, you know, to become the solution provider. But again, really good news that it was broad-based.
Speaker Change: Thank you. As a reminder, to ask a question please press star 1 1 on your telephone and wait for your name to be announced.
To withdraw your question, please press star 11 again.
Speaker Change: Our next question comes from the line of Josh Nichols from B. Riley.
Josh Nichols: Yeah, thanks for taking my question. Good to see that the record gross margins and
thinking out a little bit more.
Josh Nichols: I know you got into flat revenue, but with ARR up double digits, I would expect...
Josh Nichols: there may be some more room for expansion for that gross margin line as we think about
Josh Nichols: 25, how are you thinking about the gross margins and the ability to move higher to 60%?
Josh Nichols: level, given the outlook for the fiscal year and the ARR growth? Yeah, it's a good question. You know, ARR is definitely a creative to gross margin. Within product and services, we do have mixed
Josh Nichols: that we do pay attention to and there's some products that have better margins than others, but we do think that 60% plus gross margin
Josh Nichols: mark is when we can sustain, and it'll be driven in the long run much more by AR becoming a bigger and bigger component of our overall mix that will outweigh really product mix over time.
Thank you. Bye.
Speaker Change: Yep, and then just looking at the fiscal 1Q, I know normally that's a little bit too slowly slower. There's a slight dip in revenues, but not really anything material. Is that just because you're coming off like a relatively lower base or you're seeing a change in ordering trends? I'm just curious if you have any insight so far into the fiscal first quarter and what you're seeing, because it usually is a little bit slower.
Speaker Change: Yeah, you know it's interesting we've been not only of course looking at our metrics But then looking at benchmarks, and I think the themes are a little bit consistent that I I don't know if
Speaker Change: you know air quotes the market has bottomed necessarily but but the recovery is unclear and so we're taking I think a pragmatic approach you know not needing any help if you will to
to reach our objectives. Continued focus on ARR, of course.
Speaker Change: But you're right, you know, the last quarter were heavily channel centric on the product and services side. Channel doesn't like to have much inventory as they enter typically their, the end of their fiscal year. So it can be, it's not unusual for the last quarter of the year to be a little bit softer.
Yep.
Speaker Change: Thank you and then just looking, you touched on it really briefly. I know the company is diverse by the way for manufacturing and operations but given
Speaker Change: the change we have at the executive branch. I'm just curious like your thoughts on
Speaker Change: potential tariffs or how that may impact the business. I know you've gone through this, right, sometime before, but I'm just curious, like, what you've done since then, and how you think it may impact the industry overall.
Speaker Change: Yeah, you know I'll caveat by you know, I don't know and I'm not sure who does but but we've been probably the most concerned about China that that has felt like you know, the highest probability that those terrorists would increase
Speaker Change: Since the last tariff action, which was then sustained under the current administration, we have diversified out of China.
We're not completely out, but we're you know, we're
Speaker Change: single digits in terms of our exposure there as a total of our manufacturing and we've got plans to finalize that. I'm probably of the group that's a little skeptical of Mexican tariffs. I think there's a lot at play there. That doesn't mean there might not be some saber-rattling, but
Speaker Change: I think that it feels the least likely, and Mexico is a place where we have found safe harbor. We also have moved a lot of manufacturing to different Southeast Asian countries like Vietnam, Thailand, Cambodia, as a way to diversify as well.
Speaker Change: I think lastly, which is sort of, if you will, maybe the most dramatic potential action is this wall of tariffs that's been talked about.
Speaker Change: and we now have manufacturers with U.S.-based facilities that we can transition a good portion of our manufacturing to the U.S. if
Speaker Change: the conditions require it. So I think that's an important piece.
Speaker Change: to consider as well is that you're adding the most value in the geography that has the most optimal terra structure. So I think we're in a good position. I don't know if anybody's perfect necessarily about it. I think we really strengthen the diversity of our manufacturing footprint to
to be able to adapt to different potential terror scenarios.
Thanks for that. I'll hop back in the queue.
Thank you.
Speaker Change: As a reminder to ask a question, please press star 1 1 on your telephone and wait for your name to be announced.
Speaker Change: At this time, I would now like to turn the conference back over to Ron Konezny for closing remarks.
Digi offers compelling solutions for complex, mission-critical connectivity challenges.
Speaker Change: We are uniquely qualified as a leader in the industrial IOT market given our long history
of offering secure, reliable, and innovative solutions.
Speaker Change: We plan to attend the Stevens Annual Investment Conference in Nashville next week and would love to connect with investors interested in learning more about Digi.
Speaker Change: We appreciate you joining Digi's earnings call and for your continued support. Thank you to our customers.
Speaker Change: distributors, suppliers, and to our exceptional Digi-team. Have a great day.
Speaker Change: This concludes today's conference call. Thank you for participating. You may now disconnect.