Q3 2025 Digi International Inc Earnings Call

Speaker #3: Thank you for standing by and welcome to DIGI INTERNATIONAL INC Q3, 2025 earnings conference call. All lines have been placed on mute to prevent any background noise.

Speaker #3: After the speakers' remarks, there will be a question and answer session. If you would like to ask a estion during this time, simply press star, followed by the number one on your telephone keypad.

Speaker #3: Thank you. I would now like to turn the conference over to Jamie Locke. CFO, please go head.

Speaker #4: Thank ou. Good day, everyone. It's great talk to you again, and thanks joining us today to discuss the earnings results of DIGI INTERNATIONAL. Joining me on today's call is Ron Konezny, our president and CEO.

Speaker #4: We issued our arnings 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.

Speaker #4: This afternoon, Ron will provide a comment on our performance, and 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.

Speaker #4: 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.

Speaker #4: 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.

Speaker #4: 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.

Speaker #4: 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 #4: The earnings release is also furnished as an exhibit to Form 8-K that can be accessed through the SEC filing sections of our investor relations website.

Speaker #4: Now, I'll the call over to Ron.

Speaker #5: Thank you, Jamie. Good afternoon, everyone. Before we open the line for questions, I'd ike to share a few highlights from our third fiscal quarter.

Speaker #5: DIGI ivered a strong quarter returning to year-over-year revenue growth. Annual recurring revenue grew double digits year-over-year for the third consecutive quarter. ARR now represents a new record of approximately 30%.

Speaker #5: Of our trailing 12-month revenues, importantly, both of our reporting segments contributed to this growth. Our tailored IoT solutions make it simpler and faster for customers to deploy intelligent and cloud-connected edge solutions.

Speaker #5: Our solutions enable remote monitoring, improve machine uptime, and deliver actionable analytics which produce rapid ROI for our ustomers. This value proposition is resonating across industries and applications.

Speaker #5: Profitability improved driven by ARR, and favorable product mix. Partially offset by increased freight and duties costs. Adjusted EBITDA margins hit a record 25.6%. We expect ARR and profit growth to increasingly outpace revenue growth as our model scales.

Speaker #5: Free cash flow generation is a hallmark of our fiscal 2025 performance. Our results were driven by discipline operations, increased productivity from our AI initiatives, and continued inventory optimization.

Speaker #5: After retiring $30 million in debt this quarter, we now stand at $20 million in net debt and remain on track to be net cash positive by the end of our fiscal 2025.

Speaker #5: Our CapEx light model delivers a 9% free cash flow yield underscoring the efficiency of our business. Strategic acquisitions remain a top priority; we continue to evaluate opportunities that align with our ARR, growth, and scale objectives.

Speaker #5: Looking ahead to the final quarter of our fiscal 2025, our outlook assumes a dynamic macro environment. DIGI's 40-year legacy demonstrates our ability to adapt and to thrive.

Speaker #5: Our diversified global supply chain positions us to respond quickly when needed. While maintaining a long-term focus on our ustomer success, I'll now turn the call back to the operator for Q&A.

Speaker #2: Thank you. As a reminder to ask a question, you will need to press star, then the number keypad. And to withdraw your question, press star one again.

Speaker #2: We will pause for just a moment to compile the Q&A roster. And our first question comes from the line of Tommy Mo with Defense.

Speaker #2: Your line is open.

Speaker #6: Good afternoon, and thanks for taking my questions.

Speaker #5: Good afternoon, Tommy.

Speaker #6: Ron, on products and services, ARR, another big step higher this quarter. So I wanted to get an update from you there. A couple of aspects I had in mind, and then anything else you ant to offer.

Speaker #6: But maybe an update on how you're managing these attach rates through your channel. I know there's a there's a decision you have to make about how quickly you want to you ant to move there, and then another one that came to mind was if you can give any color on which product categories you're having the most success with.

Speaker #6: But maybe an update on how you're managing these attach rates through your channel. I know there's a there's a decision you have to make about how quickly you want to you ant to move there, and then another one that came to mind was if you can give any color on which product categories you're having the most

Speaker #6: the most challenges with, frankly, that would be interesting as well. Thank one on your telephone ou.

Speaker #5: Yeah, good questions, Tommy. We're ally seeing some increase on take rates. We've increasingly moved towards having almost all new business now being attached in the IT area.

Speaker #5: So IT would include our cellular routers, our open gear console servers, and our rastructure management devices. They're all now seeing really much higher levels of attach, and that's helping drive that recurring revenue.

Speaker #5: We saw a really good contribution across the board. We did have some product mix with some products with improved margins having a little bit higher weight than others.

Speaker #5: But we did see some broad-based contribution, which is always good to see that you got a diverse set of contributors.

Speaker #6: Ron, on the guidance for fourth quarter, looks like sales flat sequentially, EBITDA dollars, a touch lower sequentially. What do you want to call out?

Speaker #6: Maybe there was some goodness that hit the P&L in the most recent quarter that we shouldn't expect to recur. Anything you can do to bridge us from one to the other would be helpful.

Speaker #5: Yeah, Tommy, we had a similar profile to last quarter. And so we're always a little bit cautious on the mix side. And so the mix driving gross margin is the thing that would really impact that adjusted EBITDA number.

Speaker #5: I would point out, although it appears to be relatively flat quarter to quarter, it still would mark another year-over-year return to growth, which we're pretty excited about.

Speaker #5: But that profit assumption will be driven mainly by gross margin rather than, say, OpEx.

Speaker #6: That's helpful. Thank you. And I'll turn it back.

Speaker #2: Next question comes from the line of Matthew Moss with B Riley Securities. Your line is open.

Speaker #7: Hi, this is Matthew on for Josh Nichols. Thanks for taking my questions. I guess just first off, I mean, in terms of demand outside of APAC and setting tariff returns aside, are ou seeing customers move from wait-and-see mode to pulling the trigger more on larger projects?

Speaker #7: You know.

Speaker #5: What we're timistic that between US financial policy, the one beautiful bill act, as well as now tariffs becoming more certain, you know whether you like them or not, I think that's going to open up some improved decision-making.

Speaker #5: We hadn't seen as much of that in Q3, but I think we are starting to see that here in this particular period. And so we're optimistic that increased certainty will help drive more effective and timely decision-making by our ustomers.

Speaker #6: Helpful. Thank you. And if I remember correctly, I think open gear's benefiting from AI infrastructure build-out. Can you kind of size that opportunity as you ow hyperscalers kind move from planning to deploying a little bit more?

Speaker #5: Yeah, as a reminder, open gear really services both data center applications as well as edge. We saw a slight improvement increase in data center business this fiscal year, and that continued in FQ3.

Speaker #5: But it's still around a 50/50 split between those applications. The data centers that we're doing business with are both AI and non-AI, and increasingly, actually, one of the bigger trends is hybrid deployments where a customer wants to have some of their compute in the cloud, but they also want to have some compute locally.

Speaker #5: And that's becoming more important as customers look to protect their data as they're leveraging AI models. So that's been a really growth area for in that hybrid data center environment.

Speaker #6: Got it. And I guess just on inventory, I mean, it looks like it's basically normalized to historical levels. Should we expect customer reordering to accelerate in fiscal '26?

Speaker #5: Yeah, that's a good point on inventory. We feel like 're getting really to that optimized level; in fact, if anything, we want to make sure we have enough of the right product we're seeing some positive signs from the channel as well that they're velocity is improving.

Speaker #5: It's hard to say how much that will continue in FY '26, but we are seeing some improvement there.

Speaker #6: Got it. Thank ou. That was all for me.

Speaker #5: Thank you, Matthew.

Speaker #2: Next question comes from the line of James Fish with Piper Sandler. Your line is open.

Speaker #8: Hi, this is Kaden on for Fish. My first question, what was the linearity of the quarter like? What did you guys see through July?

Speaker #8: Was there any impact from tariffs/macro volatility?

Speaker #5: I think the, you know, again, we had favorable mix that navigated its way through. I think the I don't know that there was really anything unusual about the ay the linearity came into the quarter.

Speaker #5: And frankly, there's not anything unusual about the way the demand is shaping up either. There is some tariff impact. This is Jamie, by the way.

Speaker #5: There's been some tariff impact but we've really been navigating through that either through some accelerated buys that we had as well as leveraging our lower tariffed regions for manufacturing.

Speaker #5: So we've had some tariff impact. Again, that's been a very volatile situation with some of the more recent information that's come out. We're analyzing how we think that's going to play into Q4.

Speaker #5: But as it ates to FQ3, there wasn't anything unique really about the linearity.

Speaker #8: Gotcha. Thanks. And then just how are you guys feeling about the M&A environment? Like what are the opportunities you shape and out there?

Speaker #5: Yeah, it's still a robust environment out there. We've got a real healthy pipeline. You know, it's always an arm wrestle over valuations for the right opportunities.

Speaker #5: And we continue to emphasize opportunities that have really strong ARR, good growth profiles. We have a right to own them clearly. And then you know we want them to be profitable as well.

Speaker #5: So, it's a healthy market out there. We feel like we've got a good pipeline.

Speaker #8: Gotcha. Thank you.

Speaker #2: Next question comes from the line of Scott Seal with Ross Capital. Your line is open.

Speaker #9: Hey, good afternoon. Thanks for taking the questions. Hey, Ron, I was hoping you could ide a little bit of color, maybe geographically and by some of the vertical end markets.

Speaker #9: I know you had a big win with, I think it NYC DOT, but you know where is the activity? Where are you seeing the demand and the pull through in the pipeline building right ?

Speaker #5: Yeah, it's a really good estion. You know, one of the hallmarks of DIGI is we have tremendous diversity. Across different industries, and that diversity is really helped us through, you know, good times and challenging ones.

Speaker #5: And for example, right now, you know, as you can imagine, that renewable market isn't as strong as it had been traditionally. And so we're seeing maybe as much demand there as we've in previous periods.

Speaker #5: But we've seen really good demand in the utility segment and water mass transit has come back as well. As we talked about earlier, it's been good business in both the edge as well as in data center environments.

Speaker #5: And AI has been a nice boost there as well. So those positives right now are outweighing the challenges. And you ow, North America, I think, is gaining more prominence as compared to the other geos.

Speaker #5: APAC in particular, I ink, has been softer for us than you know, than maybe we would have liked. But more than offset by some strength in North America.

Speaker #5: Europe is going to be a bit of a wildcard here, as they're working through a lot of things on that side. And we remain optimistic, but there may some bumps along the way in Europe.

Speaker #9: Gotcha. You already addressed the annel issue, it sounds like things are starting to normalize there. But from a cost and component standpoint, I'm wondering if you could give some updated thoughts in terms of the competitive landscape with China-based vendors, if that's creating opportunities for you.

Speaker #9: It unds like you guys have been able manage your cost structure or your BOM pretty well from that standpoint. And sounds like if anything, just tariff certainty is going to drive decision-making, whereas we've been a little bit more of a holding pattern.

Speaker #5: Yeah, Scott, you nailed it. I ink as things become clear, even if you don't like them, it enables you to make, you know, really effective decision-making.

Speaker #5: We're really very fortunate to put in the work prior to have a diversified supply chain. So we've got some flexibility; of course, you can't just turn on a dime.

Speaker #5: But we're trying to take vantage those areas where the transit routes are very favorable, whether it's Mexico into North America or Asia into Europe.

Speaker #5: And so we've got some flexibility there. And we're going to take advantage of that. We have really moved all our manufacturing out of China.

Speaker #5: So we don't have the exposure to what we think has been more of a longer-term risk there. And there could be some opportunities as we run into some competitors that maybe don't have as flexible a supply chain.

Speaker #5: There is a tremendous amount tariff engineering going out there. Where transformation's urring, there's competitors considering opening facilities in North America. But there could be a short-term opportunity for us.

Speaker #9: Gotcha. And let's see if I could just in terms of the near-term visibility, I'm wondering if there's a terms number that's required to hit maybe the middle of the range.

Speaker #9: And Jamie, just in terms of capital allocation, you guys obviously be doing a great ob on the free cash flow generation front and paying down the debt.

Speaker #9: As ou basically get to, you know, a net cash position, you ow, where does the buyback stand in terms of the level of priorities versus, you ow, keeping a little bit more in the kitty for M&A?

Speaker #9: Thanks.

Speaker #5: Yeah. Scott, good to hear from you. I think the priority continues to be M&A. And I would say we would prioritize it that way.

Speaker #5: We've been pretty clear as that being part of our strategy and I would largely look for any deployment to go that route versus say a buyback.

Speaker #5: We are focused on finding the right acquisitions, and so we would deploy our capital with priority there.

Speaker #9: Great. Thanks. Nice job on the quarter.

Speaker #5: Thanks, Scott.

Speaker #2: And another question from Tommy Mo with Defense. Your line is open.

Speaker #6: One final one for me today. Ron, on the 2025 outlook, you've got revenue flat year-over-year, recurring revenue up, double digits. And I think I heard you saying you're preparing comments that we should continue to expect that the recurring fees would grow faster.

Speaker #6: I'm just looking at the consensus for 2026. Well aware, you're not prepared to guide today. But the consensus does assume call it a mid-single-digit growth rate on that reported line.

Speaker #6: And so I just wanted to give you the opportunity make any comment about the interplay there, where potentially the more success you have on recurring revenue, there can be some optical headwinds there on the reported revenue.

Speaker #6: Anything you could do to frame how you're thinking about next year would be helpful. Thank you.

Speaker #5: Yeah. You know, in my prepared remarks, I talked about how we expect ARR and profitability to outpace our top-line growth. And we think that will persist beyond FY '25.

Speaker #5: You know, we haven't characterized the the percentages and when there's opportunities for us to service a ustomer with more of a solution that is over a multi-year period, we're going to take that every time.

Speaker #5: And that will dampen our one-time revenue. But it's a, you know, it's got a higher IRR and it's a better opportunity for both the customer and for DIGI.

Speaker #5: We continue see those opportunities and we're going to take advantage of those. And that's one of big reasons that ARR is going to outpace revenue for the future.

Speaker #5: That ARR also contains a higher gross margin than what our one-time revenue. And that's what's going to help drive improved margins that we've seen and drive down to the bottom line, which will lift that adjusted BITDA.

Speaker #5: And we're seeing really a version of that happening as 2025 period unwound. We're seeing double-digit growths on ARR. That's contributing to the gross margin.

Speaker #5: And now you're seeing us in the last two quarters lift our profit expectations. So we expect that model to continue. If could, I'd sell all of our solutions.

Speaker #5: We have recurring. We're a record 30%. We do have customers and products that are appropriate for that, but we're going to keep emphasizing that because we think it's in the customer's best interest.

Speaker #5: It really matches investment with return. It's very cash flow friendly for our customers as well. And it's just easy. It makes it a lot easier.

Speaker #5: It holds DIGI to a higher level of responsibility than providing a product and having break-fix support. You get a real engagement at that ROI level, then you're just a component of a broader solution.

Speaker #5: So it's part of the color behind that real strong belief that ARR and profit will outpace top line.

Speaker #6: Thank you, Ron. I appreciate it. We'll turn it back.

Speaker #5: Thank you, Tommy.

Speaker #2: Seeing no further questions, that concludes our Q&A session. I'd like to turn the call back over to Ron Konezny, CEO, for closing remarks.

Speaker #5: Thank you. We look forward to participating in Piper Sandler Annual Growth Frontiers Conference in mid-September in Nashville. Please seek out our Piper representative for a eting.

Speaker #5: At that event, and thank you for joining DIGI's earnings call today. We appreciate the continued support of our customers, distributors, suppliers, and our exceptional DIGI team.

Speaker #5: Have a at day.