Digi International Inc. (NASDAQ:DGII) Q2 2024 Earnings Call Transcript

Digi International Inc. (NASDAQ:DGII) Q2 2024 Earnings Call Transcript May 2, 2024

Digi International Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and thank you for standing by and welcome to the Q2 2024 Digi International Inc. Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] 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.

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 Konezny our President and CEO. We issued our 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. 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 and the Risk Factors section of our most recent Form 10 K and subsequent reports on file with the SEC. Finally, certain of the financial information disclosed on this call includes non-GAAP measures. The information required to be disclosed about these measures, including reconciliations to the most comparable GAAP measures are included in the earnings release.

The earnings release is also furnished as an exhibit to Form 8-K, that can be accessed through the SEC filings section of our Investor Relations website. Now I will turn the call over to Ron.

Ron Konezny: Thank you, Jamie. Good morning everyone. Before we jump into Q&A just a few comments. Digi deliver record annualized recurring revenue, record gross margins, strong cash generation, lowered inventory, 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. Jim joined us from a nearly 18-year career at Medtronic. Jim’s security IP and applications experience are perfect fit for Digi’s critical needs. Secondly as announced yesterday, we’re thrilled to have Tony Puopolo joined Digi as Senior Vice President and General Manager of our managed solutions business.

Tony joined Digi from a 13-year career at Cradlepoint where he demonstrated outstanding success in sales and product management leadership positions. Tony has the right combination of technical knowledge, product strategy and go-to-market expertise. While pleased with our first half results, we are seeing more cautious customers and second half demand. We remain confident in our ARR growth projections. However, we have softened top-line expectations. To offset top-line expectations, we have implemented tighter expense controls resulting in only slightly beating our annual profit expectations. 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 in security, regulation and technology 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 our question-and-answer session. Thank you, operator?

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Q&A Session

Operator: Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] First question comes from Mike Walkley with Canaccord Genuity. Your line is open.

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

Ron Konezny: Yeah. Hey, Mike, a couple of good questions. We monitor our opportunity set and our ability to convert that opportunity set and how long it’s taking it to convert and — we don’t have a 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 a return to more robust growth levels. But the good news is the demand is there. The bad news is the era caution we’re seeing from customers before they make those decisions. Does this caution does increase a bit, okay, they get longer, the bigger the deal are.

Mike Walkley: Yeah, 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 it? Or do you have some more litigation expense as you head into whatever trials are coming?

Ron Konezny: Yeah. This isn’t something that we had in our K’s and Q’s is having something we’ve discussed on our calls here. It’s a contract dispute with a former reseller. And we’re — both parties are remaining litigation as we work to get it resolved. And it’s our best estimate at the moment.

Mike Walkley: Okay. Great. I’ll pass it on and jump in the queue.

Operator: Our next question comes from Cole Couzens with Stephens Incorporated.

Cole Couzens: Hey, guys. Thanks for taking my question.

Ron Konezny: Hey, good morning, Cole.

Cole Couzens: Hey. So just zooming in on the customer caution, is there any specific product type or end market that is being most impacted? And then also on Ventus, I know last quarter, we thought the regional bank overhang was largely done coming out of that quarter, but since things have changed a little bit. So any updates you can provide on that business would be helpful.

Ron Konezny: Yeah. 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 move with more confidence, but then there are other parts. And these verticals, as you know, we’re pretty diverse in our exposure. And so we have multiple product lines that service to multiple verticals. So I’d say it’s more dispersed in terms of this cost and that we’re seeing. And then on the second side of things, can you repeat that question one more time, please?

Cole Couzens: Yeah, it was just on the regional bank and more and — Ventus?

Ron Konezny: Yes. So we think that that’s largely behind us. There is still some wind down of some existing ATM networks, but there hasn’t been any new concerns that have come out. But for our customer base.

Cole Couzens: 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 additional color you can provide there would be helpful.

Jamie Loch: Hey, Cole, this is Jamie. I think there’s really two drivers. I think the continued growth of ARR provides positive mix in the net gross margin. And it’s one of the reasons why we continue to say that, it’s a top priority for us because you see the impact that, that has that flows its way down to the P&L. I think secondarily, to your point, we continue to be focused on controlling costs, and that’s both at an OpEx level, but it’s also at a cost of goods sold level. And our operations teams do a really nice job as we’re now navigating our way out of really the semiconductor challenges that were sitting out there, they’re doing a really nice job of helping us navigate through that cost side. So it’s kind of two-folded, but I’d really point to the growth in ARR and providing that positive mix.

Cole Couzens: Perfect. Helpful. And if I could squeeze one last one in. I thought it was a good quarter on ARR growth in Solutions. I think some of that was most of that was on Smart-sense wins. But is there any drivers that there — or any changes you’re seeing in that business — in that business that’s kind of driving some of those wins — any color there would be helpful. Thanks.

Ron Konezny: Yes. On previous calls we talked about this. We, 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 we’re seeing that finally start to occur. You saw that in last quarter results. We anticipate continued success there. And somebody would call is these opportunities have been really well vetted by the customer in a very extensive POCs, very extensive ROI mapping, implementation, discussions and we’re starting to see the fruits of that patience and that dedication to helping the customer to get that confidence.

Cole Couzens: 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. Riley.

Josh Nichols: Yes. Thanks for taking my question and great to see the ARR and the margin flow through to the cash flow generation for that quarter. Just touching on that from a working capital perspective, your inventory has been rightsized 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 rightsized inventory level that the company is looking to work to over the next couple of quarters?