Digi International Inc. (NASDAQ:DGII) Q3 2024 Earnings Call Transcript

Digi International Inc. (NASDAQ:DGII) Q3 2024 Earnings Call Transcript August 7, 2024

Operator: Good day and thank you for standing by. Welcome to the Q3 2024 Digi International Inc. Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your first speaker today, Jamie Loch, CFO. 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. Joining me on today’s call is Ron Konezny, our President and CEO. 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. This afternoon, Ron will provide a comment on our performance, and then we’ll take your questions. Some of the statements that we make during this call are considered forward-looking and are subject to significant risks and uncertainties. These statements reflect our expectations about future operating and financial performance and speak only as of today’s date.

We undertake no obligation to update publicly or revise these forward-looking statements. While we believe the expectations reflected in our forward-looking statements are reasonable, we give no assurance such expectations will be met or that any of our forward-looking statements will prove to be correct. For additional information, please refer to the Forward-Looking Statements section in our earnings release today and the Risk Factors section of our most recent Form 10-K and subsequent reports on file with the SEC. Finally, certain 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 sections of our Investor Relations website. Now I’ll turn the call over to Ron.

Ron Konezny: Thank you, Jamie. Good afternoon, everyone. Before we take questions, a few highlights. Digi’s diverse and resilient portfolio of ROI-driven industrial IoT solutions drove a record $113 million in annualized recurring revenue, or ARR, as of the end of the third fiscal quarter, up 9% year-over-year. SmartSense led the way, adding new customers and expanding business with existing customers in logistics, health care and food service industries. Our increased attach rates in IoT products and services contributed as well. ARR now represents a record 27% of our quarterly revenues. With high retention metrics, ARR drives increased visibility to performance in future periods. In addition, ARR drove record gross margins and record adjusted EBITDA margins in the third fiscal quarter.

Digi strengthened its foundation with a significantly improved balance sheet. Our disciplined operating model kept expenses in line and reduced our inventory position by $5 million. As a result, we generated nearly $25 million in cash during the period and paid down $20 million in debt. In less than 3 years, we have paid down nearly $200 million in debt. This has reduced our quarterly interest payment to $3.5 million this fiscal quarter, 43% lower than last year at this time. We expect continued debt payments, which expands our capacity for potential acquisitions in the future. Our acquisition strategy remains focused on growing industrial IoT companies that generate meaningful profitability as well as strong ARR potential. We expect to hit last quarter’s projection for fiscal 2024 revenues and profitability while exceeding our ARR expectations.

With potentially stimulative monetary policies on the way, Digi will remain on the offense to capitalize on future opportunities. As our world increases in complexity, Digi is uniquely positioned to provide secure, reliable and easy-to-manage solutions combined with responsive expert service and support. Operator, passing it to you for questions.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Tommy Moll of Stephens Inc. The floor is yours.

Tommy Moll: Good afternoon and thanks for taking my questions.

Ron Konezny: Good afternoon Tommy.

Tommy Moll: Ron, on solutions ARR this quarter, it was up $3 million sequentially, which I think is the biggest quarter-over-quarter step-up in some time. In recent quarters, we have heard you talk about elongated sales cycles there, but obviously, you closed some pretty big deals this quarter. So, I am just curious what context you can give, is this reenergized trend a durable one, do you think? Was there some favorable timing going on? Just what’s the state of the environment there?

Ron Konezny: Yes. It’s a really good question. We have been dependent on SmartSense to have more explosive ARR growth. And as you highlighted, we have been mentioning the elongated sales cycles. Fortunately, some of those came to conclusion after extensive testing and ROI validation. We do think the sales cycles have stabilized, not necessarily improved, but we do have a number of things in the pipeline that could come to realization in future periods.

Tommy Moll: Okay. Ron, you touched on some of this in the prepared, but I just wanted to circle back on cash flow generation and capital allocation. On the cash flow generation, there has been significant year-to-date, partly aided by inventory. And so I am just curious, how much more work do you think you have to do there on the inventory front? And then as you think to deploying the cash, the first callout on it this year has been de-levering, which is clearly important, but acquisitions are too. So, just give us a current state of play on the priority and likelihood of any acquisitions near-term.

Ron Konezny: Yes. The first question it’s, we do think we will see improvements in our inventory position in future periods that will start to moderate over time. So, we will have, if you will, less of an inventory dividend on the cash side. But there is still enough there that we will still see some tailwinds from getting that inventory position down. We remain on the offense, acquisition-wise. We are very active out there. We have been disciplined. I think a combination of finding the right target, but also making sure that we have got the right capital position. Acquisitions are a very, very difficult thing to predict in terms of timing, but we do remain very active and on the offense.

Tommy Moll: Thanks Ron. I will turn it back.

Operator: Thank you for your question. Our next question comes from the line of Jim Fish from Piper Sandler. The floor is yours.

Jim Fish: Hey guys, great to join here and appreciate the time. You guys mentioned software attach rates were pretty good. I guess how should we think about the attach of software at this point? And do you guys expect, as we think about fiscal ‘25, any changes coming to either the sales team or a way to incentivize customers to further adopt the software modules?

Ron Konezny: Jim, it’s a really good question. We have seen incremental improvements in attach rates, so we are pleased with the progress there. We do think there is more room to go. We have got some initiatives underway, some good planning we have been doing and some work on the back end of our systems to improve those even further. And we expect that it can contribute to ‘25 ARR growth as well.

Jim Fish: Got it. And then, Ron, you decided to partner with Atsign here this past week. Can you just walk us through the rationale to partner here rather than build or buy? I guess why not – and really, the crux of my question is why not move more into sort of that IoT security space just given that networking overlay that you guys have already? Thanks.

Ron Konezny: Yes. It’s a really good question. We would like to think of it as not an either/or, but an and, so we have got an incredible amount of security designed into our products, and we have got other initiatives underway. There are certain customers and opportunities that like certain technology, and it’s not limited to security. It can be communication protocols like ignition or spark plug. So, we like to do both where we have got the security design in our solutions, but then there is add-ons that we can bring on either for an industry or a particular customer.

Operator: [Operator Instructions] Our next question comes from the line of Scott Searle from ROTH Capital. The line is yours.

Scott Searle: Hey. Good afternoon. Thanks for taking my questions. Nice job on the quarter. Ron and Jamie, maybe just to start, could you give us some sequential indications in terms of how Opengear performed in the quarter, and how Ventus is looking? There had been some slowdown, I think in adoption in the channel on that front. And then how you are thinking about those business segments as we look into the September quarter, what should we be thinking about that sequential progression, up or down for some of those businesses? And then I had a couple of follow-ups.

Ron Konezny: Yes. If you recall, at the beginning of this fiscal year, we had cited some softness on the strategic side, and we thought that would come back. And we have seen that. We have seen some nice improvement mainly driven by the strategics being more assertive and a steadier regional and channel business that has remained in place. The Ventus business, we are really excited about some new design wins and some new customers, new logos we brought on the business in addition to retention. If you recall, last year, we had a little bit of a step-back and some soft churn in our ATM business with the regional bank crisis. And that, of course, has been put behind us. And as we look forward, we are looking for growth really from all of our product lines and offerings as we look into ‘25.

We are optimistic about some opportunities. We brought in a couple of new leaders as we have had some retirements and other things. We have got some exciting leadership that’s joined both Opengear as well as our cellular and Ventus group. So, we are really optimistic about ‘25.

Scott Searle: And Ron, kind of just looking at the macro environment, could you give us a little bit more of an update from an inventory perspective? Are there still pockets of inventory sitting out there? You have talked recently about delayed decisions. Is that starting to compress now? Are people feeling better about the economy for your product lines? What are you seeing right now?

Ron Konezny: Yes. So, Scott, if you recall, we really have never had any excess inventory out in the channel. We have had a few customers that have had inventory, they are working through, but not your traditional stocking and POS type of inventory. So, we think we have done a really nice job there. And these few customers that are working through their inventory are more isolated. But we think we have had a healthier channel there. The second part of your question, we think things, if you will, stabilized. They haven’t regressed further in terms of sales cycles and order sizes, but not yet – I don’t think yet we can call that improvement in those. I think there is the potential for it with the Fed potentially lowering interest rates in September.

And obviously, we have got an election cycle underway. And so I think there is still a little bit of deliberation and caution as we head into those periods. But I guess the good news is we don’t see it decelerating or decaying any further. We see it more stabilizing.

Scott Searle: Great. Helpful. And if I could, just on the gateway front, I know you are kind of managing some of that transition to more of a Ventus model. I am wondering if you could give us some color in terms of how that progression is going. How should we think about how hardware grows on that front versus starting to contribute more on the ARR front? And then maybe just the back end of that, as you are starting to think about going on the offensive from an M&A perspective, I am wondering what you are seeing and how you are thinking about the valuation environment. Thanks.

Ron Konezny: Yes. A big part of our story is we lead with ARR. We think that’s both providing more value to the customer, but it also ends up in stronger relationships and more predictable outcomes. And we think the cellular and Ventus combination is going to be a big part of that. You could potentially see top line be impacted in terms of growth rates by stronger ARR growth rates, but that’s going to be a central part of our strategy. I am sorry, Scott, what was the second part of your question?

Scott Searle: Just the valuation environment, yes, what you are kind of seeing out there now as you start to think about going on the M&A offensive again? Thanks.

Ron Konezny: Yes. We have seen a pretty healthy flow of opportunities. We have seen a lot of things that we would be maybe more active in the past. But due to size, we are really cautious. We are looking for fewer larger acquisitions that can have a more material impact on our business and our outcomes that we have seen actually some of the properties that we think – and assets that are probably best suited are pausing. They are waiting things out for better conditions. I think with interest rates where they are, the financial buyers are not quite as strong. We have seen a lot of financial buyers be focusing on their portfolio companies, helping them improve, adding some tuck-ins to prepare for better conditions. So, it’s a real mixed market out there with maybe each end of the barbell having different dynamics, I think smaller companies wanting to exit, larger companies waiting for better conditions.

Scott Searle: Thank you. Nice job.

Ron Konezny: Thank you.

Operator: [Operator Instructions] At this time, I am showing no further questions. And I would now like to hand it back to Ron Konezny, CEO, for closing remarks.

Ron Konezny: Thank you. We plan to attend Piper Sandler’s Growth Frontiers Conference in Nashville on September 10th. We appreciate you joining Digi’s earnings call and for your continued support. Thank you to our customers, distributors, suppliers and our exceptional Digi team. Have a great day.

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