Digi International Inc.

Good day, and thank you for standing by. Welcome to the Q3 2024 Digi International Inc. 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 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. 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 Locke, CFO, please go ahead.

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 Konesny, 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 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. 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 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, a few highlights. JG'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, healthcare, 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 three 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 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 1 1 on your telephone and wait for your name to be announced to draw your question please press star 1 1 again please stand by while we compile the q a roster our first question It comes from the line of Tommy Mall of Stevens Inc. The floor is yours.

Good afternoon and thanks for taking my questions.

Good afternoon, Tommy.

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've heard you talk about elongated sales cycles there, but obviously you closed some pretty big deals this quarter. So I'm just curious what context you can give. Is this re-energized trend a durable one, do you think? Was there some favorable timing going on? Just what's the state of the environment there?

Yeah, it's a really good question. We have been dependent on SmartSense to have more explosive ARR growth. And as you highlighted, we've been mentioning the elongated sales cycles. Fortunately, some of those came to conclusion after extensive research 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.

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's been significant year to date, partly aided by inventory. And so I'm 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 call 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.

Yeah, the first question, you know, we do think we'll see improvements in our inventory position in future periods that will start to moderate over time. So we'll have, if you will, less of an inventory dividend on the cash side, but there's still enough there that we'll still see some tailwinds from, you know, getting that inventory position down. We remain on the offense acquisition-wise. We're very active out there. We have been disciplined. I think a combination of finding the right target, but also making sure that we've 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.

Thanks, Ron. I'll turn it back.

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

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, you know, further adopt the software modules?

Yeah, Jim, it's a really good question. We've seen incremental improvements in attach rates, so we are pleased with the progress there. We do think there's more room to go. We've got some initiatives underway, some good planning we've 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.

Got it. And then Ron, you decided to partner with AppSign 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.

Yeah, it's a really good question. We'd like to think of it as not an either or but an and. So we've got an incredible amount of security designed into our products and we've 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've got There's security design in our solutions, but then there's add-ons that we can bring on either for an industry or a particular customer.

Thank you for your question.

Again, as a reminder, to ask a question, please press star 1-1 on your telephone. One moment, please. Our next question comes from the line of Scott Suriel from Ruth Capital. The line is yours.

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

Yeah, 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've 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're really excited about some new design wins and some new customers, new logos we've brought on the business, in addition to retention if you recall last year we had a little bit of a step back and some some soft churn in our ATM business with the regional bank crisis and that of course is has has been put behind us and as we look forward you know we're looking for growth really from all of our all of our product lines and offerings as we look into 25 we're optimistic about some some opportunities we brought in a couple of new leaders as we've got some retirements and other things we've got some exciting leadership that's joined both OpenGear as well as our cellular and Ventus group.

So we're really optimistic about 25.

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've 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?

Yeah, so Scott, if you recall, we really have never had any excess inventory out in the channel. We've had a few customers that have had inventory they're working through, but not your traditional stocking and POS type of inventory. So we think we've done a really nice job there and These few customers that are working through their inventory are more isolated. But we think we've had a healthier channel there. The second part of your question, we think things have, 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 the improvement in those. I think there's the potential for it with the Fed potentially – lowering interest rates in September. And obviously, we've got an election cycle underway. And so I think there's 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.

Great. Helpful. And if I could, just on the gateway front, I know you're kind of managing some of that transition to more of a Ventus model. I'm 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 to more on the ARR front. And then maybe just the back end of that, as you're starting to think about going on the offensive from an M&A perspective, I'm wondering what you're seeing and how you're thinking about the valuation environment. Thanks.

Yeah, you know, a big part of our story is, you know, we lead with ARR. We think that's both providing more value to the customer, but it also, you know, ends up in stronger relationships and more predictable outcomes and we think the cellular inventors combination is going to be a big part of that you could potentially see top line you know be impacted uh in terms of growth rates by a stronger ar growth rates but that's that's going to be a central part of our strategy uh i'm sorry scott what was the second part of your question just the devaluation environment

Yeah, you know, what you're kind of seeing out there now as you start to think about going on the M&A offensive again. Thanks.

Yeah, you know, we've seen a pretty healthy flow of opportunities. We've seen a lot of things that we would be maybe more active in the past, but due to size, we're really cautious. We're looking for fewer, larger acquisitions that can have a more material impact on our business and our outcomes. We've seen actually some of the properties that we think and assets that are probably better probably best suited are pausing. They're waiting things out for better conditions. I think those interest rates where they are, the financial buyers are not quite as strong. We've 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.

Thank you. Nice job.

Thank you.

Thank you for your question. Again, as a reminder, please press star 1 1 on your telephone to ask a question. At this time, I'm showing no further questions. And I would now like to hand it back to Ron Koensny, a CEO, for closing remarks.

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.

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