Digi International Inc.

Good day and thank you for standing by. Welcome to the Fiscal Q2 2026 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. 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, Chief Financial Officer. 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 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 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. And welcome, everyone, to Digi International's second fiscal quarter of 2026 earnings call. As you can tell, we're doing things a little bit differently this time. For the first time, we're doing this via video conference. We're actually live at Digi's headquarters in Hopkins, Minnesota. And this is Ron Koneczny. I'm joined by our CFO, Jamie Locke. We've got a brief presentation we're going to run through as we talk about some of the comments on the quarter and outlook. And then we'll have time for Q&A. with our analysts, followed by some closing comments. As a reminder, we have sent out an earnings release, an investor presentation, and the materials we're going to review, as well as this video, will be posted on our website for you to view if you're not able to attend live. So, grand experiment. Thank you for joining. So, let's digi as a background. Digi participates in what's called the industrial Internet of Things market. So, we're not involved with consumer applications. We help our customers connect, and help manage and control their remote assets and resources. We do that with a combination of technologies. The technologies include edge-based hardware, which is the largest portion of the industrial IoT market. It's been around the longest. It's actually growing the slowest, but a critical part of any IoT solution. The next biggest part of the market is the connectivity, the transport layer that gets you the data from that edge device that's connected to your resources remotely, and brings that information typically to cloud-based software, sometimes on-prem. Software is the third largest and the second fastest growing part of the industrial IoT market. And finally, what you do with all that data, the services required to understand, to implement, and to ultimately get that ROI from your industrial IoT application is the fastest growing and the smallest piece of the industrial IoT market. It's growing double digits, so it's a great place to be. It is incredibly fragmented. There are a lot of different players out there, but the ROI from remotely managing, controlling, and improving your assets and resources is compelling. And what we're seeing in the marketplace, and it's a hypothesis we've had since we started, since I started here at Digi, and we're seeing it play in the real world is people are looking for providers to bring the entire solution set versus putting those pieces together on their own and then having to manage those things with all of the change that's going on in the world. Digi's in a perfect spot to meet those customers' needs. We have four key attributes that customers are looking for, and we survey our customers annually to make sure we understand the trends and what's important to their business and to their industrial IoT solution. The number one, which has risen up the ranks dramatically as security, is in the age of more dynamic exposure and attacks, your IoT device needs to be secure or critical infrastructure could be vulnerable. The second thing has got to be incredibly reliable. Oftentimes, our equipment and solutions being deployed in remote areas, and if that solution doesn't stand the test of time and provide that constant connection, it really eats into the ROI. The third is it's got to be scalable. We deal with large customers, so it's got to be scalable in numbers, but we also deal with global customers. So it's got to scale across geographies as well. And finally, it's got to be easy. It's got to be easy to implement. It's got to be easy to configure. It's got to be easy to get ultimately that ROI. That combination of attributes is something we really work hard on to become that complete solution provider that we see the market looking for. And ultimately, This combination of attributes is helping our customers improve their time to value. We want to get them ROI quicker than if they had to do it themselves. And it's got to be managed fully and indefinitely. With all of the dynamics going on with security, technology, regulation, with business opportunities and challenges, an actively managed system is critical in today's age. A new vector, of course, that's come up in the industrial IoT world is rapid advancement of artificial intelligence. And Digi's hard at work taking advantage of these incredible tools, both internally and in our product set. I've got two images here to explain some of the work we're doing here at Digi. On the left-hand side is actually a Google framework called the Model Context Protocol. Long story short, it's a framework that allows you to put in technology that can access your corporate data in a highly governed and secure way. And you use the LLM of your choice to then be able to interrogate that data in a natural language. You can use these tools now for internal use to examine, say, the attributes of your demand profile with your supply chain to make sure you're going to have enough supply to meet your customer's demands. You can look at it for financial reporting and for analysis to help speed the process for understanding what's likely to happen in the future. And we can help it to build products. On the right-hand side is an example that comes from our SmartSense division. The use of one of our AI tools, we're now able to use those tools to create incredibly accurate systems that not only identify challenges in this case with an asset, that you may be monitoring, a refrigerator, a walk-in freezer, but also what is the likely scenario? What's the likely problem? What's the likely root cause that needs attention? How much confidence do you have? And that information can be shared in more layman's term to a store operator or employee and more technical term to a technician or a facilities professional. And we're able to do this in weeks, which is some of the incredible power that AI has. And as we expose these technologies and offerings to our customers, we're going to get feedback and we're going to improve this, these types of offering continuously. So an exciting age of edge-based AI. Edge-based AI has a slower trajectory, a more uneven path because there's so many different types of equipment out there. And these models need to be constructed and consume this data to give high confidence answers that you can act on. With that, I'm going to pass it to Jamie for some comments on our financial results.

Thanks, Ron. Well, I have the easy page to talk about because you see a page like this and it's just records all over the place. $131 million of revenue this quarter, 25% up year over year. That is a quarterly record. 64% gross margins. That's 190 basis points up year over year. 64 is an all-time record for us. Driving kind of to the 64 is a combination of things. We had As you can see with ARR continuing to grow, that mix in and of itself is going to help drive margins forward. We also continue to see good mix inside of each of our product lines. Inside of there, there is the impact of the current pricing related to memory. That pricing is being somewhat offset by other positive pricing impacts that we're seeing elsewhere inside of our costs of goods sold. So it's having maybe an impact of basis points rather than a real significant impact. And 64% is a real strong number for us. I think in any given period of time with the mix, we settle somewhere in between, say, the low to mid 60s, just like we are today. $41 million cash flow from operations also is a quarterly record. That is up 58% year over year. Just phenomenal cash, and we'll get to that here in a couple more minutes. On an on-gap basis, $184 million in ARR, annualized recurring revenue. That's up 50% year over year. We've got $34 million of adjusted EBITDA, which is also a record, and 26.3 on adjusted EBITDA margins, another quarterly record. Digi continues to see things progressing forward. The benefit of the ARR model is that as you continue to add to that, it continues to drive the business forward in more reliable, predictable results and continues to assist in setting records quarter over quarter. With those as the backdrop, a lot of people then want to know how are we performing against our March to our objectives of 200 that we set out at the beginning of fiscal 24 of 200 million in ARR and 200 million in adjusted EBITDA. The ARR trajectory has been luminous, as you can see on the chart here. 28% CAGR over that two-year period. And based on the guidance that we issued today of 25% ARR growth this year, we project that we will end the year at $190 million in ARR. Looking at adjusted EBITDA using the midpoint of the guidance that we provided today, you can see that we are seeing tremendous growth, 17% CAGR. Admittedly, we've got a little bit of work to do in order to get to that $200 million objective. But as we continue to see growth in revenue, as we continue to see expansion in ARR, we fully expect to see that leverage down to the bottom line in terms of profits growing faster than revenue. We believe that that goal is still within our reach.

You know, Jamie, reflecting back to those earlier comments, ARR is the most important measure in this company. It ties those opening comments into results. It's a sign that we're selling solutions. We're delivering value. Customers are willing to pay for an actively managed system that's always on.

Agreed. Everybody wins. Our customers win. Our shareholders win. We provide value to our customers that clearly they see as important.

So the last slide we have for you on this presentation is the DigiFly wheel. The DigiFly wheel is really explained in four parts. We have strong organic growth, double digit grower. We complement that with select acquisitions. We've done 11 acquisitions over the last 11 years. So we've developed some expertise there. The first starts with identification, selection. We've got a database of 400 companies that we're monitoring for potential acquisitions. We're looking for companies, unique companies, that have strong growth characteristics, that have an ARR profile, and that are either profitable or combined with Digi, we can accelerate their profitability. Once that identification process happens, then the hard work starts. It's all about integration. And we've got to integrate our cultures, our systems, our processes, our teams, our offerings to the end market, our messages. And that's where we really think we shine. We do a good job of not only acquiring companies, but most importantly, where the hard work begins is integrating those companies to achieve our joint objectives. Now, how do we pay for this, Jamie?

Well, we get the lucky part of collecting the cash. And if you move down to box three, you can see that this year, year to date, we've collected more cash than our adjusted EBITDA. There's a couple of things that drive that. The first impact on being able to do that is organic growth, double digit growth in both ARR and revenue. combined with acquisition impact, followed by really great cash management from our AR teams and our AP teams. Then you correlate that cash into being able to get continued pay down of our debt. Typically in our environment, you would expect that our cash generated from operations would be around that 85% mark of our adjusted EBITDA, Last year, fiscal year, it was about 100% where we had cash generation from operations at about 108 million compared to adjusted EBITDA of 108 million. This year so far, we're outpacing that. Year to date, we've generated $77 million of cash on $65 million of adjusted EBITDA. And you can see in Q2 alone, we generated $41 million of cash on $34 million of adjusted EBITDA. We take that cash, we pay down our debt, and then we were able to wash, rinse, and repeat through the flywheel.

So that identification, that integration, we use debt to finance these, so we protect our equity shareholders. We've got a clean cap table. We pay down that debt to position ourselves for the next opportunity. With that said, we're going to hand it over for questions from our analyst community. And thank you again for enjoying that presentation.

Thank you. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. And our first question comes from Tommy Moll of Stevens. Your line is open.

Good afternoon. Thanks for taking my questions.

Hey, thank you, Tommy. Hey, Tommy.

Ron, in the release, you used the word accelerating to describe some customer behavior. This sounds better compared to last quarter. So two-part question. What anecdotes can you share that give you the confidence to say that and how much of the impact comes from data centers? Thank you.

That's a really good question. You know, this is a team sport, and we've got a beautiful team that's executing, I think, at a higher level. than we have in the past. You obviously need favorable market conditions. I think there's certain verticals. You mentioned AI data centers. We're also seeing strong results in utilities. You're seeing strong results in the medical field, mass transit. So there's some verticals that we really do well in that are really willing and ready to make that investment in IoT. And I think we're in some cases out hustling our competition. So I think that combination of things Tommy, I know you report on PMI. It's nice to see a PMI above 50 the last couple of months here. That's certainly helpful to take a backdrop. We are mainly exposed to industrials. So if you have a healthy industrial market, that certainly helps us. I think we have the chance to be leaders in applying AI to the industrial IoT market. And so I think we're starting to get some traction there. So it's a combination of things, but I think that execution is really helping us.

Tommy, I would just add to that when you talk about how maybe you measure that. We've talked about this in previous calls where we measure at each of our product lines the days to win inside of our funnel. And you can see inside of certain areas and inside of certain offerings where those days to win are starting to shorten. I would say we're not necessarily seeing it back to maybe levels that they were pre-COVID already. But definitely you're seeing improvement in those areas. And that, at the very least, provides a data set that says you're seeing some acceleration.

Thank you both. And as a follow-up, likely going to Jamie here on your guidance. Jamie, if I just take the full year outlook, the results to date, the third quarter outlook, and back into what you're implying for fourth quarter, it looks like From a sequential basis, you've got revenue dollars up quarter over quarter, Q3, Q4, but EBITDA dollars down quarter over quarter. What's behind that?

I don't know. I don't think that's intended. I think that's intended. I would say, I don't know that that would actually, I believe last year Q4.

I think he's talking about sequentially, not year over year, but I believe it.

Oh, sequential. Yeah, I would tell you it's less around intention and more around there are certain costs that come into Q4 that are more annualized in that basis. I think there's a second condition where in the pipeline right now, there's a potential mix that we're looking at. So when we talk about gross margins, we've not established 64 necessarily as a base camp. That has a range to it. And when we look at the pipeline, there's a potential that that range probably has a point or two of impact on mix in FQ4. If that turns out to be differently, that would be reflected. But right now, I would say it's probably a little bit more generated by maybe some mixed things that we're looking at. There's also maybe a little bit of hedging that we're doing on what we're seeing in the memory market. And so the combination of those things, while only, say, one plus one quarter from where we're at today, it's still a murky enough that we're trying to make sure that we land at a spot that both our shareholders and our analysts can rely on us for.

Thank you for the insight. I'll turn it back.

Thank you. And our next question comes from Timothy Shubsta of Piper Sandler. Your line is open.

Hey, guys. Thanks for taking our questions. This is Tim on for Jim Fish. Hey, Tim. Just kind of hoping you guys could give us – how are you guys doing? Just hoping you guys could give us a little bit of insight on how the Particle and Jolt integrations have been going. You have a full quarter of each. And additionally, what are you guys seeing as some of the most attractive areas for potential future investment? Thanks so much.

Yeah, great questions, Tim, and nice to meet you here. So the Jolt acquisition, we completed that in August of last year. The integration has gone really well. We actually was just out with the team last week in Las Vegas for a Jolt SmartSense project. in-person summit and some great in-person work and combinations. One of the validations of the integration is, hey, what's happening on the customer acquisition front? And you'll see from our solutions ARR, which took a little bit of a bump, that's the result directly of a jolt and smart sense collaboration that it's exciting to see that kind of result. But I think the cultures are now integrated, the teams, the processes. The technology always takes a little bit more time, but that's well underway, and we're really happy about that combination. Particle is a little bit newer. We completed that acquisition in January. We're equally thrilled about that acquisition. It's a smaller team than the Jolt team, but there are quite a bit of opportunities in both taking Digi legacy products and selling that in conjunction with the Particle Cloud, as well as taking the Particle ecosystem traditional solution and bringing that to DIGI opportunities. So we're excited about both acquisitions. We feel like the integrations are on track. We're moving towards a common set of CRM and ERP systems that we'll have done by the end of the fiscal year as well.

Thank you. And our next question comes from Scott Searle of Roth Capital Partners. Your line is open.

Hey, good afternoon. Thanks for taking the questions. Great job on the quarter, guys. Nice outlook. Thanks, Scott.

Thanks, Scott. Good to hear your voice.

Hey, maybe just to dive in real quickly, could you calibrate us how big Particle was in the quarter? Could you talk a little bit as well about any impact from the China exclusion list and expansion there, what you're seeing kind of in terms of channel, inventories, availability of parts, etc.? ? And federal spend. It sounds like there are a bunch of areas that are doing pretty well. I've heard some comments from others that federal is struggling a little bit. I'm wondering how you guys are doing with that. And then I had a follow up.

Yeah, so I think it's a three part question. We'll see if we can keep track of everything. So Particle, as you recall, it's about 20 million of recurring revenue, which is the vast majority of the revenue. We had them for about two thirds of a quarter. So it was basically around 4 million or so of contribution that Particle had in the fiscal second quarter. The second question I believe is regarding the supply chain. Channel inventory. And channel inventory is actually probably too low to be honest.

Yeah, Scott, I would say it's in the zone. It is not, but it's on the low end of the zone, right? I think if you look historically, there's quite a bit of room there to go from a channel inventory perspective. So it's, it's getting better. You know, you kind of have this cycle where coming out of COVID channel inventory got high. They were trying to work that down. They actually probably let it go too low. And now the trajectory is making its way back up. So I'd say it's in the zone, but it's still on the low end of the range.

Yeah. And we're seeing channel also being more incremental, not willing to, you know, places big, much bigger bets without a customer CEO. There's certainly a run rate business, but they don't want to step out too far and other balance sheet extended. Um, The supply chain world is never calm. You know, we've got conflict in Iran that has increased the price of energy and that impacts freight. Memory is for especially the newest forms of memory is quite high. The good news is our supply chain team is fantastic. They're making sure we've got availability and allocation. While we may not like the price for things, but we're not upsetting customers with availability and lead times. And The most recent U.S. regulations really affected consumer routers. It hasn't really bled yet into industrial applications where we play. And we have a very good supply chain that we feel like is the type that appeals to U.S. utilities, to government opportunities where they can be confident in American supplier with American made products. And we're not hugely exposed to the federal market. So we don't. have the same kind of surge that someone would have that's got a lot of DOD business or other departments. We do have some business, but it's not a major vertical for us.

That's very helpful. And Ron, if we could just to dive in a little bit in terms of ARR demand trends, you know, getting a layer down, where are you seeing some of the strength in terms of SmartSense and some verticals within SmartSense? And then maybe on the Ventus side in terms of some of the managed services, just trying to get a little bit of color. in terms of what's healthy, what's got you concerned or you're watching carefully?

Yeah, SmartSense has really been sticking to their lanes. They're mainly food applications and healthcare. With the addition of Jolt, we've added a couple of capabilities, labeling services, calendar services, inventory management. So it's actually really bolstered our food service offering. We signed a large opportunity last quarter that takes advantage of some of Jolt's capabilities and SmartSense's enterprise selling and contracting. And so that's really been, I think, par for the course with the Jolt, you know, supercharger added. Within Ventus, we've got a tremendous amount of success within financial services. Within financial services, also point of sale opportunities, lottery gaming and other types of applications in that point of sale. And we're excited about some future applications around digital signage and some other areas that we have traditionally not been dominant, but are getting into now. unmanned kiosks, digital signs, and other opportunities for connectivity.

Hey, great. Thanks so much.

Thank you. And our next question comes from Ryan Bisson of Craig Hallam. Your line is open.

Hey, guys. It's Ryan. I'm for Tony Stoss. Thanks for taking my questions. So the gross margin expansion has been real nice to see. And J.B., I think you mentioned some positive offsetting from some of the memory pricing impacts. I guess I just wonder where you guys think you can grow gross margins long term, maybe over the next couple of years, or if you have a target maybe you could speak to.

Thanks. Yeah, I think it's a little bit of a mixed question. while we are continuing to see expansion in ARR, and ARR is growing faster than revenue, there's still that pocket of one-time revenue that's there. And that one-time revenue can have some variability, both in terms of the mix inside of a product line, where you can have certain cellular products, as an example, that range in certain gross margins. You combine that with things like a memory shortage, like fuel surcharges, different things like that. You can get more variability in a 90-day window. I would say that Setting a base camp in that low to mid 60s is the right place. When you start getting beyond, say, maybe a three-year window, I think as ARR continues to expand and continues to grow, you're going to see basis points improvement. I still think the general rule of thumb fits over a long period of time. 15 to 25 basis points of improvement per quarter seems reasonable. You're going to have quarters of maybe up more than that, down more than that based on that large product volume that sits there. But as ARR as a percentage of revenue continues to grow in that count, that spread will certainly shrink, but you're going to continue to see margin expansion. So I don't know if I would necessarily say that there's a number in mind as much as I continue to see ARR growing faster than revenue, which means there's for sure a reliable longer kegger of 15 to 20 basis points per quarter.

Okay, got it. Super helpful. Thanks, guys. Congrats on the results. Thanks, Ron.

Thank you. And as a reminder, if you have a question, please press star 1-1. I'm showing no further questions at this time. I'd like to turn it back to Ron Konesny for closing remarks.

Hey, thank you, DeeDee. First of all, thank you all for joining This first ever video earnings call from Digi headquarters. Hope you enjoyed it. A little more personal than just having audio. I can't thank my team enough. This is a team sport. We can't win with one function or one person. And Digi is building something very special here. I'm so excited to be a part of this. And I think there's so much more to come here. I want to thank all of our stakeholders, our suppliers, our channel, partners, our investors, and of course, most importantly, our team and our customers. So thank you all and look forward to an update three months from now.

And Ron looks great on camera, by the way. So there you go.

This concludes today's conference call. Thank you for participating and you may now disconnect.