Digi International Inc.
Q4 2020 Earnings Call Transcript

Published: 12 Nov 2020

[Operator:]

Ladies and Gentlemen, thank you for standing by and Welcome to Q4, 2020 Digi International Inc Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I'll now like to hand the conference over to your host, CFO, Jamie Loch.

[Jamie Loch:]

Thank you, Latif. Good afternoon, everyone and thank you for joining us today to discuss the fiscal 2020 fourth quarter results of Digi International. Joining me on today's call is Ron Konezny, our President and CEO. Ron will provide his thoughts on our business and I will follow with highlights of our financial performance. Following our prepared remarks, we'll take your questions. We issued our earnings release shortly after the market closed today. You may obtain a copy through the Financial Releases section of our Investor Relations website at digi.com.

[Ron Konezny:]

Thank you, Jamie and welcome to Digi internationals 2020 fourth fiscal quarter and end of fiscal year earnings call. We are pleased with both to finish to a record fiscal year and the excitement on our future potential. Our team achieved several new annual records, revenues, profitability, cash generation subscribers and annualized recurring revenue. We're able to accomplish all of these goals under the unprecedented heavy cloud of the pandemic. Digi's value proposition of remote, automated, zero touch and intelligently connected offerings has strengthened setting the stage for new records in the future. Consistent with our commentary from last quarter's earnings call, our fourth fiscal quarter performance demonstrated growth from the previous quarter and double-digit growth year-over-year. We maintain our new model over 50% gross margins. Over 15% adjusted EBITDA margins, pay down $15 million in debt, leveraging strong cash collections and exceeded 70,000 subscribers in SmartSense, our solutions business segment. Inspired by the success of both SmartSense and Opengear, Digi has implemented the new organizational structure to bring focus to our key product lines. Kevin Wiley and Gary Marks continue to lead those respectable organizations. And we have implemented new leaders in Cellular Routers with Mike Ueland, OEM Solutions, our embedded product line with Steve Ericson; Infrastructure Management with Brian Kirkendall and Technology Services with Tracy Roberts.

[Jamie Loch:]

Thanks, Ron. Good afternoon, everyone. Hope that you're all safe and healthy. Today, I'll start with some of the key financial highlights that contributed to the results of our fiscal fourth quarter and our record fiscal year. Our strong fourth quarter performance continued the trend of growth and margin expansion driven by vision and execution despite the ongoing macroeconomic uncertainty fueled largely by the continuing pandemic. Quarterly revenue once again surpassed the $70 million mark finishing at $73.2 million for the fourth fiscal quarter. That strong revenue performance combined with gross margins in excess of 50%. And our continued diligence and focus on operating expenses led to an adjusted EBITDA of $12.1 million or 16.5% of our revenues. The adjusted EBITDA percent is an all-time high mark for our company, as is the $12.1 million EBITDA mark. Last quarterly call while we did not provide specific guidance, we noted that we believed we had the potential to perform slightly ahead of our fiscal third quarter results. And our fourth fiscal quarter performance supports that position. On a per diluted share basis, our non-GAAP EPS for the quarter was $0.32, which was an all-time high for Digi with our GAAP EPS of $0.15. Those results for the quarter have surpassed consensus among analysts' estimates for revenue, adjusted EBITDA, non-GAAP EPS and EPS.

[Operator:]

Our first question comes from the line of Michael Walkley of Canaccord Genuity.

[MichaelWalkley:]

Great, thank you. Congratulations on another strong quarter. So I guess, high level question for Jamie and Ron, just with the free cash flow and over 50% gross margin and paying down debt again, as you look at your balance sheet getting kind of close to net debt neutral or no longer a debt position. What type of debt levels would you be willing to take on for another opportunity, like an Opengear? Since you've highlighted Ron that you're still looking to make acquisitions to grow the business?

[Ron Konezny:]

Yes, Mike, listen, first off, I hope you are doing well and to that question, we remain on the offense acquisition wise, some of it does depend on the target, as we've talked about in the past on product and services acquisitions, they tend to be profitable and we can value them as multiple of EBITDA. And so we'd be willing to go, it got profile up to many times EBITDA on leverage. On the solutions side, it's little bit different story, many of those solutions acquisitions aren't at profitability or if they are they - we don't necessarily expect them to be significant profitable in the near term. And so that might alter the level of debt that we return. But I'd say, as a rule of thumb, we want to comfortably go up to four.

[MichaelWalkley:]

Okay, that's helpful. And then just on the solutions business, any update on competitive environment or the certain areas you feel like there's competitors have something that you don't have? And then if you could also just update us on just with the strong gross margin and the solutions this quarter on a year-over-year basis? Can you remind us what the recurring revenue mix is on a run rate for the quarter?

[Ron Konezny:]

Yes. We finished the quarter at about $18 million annualized recurring revenue. So if you kind of back that into divide that by four that gives you about the recurring revenue portion for the previous quarter. And that margin has been at nearly 80% gross margin for that piece. We've been really encouraged by a couple segments really returning if you notice in my comments, we talked about healthcare, we talked about grocery and we even had a nice food service or restaurant win and we're really pleased to see the enterprise come back. Groceries are really nice opportunity for us. We've been a leader in healthcare. And we continue to see interest there, especially with the talk of a temperature sensitive vaccine being potentially mass distributed. But it was nice to see those groceries - those grocery accounts come back, they have been really adapting to a new normal with flex glass and mass and special hours for vulnerable folks. And as they've calibrated - they're now looking at investments to make sure they're optimizing, but in many cases is kind of hazard pay labor. So it's nice to see that grocery activity come back. And regards to compensate? We haven't seen any big changes. We, although we think this is early innings, so maybe we're the biggest kid in the room. We haven't seen any significant competitive changes out there.

[MichaelWalkley:]

Great. Thanks. And last question for me, I'll pass it on. Just, Jamie, I know, thanks for the guidance for next year. I know it's tough. But as you look to kind of December quarter and the channel inventory remaining stable, do you think there'll be some tightening maybe of channel inventory year end? So if you should be a little cautious on kind of year-end sales with losing the holiday season? Any thoughts just on maybe seasonality for the year? I know it's tough in this environment. Thank you.

[JamieLoch:]

Yes. Thanks Mike. Good to hear from you. I think historically, there's been seasonality in the business as it relates to Q1, I think is as you look it's one of the challenges is with this dynamic kind of roll back to table, historically, there's been seasonality, we are kind of watching that channel inventory level, there's a portion of that inventory that has already - inventory. So it's already assigned for customers. So some of that will naturally flow out and not be in it. But it is something to watch. We're at a normalized level right now, anything less than that would be a little bit of a lower level, but would be in the range. So we are keeping an eye on that for FQ1.

[Operator:]

Our next question comes from the line of Anthony Stoss of Craig-Hallum.

[AnthonyStoss:]

Thank you. Great execution, guys. Shifting gears a little bit, Ron, just on Ericsson Acquisition of Cradlepoint for $1.1 billion, with your business being - you'll likely the second biggest behind them. How do you think this will affect your business? Have you - is there a chance that you guys would get an offer too good to refuse how vital with that business be? And also maybe it'd be a good refresher to take us through kind of your growth rates in that cellular business, if you've seen an impact from 5G. And then the last a follow-up would be, maybe more detail related to the COVID vaccine distribution. I know you put out a press release a few weeks ago. I'm just curious if anything is changed in that regard. Thanks.

[Ron Konezny:]

Thanks, Tony. Yes, Cradlepoint, what a great opportunity, they were able to secure their sale to Ericsson. Congratulations to that team, they've done a nice job and we've had a lot to learn from what they've done. And we've incorporated a lot of winning customer playbook into our side of the router business. And so we think it's a great time to go on the offense, we've got our first 5G product and we're prototyping, it will be released this year. 5G and the industrial Internet of Things world has a little bit more modest adoption, you'll probably see a little bit more on indoor applications where people are looking for those higher speeds and also customers wanting assurance that their products won't be more at the end of life or have future proofing issues. So if it's important to carriers, it's important to us. And yes, we do think that's a valuable business. It's been really the heart of our IoT Products and Services business. And Opengear arrived about a year ago and we implemented that there's a lot of technologies that are shared between the open view of conferencing and our site of router group as well. So that makes for a great pairing. And we'll eventually be able to leverage that 5G technology in addition to the site of our router business. On the vaccine side, we've had a lot of discussion and interest. It's been great to speak with our existing customers, we've got a lot of pharmacy clients and they're very important to us and they're navigating their role. A lot of our pharmacy clients will also be looking to get into health courses to get those pharmacists about behind the desk and offering healthcare services and flu shots and vaccine shots are a great entry point. So they're all about fitting the supply chain and a potential team and whether that's adding additional sensors and recurring sponsoring to existing customer as well as it's been a nice opportunity for Asian folks that we've been talking to but maybe weren't ready to pull the trigger and this gives them that extra incentive to move forward.

[AnthonyStoss:]

Got it thanks and then if I can follow-up just an overall gross margins but also on Opengear's gross margins. They've been great maybe refresh us on where Opengear itself ended for the quarter on the gross margin front and also where you see overall gross margins for them. Did you go on maybe say a year from now?

[Ron Konezny:]

Yes, we're for what - we probably not get too specific but we put some targets out there to help investors understand when we purchased Opengear what to expect, and we really met those expectations. And that is really been the single biggest reasons why you saw gross margins exceed 50% to a lesser extent the contribution from solutions, which has nice margin increase, we do expect the model of 50% plus gross margins, 15% plus adjusted EBITDA margins to really hold. Opengear honestly is a big part of that.

[Operator:]

And next question comes from the line of Greg Burns of Sidoti & Company.

[GregBurns:]

Good afternoon. What was the organic growth rate on your products and solutions for the quarter? And then maybe if you give us a little bit of detail from a product segment perspective on any areas of particular strength or weakness within that segment? Thank you.

[Ron Konezny:]

Yes, Greg, hope you're doing well. Thanks for the question. As we mentioned in our comments really Opengear was a big contributor for products and service to seeing growth, it was partially offset by a decline, we did see some strengths in our cellular router business, saw some strengths in our embedded business as well. So they were partially offset by some declines in our network and infrastructure management group. But overall, we're really proud of how that group came together and produced a nice positive net result. And we do expect those trends to hold that the core Digi product and services group will continue to have success through the pan. And be complemented by the Opengear business as well.

[GregBurns:]

Great. And then you mentioned year-over-year, I guess across the business, I think the number was like $30 million or so and total recurring revenue, what's the attach rate for like digital manager and some of the services you're trying to provide on the products and services side? And how big is that business? And where do you think that could go over the next couple of years?

[Ron Konezny:]

Yes, we've been seeing really strong double-digit growth in our recurring revenue business within product and service albeit it is on a lower base. So it's less impressive on an absolute dollar basis. Actually, both Opengear and Digi are in that 30% to 40% hit, which is up significantly from historical norms, we're obviously not happy, we want to get toward the 100% take rate, because we believe so strongly in the value proposition. And the benefit it provides our customers. Earlier, there was a question on Cradlepoint; they do not sell single equipment without software to give you an example. And so that tells you that we've got a lot of opportunity to improve that take rate for us, because we've been in business for decades, we are more gradual, and how we introduce that versus maybe a hard switch. But that's the direction we're going as we really need to keep climbing that take rate, it's a little bit harder to go back to existing customers who maybe have already implemented a different solution. But certainly with new business, it's really the customer opting out versus us having them opt in.

[GregBurns:]

Okay. And then just switching gears to the solution side of the business, I miss some of the numbers you mentioned about your outlook for next year, I think, maybe 75,000 customers, could you just maybe run through those again, like what the outlook is for next year, the group growth of ARR and customers?

[Ron Konezny:]

Yes, - the quarter is really solution - and this was hardest hit by the pandemic, a lot of their addressable market was dealing with flattening the curve or businesses shutdown. And it's been really nice to see that group improve sequentially throughout fiscal Q2, and this last quarter had a nice jump up from just three, we finished the year just over 70,000 subscribers, we've got a real clear line of sight to 75,000 subscribers just with what we've signed to date. And so we're - now those get implemented of next few quarters. And we'll have new bookings that come on as well. And so we really expect to return to that 3,000 to 4,000 sites a quarter on average as these enterprise deals have been unlocked, and it's been driven by healthcare. By grocery, we had our first really large success in restaurants since the pandemic.

[GregBurns:]

Okay, and then just on, so I understand the expectations here. So if you're going to be adding three to four and growing to 75, or you're at 70 does that imply like churn, you're expecting churn to remain high within the existing subscribers' base?

[Ron Konezny:]

No, to be clear, Greg, I'm just talking about we finished at 70,000 just with agreements we already have signed, but not yet implemented. We have a path to 75,000 just with what we've signed to date. So that is what these new agreements, for example, we announced Schwan's in a press release that will bring over 3,000 sites. That agreement I mentioned in my transcript, a couple regional grocery chains, pharmacy chain and a restaurant that really gives us visibility to 75,000 just with those signed customers, that's not an annual forecast. That's just what we booked to date.

[Operator:]

Our next question comes from the line of Dick Ryan of Colliers.

[DickRyan:]

Thank you. So, Ron, back on the vaccine question, where would you guys start playing? And how broad could you participate? Not necessarily at the manufacturing and to the vaccine, but through distribution and transportation and all the other touch points? How broad of participation could you guys maybe capture?

[Ron Konezny:]

Yes, I think it's a really good question. And it's a little volatile at the moment, there are a couple different candidates and those candidates have different storage requirements. An ultra-low freezer requirement, like you see with the Pfizer is different from saying Moderna that could handle in a standard freezer situation. Now, of course, there's the pace of production and there's the distribution and where that goes over time that you make, we see for those that need ultra-low temperature initially dry ice being used in portable packaging, because it needs to be delivered to those that are most in need. And not necessarily stored in centralized area. But a lot of the conventional wisdom has it being stored and distributed more broadly into hospitals, clinics, and as I mentioned earlier, pharmacies, lots to uncover still, but our ability to participate within the supply chain, as well as that retail distribution side. So the benefits for us are certainly additional business opportunities with existing customers, as well there's been a lot of interest from folks that either we've been talking to in the past or their new relationships, and it highlights the need for monitoring.

[DickRyan:]

Okay, and on Schwan's, has that started rolling out? Was there any sale in the quarter at least upfront for sensors, maybe not service obviously in September, but how does that roll out?

[Ron Konezny:]

Yes, Schwan's was - the rollout really started last quarter and will complete this quarter. We don't recognize those sites as subscribers until they're up and running. And so we saw some one-time equipment revenue associated with that opportunity last quarter. We'll see a little bit more this quarter, and then you'll start to recognize those subscribers in the current quarter.

[DickRyan:]

In the December quarter, okay.

[Ron Konezny:]

In Q1.

[Operator:]

Thank you. At this time, I'd like to turn the call back over to President and CEO, Ron Konezny for closing remarks. Sir?

[Ron Konezny:]

Thanks Latif. We really appreciate everyone that joined the call today. And thank you to our team, our partners and our investors. Next week Digi is participating in Annual Craig-Hallum Alpha Select Virtual Conference on November 17, 2020. Please contact Craig-Hallum if you'd like to schedule one-on-one meeting. In the meantime stay healthy and safe and I look forward our next earnings call.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.