Earnings Call Transcript - DGII Q4 2021

James Loch, SVP & CFO

Thank you. Good afternoon, everyone, and thank you for joining us today to discuss the fiscal 2021 fourth quarter and fiscal 2021 year end 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 the 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 obtained a copy through the financial release section of our investor relation website at digi.com. 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. 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 2024 10-K and subsequent reports on file with the SEC. Finally, certain financial information disclosed in 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 an exhibit to a form 8-K that can be accessed through SEC filings section of our Investor Relations website. Now I will turn the call over to Ron.

Ronald Konezny, President & CEO

Thank you, Jamie and welcome to Digi International's 2021 fourth fiscal quarter and end of fiscal year earnings call. We are thrilled with both the finish to our record fiscal year and the excitement on our future potential with the addition of Ventus. Double digit year over year growth fueled several new annual records. Revenues eclipsed $300 million for the first time, gross margins of 54% fueled by high growth, recurring revenues, profitability, cash generation, subscribers and annualized recurring revenue of approximately $38 million. We were able to accomplish all of these goals while fighting through the pandemic-induced supply chain challenges. Digi has never been better positioned to add more value for our customers as they accelerate their digital and IoT initiatives. Digi has a unique combination of revenue growth, profitability growth and cash generation combined with accelerating recurring revenues. Leveraging our successful equity raise earlier this year combined with access to affordable debt capital, we acquired Ventus Holdings to further jumpstart all of these metrics. Ventus is a combination of leading technical design, lightning implementation, impeccable uptime, and responsive expert service that delivers managed network as a service to distinguished customers like IDT, Cardtronics and Adidas. With Ventus, the new Digi model will service over 250,000 sites and more than double our recurring revenue. We have multiple opportunities to further Ventus' success with account mapping, cellular router cooperation and international expansion. We welcome the Ventus team to the Digi family and are excited to capture revenue growth, as well as supply chain and R&D opportunities. The supply chain has clearly been our biggest challenge for the past few quarters, as customer demand continues to outstrip our forecasts, as well as our ability to secure all components required. In addition, increased material costs, labor costs, and transportation costs have further pressured our operating model. I'm privileged to work with the Digi supply chain team who have weathered numerous storms to ensure our customer demands are met as best as possible. We anticipate the supply chain situation to limit our full potential for the first half of this fiscal year, but we're seeing signs that things could ease in the second half of our fiscal 2022. Now a few comments on each of our business segments. In IoT products and services, our console server infrastructure management and embedded product lines drove an over 8% increase in revenues from last year. This growth was moderated by a modest decline in our cellular router product line. We have a new cellular router leader and we are already experiencing positive results. We are experiencing increased take rates of lighthouse and beacon now joined by the Exon Laura platform collectively, this field an increase in ARR to nearly $14 million. We launched new and enhanced customer and channel partner portals to better service and engage with our channel partners and end users for marketing materials, deal registrations, and software purchases and renewals. Record bookings led by embedded console server and cellular router product lines have built a mountain of backlog showing the trust our customers have placed in Digi. We recently received the IoT Deployment of the Year Award from IoT World for our work with the Chicago Transit Authority, emphasizing the role Digi can play as the recently passed US infrastructure stimulus bill in parts, targets mass transit improvements. We look forward to leveraging Ventus's experience and technologies to further the value propositions for each of our product lines and build recurring revenues. The supply chain challenges mentioned earlier have increased lead times and have forced us to direct some of our talented engineering resources to update existing designs and components. This decision is consistent with our customer-centric approach. SmartSense our IoT solutions business segment added over 2000 subscribers in the quarter driven by healthcare and retail verticals. We are invested in additional account management resources and customer success to ensure we add continual value and experience strong retention. We ended the fiscal year with over 81,000 subscribers powering over $24 million in ARR which grew to 38% from last year. Rising labor costs and increased interest in digitization fuel a strong pipeline of opportunities for continued growth. SmartSense 4, the destination consolidation of the cloud and mobile interface now services approximately 44,000 subscribers or 54% of our total customer base. We are prioritizing growth and innovation as we look to expand our leadership position and add more value to our customers' implementations. We remain focused on our key verticals in food service, healthcare, and transportation. The multibillion dollar opportunity has significant greenfield opportunity and SmartSense is well positioned to capture increased market share. With the Ventus acquisition completed, we will be focused on integration and execution. Ventus marks the ninth acquisition of my nearly seven year tenure and we are confident in our ability to leverage our newest collective team and offerings similar to the 2019 acquisition of Open. We have leveraged affordable debt capital to finance this stage of our growth. We have proven experience, but we will not take anything for granted. The new Digi model will target double-digit growth, high 50% gross margins, and set our eyes on 20% adjusted EBITDA margins. ARR will exceed 20% of our combined revenues. And we will generate significant operating cash in our capital-like model. As the pandemic continues, I am so happy to be leading the Digi team, the safety and health of our team is of utmost importance. While no one knows how conditions will evolve, I am confident Digi's resilience and commitment to our stakeholders will not waver. I will now turn the call over to Jamie for more detail on our financial performance.

James Loch, SVP & CFO

Thanks, Ron. And good afternoon again, everyone. Today I'll start with the key financial highlights that contributed to the results of our fourth fiscal quarter and fiscal year end for 2021. Digi continues to set records in fiscal 2021 with nearly $38 million in ARR, which is up 30% for the year, $308.6 million in revenue which is up over 10% for the year, and up over $152 million in cash. We delivered $79.1 million in revenue in the fourth fiscal quarter, representing 8.1% growth over the prior year. Gross margins were 53.9% and that went to an adjusted EBITDA of $12 million or 15.2% of our revenue. Gross margins excluding amortization were 55.4% for the quarter. That performance plans annual adjusted EBITDA growth to just over 20% or twice our revenue growth for $48.3 million for fiscal 21. On a per diluted share basis, our GAAP EPS was $0.13. And our non GAAP EPS for the quarter was $0.25. That brings our total GAAP EPS for the year to $0.31 per diluted share, an increase of nearly 11%. Our adjusted EPS goes to $1.08 per diluted share, up over 10% from the prior year. Revenue, adjusted EBITDA, and adjusted EPS all beat consensus estimates for the quarter, and all were on the high end of the ranges we provided in our guidance. Among other financial highlights, Digi has generated strong cash consistently in this quarter, and this is no exception. We have added $23.9 million of cash in the fourth fiscal quarter of 2021. This type of consistent cash generation is a strong indicator of the value our customers received from Digi and helping them deliver on their missions. We maintain our expectations and will continue to generate positive operating cash for the foreseeable future. With that cash flow, we ended the fiscal year with $152.4 million in cash which resulted in a net cash positive position of $104.3 million as of yearend. Our ending deposition at the end of fiscal Q4 was $48.1 million. These figures do not consider the treatment of leases, which based on the new accounting standard, is classified as $21 million of what is now classified as debt on the books, with $18.4 million of that classified as long-term. As subsequent to our quarter, the acquisition of Ventus has replaced and retired our credit facility that was outstanding at the end of fiscal year. The acquisition will move the deposition up and as we work on finalizing the syndication of that debt, we will provide more details once that syndication is complete. We are in compliance with both facilities covenants and remained in compliance through the retirement of the previous debt. As our new debt structure is finalized, we will provide an update. On the balance sheet items, our ending ARR position is $43.7 million, up $2.5 million sequentially from our last fiscal quarter end with no material changes to our reserves. Our ending inventory balance is $43.9 million, down $3.3 million sequentially from our last fiscal quarter, with no material changes to our ENO reserves. Current inventory in the channel is $24.1 million, down $2.3 million sequentially from the prior quarter. We monitor inventory levels in the channel closely and regularly. If I move into our segment performance, IoT products and services revenue increased 4% year over year in the fourth fiscal quarter of ‘21 to $69.9 million, and gross margins increased 201 basis points to 53.7%. Year over year, revenue impact was driven primarily by sales in our console server product portfolio. Operating income decreased $1.7 million year over year to $6.3 million for the fourth fiscal quarter, driven partially by increased operating expenses, including items that are added back for adjusted EBITDA purposes, but not for segment operating income purposes. The increase in margin rate is driven by favorable product mix within and among nearly all product portfolios, partially offset by increased production and distribution costs due to the global supply chain challenges. IoT products and services achieved an annual revenue record of $264.2 million in fiscal ’21, a 5.9% increase year over year. This increase was primarily attributable to nearly all product portfolios. Gross margins increased 285 basis points to 54.7% due to product and customer mix. Operating income decreased $9 million year over year to $18.2 million for the full year 2021, driven partially by increased operating expenses previously mentioned. Our ARR in products and services grew nearly 20% from the prior year to $13.7 million. In IoT solutions, revenue increased 6.3% year over year in the fourth fiscal quarter of 2021 to $9.2 million and gross margins increased 713 basis points to 55.6. The increase in revenue was driven by subscription revenue, partially offset by a slight decrease in one-time revenue. Operating income decreased $0.5 million year over year to a $3 million loss for the fourth fiscal quarter, driven partially by increased operating expenses. RG solutions revenue increased 49.5% year over year for the full fiscal year of 2021 to $44.5 billion and gross margins increased 73 basis points to 49.9. The increase in revenue was driven both by one-time and subscription revenue. We continue to invest to support the growth objectives of IoT solutions. The operating performance for solutions for the full fiscal year improved $8.2 million year over year, resulting in a $7.7 million loss compared to the prior year loss of $15.9 million. The key measurements of the health and performance of our solutions business, our sites and ARR. Our cycle grew by approximately 11,000 in net sites in fiscal 2021, pushing our total count just over 81,000. Recurring revenue increased 3.8% sequentially and 3% year over year to an annual recurring revenue number of $24.3 million. As it relates to forward-looking guidance, we have confidence in our execution and our performance, even in the midst of the ongoing pandemic coupled with supply chain and trade constraints. We expect the current supply chain challenges will impact our results adversely for at least the first half of fiscal 2022. At present, we do believe these challenges will improve during the second half of fiscal 2022. As well and highlight in those remarks. These expected impacts are not indicative of demand from our customers, which is demonstrated by record bookings that we continue to see. As part of the overall supply chain challenges, we are providing the following guidance for the first fiscal quarter of 2022. Using a fully diluted share count as of the end of fiscal Q4 21 approximately 35.4 million shares, we expect revenue of $81 to $85 million, providing growth year over year of 11% to 16%. We expect our GAAP EPS to be between a loss of $0.01 to a gain of $0.02 per diluted share. We expect our adjusted EPS to be between $0.30 and $0.34 per diluted share, with adjusted EBITDA to be between $14 and $15.5 million. Please note, these forward-looking numbers include two months of the acquisition of Ventus. The supply chain challenges eliminate from providing any specific annual guidance. However, we do want to highlight significant positive impacts on Digi's financial model going forward through our acquisition of Ventus. In large part because of the acquisition in fiscal 22, we would expect revenues to grow between 16.5% and 23%. We expect profitability at an adjusted EBITDA and adjusted EPS level to grow even faster between 35% and 55%. We see our gross margin rates holding firm through the current supply chain challenges. And we expect at the end of fiscal 2022, we will have annual recurring revenue of at least $90 million. We believe that our strong balance sheet position combined with the performance we see in our pipeline are leading indicators of the value Digi provides to our customers in helping them deliver on their missions, particularly during a time of global capital and liquidity concerns. We are excited for the way that Ventus is going to transform our business model, and we are excited for what fiscal 2022 is going to bring us. That concludes our prepared remarks. We're now available to take your questions. Could you please provide instructions to our caller?

Harsh Kumar, Analyst

Yes. Hey, Ron. And Hi, Jamie. First of all, congratulations on solid results. And also congratulations on the Ventus deal. I wanted to begin with something you talked a lot about in the call, which is basically supply constraints and strong demand. I would be curious if you would be willing to give us an impact, as you've done in the past, of maybe how much revenues you have left behind because of supply challenges or COVID costs and also kind of like the performance impact on your margins if you've seen any from these two factors.

Ronald Konezny, President & CEO

Yes, thanks. Harsh. Good to hear your voice. We've had really good fortune with tremendous demand and bookings. Unlike some other scenarios, the bookings are showing us confidence in customers willing to commit to multiple quarters worth of their business to help us with that visibility and ensuring that our product gets there. Our revenue shortfalls have increased a little bit over the quarters. If you recall, we felt like it was probably about $5 million in the June quarter that we were not able to recognize in that quarter, I want to emphasize that these revenues are deferred, not lost. It was probably a small tick up from that last quarter. The current quarter's guidance indicates another tick up. Our FY ‘22 Harsh does anticipate a more impactful supply chain situation for the first half. But we do see signs of easing. As you know, it's a really dynamic environment. So things can change quickly. From a margin perspective, we've been very, very careful to work closely with our suppliers to understand price increases. As you know, it's not just the components but the transportation costs as well. We've had to maintain good pricing discipline. As you can see from those gross margins, we've been able to balance those two quite effectively.

Harsh Kumar, Analyst

Fantastic, Ron. I had one or two more questions. You folded the addition of Ventus into your business and you guys seem pretty excited about it. I was curious if you could help us understand how we should think about the potential for Ventus to grow under the Digi umbrella. Are we talking a lot of cross-selling? Is that what you're most excited about? Are you excited about just going with Ventus itself? Maybe just help us think from a color and qualitative standpoint?

Ronald Konezny, President & CEO

Yes, great question. Harsh. First of all, Ventus has been growing at double digits. So they've got very good volumes in terms of their growth rate on a standalone basis, and we do anticipate that continuing. We are exploring several opportunities to collaborate together, both from an R&D perspective and a supply chain perspective. But also, of course, growth synergies, doing some account mapping with our other business units where we have some common targets and opportunities to grow together. So we're excited to supplement their standalone growth with internal collaboration and have an even stronger go-to-market.

Harsh Kumar, Analyst

Great. I had one more Ron, and then I'll get back in queue. Your IoT business, the solutions business, declined on a sequential basis. So effectively went from like $12.2 million to $9.2 million. You cited some one-time kind of things that might have impacted that business. I was curious if you could talk about that. And then secondly, the world seems to be moving in favor of kind of like reopening and dining among restaurants and things that retail, which you're well-versed with. I was curious what you're seeing and how you feel about growth now that things are sort of swinging back around and everything is opening up. But should we actually see any really good growth?

Ronald Konezny, President & CEO

Yes, thanks. In that IoT solutions business, I want to remind the audience, we really focus on subscribers and annualized recurring revenue. There is one-time revenue we get from deployments that will contribute to that top line but seeing that analyzed recurring revenue grow another million dollars on the back of yet another 2000 subscribers added and eclipsing the 81,000 subscriber mark. Those are the key metrics we have. We didn't have an enterprise deal that occurred in the quarter that would have added that one-time revenue to push us into the eight-digit revenue that we've seen in the last couple of quarters. However, we are seeing a really strong pipeline and value proposition from our existing customers. To your point Harsh, the restrictions are easing. They’re easing not unilaterally in an even way. Some are easing more so than others. But the bottom line is that food service segment, which has been the one that has been the most impacted, we're seeing really good signs of them looking for opportunities as they're all facing rising labor costs and making sure that they get the most out of their team. They want to be as efficient as possible while providing good service. So we are excited about that portion of our addressable market opening up and it is still largely greenfield.

Harsh Kumar, Analyst

Great guys, congrats again.

Scott Searle, Analyst

Hey, good afternoon. Thanks for taking my questions. Ron and Jamie, congratulations on getting the Ventus deal done. I apologize if this got covered earlier. I hopped on the call a couple of minutes late. But I was wondering if you could walk through some of the details around Ventus. I know it's been growing at double digits, but maybe some color in terms of what you're building into that 16% to 23% growth in fiscal ‘22, kind of the assumption around Ventus. The gross margins there, kind of the employees and what you've been seeing from a churn rate. I'd be curious what you're seeing in terms of performance.

Ronald Konezny, President & CEO

Yes, thanks, Scott. We really have our assumptions include their growth rates continuing at that double digit pace. And as we mentioned earlier, we're looking for opportunities to accelerate that growth rate because we share a lot of customers in common. There are some new customers that they would like to target. That recurring revenue piece, of course, is the one that we're most focused on, as it reflects the valuable services we're providing to our customers, and their retention has been fantastic at over 99%. So they have this incredible service-oriented mentality, and the customers view that what Ventus provides is not only of higher quality but also at a significantly lower total cost than what they could do on their own. So we're really excited. The expectations for ‘22 include 11 months of Ventus, so it's not quite a whole year. We do expect that growth rate to continue. We expect margins to really hold at these levels that we demonstrated last quarter, and this shows you that that contribution is going to help not only improve the financial model from a growth rate but also you'll see adjusted EBITDA margins start to tick up. We're really targeting a new normal of around 20%. How many companies have you seen growing double digits rates, with gross margins well in excess of 50%, and adjusted EBITDA margins approaching 20%. This is a really, really healthy model that we've been able to construct with the latest help of Ventus.

Scott Searle, Analyst

Ron, I wish I had more companies like you. To follow up in terms of the sequential outlook down a little bit. Once you adjust for the Ventus contribution, I was wondering if you could kind of tick through the key components in terms of what you're seeing from router, gateway standpoint, from the console business, and maybe kind of grouping things together. And if you could dig in a little bit on the supply chain. I know that that's headwinds, and you guys are clearly articulating that. But I'm wondering if there are some specific areas that are more challenging than others?

Ronald Konezny, President & CEO

Yes, Scott, that's a good question. I want to remind the audience that Q1 is typically our softest quarter of the fiscal period. We're very channel-centric in our products and services group. If you look at last year's quarter, we did a tick over $73 million. So what the guidance implies is slower growth than what we've been seeing. It's mainly supply chain constraint. That supply chain constraint has been, unfortunately, pretty focused on our embedded group. Our team has had to work with existing products to transition to components that are more available. We've had some component shortages. So imbedded in that guidance and that lower than expected organic growth rate is really concentrated on our embedded team. We do expect that between our efforts and the supply chain easing, you'll see improvements, especially by the midpoint of the year. If you put it in the context of year over year, and of course add Ventus, you will see modest organic growth rate in that center point.

Scott Searle, Analyst

Got you. And just to clarify, Console and Gateway seem like they're doing actually pretty well at this point in time. And you're not seeing component constraints on that front that really impact that line of business?

Ronald Konezny, President & CEO

Yes, so we are facing component constraints and those we've been managing through. Our supply chain team and our management have been just doing a fantastic job. Scott, of working through those issues. The console server side has been fantastic, as has a new leader in place for the router group, which has had an immediate positive impact. Our infrastructure management team has also been delivering well. It's really the OEM solutions where we're having more of the supply chain concentration. There is still revenue that we’re not able to recognize in the quarter because we couldn’t get all the components needed. But that revenue gets deferred largely to the next quarter.

Scott Searle, Analyst

Perfect. Thanks so much. Congratulations, guys.

Ronald Konezny, President & CEO

Thank you, Scott. Thank you all for joining the call today. We really appreciate everyone that joined the call and thank you to our customers, our team, our partners and our investors. Next week, Digi is participating in the 12th Annual Craig Hallum Alpha Select Virtual Conference on November 16, and the 10th Annual Roth Capital Tech Conference on November 18. Stay safe and healthy. I look forward to our next earnings call.

Operator, Operator

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