Digi International inc (DGII) Q4 2021 Earnings Call Transcript

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Digi International inc (DGII -0.98%)
Q4 2021 Earnings Call
Nov 10, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for standing by, and welcome to Digi International's Fourth Quarter and Fiscal Year 2021 Year End Results Conference Call. [Operator Instructions] After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to your host Digi's SVP and CFO, Jamie Loch.

Jamie Loch -- Senior Vice President, Chief Financial Officer, and Treasurer

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-up 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 obtain a copy through the Financial Releases section of our Investor Relations 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 followed by these forward-looking statements. But 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 2020 Form 10-K and subsequent reports on file with the SEC.

Finally, certain of the 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 the SEC filings section of our Investor Relations website.

Now I will turn the call over to Ron.

Ron Konezny -- President and Chief Executive Officer

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 a 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 jump-start all of these measures. That, this is combination of leading technical design, lightening implementation, impeccable uptime and responsive expert service delivers Managed Network as a Service to distinguish customers like IGT, 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 clearly has been our biggest challenge the past few quarters, as customer demand continues to outstrip our forecast, 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 am privileged to work with Digi supply chain team, who have weathered variable 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 are seeing signs that things could ease for 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 Digi Remote Manager and now joined by the Exxon Laura platform collectively, this fueled an increase in AR 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've recently received the IoT Deployment of the Year Award from IoT World for our work with the Chicago Transit authority emphasizing the world Digi can play as the recently passed US infrastructure stimulus bill in part targets mass transit improvements.

We look forward to leveraging Ventus' 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 2,000 subscribers in the quarter, driven by healthcare and retail verticals. We are invested an additional account management resources and customer success to ensure we had continual value and experienced strong retention. We ended the fiscal year with over 81,000 subscribers powering over $24 million in ARR, which grew 38% from last year.

Rising labor costs and increased interest and 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 customer's implementations. We remain focused on our key verticals of foodservice, healthcare and transportation. The multi-billion dollar opportunity has significant greenfield opportunity and SmartSense is well positioned to capture increased market share.

With the Ventus acquisition completed, we will be heads down on integration and execution. That just 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 Opengear, and 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 light model. As the pandemic continues, I'm still happy to be leading the Digi team, the safety and health of our team is utmost importance. While no one knows how conditions will evolve, I'm confident Digi's resilience and commitment to our stakeholders will not waiver.

I will now turn the call over to Jamie for more detail on our financial performance.

Jamie Loch -- Senior Vice President, Chief Financial Officer, and Treasurer

Thanks Ron, and good afternoon again everyone. So now 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 ending 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 over $152 million in cash. We delivered $79.1 million in revenue in the fourth fiscal quarter, it represents 8.1% growth over prior year.

Gross margins were up 53.9% and that led to an adjusted EBITDA of $12 million or 15.2% of our revenue. Gross margins, excluding amortization, were 55.4% for the quarter. The performance [Indecipherable] 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 or an increase of nearly 11%. Our adjusted EPS grows to a $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 exceeded the high end of the ranges we provided in our guidance.

Among other financial highlights, Digi has generated strong cash consistently in this quarter is no exception. We generated $23.9 million of cash in the fourth fiscal quarter of 2021. This type of consistent cash generation is strong indicator of the value our customers receive from Digi and helping them deliver on their missions. We maintain our expectation that will continue to generate positive operating cash for the foreseeable future.

With that cash flow, we ended the fiscal year with a $152.1 million in cash, which went down to a net cash positive position of $104.3 million as of year-end. Our ending debt position 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 will add $21 million of what is not classified as debt on the books with $18.4 million of that classified as long-term.

As a subsequent event to our quarter, the acquisition of Ventus will place the return of our credit facility that was outstanding at the end of the fiscal year. The acquisition will [Technical Issues] acquisition 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 our bank facilities covenants and remained incompliance through the retirement of the old debt. As our new debt structure is finalized, we will provide an update.

On the balance sheet items of note: 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 end with no material changes to our E&O reserves. Current inventory in the channel was $24.1 million, down $2.3 million sequentially from the prior quarter. We monitor our inventory levels in the channel closely and regularly.

If I move into our segment performance, IoT Products and Services revenue increased 8.4% year-over-year in the fourth fiscal quarter of '21 to $69.9 million and gross margins increased 201 basis points to 53.7%. The year-over-year revenue impact was driven primarily by sales of 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 of our 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 is primarily attributable to nearly all of our 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 of 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. The 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.

IoT 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 are sites and ARR. Our site count grew by approximately 11,000 net sites in fiscal 2021 pushing our total site count to just over 81,000. Recurrent revenue increased 3.8% sequentially and 38% year-over-year to an annual recurring revenue number of $24.3 million.

Now as it relates to the 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 freight 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 Ron highlighted in his remarks, these expected impacts are not indicative of demand from our customers, which is demonstrated by record bookings that we continue to see. Reflective of those supply chain challenges, we are providing the following guidance for our first fiscal quarter 2022.

Using a fully diluted share count as of the end of fiscal Q4 '21 of approximately 35.4 million shares, we expect revenue of $81 million 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 million and $15.5 million. Please note these forward-looking numbers include two months of the acquisition of Ventus.

The supply chain challenges limit us from providing any specific annual guidance. However, we do want to highlight significant and 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 will expect revenues to grow between 16.5% and 23%. We expect profitability at an adjusted EBITDA and adjusted EPS level [Technical Issues] overall even faster between 35% and 55%.

We see our gross margin were holding from [Phonetic] 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 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?

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Harsh Kumar of Piper Sandler. Your line is open.

Harsh Kumar -- Piper Sandler -- Analyst

Yes. Hey, Ron, and hi Jamie. First of all congratulations on solid results and also congratulations on the Ventus steel. I wanted to begin with something you talked a lot about in the call, which is basically supply constraints and strong demand, kind of two things. 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 cost and also, kind of, like the pro forma impact on your margins if you've seen any from these two factors?

Ron Konezny -- President and Chief Executive Officer

Yes, thanks, Harsh. Good to hear your voice. We've had really good fortune with tremendous demand in bookings and unlike some other scenarios, the bookings are showing us confidence and 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 by about $5 million in the June quarter, we were not able to recognize in that quarter. I want to emphasize that these revenues are deferred, not lost. It was probably a tick up from that last quarter and the current quarter's guidance is yet 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 that 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 and as you know, it's not just the components of the transportation cost as well, and we've had to have good pricing discipline. As you can see from those gross margins, we've been able to balance those two pretty effectively, Harsh.

Harsh Kumar -- Piper Sandler -- Analyst

Fantastic, Ron. I had one or two more, you folded -- acquired Ventus into your fold and you guys seem pretty excited about it. I was curious if you could, you know, set us up, how we should think about the potential for Ventus to grow under the Digi umbrella. Is it -- are we talking a lot of cross selling, is that what you're most excited about? Are you excited about just growing Ventus by itself? Maybe just help us think from a color and qualitative standpoint?

Ron Konezny -- President and Chief Executive Officer

Yes, great question, Harsh. I mean, first of all, Ventus has been growing double digits. So they've got very good bones in terms of their growth rate on a stand-alone 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 some opportunities to grow together. So we're excited to supplement their stand-alone growth with collaborating internally and have an even stronger go-to market.

Harsh Kumar -- Piper Sandler -- 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, first of all talk about that.

And then secondly, the world seems to be moving in the favor of, kind of, like reopening and prime among that is restaurants and things that retail, which you're all widespread. I was curious what you're seeing and how you feel about growth now that things are sort of shrinking back around and everything is opening up, which should be actually honestly really good for you?

Ron Konezny -- President and Chief Executive Officer

Yes, thanks, you know, at IoT Solutions business, we 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 annualized recurring revenue grow another million dollars on the back of another 2,000 subscribers added and eclipsing the 81,000 subscriber mark, that -- 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 digits revenue that we've seen in the last couple of quarters, but we are seeing a really strong pipeline and value proposition from our existing customers.

And to your point, Harsh, that restrictions are easing, they are easing, not unilaterally in an uneven way, some are using more so than others. But bottom line is that foodservice segment, which has been the one that's been the most impacting we're seeing really good signs of them looking for opportunities as they are all facing rising labor costs and making sure that they get the most out of their team. And there is a vision as possible while providing good service. So we are excited about that portion of our addressable market opening up and it's still largely greenfield.

Harsh Kumar -- Piper Sandler -- Analyst

Great guys, congrats again.

Ron Konezny -- President and Chief Executive Officer

Thanks, Harsh.

Operator

Thank you. [Operator Instructions] Our next question comes from the line Scott Searle of ROTH Capital, your line is open.

Scott Searle -- ROTH Capital -- Analyst

Hey, good afternoon. Thanks for taking my questions. Ron and Jamie, congratulations on getting the Ventus steel done. Hey, 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 as to how Ventus has performed?

Ron Konezny -- President and Chief Executive Officer

Yes. Thanks, Scott. Yes, we really have in our assumptions 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 and 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. It's a sign of a really valuable services you're providing to your customers and their retention has been fantastic, over 99% retention. So they have this incredible service oriented mentality and the customers view that what Ventus provides is not only of higher quality, but have a significant lower total cost and if they could do that 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, but we do expect that growth rate to continue. We expect margins to really hold at these levels that we just demonstrated last quarter and that shows you that, that contribution is going to help, not only improve the financial model from a growth rate, but also you will see adjusted EBITDA margins start to tick up and we're really targeting this new normal of 20%, which -- listen, how many companies, Scott, have you seen growing double-digit rates? Gross margins, you know, well in excess of 50%? Adjusted EBITDA margins approaching 20% and that adjusted EBITDA to cash conversion is in excess of 90%? So this is a really, really healthy model that we've been able to construct with the latest help of Ventus.

Scott Searle -- ROTH Capital -- Analyst

Hey 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 take through the key components in terms of what you're seeing from router gateway standpoint, from the console business and maybe, kind of, group and things together other? And if you could dig in a little bit on the supply chain, I know that's the headwinds and you guys are clearly articulating that, but I'm wondering if there were some specific areas that are more challenged than others? Thanks.

Ron Konezny -- President and Chief Executive Officer

Yes, Scott, it's a good question. I want to remind the audience that F Q1 is typically our softest quarter of the fiscal period. We're very channel centric in our products and services group and so if you look at last year's quarter, we did a tick over $73 million. And so what the guidance implies is slower growth than what we've been seeing, it's mainly supply chain constraint and that supply chain constraints has been unfortunately pretty focused on our embedded group.

Our team has had to work with existing products to transition, so it's components are more available. We've had some component shortages. So embedded 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 that throughout the year, you'll see improvements and especially by the mid-point of the year. And so if you put it in the context of year-over-year and in the course add to Ventus, you see modest organic growth rate in that center point.

Scott Searle -- ROTH Capital -- 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?

Ron Konezny -- President and Chief Executive Officer

Yes. So we are facing component rates in those, but we've been -- our supply chain team and our management has been just doing a fantastic job, Scott of working through those console servers done fantastic, the cellular router group has a new leader in place and it's been an immediate positive impact there. Our infrastructure management team has been delivering as well. So it's really the OEM solutions where we're having more of the supply chain concentration. There is still, Scott, to be fair revenue -- they were not able to recognize in the quarter, because we couldn't get all the components, you want, but that revenue gets deferred largely to the next quarter.

Scott Searle -- ROTH Capital -- Analyst

Perfect. Thanks so much. Congratulations, guys.

Ron Konezny -- President and Chief Executive Officer

Thanks, Scott.

Jamie Loch -- Senior Vice President, Chief Financial Officer, and Treasurer

Thanks, Scott.

Operator

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

Ron Konezny -- President and Chief Executive Officer

Thank you Lateef. We really appreciate everyone that joined the call today, 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 16th and the 10th Annual ROTH Capital Tech Conference on November 18th. Stay safe and healthy. And I look forward to our next earnings call.

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

Jamie Loch -- Senior Vice President, Chief Financial Officer, and Treasurer

Ron Konezny -- President and Chief Executive Officer

Harsh Kumar -- Piper Sandler -- Analyst

Scott Searle -- ROTH Capital -- Analyst

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