Digi International Inc (DGII) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Digi International First Fiscal Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Mike Goergen, Chief Financial Officer. Sir, you may begin.

Thank you, Amanda. Good afternoon, and thank you for joining us today. Joining me on today's call is Ron Konezny, our President, CEO and Director. Ron will provide his thoughts on our business, and I will follow with the highlights of our financial performance for our first fiscal quarter of 2018.

Following our prepared remarks, we will take your questions until 6:00 p.m. Eastern. We issued our earnings release shortly after the market closed. If you do not have a copy of our earnings release, you may obtain a copy through the Financial Releases section of our Investor Relations website at www.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 for any reason. We believe the expectations reflected in our forward-looking statements are reasonable, but give no assurance of such expectations or any of our forward-looking statements will prove to be correct.

Please refer to the forward-looking statements section in our earnings release today and under the heading Risk Factors in our 2017 annual report on Form 10-K and subsequent reports on file with the SEC for additional information.

Finally, certain other 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 an exhibit to a Form 8-K that can be accessed through the SEC filings section of our Investor Relations website.

Now I'd like to turn the call over to Ron.

Thank you, Mike, and thank you to everyone that has joined our call today. Today's remarks provide both an operational and strategic update for Digi's community. We've started our fiscal 2018 year on a positive note by meeting expectations for both revenue and adjusted EBITDA. In addition, we are experiencing the impact of our new more athletic business with stronger gross margins, increased subscribers and recurring revenue, and strength in marketing Digi's leading portfolio of IoT products, services and solutions.

We have brought on several new leaders, and these athletes are making their impact both tangibly, with results on our scoreboard, and intangibly with culture and customer experience and delivery. Two quarters ago, we transitioned to the use of 2 business segments to manage our business. We feel this better aligns with our value proposition and industry nomenclature. We are now making the move to more effectively communicate this externally. We will be moving away from our traditional product categories like cellular and RF and moving towards industry solutions. This approach appeals to customers and breaks down the internal silos to take advantage of our new business and product line strategies.

These segments include IoT products and services, which we formally refer to as M2M. This business is comprised of our IoT products such as cellular, network embedded and RF, and IoT services, such as Wireless Design Services, Digi Remote Manager and professional and support services. We will be including our newly acquired Accelerated Concepts team and results in this business segment since its primary products are cellular.

IoT solutions also called Digi Smart Solutions includes our condition monitoring and task management offerings. It produces most of our recurring revenue stream. We expedited our industry-leading platform and team via 4 strategic acquisitions. We've been thrilled with the alignment of these 4 teams and their commitment to customer success, continuous innovation, market focus and leadership.

Our IoT products and service businesses provide OEM and enterprise products with complementary software and support services. Our objective is to sustain revenue growth and profitability in addition with the add of Accelerated Concepts to the Digi family. A few business updates, include, we have a stronger direct sales efforts by adding new leaders in each of our key geographies. We have turned over nearly 25% of our sales force to achieve higher win rates at our largest opportunities. We have more clearly defined territories and incentives that align with generating new businesses. Second, we've improved our channel programs. We are more engaged with our dedicated partners to ensure that they have training, documentation and co-selling support to more effectively grow our businesses together.

Third, we've improved our new product introduction. New leadership has prioritized our road map, emphasize modularity and reuse the products internally and that design accumulative innovation path to help us win. This path coexists with custom innovation approaches, which are required by some of our largest opportunities and facilitated by our Wireless Design Services team.

Lastly, we've streamlined our operations. We're making great progress toward our goal of 1,000 SKUs, which we expect to hit in our second fiscal quarter. We continue to improve our systems and processes, which we believe will improve gross margins. We've been targeting IoT products and services to grow 5% to 10% over time, while producing double-digit EBITDA margins. With the addition of Accelerated, our near-term expectations clearly upfront. Digi has a strong market presence with industrial customers and accelerated strength in the enterprise, makes this an exceptionally complementary acquisition.

We are also running on the organizational road map and go-to-market integration of our companies. We expect to introduce Accelerated products and services to Digi's direct and channel teams. Planning is well underway to leverage our combined technical strengths as we embrace Accelerated's cultural alignment and entrepreneurial spirit. The IoT solutions business is focused on subscriber and recurring revenue growth. We believe we had a strong -- we have a strong leadership position in a large addressable market that has fragmented competition and low penetration. Our superior technology talented team and ROI-generating solutions have been embraced across food service, health, and transportation logistics vertical markets creating the only provider with this level of offering breadth.

The recent broad-based additions of key customers such as Trailcon in transportation and logistics, Taco John's in food service and several pharmacies and hospitals in our health sector, plus the inclusion of our TempAlert team that swells across the customer base to over 38,000 subscribers. We experienced positive net revenue retention driven by customer expansions and additions. As our subscriber base has grown, our annualized recurring revenue now surpasses the $11 million. With the expectations of new customers and positive net revenue retention, we anticipate strong double-digit growth rates for this segment.

We have integrated our acquisitions into one organization and functional heads in vertically specific go-to-market resources. We are collapsing the technology stacks over time to form a best-in-breed solution that will be easier to maintain and innovate, while maximizing the customer's experience. We expect IoT solutions to experience sequential growth throughout the fiscal year and we have confidence we can grow this business to $50 million to $100 million in revenue over the next 3 to 5 years fueled by strong double-digit growth.

In summary, we are encouraged by the start of our fiscal 2018. The acquisition of Accelerated will strengthen our IoT products and services team and results. We take pride in the breadth and strengths of our IoT offerings. And we believe our expected growth in revenues and margins combined with our relentless operational discipline will generate free cash flow and build on an already strong balance sheet.

This combination allows us to pursue both organic and inorganic opportunities to further accelerate Digi's strategy and business.

Now I will turn over to Mike for more detail on our performance in the first fiscal quarter of 2018, and our expectations for the second fiscal quarter and updated full year guidance. Mike?

Thank you, Ron. We had a lot of moving parts in the quarter, and I'll start with a few key highlights.

We were happy to the start of our fiscal 2018, both our consolidated top line and adjusted EBITDA were well within our expectations. Tax reform will improve our long-term effective cash tax rate, which we are modeling at 21%. However, for fiscal Q1, the revaluation of our deferred tax asset, the initial review of the transition tax as well as the adoption of ASU 2016-09 had a negative noncash impact on our EPS of $0.12 in aggregate.

As discussed in our last call, we closed the TempAlert acquisition in late October, and have already made substantial progress on integration. We expect to hold purchase accounting open for at least one more quarter, but our initial work reflects $24 million of intangible assets, which will be amortized over 5 to 7 years. This will result in approximately $4 million in annual expense or $0.14 per share, of which approximately $1 million was recognized in fiscal Q1 or $0.04 per share.

Lastly, subsequent to quarter end, as Ron mentioned, we acquired Accelerated Concepts, Inc. We are excited to have this double-digit growth company and its products to our business. We expected to be accretive for us in fiscal 2018.

In fiscal Q3 2017, we detailed Digi as 2 operating and reporting segments. We are now describing those 2 segments as follows: IoT products and services and IoT solutions. IoT products and services includes all 4 of our product family: cellular, network, embedded, RF and now Accelerated Concepts, as well as our services consisting of Digi design services, Digi Remote Manager and support services.

IoT solutions includes our Smart Solutions offerings, which includes the integrated businesses from our 4 acquisitions of Bluenica, FreshTemp, SMART Temps, and most recently, TempAlert. I will take you through our P&L first with consolidated results and then highlights from both of our segments. I'll wrap up with our balance sheet.

Starting at consolidated revenue, we generated $45.2 million of total revenue, which is comparable to our first fiscal quarter revenue a year ago, as well as within our guidance range of $44 million to $47 million. Geographically, North America revenue decreased by 0.3% in fiscal Q1 2018. EMEA revenue increased by 3.5% versus the prior year comparable quarter. We are very encouraged by a strengthening EMEA given the softer performance there in fiscal 2017 and the restructuring of plants in fiscal Q3 of 2017.

Combined revenue in Asia and Latin America decreased by 4.2% year-over-year. Our overall gross margin increased to 48.5% compared to 47.5% in fiscal Q1 2017. Gross margin increased fiscal Q1 2018 versus the year-ago quarter due primarily to IoT product and services mix, improved IoT solutions margin as well as improved manufacturing efficiency. Operating expenses in fiscal Q1 2018 increased by 26.4% compared to the year-ago quarter. However, this includes incremental expense of $3.8 million related to the TempAlert and SMART Temps acquisitions, and $1.2 million of incremental merger and acquisition expenses. Excluding these expenses, operating expenses would have been comparable year-over-year.

As I mentioned earlier, we recorded a noncash income tax provision of $2.5 million for the quarter compared to $800,000 in the first quarter a year ago. Our current quarter provision was impacted by the recently enacted Tax Cuts and Jobs Act. We also adopted ASU 2016-09 in fiscal Q1 2018. The first is a one-time adjustment of $2.5 million related to the remeasurement of our net deferred tax assets as a result of the Tax Cuts and Jobs Act, which lowered the U.S. corporate tax rate from 35% to 21%. The second is an adjustment of $500,000 for the adoption of FASB ASU 2016-09, which requires the expensing of the tax deficiencies related to stock awards that historically were reported in additional paid in capital.

Net loss for the quarter was $4.6 million or $0.17 per diluted share compared to net income of $2.4 million or $0.09 per diluted share in fiscal Q1 2017. As mentioned earlier, the one-time income tax provision items and ASU 2016-09 reduced our diluted earnings per share by approximately $0.12. Additionally, amortization expense related to the TempAlert acquisition reduced our diluted earnings per share by $0.04 in the current quarter. Adding back these items, our net loss per share would have been above our fiscal Q1 guidance range of $0.06 loss to $0.02 loss per share.

As discussed during our last call, we now report adjusted EBITDA, as we believe it is a more effective measure to evaluate the performance of our business, especially when comparing our performance to other IoT and technology companies. Adjusted EBITDA for fiscal Q1 was $2.8 million or 6.2% of revenue compared to $5.4 million or 12% of revenue for fiscal Q1 2017. We've provided a full reconciliation table for non-GAAP items in our earnings release for your convenience.

Next, I will share some details in our 2 operating segments. I'll begin with IoT products and services. Revenue in the first fiscal quarter of 2018 was $40.9 million compared to $44.9 million in the same period a year ago. Although a decline of 9%, this segment performed well relative to our expectations and guidance. The decline was primarily the result of decreased cellular network sales, partially offset by good growth of RF sales. In the prior year fiscal quarter, we had a large channel stocking order for cellular products that was not repeated in fiscal Q1 2018. A decline in network was primarily due to significant sales to a large customer in the prior fiscal quarter. We continue to expect that network products will decline in the future at an annual rate of 10% to 15%. In the aggregate, we expect this segment to grow approximately 11% year-over-year from a combination of organic and our recent Accelerated acquisitions.

IoT products and services operating income was $1.3 million compared to $3.1 million in the prior year quarter. IoT products and services adjusted EBITDA was $4.5 million compared to $5.9 million in the same period last year or 11% versus 13.1%. Our focus in this segment will continue to be driving low- to mid-teen adjusted EBITDA margins.

Moving to our IoT Solutions segment. IoT Solutions revenue in the first fiscal quarter 2018 was $4.3 million compared to $200,000 in the same period a year ago. The growth was a combination of incremental revenues of $3.5 million related to the acquisitions of SMART Temps and TempAlert, and organic growth from our prior solution acquisitions, which increased $600,000 year-over-year.

Our sites under management now exceed 38,000 compared to just over 2,000 sites last year. We expect exciting growth from this segment and should triple the year-over-year revenues from fiscal 2017. IoT Solutions operating loss was $3.4 million compared to $700,000 in the prior-year quarter.

IoT Solutions adjusted EBITDA was a negative $1.7 million compared to $500,000 loss in the same period last year. Our focus in this segment will continue to be on double-digit top line growth.

Finally, our balance sheet continues to be very strong, with a current ratio of 6:1 at December 31, 2017, compared to 9.7:1 at September 30, 2017. Cash and investments, including long-term investments, totaled $78.1 million, a decrease of $36.9 million over the comparable balance at September 30, 2017.

The decrease in cash was primarily a result of cash generation of $3.8 million, offset by the TempAlert acquisition for a total cash expenditure of approximately $40.7 million. Subsequent to quarter end, we paid $16.8 million in cash for the Accelerated Concepts, Inc. acquisition. Now I'd like to provide our updated guidance, which includes the second quarter and the full year of fiscal 2018.

For the second fiscal quarter of 2018, we expect total company revenue in the range of $50 million to $54 million, and net loss per diluted share to be in the range of $0.02 to $0.00. Adjusted EBITDA is projected to be between $3 million and $4 million. We have included Accelerated Concepts in the second fiscal quarter guidance.

For the full fiscal year, we are projecting revenue to be in the range of $211 million to $224 million and net income per diluted share to be in the range of $0.01 to $0.09. Adjusted EBITDA is projected to be between $20 million and $24 million. Again, included in this full year guidance is Accelerated. I thought it might be helpful to detail the EPS impacts related to our revised guidance. Our previous midrange guidance was $0.24. Amortization of new intangibles is a negative $0.14 per share. The Tax Cuts and Jobs Act resulted in negative $0.09 per share. ASU 2016-09 is a $0.02 per share loss. And then we add Accelerated Concepts for $0.06. So that gets us to a revised midrange of $0.05.

That completes our prepared remarks. At this time, Ron and I, are pleased to open the call for your questions. Amanda?

(Operator Instructions) Our first question is from the line of Mike Walkley of Canaccord Genuity.

Ron, just with your 5 -- 4 priorities to build sustainable profitable growth. It appears new product introductions is a key area. Can you update us maybe on the product pipeline how Scott Nelson and Scott Wilken are doing in driving that process? And particularly within cellular, how do you see that product portfolio developing and driving growth for your overall IoT business?

Mike, we've been really excited about Nelson and Wilken joining the company. They've worked together in the past, with tremendous amount of respect for each other. And what they've really driven in this first quarter since they've been here is alignment with Mike Ueland and the sales team. So we've got a lot of great confidence in the products that have been released in this previous quarter, as well as really good alignment on the best efforts that we should put forth moving forward. Now what's happened in particular on cellular is, with the acquisition of Accelerated, we now have the opportunity to combine the road maps. Fortunately, there is not a lot of overlap. Accelerated's product line is oftentimes used for communications applications, oftentimes in indoor environments. And Digi's rather line up is typically more industrial and machine-to-machine and used in many times in more outdoor or extreme environments. But there is a lot of technology sharing that we're going to do both at the device level as well as the web and SD-WAN type of area. So we're really excited about having the Accelerated team join as well.

And George, just on the new reporting structure, you're not going to report the different hardware divisions going forward just put it into one area. Just wondering how you're going to report? And then, with your changing to adjusted EBITDA, do you -- can you give us or do you have anywhere the adjusted EBITDA, say, for the prior year quarters for fiscal '17?

Yes. So obviously you'll get that adjusted EBITDA as we march through the quarters, but I think we can probably post something to the IR site that gives it to you ahead of time, Mike, so you can adjust your model. I do think we'll move away from the detailed product categories as we talk more about the 2 segments. There is a little bit more work there for us to do. But I think even internally as we're structuring the business and how we are managing those different product lines that already are kind of coming together for us. So I would expect us to move away from those discrete product categories and maybe move to something that aggregates those in both the solutions and products and services segments.

Mike, what's happened in a more explicit terms is, as we go and interact with customers, they oftentimes are considering buy versus build. And we don't want to lose that customer focus of what's the right solution for the customer even if an individual is at the time motivated to sell a box versus and an embedded solution. In addition, we're really emphasizing a lot of reuse of technology internally. So the newest line of our routers that are in development were actually using our embedded products and in some cases our RF solutions as well. And so by moving away from that nomenclature, we're encouraging that modularity, we're encouraging that reuse. We're driving more of a customer focus versus our internal product line focus, which has been a big objective of ours culturally.

It makes a lot of sense and just curious to the mechanics for the model. Last question from me and I'll pass on the line here. Just on your services business or your solutions business, just how should we think about kind of the pipeline with your 4 acquisitions now coming together? And with this business now reported separately, going forward, how should we think about gross margins on this business as it scales up over time?

I'll handle the pipeline side. Mike can comment on the gross margin side. The Smart Solutions group has been organized by vertical, so there is common functions of customer success, of technology and shared services with finance and HR, but a real distinct go-to-market, where we really understand our customer needs, who our competitors might be. The pipeline is very strong in all 3 of our verticals. We've been very pleased with the reception in food as well as transportation and health. And that really gives us some broad-based demand, because if one vertical is having softness or acceleration that may offset another. So we're really excited about it. We think we have the ability to accelerate the number of subscribers that we add to the combined platforms, both on a quarterly basis and, of course, annually.

Yes, I think, -- so from a margin perspective, Mike, I think, if we can strip out some of those amortization costs and -- that's probably for those 4 acquisitions, we're probably seeing somewhere close to $500,000 on a quarterly basis. We would expect that business to really perform anywhere from 55% to 57% gross profit margins. And then that gets better as the service or the subscription component of that becomes a larger piece. And so we really think that, that monitoring service, which we're all coveting can really perform in the 80% gross profit, then you've got hardware margins of may be 25%. But -- so think about it. Without that amortization, really 55% to 57% over the short run.

(Operator Instructions) Our next question comes from the line of David Gearhart of First Analysis.

My first question is can you drill down a little bit more on the Accelerated acquisition and provide some sense of its revenue contribution, what it was running at in '17, and its margin profile?

Yes, I can give you a little bit more detail there, David. So I'll caveat this with these are somewhat non-GAAP. They've gone through annual reviews, but not audited financial statements. So -- but these, I think, are directionally correct for you. So 2017, it performed at around $18 million top line and had roughly 10% EBITDA margins. And then in 2016, it was just over $12 million and 8% EBITDA margin. So I think what we had articulated in the earnings release is kind of that the 5-year look back, the 5-year CAGR, they've been in the 25% growth rate so we're really excited about that.

Okay. And then to stay on Accelerated, I was hoping you could provide a little more color around the rationale to acquire it, specifically, from the perspective of cold chain and focusing on retail enterprises, is there an opportunity there for Digi to cross-sell coaching solutions into Accelerated customers that are using primary or backup or vice versa? I'm just wondering if you could discuss that?

Yes, David, that's a really good point. We -- that hasn't been a primary motivator of the acquisition rationale. But there are certainly some crossover in terms of not only customer base, but even technology. One of the core pieces of the Smart Solutions' solution is a smart gateway that includes cellular, Wi-Fi and Bluetooth. And so there is a lot of opportunities to leverage each other's technology and drive out further cost. And in some cases there will be some customer opportunities. Once you get that gateway into a site, there is a wonderful set of opportunities that can be captured to further enhance the business you do with that customer, whether it'd be business continuity services on telecommunication's additional sensors, video, et cetera. So that's I'd say a second priority at the moment compared to the synergies we see with the existing Digi cellular router line up.

Okay. And then, last one from me. I was hoping you could just maybe look at the cellular product line a little bit more. I'd recognize that you're going to be changing your format, but since we do have the detail I know you said strong product orders and activity a year ago quarter. But just looking at the sequential step down from September to December, what is the explanation for that? Is it orders pushing? And alongside that, I know you had talked in the past about $3 million or so in revenue that's moving around I think related to a lottery kiosk customer, just wondering if you could discuss that as well?

Yes, this is absolutely one of the big reasons that we frankly want to move away from getting too buried into a particular segment performance. As you know, we will have lumpy performance from quarter-to-quarter. We do expect cellular to improve next -- this current quarter and throughout the year, especially with the addition of Accelerated, obviously. And we have some orders that have been deferred, very large rollouts that we're expecting to happen last fiscal year that are going to happen this year. And those orders are still very much intact. And we're working very closely with our channel partners as well to make sure that, that equipment is staged. So that particular order has not been impacted either way.

And at this time, I'm showing no further questions. I'd like to turn the conference back over to Mr. Ron Konezny, President and Chief Executive Officer for any closing remarks.

Great. Thank you, Amanda. And on behalf of the entire Digi team, thank you for your continued support and interest in our company. We've begun our fiscal 2018 as expected, and we plan to deliver improved results throughout fiscal 2018. In addition, the addition of the Accelerated Concepts strengthens our IoT products and services business, and we are extending our IoT solutions leadership. We look forward to discussing our continued progress next quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.