Mike Goergen - SVP, CFO & Treasurer Ron Konezny - President & CEO.

Greg Burns - Sidoti & Company David Gearhart - First Analysis Jaeson Schmidt - Lake Street Capital Markets Mike Walkley - Canaccord Genuity.

Good day, ladies and gentlemen, and welcome to the Digi International Fourth Fiscal Quarter and Full Year 2017 Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host for today Mike Georgian, Chief Financial Officer. You may begin..

Thank you, Sonia. Good afternoon, and thank for joining us today. 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 for our fourth fiscal quarter 2017.

Following our prepared remarks, we will take your questions until 6:00 PM 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 risk 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 such expectations or any of our forward-looking statements will prove to be correct.

Please refer to the forward-looking statement section in our earnings release today, and under the headings Risk Factors in our 2016 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 good afternoon to everyone on the call. I have organized comments for today's call to reflect on the past fiscal year and build a new framework for Digi's current fiscal year. We concluded our fiscal 2017 year on a positive note. Digi met expectations for the fourth fiscal quarter of 2017.

We're pleased with the market adoption, recurring revenue growth and trajectory of our smart solutions business. In addition, we continue to streamline our products businesses with fewer SKUs, consolidated offices, closer collaboration between products and services and a crisper market identity and presence.

Our fiscal 2017 year was exciting and challenging. We completed two acquisitions and formed Smart Solutions with the vertical focus on foodservice, health service and transportation logistics.

Within our products business, we consolidated our European presence in Munich, reduced our SKU count to less than 1400, and brought in new leadership in sales, product and technology.

We introduced and gained traction with our CC6UL and XP cellular offering, and we showed great resolve to deliver strong margins and profitability but we have higher aspirations for growth of our products businesses. Entering fiscal 2018, we have two distinct operating segments.

M2M or machine-to-machine is comprised of products, which includes cellular network embedded in RF, and services which includes Wireless Design Services, Digi Remote Manager, and professional services. Our second operating segment is Smart Solutions. This includes SafeTemps, SMART Temps, FreshTemp and the recently acquired TempAlert business.

These four acquisitions over the past 24 months are integrating nicely.

The M2M business provides our distributors, OEMs and direct customers with key tools to create, deploy and manage their business and mission-critical IoT applications largely in heavy commercial and industrial application where securing, reliability, scalability and manageability are critical.

We have four key priorities to build sustainable and profitable growth. First is a stronger direct sales team, Mike Ueland, our Senior Vice President of Global Sales has led efforts to attract new talent to the sales team and we’re seeing progress in converting large and more strategic customers. Second is improved channel programs.

Mike is also leading our efforts to improve the service and support we provide to our important channel partners including co-selling initiatives. Third is improved new product introduction. We've added Scott Nelson to lead Product Management and Scott Wilken to lead our technology team.

They will be more effective prioritization, collaboration, and ultimately introduction and success of market appealing products that solve our customer's problems. We are excited to have these widely respected leaders join our executive team. And lastly streamlined operations, we continue our drive and our goal of less than 1000 SKUs in fiscal 2018.

We are improving our systems and our processes for the implementation of NetSuite and we are working hard to make Digi a more customer focused responsive and easier to do business with the company. We are targeting M2M in total to grow 5% to 10% over time while producing double-digit EBITDA margins.

Our cellular product family will lead our growth path. We expect both embedded and RF to grow as well, services are projected to grow at a faster double-digit growth rate. This combined growth will be partially offset by an anticipated decline in our network product family.

In fiscal 2018 we expect growth to build quarterly as design wins, new products and a more productive go-to-market approach set in. The Smart Solutions business is more squarely focused on growth. We have a leadership position and a large addressable market that has fragmented competition and low penetration.

Our vision is to provide task management, condition monitoring and analytical insight across the supply chain of food, medicine and other sensitive assets. Our customers are saving money, improving compliance and safely protecting their customers and their companies.

We are thrilled that TempAlert team has joined Digi to deepen and broaden our offerings. TempAlert's leading customer base includes CBS, Walmart, Apple, Coca-Cola and Cosco. Digi now has over 100 professionals dedicated to the success of our combined customer base.

TempAlert's cutting-edge technology will enhance Digi's combined offering in addition, TempAlert's brings a strong analytics team which will add value across the Smart Solutions portfolio. We welcome Harry Schechter, President, Jerry McDonald, Chief Customer Officer and the entire TempAlert team.

As with our products business, we're focused on ensuring our customers a capturing value from Digi's offerings and have the support and continued innovation they rightfully expect. Our customer's success teams are focused on both implementing new customers, as well as ensuring our existing customers, meeting or exceeding our mutual goals.

We are vertically focused on our go-to-market across food, health, transportation and industrial applications. This ensures we understand our customers business challenges and are bringing well-designed easy to use and compliance solutions to the businesses.

We will be integrating best-in-class offerings, processes and teams across the four acquisitions to leverage each business's strength. We are focused on building our customer and subscriber base. We believe Smart Solutions can grow to over $50 million to $100 million of revenue over the next 3 to 5 years fueled by strong double-digit growth.

The work completed and changes made during fiscal 2017 created a foundation that we can build on for our success in fiscal 2018. We continue to explore additional acquisitions that could accelerate our product and solutions businesses.

We take pride in our strong balance sheet as it enables our acquisition strategy and provides confidence in our same power and vitality. Now I'll turn over to Mike for a comprehensive update of our fiscal 2017 financial performance and guidance for both our first fiscal quarter of 2018 and for the fiscal 2018 period.

Mike?.

Thank you, Ron. We had four key financial highlights during the quarter. One, we were pleased our revenue performed as expected for the quarter and met the midrange of our guidance. Three of our product categories grew sequentially and we had another strong quarter from our Smart Solutions business.

Two, income from continuing operations per diluted share was $0.16 which beat the high-end of our fiscal fourth quarter guidance. Three, we are expanding our recording and guidance to include adjusted EBITDA. As I mentioned earlier full non-GAAP reconciliations are included in our earnings release.

And four, as Ron mentioned and we highlighted in our earnings release we closed on the TempAlert acquisition which is our fourth strategic acquisition to grow our Smart Solutions business. TempAlert adds significant scale to our platform and adds deep expertise in healthcare, industrial and foodservice markets.

I’ll now move to some additional details of the fiscal fourth quarter performance starting with revenue. We generated $45.1 million of total revenue which approximated the midpoint of our guided range of $44 million to $47 million. Revenue decreased by 10.6% compared to the same quarter last year.

Cellular grew sequentially from the third quarter but was down 11.4% year-over-year. We still feel cellular is positioned well with our pipeline, planned new product introductions and new talent to drive this category.

Our module business categories have all been embedded also both sequentially improved but declined versus a year ago quarter by $3.2 million primarily in embedded. Embedded category is experiencing a decline in our Rabbit system module which is in its mature face. We have new products launched in 2017 for both RF and embedded.

We expect design-wins this year to lead the pipeline and opportunities for growth in fiscal 2018. The new products include our ConnectCore 6UL as well as our cellular XBee modules. Network continued its decline with a 24.2% decrease year-over-year.

The decline in network has been steeper than expected and primarily driven by softness in terminal and device server revenue. We outlined during our fiscal Q3 call some targeted investments recently made to slow the pace of decline. The targeted investments include both NPI and sales.

Our service and solutions revenue continue its strong growth feel primarily from our solutions business. We grew revenues more than $2.3 million year-over-year and reached nearly 14,000 sites during the quarter. The TempAlert acquisition lagged nearly 21,000 sites to our portfolio which more than doubled our site count to approximately 35,000.

Geographically, North America revenue decreased by 15.3% in fiscal Q4 2017 largely resulting from lower sales of network and embedded products compared to the same quarter in the prior fiscal year. EMEA revenue decreased by 8.2% versus the prior year comparable quarter.

However we are happy to see EMEA rebound from fiscal Q3 2017 given the restructuring that took place last quarter. Results were up 6.2% from fiscal third quarter to fiscal fourth quarter 2017. Combined revenue in Asia and Latin America also improved year-over-year increasing by over 10.7%.

Our overall gross margin was 47.3% compared to 48.8% in fiscal Q4 2016, a decrease of 150 basis points. Gross profit decreased by 13.3% in fiscal Q4 2017 versus a year ago quarter due primarily to lower topline revenue performance and shifting product mix. Our fiscal Q4 2017 product gross margin was 47.6% compared to 50.2% in fiscal Q4 2016.

This decrease was a result of the decline in network products and lower volume in other categories. Services and solutions gross margin for fiscal Q4 2017 was 44.8% compared to 10.8% in the year ago quarter. This includes intangible amortization expense of 400,000 and 200,000 respectively.

This is in line with our expected margin in the service category of 40% to 45%. Operating expenses in fiscal Q4 2017 decreased by 12.2% compared to the year ago quarter.

The operating expense decline included a benefit of $3 million compared to a benefit of $700,000 in the fourth quarter of 2016 related to adjustments to contingent consideration related to Bluenica and FreshTemp acquisitions. Although certain growth milestones were not met, we remain bullish on this business and their growing pipeline.

Additionally, incentive based compensation expense decreased by $1.8 million for the fourth quarter of fiscal 2017 compared to the same period a year ago partially offset by incremental operating expense for the SMART Temps acquisition of $1.5 million.

Operating expense for the fourth quarter of 2017 also included acquisition and severance expense of approximately $700,000. We recorded an income tax benefit of $100,000 for the quarter compared to income tax expense of $1.1 million for the fourth quarter a year ago.

Our overall effective tax rate is impacted by the mix of income between tax and jurisdictions, many of which have lower statutory tax rates than the U.S. We had an overall effective tax rate of approximately 11% for the full fiscal year 2017.

Income from continuing operations for the quarter was $4.3 million or $0.16 per diluted share compared to $3.8 million or $0.15 per diluted share in the fiscal fourth quarter 2016. As mentioned earlier, the $0.16 beat the high-end of our fiscal fourth quarter guidance.

EBITDA from continuing operations was $5.5 million or 12.2% of revenue compared to $5.9 million or 11.8% of revenue for fiscal Q4 2016. We have provided a full reconciliation table for non-GAAP items in our earnings release for your convenience.

In fiscal 2018, we will be recording adjusted EBITDA as we believe it is an effective measure to evaluate the performance of our business especially when comparing outperformance to other IoT and technology companies. We will be adding back stock-based compensation, restructure and acquisition related expenses.

Moving to the balance sheet, cash and investments including long-term investments totaled $115 million, a decrease of $22.7 million over the comparable balance at September 30, 2016.

The decrease in cash was primarily a result of the SMART Temps and FreshTemp acquisitions for a total expenditure of approximately $30.1 million, net of cash acquired of 500,000. Subsequent to year-end, we had $45 million as customary working capital adjustments and debt like items were net $41 million in cash for the TempAlert acquisition.

Our balance sheet continues to be very strong with a current ratio of 9.7:1 at September 30, 2017 compared to 8.2:1 at September 30, 2016. Now I would like to provide a updated guidance which includes the first quarter and the full-year of fiscal 2018.

We expect to see product revenue grow sequentially throughout the year, and as has been typical for Digi fiscal Q1 is our softest quarter but we expect increasing from this space. We are including estimates for TempAlert in our guidance. We do not expect TempAlert to be accretive.

For the first fiscal quarter of 2018, we estimate total company revenue in a range of $44 million to $47 million and adjusted EBITDA projected to be between $2 million and $4 million.

Net income per diluted share from continuing operations to be in a range of $0.06 loss to $0.02 loss, included in this EPS guidance, our TempAlert transaction expenses of $1.5 million or $0.04 per share.

For the fourth fiscal year, we are projecting revenue to be in a range of $200 million to $212 million and adjusted EBITDA projected to be between $20 million and $24 million, net income per diluted share to be in a range of $0.19 to $0.28.

Again included in this full year guidance our TempAlert transaction expenses of $1.5 million or $0.04 per share. Despite our product revenue challenges in 2017, we are forecasting a return to modest growth in 2018 for our M2M segment. Growth should be led by our cellular category followed by embedded and then RF. Network will continue its decline.

Overall topline increases by 14% led by our solutions group which is expected to be in a range from $25 million to $30 million in FY 2018 and end with annualized recurring revenue north of $20 million. Margins were improved slightly to 50% as we continue to optimize our manufacturing cost and the solutions mix gross.

Operating expenses will show year-over-year increase as we reinvest in sales, solutions and revenue bearing resources and services. Adjusted EBITDA margin should be in a double digits for the year. We continue to plan for our effective tax rate to be around 28%. That completes our prepared remarks.

At this time Ron and I are pleased to open the call for your questions.

Operator?.

[Operator Instructions] Our first question comes from Greg Burns of Sidoti & Company. Your line is now open..

So maybe a little bit more color on TempAlert's in terms of how much of revenue contribution is considered in the guidance for TempAlert's for the first quarter and the full year and then maybe if you just give us some color on recent growth from TempAlert, how fast it’s growing margin profile of the business or any other kind of financial metrics you could help us out with this?.

So I think we’re going to guide to the solutions portfolio in total and so that's the $25 million to $30 million that we provided in my prepared remarks. In terms of how we think about this business growing, we really think it’s a north of 20% CAGR.

Ron alluded to in his comments a $50 million to $100 million expectations over the next three to five years. And so I think you had to throw that CAGR on there, you got a good feel for where will be really in the short term but think about the business as $30 million for FY 2018 growing at 20% plus organically..

But you can't give us - what was their trailing 12-month revenue?.

Yes, I think we’re going to punch on that Greg we really just going to focus on the portfolio as its combined today..

We guided last year of calendar year $10 million to $15 million in solutions excluding TempAlert, so you can get a feel for it's doubled our subscriber base, you can kind get a relative feel for the TempAlert contribution..

So in terms of the issues you’ve been having with the cellular again the L-series up to speed where we stand in terms of getting that product to where it needs to be?.

If you recall we actually - earlier in fiscal 2017 we diverted some of our resources to producing additional variance of our WR series and so those variants are being introduced to the market over the next few quarters.

And the work on the Linux base system continues and we’re making very good progress there and back on track and feel like we’ll have an equivalent feature set in Linux in this fiscal year in the first half of this fiscal year.

So we’re doing really both initiatives within cellular which is gaining confidence for us and the ability for cellular to grow from 2017 to 2018..

And then lastly, I guess you mentioned the M2M business to be a - still in that double digit margin target on a consolidated basis now how should we think about the company with the M2M solutions?.

Yes, so I think - our consolidated basis were really looking for double-digit adjusted EBITDA. So we’re changing that metric a little bit right so we’ll have to kind of call us around as we march through 2018.

The solutions business on a combined basis will not be accretive for the short-term but I don't think it's really going to really deteriorate our expectations for performing at that level..

And our next question comes from David Gearhart of First Analysis. Your line is now open..

My first question I wanted to look at the solutions business before you layer in TempAlert. If you look at the fiscal Q3, $5.1 million in a declining quarter-over-quarter.

Just wondering what the causes are because I think we were at $3 million in services revenue from the solutions business in Q3 it looks like the press release that was around $2.1 million so wondering what's going on there just with your net locations up on the quarter?.

I think you’re right to think about that solutions business anywhere from $2.5 million to $3.5 million on run rate basis.

We also as we think about the different revenue streams in that business there is still is a good portion of that which is upfront hardware deployments and so on a recurring revenue basis that business grew obviously both year-over-year but it also grew sequentially from really what we interested in we just got recurring revenue.

It was the $2.1 million I referenced in the prepared comments was a total services number of 5.5 million relative to fiscal Q4 2016.

So $2.1 million was year-over-year growth and I think it was down may be 500,000 sequentially but I think about that and really it’s kind of that the upfront deployments you’re going to see some fluctuations in that business till the recurring revenue gets to scale..

So I should think about as $2.5 million coming from the services piece that’s both hardware and recurring and that's what is, not the $2.1 million that is the growth year-over-year?.

Yes, $2.1 million is growth year-over-year and I would think of that, just on a - exiting the year it was $2.5 million all in on solutions..

And then in terms of a TempAlert can you give some sense of the mix between hardware and services is it roughly 50/50 or is there different models being in play where its upfront hardware versus fully bundled customer’s choice what is that look like?.

Yes, it’s good question. I think with the addition of Digi we provide some flexibility David for the Smart Solutions portfolio. There were some customers that actually prefer an upfront investment and maybe a lower recurring fees. They were some customers that want really in all recurring fee.

And so we kind of to want to do what the customers looking for versus necessarily forcing our model on them. We also see again average recurring revenue per month change depending upon the application and it's roughly correlated to the size of the asset or the facility.

You would see lower ARPUs on a trailer or pharmacy higher ARPUs in the grocery store and warehouse. So it does fluctuate depending upon the application as we grow you'll start to see those ARPUs really start to smooth out in aggregate as that consolidated base grows..

And then there are two more quick ones for me, I mean since you mentioned mobile I have tended to think of SMART Temps an existing cold chain solutions you have is mainly on fixed location versus mobile and looking at TempAlert it looks like there is a decent mobile solution there.

Just wondering if you can give us some sense of what the split is on a mix basis between fixed location, cold chain versus mobile just given that there's really strong competitors on the mobile side.

And do you think that gives you some advantage having fixed and mobile providing full visibility from production to distribution to final sell-through if that can may be help you win a little bit on the mobile side?.

The TempAlert subscriber base is definitely bias towards more of a fixed location if you look at the customer base of CBS, Walmart, Cosco those are largely fixed locations.

Those same customers have been asking TempAlert for mobile solutions as well and the solutions that we have in particular in Safe Temps are really not complement and so we do think David being able to go to these strategic customers were asking us to do more with a broader portfolio to give them more complete supply chain visibility not just in-store but inbound shipments or outbound product going in a tot or in another vehicle is going to be a winning approach.

It will certainly take time for customers to adopt the solution, but we feel like there's great up selling opportunities..

One more quick one for me, I know that - I thought it was interesting seeing that TempAlert has CBS's as a customer and from what I heard TempAlert has now been doing the pharmaceutical the drug side of it and Smart Temps is really strong in that area as a customer in Rite Aid do you think that will help your cross-sell initiatives with your existing portfolio into TempAlert space and maybe gain some opportunity there?.

We absolutely do and TempAlert has had a lot of success in the convenient store and pharmacy and they really have started gaining traction in food and industrial gases in particular. So there is a lot of synergies between what TempAlert does and the Digi Smart Solutions portfolio.

The other big piece which we mentioned is TempAlert has got really strong analytics capability much more advanced than what the Digi Smart Solutions portfolio had prior to the acquisition. And so that's another really important dynamic.

TempAlert has got some really nice resources and applications that have been studying this data and can become much predictive and insightful on performance of equipment of store operations and other metrics..

Our next question comes from Jaeson Schmidt of Lake Street Capital Markets. Your line is now open..

I apologize if they have already been addressed but just want to - looking at the Smart Solutions business I know previously you mentioned targeting kind in that $10 million to $15 million and revenue for this calendar year.

Are you still on track to that range excluding this recent acquisition?.

Yes we are..

And then are you seeing anything out of the ordinary from a pricing standpoint in any of your product line?.

No, the pricing hasn't been as much issue as the key for us to grow at faster rates than even the 20% plus that Mike mentioned is really a market adoption most customer are performing these pass manually.

They are writing stuff down on paper, they might be logging it to a USB drive and so there is a lot of education and a lot of piloting that you need to do to get customers comfortable with the solution that they can operate it and get the ROI that we jointly expect.

We think that Digi Smart Solutions with deployments like Rite Aid, CBS, Walmart, Love's Travel Stops, Tim Hortons we are one of the very few companies that have had deployments of over a thousand sites across multiple companies.

And so larger enterprises are looking for companies like Digi to give them the assurance that they could be successful not just implementing the solution but attaining the all line the business case and of course the compliance and safety that they are out for..

Jaeson this is Mike I’ll just piggy back on that. So in the M2M segments specifically the product piece we did see some margin degradation I think it was 150 basis points year-over-year. We would really point to the network decline network has the highest margins of the four product families and then volume kind of heard us a little bit as well.

But we looked at other sales prices and all that is holding up pretty well. So just kind of echo around sentiments there is really not anything going on from a pricing perspective that's impacting margins, its more mix than anything else..

And then just last one from me, how should we think about CapEx for this fiscal year?.

We just aren't that capital intensive so I would suggest you about 3 million to 4 million in CapEx but I think you’ll be pretty close..

[Operator Instructions] Our next question comes from Mike Walkley of Canaccord Genuity. Your line is now open..

Just embedded in your full year guidance I was just hoping you could maybe walk us through gross margin, should they improve throughout the year as the hardware business grows sequentially and with the TempAlert acquisition is your service solution target gross margin still kind of in a 40% to 45% range or is that change that gross margin at all..

I think gave you target of overall gross profit margin that gets closer to 50% so you can see we are expecting improvement and the improvement I think is kind of coming from a couple of different areas and you mentioned [indiscernible]. So we are trying to really optimize some of our manufacturing cost.

And so we are expecting some margin improvements there volume certainly will help us. We’ll give some of that back just with the mix on the network component and continue to decline but that solutions and services business its 25 million to 30 million for solutions and so may be another $9 million or $10 million on there for services.

So yes, we are expecting some margin improvements really through all of those components. And the 40% to 45% gross profit we are kind of calling out on services I think it’s actually is kind an improvement from what we are signaling as recently as our Q3 call.

So, but yes we’re targeting 30% in gross profit margins at a consolidated basis for FY 2018..

And then Ron just as you look at the year-on-year lots of changes going on with your sales and chief technology and product teams.

Can you talk maybe about how this new teams in place to drive growth and what gives you the confidence for this nice sequential growth throughout the year?.

Yes, I think it’s a really good question.

The thing we have been really working hard towards is improved collaboration, better alignment and improved transparency between sales, R&D and product management and Scott Wilken and Scott Nelson two really well respected technology and product management IoT leaders have worked together in the past and had to great success.

So there is a lot of confidence in those two have work well together and will continue to work well.

And then Mike you have been here now about a year has really started setting in - he has had a chance to bring in new talent and as you can commenced on the sales side it takes time to attract new resources to get them indoctrinated in Digi’s product portfolio and culture and we’re really starting to see results of that.

And then the collaboration between the three is really critical to making sure we've identified the right products and go out in the market and train the sales people and we’re executing against our game plan. We certainly has a lot of these things in place in fiscal 2017.

We weren’t quite getting as good results as we would hoped at the beginning of the year. And so having these people on place for fiscal 2018 really helps us execute better on a plan that we largely thought was a good one but needed to improve execution..

Last question from me just a quick clarification on the model, with general ministry down sequentially that just kind of lower year-end bonus accrual or that kind of new run rate we should think about on G&A?.

I think there is a bridge that we kind of provide you with might so, I think G&A was roughly$17 million for the quarter I think you can add that to that the $3 million contingent consideration and then back off of that kind of that severance and acquisition expense.

And I think that will get you pretty close so we did that math for you, I think year-over-year it would be total OpEx of $19.8 million to $19.2 million or something like that but I think if you think about it, overall right if you think overall OpEx from $17 million may be $19.2 million is probably a good number.

And then you got to add into that the expenses that that we would expect to see from TempAlert..

Thank you. And ladies and gentlemen this does conclude our question and answer session. I would now like to turn the call back over to Ron Konezny, President and Chief Executive Officer for any further remarks..

Thank you very much. On behalf of the entire Digi team thank you for your continued support and interest in our company. We concluded our fiscal 2017 period in a great position to deliver improved results in fiscal 2018. Addition of TempAlert creates a market leadership for our Smart Solutions business. We look forward to our next update. Good evening..

Ladies and gentlemen, thank you for participating in today conference. This concludes today’s program. You may all disconnect. Everyone have a great day..