Good afternoon, ladies and gentlemen, and welcome to the Digi International Third Fiscal Quarter 2017 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the call over to Mike Georgian, CFO. You may begin your conference.

Thank you, Chelsy. 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 third 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 heading 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, everyone. I’m pleased with our performance during the fiscal third quarter. We exceeded our profitability expectations, while meeting our revenue expectations. In addition, we’re in line with the double-digit EBITDA margin targets we had established. We continue to streamline our operations and we continue to improve the company’s profitability capabilities. We believe further operating leverage is possible, especially when we hit our stride on our revenue growth plan. A significant component of our revenue growth plan is our Smart Solutions business, which had a solid quarter, growing our subscriber base and recurring revenue stream. Each of our business segments has significant activity during the quarter. In cellular, we made progress in this category, however, revenue results were a bit short of our expectations. This product line has large lumpy projects that cannot always be accurately forecasted. We continue to have strong interest in our product offerings. We’re refreshing our WR cellular router series adding additional pages to our LR router series, while expanding both carrier and geographic coverage. In addition, we are both changing and adding direct sales resources in both North America and Europe. In network targeted R&D resources have been added to start MPI in increased maintenance of line activity. We narrowed this product families at SKUs to better leverage R&D and to have investments. We expect this category to decline, but at a slower rate than what we would experience in this fiscal year. Embedded, expectations were met for the product line. Our CC6UL offering continues to see increased adoption via design wins and we integrated the offering with Amazon’s Greengrass IoT platform. In addition, we refreshed the ConnectCore 6 offering with improved pricing. In our offering, we are in line with our revenue expectations as demand for existing products, drop…

Thanks, Ron. We had a four key financial highlights during the quarter. One, we are pleased our revenue performed as expected for the quarter and met the mid-range of our guidance. A key factor of our revenue performance was another great quarter for our Smart Solutions business. Two, we implemented restructuring initiatives, which primarily impacted our local office in France and certain employee costs in the U.S. The restructuring was a result of our decision to consolidate our French operations into our EMEA headquarters in Munich. These actions resulted in charges of $2.5 million. The benefits include streamlined EMEA operations and reduced operating expenses of an estimated $2 million annually. Three, income from continuing operations per diluted share was $0.05, which was near the high-end of our third quarter guidance. Income from continuing operations per diluted share was $0.08, when adjusted for restructuring charges and other discrete tax benefits, which exceeded our third quarter guidance. And fourth, starting with the third quarter, we have expanded our reporting to two reportable operating segments. Our M2M segment contains our four hardware product categories; cellular, RF, embedded, and network. And our Legacy Services, Wireless Design Services, Device Cloud and Support. Our Solutions segment contains our three acquired Smart Solution businesses; SMART Temps, FreshTemp and Bluenica. Our income statement will continue to report two line items; hardware product revenue and service and solutions. In addition, we’ll continue to provide details by product category like you’re used to seeing. Essentially, the only change you will see is an expanded reportable segment footnote in our financial statements. We will do this for the first time when we file our 10-Q later this quarter. I’ll now move to some additional details of the third quarter performance starting with revenue. We generated $45.7 million of total revenue, which…

[Operator Instructions] Our first question comes from the line of Jaeson Schmidt with Lake Street Capital. Your line is open.

Hey, guys, thanks for taking my questions. I just want to start on your feelings on general visibility. I know it sounds like inventory in the channel has tweaked up a little bit. But how are you feeling just about overall visibility looking into the back-half of this calendar year?

Yes, we feel pretty good obviously, but the current quarter, given some of the comments Mike made about a few larger cellular projects that were delayed a bit. They – we will loose these opportunities. The timing of the delivery just shifted on us a little bit. So we feel good about great building on the base that’s been established here and accelerating from here.

Okay.

Jaeson, it’s – sorry, it’s Mike. I’ll just – I’ll just comment on the inventory – the channel inventory. So it’s $50 million, I think, which is a little bit higher than we’d like to see it sequentially, it’s actually, I think, it may even be down a little bit, but it’s very similar to what we had in fiscal Q2. But – so it’s – it hasn’t grown substantially quarter-on-quarter, but it’s a little bit higher than what we’d like to see.

No, that’s helpful. And then just shifting to the network business and more specifically looking at the legacy products, I think, in the past, you’ve talked about an annual decline of 10% to 15% and understanding that visibility within that product line is a bit cloudy. How should we think about that moving forward, given that it sounds like you’re going to be investing to offset some of the declines there?

Yes, I guess, if we roll across back to fiscal 2016, we actually experienced growth in that category, which was a bit of a surprise for us. And so I think the decrease that we’re experiencing this year is larger than we would have expected, because we came off of a higher base in 2016. We do think that the investments we’re making bring us back within that range that we have expressed in the past and we do not expect network to decline at the rate that has declined from 2016 to 2017.

Okay. And then just last one for me and I’ll jump back into queue. How should we think about the economics surrounding your Smart Solutions?

I don’t think it would be more clear, Jaeson, in terms of what you’re looking.

I know, but how should we think about average revenue per site or just monthly fee per site?

Yes, that – I think we’re quite ready to show that information. There is a wide range out there, Jaeson. The fees can vary depending upon the implementation we’re in pharmacies, hospital, schools, or in trucks and trailers, we’re in warehouses, restaurants, grocery stores, so there is a pretty wide range. And I think the group is getting bigger and certainly it’s a point where we can be more predictable. But right now, we’re not quite as eloquent on establishing that baseline that would be with strong merit.

Yes. So, Jaeson, you’re going to get a little bit more information with our segment reporting. So you’ll be able to kind of – you’ll be able to peal out the revenue associated with it through Smart Solutions. But on top of Ron’s comments, we also have a couple of different models that kind of operate within those three business units. We’ve got an OpEx model that has well upfront and higher recurring. And then you’ve got a CapEx model, where there’s a modest investment in product and hardware on the up front, and then that obviously changes the recurring on the back-end. So you will get a little bit more information in the segment reporting. But to Ron’s point, I think, it’s a little bit too premature to start talking about average revenue across the deployments.

Okay. That make sense. Thanks a lot, guys.

Thanks, Jaeson.

Thank you. Our next question comes from the line of Mike Walkley with Canaccord Genuity. Your line is now open.

Great, thank you. Yes, just following up on some of those questions. Just a little more color on the new product development, how is that tracking for your hardware business and when you guys see visibility on maybe returning to a year-over-growth for your hardware businesses? Is that something, we would maybe expect starting to happen exiting this calendar year, or just kind of how you see the pipeline in the new product development?

Hey, Mike, this is Ron. Good question. We’re very enthusiastic about some of the products we released in fiscal 2017, as Mike mentioned, particularly, the XBee cellular and CC6UL that have a little bit longer gestation periods. We get debt kicked out there, we get design wins and start seeing that revenue. But we’re planning on some more demonstrated revenue out of those products. We’ve got a number of cellular router enhancements that have been made some more incremental than others. And those are more quick hitters as we expose our product line to different wireless carriers. We enter new geographies. So we’re really expecting that cellular product line to have a more near-term opportunity to help us out on the revenue side, and it’s critical. We’re going to have to get revenue from our new products in order to hit our growth objectives.

Okay.

I did, I’m sorry, I was just going to throw a couple of comments on top of that as well. So, obviously, next quarter we’ll guide into FY 2018 guidance. But we actually had – really had implied a sequential growth as early as this quarter. And in my closing comments when I gave you guidance for Q4, I kind of pointed out the fact that within North American cellular, we had a few other large opportunities that really underwrite into new product introduction, but really more customer timing moved out of the quarter. But I think absent that, we would have seen sequential growth this quarter.

Okay, that’s helpful. And then just with the changing business next very strong on this kind of the recurring revenue business that you’re growing. How should we think about just gross margin trends? You’ve lots of different businesses and moving parts. But as we look out into maybe next year and even the short-term, how do you see gross margins trending for your business?

Well, so obviously, it’s going to change as annualized recurring revenue becomes a bigger component. We’d really have settled into that 40% gross profit on the service business. But as we kind of overcome some of the amortization of some of those intangibles associated with those acquisitions, I think, those margins could go north of 57%, 58%. And so that obviously, will have an impact on the overall margins. We should – we’ll see some compression on the hardware side as network continues to decline, that’s going to take the higher margin with it. But we’re making other changes within the cost of goods sold as well. So for the near-term, I’ve got – I don’t know that you would model really anything substantially different than what you’re seeing now.

Okay, that’s helpful. And then with the restructuring and OpEx coming down, is there a kind of OpEx run rate target maybe by the end of the fiscal year and the calendar year?

So the actions we just took were about $2 million of annualized cost. And so I think if you kind of build that into your Q4, you’re going to be pretty close. We actually – we had that $2.5 million of restructuring in Q3, so you can take that into account. But that that should give you a pretty good math for how we’re going to exit the year.

Okay, great. So it’s something around $19 million – $18 million, $19 million from that?

Yes.

Perfect. And then just the last question for me and I’ll pass it on. Just as you look at kind of your cold chain business and how it’s growing, what is the kind of a run rate revenue gold ticket to kind of that high 57% gross margin? And then when do you think you might hit that just help us in long-term modeling?

So it’s interesting. If we look at just the solutions business, I really don’t feel like we’re that far off even today. I think, if you look at the solutions business and again you’re going to see just how big of a component, I’ll just give it to you, because you will see it in a queue, so the $5 million of services, $3 million of that roughly was the solutions business. That business is already really kind of generating 50%-plus margins, so you could get there in 2018.

Well, perfect, that’s helpful. And then Ron, just building on that just within the solutions business very fragmented market. You guys have been early kind of rolling up the space. How do you see the competitive dynamics in the market? And do you think, you’d still need to add more to – both to your solutions, I think, you have the right business in place and just a matter of winning customers?

Yes, Mike, it’s a really good question. We think we’re really uniquely positioned to go after these three verticals with really strong go-to-market. We have proven solutions that get better as we integrate them. Part of our inorganic activities we’re considering adding to that that group. We’re trying to be very selective. We’re also looking at areas outside of Smart Solutions and products, but wouldn’t exclude Smart Solutions from that list.

Great. Thank you very much. We look forward to seeing you guys at a conference in a couple of weeks.

Thanks, Mike.

Thanks, Mike.

Thank you. Our next question comes from the line of Scott Searle with Benchmark. Your line is open.

Hey, good afternoon. I apologize, I got on the call a little bit. But I was wondering if you could just run down quickly again the gross margin structure between hardware and solutions? And then I’ve got some follow-ups?

Yes, so I’ll just give you the exact numbers here, Scott. So let me just read the section here for you. So gross profit decreased 13.4% in the third quarter. Overall, gross profits margin was 49.2%, and then the hardware mix was 50.1%, and then services and solutions was 41.6%.

Gotcha.

So…

Okay. And did you provide operational metrics on the solution side of the equation in terms of number of sites where you deployed, and maybe kind of expanding on that a little bit about the pipeline, right? There are a lot of activity going on out there in terms of FSMA and other initiatives form the fork and fresh food initiatives in general. How big is the pipeline looking right now? Is there a way for – to qualitatively or quantitatively give us a better idea of what that’s looking like?

So we gave a few metrics out, Scott. So overall, the Solutions business was $3 million for the quarter, so it was $3 million of the $5 million that you see on the services line, where nearly 13,000 sites, which are now deployed and under contract. And I think we gave a pretty good overview actually in Ron’s comments in terms of pipeline, as well as activity in terms of where we’re wining. I think, we’re seeing strong performance in pipeline in the kind of the three verticals that we’re servicing there; the transportation, the restaurant, and then the healthcare. Ron, I don’t know if you have anything to talk about.

Yes, Scott, I’ll come out with relative comments. The market is very large. There’s a lot of targets. It’s a fragmented customer base to go after between transportation of logistics, food service and health services. We are largely competing against paper-based processes that are put in place. And so we’re having an educational sale process, in some cases, where the customer wants to try the solution as a work through the change to go from paper to digital. The translation market is a little more advanced than the other two. And that’s, as you’ve mentioned, they’ve been exposed to the Food Safety Modernization Act. And in the case of vehicles have somehow been exposed to a solution that go inside their trailers and/or their trucks. But we’re very, very excited about the pipeline. We think we have a unique, because it expands the different segments. And so customer can have a real consistent vendor experience, whether we’re operating in warehouse, truck, store or some combination of those locations. And we think that makes us uniquely positioned with that their new technology as well. And so that’s exiting for our customers to get visibility. I think, our biggest opportunity right now is on the go-to-market side. We’re still relatively new to the space and giving our name established through great customer, success stories, and of course being and participant in those industries. Those are some of our key objectives.

And if I could just in terms of the sequential guidance. If you’re looking at the different product categories, did you give any indication of what you expect to be up or down sequentially? I know that there are a lot of – there’s some inventory issues or some product transition issues, which have slipped a little bit to the right? But in the context to that, what you’re kind of expecting maybe in some of the key categories? And then with that in mind extrapolating, looking at the December quarter just traditional seasonality hold where it’s a little bit weaker, or because of some of these later product introductions, you start to see non – some nontraditional seasonality for a lack of better expression, as things ramp up, you start to get out some of the new XP products, et cetera? Thanks.

Well, Scott, so we just simply got it on top line revenue. So we didn’t break down into either the product categories individually or collectively. So we just gave the top line revenue. In terms of the Q – the – well, I guess, the calendar Q4, I think, we’ll be better prepared to comment on that – on next quarter’s call. To answer your question on seasonality, there always traditionally has been some level of seasonality for us in that, our fiscal Q1, calendar Q4, a lot of it has to do I think with the channel trying to keep their selves bare as they go into their year-end calendars. New product introduction obviously is something that is very important for us, as we think about the 2018 numbers. But I don’t know that we’ll see anything different seasonality because of that.

We always knew where process is going to be as we manage the Smart Solutions business through the calendar fourth quarter. There’s likely to be different dynamics than what we’re seeing on the product side.

Yes.

Okay, great. Thank you.

Thank you. Our next question comes from the line of David Gearhart with First Analysis. Your line is open.

Hey, good afternoon, guys. Thanks for taking the time for my questions. I want to look at the Smart – the cold chain solutions first. I know you mentioned $3 million in revenue from that business in the quarter. Just wondered how it tracks to your expectations at the beginning of the quarter? And previously, you gave guidance of $10 million to $15 million for the calendar year and then December 31, just wanted to make sure if that’s still intact, or if there’s any changes on the guidance range for that business?

Yes, I think, overall, David, we remain on track with that business. Again, you’ll see in the Q, it’s – sequentially we – we’re really satisfied with how the whole group performed, but I would say, we’re still on track to deliver that that calendar number.

Okay. And then just shifting back to the network business, since you have a different calendar year – calendar, excuse me, fiscal year-end versus calendar, just want to make sure that I understand it correctly? You’re saying that after and further investment is put into the networking products that in fiscal 2018, we’ll be back to that roughly 10% decline per year versus the 25% or so that we’re going to see in fiscal 2017?

Yes, that’s really – we think there’s some increased focus there. We think we’re going to really soften that decline and get back to our – the expectations that we had set previously of around 10% to 15% decline versus the more severe drop we’ve seen this fiscal year.

Okay. And my last question is, in regards to the take out offer that was on the table for Digi previously. I’m just wondering if there was any hesitation on the part of buyers, potential customers holding back orders to kind of see how the dust settled out there. I’m just wondering if you’re seeing activity return, just because that dynamic is off the table. jJust wondering if you could provide some business color there?

Yes, David, this is Ron. That’s a very fair comment, and it was a distracting process and we did get some comments from distributors and certainly was official or non-official discussion amongst employees and amongst customers in some cases as well. So we do think that having that behind us really helps internally that focus on the business and helps our partners as well concentrate on our roadmaps and our day-to-day activity.

Okay. That’s it for me. Thanks for the color.

Thank you, David.

Thank you. [Operator Instructions] And our next question comes from the line of Greg Burns with Sidoti. Your line is now open.

Good afternoon. In the Cellular segment, I think, last quarter, you had a little bit of a issue or not – maybe not an issue, but there is some resource reallocation that needed to be done between focusing on the LR routers versus the WR, maybe you’re missing some opportunities. So I just wanted to see, have you realigned your resources and how do you feel about your positioning in the cellular market now? Thank you.

Well, Greg, very good question, and you’re absolutely correct. We – we have been investing pretty hard on the – pretty heavily, excuse me, on the LR-34 product line. And we had a number of opportunities on the WR product line that we won’t able to take advantage of. We have repurposed a portion of our resources. And so they have now started to introduce the additional WR refractures and variance, in some cases with specific carriers, in some cases it adds new cellular and/or Wi-Fi capabilities. And then in some cases, it allows us to get into new geography. So we just started seeing the results of that change at the end of last quarter and there’s a lot more activity than there was new product introduction. But as these next three or six months unfold here, we’re going to see the benefit of that decision that we made.

Okay. And the – as part of the restructuring the engineering positions that were taken out domestically. Does that come from any one particular area, or where was that focused on?

Yes, we’re focused on a particular area that we thought would actually help our streamline or process. We have some areas in particular that were closer to a testing function that we rely on our manufacturing team and manufacturing partners to help fill that gap. So we feel like those are the opportunities to streamline the company that we, sort of own the right to do, if you will. It’s always unfortunate, of course, to do things. But we don’t think it affects our productivity in anyway.

All right. Thank you. Thank you. And I’m showing no further questions at this time. I would now like to turn the call back to Ron Konezny, President and Chief Executive Officer for any closing remarks.

Thank you, Chelsy. On behalf of the entire Digi team, thank you for your continued support and interest in our company. While we’re meeting our profitability expectations, we have higher expectations for growth. We’re encouraged by our progress in services and solutions and are committed to improve results in our products group. We look forward to our next update and have a good evening.

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