Good day, ladies and gentlemen, and welcome to the Digi International Third Fiscal Quarter 2018 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instruction 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 Gokul Hemmady, Chief Financial Officer. Sir, you may begin.

Thank you, Mark. Good afternoon and thank for joining us today to discuss the third fiscal quarter of 2018 for Digi international. Joining me on today's call is Ron Konezny, our President and CEO. Ron will provide his thoughts on our business and I will follow with the highlights of our financial performance. Following our prepared remarks, we will take your questions. We issued our earnings release shortly after the market closed. 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. 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. For additional information, please refer to the forward-looking statement section in our earnings release today, the Risk Factors in our 2017 on Form 10-K, and subsequent reports on file with the SEC. 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 would like to turn the call over to Ron.

Thank you, Gokul, and welcome to everyone that has joined our call today. Digi set a record for quarterly revenue during our third fiscal quarter and I'm pleased that this performance is based on broad based growth from both of our business segments, IoT products and services and IoT solutions. Our strong performance builds on the momentum established in our second fiscal quarter. In addition to exceeding our guidance for revenue, adjusted EBITDA and EPS, we are positioned well to present our fiscal year strong. Our performance in fiscal 2018 is especially fulfilling coming off a challenging fiscal 2017. Our IoT products and services business provides OEM an enterprise product and complementary enterprise software, professional services and support services. Our objective of sustainable profitable growth was reinforced in the quarter. Our key objectives include, number one, a stronger direct sales effort. We are seeing results from our key accounts and top opportunities initiatives with a significant increase in both bookings and contributions from opportunities over 100,000 in value. We have increased our win rate on large Ideals enterprise deals and we still have more room to improve. Our signs of success give us the confidence in adding select resources in certain geographies where we can extend our success. Secondly, improved channel programs. Our focused channel strategy is beginning to bear fruit. We are developing stronger and more committed relationships, which is increasing our channel and point of sale revenue. Third, improved new product introduction, this continues to be one of our biggest opportunities for improvement. We are seeing revenue build on our newest embedded product for instance. We are consolidated the technology sacs of our cellular router product and remote management enterprise software tools, which we expect will improve R&D efficiency. Lastly, we announced two products a cellular router the…

Thank you, Ron. I’m delighted to be on Board at Digi. I have been at Digi a little over a month and every days that goes by I get more excited about the team and the Company I have joined. As Ron mentioned, I have spent nearly my entire career in the technology in telecom space. Technology is fascinating to me as it has connect people, places and things through opportunity. Over my career, particularly when I was based in the twin cities with [ADC] (Ph) I was familiar with Digi and knew it as a solid Company with impressive products and a strong balance sheet. When I first met Ron and he presented me with a vision on where he wanted to go with our two growth engines, I knew very quickly this was an opportunity I did not want to pack up. More importantly, I believe my background and experience with recurring revenue operations could make an immediate and significant impact to help translate vision to reality. I have been impressed from day one with the Digi team I have met to-date. The energy level and the passion to excel is visible within the organization, as we begin to realize the benefits of all the hard work from the last several quarters to put Digi on a solid growth track. I look forward to working with each of you in the investment community as we communicate our performance and strategy with consistency and transparency. Now I will turn to the key highlights from our third quarter. First, we had a record quarter on revenues, our revenue of 62.7 million was highest total revenue for the quarter in our Company’s history; it grew sequentially from the second quarter at 15% and was well above our guidance range of 56…

Thank you sir. [Operator Instructions] And our first question comes from the line of Mike Walkley from Canaccord Genuity. Sir, your line is now open.

This is Josh for Mike. Congrats on the strong quarter. So just starting off, now that you have got the SKU optimization program close to where you wanted to be. How should we think about the long-term growth rate for IoT product and services revenue?

Yes, Josh it’s a really nice question. We expect the growth rate to be 5% to 10%. We are aiming for the higher end of that range, certainly aspirationally, we think that the mix is in that 5% to 10%. The growth of our stronger products will more than outweigh the growth of the products that are more mature.

And then $8 million in Accelerated this quarter I think you were $6.2 million last quarter. Can you talk about how that those products are benefiting from the cross-selling with having the combined Digi sales force?

Yes, I think the Accelerated acquisition has been very nice for us and the integration of their team and the Digi team has gone very well. I think there is a lot more room for us to collaborate, but the teams are sharing leads where there is an opportunity that is more business continuity. Accelerated is really the product we lead with, its machine-to-machine, more of a rugged industrialized application, Digi is the lead product. Importantly on the technology side, there is a lot of technology sharing going on, and you will see future products in our side of outer lineup really demonstrate a combination of shared technology on the device, but also on the remote to enterprise software as well.

Olay great. And then just one question on the solutions business. 6000 net adds in the quarter is really strong obviously. Are there any specific vertical markets that you were successful within the quarter or was it pretty broad based strength across all the verticals?

Yes, it’s a good question. We continue to see strength in transportation and health. There is a tremendous opportunity in food that we are anxious to unlock, but the health and transportation verticals are the ones that are really contributing more so.

Okay, great. Thank you.

Thank you. And our next question comes from the line of Greg Burns of Sidoti and Company. The line is now open.

What exactly are these $1 million charges for Accelerated are they just earn outs and were they considered in your guidance that you gave last quarter or are they something else unexpected that hit this quarter and it’s looking like it’s going to hit next quarter. And then when we look at the full year EBITDA guidance you narrowed it down to the bottom end of the range, is that a function of these payments to Accelerated and some of these one-time inefficiencies and run the manufacturing some other things that you called out? Thanks.

Yes, good question. So the terms of the Accelerated acquisition had an upfront payment of $17 million and then in both calendar 2018 and calendar 2019 there is an opportunity for them to earn $3 million in each of those calendar periods, at the beginning of our relationship after the close we did an estimate of what we thought that earn out opportunity would be how much they capture of it and they have obviously done better than we initially expected and so what we calculated initially was not [indiscernible] making such an important note of those figures, because they were not anticipated to be captured at the beginning of the acquisition, but their performance has clearly been higher than expected, and we have had to increase the reserve for that earn out.

And then can you just talk about the full year EBITDA guidance, are these earn outs the reason kind of you are narrowing it to the lower end or are these kind of the one-time items like - or the inefficiencies around manufacturing and some of these other items you called out also impacting that full year like that.

Yes. So there is $2 million that weren’t originally in the guidance for the year, so that's certainly an impact. And then the other impact is what is just appearing in gross margin, which is a lower-than-expected gross margin as compared to what we had contemplated at beginning of the year. There is a couple of dynamics, one is the manufacturing transition is taking longer and so that's impacting our operating expense associated with our cost of goods. The other aspect is the supply chain for electronics is under tremendous pressure. It started in the memory areas when a couple of large providers did not expected last time buys and that had a ripple effect. As far as into certain capacitors and even some cases resistors so there has been some hoarding going on and so our ability to get our allocations has been under pressure and has forced higher transportation costs as well as in some cases higher component costs. So the combination was two, we really had the biggest impact on gross margin being up this quarter about 200 or more basis points and giving us reason to be cautious even in the current quarter.

Okay thanks. This quarter very strong performance in the solutions business you know what was the mix of hardware versus recurring in this quarter, was the strong performance a function at big pharma customer you announced last quarter and if so kind of how what is the I guess timeframe on completing that roll out?

Yes. So, we had over 50% of the solutions revenue was driven by one-time implementation whether it’s professional services or the equipment itself and so that also had an impact on the overall gross margins. We are still seeing and have confidence in really high gross margin on the recurring side. We do expect a significant amount of net adds this current quarter as well, there is a portion of it that’s driven by large national retail chain, but were also having success in transportation and in healthcare as well. So we expect to see improvement in margin, but that we will still see probably in excess of 50% of our revenue be one time in nature even in the current quarter.

Okay, so is there like a bulge in revenue here from these kind of rollouts that are more hardware upfront hardware dependence as opposed to maybe looking forward. So a slower run rate of growth at some point after these large roll outs.

NO. It's a really good question. We are hopeful that we can continue to have strong additions, now how we offer our product. We give our customers the choice of more of a managed service, where they are paying lower no money upfront and have more of that the obligation on the recurring, but there are many customers that want to have some of that obligation to fill in the form of the capital expense and then have a lower recurring. So we are going let the market decide, the market is still maturing, so we feel that it's the right thing to do to give the customers the choice rather than to force it in one model, but we do anticipate that in general, larger customers are going to want to have some of that implementation in the form of a onetime CapEx and than associated with that is the recurring.

Okay. Thank you.

Thank you. And our next question comes from the line of Scott Searle of ROTH Capital. Your line is now open.

Hey good afternoon, nice quarter, Gokul congratulations and welcome on board. Just quickly follow-up on the gross margin front, sounds like just some headwinds in terms of the manufacturing transition from Eden Prairie, but you know your supply chain as well, it sounds like that exits or it will continue into the September quarter, when do you see that starting to alleviate and how should we think about gross margins as we get into December into calendar 2019, what is the expectations we should get out a little bit.

We are really anticipating a more deliberate pace to it, that it’s not a step level if you will, but that will improve, none of us have probably the crystal ball to say what is going to happen within the supply chain as things rebalance, but history would say that things will rebalance, but we are being I guess very deliberate in having gross margin improve on a more gradual basis than say a step level basis.

Got you and looking at the guidance into September of 60 million to 64 million, could you give us a guide or an idea sequentially about how you see both on the hardware products side performing in terms of some of the traditional categories that you talked about in routers embedded et cetera. And then also with regard to the solution side of the equation, I think talking about 25 million to 30 million will be the target for this year, implies you are kind of flat to up sequentially. Maybe give us some frame work for how you're thinking about seeing things swing in that range for solutions as we going to September, what are going to be the driving factors there to move it either get it flat or move it up.

Yes I think Scott, you picked up on this really nicely when you kind take that 25 to 30 brackets and you backfill based on what's been accomplished so far. You're looking at kind of flat to maybe modestly up quarter for solutions. It’s going to be driven quite frankly a lot by our ability for our customers to absorb the rollouts. We are anticipating success there but some of these larger implementations can run into some timing issues with access to facilities training and resources and et cetera. But I think you've got the brackets there in terms of solutions and then off course backed from what that means for IoT products and services. We do think that Accelerated will continue to have a nice contribution, we don’t think the contribution is going to be quite as strong as what we experience in fiscal Q3, but will make up for that if you will with performance with Digi's core IoT products and services.

And one last question on solutions. I guess it's probably a little dangerous and misleading to look at things necessarily on a per site basis depending on what the hardware mix looks like versus managed services, but could you give us an idea of what the pipeline looks like. Is there some way to give us at least qualitatively if not quantitatively how big that pipeline looks like in terms of the number of sites, number of RFPs out there, otherwise some color on that front and is there a big financial difference in terms of the different verticals, and ultimate implementation whether we talking about transportation, pharma or otherwise? Thanks.

Yes. Let me remind people this is a $3.5 billion TAM so there is a large opportunity. The vast majority, well over 95% of that TAM is recording this information manually, typically using old fashion pen and paper. And so we are eventualizing in many cases the advantages of automated monitoring, pattern recognition, better decision-making. And so that the human elements is the factor that is the one that we've got to convert more so then the technology and does this work if you will and other benefits. And so as we think about the pipeline the level of interest continues to grow, I mean we've got enough pipeline to more than satisfy our needs and represents more than the number of installations that we even have. The pace of which the market goes from interest and piloting to convergent of rollout is varying and you're seeing us having some more success with transportation, transportation tends to have the lower side of the ARPU with trailers and trucks, the ARPUs there stronger with warehouses and distribution facilities. And we are also seeing some real success in healthcare where there is tremendous benefits, there are value goods, the penalties are more severe for non-compliance, so you are seeing us have success with hospitals and pharmacies and clinics. The food side equation, cash management becomes a real critical part of the value proposition and you're affecting store operation and it’s a more complex implementation, so you're seeing food be deliberate in their evaluation and implementation. But if you look at the large opportunity in front of us, we are really excited that we can grow this business, confidently to 50 to 100 million just what the pipeline that we've got in front of us.

Great. Thank you.

Thank you. And our next question comes from the line of Jaeson Schmidt from Lake Street Capital. Your line is now open.

Hey guys thanks for taking my question. Ron, wondering if you could comment, if you're seeing anything out of the ordinary from a pricing standpoint on the product side?

No, we haven't seen anything crazy, there is some always strong competition especially in the side of our business where there is lot of growth and that attracts more competitors, but at the same time there is new and exciting use cases and implementation that people are looking for. In addition to higher and higher take rates of the enterprise software that gets associated with the product, which increases the overall value of the solution for the customer, but also increases the amount of opportunity that we can extract. But other than that because of the supply chain challenges the biggest issues we have quite frankly in more servicing and lead times. Customers have been used to and acclimated to getting product within weeks and because of supply chain challenges that's not always the case. And so we are having to educate customers to get out ahead of their demand and try to get more visibility into their forecast and in some cases get right appeals in place in order to secure their product in their lead times.

Okay that’s helpful. And then wondering if you could comment on your view on the inventory and the distribution channel on product side.

Yes. So our inventory is at an all-time high since I've been here its 41 million, but the challenge is for 70 million so it’s in a relative basis never going to lower in terms of ratio, and also a comfortable level from where we have been at in the past.

Okay and then last one from me and I will jump into queue. I know you just outlined some of the challenges and successes in the transpiration healthcare and food market, and given some of the challenges in the food market on the solutions side. Should we think that market is a big part of the story in calendar 2019 or will transportation and healthcare really continue to be the drivers?

We are committed. We think that we can attract a significant number of food customers throughout calendar 2019. We've got a number of large engagements that had begun deploying. In some cases food, especially QSR restaurants has a franchise model so that can introduce friction in terms of how fast and how large an implementation can get. But with the constant drumbeat of recalls and food bone illnesses and the amount of press, there has never been more interest in companies getting a hold of their operations, getting a hold of their product safety and making sure that they have done what they can to deliver safe and effective service and products to the customer. So, we think there will be continued interest and the trends are favoring remote monitoring and patent recognition.

Okay. Thanks a lot guys.

Thank you. [Operator Instructions] Our next question comes from the line David Gearhart of First Analysis. Your line is now open.

Hey good afternoon. Thank you for taking my questions and congratulations on a nice quarter. So first I wanted to ask about the network product portfolio. I know you're not breaking out the revenue that way. But your commentary was that you saw a growth across all your categories. I just wondered did that include the legacy networking products that have been in decline? And if you could provide some color on what you're seeing with that product category?

Thanks David. Yes, we did see some growth that was more modest compared to other product lines, but there were some modest growth that we saw in network not outside as has happened in some other reporting periods.

Okay. And then in terms of professional services 2.7 million for the quarter. It seems like it’s a multi-quarter high. Just wondering if you could comment on what you're seeing there? And if that looks like it’s a sustainable run rate or just given this business is lumpy, that we shouldn’t kind of forecast that out going forward?

David, thanks for pointing it out. We do expect services to continue double-digit growth rates, there is two big elements, there is a professional services element, our wireless is on services group has really performed well both in this quarter, but also in trending. What is nice is they are being associated with Digi products more and more as well and so they are ends up being an effect that’s just beyond just the professional services revenue, but helps our customers adopt Digi products. The other big portion of that is our enterprise software and we are seeing higher take rates associated in particular with our cellular router business that includes revenue from both our Accelerated and Digi side of the product lines, quite frankly Accelerated take rates on enterprise software are higher than Digi take rates. But that’s having a positive influence on Digi’s ability to connect and get that recurring device management and enterprise software revenue. So we do expect that revenue category to continue to grow.

Okay. And then lastly back to the large pharma opportunity when that you announced last quarter you haven’t provided a name, I’m curious if you are able to speak who that customer or provide some indication, the size or scope as well as the expansion opportunity with different products or even geographies?

Yes. I would be more than happy to provide the names I could, I can’t for confidentiality reasons. What I can say is that we began implementation last quarter, it does continue into this quarter, we feel like we will be substantially complete with that implementation by the end of our fiscal year and it is a multi-1000 unit deployment as I mentioned earlier. Our ability to execute those large widely distributed types of implementations are really - it has really become a competitive advantage. It’s not just the product and the offering, it’s not the price, it's not just the remote support, but our ability to train and to implement cost effectively is a real advantage for us.

And just because it’s a large pharmacy chain I’m assuming drugs, medication, temperature monitoring which also could do front of the stores with some of the food cases and whatnot, so are there expansion opportunities within these accounts or is this pretty much one is done, once it’s deployed that’s going to be the recurring you get and you want to revisit RPM another sites of the shop later?

David that’s a very keen question, you know we think there is great opportunity actually both within the pharmacy as well as in the front of the store. In a pharmacy it’s mainly a temperature application, but as some pharmacies do compounding, differential pressure is a key attribute as well as humidity sensors so there is additional sensor opportunities. And of course front of the store, they have got a gateway installed, they can leverage that gateway and have more incremental expense associated with covering their store rather than an entirely new implementation. And of course you're confident in the implementation, you're confident in the training that the user's acceptance of the system. So we feel like we are well positioned while we are certainly not taking anything for granted.

Okay, thanks for the color and that’s it from me. Thank you.

Thanks David.

Thank you. And I’m showing no further questions at this time. I would now like to turn the call back to Ron Konezny for closing remarks.

Thank you, Mark. On behalf of the entire Digi team, we appreciate your support and belief in our mission. Digi is demonstrating some of our potential and we aim to build on our results. We have a large opportunity in the IoT marketplace allowing us to focus on execution. Thank you for your continued support and trust in Digi, and we look forward to our next update.

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