Good day, ladies and gentlemen and welcome to the Digi International First Fiscal Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, Gokul Hemmady, Chief Financial Officer. Sir, you may begin.

Thank you, Heather. Good afternoon, everyone and thank you for joining us today to discuss the fourth fiscal quarter of 2019 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 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. We believe the expectations reflected in our forward-looking statements are reasonable, but give no assurance of such expectations or that any of our forward-looking statements will prove to be correct. For additional information, please refer to the forward-looking statements section in our earnings release today, the risk factors of our 2018 Form 10-K and subsequent reports on file with the SEC. Finally, certain of the 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 our Form 8-K that can be accessed throughout 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. We kicked off our fiscal 2019 with strong performances from both of our business segments, IoT Products and Services and IoT Solutions. Revenues and earnings exceeded our expectations. While we certainly have more work to do, we remain positive in our outlook for the remainder of the fiscal year. We are committed to our key strategic imperatives and we are motivated by progress made toward our transformation from a communication hardware manufacturer to a premiere software services and subscription provider. Underpinning our transformation are key cultural tenants, laser focused on our customers, startup level of urgency, positive energy bringing solutions to problems, commitment to outcome of the results and caring about our work and about each other. A physical and symbolic representation of the new Digi and these cultural values took flight earlier this month as we moved into our new corporate headquarters, configured for collaboration, equipped with the latest productivity tools, highlighted by our decades of innovation and celebrating our customers and our employees, our new headquarters has been invigorating for our entire organization. A hearty thank you to our team that helped make our new corporate home a reality while still executing on their key responsibilities. Our IoT Products and Services results were driven by broad contributions across our product lines and geographies. We saw significant increase in revenue associated with products introduced within the last 3 years. This NPI revenue is critical to enabling Digi’s sustainable growth, XBee Cellular, CC6UL, and our U115 cellular router helped lead the way. We also saw significant increase in our win rate with key accounts defined as over $100,000 in opportunity value. We have integrated the Accelerated product line into Digi’s branding and product lineup of enterprise, industrial…

Thank you, Ron. I appreciate the comment. My decision to leave Digi was a challenging and difficult choice to make. An opportunity presented itself with a startup company in an emerging market located in Silicon Valley. Like Digi this was a great opportunity and I felt my experience and background would help make a difference quickly. What made my decision really tough is that Digi is positioned very well for the future. I remain very encouraged with the growth and progress that Digi team is making as it expands each of its business segments. I sincerely thank Ron and the entire Digi team for welcoming me for the opportunity and for my experiences here. I know that Digi is in great hands as I depart. Now, moving on to our financial update, we are pleased with our fiscal first quarter performance, which included three key financial highlights. First, our overall revenue performance of $62.3 million was strong and driven through increased contributions by both of our business segments. Our IoT Solutions business grew over 120% compared to the same period a year ago and our IoT Products & Services business grew over 30%. Additionally, our revenue performance was above our guidance range of $56 million to $60 million and shows an encouraging start to fiscal year 2019. Second, we delivered strong bottom line performance. Our net income per diluted share improved to $0.17 versus a net loss per diluted share of $0.17 in the year ago comparable quarter. Also, our adjusted EBITDA increased to $6.2 million or 9.9% of fiscal first quarter revenue compared to $3 million or 6.6% a year ago. Included in the first quarter adjusted EBITDA figure is $250,000 of Accelerated earn-out expense. The adjusted EBITDA performance was above our guidance range of $4 million to $6…

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

Hi, guys. Thanks for taking my questions. Wondering if you could comment how customer feedback has been so far, now that you’ve started to bundle software and services with some of your products?

We are having some really good selective feedback especially with key accounts we have some customers that either are time constrained or skill restrained and they are looking for us to provide more than just the product and so with key accounts, we’re really excited about some early traction and as we institutionalize the offering even more, we expect to see broader take rates.

Okay, that’s helpful. And looking at the IoT Solutions business, I know sites remains relatively flat, sequentially but how should we think about that ramping throughout this year?

As we saw from this quarter, we had about the site count, we expected in terms of additions we obviously weren’t planning on this transportation leasing company transitioning to a new model but we do expect to continue to add subscribers and we feel very good about our projections for solutions throughout the year we are, as we mentioned in the past, we do see quite a variance in terms of both ARPU as well as the upfront ASPs depending upon the customer this past quarter, we saw increased contributions from food service and we had still got good contributions from healthcare we had less contributions from the transportation side the transportation side tends to have lower financial contribution so although we didn’t see as much, it didn’t have as much of an impact on our financials.

Okay. And the last one for me and I’ll jump back in the queue just given the macro backdrop, have you seen any significant change in visibility across any of your product lines?

Visibility on our Products & Services group has never been a real strong point for us we have got we continue to work on that with larger accounts and more strategic relationships that involve just more than just products into services and software from that perspective, our visibility is stronger because we weren’t doing those things in the past but macro-economic conditions haven’t had as much an influence on that.

Okay. Thanks a lot, guys.

Thank you.

Thank you. Your next question comes from Anthony Stoss with Craig-Hallum. Your line is open.

Hi, guys. Ron, if you wouldn’t mind, I would love to hear your thoughts or what you are hearing from your customers in the cellular router side regarding 5G, if you think that will accelerated, your growth within that group and how that might impact gross margins? And then secondly, I’d love to hear little bit more detail and color after you established a beachhead in lot of these pharmacies on the IoT side? Are you gaining traction in front of the house? And any kind of color you can provide on kind of the pipeline on IoT right now in backlogs?

Yes, let’s see. Thanks, Tony. Let’s see if I can get all this done the first on 5G. 5G is going to take a little while there is quite a hype out there and the wireless carriers lead that hype of the advent of 5G the first 5G smartphones will be available this year they are likely to be more expensive than any consumer would like and the network availability will not be as strong so 5G will have an impact but it will be more gradual for our business and really not start until at least next year, fiscal ’20 we do not participate in the 5G that’s for fixed wireless for Internet access for consumers or businesses that has come on a little bit earlier than the 5G that’s affecting smart devices and cellular routers but you’re going to see that impacting starting in ‘20 and then ramping from there the second is in terms of broadening existent relationships as I noted in my comments, we were pleased to have one of our customers expand their relationship that and was providing more monitoring capabilities for their pharmacy we still have the ability to for that particular customer to extend our business into the front of their house, into the food and convenience store area so that provides great opportunity it doesn’t always show up in site count because we’re not counting that as an additional site even though we are broadening the number of things we do for that customer it being one of our larger customers, we are very pleased with their confidence that they’ve placed in Digi the last piece, the solutions pipeline we are very positive on the pipeline we have got some very large enterprise deals in the pipeline we are also pleased as I mentioned in the first question that we’re seeing more activity in the food side food represents half of our TAM and between grocers and restaurants and other food service providers, we’re seeing increased visibility as for these types of projects as mobile ordering and food delivery investments are starting to stabilize and they are focusing more squarely on food safety and on cost optimization.

Okay, nice execution. Thank you.

Thank you.

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

Great. Thanks, Ron. Just on the strong Q2 results, can you kind of rank order some of the areas that created the most upside relative to your guidance? And did you see maybe large projects pull in during the quarter leading to maybe a little more cautious next quarter guidance relative to the strong quarter you are coming off of?

Yes, it’s a fair question. We were pleased with the results from both of our business segments both segments exceeded our expectations so that was quite positive as I noted, there was about $1.5 million of revenue that was a very positive impact on our Solutions business in the quarter from the existing client and so that that had a very favorable impact on last quarter’s results. And in terms of this quarter, we are looking to execute at a similar level to what we’ve done the previous quarter the guidance in both revenue and profitability are sort of in line with the results that are similar to what we’re seeing what we saw in the first fiscal quarter but without a doubt, there was some impact on last quarter particularly on the solutions side, where we got that large additional order.

Great, thanks. And just following up on the Solutions business some nice customer wins announced in there and then expanding your business with one of the largest retailers can you just talk about growing success of your business, getting these brands and how that’s leading for reference design for future customers? And do you think you have the right sales force to execute on potentially growing pipeline?

Yes, good questions, Mike. The emphasis as we covered is really growth and so we’re making investments both on the technology side as well as on the customer facing side of our business both sales and marketing as well as customer success and I can’t emphasize how important that customer success group is this business is about getting and keeping customers and it’s an and it’s not an or so we can’t just have an investment in sales without a requisite investment on the service and success side we are also still converting customers from largely paper-based processes to digitize cloud-based actively monitored systems and so every customer win is really important that they have great success and we’re getting a lot of inbounds from customers that say, something nice about us when we’re not in the room and that’s how we’re going to grow this business is customers having success and then be willing to share that with their network and their colleagues.

One follow on for me just you talked about opportunities once you are in some of these larger sites to cross-sell to fund the store etcetera. is there anyway you can maybe look at your customer base and see how penetrated they are and could you from your current business? Is there opportunity just your base still materially higher than your current run rate in the business or is it more about driving new customers? Thanks.

Yes, it’s really both we have we do have significantly add-on opportunities we haven’t sized that dollar wise but whether it’s fully rolling out an existing customer or converting a pilot into a larger rollout as well as in some cases, completing a broader footprint within a site so they don’t always show up in the site numbers but they’re showing up in the revenue numbers so we haven’t sized it but we’re as excited about continuing to do additional work with existing customers as we are about gaining new customers and we’re investing in analytics which is a real key element for us to further distinguish our leadership position beyond monitoring, alerting and recording is into the analysis of how customers can make better decisions and so, we’re committed to building out analytics as a service as well and that’s future opportunity to further partner with our customers.

Great, congrats on the strong start to the year and Gokul, best wishes to your new job I am sure the weather in Minneapolis is freaking moving move a little bit easier.

That’s fine. Thank you.

Thank you. Your next question comes from Greg Burns with Sidoti & Company. Your line is open.

Good afternoon. What was the split of solutions revenue between recurring and hardware?

So, it was about one-third, two-thirds 40%.

About 40% of recurring.

And the exit monthly recurring revenue run rate for the quarter?

It’s about monthly is about $1.1 million, $1.2 million, I think so annually ERR is about 13% plus.

Okay. And you mentioned, you’re seeing strong growth from new products I guess, first, how do you define new products and what’s your position now? I know, you had maybe some issues with the on the product development front, I think Accelerated is helping out with that but can you just talk about where you are in terms of new product development and maybe what’s in the roadmap for this year? Thanks.

Yes. So, we define new product as any revenue associated with product that’s introduced within the last three years there is a little the box product side of their network, they tend to have revenue that accretes more quickly because these are solutions that can be deployed embedded products typically take a while to get the design win, and have it converted into revenue so things like XBee Cellular take a little bit more time than say a U115 router. We are improving our MPI process. We have more work to do both as an organization, but also making sure that we’re picking the right products. We’re excited about the potential of MPI, because we think it will be about 30% [ph] increase off of last year’s base and we’re off to a good start that’s in track – on track with that projection. And so that’s the ultimate evidence of how well we are doing in new products. New products release for this year will not have as much an impact because of the amount of time we have in the year for us to convert that to revenue, but we’re making investments across our entire portfolio. We have new routers coming out. We have additions to our XBee product line within RF. We have select products coming out within network. And we’re partnering with NXP on the next-generation of i.MX processors, the i.MX8 for potential new product introduction there. So, we are maintaining a well-balanced portfolio of MPI.

Okay, great. And just lastly in terms of the profitability of the Solutions business and how you’re looking to run that business. I think it was a $5 million drag on EBITDA last year, a little bit of improvement in terms of profitability in the first quarter. But just generally, what’s your view on that business? How do you look to operate it? Do you foresee losses narrowing this year or you’re going to continue to operate this at a loss to grow the business? Thank you.

Yes, good question, Greg. And we’re trying to be real athletic about it. We’re committed to the investments we’ve made. We feel positive about the growth opportunities. If for some reason, our growth opportunities and the outlook change, we would certainly tighten the screws on additional investments, but we’re not at that point. We think growth is the primary objective. Although, we report operating income in our financial statements on an adjusted EBITDA perspective, as well as operating income, we’re seeing dramatic improvements in the profitability, which is fewer losses or lower losses. But our clear objective is growth, where we want to grow this business and we will do – make the investments necessary to continue that growth as long as the opportunity persists.

Yes. Thank you.

Thank you. Your next question comes from Scott Searle with ROTH Capital. Your line is open.

Hey, good afternoon. Thanks for taking my question. Gokul, I wanted to just wish you all the best in your future endeavours. And as Mike said, at least, you’ll have some warmer weather as well. Hey, just to get a couple of quick clarifications. I want to make sure, I understood the gain on the headquarters ended up being accounts for G&A entry. Is that correct? And then also you indicated in terms of the guidance on the tax rate as higher tax rate. Just want to get an idea what that was and then I had a couple of follow-ups?

Sure. So yes, it is G&A that $4.4 million in gain. And if you look at the first quarter tax rate, we’ve accrued about $1 million in taxes. It’s largely from the gain on the sale of the headquarters building and none of that tax expense is really cash-related. So, there is no cash expense on that tag. In addition to that about maybe 10% of that – 10% to 15% of that $1 million is related to the fact that we had better performance in Q1 and we’ve accrued about, I would say, excluding the gain from the headquarters, we’ve accrued a rate of somewhere between 5% and 10%. And so, we are also taking that into account as we’ve updated our guidance for the full-year. As we go along, we’ll continue to look at how this shapes up, but right now, our forecast is that it’s about that kind of 10% range.

So, 10% is what we should be modelling going forward?

Yes, yes.

Okay. And just to clarify, I thought I heard in terms of the overview on the product front adjusted for Accelerated was about 18% growth. I was wondering, if you could provide a little bit more color in terms of some of the product categories underneath it, RF, embedded, network in terms of just kind of sequentially how they were? And really what the expectation is for the current fiscal year for gateway and router products, which have been the star along with Accelerated growing pretty well. Is this 20% grower going forward for the rest of this year, I mean, how are you kind of thinking about that product category?

Yes, we – the good news in the last quarter is we had contributions from each of our product families. Cellular routers led the way and they will – we plan on that continuing to be the case. Networks slightly outperformed to our expectations, but we wouldn’t expect network to necessarily continue to sustain. Now network is becoming a lower, a smaller portion of our overall revenue contribution. So, declines that may happen in network don’t have the same impact they had 1 year or 2 years or 3 years ago. So networks down to less than 20% of our overall revenue for the quarter. So – but again, good news that we had strong sequential improvement throughout the business. Cellular routers leading the way and will continue. Our embedded products, RF and embedded solutions or embedded compute are tending to track towards marking conditions in that kind of 5% to 10% range, cellular routers in excess of 10%, in excess in many cases of 15%. And then network, we would expect to have a modest decline of 5% to 10%.

Got it. And lastly, I know you hit on this a couple of different ways, but on the solutions front, I was wondering if you could quantify what that pipeline or funnel looks like at the current time. I know it’s been growing, there’s been a lot of inbounds you provided some color in terms of the customer base and some of the verticals. But is there a number that you could put out and what the sales cycle is looking like in the current competitive landscape? Thanks.

Yes. Good question, Scott, and a fair question. We’re trying to be real careful about metrics we put out and making sure that we put our metrics that not only are meaningful, but things that we understand and would continue to report on. So, we don’t have any specific metrics to share with you. But we feel very good about the interest level, about the conversion rates of the pilots and how that’s projecting for the balance of the year. We still don’t see any competition in our particular offering that has changed the dynamics. We think we are the leader albeit in an emerging market and we’re really looking to further extend that leadership and capitalize on the fast start here.

Great, thank you.

Thank you. [Operator Instructions] Your next question comes from David Gearhart with First Analysis. Your line is open.

Hi, good afternoon. Thank you for taking my questions and congratulations again on a strong quarter. I first wanted to ask about component shortages, other hardware providers in the industry have been impacted by various components and this inability to actually build product and meet some demand pushing out or hurting revenue. Just wondering, if you are seeing much of an impact to your business and things would be much stronger absent those impacts. Just wanted to get some color on where component shortages and issues are affecting on the Digi side?

Yes, David, that’s a various two questions. We’ve been dealing with supply chain issues throughout calendar ‘18 and even prior to that in ‘17. Our inventory balance in part shows how we have extended ourselves on some of those components in an effort to compress lead times. We are working with our customers wherever possible to educate them of some of the challenges in the marketplace. We have seen it sequentially improve a bit, so it’s not as challenging as it had been in the past, still not ideal. But we’re using this opportunity to really work with our sales team and our customers to get longer POs in place and better commitments that can help us plan inventory and meet their needs. But there are still a lot of supply chain challenges out there. I think the biggest impact right for us now is more on the inventory side than it is on specific deliveries. But in some cases, it certainly affected our ability to deliver the product.

Okay. And then lastly for me, services had increased on the professional services – excuse me, professional services side 2 quarters in a row and then this quarter was down. And I think you commented last quarter that it should stay at roughly the run rate of Q4 but were down this quarter. Is it just a function of the time and the year, would you expect that to pick up? Just a little color on that side? Thank you.

Yes. It’s a good question. It’s a smaller part of our overall picture, but still an important one. And we do think that we’ll see a little lumpiness there, but that you’ll see it really start to stabilize and improve here. We’ve got some exciting work we’re doing and some of the work is timing and holidays and vacations and such from last quarter, but we’re still very positive on that business.

Okay. That’s it from me. Thank you.

Thank you.

Thank you. And your next question is a follow-up from Greg Burns with Sidoti and Company. Your line is open.

Hi. Just wanted to ask about the commentary about looking again at acquisitions this year, could you just give us an idea of exactly what you might be looking for and what parts of the business? Thank you.

So, yes, so we – yes, we have taken a pause from our five acquisitions, the most recent was Accelerated about a year ago, and really to get the SmartSense team organized and get Accelerated on-boarded, we think last quarter’s results, it shows that we’ve made some progress there. And so, we’re looking at acquisitions. We’re looking at companies that can help us transform our business from being more hardware-centric to services, software and subscription. So, whether it’s in the Products & Services Group or the Solutions Group, those are key attributes. And we’re very active and we’re looking at things. We don’t have any specific comments on particular acquisitions other than those attributes.

Okay. Thank you.

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

Thank you, Heather. On behalf of the entire Digi team, we appreciate your support and belief in our transformation. Digi is focused on software, services and subscription, offers to build value across both of our business segments. We’re confident in our strategy. We’re committed to building shareholder value. Thank you for your trust and we look forward to our next update.

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