Good day, and thank you for standing by. Welcome to Digi International's Fourth Fiscal Quarter 2022 Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jamie Loch, Chief Financial Officer. Please go ahead, sir.
Thank you. Good day, everyone. It's great to talk to you again, and thanks for joining us today to discuss the earnings results of Digi International. Joining me on today's call is Ron Konezny, our President and CEO. We issued our earnings release before the market opened this morning, and we posted a shareholder letter this morning as well. You may obtain a copy of the press release and shareholder letter through the Financial Releases section of our investor relations website at digi.com. This morning, Ron will provide a comment on our performance, and then we'll take your questions. 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.
While we believe the expectations reflected in our forward-looking statements are reasonable, we give no assurance such expectations will be met 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 and the Risk Factors section of our most recent Form 10-K and subsequent reports on file with the SEC. Finally, certain 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, aren't included in the earnings release. The earnings release is also furnished as an exhibit to Form 8-K that can be accessed through the SEC Filings section of our investor relations website. Now, I'll turn the call over to Ron.
Thank you, Jamie. Good morning, everyone. I hope you've had a chance to review our fiscal Q4 and full year 2022 shareholder letter. Before we jump into Q&A, just a few highlights. Digi delivered a remarkable fiscal year. We set new records for revenue, ARR, Adjusted EBITDA, and adjusted EPS. We hit the first of our three $100 million goals with consecutive quarters of over $100 million in revenues. We remain committed to our remaining goals of $100 million in ARR and $100 million in annualized Adjusted EBITDA. I'm so proud of our teammates for their resilience, determination, and customer focus in the face of dynamically challenging business conditions. As we look forward to the current year, we continue to see strong demand coupled with gradually easing but still constrained supply and challenging macroeconomic conditions.
With over $300 million in backlog, up from $250 million at the end of the 2021 calendar year, we are poised for growth. At this time, I'd like to turn the call back to the operator for our questions and answer session. Thank you, operator.
Thank you. As a reminder, to ask a question, you'll need to press star one one on your telephone. Please wait for your name to be announced. Please stand by while we compile the Q&A roster. Our first question comes from the line of Harsh Kumar with Piper Sandler. Your line is now open.
Yeah. Hey, Ron, Jamie, and the entire Digi team. You know, congratulations, not just for the current quarter, but I think for the whole of last year. It's been a pretty tough environment between supply and macro, and you guys have just done very well over the last several quarters. I just wanted to note that and congratulate you guys. Having said that, the question is around those lines. You know, at one level, restaurants are doing extremely well. At the other level, we're seeing the economy start to crumble with pressure on the consumer. You talked about supply getting better. Can you, like, sum it up for us? What does this mean for Digi if we put all this together and try to peer into the future for you guys?
Yeah. Hey, Harsh. Thank you for the comments and the question. You know, I wanna just reemphasize that Digi's got a really diverse set of customers. Our customers are in medical devices, in industrial application, agriculture, certainly food services, you mentioned with our SmartSense group. We're in financial services and retail. That diversity, I think, has proven to be a really nice asset for us because as I mentioned in my opening comments, our backlog has increased since the last time we updated shareholders. You can see that demand has not been the challenge for us, that it's been more of supply constraint. We are seeing that customers see real value in the ROI from their industrial IoT initiatives. It's helping them save on labor, on energy costs, and in a rising inflationary environment.
You know, those are pretty powerful tools that become much more urgent than discretionary. We're seeing continued demand. We certainly don't want to ignore the macroeconomic conditions. We're being very careful about how we look at our pipeline, our backlog, and making sure our inventory is flowing. We have been using our balance sheet to make some part purchases to ensure that our customers have those parts available. I'd say the theme for us, as we speak today, is much more of trying to get more supply than worrying about the demand side.
Thanks, Ron, and then I'll just ask two questions and one, and then I'll cede the floor. Is this a good gross margin level for us to think about as we look into the future, Ron? You're in the high fifties, you know, somewhere in the 57% range. Is this a good level? Part two or a separate question is, you've typically been leaving a bit of revenue behind and sometimes a lot of revenue behind. I believe last quarter was a kind of a big number. I was curious if you can give us some insight into into how much you left behind and how, you know, how that will come back to you.
Yeah. We're still, you know, at that point where we're supply constrained and, you know, there's. Like we mentioned prior quarters that, you know, we're leaving tens of millions of dollars on the table just in the quarter. We're working very, very closely with our customers to make sure that their businesses are kept running. We don't have enough parts to meet all the demands, as you can see from that growing backlog number as well. The same theme is incorporated in the current quarter guidance and quite frankly, the entire fiscal 2023. Jamie, I'll let you comment on gross margins.
Yeah, Harsh, it's good to talk to you. I think you kind of hit the nail on the head. As our shareholder letter indicated, you know, we're very cognizant of pricing action and not wanting to take advantage of supply challenges. We're really collaborating with our customers to make sure that all of us are accomplishing our goals and missions. I think as ARR continues to grow faster than our revenue base, that positive mix will have an uptick on margins as time passes. I think based on what we've seen, you know, you're seeing a level of consistency with basis point improvement quarter after quarter, and that feels like that's in that range where we will most likely continue to stay for a while.
Okay, guys. Thank you so much, and congratulations again. I'll get back in line.
Yeah. Thanks, Harsh.
Thank you. One moment for our next question. Our next question comes from Tommy Moll with Stephens. Your line is now open.
Good morning, and thanks for taking my questions.
Morning, Tommy. [crosstalk]
Morning, Tom.
Ron, I wanted to start on ARR for products and services. You referenced in your letter the currently low attach rate for software, particularly around cellular and console servers, but those are also areas of opportunity going forward. My questions are, is there anything you can do to size or dimensionalize those opportunities? And is there anything you're doing in terms of sales force incentive structure or any kind of internal initiatives to really drive those attach rates higher as we move forward?
Yeah, Tommy, thanks for the question. ARR is a tremendous focus of the company and most importantly because it adds more value to the customer solution. We, of course, benefit from hopefully their success. I wanna be clear that it's a real customer-focused metric. It's just that it's a good way for us to measure how complete a solution we're providing and that leads to hopefully a longer-term relationship as well. We've got several initiatives underway, both on the process and the system side, but also to your point on the incentive side to ensure from management down to the individual salesperson that we're leading and highlighting the complete solution and really backing out if that's not appropriate for the customer's application.
We do anticipate if we're able to get those take rates up, that we would see much higher growth rates, especially from product services on that ARR, which would have a much bigger contribution to the company's ARR levels.
Thanks. I appreciate the insight. I did wanna shift gears to cash flow and capital allocation. Looks like you repaid some debt in the fiscal Q4 that you just concluded, and if I'm reading between the lines here on what you said around inventory and the materials you published this morning, plus your guidance, it would imply that there will be meaningful cash flow in the next fiscal year. I'm just curious what the relative priorities there would be in terms of continued debt reduction, M&A, anything else that you would wanna highlight for us. Thanks.
This is Jamie. I think on the cash flow side, you know, we're, you know, first of all, we're being very mindful of inventory and ensuring that we're able to meet our customers' needs. As you've seen throughout fiscal 2022, we've deployed our capital in a way that we've acquired component inventory when available. As you're waiting for that proverbial golden screw, we're kind of ready to go and make sure that we can meet customer needs and deliver on their needs and drive that revenue. I think, secondly, you know, we look at paying that debt down, especially in an environment where interest rates are rising.
You saw that we took a very aggressive posture in fiscal 2022 to lower that principal payment, to really make sure that we're minimizing that interest cash that's going out the door, and I think you would continue to see that in 2023. I do think that we are confident of what our outlook is. We're confident in the demand that we're seeing, and so we're also evaluating on a regular basis how we deploy that capital in terms of investment.
To secure growth in the periods beyond 2023, across Digi. I do think, you know, we've stated that we're heads down on our acquisition work. We're continuing to integrate Ventus, which has been a fantastic acquisition for Digi. I think the teams have really collaborated well. I think we're really proceeding against our integration plan, and that's gonna continue to be the case. Of course, you know, we're always trying to be opportunistic in terms of what makes sense. As it sits right now, I would tell you those are our top three priorities. If M&A became opportunistic, we'd address that as it came up. Right now, we're really focused on making sure we've got the inventory on-hand to deliver for our customers.
We're gonna minimize that principal debt and really focus on trying to minimize that interest expense that goes out the door and evaluating what the right investments are for Digi to secure future growth.
Thanks, Jamie. I appreciate it, and I'll turn it back.
Thanks, Tommy.
One moment for our next question, please. Our next question comes from Anthony Stoss with Craig-Hallum. Your line is now open.
Hi, guys. My congrats as well on the execution. Jamie just answered a lot of my questions, but Ron, maybe throwing one to you on the $300 million in backlog. How far out does that stretch? And is it, maybe give us a sense of the breakout on the components in the backlog. Is it similar to what you have on products and solutions right now? And then also, on the cellular gateway side of the business, I'm curious for an update, just what you're seeing, 5G, if things are kicking in. Thanks.
Hey, thanks, Tony. Yeah, great questions. The backlog does spread out for the most part over the next four quarters. There is some backlog that actually goes into FY 2024. It's just a credit to our customers in addition to our team collaborating on the lead times and the importance of getting those orders and giving us the confidence, as Jamie mentioned, to purchase those long lead parts as we wait for the final kit to be completed.
If you look at the cellular router cellular solutions group, we're seeing a real interesting dynamic in that there's the traditional market, which is still alive and well of the solutions that have been deployed over time, either to back up wire-based solutions or to be primary communications in a lot of connections to mass transit, to public safety, to retailers. We're also seeing some exciting opportunities in private networks. There's a number of companies now that are starting to really deploy private networks. Recently here in Minnesota, they announced Xcel Energy is licensing some private spectrum for use to monitor their assets.
There's some exciting things that are going on in cellular beyond just the traditional public carriers into private as well as even into IoT-type applications like Cat-M and NB-IoT to a lesser extent, as well as, of course, fixed wireless access, which is, you know, really displacing wires for more traditional internet service.
Got it. Thanks for the update.
Thank you. One moment for our next question. Our next question comes from Derek Soderberg with Cantor Fitzgerald. Your line is now open.
Yeah. Hey, guys. Thanks for taking my questions, and my congrats as well on the quarter. You know, as it relates to the $100 million Adjusted EBITDA goal for you guys, I mean, just given the strength here, I'm wondering if you can put sort of a timeline on when you think you can maybe hit that. You know, certainly driving subscription growth is a great way to get there. I guess related to that, Ron, you know, are you seeing customers more willing to attach software than maybe they were a year ago? And what are some of the initiatives that you might have for 2023 and beyond, on really driving those attach rates?
Yeah. Hey, Derek. Thanks for the note and the comments here and the question as well. Let me just kind of phrase or categorize a couple things. One is we're seeing a real opportunity based on some pretty intense survey work in collaboration with our channel partners that a bundle of software and service is very, very compelling. It's the combination of the two. It's not just software, it's not just service, but that combination is very compelling. That's really what we're driving to increase attach rate. That's a combination of expert support. It's a limited lifetime warranty in addition to our device and system management capabilities through our software applications.
We do think that those attach rates will increase, and those attach rates are gonna have a much higher margin than what we're displaying at the consolidated level. We do think that margin expansion, to Jamie's point earlier, will progress over time. The careful thing we're balancing is we feel there's an opportunity to go on offense. We're not talking about a crazy level investment. We're making some modest investments to take advantage of some opportunities where we can further our leadership. That's the only thing that balances the progression of EBITDA.
We do think EBITDA, Adjusted EBITDA, will progress throughout the year, but we are tempering that a bit by making some really targeted investments in our sales and marketing team as well as our R&D team, in particular on the software side, to make sure that we're really pacing with the opportunity in front of us. The compelling vision is really providing a more complete IoT solution. It's no longer set it and forget it. It is about managing the lifecycle of that deployment. We've got some really good feedback and survey data that really validates that opportunity.
Got it. That's helpful. As my follow-up, I wanted to touch on international markets. You know, Ron, maybe if you could talk about some trends going on internationally. Curious if you're benefiting from any of those, whether it be you know, a shift to you know, these companies using Western-based providers, you know, Ventus adoption internationally. Just curious if you can comment on you know, how are you feeling about international growth going forward, and anything you know, in terms of trends that you're seeing internationally. Thanks.
Yeah. It's a very good question. There is a nationalization that's going on, without a doubt, and you're seeing that protectionism, you know, be implemented in the U.S. here and to probably a little bit lesser extent Europe. Yeah, there's a more concerted effort, I think, to buy either within countries that share similar values or even within countries. We think that positions us well, because we aren't gonna be competing quite as much as we would in the past with people from certain geographies. And particularly with China, you know, their expectations for gross margin are quite different, and they're more, I'd say, hardware centric than complete solution centric.
That's another thing that really validates this tremendous opportunity we believe we have in offering this combination of service and software to help further distinguish Digi, but first and foremost, add more value to the customer solution.
Great. Thanks, guys.
Thank you. As a reminder, to ask a question, you'll need to press star one one. I have a follow-up. One moment please. Harsh Kumar from Piper Sandler, your line is now open.
Yeah. Hey, Ron, quick question. I know you. I don't wanna get into numbers and specific penetration rate, but I know you have a pretty substantial console server install base. I know when you acquired Opengear, I bet one of the thoughts in your mind was to take that software and be able to penetrate that software into your current install base. If I can ask you just, not the specific numbers, but just color-wise, where do you stand, and where do you think the optimal penetration is down the line as you in your goal?
Yeah. It's a really good question. You know, we've got hundreds of thousands of devices that we've shipped out there, so there's both the new unit opportunity, of course, to improve the attach rate, and there's ability to go back into the install base and, you know, both offer more software and services to that install base, in addition to potentially, refreshing even their underlying hardware. There's a tremendous opportunity. I think our focus first and foremost is on the new 'cause it's for us, it's a little bit easier to get that attach on new than going back to the install base whose budgets and the priorities that may have moved on.
We do think that as we add new, especially if you're an existing customer, there's an opportunity then to say, "Well, why don't we protect and manage all of your devices, not just this incremental new device?" Because they've got an add-on order, they've got a refresh of their hardware. To your point, Harsh, the attach rate on new is our focus right now, but there's a broader opportunity to go to that base.
Great. Thanks, Ron.
Thank you. I'm showing no further questions at this time. I'd like to hand the conference back over to management for any closing remarks.
Thank you. It's a very exciting time for Digi. We look forward to connecting with you throughout the quarter here. We've got a couple of conferences we'll be attending. We have our first attendance at Stephens Annual Investment Conference, November 16th and 17th in Nashville. We're also attending ROTH's 11th Annual Technology Conference 16 November 2022 in New York City, as well as Craig-Hallum's 13th Annual Alpha Select Conference on 17 November 2022 in New York City. Please contact your representatives to schedule time with us. In the meantime, stay safe, and we look forward to connecting with you.
This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.