James Loch; Chief Financial Officer, Executive Vice President, Treasurer; Digi International Inc
Ronald Konezny; President, Chief Executive Officer, Director; Digi International Inc
Tommy Moll; Analyst; Stephens Inc.
Caden Dahl; Analyst; Piper Sandler Companies
Scott Searle; Analyst; Roth Capital Partners, LLC
Operator
Good day, and welcome to the Digi International Inc., second quarter fiscal 2025 earnings conference call. (Operator Instructions) Please be advised that today's conference is being recorded.
I would now like to hand the conference over to your speaker, Chief Financial Officer, Jamie Loch. Please go ahead.
James Loch
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 after the market closed today. You may obtain a copy of the press release through the Financial Releases section of our Investor Relations website at digi.com. This afternoon, 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 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 furnished as an exhibit to Form 8-K that can be accessed through the SEC Filings sections of our Investor Relations website.
Now I'll turn the call over to Ron.
Ronald Konezny
Thank you, Jamie. Good afternoon, everyone. Before we take questions, a few highlights from our second fiscal quarter of 2025. Digi's solution-oriented approach to the industrial IoT market continues to shine, with ARR growing 12% year over year to a record $123 million in the quarter. Both of our reporting segments contributed to ARR growth in the quarter.
Our solution focus enables customers to get quick ROI from remote monitoring, machine uptime and integration and analytics. ARR now represents a record 29% of our annualized quarterly revenues. Expanding ARR and favorable product mix helped improve our profitability. Our business model is demonstrating its scalability as ARR and profits grow faster than our top-line revenue.
Free cash flow generation of $26 million in the quarter allowed us to reduce our net debt to $45 million after paying down $25 million of debt during the quarter. In addition, we improved our inventory position significantly, and we are approaching historical norms.
Given our modest capital expenditures, less than 1% of total revenue, our current free cash flow yield sits at 9%. We now expect to be net cash positive by the end of our fiscal year, a one-quarter improvement from our initial goal at the end of the calendar year.
As our balance sheet improves, we are even better positioned to pursue solution-oriented acquisitions of scale. Our outlook for the balance of our fiscal 2025 year assumes the current tariff rates and does not contemplate a drop-off in what we have seen to date as steady demand. We acknowledge the macro environment is fluid. However, Digi has a robust history of adaptability and resiliency, and we will adjust accordingly.
Over the last several years, we have diversified and optimized our supply chain across geographies and suppliers. We plan to be diligent with our operating expense investments. As always, we remain steadfast in putting our customers' interest first just as we navigated the supply chain challenges coming out of the COVID pandemic.
Operator, I will now hand the call back to you for Q&A.
Operator
(Operator Instructions) Tommy Moll, Stephens.
Tommy Moll
Ron, my first question is on the recurring revenue trends in P&S, up over 20% in the quarter. You've been accelerating there for some time now, but I feel like we need to ask again, what are some of the operational levers you're unlocking or you're using to unlock some of that growth?
Ronald Konezny
Yes. Thanks, Tommy. The two big levers that we're really emphasizing is one is certainly providing a solution and attaching software and services to that product to provide a more complete solution. And those attach rates continue to improve and we are -- when the opportunity presents itself, providing a Ventus type model to customers where it's zero down Xbox a year or a month instead of a onetime upfront to better match their ROI. So the combination of those two things are really helping ARR improve.
Tommy Moll
And is some of this, do you feel like just the channel becoming more accustomed to driving higher attach rates? Or is it not as much a channel dynamic and maybe something else?
Ronald Konezny
No, we're very channel-centric in products and services. In solutions, we're more direct. So we absolutely want to partner and go with and through our channel. And so they are reacting to this model in a real positive way. They realize it helps them build a recurring revenue business.
Tommy Moll
Yeah. Shifting gears to some of the onetime sales in the same segment. It sounds like you've got some customers continuing to bleed their own inventories lower. I'm just curious what anecdotes or visibility you can share as to how much longer that might persist?
Ronald Konezny
It's a good question. I think it's becoming both a smaller set of customers, but also less inventory for them to worry about. I'd say the other factor, Tommy, is if you look at -- and you'll see this eventually in the Q, you'll see the split. Revenue has been a little bit weaker in the APAC region, and you can probably understand why. So there's a little bit of that dynamic going on as well.
But I think the inventory situation is resolving itself. You'll see in our numbers that inventory has come down quite a bit, and we're getting back to normalized levels, and that's a real positive sign.
Operator
James Fish, Piper Sandler.
Caden Dahl
This is Caden on for Jim. Just a quick one on macro volatility. How has this changed your customers' willingness to spend across your product portfolio?
Ronald Konezny
Yes, it's a good question. To date, we see steady demand. Certainly, again, we acknowledge there's some fluidity out there. I'd say the exception is in the APAC region. But if you look at our sales ops statistics, our pipeline, days to close, average order size, those have stayed pretty stable.
Again, there's a lot of change out there potentially, so we have to be prepared. But for now, it's holding firm.
Caden Dahl
And just another quick one. Any update on the software attach rates?
Ronald Konezny
Yes. We're seeing a very good improvement. I'd say it's more of an evolution than a revolution. We've been getting higher and higher take rates across the portfolio. We're still, I'd say, under 50% across the portfolio, less the OEM solutions business, of course. So there's still room to improve.
Operator
I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Ron Konezny for any closing remarks.
Actually, we do have a question that just came in. Scott Searle, ROTH Capital.
Scott Searle
I apologize, Ron, I got on a couple of minutes late. But just wondering if you could give us a quick view in terms of time lines to close deals now are things starting to lag a little bit more? What are you seeing in terms of your supply chain?
And interestingly, your inventories, you guys have been working them down for a while where most companies have been patting their balance sheet with inventory ahead of tariffs. You guys continue to be pretty efficient on that front. So I'm wondering if you could give us some thoughts in terms of how you're approaching the current environment.
Ronald Konezny
Yeah, Scott, good questions. We monitor our opportunities very closely. We saw coming out of the COVID period, sales cycles lengthening, order sizes coming down, and it's really stabilized. So we haven't seen a deterioration with the only exception of the APAC region. And so we think that's steady so far.
Again, I think there's a lot of waiting on what's going to happen with tariffs on a more permanent basis. But for now, we're holding firm on our opportunities.
The inventory, I think during COVID, we probably accumulated more inventory than many other peers and made sure that both the channel and customers didn't have too much that they couldn't digest. And so we've been able to slowly burn down that inventory, took a nice step here.
We do think inventory has a chance to go up slightly in some future periods because we're at relative normalization now. And we're in a good shape from the diversity and optimization of our both suppliers and the locations. So we've got some flexibility to move products around to try to minimize tariff impact. So we're probably less subject to stockpiling that you might see at other companies and more willing to see how this evolves and then react accordingly.
Scott Searle
Got you. Very helpful. And Ron, maybe just to follow up on that. I'm not sure if you're willing to share, but in terms of looking at tariff exposures in terms of where they stand today, what's the range of outcomes in terms of gross margin impact as you look at the potential landscape, particularly as we get into the September quarter?
Ronald Konezny
Yes. Our outlook really incorporates the current state of tariffs. So we feel like we've got a good handle on things. And let's kind of -- for this discussion, assume a 10% tariff rate is the most common tariff rate. We know China is higher and some other things like things that comply with USMCA are lower.
But we think we've got a good handle on that. I think the range of outcomes that become a little more interesting is if there's portions of the world that start enacting more reciprocal tariffs, that is going to require a little bit more agility.
About 70% of our business is in North America. So to the extent that we're importing things for our US and North American customers, that can require -- we do have quite a bit of product and facility that complies with USMCA. So as long as that stays in place, that's a good tool for us to leverage. So we think we're in good shape.
The way things stand right now. I think we're all having a tough time predicting what might happen. But we do have some options in some of these maybe more extreme tariff situations where you might have reciprocal put in place. We're going to have to move our feet to juggle some things a bit.
Scott Searle
Got you. Very helpful. And lastly, if I could, just on the solutions front, you continue to see some pretty good demand there and growing your ARR. I'm wondering if you could go one layer down and give us a little bit of color in terms of Ventus, both higher-end solutions versus lower end. Is there any difference in terms of how things are performing there?
And I think SmartSense was going through a little bit of a refresh or upgrade cycle in terms of expanded capabilities. How is that being received in the marketplace right now?
Ronald Konezny
Yes. We're really pleased with the additions we've had, both in Ventus and SmartSense. They have been offset to a lesser degree by what we would describe as some soft churn, where we have a larger customer that maybe closes a smaller percentage of their locations. We still retain the customer, but we have fewer locations, but they're being more than offset with growth. And we're really extending the Ventus model really into our cellular router business.
And that has a tendency to tamp down top-line revenue, but of course, contribute to ARR. So we're excited about that initiative and really extending that core capability and business model into the channel.
Scott Searle
Ron, just to follow up on that last point, right? In terms of extending your existing router gateway business into the Ventus model, where are we in terms of that time line now? How long before we get through a majority of that conversion or attach process?
Ronald Konezny
Yes. I think it will be more of an evolution than a revolution. We work really closely with the channel. We're signing up our initial launch channel partners and getting them educated on the model and making sure that they know when that model applies and quite frankly, when it's a more traditional model. So it's not a light switch.
It's more like a dimmer switch that happens over time. So I expect it really to be a multi-quarter evolution.
Operator
(Operator Instructions) I'm showing no questions at this time. So again, I'll turn the call back over to Mr. Ron Konezny for any closing remarks.
Ronald Konezny
Thank you. We appreciate you joining Digi's earnings call and for your continued support. A huge thank you to our customers, distributors, suppliers and to our exceptional Digi team. Have a great day.
Operator
This concludes today's program. Thank you all for participating. You may now disconnect.
