Digi International Inc. — Q2 FY2020 Form 10-Q
Reporting period: Three and six months ended March 31, 2020. Amounts are in U.S. dollars; financial statement figures below are in millions unless otherwise noted. Digi provides IoT connectivity products, services and solutions through its IoT Products & Services and IoT Solutions segments.
Financial performance
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $73.4 | $65.8 | $135.8 | $128.1 |
| Gross profit / margin | $38.6 / 52.6% | $30.3 / 46.1% | $69.1 / 50.9% | $60.1 / 46.9% |
| Operating income | $3.7 | $0.8 | $3.2 | $6.3 |
| Net income | $2.0 | $1.3 | $2.2 | $6.0 |
| Diluted EPS | $0.07 | $0.05 | $0.07 | $0.21 |
| Operating cash flow | $9.4* | Not stated by quarter | $(12.7) | $6.2 |
*Management reported $9.4 million of operating cash flow for the second quarter. The six-month cash flow statement reports $(12.7) million, reflecting substantial working-capital outflows.
- Q2 revenue: Increased 11.7% year over year. Product revenue was $65.6 million, up from $58.5 million; service revenue was $7.8 million, up from $7.3 million.
- Segments: IoT Products & Services revenue rose 19.4% to $66.9 million in Q2, primarily with Opengear contribution and higher sales to a cellular-products customer. IoT Solutions revenue fell 32.6% to $6.6 million, as prior-year customer equipment upgrades did not recur; recurring subscription revenue partly offset the decline.
- Margins and expenses: Consolidated Q2 gross margin expanded 6.5 percentage points. IoT Products & Services margin improved, while IoT Solutions’ Q2 margin declined 0.5 percentage point. Q2 operating expenses rose 18.2% to $34.9 million, chiefly due to Opengear.
- Six-month comparison: Revenue grew 6.0%, but operating income fell 48.9% and net income fell 63.3%. Prior-year results included a $4.4 million gain on sale of the former headquarters; current-year results include acquisition-related costs and higher amortization and interest.
- Non-GAAP measures: Management reported Q2 adjusted net income of $8.3 million ($0.28 per diluted share) versus $4.8 million ($0.17) and Adjusted EBITDA of $11.2 million (15.2% of revenue) versus $6.5 million (10.0%). These are company-defined non-GAAP measures, not substitutes for GAAP results.
Financial position, liquidity and debt
- At March 31, 2020, cash and cash equivalents were $58.1 million, compared with $92.8 million at September 30, 2019. Total current assets were $188.4 million and current liabilities $53.2 million.
- Debt was $109.4 million gross: $60.0 million drawn on the revolving facility and $49.4 million on the term loan. Net carrying debt was $106.9 million, including current maturities and unamortized issuance costs. $40 million remained available under the revolving facility. The debt bears variable interest; the six-month weighted average rate was 3.4%. Digi reported compliance with its covenants.
- Six-month cash decreased $34.7 million, principally reflecting $136.1 million net cash used to acquire Opengear, partly funded by $110.0 million of new debt. Management expected positive future operating cash flows and said available cash, operating cash flow and borrowing capacity should fund operations and capital expenditures for at least 12 months.
- Goodwill rose to $207.4 million and net intangible assets to $129.3 million, largely following the Opengear acquisition. The acquisition’s purchase-price allocation remained preliminary.
Outlook, risks and unusual items
- Opengear acquisition: Completed December 13, 2019, for $148.1 million in cash, funded with cash on hand and credit-facility proceeds. The acquisition added $54.7 million of goodwill and significant identifiable intangible assets, increasing amortization and leverage. Future earn-outs depend on revenue performance.
- COVID-19: Management said the pandemic began affecting the business in March, with uneven customer demand across industries and greater expected sales volatility. At filing time, the duration and financial impact could not be reliably estimated. Supply-chain and delivery operations had not been materially constrained, but that could change. Digi identified possible future goodwill impairment if economic conditions or operating results deteriorate.
- Cost actions announced in April: Hiring, travel, discretionary spending and capital spending were reduced; 21 positions were eliminated; the U.S. and Canadian retirement matching programs were suspended; and directors and executives reduced cash compensation/base salaries by 10% for six months in exchange for equity.
- PPP loan: Digi received a Paycheck Protection Program loan on April 14, 2020, then decided to repay it under subsequent program rules. It repaid the full amount plus interest on May 4, 2020.
- Contingency: A Canadian customer lawsuit alleges Digi products caused street-lighting malfunctions and seeks damages of just over CAD 1.0 million. Digi intends to defend the case and said it could not assess the likelihood or amount of a potential loss.
- No numerical full-year guidance was provided in the supplied filing text. Management described long-term IoT market growth opportunities, while noting mature product lines, competitive and technology risks, acquisition-integration risks, and pandemic-related uncertainty.
Most important facts to verify
- How much of Q2 and first-half growth and margin improvement is attributable to Opengear, and whether it is sustainable after integration costs and acquired-intangible amortization.
- Why six-month operating cash flow was negative despite management’s report of positive Q2 operating cash flow; monitor receivables, payables and other working-capital movements.
- COVID-19’s subsequent effect on demand, supply continuity, cost reductions, liquidity and goodwill/intangible-asset impairment assumptions.
- Debt balances, variable-rate exposure, covenant headroom, remaining revolver availability and the timing of required repayments.
- The preliminary Opengear purchase-price allocation, contingent earn-out outcomes, and the status or potential exposure of the Canadian litigation.