Digi International Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2017, the three months ended December 31, 2016. Comparisons are with the three months ended December 31, 2015, unless otherwise noted. Digi provides machine-to-machine and IoT connectivity products and services, with one operating and reporting segment.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Revenue | $45.2 million | $50.3 million | Down 10.1% |
| Gross profit / margin | $21.5 million / 47.5% | $24.4 million / 48.5% | Margin down 1.0 percentage point |
| Operating income / margin | $2.4 million / 5.4% | $3.3 million / 6.6% | Down 26.4% |
| Continuing-operations income | $2.4 million | $3.1 million | Down 24.7% |
| Net income | $2.4 million ($0.09 diluted EPS) | $6.5 million ($0.25 diluted EPS) | Down 63.5% |
| EBITDA from continuing operations (non-GAAP) | $4.0 million; 8.8% of revenue | $4.6 million; 9.1% of revenue | Down from $4.6 million |
Prior-year net income included $3.3 million of after-tax income from discontinued operations, including a gain on the Etherios sale; continuing-operations results are more comparable. The effective tax rate for continuing operations was 24.5%, versus 10.9% a year earlier; the prior period benefited from reinstatement of the federal R&D tax credit.
Revenue, margins and operating changes
- Hardware revenue fell 10.5% to $43.2 million; service revenue was essentially flat at $2.0 million. Hardware represented 95.6% of revenue.
- Cellular routers and gateways grew 13.1% to $13.8 million, benefiting from a large North American customer sale and a new product. RF revenue declined 28.4%, embedded revenue 9.8%, and network revenue 20.1%.
- Management attributed weaker gross margin primarily to product mix, especially lower sales of higher-margin network products. It expects revenue from mature network products generally to decline, although project timing can make quarterly results fluctuate.
- Revenue declined across all reported regions: North America 3.0%, EMEA 10.9%, Asia 10.9%, and Latin America 68.1%. Prior-year RF project sales in Latin America and EMEA contributed to the comparison. Currency movements reduced revenue by approximately $0.3 million.
- Operating expenses decreased 9.7% to $19.0 million, partly reflecting lower R&D and the absence of the prior-year $0.7 million restructuring charge. Other income increased to $0.7 million, largely from foreign-currency gains.
Cash, liquidity and capital resources
- At December 31, 2016, cash and cash equivalents were $81.1 million, marketable securities were $55.2 million, and cash, cash equivalents and short-term securities totaled $133.1 million. Including long-term securities, the total was $136.4 million.
- Working capital was $174.2 million, versus $171.8 million at September 30, 2016. Total liabilities were $29.4 million and stockholders’ equity was $302.1 million. The balance sheet lists no borrowings; it does include $10.7 million of contingent acquisition consideration.
- Operating cash flow was a use of $2.0 million, versus a source of $3.6 million in the prior-year quarter. Management cited lower net income and working-capital uses, including receivables and accrued liabilities.
- Investing activities provided $7.4 million, including marketable-security maturities and $3.0 million received on the Etherios sale, partly offset by the $1.7 million FreshTemp acquisition payment. Financing activities provided $2.4 million. Cash increased $5.4 million to $81.1 million.
- Management anticipated fiscal 2017 capital expenditures of approximately $3.2 million, with $0.6 million spent through December 31. It said existing liquidity, expected operating cash flow and potential financing would be sufficient for operations, possible acquisitions and capital expenditures over the next 12 months and beyond.
Outlook, transactions and risks
- No specific revenue or earnings forecast was provided. Management highlighted the expected continuation of declines in mature network products and quarter-to-quarter variability in project-driven cellular and RF sales.
- FreshTemp was acquired November 1, 2016, for $3.3 million of preliminary consideration, including $1.3 million of contingent consideration; its first-quarter revenue contribution was immaterial. The purchase-price allocation remained preliminary.
- On January 9, 2017, after quarter-end, Digi acquired SMART Temps for $28.8 million cash plus potential earn-outs of up to $7.2 million. Preliminary allocation and pro forma information were not available in the filing.
- Foreign-currency exposure is not formally hedged. Management estimated that a 10% currency movement could change revenue by 1.2% and stockholders’ equity by 2.0%, before any pricing responses. Investment securities were assessed as temporarily impaired where applicable; management noted deterioration in markets or issuer credit could lead to impairment charges.
- The filing reports ordinary-course claims and litigation but gives no specific matter or quantified exposure. It says risk factors were unchanged from the prior Form 10-K.
- A material weakness involving segregation of duties over manual journal entries at a German subsidiary, disclosed at September 30, 2016, was reported as remediated during this quarter. Disclosure controls were assessed as effective at December 31, 2016.
Important facts for investors to verify
- Whether cellular growth can offset ongoing weakness in RF, embedded and mature network products, and whether project timing affects subsequent quarters.
- Whether gross margins stabilize as product mix changes and whether the operating cash-flow shortfall reverses.
- The final FreshTemp purchase-price allocation and performance-based earn-out exposure, alongside SMART Temps’ final transaction accounting and cash impact.
- Whether the German subsidiary control remediation remains effective, and whether currency movements or investment-credit conditions create material effects.
- Progress against the approximately $3.2 million fiscal 2017 capital-expenditure estimate and management’s liquidity expectations.