Digi International Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2019. The interim financial statements are unaudited. Comparative 2018 figures were restated for adoption of ASC 606.
Business context and results
Digi provides IoT connectivity products, services and solutions through its IoT Products & Services and IoT Solutions segments. Q3 revenue was nearly flat as growth in services and solutions was offset by lower product sales.
| Metric | Three months ended June 30, 2019 | Prior-year comparable | Nine months ended June 30, 2019 | Prior-year comparable |
|---|---|---|---|---|
| Revenue | $61.2 million | $62.3 million | $189.2 million | $161.8 million |
| Gross profit / margin | $28.3 million / 46.3% | $29.6 million / 47.6% | $88.4 million / 46.7% | $78.4 million / 48.5% |
| Operating income | $1.6 million | $2.4 million | $8.0 million | $1.2 million |
| Net income (loss) | $1.6 million; $0.06 diluted EPS | $2.9 million; $0.10 diluted EPS | $7.7 million; $0.27 diluted EPS | $(1.7) million; $(0.06) diluted EPS |
| Adjusted EBITDA, non-GAAP | $6.1 million; 10.0% of revenue | $7.9 million; 12.6% | $18.8 million; 10.0% | $16.1 million; 9.9% |
Material changes and segment performance
- Q3 revenue declined 1.8% year over year: product revenue fell 8.8% to $47.1 million, while services and solutions revenue rose 32.6% to $14.0 million. Management attributed the product decline mainly to lower terminal-server sales to a significant customer and the margin decline to product and customer mix.
- For the nine-month period, revenue increased 17.0%. Services and solutions grew 63.0%, primarily from SmartSense by Digi deployments, additional purchases and recurring revenue; product revenue grew 8.9%, including $5.4 million of incremental Accelerated revenue.
- IoT Products & Services Q3 revenue was $50.5 million, down 7.2%, and operating income was $3.1 million, down from $4.5 million. IoT Solutions revenue was $10.7 million, up 35.5%; its operating loss narrowed to $1.5 million from $2.1 million. Solutions served just over 61,000 sites, versus nearly 48,000 a year earlier; recurring revenue was approximately 34.2% of segment revenue for the nine months.
- Nine-month net income improved from the prior-year loss, but results include a $4.4 million pretax gain on sale of the former headquarters building. The sale generated $10.0 million of cash proceeds.
Cash, liquidity and obligations
- At June 30, cash and cash equivalents were $84.1 million and marketable securities were $2.3 million, totaling $86.3 million. Working capital was $142.9 million, versus $126.5 million at September 30, 2018.
- Nine-month operating cash flow was $22.5 million, compared with cash used of $8.8 million in the prior year. The improvement included favorable working-capital movements, particularly collections of receivables; management notes working capital increased cash by $26.0 million compared with the prior-year period.
- Investing cash flow was positive $3.9 million, including $10.0 million from the headquarters sale, offset by $8.6 million of property and equipment purchases. Financing cash flow was positive $0.1 million and included $3.7 million of acquisition earn-out payments.
- The balance sheet reports no debt balance; interest expense was nil in Q3 and $94,000 for the nine months. Current liabilities were $35.0 million. Operating lease commitments totaled $23.2 million, including a 13-year new-headquarters lease.
- Management expected fiscal 2019 capital expenditures of approximately $11.1 million before tenant-improvement incentives, or $7.8 million net. It stated available liquidity, operating cash generation and potential financing capacity should fund operations, possible acquisitions and capital expenditures for the next 12 months and beyond.
Outlook, risks and unusual items
- Management expects IoT Solutions revenue to increase over time and expects its gross margin to improve as recurring revenue grows. It cautioned that deployments, equipment upgrades and replacement orders may cause quarter-to-quarter fluctuations. No specific consolidated revenue or earnings guidance is provided in the filing.
- On June 12, Digi received purchase orders for more than $20 million of cellular routers for an existing enterprise customer’s government project. Revenue recognized from the orders was not significant through June 30; delivery timing and service deployment are uncertain, shipments are subject to customary acceptance provisions, and the company reported no material purchase commitments related to the orders as of August 9.
- Risks cited include competition and technology changes, reliance on distributors and significant customer orders, order cancellations or delays, product defects, acquisition integration, global economic conditions, supply-chain disruption, and foreign-exchange exposure. The company reported no material changes to previously disclosed risk factors.
- A Canadian customer lawsuit alleges Digi products contributed to malfunctioning street lights and seeks just over CAD 1.0 million. Digi intends to defend the claim; it could not assess the likelihood or amount of any loss.
- Contingent consideration was $5.4 million at quarter end, measured using significant unobservable estimates. Management stated a significant change in estimated achievement of earn-out targets could materially change the liability. Goodwill testing found fair value more than 10% above carrying value for each reporting unit at June 30.
- The $20 million share-repurchase authorization expired May 1, 2019; no shares were repurchased under the program. The 540 shares shown as purchased in Q3 were employee share forfeitures for tax withholding.
Important facts for investors to verify
- Whether and when the more-than-$20-million router orders convert to accepted shipments and recognized revenue.
- Whether SmartSense recurring growth and site expansion continue, and whether the IoT Solutions segment approaches operating profitability.
- Whether product sales to significant customers, particularly terminal-server demand, stabilize; product mix also affected Q3 gross margin.
- How much of the cash-flow improvement persists after the favorable working-capital movements and one-time headquarters sale proceeds.
- Potential outcomes of the street-lighting litigation and changes to acquisition earn-out estimates or payments.