Digi International Inc. — Q3 FY2011 Form 10-Q
Reporting period: Three and nine months ended June 30, 2011; filed August 9, 2011. Digi provides products and services that connect, monitor, and control electronic devices over networks, the Internet, or satellite. Results are unaudited.
Financial highlights
| Metric | Q3 FY2011 | Q3 FY2010 | Nine months FY2011 | Nine months FY2010 |
|---|---|---|---|---|
| Revenue | $54.3 million | $47.2 million | $152.3 million | $135.3 million |
| Gross margin | 53.0% | 50.2% | 51.9% | 50.4% |
| Operating income | $6.2 million | $2.5 million | $12.5 million | $6.6 million |
| Net income | $3.6 million | $3.8 million | $8.2 million | $6.7 million |
| Diluted EPS | $0.14 | $0.15 | $0.32 | $0.27 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $16.2 million | $12.3 million |
At June 30, cash and cash equivalents were $59.9 million and current marketable securities were $38.5 million. Working capital was $132.4 million, up from $122.1 million at September 30, 2010. Total liabilities were $28.0 million; the balance sheet reports no conventional borrowings. Capital expenditures were expected to be approximately $3.2 million for FY2011.
Changes versus comparable periods
- Q3 revenue rose 14.9%; nine-month revenue rose 12.6%. Growth came from both embedded and non-embedded products, with wireless products a key Q3 contributor. Wireless revenue increased to $22.5 million from $18.9 million.
- Q3 gross margin improved 2.8 percentage points, primarily from product mix, cost reductions, and lower technology amortization. Operating income more than doubled in Q3 and increased 90.2% for the nine-month period.
- Q3 net income declined 5.2% despite higher operating income, largely because the prior-year quarter included a $2.2 million discrete tax benefit. Nine-month net income increased 22.0%; the prior-year comparison also included substantial discrete tax benefits.
- Operating expenses increased 6.7% in Q3 and 8.1% over nine months, including restored incentive compensation, higher headcount, and investment in the iDigi platform. Prior-year Q3 G&A included $1.0 million of internal-investigation expenses.
- Nine-month operating cash flow increased by $3.9 million. Cash and cash equivalents rose $9.0 million from the fiscal year-end balance; net investing cash use was $10.8 million, mainly reflecting purchases and maturities of marketable securities.
Outlook, risks, and unusual items
- Management expected FY2011 operating expenses of approximately 43%–44% of sales and an annualized effective tax rate of approximately 32%–34%. It expected positive operating cash flow and said available cash, securities, operating cash generation, and financing access should fund operations for the next 12 months and beyond.
- After quarter-end, Digi announced a Breisach, Germany restructuring affecting approximately 25 employees, with estimated pre-tax charges of $600,000–$700,000, mostly severance. Charges were expected in Q4 FY2011 and Q1 FY2012; payments were expected to finish in Q2 FY2012.
- Digi paid the final $3.0 million deferred consideration for its Spectrum acquisition in July 2011; the amount was recorded as a liability at quarter-end.
- Patent cases involving MOSAID, Advanced Processor Technologies, and SIPCO remain unresolved. Digi said outcomes and potential losses could not be determined for certain cases; it expected no material impact from the MOSAID matter at that time. The IPO securities litigation settlement was expected to be covered by insurance apart from a $250,000 deductible per claim; a $300,000 liability and $50,000 insurance receivable were recorded.
- Other disclosed risks include competition, rapid technology change, pricing pressure, reliance on distributors, product-development and acceptance uncertainty, global economic conditions, supply-chain disruptions, litigation, and foreign-exchange exposure. Digi had no formal currency-hedging strategy. It reported 31 securities below amortized cost but assessed the declines as temporary.
Important facts for investors to verify
- Whether wireless and other product-line growth continues, and whether serial-card sales keep declining as management expected.
- Whether reported margin gains persist as product mix, costs, and technology amortization change.
- The realized cost and timing of the German restructuring and the July Spectrum payment.
- Developments in the patent litigation, the IPO settlement appeal, and related potential liabilities or insurance coverage.
- Cash conversion, investment-portfolio credit and fair-value risk, and sensitivity to foreign-exchange movements.