Digi International Inc. — Form 10-Q
Reporting period: Third quarter and first nine months of fiscal 2016, ended June 30, 2016. The company provides machine-to-machine and Internet-of-Things connectivity products and services. Etherios, sold in October 2015, is presented as discontinued operations.
Financial performance
| Metric | Three months ended June 30, 2016 | Prior-year quarter | Nine months ended June 30, 2016 | Prior-year period |
|---|---|---|---|---|
| Revenue | $52.1 million | $52.1 million | $152.6 million | $149.7 million |
| Gross profit / margin | $26.0 million / 49.8% | $25.0 million / 48.1% | $75.1 million / 49.2% | $70.8 million / 47.3% |
| Operating income / margin | $5.1 million / 9.8% | $3.8 million / 7.3% | $12.1 million / 7.9% | $5.6 million / 3.7% |
| Income from continuing operations | $4.3 million | $3.1 million | $9.6 million | $5.8 million |
| Net income | $4.3 million | $2.5 million | $12.9 million | $3.6 million |
| Diluted EPS | $0.16 | $0.10 | $0.49 | $0.14 |
| Adjusted EBITDA from continuing operations (non-GAAP) | $5.9 million; 11.4% of revenue | $5.2 million; 9.9% | Not stated in the provided filing text | Not stated in the provided filing text |
Quarterly revenue was essentially unchanged: hardware grew 1.1% to $50.5 million, while service revenue fell 22.9% to $1.6 million. For the nine-month period, revenue rose 1.9%; product growth of 3.1% was partly offset by a 24.2% decline in services. Improved gross margin reflected a stronger mix of higher-margin network products and manufacturing cost reductions.
Quarterly net income was entirely from continuing operations. Nine-month 2016 net income included $3.2 million of after-tax income from discontinued operations, including a $2.9 million pre-tax gain on the Etherios sale; prior-year nine-month results included a $2.2 million discontinued-operations loss.
Cash flow, liquidity and capital
- Operating cash flow for the first nine months was $20.6 million, versus $9.0 million a year earlier. Management attributed the improvement principally to higher net income and working-capital changes, including lower inventory and higher accounts payable.
- Cash and cash equivalents were $61.1 million at June 30. Cash, cash equivalents and short-term marketable securities totaled $124.2 million; including long-term marketable securities, the total was $131.5 million. Working capital was $162.1 million.
- Total liabilities were $36.7 million, including $10.6 million of contingent acquisition consideration. The balance sheet presents no borrowings or other debt line item.
- Investing activities used $11.2 million and financing activities provided $7.1 million during the nine-month period. The company reported $1.6 million of capital expenditures to date and anticipated approximately $2.3 million for all of fiscal 2016.
Material changes and management commentary
- Product-category trends were mixed in the quarter: network revenue grew 19.3% and RF grew 24.6%; cellular routers and gateways declined 22.6%, and embedded products declined 5.9%. Management said cellular revenue can fluctuate with large customer projects and noted awards received in the quarter for future deployment. Network sales benefited from significant terminal-server purchases that management expects to decrease in future quarters; many network products are mature.
- North America revenue increased 7.1% in the quarter, while EMEA and Asia declined 10.0% and 17.7%, respectively. Foreign exchange reduced revenue by $0.1 million for the quarter and $0.9 million year to date.
- The October 2015 Bluenica acquisition established Digi Cold Chain Solutions. Its earn-out is tied to revenue targets over up to four years; the recorded fair-value liability was $10.6 million at June 30 and is based on significant unobservable assumptions.
- Fiscal 2016 restructuring eliminated approximately 15 positions across two plans. Management estimated annual savings of approximately $1.4 million; associated payments were completed by June 30.
- The board authorized a common-stock repurchase program of up to $15 million, expiring May 1, 2017. No shares had been repurchased under the program by June 30; reported quarterly share withholding was for employee tax obligations.
Outlook, risks and contingencies
The filing provides no specific revenue or earnings guidance. Management said it generally expects positive operating cash flows and believes available liquidity, operating cash generation and potential access to financing should fund operations, possible acquisitions and capital expenditures for the next 12 months and beyond. This is forward-looking and not a guarantee.
Risks identified include intense competition, rapid technology change and product obsolescence, variable project-driven demand, reliance on distributors and third parties, product defects, acquisition and divestiture integration, global economic conditions, supply-chain disruption, and foreign-currency exposure. The company does not have a formal currency-hedging strategy. A 10% currency-rate change from the stated nine-month averages would have affected revenue by an estimated 1.1% and stockholders’ equity by 2.2%, before potential pricing responses.
A mesh-networking patent dispute was settled in April 2016 with no future payment obligations; the settlement payment was described as immaterial. The company said there were no material changes to previously disclosed risk factors and reported effective disclosure controls.
Important facts for investors to verify
- Whether the recovery in operating income and margins is sustainable, given flat quarterly revenue and declines in services and cellular products.
- How much future revenue depends on large, timing-sensitive customer projects, particularly network and cellular sales.
- Progress and economics of Digi Cold Chain Solutions, including revenue performance against earn-out targets and the resulting contingent liability.
- Cash conversion and working-capital trends, including whether inventory reductions and increased payables are repeatable.
- Whether the estimated $1.4 million annual restructuring savings are realized, and whether the company uses the authorized repurchase program.