DIGI INTERNATIONAL INC quarterly report, Q1 FY2015

Digi International Inc. — Q1 FY2015 Form 10-Q

Reporting period: Three months ended December 31, 2014; unaudited. Digi provides machine-to-machine networking products and related services.

Metric	Q1 FY2015	Q1 FY2014
Revenue	$48.7 million	$47.3 million
Gross profit / margin	$21.9 million / 45.0%	$22.9 million / 48.4%
Operating income (loss)	$(1.6) million	$0.6 million
Net income (loss)	$(0.3) million	$0.7 million
Diluted earnings (loss) per share	$(0.01)	$0.03
Operating cash flow	$5.3 million	$(0.3) million

Hardware revenue rose 7.0% to $44.9 million; services revenue declined 28.9% to $3.8 million. Growth hardware products increased 18.6%, while mature hardware products fell 5.5%.
Hardware gross margin was 48.6%, down from 51.7%; service gross margin was 2.7%, down from 22.2%. Total operating expenses increased 5.7% to $23.5 million.
Other income was $0.4 million, including higher foreign-currency gains. The $0.9 million income tax benefit included approximately $0.5 million of period-specific benefits, including the R&D tax credit reinstatement and reversals of tax reserves.
Cash and cash equivalents were $45.0 million; current and long-term marketable securities totaled $47.2 million. Working capital was $119.7 million. Total assets were $287.3 million and total liabilities $25.9 million. The balance sheet presents no separate interest-bearing debt line.
Operating cash flow improved largely because of changes in operating assets and liabilities, including stronger receivable collections. Investing activities used $4.3 million; financing activities used $2.0 million, including $2.3 million of October share repurchases under the prior authorization.

Revenue grew 3.0%, but gross profit declined 4.3% and results shifted from operating income to an operating loss. Service-project volume and consulting-labor underutilization weighed on results; operating expenses also rose by $1.3 million.
A November 12, 2014 fire at a subcontractor’s Thailand facility reduced estimated quarterly revenue by about $1.5 million and diluted EPS by about $0.03. Digi said it could not estimate any future impact with certainty. Insurance proceeds for company-owned equipment destroyed in the fire are to be recognized as non-operating income when received.
Foreign-currency translation reduced other comprehensive income by $2.4 million. The company cited a stronger U.S. dollar as a factor in EMEA revenue and reported foreign-currency transaction exposure.
After quarter-end, Digi said it would exit its India operations in Q2 FY2015 and anticipated a restructuring charge of $0.2–$0.3 million, or approximately $0.01 per diluted share.
The company repurchased 287,787 shares for $2.3 million in October under its expired program. A new authorization permits up to $15 million of repurchases through October 31, 2015; no purchases were made under the new program during the quarter.

Digi anticipated approximately $3.0 million of fiscal 2015 capital expenditures and expected positive operating cash flow. Management believed available liquidity, operating cash generation, and financing capacity would fund operations and capital expenditures for at least the next 12 months.
Management expected mature-product revenue to continue declining and service revenue and service margins to fluctuate. It cited competition, technology changes, product pricing, distributor reliance, longer solution-sales cycles, customer acceptance, supply-chain disruption, acquisition execution, economic conditions, and foreign exchange among the risks to results.
Approximately $34.0 million of cash and cash equivalents was held by controlled foreign subsidiaries; about $25.0 million represented undistributed foreign earnings. Digi stated it did not currently intend to repatriate those earnings and estimated an unrecognized deferred tax liability of $0.5–$1.5 million if its position changed.
Disclosure controls were deemed ineffective because of a material weakness in internal control over financial reporting related to income-tax controls. Management described remediation efforts, including stronger tax-account reconciliations and reviews and additional tax-department resources.
Digi reported no legal proceedings in Part II; it noted that ordinary-course claims and litigation could still arise. No material changes to previously disclosed risk factors were reported.

Whether service-project activity recovers and labor utilization improves, and whether service revenue and margins stabilize.
The duration and full financial and operational effects of the Thailand facility fire, including timing and amount of any insurance proceeds.
Execution and final costs of the India exit, and any further restructuring actions.
Progress in remediating the tax-control material weakness and whether disclosure controls become effective.
Cash generation, capital spending, share repurchases, and any tax cost if foreign earnings are repatriated.