Digi International Inc. — Q3 FY2023 Form 10-Q
Reporting period: Three and nine months ended June 30, 2023. The quarter was fiscal Q3; financial amounts below are in millions of dollars except per-share data.
Business context
Digi provides IoT connectivity products, services and solutions through IoT Products & Services and IoT Solutions. Its stated priorities include expanding software and service offerings to grow annualized recurring revenue (ARR) and improving customer service.
Financial performance
| Metric | Q3 FY2023 | Q3 FY2022 | Nine months FY2023 | Nine months FY2022 |
|---|---|---|---|---|
| Revenue | $112.2 | $103.5 | $332.7 | $282.5 |
| Gross profit / margin | $63.8 / 56.9% | $57.4 / 55.5% | $188.2 / 56.6% | $157.3 / 55.7% |
| Operating income | $12.5 | $10.0 | $36.6 | $21.3 |
| Net income | $6.7 | $4.1 | $18.4 | $8.2 |
| Diluted EPS | $0.18 | $0.12 | $0.50 | $0.23 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $27.8 | $31.2 |
Quarterly revenue rose 8.4%; product revenue was $81.7 million and service revenue $30.5 million. For the nine-month period, revenue rose 17.8%. Adjusted EBITDA, a non-GAAP measure, was $24.3 million for Q3 versus $21.0 million, and $71.6 million for nine months versus $57.5 million. Adjusted diluted EPS was $0.50 for Q3 versus $0.45, and $1.48 for nine months versus $1.21. Management cautions that non-GAAP measures are not substitutes for GAAP results.
Segments and recurring revenue
- IoT Products & Services: Q3 revenue of $87.4 million, up 9.5%; operating income was $12.1 million. Nine-month revenue rose 18.8% to $257.6 million.
- IoT Solutions: Q3 revenue of $24.9 million, up 4.7%; operating income was $0.4 million versus an operating loss of $0.9 million. Nine-month revenue rose 14.4% to $75.1 million, while the segment recorded a $1.1 million operating loss.
- ARR was $104 million at June 30, up from $92 million a year earlier. IoT Products & Services ARR was $22 million; IoT Solutions ARR exceeded $82 million.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $29.6 million at June 30, 2023, down from $34.9 million at September 30, 2022. Current assets were $167.4 million and current liabilities $89.0 million.
- Gross term-loan principal was $220.6 million, including $15.5 million of current maturities; the balance-sheet long-term debt, net of issuance costs and current maturities, was $194.6 million. The company had no revolver borrowings and reported $35 million available under its revolving facility.
- The term loan’s weighted-average interest rate was 10.16% at June 30. Interest expense was $6.6 million for the quarter and $19.0 million for nine months. The filing says borrowings move to SOFR following LIBOR discontinuation and warns that persistently elevated rates would increase interest expense.
- Operating cash flow was $27.8 million for nine months, compared with $31.2 million. Investing used $3.8 million, while financing used $28.9 million, including $29.4 million of debt repayments. Cash declined $5.3 million over the period.
- Management expects positive operating cash flow and believes cash, operating cash generation and borrowing capacity will fund operations and capital expenditures for the next 12 months and beyond.
Changes, outlook and notable items
- Gross margin increased 140 basis points in Q3 and 90 basis points for nine months. Management attributed segment margin improvements mainly to product and customer mix. Operating expenses rose 8.2% in Q3, primarily due to investments in Opengear and SmartSense, higher stock-based compensation and litigation costs.
- Net income increased despite higher interest expense. The nine-month 2023 income tax benefit included a $2.9 million discrete benefit, primarily from excess tax benefits on stock compensation.
- The company restated its nine-month 2022 cash flow statement for debt-issuance-cost classification errors. It said the corrections were not material and did not affect balance sheets, statements of operations or comprehensive income.
- Management provided no specific revenue or earnings guidance in the supplied filing text. It reported approximately $154.7 million of remaining performance obligations on contracts with original terms of at least one year, with about $67.3 million expected to be recognized over the next 12 months.
- The annual goodwill impairment test completed in Q3 found fair value above carrying value for all reporting units; no impairment was recorded. Contingent consideration was reported at zero, although Ctek earn-out performance conditions remain in effect through December 31, 2023.
- Risks cited include supply-chain and transportation challenges, inflation and recession concerns, competition and technology change, acquisition integration, litigation, customer concentration, and interest-rate and currency exposure. The company also disclosed potential adverse effects from losing key customers, pricing pressure or slower customer payments. It reported that disclosure controls were effective and that no material change in internal control occurred during the nine months.
Important facts for investors to verify
- Whether ARR growth converts into recognized revenue and cash flow, particularly within IoT Solutions.
- Debt repayment capacity and the cash-flow impact of the 10.16% borrowing rate and SOFR transition.
- Whether inventory growth, customer payment terms and customer concentration affect working capital or margins.
- The nature, expected cost and status of ongoing litigation, and any resolution of Ctek earn-out conditions.
- How much of reported earnings growth is sustainable apart from discrete tax benefits and non-GAAP adjustments.