Digi International Inc. — Q1 FY2019 10-Q
Reporting period: Three months ended December 31, 2018. Comparative figures are for the three months ended December 31, 2017 and were retrospectively adjusted for adoption of ASC 606 revenue accounting. Digi provides IoT connectivity products, services and solutions through its IoT Products & Services and IoT Solutions segments.
Key financial results
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Revenue | $62.3 million | $45.0 million |
| Gross profit / margin | $29.8 million / 47.8% | $22.0 million / 48.8% |
| Operating income (loss) | $5.6 million | ($2.0 million) |
| Net income (loss) | $4.7 million; $0.17 per diluted share | ($4.5 million); ($0.17) per diluted share |
| Adjusted EBITDA (non-GAAP) | $6.2 million; 9.9% of revenue | $3.0 million; 6.6% of revenue |
| Operating cash flow | $6.1 million | ($1.3 million) |
Revenue rose 38.6%. Product revenue increased 32.1% to $50.8 million; services and solutions revenue increased 76.9% to $11.5 million. Gross margin declined 1.0 percentage point, primarily due to product and customer mix and higher acquisition-related amortization, partly offset by manufacturing-transition savings and more recurring revenue.
At December 31, cash and equivalents were $72.2 million and marketable securities were $4.2 million, totaling $76.5 million. Working capital was $132.9 million; total liabilities were $46.7 million. The balance sheet reports no borrowings or debt. Quarterly investing cash flow was $8.8 million, including $10.0 million of headquarters-sale proceeds; financing cash flow was a $0.2 million use. Capital expenditures were $1.8 million in the quarter, and management expected approximately $7.8 million for FY2019.
Material changes and business drivers
- IoT Products & Services revenue grew 30.4% to $53.3 million, with operating income of $7.4 million versus $1.3 million. Growth included $5.2 million of incremental Accelerated revenue and stronger cellular, RF, USB-connected and embedded product sales; mature terminal-server products declined.
- IoT Solutions revenue grew 121.3% to $9.0 million. The segment’s operating loss narrowed to $1.8 million from $3.3 million. SmartSense by Digi served just over 54,000 sites, versus just over 38,000 a year earlier.
- North American revenue increased 57.9% to $46.3 million; EMEA was essentially flat, Asia rose 12.2%, and Latin America declined 15.0%.
- The 2017 comparison included a $2.8 million discrete tax expense related primarily to the U.S. Tax Cuts and Jobs Act. Q1 FY2019 earnings included a $4.4 million pre-tax gain ($3.4 million after tax) from selling the former headquarters. The gain materially contributed to reported operating profit; it is excluded from Adjusted EBITDA.
Outlook, risks and contingencies
The filing gives no formal consolidated revenue or earnings guidance. Management expects IoT Solutions revenue to increase over time and anticipates gross-margin improvement as recurring revenue grows. It also expects mature network products to decline, and cautions that large customer projects and deployments can cause quarterly revenue fluctuations. Management stated that cash, operating cash generation and potential access to debt or equity financing should be sufficient for operations, acquisitions and capital expenditures for the next twelve months and beyond.
- A 13-year headquarters lease carries stated minimum obligations of $14.8 million.
- A Canadian lawsuit alleges Digi products caused street-lighting malfunctions and seeks damages of just over C$1.0 million. The company intends to defend the claim and said it could not assess the likelihood or amount of any loss.
- Acquisition contingent consideration was valued at $10.1 million at quarter-end. The Accelerated earn-out liability increased as the business exceeded initial revenue expectations; estimates depend on future performance and valuation assumptions.
- Management cites competition, technology changes, product defects, customer and distributor reliance, acquisition integration, economic conditions, supply-chain disruptions, customer/project variability, foreign-currency exposure and litigation among relevant risks. No material changes to previously disclosed risk factors were reported.
- The $20 million share-repurchase authorization had no purchases under the program through December 31, 2018 and was scheduled to expire May 1, 2019. Shares withheld for employee tax obligations were not program repurchases.
Important facts for investors to verify
- How much future operating performance depends on large customer deployments, the Accelerated acquisition and continued SmartSense site growth.
- Underlying operating profitability excluding the headquarters-sale gain, and the drivers of the year-over-year gross-margin decline.
- Cash conversion and working-capital trends, particularly inventory growth, alongside the FY2019 capital-spending outlook.
- The timing and potential amount of acquisition earn-outs, and any developments in the DimOnOff litigation.
- Effects of ASC 606 restatement when comparing reported historical periods; the filing reports modest adjustments to the 2017 quarter’s revenue and results.