Digi International Inc. — FY2019 Form 10-K Summary
Reporting period: Fiscal year ended September 30, 2019. Although the request references 2019 Q4, this filing is an annual report; unaudited fourth-quarter results are also summarized below. Fiscal 2018 comparative figures were restated for adoption of ASC 606.
Business context
Digi provides IoT connectivity hardware, services and solutions through two segments: IoT Products & Services (hardware, Digi Remote Manager and support services) and IoT Solutions (SmartSense by Digi condition-monitoring and task-management subscriptions). The company served more than 63,000 SmartSense customer sites. Its strategy emphasizes modest growth in Products & Services and faster growth in IoT Solutions, including through acquisitions.
Financial performance and liquidity
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $254.2 million | $226.9 million |
| Gross profit / margin | $119.0 million / 46.8% | $109.1 million / 48.1% |
| Operating income / margin | $10.1 million / 4.0% | $2.8 million / 1.2% |
| Net income | $10.0 million | $1.6 million |
| Diluted EPS | $0.35 | $0.06 |
| Operating cash flow | $29.0 million | $(2.8) million |
Revenue rose 12.0%; net income rose substantially from the prior-year level. Adjusted EBITDA, a non-GAAP measure, was $26.5 million (10.4% of revenue), versus $23.4 million (10.3%). Adjusted net income was $18.7 million, or $0.65 per diluted share, versus $16.8 million, or $0.61. These measures exclude specified items and should be considered alongside GAAP results.
Products & Services revenue increased 6.8% to $215.3 million; Solutions revenue grew 53.3% to $38.9 million. Segment operating income was $18.7 million for Products & Services; Solutions reported an $8.6 million operating loss. Consolidated gross margin declined 1.3 percentage points, reflecting mix and lower-margin Products & Services sales, partly offset by improved Solutions pricing and recurring revenue.
At September 30, 2019, cash and cash equivalents were $92.8 million, working capital was $148.1 million, total assets were $398.7 million and stockholders’ equity was $349.0 million. No borrowings are listed on the balance sheet; the filing does not disclose a debt balance at year-end. Operating cash flow improved by $31.7 million, with management attributing much of the change to working-capital movements and higher net income. Capital expenditures were $9.3 million. Management said available resources and expected operating cash flow should fund operations and capital needs for the next twelve months and beyond.
For the unaudited fourth quarter, revenue was $65.0 million, gross profit $30.6 million, net income $2.3 million and diluted EPS $0.08. In Q4 FY2018, revenue was $65.1 million, gross profit $30.6 million, net income $3.3 million and diluted EPS $0.12.
Material changes and unusual items
- Operating income included a $4.4 million gain on sale of the former headquarters, sold in October 2018 for $10.0 million. The gain was $3.4 million after tax.
- FY2019 operating cash flow benefited from a $27.2 million improvement in working capital compared with FY2018; the prior year included elevated inventory associated with the manufacturing transition.
- The effective tax rate was 10.7%, compared with 49.8% in FY2018; discrete tax items affected both periods.
- Backlog was $39.8 million at year-end, versus $34.4 million a year earlier; management cautioned backlog is not necessarily indicative of future sales.
- Distributors, systems integrators and resellers accounted for 46.1% of consolidated revenue, down from 51.3%. No customer exceeded 10% of annual revenue, but one customer represented 14.7% of year-end receivables.
Outlook, risks and contingencies
Management gave no numerical revenue or earnings guidance. FY2020 priorities include SmartSense growth, new Products & Services introductions, strategic acquisitions and optimizing the outsourced manufacturing footprint. Management expects Solutions revenue to grow more significantly than the mature Products & Services business and expects recurring subscription revenue to support gross-margin improvement over time; these are expectations, not guarantees.
On November 7, 2019, after year-end, Digi agreed to acquire Opengear for approximately $140 million in cash, with up to $15 million of potential contingent consideration. The proposed financing includes cash on hand and a committed $150 million credit facility. Closing remained subject to routine conditions, including federal antitrust review; execution, financing, integration and debt-service risks are material considerations.
Key risks include intense competition and technology obsolescence, declining mature-product sales and margin pressure, dependence on project-based deployments and channel partners, outsourced manufacturing and single-source component supply, cybersecurity and cloud-service risks, and execution risks in the emerging SmartSense business. The company disclosed a Canadian lawsuit alleging defective products and damages of just over CAD 1.0 million; Digi intends to defend the claims and could not assess the likelihood or amount of loss. The filing also notes other claims and litigation that may have a material effect in a particular period. The independent auditor issued unqualified opinions on the financial statements and internal controls; management reported effective controls as of year-end.
Important facts for investors to verify
- Whether recurring SmartSense and Digi Remote Manager revenue can grow enough to improve margins, while Solutions remains operating-loss-making.
- How much FY2019 reported profitability depended on the headquarters gain, tax items and other adjustments; compare GAAP results with the company’s non-GAAP reconciliations.
- Whether the operating-cash-flow rebound is sustainable, given the large working-capital contribution and FY2018 cash outflow.
- Opengear’s closing, final purchase price, debt drawn under the facility, financing terms and post-acquisition performance.
- Progress in managing mature-product declines, customer deployment variability, supply-chain exposure and the disclosed lawsuit.