Digi International Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2017. Amounts are in U.S. dollars; financial figures below are in millions unless noted. The statements are unaudited.
Business context
Digi provides machine-to-machine (M2M) and Internet of Things connectivity products and services. It reports two segments: M2M, including hardware and related services, and Solutions, which provides subscription-based temperature and environmental monitoring and task-management services. Solutions expanded through acquisitions of FreshTemp and SMART Temps.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Revenue | $45.7 | $52.1 | $136.5 | $152.6 |
| Gross profit / margin | $22.5 / 49.2% | $26.0 / 49.8% | $65.8 / 48.2% | $75.1 / 49.2% |
| Operating income | $0.7 | $5.1 | $4.6 | $12.1 |
| Net income | $1.3 | $4.3 | $5.0 | $12.9 |
| Diluted EPS | $0.05 | $0.16 | $0.19 | $0.49 |
| Operating cash flow | Not presented quarterly | $(0.5) | $20.6 |
Q3 adjusted EBITDA from continuing operations, a non-GAAP measure, was $2.1 million (4.7% of revenue), versus $5.9 million (11.4%) a year earlier. The company cautions that this measure is not a substitute for GAAP results.
Material changes and segment trends
- Q3 revenue declined 12.3%; hardware revenue fell 19.6%, while services and solutions revenue increased 220.8% to $5.1 million. For the nine-month period, revenue declined 10.5%.
- Hardware weakness was broad, except cellular routers and gateways, which were essentially flat in Q3. Network products fell 33.4% in Q3, reflecting prior-year large customer sales and a longer-term decline in mature products. RF and embedded revenue also decreased.
- Solutions revenue rose to $2.9 million in Q3 and $4.9 million for nine months, primarily reflecting acquisitions. Digi said it was servicing more than 12,000 sites and that recurring revenue was growing. The segment remained loss-making: Q3 operating loss was $0.8 million; nine-month loss was $2.2 million.
- M2M revenue fell 17.4% in Q3 and 13.4% for nine months; operating income fell 73.0% and 48.8%, respectively. Lower revenue and a less favorable product mix weighed on gross profit.
- Q3 operating expenses included $2.5 million of restructuring charges. Digi consolidated France operations into its EMEA headquarters in Munich and eliminated 18 positions across France and the U.S.
Liquidity, cash flow and capital resources
- At June 30, cash and cash equivalents were $92.1 million and marketable securities totaled $19.2 million, including $2.0 million classified as long-term. Working capital was $154.7 million, down from $171.8 million at September 30, 2016.
- Cash from operations was negative $0.5 million for nine months, compared with positive $20.6 million in the prior-year period. Management attributed the decline principally to working-capital uses, including inventory and accrued liabilities.
- Investing cash flow was positive $14.0 million, including marketable-security maturities and sales, offset in part by $30.1 million of net acquisition spending. Financing cash flow was positive $2.8 million.
- The balance sheet lists no conventional borrowings. Total liabilities were $32.1 million, including $9.4 million of acquisition-related contingent consideration. Total stockholders’ equity was $311.6 million.
- Management expected fiscal 2017 capital expenditures of approximately $3.2 million, of which $1.6 million had been spent by June 30. It believed available liquidity, operating cash generation and potential access to financing would fund operations, possible acquisitions and capital expenditures for the next 12 months and beyond.
Outlook, risks and unusual items
- No specific revenue or earnings guidance was provided. Management expected mature network products to face continuing declines and pressure gross profit, while saying Solutions margins could improve as recurring revenue grows.
- Digi cited design wins and a growing pipeline for the cellular XBee and ConnectCore 6UL products, with production-related revenue expected to contribute in fiscal 2018.
- A June 2017 patent-infringement complaint by Weatherproof Wireless alleges infringement involving Digi public-safety access gateways and wireless router pods. Digi could not predict the outcome or estimate a loss range.
- Goodwill totaled $131.1 million. Annual impairment testing found estimated fair value exceeded carrying value by approximately 7% for M2M and 8% for Solutions; no impairment was recorded. A sustained decline in results or market value could lead to future impairment.
- Foreign currency movements reduced revenue by approximately $0.1 million in Q3 and $0.6 million for nine months versus the comparable periods. Digi did not have a formal foreign-currency hedging strategy.
- The Q3 tax benefit of $0.7 million primarily reflected reversal of tax reserves following statute-of-limitation expirations. Nine-month 2017 tax expense was $0.2 million, compared with $2.1 million in the prior-year period.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. It said risk factors had not materially changed from the prior annual report.
Important facts for investors to verify
- Whether M2M hardware demand stabilizes, particularly in mature network products, and whether new product design wins convert to meaningful production revenue in fiscal 2018.
- Whether Solutions recurring revenue and site growth translate into lower operating losses and improved margins, apart from acquisition-driven growth.
- The drivers and sustainability of negative operating cash flow, including inventory and accrued-liability movements.
- Progress integrating SMART Temps and FreshTemp, future acquisition-related earn-out payments, and the assumptions underlying contingent consideration.
- Developments in the Weatherproof Wireless litigation and any change in potential exposure.
- Whether reporting-period comparisons are affected by the prior-year Etherios discontinued-operation gain and by the different acquisition contribution in 2017.