Digi International Inc. — Q1 FY2018 Form 10-Q
Business context and reporting period. The filing covers the three months ended December 31, 2017, Digi’s first fiscal quarter of 2018. Digi provides IoT products, services and solutions through its IoT Products & Services and IoT Solutions segments. Results are unaudited; amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Revenue | $45.2 million | $45.2 million |
| Gross profit / margin | $21.9 million / 48.5% | $21.5 million / 47.5% |
| Operating income (loss) | $(2.1) million | $2.4 million |
| Net income (loss) | $(4.6) million; $(0.17) per diluted share | $2.4 million; $0.09 per diluted share |
| Adjusted EBITDA (non-GAAP) | $2.8 million; 6.2% of revenue | $5.4 million; 12.0% of revenue |
| Operating cash flow | $(1.3) million | $(2.0) million |
- Revenue mix: Hardware revenue fell 10.9% to $38.5 million; services and solutions revenue rose 236.8% to $6.7 million. Hardware was about 85% of total revenue.
- Margins and expenses: Gross margin improved by 1.0 percentage point, but operating expenses increased 26.4% to $24.1 million. Higher acquisition-related costs and expenses from acquired businesses contributed to the operating loss.
- Cash and liquidity: At December 31, cash and cash equivalents were $45.6 million, current marketable securities $28.2 million, and long-term marketable securities $4.2 million. Working capital was $116.6 million, versus $156.4 million at September 30, 2017. Cash and cash equivalents declined $32.6 million during the quarter, primarily reflecting the TempAlert acquisition.
- Investing and financing: Investing activities used $34.2 million, including $40.1 million for acquisitions, net of cash acquired. Financing activities provided $2.7 million, including stock-option and employee stock purchase plan proceeds. The balance sheet reports no borrowings or other debt balance.
- Other balance-sheet changes: Goodwill rose to $149.3 million from $132.0 million, and identifiable intangible assets rose to $34.5 million from $11.8 million, mainly reflecting TempAlert. Current liabilities increased to $23.5 million from $18.0 million, including higher unearned revenue and contingent consideration.
Material changes and management commentary
- Total revenue was nearly unchanged year over year. IoT Products & Services revenue declined 9.0% to $40.9 million, while IoT Solutions revenue increased to $4.3 million from $0.2 million. The Solutions comparison reflects acquisitions, including TempAlert and SMART Temps.
- Within hardware, RF revenue increased 32.1% to $8.7 million. Cellular routers and gateways declined 30.4% to $9.6 million, partly because the prior-year quarter included a large customer sale. Embedded revenue fell 6.6%; network revenue fell 17.0%.
- Management described most network products as mature and said it expects network revenue, absent unusual customer changes, to decline approximately 10%–15% annually. It noted design wins and a growing pipeline for the ConnectCore 6UL, with production-volume revenue expected later in the fiscal year.
- IoT Solutions served more than 38,000 sites, and management said recurring revenue continued to grow. It expects Solutions gross margin to increase as recurring revenue expands; service margins can vary with personnel utilization.
- Management reported that cellular product revenue is affected by large, award-based customer projects and can fluctuate from period to period. It also cited ongoing challenges for mature embedded products.
Outlook, acquisitions, risks and unusual items
- Digi anticipated approximately $2.2 million of capital expenditures for fiscal 2018, of which $0.5 million had been spent by December 31. Management said cash, securities, expected operating cash generation and potential access to financing should fund operations, possible acquisitions and capital expenditures for the next 12 months and beyond.
- In October 2017, Digi acquired TempAlert for a stated purchase price of $45.0 million, subject to working-capital adjustments; $40.7 million, net of cash acquired, was paid at closing. TempAlert contributed $2.1 million of revenue and a $1.1 million net loss from its acquisition date through quarter-end. Its purchase-price allocation was preliminary.
- After quarter-end, Digi acquired Accelerated Concepts for $16.8 million in cash at closing, plus future earn-out payments. This subsequent acquisition is not reflected in the December 31 balance sheet.
- The quarter included a $2.6 million income-tax provision despite a pretax loss. Digi recorded provisional tax effects related to the Tax Cuts and Jobs Act, including a $2.5 million deferred-tax remeasurement and a $0.1 million transition-tax provision, and recorded $0.5 million of tax expense related to share-based compensation accounting. The company said its accounting for the new tax law was incomplete and estimates could change.
- Digi reported $1.5 million of acquisition expense in its Adjusted EBITDA reconciliation. Adjusted EBITDA is a non-GAAP measure and should be considered alongside GAAP results, not as a substitute.
- Risks highlighted include intense competition, technology changes, pricing pressure, reliance on distributors, product-development and customer-acceptance uncertainty, product defects, acquisition integration and benefit realization, foreign-exchange exposure, and fluctuations in demand and profitability. Digi had not implemented a formal foreign-currency hedging strategy. The filing says there were no material changes to previously disclosed risk factors and no material changes in internal control over financial reporting; TempAlert was excluded from the controls assessment as permitted for a recently acquired business.
- Contingent consideration was $6.0 million at quarter-end, measured using Level 3 inputs and estimates of revenue-target achievement. Digi also disclosed ordinary-course claims and litigation but did not identify a specific proceeding or quantify a potential loss.
Important facts for investors to verify
- Whether the acquisition-driven growth in services and solutions can persist and improve segment profitability, given the IoT Solutions operating loss of $3.4 million.
- Whether hardware declines—particularly in cellular and mature network products—continue, and whether ConnectCore 6UL design wins convert to production revenue as management expected.
- How final tax-law accounting changes the reported tax expense, deferred-tax balances and effective tax rate.
- The final TempAlert purchase-price allocation, earn-out exposure, integration costs and contribution to recurring revenue; also the financial impact of the post-quarter Accelerated Concepts acquisition.
- Whether operating cash flow improves and liquidity remains adequate after acquisition spending; quarter-end cash and securities should be distinguished from cash remaining after the subsequent acquisition.
- The assumptions underlying contingent consideration and goodwill valuations, and any changes in customer demand, market capitalization or forecasts that could trigger impairment.