Digi International Inc. — Q3 FY2020 Form 10-Q
Reporting period: Three and nine months ended June 30, 2020. Amounts below are U.S. dollars; financial statement amounts are in millions unless noted.
Business context
Digi provides IoT connectivity products, services and solutions through its IoT Products & Services and IoT Solutions segments. Results include Opengear, acquired December 13, 2019, within IoT Products & Services.
Key financial metrics
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Revenue | $70.3 | $61.2 | $206.1 | $189.2 |
| Gross profit / margin | $37.3 / 53.1% | $28.3 / 46.3% | $106.5 / 51.7% | $88.4 / 46.7% |
| Operating income / margin | $2.9 / 4.1% | $1.6 / 2.7% | $6.1 / 3.0% | $8.0 / 4.2% |
| Net income | $1.8 | $1.6 | $4.0 | $7.7 |
| Diluted EPS | $0.06 | $0.06 | $0.13 | $0.27 |
| Adjusted EBITDA (non-GAAP) | $10.5; 15.0% of revenue | $6.1; 10.0% | $28.1; 13.6% | $18.8; 10.0% |
| Adjusted net income (non-GAAP) | $6.6; $0.23 diluted EPS | $4.6; $0.16 | $19.3; $0.66 | $13.9; $0.49 |
Liquidity and debt at June 30, 2020: Cash and equivalents were $55.1, versus $92.8 at September 30, 2019. Current assets were $166.5 and current liabilities $50.3 (approximately 3.3x current ratio). Credit-facility borrowings totaled $78.8 gross—$48.8 term loan and $30.0 revolver—with $70.0 of revolving capacity available. The company reported compliance with debt covenants. Gross debt less cash was approximately $23.7.
Cash flow: For the nine months, operating cash flow was $19.2 (prior year $22.5); investing cash flow was negative $136.8, including $136.1 net cash paid for Opengear; financing cash flow was positive $78.2. Cash declined $37.7 over the period.
Material changes versus prior comparable periods
- Q3 revenue rose 15.0%, driven by 25.7% growth in IoT Products & Services, including Opengear and stronger embedded-module sales. IoT Solutions revenue fell 35.6%, reflecting COVID-related rollout delays and prior-year enterprise deals that did not recur.
- Q3 gross margin expanded 6.8 percentage points, primarily from Opengear’s higher-margin contribution and increased support-services sales. Operating expenses rose 29.2%, including acquisition-related costs and incremental Opengear expenses.
- Q3 GAAP net income increased modestly; for the nine months, net income fell to $4.0 from $7.7, while operating income declined to $6.1 from $8.0. Nine-month results included higher amortization and acquisition-related interest expense; prior-year results included a $4.4 gain on sale of the former headquarters building.
- Opengear increased goodwill to $206.7 from $153.4 and intangible assets to $125.2 from $30.7. Its purchase-price allocation remained preliminary.
Outlook, commentary, risks and unusual items
- Management expects positive operating cash flows and believes cash, operating cash generation and available credit will fund operations and capital expenditures for the next 12 months and beyond. No quantified revenue or earnings guidance is provided.
- COVID-19 effects remain uncertain. Some product categories experienced increased demand, while customers in areas including hospitality, entertainment and retail reduced or delayed purchases. Management cited no material supply-chain disruption to date, but warned conditions could change.
- Cost actions included hiring and discretionary-spending limits, reduced capital spending and travel, elimination of 21 positions, suspension of U.S. and Canadian retirement-plan matching, and temporary 10% cash-compensation reductions for directors and executives in exchange for equity.
- The company repaid a $9.0 PPP loan plus interest on May 4, 2020. It also paid acquisition earn-outs, including the final installments for Bluenica and Accelerated Concepts; $4.2 remained recorded for Opengear contingent consideration.
- Annual goodwill testing at June 30 found estimated fair value exceeded carrying value by more than 10% for each reporting unit. Future underperformance, COVID-related demand impacts or a sustained stock-price decline could result in impairment.
- A Canadian lawsuit alleges Digi products caused street-light malfunctions and seeks just over CAD 1.0 million. Digi intends to defend the claim; the filing says potential loss cannot currently be assessed.
- Management reported effective disclosure controls. Opengear, representing 33% of consolidated assets, was excluded from the current internal-control assessment; inclusion is expected beginning Q1 FY2021.
Investor verification points
- Reconcile management’s statement that Q3 operating cash flow was $31.8 with the cash-flow statement, which reports $19.2 for the nine months; the filing does not present a quarterly cash-flow statement.
- Assess the durability of IoT Products & Services growth and the recovery of IoT Solutions after substantial COVID-related declines.
- Review Opengear’s contribution, integration progress, preliminary purchase-price allocation, earn-out assumptions and acquisition-related costs.
- Monitor cash conversion and working-capital movements, debt service and covenant headroom, and the effect of variable interest rates.
- Track goodwill impairment assumptions and the outcome or potential exposure from the DimOnOff litigation.