Digi International(DGII) - 2019 Q4 - Annual Report

Part I Item 1. Business Digi International Inc. offers IoT connectivity products and services through two segments, focusing on strategic growth and acquisitions - Digi operates through two segments: IoT Products & Services (hardware/platforms) and IoT Solutions (SmartSense™ monitoring services for various markets)[11][12][13] - The company's strategy targets modest growth for IoT Products & Services and significant revenue growth for IoT Solutions, supported by acquisitions[21][22] Recent Acquisitions (Fiscal 2015-2019) | Acquisition Date | Company Acquired | Business Focus | Segment | | :--- | :--- | :--- | :--- | | October 2015 | Bluenica Corporation | Temperature monitoring for food industry | IoT Solutions | | November 2016 | FreshTemp, LLC | Temperature monitoring and task management for retail/restaurants | IoT Solutions | | January 2017 | SMART Temps, LLC | Real-time temperature management for various sectors | IoT Solutions | | October 2017 | TempAlert, LLC | Temperature monitoring and task management solutions | IoT Solutions | | January 2018 | Accelerated Concepts, Inc. | Cellular (LTE) networking equipment | IoT Products & Services | Sales Channel Revenue Contribution | Sales Channel | FY 2019 | FY 2018 | FY 2017 | | :--- | :--- | :--- | :--- | | Distributors, Integrators, VARs | 46.1% | 51.3% | 61.6% | | Direct Sales Organization | 53.9% | 48.7% | 38.4% | - Manufacturing operations are outsourced to contract manufacturers in Thailand, China, Mexico, and Taiwan for cost reduction and production flexibility[42] - Backlog increased to $39.8 million as of September 30, 2019, up from $34.4 million, with most expected to ship in fiscal 2020[50] Item 1A. Risk Factors The company faces significant risks including intense competition, rapid technological change, supply chain disruptions, cybersecurity threats, and acquisition integration challenges - The company faces intense competition from established firms with superior resources, potentially leading to market share loss[64][65] - Rapid technological change and evolving industry standards can render products obsolete, requiring significant R&D investment[68][69] - Substantial revenue depends on channel partners, whose performance or prioritization of competitors' products could adversely affect results[79][80] - Gross margins may decline due to maturing hardware products, pricing pressures, and early-stage software/IoT solutions offerings[81] - Future acquisitions, like Opengear, Inc., pose risks including integration difficulties, unanticipated costs, and potential stockholder dilution[95][96] - Cybersecurity risks, particularly for cloud-based solutions like SmartSense by Digi™ and Digi Remote Manager®, could damage brand and incur costs/liability[101][102][103] - Dependence on third-party manufacturing and limited-source suppliers creates supply chain disruption risks, impacting customer relationships and profitability[118][120][121] Item 1B. Unresolved Staff Comments The company reports no unresolved staff comments from the SEC - There are no unresolved staff comments[161] Item 2. Properties The company's material properties as of September 30, 2019, include leased headquarters, an owned manufacturing facility, and other leased offices Material Property Locations (as of Sep 30, 2019) | Location | Use | Approx. Square Footage | Ownership/Lease Expiration | | :--- | :--- | :--- | :--- | | Hopkins, MN (HQ) | R&D, Sales, Marketing, Admin | 59,497 | Leased (Jan 2032) | | Eden Prairie, MN | Manufacturing & Warehousing | 58,000 | Owned | | Boston, MA | R&D, Sales, Marketing | 13,302 | Leased (Aug 2026) | | Mishawaka, IN | Sales, Support, Admin | 7,829 | Leased (Aug 2026) | Item 3. Legal Proceedings The company is subject to various claims and litigation in the normal course of business, with unpredictable outcomes - The company is subject to various claims and litigation in the normal course of business, including potential patent infringement claims[163] Item 4. Mine Safety Disclosures The company reports no mine safety disclosures - None[164] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on Nasdaq, has never paid dividends, and a $20.0 million share repurchase program expired unused - The company's common stock is listed on the Nasdaq Global Select Market under the symbol DGII[165] - Digi has never paid cash dividends and intends to retain earnings for business operations[166] - A $20.0 million share repurchase program authorized in April 2018 expired in May 2019 with no shares repurchased[168] Issuer Purchases of Equity Securities (Q4 FY2019) | Period | Total Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | Jul 1 - Jul 31, 2019 | 434 | $13.13 | | Aug 1 - Aug 31, 2019 | 1,114 | $12.84 | | Sep 1 - Sep 30, 2019 | 0 | N/A | | Total | 1,548 | $12.92 | All shares reported were forfeited by employees to satisfy tax withholding obligations related to the vesting of restricted stock units. Item 6. Selected Financial Data This section provides a five-year summary of selected financial data, including income statement and balance sheet figures, with restated data for revenue recognition Five-Year Selected Financial Data (in thousands, except per share data) | Metric | 2019 | 2018 (adjusted) | 2017 (adjusted) | 2016 | 2015 | | :--- | :--- | :--- | :--- | :--- | :--- | | Revenue | $254,203 | $226,893 | $181,340 | $203,005 | $203,847 | | Gross Profit | $119,035 | $109,054 | $87,233 | $99,680 | $97,121 | | Operating Income | $10,072 | $2,782 | $8,866 | $17,105 | $10,889 | | Net Income | $9,958 | $1,631 | $9,403 | $16,708 | $6,588 | | Diluted EPS | $0.35 | $0.06 | $0.35 | $0.64 | $0.26 | | Total Assets | $398,698 | $372,146 | $345,696 | $336,166 | $300,360 | | Stockholders' Equity | $348,978 | $330,493 | $319,029 | $300,029 | $274,938 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Fiscal 2019 saw consolidated revenue grow 12.0% to $254.2 million, with significant increases in operating income and cash flow from operations Fiscal 2019 Financial Summary | Metric | FY 2019 | FY 2018 | % Change | | :--- | :--- | :--- | :--- | | Consolidated Revenue | $254.2M | $226.9M | 12.0% | | Consolidated Gross Profit | $119.0M | $109.1M | 9.2% | | Consolidated Operating Income | $10.1M | $2.8M | 262.0% | | Net Income | $10.0M | $1.6M | 510.5% | | Diluted EPS | $0.35 | $0.06 | 483.3% | | Adjusted EBITDA | $26.5M | $23.4M | 13.2% | - Key fiscal 2020 objectives include growing SmartSense by Digi®, launching new IoT Products & Services, pursuing strategic acquisitions, and optimizing third-party manufacturing[185] - Gross margins are expected to increase as recurring subscription and cloud monitoring revenue grows as a proportion of total revenue[188] Revenue by Segment Fiscal 2019 revenue growth was driven by a 6.8% increase in IoT Products & Services and a 53.3% surge in IoT Solutions Revenue by Segment (FY 2019 vs. FY 2018) | Segment | FY 2019 Revenue | % of Total | FY 2018 Revenue | % of Total | % Change | | :--- | :--- | :--- | :--- | :--- | :--- | | IoT Products & Services | $215,287 | 84.7% | $201,506 | 88.8% | 6.8% | | IoT Solutions | $38,916 | 15.3% | $25,387 | 11.2% | 53.3% | | Total Revenue | $254,203 | 100.0% | $226,893 | 100.0% | 12.0% | - IoT Products & Services growth was driven by $5.4 million incremental revenue from the Accelerated acquisition and increased RF/embedded product demand[190] - The 53.3% growth in IoT Solutions resulted primarily from new customer deployments and expanded existing customer business[193] Cost of Goods Sold and Gross Profit by Segment IoT Products & Services gross margin decreased to 46.7%, while IoT Solutions margin improved to 47.6%, resulting in a slight overall decline Gross Profit by Segment (FY 2019 vs. FY 2018) | Segment | FY 2019 Gross Profit | Gross Margin % | FY 2018 Gross Profit | Gross Margin % | Margin Change (bps) | | :--- | :--- | :--- | :--- | :--- | :--- | | IoT Products & Services | $100,522 | 46.7% | $97,895 | 48.6% | (190) | | IoT Solutions | $18,513 | 47.6% | $11,159 | 44.0% | 360 | | Total Gross Profit | $119,035 | 46.8% | $109,054 | 48.1% | (130) | - The decrease in IoT Products & Services gross margin was primarily due to a product mix shift with lower high-margin network product sales[194] - The increase in IoT Solutions gross margin was driven by improved pricing and a higher mix of recurring subscription revenue[195] Liquidity and Capital Resources Fiscal 2019 liquidity improved significantly, with cash increasing by $34.8 million to $92.8 million, driven by strong operating cash flow Summary of Cash Flows (in thousands) | Activity | FY 2019 | FY 2018 (adjusted) | | :--- | :--- | :--- | | Net cash from operating activities | $28,964 | $(2,778) | | Net cash from investing activities | $5,511 | $(23,337) | | Net cash from financing activities | $1,113 | $5,827 | | Net increase (decrease) in cash | $34,778 | $(20,208) | - The significant increase in cash from operations was primarily due to a $27.2 million positive change in net working capital and an $8.3 million increase in net income[211] - The company believes current cash, operating cash flow, and financing capacity will fund operations and capital expenditures for the next twelve months and beyond[210] Critical Accounting Policies and Estimates Critical accounting policies requiring significant judgment include revenue recognition, inventory valuation, goodwill impairment, contingent consideration, and income taxes - Revenue Recognition: Revenue is recognized upon transfer of control, with transaction prices allocated based on standalone selling prices for multiple performance obligations[222][231] - Goodwill: Tested annually for impairment by comparing fair value to carrying value for each reporting unit; no impairment recorded in fiscal 2019[233][234][237] - Inventories: Valued at lower of cost (FIFO) or net realizable value, with reserves for excess/obsolete inventory based on demand assumptions[232] - Contingent Consideration: Liabilities from business combinations are measured at fair value using a probability-weighted discounted cash flow approach, with changes recognized in G&A expense[239] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company is exposed to foreign currency risk from international sales and translation, and credit risk from accounts receivable - The company faces foreign currency risk from foreign-denominated sales and subsidiary translation; a 10% change in key rates would impact annual revenue by 0.1%[246][247] - The company does not use derivative financial instruments for interest rate risk or a formal hedging strategy for foreign currency risk[245][246] - Credit risk from accounts receivable is managed by monitoring customer financial status and credit limits[248] Item 8. Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements and notes, with an unqualified opinion from Grant Thornton LLP - Grant Thornton LLP issued an unqualified opinion on the consolidated financial statements, confirming fair presentation in conformity with U.S. GAAP[252] - The auditor also issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of September 30, 2019[253] Consolidated Financial Statements The consolidated financial statements show fiscal 2019 revenues of $254.2 million, operating income of $10.1 million, and net income of $10.0 million Consolidated Statement of Operations Highlights (FY 2019, in thousands) | Line Item | Amount | | :--- | :--- | | Total Revenue | $254,203 | | Gross Profit | $119,035 | | Operating Income | $10,072 | | Net Income | $9,958 | | Diluted EPS | $0.35 | Consolidated Balance Sheet Highlights (as of Sep 30, 2019, in thousands) | Line Item | Amount | | :--- | :--- | | Cash and cash equivalents | $92,792 | | Total current assets | $192,547 | | Total assets | $398,698 | | Total current liabilities | $44,458 | | Total liabilities | $49,720 | | Total stockholders' equity | $348,978 | Notes to Consolidated Financial Statements The notes detail accounting policies, acquisitions, goodwill, segment information, income taxes, and the adoption of new revenue recognition standards - The company adopted the new revenue recognition standard, ASU 2014-09 (Topic 606), on October 1, 2018, retrospectively adjusting prior period financial statements[328][331] - In January 2018, Accelerated Concepts, Inc. was acquired for $16.4 million cash plus earn-outs; in October 2017, TempAlert LLC was acquired for $40.7 million cash plus earn-outs[339][342] - As of September 30, 2019, goodwill totaled $153.4 million, allocated $103.5 million to IoT Products & Services and $49.9 million to IoT Solutions, with no impairment recorded[353] - On November 7, 2019, the company agreed to acquire Opengear, Inc. for approximately $140 million cash, plus up to $15 million in contingent consideration[427] Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - None[429] Item 9A. Controls and Procedures Management concluded disclosure controls and internal control over financial reporting were effective as of September 30, 2019 - The CEO and CFO concluded that disclosure controls and procedures were effective as of September 30, 2019[432] - Management concluded that internal control over financial reporting was effective as of September 30, 2019, based on the COSO framework[434] - Grant Thornton LLP issued an unqualified opinion on the effectiveness of internal control over financial reporting as of September 30, 2019[435][439] - No material changes in internal control over financial reporting occurred during the fourth quarter of fiscal 2019[436] Item 9B. Other Information This section discloses the departure of the VP of Manufacturing Operations and related severance, with no replacement due to manufacturing transition - Jon A. Nyland, VP of Manufacturing Operations, resigned effective March 1, 2019, receiving $116,000 severance; the position was not filled due to manufacturing transition[445] Part III Item 10. Directors, Executive Officers and Corporate Governance This section provides executive officer information and incorporates by reference details on directors, corporate governance, and ethics codes - Information on directors and corporate governance is incorporated by reference from the 2020 Proxy Statement[446] - The company maintains a code of ethics for senior financial management and a code of conduct for all employees, available on its website[455] Item 11. Executive Compensation Executive and director compensation information is incorporated by reference from the 2020 Proxy Statement - Details on executive compensation are incorporated by reference from the 2020 Proxy Statement[456] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Security ownership and equity compensation plan details are incorporated by reference from the 2020 Proxy Statement - Details on security ownership and equity compensation plans are incorporated by reference from the 2020 Proxy Statement[457] Item 13. Certain Relationships and Related Transactions, and Director Independence Information on related party transactions and director independence is incorporated by reference from the 2020 Proxy Statement - Details on related transactions and director independence are incorporated by reference from the 2020 Proxy Statement[458] Item 14. Principal Accounting Fees and Services Information on principal accounting fees and services is incorporated by reference from the 2020 Proxy Statement - Details on principal accounting fees and services are incorporated by reference from the 2020 Proxy Statement[459] Part IV Item 15. Exhibits, Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed as part of the Form 10-K report - This section lists all financial statements, schedules, and exhibits filed with the annual report[461] - Key exhibits include governance documents, material contracts, and required CEO/CFO certifications[462][464][468] Item 16. Form 10-K Summary The company indicates that no Form 10-K summary is provided - None[471]