Digi International(DGII) - 2020 Q1 - Quarterly Report

PART I. FINANCIAL INFORMATION Financial Statements Digi International reported flat revenue, a net income decline, and balance sheet growth driven by the Opengear acquisition and new debt Condensed Consolidated Statements of Operations (Unaudited) | Metric | Three months ended Dec 31, 2019 (in thousands) | Three months ended Dec 31, 2018 (in thousands) | | :--- | :--- | :--- | | Total Revenue | $62,317 | $62,313 | | Gross Profit | $30,464 | $29,783 | | Operating (Loss) Income | $(483) | $5,558 | | Net Income | $208 | $4,682 | | Diluted EPS | $0.01 | $0.17 | Condensed Consolidated Balance Sheets (Unaudited) | Metric | Dec 31, 2019 (in thousands) | Sep 30, 2019 (in thousands) | | :--- | :--- | :--- | | Cash and cash equivalents | $49,072 | $92,792 | | Total Assets | $560,904 | $398,698 | | Long-term debt | $105,470 | $0 | | Total Liabilities | $204,589 | $49,720 | | Total Stockholders' Equity | $356,315 | $348,978 | Condensed Consolidated Statements of Cash Flows (Unaudited) | Metric | Three months ended Dec 31, 2019 (in thousands) | Three months ended Dec 31, 2018 (in thousands) | | :--- | :--- | :--- | | Net cash (used in) provided by operating activities | $(22,067) | $6,111 | | Net cash (used in) provided by investing activities | $(136,294) | $8,763 | | Net cash provided by (used in) financing activities | $112,869 | $(174) | | Net (decrease) increase in cash | $(43,720) | $14,208 | - The company adopted the new lease accounting standard (ASU 2016-02) in the first quarter of fiscal 2020, resulting in the recognition of a right-of-use asset of approximately $14.1 million and a lease liability of approximately $17.9 million on the balance sheet[25][26] Note 2: Acquisitions - On December 13, 2019, the company acquired Opengear, Inc., a provider of secure IT infrastructure products, funded with $148.1 million in cash from cash on hand and a new credit facility[30][31] - The acquisition includes contingent consideration based on Opengear's revenue performance, with potential earn-out payments not to exceed $5.0 million for the period ended Dec 31, 2019, and $10.0 million for the period ending Dec 31, 2020, with the fair value estimated at $9.1 million[31] Preliminary Purchase Price Allocation for Opengear (in thousands) | Item | Fair Value (in thousands) | | :--- | :--- | | Fair value of net tangible assets acquired | $19,032 | | Customer relationships | $81,000 | | Purchased and core technology | $13,700 | | Trademarks | $8,000 | | Deferred tax liability | $(25,053) | | Goodwill | $60,479 | | Total | $157,158 | Note 6: Goodwill and Other Intangible Assets - Total goodwill increased from $153.4 million at September 30, 2019, to $214.8 million at December 31, 2019, primarily due to $60.5 million in goodwill from the Opengear acquisition, allocated to the IoT Products & Services segment[51] - Net amortizable intangible assets increased significantly from $30.7 million to $131.0 million during the quarter, mainly due to the addition of customer relationships, technology, and trademarks from the Opengear acquisition[47] Note 8: Segment Information Segment Revenue and Operating Income (in thousands) | Segment | Revenue (Q1'20, in thousands) | Revenue (Q1'19, in thousands) | Operating Income (Q1'20, in thousands) | Operating Income (Q1'19, in thousands) | | :--- | :--- | :--- | :--- | :--- | | IoT Products & Services | $54,613 | $53,294 | $2,388 | $7,402 | | IoT Solutions | $7,704 | $9,019 | $(2,871) | $(1,844) | | Total | $62,317 | $62,313 | $(483) | $5,558 | Note 9: Revenue Revenue by Geographic Location (in thousands) | Region | Three months ended Dec 31, 2019 (in thousands) | Three months ended Dec 31, 2018 (in thousands) | | :--- | :--- | :--- | | North America | $47,536 | $46,335 | | Europe, Middle East & Africa | $8,516 | $10,104 | | Rest of world | $6,265 | $5,874 | | Total Revenue | $62,317 | $62,313 | - As of December 31, 2019, the company has approximately $13.2 million of revenue expected to be recognized from remaining performance obligations for subscription contracts, with $8.4 million expected over the next twelve months[64] Note 13: Debt - In connection with the Opengear acquisition, the company entered into a new credit agreement on December 13, 2019, for a total of $150 million, consisting of a $50 million term loan and a $100 million revolving loan[77] Long-Term Indebtedness at Dec 31, 2019 (in thousands) | Component | Amount (in thousands) | | :--- | :--- | | Revolving loan | $60,000 | | Term loan | $50,000 | | Total loans | $110,000 | | Less unamortized issuance costs | $(2,558) | | Less current maturities | $(1,972) | | Total long-term debt, net | $105,470 | - The credit facility contains financial covenants requiring the company to maintain a maximum debt-to-EBITDA ratio and a minimum interest expense-to-EBITDA ratio, with compliance as of December 31, 2019[81][83] Management's Discussion and Analysis of Financial Condition and Results of Operations Management reported flat consolidated revenue, an operating loss due to surging expenses from acquisition costs and a prior-year gain, with liquidity significantly impacted by the Opengear acquisition and new debt Overview - The company operates through two segments: IoT Products & Services and IoT Solutions, with the IoT Products & Services segment recently expanded by the Opengear acquisition on December 13, 2019[111][112][113] - Key operating objectives for fiscal 2020 include growing the SmartSense by Digi® business, driving growth in the IoT Products & Services segment with new products, seeking further strategic acquisitions, and optimizing the manufacturing footprint[117] Key Financial Metrics (Q1 FY20 vs Q1 FY19) | Metric | Q1 FY2020 | Q1 FY2019 | | :--- | :--- | :--- | | Consolidated Revenue | $62.3M (flat) | $62.3M | | Gross Margin | 48.9% | 47.8% | | Net Income | $0.2M | $4.7M | | Diluted EPS | $0.01 | $0.17 | | Adjusted EBITDA | $6.4M (10.3% of revenue) | $6.2M (9.9% of revenue) | Revenue by Segment Analysis - IoT Products & Services revenue increased by 2.5% year-over-year, driven by sales of cellular products, incremental revenue from the Opengear acquisition, and increased sales of Digi Remote Manager® and support services[125][126][127] - IoT Solutions revenue decreased by 14.6% year-over-year, primarily due to large, non-recurring product purchases from existing customers in fiscal 2019, partially offset by an increase in recurring subscription revenue[128][129] Operating Expenses Analysis - Total operating expenses increased by $6.7 million (27.7%) year-over-year, primarily due to a $4.4 million gain on the sale of the corporate headquarters in the prior-year quarter, a $2.0 million increase in acquisition costs related to Opengear, and incremental operating expenses from the newly acquired Opengear business[134] Liquidity and Capital Resources - Cash flows from operating activities decreased by $28.2 million, resulting in a net use of $22.1 million, primarily due to negative changes in working capital and lower net income[145] - Cash used in investing activities was $136.3 million, a significant increase from the $8.8 million provided in the prior year, mainly due to the $136.1 million net cash used for the Opengear acquisition[146] - Cash from financing activities was $112.9 million, driven by $110.0 million in proceeds from new debt taken on to fund the Opengear acquisition[147] Quantitative and Qualitative Disclosures About Market Risk The company is exposed to interest rate risk from its new $110 million variable-rate credit facility, where a 25 basis point change would impact annual interest expense by $0.3 million, and foreign currency risk from transactions in Euros, British Pounds, Japanese Yen, and Canadian Dollars, though a 10% change in key foreign exchange rates would have a minimal 0.1% impact on revenue - The company is exposed to interest rate risk on its new Credit Facility, where with $110 million outstanding as of December 31, 2019, a 25 basis point change in interest rates would change annualized interest expense by approximately $0.3 million[153] - The company has foreign currency transaction and translation risk, primarily from sales denominated in Euros and Canadian Dollars, where a hypothetical 10% change in average exchange rates for key foreign currencies would have resulted in a 0.1% change in revenue for the quarter[154][157] Controls and Procedures Management, including the CEO and CFO, evaluated the company's disclosure controls and procedures as of December 31, 2019, and concluded they were effective, with no material changes to internal control over financial reporting during the quarter - The Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report[160] - There were no changes in internal control over financial reporting during the quarter that have materially affected, or are reasonably likely to affect, internal controls[161] PART II. OTHER INFORMATION Legal Proceedings The company is involved in a lawsuit filed by DimOnOff Inc. in Quebec, Canada, which alleges that certain Digi products were defective, causing street light malfunctions, with DimOnOff claiming damages of just over CAD 1.0 million, which Digi intends to defend against - The company is being sued by DimOnOff Inc. in Quebec, Canada, over allegedly defective products used in street lighting systems, with the plaintiff alleging damages of approximately CAD 1.0 million[85][163] Risk Factors The company has identified new material risk factors, including its new credit facility where failure to comply with financial covenants could lead to default, and the potential adverse impact of health epidemics, such as the novel coronavirus, on its international sales, supply chain, and customer demand - A new risk factor has been added regarding the credit facility entered into in December 2019, where failure to comply with financial covenants could result in a default, potentially having a material adverse effect on the business[164][166] - The company has identified risks related to health epidemics, such as the novel coronavirus, which could disrupt operations, supply chains, and customer facilities, negatively impacting sales and operating results[167][168] Unregistered Sales of Equity Securities and Use of Proceeds During the first quarter of fiscal 2020, the company repurchased a total of 88,723 shares of its common stock at an average price of $17.77 per share, which were not part of a publicly announced program Common Stock Purchases (Q1 FY2020) | Period | Total Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | Oct 2019 | 766 | $14.42 | | Nov 2019 | 65,268 | $17.97 | | Dec 2019 | 22,689 | $17.32 | | Total | 88,723 | $17.77 | Exhibits This section lists the exhibits filed with the Form 10-Q, including the merger agreement for the Opengear acquisition, the new credit agreement, and officer certifications, with most documents incorporated by reference from previous filings