What changed in this filing

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Item 7. Management’s Discussion and Analysis

2020-11-25 compared with 2019-11-27 · 148 added, 158 removed, 206 unchanged (60% of the section changed)

6 unchanged sentences

All statements, other than statements of historical fact are forward-looking statements.

Words such as "assume," "believe," "anticipate," "intend," "estimate," "target," "may," "will," "expect," "plan," "project," "should," or "continue" or the negative thereof or other expressions, which are predictions of or indicate future events and trends and which do not relate to historical matters, identify forward-looking statements.

Among other items, these statements relate to expectations of the business environment in which the company operates, projections of future performance, perceived marketplace opportunities and statements regarding our mission and vision.

Words such as "assume," "believe," "anticipate," "intend," "estimate," "target," "may," "will," "expect," "plan," "potential," "project," "should," or "continue" or the negative thereof or other expressions, which are predictions of or indicate future events and trends and which do not relate to historical matters, identify forward-looking statements.

Among other items, these statements relate to expectations of the business environment in which Digi operates, projections of future performance, perceived marketplace opportunities and statements regarding our mission and vision.

Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions.

Among others, these include risks related to the highly competitive market in which our company operates, rapid changes in technologies that may displace products sold by us, declining prices of networking products, our reliance on distributors and other third parties to sell our products, the potential for significant purchase orders to be canceled or changed, delays in product development efforts, uncertainty in user acceptance of our products, the ability to integrate our products and services with those of other parties in a commercially accepted manner, potential liabilities that can arise if any of our products have design or manufacturing defects, our ability to defend or settle satisfactorily any litigation, uncertainty in global economic conditions and economic conditions within particular regions of the world which could negatively affect product demand and the financial solvency of customers and suppliers, the impact of natural disasters and other events beyond our control that could negatively impact our supply chain and customers, potential unintended consequences associated with restructuring or other similar business initiatives that may impact our ability to retain important employees, our ability to close the pending acquisition of Opengear, Inc.

that was recently announced, the ability to achieve the anticipated benefits and synergies associated with the pending acquisition or other acquisitions or divestitures, and changes in our level of revenue or profitability which can fluctuate for many reasons beyond our control.

These and other risks, uncertainties and assumptions identified from time to time in our filings with the United States Securities and Exchange Commission, including without limitation, those described in Item 1A, Risk Factors, of this Form 10-K and subsequent quarterly reports of Form 10-Q and other filings, could cause our future results to differ materially from those expressed in any forward-looking statements made by us or on our behalf.

Among others, these include risks related to the ongoing COVID-19 pandemic and efforts to mitigate the same, risks related to the global economic downturn that commenced during the COVID-19 pandemic and the ability of companies like us to operate a global business in such conditions, the highly competitive market in which our company operates, rapid changes in technologies that may displace products sold by us, declining prices of networking products, our reliance on distributors and other third parties to sell our products, the potential for significant purchase orders to be canceled or changed, delays in product development efforts, uncertainty in user acceptance of our products, the ability to integrate our products and services with those of other parties in a commercially accepted manner, potential liabilities that can arise if any of our products have design or manufacturing defects, our ability to defend or settle satisfactorily any litigation, uncertainty in global economic conditions and economic conditions within particular regions of the world which could negatively affect product demand and the financial solvency of customers and suppliers, the impact of natural disasters and other events beyond our control that could negatively impact our supply chain and customers, potential unintended consequences associated with restructuring, reorganizations or other similar business initiatives that may impact our ability to retain important employees or otherwise impact our operations in unintended and adverse ways, the ability to achieve the anticipated benefits and synergies associated with acquisitions or divestitures and changes in our level of revenue or profitability which can fluctuate for many reasons beyond our control.

These and other risks, uncertainties and assumptions identified from time to time in our filings with the United States Securities and Exchange Commission, including without limitation, those set forth in Item 1A, Risk Factors, of this Annual Report on Form 10-K and subsequent other quarterly filings on Form 10-Q and other filings, could cause our actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf.

Many of such factors are beyond our ability to control or predict.

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This report includes adjusted net income, adjusted net income per diluted share and adjusted earnings before interest, taxes and amortization ("adjusted EBITDA"), each of which is a non-GAAP financial measure.

We understand that there are material limitations on the use of non-GAAP measures.

Non-GAAP measures are not substitutes for GAAP measures, such as net income, for the purpose of analyzing financial performance.

The disclosure of these measures does not reflect all charges and gains that were actually recognized by the company.

Non-GAAP measures are not substitutes for GAAP measures for the purpose of analyzing financial performance.

The disclosure of these measures does not reflect all charges and gains that were actually recognized by Digi.

These non-GAAP measures are not in accordance with, or, an alternative for measures prepared in accordance with GAAP and may be different from non-GAAP measures used by other companies or presented by us in prior reports.

In addition, these non-GAAP measures are not based on any comprehensive set of accounting rules or principles.

We believe that non-GAAP measures have limitations in that they do not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP and that these measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP measures.

We believe that non-GAAP measures have limitations in that they do not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP.

We believe these measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP measures.

Additionally, Adjusted EBITDA does not reflect our cash expenditures, the cash requirements for the replacement of depreciated and amortized assets, or changes in or cash requirements for our working capital needs.

We believe that providing historical and adjusted net income and adjusted net income per diluted share, respectively, exclusive of such items as reversals of tax reserves, discrete tax benefits, restructuring charges and reversals, intangible amortization,

stock-based compensation, other non-operating income/expense, adjustments to estimates of contingent consideration and acquisition-related expenses permits investors to compare results with prior periods that did not include these items.

We believe that providing historical and adjusted net income and adjusted net income per diluted share, respectively, exclusive

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

of such items as reversals of tax reserves, discrete tax benefits, restructuring charges and reversals, intangible amortization, stock-based compensation, other non-operating income/expense, adjustments to estimates of contingent consideration, acquisition-related expenses, interest expense related to acquisition and gains from the disposition of our former corporate headquarters permits investors to compare results with prior periods that did not include these items.

Management uses the aforementioned non-GAAP measures to monitor and evaluate ongoing operating results and trends and to gain an understanding of our comparative operating performance.

In addition, certain of our stockholders have expressed an interest in seeing financial performance measures exclusive of the impact of these matters, which while important, are not central to the core operations of our business.

Management believes that Adjusted EBITDA, defined as EBITDA adjusted for stock-based compensation expense, acquisition-related expenses, restructuring charges and recoveries, and gains from the disposition of our former corporate headquarters is useful to investors to evaluate the Company’s core operating results and financial performance because it excludes items that are significant non-cash or non-recurring expenses reflected in the Consolidated Statements of Operations.

Management believes that Adjusted EBITDA, defined as EBITDA adjusted for stock-based compensation expense, acquisition-related expenses, restructuring charges and reversals, and gains from the disposition of our former corporate headquarters is useful to investors to evaluate our core operating results and financial performance because it excludes items that are significant non-cash or non-recurring expenses reflected in the Consolidated Statements of Operations.

We believe that the presentation of Adjusted EBITDA as a percentage of revenue is useful because it provides a reliable and consistent approach to measuring our performance from year to year and in assessing our performance against that of other companies.

We believe this information helps compare operating results and corporate performance exclusive of the impact of our capital structure and the method by which assets were acquired.

We are a leading global provider of business and mission-critical and Internet-of-Things ("IoT") connectivity products, services and solutions comprised of two reporting segments:

We are a leading global provider of business and mission-critical and Internet-of-Things ("IoT") connectivity products, services and solutions.

Our business is comprised of two reporting segments:

IoT Products & Services and IoT Solutions.

In fiscal 2020, our key operating objectives include the following:

In fiscal 2021, our key operating objectives include:

• continued growth of our SmartSense by Digi ® business that is the base of our IoT Solutions segment;

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• optimizing our reduced fixed cost footprint with third-party manufacturing.

Fiscal 2019 summary of results:

Below is a summary of our fiscal 2020 results:

• Consolidated revenue was $279.3 million, an increase of 9.9% over fiscal 2019.

This increase was driven by growth in our IoT Solutions segment and incremental revenue from our January 2018 acquisition of Accelerated, as well as increased sales to existing customers and significant new customers and new product introductions.

A decrease in sales of our terminal servers in our network product category due to the loss of a significant customer partially offset this increase.

This increase was driven by incremental revenue from our December 2019 acquisition of Opengear.

This was partially offset by large sales to certain customers in the prior year that did not reoccur in fiscal 2020 for our RF products, infrastructure management and cellular products.

In addition, revenues from Smartsense by Digi ® declined due to delays in customer rollouts, expansions and equipment upgrades largely as a result of COVID-19.

• Consolidated gross profit was $144.0 million, an increase of 20.9% percent over fiscal 2019.

This increase was driven by increased revenue and incremental gross profit from our January 2018 acquisition of Accelerated.

This increase was driven by increased revenue and incremental gross profit from our December 2019 acquisition of Opengear.

This increase was partially offset by unfavorable customer and product mix.

• Consolidated operating income was $11.3 million, an increase of 12.4% percent.

This increase largely was driven by increased revenue and gain on the sale of our corporate headquarters building, partially offset by an increase in operating expenses due to increased headcount and occupancy expenses.

Net income was $10.0 million, compared to net income of $1.6 million for fiscal 2018.

Diluted earnings per share was $0.35, compared to $0.06, an increase of 483.3%.

• Net income was $8.4 million, compared to net income of $10.0 million for fiscal 2019, a decrease of 15.5%.

• Diluted earnings per share was $0.28, compared to $0.35, a decrease of 20%.

Included in fiscal 2019 was a gain on the sale of our corporate headquarters building that contributed $0.12 (net of tax) per diluted share.

• Adjusted EBITDA was $40.2 million, or, 14.4% of revenue, compared to $26.5 million or 10.4% of revenue in fiscal 2019.

Adjusted net income and adjusted income per share was $18.7 million, or $0.65 per diluted share, compared to $16.8 million, or $0.61 per diluted share, an increase of 11.4%.

• Adjusted net income and adjusted income per share were $29.0 million, or $0.98 per diluted share, compared to $19.0 million, or $0.66 per diluted share, an increase of 52.7%.

Key trends regarding our existing business

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• We believe the market for IoT products and related services is in the midst of a long-term expansion.

We believe our IoT Products & Services business is positioned for modest revenue and profitability growth and that our IoT Solutions business is positioned for more significant revenue growth given the large total addressable market for condition monitoring and asset tracking services that is in earlier stages of adoption.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

As recurring revenue from subscription and device cloud monitoring services becomes a greater portion of our overall revenue, we expect gross margins to increase as the revenue of incremental subscriptions is not offset at the same rate as expected increases in costs associated with implementing new subscribers.

During fiscal 2018, we restructured our manufacturing operations to become more reliant on third parties.

We expect this restructuring will provide increased gross margins over time.

We expect revenues from our network product offerings within our IoT Products & Services business will decrease over time as many of these products are in the mature phase of their product life cycles.

We believe our IoT Products & Services business is positioned for modest revenue and profitability growth and that our IoT Solutions

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

business is positioned for more significant revenue growth given the large total addressable market for condition monitoring and asset tracking services that is in earlier stages of adoption.

• As recurring revenue from subscription and cloud monitoring services becomes a greater portion of our overall revenue, we expect gross margins to increase as the revenue of incremental subscriptions is not offset at the same rate as expected increases in costs associated with implementing new subscribers.

• We expect revenues from our infrastructure product offerings within our IoT Products & Services business will decrease over time as many of these products are in the mature phase of their product life cycles.

CONSOLIDATED RESULTS OF OPERATIONS

The following table sets forth selected information derived from our Consolidated Statements of Operations, expressed as a percentage of revenue and as a percentage of change from year-to-year for the years indicated:

Year ended September 30,

% Increase (decrease)

($ in thousands)

(as adjusted)*

Year ended September 30, % Increase (decrease)

2020 2019 2020 compared to 2019

Revenue 100.0 100.0 9.9

Cost of sales 48.4 53.2 0.1

Gross profit 51.6 46.8 20.9

Operating expenses 47.5 42.8 21.7

Operating income 4.1 4.0 12.4

Other income (expense), net

Other (expense) income, net (1.4) 0.4 (459.2)

Income before income taxes 2.7 4.4 (33.0)

Income tax provision

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

REVENUE BY SEGMENT

Income tax (benefit) expense (0.3) 0.5 (179.9)

Net income 3.0 % 3.9 % (15.5)

Year ended September 30,

($ in thousands)

(as adjusted)*

% Increase (decrease)

($ in thousands) 2020 2019 % Increase (decrease)

IoT Products & Services $ 249,530 89.4 % $ 215,287 84.7 % 15.9

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Total revenue $ 279,271 100.0 % $ 254,203 100.0 % 9.9

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

The 15.9% increase in IoT Products & Services revenue in fiscal 2020 from fiscal 2019 primarily was the result of:

$5.4 million of incremental revenue from Accelerated, which we acquired in January 2018 (see Note 2 to our consolidated financial statements);

increased sales of our RF and embedded product categories due to increased customer demand, some significant new customers and introductions of some new products;

increased sales of our Digi Remote Manager ® and support services.

• incremental revenue from Opengear, which we acquired in December 2019 (see Note 2 to our consolidated financial statements);

• increased sales of our support services.

This increase partially was offset by:

decreased sales of our terminal servers in our network product category to a significant customer;

• large sales to certain customers in the prior year that did not reoccur in fiscal 2020 for our RF products, infrastructure management and cellular products.

This segment has many large project-based customer deployments that were deferred or delayed due to the COVID-19 pandemic;

• decreased sales of our wireless design services.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

The 53.3% percent increase in IoT Solutions revenue in fiscal 2019 from fiscal 2018 primarily was the result of:

new customer deployments and additional product purchases from existing customers.

COST OF GOODS SOLD AND GROSS PROFIT BY SEGMENT

Year ended September 30,

Basis point increase (decrease)

The 23.6% percent decrease in IoT Solutions revenue in fiscal 2020 from fiscal 2019 primarily was the result of:

• delays in customer rollouts, expansions and equipment upgrades which occurred primarily as a result of COVID-19 and the economic downturn;

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

• large enterprise deals in fiscal 2019 that did not reoccur in fiscal 2020;

• equipment upgrades from existing customers in fiscal 2019 that did not reoccur in fiscal 2020.

This decrease partially was offset by:

• increase in recurring revenue from our subscription services as we served over 70,000 sites at September 30, 2020 compared to just over 63,000 sites at September 30, 2019.

COST OF GOODS SOLD AND GROSS PROFIT

Below are our segments' cost of goods sold and gross profit as a percentage of their respective total revenue:

Year ended September 30, Basis point increase (decrease)

($ in thousands) 2020 2019

(as adjusted)*

Cost of Goods Sold

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Total cost of goods sold $ 135,299 48.4 % $ 135,168 53.2 % (473)

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

Year ended September 30,

Basis point increase (decrease)

Year ended September 30, Basis point increase (decrease)

($ in thousands) 2020 2019

(as adjusted)*

IoT Products & Services $ 129,349 51.8 % $ 100,522 46.7 % 514

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Total gross profit $ 143,972 51.6 % $ 119,035 46.8 % 473

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

The 1.9 percentage point decrease in IoT Products & Services gross profit primarily was the result of:

lower sales of network products, which typically have higher gross margins

This decrease partially was offset by:

increased sales of our Digi Remote Manager ® service.

As recurring revenue increases and becomes a greater percentage of total revenue, we expect gross margins to increase over time.

The 3.6 percentage point increase in IoT Solutions gross profit primarily was the result of:

improved product pricing and increased recurring revenue from our subscription services.

This increase was partially offset by:

increased costs from additional site deployments

The 514 basis point increase in IoT Products & Services gross profit primarily was the result of:

• incremental gross profit from our acquisition of Opengear in December 2019, which has higher gross margins than many of our other products;

• increased sales of our support services, which typically has higher gross margins.

This increase partially was offset by:

• unfavorable product mix as we experienced lower sales of RF and certain infrastructure management products, which typically have higher gross margins.

The 160 basis point increase in IoT Solutions gross profit primarily was the result of:

• one-time non-recurring revenue and increased recurring revenue from our subscription services, which typically have higher gross margins.

OPERATING EXPENSES

Below is our operating expenses and operating expenses as a percentage of total revenue:

Below are our operating expenses as a percentage of total revenue:

Year ended September 30,

($ in thousands)

(as adjusted)*

$ increase (decrease)

% Increase (decrease)

($ in thousands) 2020 2019 $ increase (decrease) % Increase (decrease)

Operating expenses:

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Total operating expenses $ 132,655 47.5 $ 108,963 42.8 $ 23,692 21.7

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The $23.7 million increase in operating expenses in fiscal 2020 from fiscal 2019 primarily was the result of:

incremental expenses for Accelerated of $2.8 million;

increased employee-related expenses due to additional headcount;

increased professional fees, occupancy costs and depreciation expenses.

• incremental operating expenses for Opengear;

• a $4.4 million gain on the sale of our corporate headquarters building recorded in the first quarter of fiscal 2019;

• a $1.4 million increase in acquisition expenses.

This increase partially was offset by:

gain on the sale of our corporate headquarters building of $4.4 million;

a reduction on acquisition expense of $1.3 million.

OTHER INCOME, NET

• a reduction in compensation related expenses of $3.2 million, primarily related to a reduction in incentive compensation;

• a reduction $1.3 million in acquisition earnout expenses primarily related to earnout expenses recorded in fiscal 2019;

• a decrease in trade shows and related travel expenses of $1.6 million as events and travel were restricted due to the COVID-19 pandemic.

Year ended September 30,

($ in thousands)

(as adjusted)*

$ increase (decrease)

% Increase (decrease)

Other income, net:

($ in thousands) 2020 2019 $ increase (decrease) % Increase (decrease)

Other (expense) income, net:

Interest income $ 304 0.1 $ 733 0.3 $ (429) (58.5)

Interest expense (3,592) (1.3) (102) (0.1) (3,490) 3,421.6

Other income, net

Total other income, net

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

The $0.6 million increase in other income in fiscal 2019 from fiscal 2018 primarily was the result of:

increased interest income of $0.3 million , driven by higher levels of marketable securities, cash and cash equivalents in fiscal 2019 and higher average interest rates;

a $0.4 million increase other income, net primarily related to an increase in foreign currency gains mostly related to the Euro.

Other (expense) income, net (566) (0.2) 442 0.2 (1,008) (228.1)

Total other (expense) income, net $ (3,854) (1.4) $ 1,073 0.4 $ (4,927) (459.2)

The $4.9 million increase in other (expense) income in fiscal 2020 from fiscal 2019 primarily was the result of:

• an increase in interest expense of $3.5 million related to the balance outstanding under the Credit Facility in connection with the acquisition of Opengear in December 2019 (see Note 8 to the consolidated financial statements);

• a $1.0 million increase in other expense primarily related to increased in foreign currency losses mostly related to the strengthening of the Euro against the U.S.

• interest income decreased $0.4 million, driven by higher balances of marketable securities, cash and cash equivalents in fiscal 2019 in addition to lower average interest rates in fiscal 2020.

Our effective income tax rates were (12.7)%, 10.7% and 49.8% for fiscal 2020, 2019 and 2018, respectively.

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Management believes that during fiscal 2020, 2019 and 2018, inflation did not have a material effect on our Consolidated Statements of Operations or financial position.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NON-GAAP FINANCIAL INFORMATION

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(In thousands)

Fiscal years ended September 30,

(as adjusted)*

Fiscal year ended September 30,

revenue % of total

Total revenue $ 279,271 100.0 % $ 254,203 100.0 %

Interest income, net

Income tax expense

Net income $ 8,411 3.0 % $ 9,958 3.9 %

Interest expense (income), net 3,288 (631)

Income tax (benefit) expense (948) 1,187

Depreciation and amortization 19,299 13,396

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Gain on sale of building — (4,396)

Restructuring (reversal) charge

Restructuring charge (reversal) 117 (87)

Acquisition expense 2,772 1,390

Adjusted EBITDA $ 40,176 14.4 % $ 26,472 10.4 %

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

Reconciliation of Net Income and Net Income per Diluted Share to

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(In thousands, except per share amounts)

Fiscal years ended September 30,

(as adjusted)*

Fiscal year ended September 30,

Net income and net income per diluted share $ 8,411 $ 0.28 $ 9,958 $ 0.35

Amortization 14,754 0.50 8,818 0.31

Stock-based compensation 7,237 0.24 5,655 0.20

Other non-operating income

Other non-operating expense (income) 566 0.02 (442) (0.02)

Acquisition expense 2,772 0.09 1,390 0.05

Acquisition earn-out adjustments (128) — 1,191 0.04

Restructuring (reversal) charge

Restructuring charge (reversal) 117 — (87) —

Interest expense related to acquisition 3,558 0.12 — —

Gain on sale of building — — (4,396) (0.15)

Tax effect from above net income adjustments (1)

Discrete tax (benefits) expense (1)

(7,106) (0.24) (2,565) (0.09)

Discrete tax benefits (2)

(1,216) (0.04) (549) (0.02)

Adjusted net income and adjusted net income per diluted share (3)

$ 28,965 $ 0.98 $ 18,973 $ 0.66

Diluted weighted average common shares 29,546 28,554

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

For the twelve months ended September 30, 2019, discrete tax (benefits) expense primarily includes reversals of tax reserves due to the expiration of statutes of limitation.

For the twelve months ended September 30, 2018, discrete tax (benefits) expense primarily includes one-time adjustments for the re-measurement of deferred tax assets and the impact of ASU 2016-09 relating to the accounting for the tax effects of stock compensation.

This was partially offset by net tax benefits for the release of a valuation allowance against U.S.

federal capital loss carryforward related to the expected gains tax in fiscal 2019 as a result of the sale of our Corporate Headquarters building in October 2019 and reversals of tax reserves due to the expiration of statutes of limitation and certain domestic tax credits.

(1) The tax effect from the above adjustments assumes and estimated effective tax rate of 20.2% for fiscal 2020 and 18% for fiscal 2019 based on adjusted net income.

(2) For the twelve months ended September 30, 2020, discrete tax benefits include excess tax benefits recognized on stock compensation, an adjustment of our state deferred tax rate due to the Opengear acquisition and expiring statute of limitations.

For the twelve months ended September 30, 2019, discrete tax benefits primarily includes reversals of tax reserves due to the expiration of statutes of limitation.

(3) Adjusted net income per diluted share may not add due to the use of rounded numbers.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES

Historically we have financed our operations and capital expenditures principally with funds generated from operations.

Our liquidity requirements arise from our working capital needs, and to a lesser extent, our need to fund capital expenditures to support our current operations and facilitate growth and expansion.

We have financed our operations and capital expenditures principally with cash generated from operations.

We are focused on increasing our cash flow to fund potential future growth opportunities, including organic growth and growth through acquisition.

In the first quarter of fiscal 2020, we incurred debt of $110 million associated with our acquisition of Opengear.

As of September 30, 2020, $85 million remained available under the Revolving Loan, which included $10 million available for a letter of credit subfacility and $10 million available under a swingline subfacility, the outstanding amounts of which decrease the available commitment.

During the last half of fiscal 2020, we repaid $45 million of the Revolving Loan.

For additional information regarding the terms of our Credit Facility, including the Revolving Loan and its subfacilities, see Note 8 to our consolidated financial statements.

On April 14, 2020, we were granted a loan for $9.0 million under the Paycheck Protection Program ("PPP") established as part of the Coronavirus Aid, Relief and Economic Security Act ("CARES Act").

Based on our evaluation of additional rules for the PPP established after the grant acceptance, on May 4, 2020 we voluntarily repaid the full amount of the loan of $9.0 million, plus interest.

We expect positive cash flows from operations.

We believe that our current cash, cash equivalents and marketable securities balances, cash generated from operations and our ability to secure debt and/or equity financing will be sufficient to fund our business operations and capital expenditures for the next twelve months and beyond.

We believe that our current cash and cash equivalents balances, cash generated from operations and our ability to borrow under our credit facility will be sufficient to fund our business operations and capital expenditures for the next twelve months and beyond.

As follows, our Consolidated Statement of Cash Flows for the years ended September 30, 2020 and 2019 is summarized:

1 unchanged sentence

($ in thousands) 2020 2019

(as adjusted)*

Operating activities $ 34,478 $ 28,964

2 unchanged sentences

Effect of exchange rate changes on cash and cash equivalents 253 (810)

Net increase (decrease) in cash and cash equivalents

*Prior period information has been restated for the adoption of ASU No.

2014-09, “ Revenue from Contracts with Customers (Topic 606) ”, which we adopted on October 1, 2018.

Net (decrease) increase in cash and cash equivalents $ (38,663) $ 34,778

Cash flows from operating activities increased $5.5 million primarily as a result of:

positive changes in net working capital of $27.2 million.

Working capital improved primarily due to increased inventory in the prior fiscal year resulting from our manufacturing transition and strategic purchases of finished goods;

increased net income of $8.3 million, partially offset by non-cash adjustments of $3.8 million.

This primarily is related to the gain on the sale of our corporate headquarters building.

Cash flows from investing activities increased $28.8 million primarily as a result of:

no acquisition of a business in fiscal 2019;

proceeds from the sale of our corporate headquarters building in the current fiscal year;

a partial offset to these gains from a decrease in proceeds from marketable securities, proceeds from the disposition of businesses in the prior fiscal year and increased purchases of property, equipment and improvements (mostly related to the build-out of our new corporate headquarters space).

Cash flows from financing activities decreased $4.7 million primarily as a result of:

contingent consideration payments to the former shareholders of Accelerated, FreshTemp and Bluenica in fiscal 2019;

decreases in proceeds from exercises of stock options and employee stock plan transactions from the prior fiscal year.

• positive changes in non-cash adjustments $10.7 million, primarily related to depreciation and amortization and a gain on the sale of the building in the prior fiscal year;

• a partial offset to those increases by decreased net income of $1.5 million and decreased working capital of $3.7 million.

Working capital decreased $3.7 million primarily due to increased inventory and decreased income taxes payable primarily in fiscal 2020.

In addition there was a decrease in cash inflows related to accounts payable in fiscal 2020 compared to fiscal 2019.

These factors that lowered working capital were partially offset by a decrease in accounts receivable.

Cash flows from investing activities decreased $142.5 million primarily as a result of:

• $136.1 million net cash used for the purchase of Opengear during fiscal 2020;

• $10.0 million of proceeds from the sale of our corporate headquarters building and $4.8 million of proceeds from maturities of our marketable securities both in fiscal 2019;

• a partial offset to those decreases by $8.4 million of additional purchases in the prior fiscal year related to property, equipment and facility improvements (mostly related to the build-out of our new corporate headquarters space).

Cash flows from financing activities increased $62.5 million primarily as a result of:

• proceeds, net of payments, of long-term debt of $63.1 million from the Revolving Loan and Term Loan (see Note 8 to the consolidated financial statements);

• increases in proceeds from stock award plans of $0.3 million;

• a partial offset to these increases relates to additional contingent consideration payments.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CONTRACTUAL OBLIGATIONS

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Payments due by fiscal period

($ in thousands)

Less than 1 year

($ in thousands) Total Less than 1 year 1-3 years 3-5 years Thereafter

Operating leases $ 27,917 $ 3,757 $ 6,569 $ 5,735 $ 11,856

Contingent consideration 4,228 4,228 — — —

Revolving loan 15,000 — — 15,000 —

Term loan 48,125 2,500 7,188 38,437 —

Interest on long-term debt 4,379 1,106 1,975 1,298 —

Total $ 99,649 $ 11,591 $ 15,732 $ 60,470 $ 11,856

The operating lease agreements included above primarily relate to office space.

The table above does not include our contingent consideration obligations or possible payments for uncertain tax positions.

The estimated fair value of our contingent consideration at September 30, 2019 was $5.4 million and is due in fiscal 2020.

Our reserve for uncertain tax

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

positions, including accrued interest and penalties, was $1.8 million as of September 30, 2019.

The table above does not include our possible payments for uncertain tax positions.

Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.7 million as of September 30, 2020.

Due to the nature of the underlying liabilities and the extended time often needed to resolve income tax uncertainties, we cannot make reliable estimates of the amount or timing of future cash payments that may be required to settle these liabilities.

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We believe the following critical accounting policies impact our more significant judgments and estimates used in the preparation of our consolidated financial statements.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

REVENUE RECOGNITION

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Sales to authorized domestic distributors and Direct/OEM customers typically are made with certain rights of return and price adjustment provisions.

Estimated reserves for future returns and pricing adjustments are established by us based on an analysis of historical patterns of returns and price adjustments as well as an analysis of authorized

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

returns compared to received returns and distribution sales for the current period.

Estimated reserves for future returns and price adjustments are charged against revenue in the same period as the corresponding sales are recorded.

Material differences between the historical trends used to determine estimated reserves and actual returns and pricing adjustments could result in a material change to our consolidated results of operations or financial position.

Equipment revenue from SmartSense by Digi ™ within our IoT Solutions segment is recorded as an up-front sale at its stand-alone selling price.

This is because the customer could utilize our equipment with other monitoring services or could use our monitoring services with hardware purchased from other vendors.

Our installation charges from these sales are recorded when the product is installed.

Estimated reserves for future credit returns and pricing adjustments are established based on an analysis of historical patterns of credit returns and price adjustments compared to received credit returns and distribution sales for the current period.

Estimated reserves for future credit returns and price adjustments are charged against revenue in the same period as the corresponding sales are recorded.

Estimated sales returns for our distributor stock rotation program are accounted for under the guidance of ASC 845 Nonmonetary Transactions .

Material differences between the historical trends used to determine estimated reserves and actual credit returns and pricing adjustments could result in a material change to our consolidated results of operations or financial position.

Equipment revenue from SmartSense by Digi ® within our IoT Solutions segment is recognized upon shipment of the equipment to a customer.

Installation service charges from these sales are recorded when the product is installed.

Subscription and Support Services Revenue

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When we retain ownership of the equipment, we charge an implementation fee to the customer so they can begin using the equipment.

In these instances, all revenue derived from the above obligations is recognized over the subscription term of the contract.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

these instances, all revenue derived from the above obligations is recognized over the subscription term of the contract.

If the customer purchases the equipment out-right, that portion of the revenue is recognized at the stand-alone selling price at the time the equipment is shipped and all other revenue is recognized over the subscription term of the contract.

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Goodwill is tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

quantitative goodwill impairment tests, we determine the estimated fair value of each reporting unit and compare it to the carrying value of the reporting unit, including goodwill.

For our quantitative goodwill impairment tests, we determine the estimated fair value of each reporting unit and compare it to the carrying value of the reporting unit, including goodwill.

If the carrying amount of a reporting unit is higher than its estimated fair value, an impairment loss must be recognized for the excess.

We have two reportable operating segments, our IoT Solutions segment and our IoT Products & Services segment.

We have two reportable operating segments, our IoT Products & Services segment and our IoT Solutions segment.

Both operating segments constitute separate reporting units and both units were tested individually for impairment.

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Assumptions and estimates to determine fair values under the income and market approaches are complex and often subjective.

They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts.

For example, if our future operating results do not meet current forecasts or if we experience a sustained decline in our market capitalization that is determined to be indicative of a reduction in fair value of one or more of our reporting units, we may be required to record future impairment charges for goodwill.

They can be affected by a variety of factors.

These include external factors such as industry and economic trends.

They also include internal factors such as changes in our business strategy and our internal forecasts.

We believe we made a reasonable estimate with the assumptions used to calculate the fair values of our two reporting segments.

Changes in circumstances or a potential event could negatively affect the estimated fair values.

We will continue to monitor potential COVID-19 industry and demand impacts as this could potentially affect our cash flows and market capitalization.

If our future operating results do not meet current forecasts or if we experience a sustained decline in our market capitalization that is determined to be indicative of a reduction in fair value of one or more of our reporting units, we may be required to record future impairment charges for goodwill.

Results of our Fiscal 2020 Annual Impairment Test

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The implied fair values of each reporting unit were added together to get an indicated value of total equity to which a range of indicated value of total equity was derived.

This range was compared to the total market capitalization of $356.6 million as of June 30, 2019 , which implied a range of control premiums of 13.3% to 20.3% .

This range was compared to the total market capitalization of $338.2 million as of June 30, 2020.

This implied a range of control premiums of 17.0% to 29.1%.

This range of control premiums fell below the control premiums observed in the last five years in the communications equipment industry.

As a result, the market capitalization reconciliation analysis proved support for the reasonableness of the fair values estimated for each individual reporting unit.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

During the fourth quarter of fiscal 2020, we assessed various qualitative factors to determine whether or not an additional goodwill impairment assessment was required as of September 30, 2020, and we concluded that no additional impairment assessment was required.

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We routinely monitor the potential impact of such situations and believe that liabilities are properly stated.

Valuations related to amounts owed and tax rates could be

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

impacted by changes to tax codes and our interpretation thereof, changes in statutory rates, our future taxable income levels and the results of tax audits.

Valuations related to amounts owed and tax rates could be impacted by changes to tax codes and our interpretation thereof, changes in statutory rates, our future taxable income levels and the results of tax audits.

In general, we warrant our products to be free from defects in material and workmanship under normal use and service.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis