Item 1. Business
ITEM 1. BUSINESS
General Background and Product Offerings
Digi International Inc. ("Digi," "we," "our," or "us") was incorporated in 1985 as a Minnesota corporation. We were reorganized as a Delaware corporation in 1989 in conjunction with our initial public offering. Our common stock is traded on the Nasdaq Global Select Market tier of the Nasdaq Stock Market LLC under the symbol DGII. Our World Headquarters is located at 9350 Excelsior Blvd., Suite 700, Hopkins, Minnesota 55343. The telephone number at our World Headquarters is (952) 912-3444.
We are a leading global provider of business and mission-critical Internet of Things ("IoT") connectivity products, services and solutions. We help our customers deploy, monitor and manage critical communications infrastructures that deliver important information in demanding environments with high levels of security and reliability. We have two reportable operating segments under applicable accounting standards: (i) IoT Products & Services; and (ii) IoT Solutions.
Our IoT Products & Services segment offers products and services that help original equipment manufacturers ("OEMs"), enterprise and government customers create and deploy, secure IoT connectivity solutions. From embedded and wireless modules to console servers as well as enterprise and industrial routers, we provide a wide variety of communication sub-assemblies and finished products to meet our customers' IoT communication requirements. In addition, this segment provides our customers with a device management platform and other professional services to enable customers to capture and manage data from devices connected to networks.
Our IoT Solutions segment offers wireless temperature and other condition-based monitoring services as well as employee task management services. These solutions are focused on the following vertical markets: food service, healthcare (primarily pharmacies) and supply chain. These solutions are marketed as SmartSense by Digi ® . We formed, expanded and enhanced the IoT Solutions segment primarily through four acquisitions.
For more in-depth descriptions of our products and services, please refer to the heading "Principal Products and Services" at the end of Part I, Item 1 of this Form 10-K.
Our corporate website address is www.digi.com. In the "Company - Investor Relations" section of our website, we make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, our proxy statement and any amendments to these reports available free of charge as soon as reasonably practicable after these reports are filed with or furnished to the United States Securities and Exchange Commission ("SEC"). Information on our website is not incorporated by reference into this report or any other report we file with or furnish to the SEC.
Impact of COVID-19 and Global Economic Downturn on Our Business
As is the case with many businesses, the ongoing pandemic and related global economic downturn creates significant uncertainty regarding the nearer term outlook for the markets where we provide products and services. The pandemic and the economic downturn it triggered represents a fluid situation that presents a wide range of potential impacts on our own business and those of our customers, vendors and other business partners. As our products and services serve companies across a broad range of industries, in some instances we have seen demand increase while in others we have observed declines as a result of the societal impacts of the pandemic. At present, the duration and severity of the pandemic and the resulting economic downturn remain unclear.
Present State of Our Operations
During fiscal 2020 (which ended on September 30, 2020), we took steps to lower our operating expenses as a result of the pandemic. We continue to monitor the impacts of COVID-19 on our operations closely and could increase or take further steps to decrease expenses as we believe circumstances warrant. Since the start of the pandemic there have not been any material changes to our assets on our balance sheet and, at present, we do not expect there to be material changes. During the second, third and fourth fiscal quarters of 2020, we reviewed the potential impacts of the COVID-19 pandemic on goodwill and intangible assets and determined there to be no material impact at that time. We also reviewed the potential impacts on future risks to the business as it relates to collections, returns and other business related items. No significant changes to these reserves have been made.
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Potential Impacts on Our Supply Chain
To date, travel restrictions and border closures have only had minor impacts on our ability to obtain inventory or manufacture or deliver products or services to our customers. The impacts we have experienced have primarily impacted our IoT Solutions segment. We continue to monitor restrictions and border closures closely so we are positioned to mitigate the negative impacts of any future restrictions or closures. It is possible, however, that future restrictions or closures could negatively harm our business. Travel restrictions impacting people so far have not materially restrained our ability to assist our customers with on-site installation activities or product troubleshooting. At present, we do not expect impacts on personal travel to be material to our business operations or financial results. We have taken steps to restrain and monitor our operating expenses and therefore do not expect and such impacts to materially change the relationship between our costs and revenues.
Proactive Efforts to Mitigate the Negative Impacts of COVID-19
Like most companies, we have taken a range of actions with respect to how we operate to assure we comply with government restrictions and guidelines as well as best practices to protect the health and well-being of our employees and our ability to continue operating our business effectively. To date, we have been able to operate our business effectively using these measures and to maintain all internal controls as documented and posted. We also have not experienced challenges in maintaining business continuity and do not expect to incur material expenditures to do so. However, the impacts of the pandemic and efforts to mitigate the same have remained unpredictable and it remains possible that challenges may arise in the future.
Industry and Marketplace Conditions
We believe the IoT industry is in the midst of a multi-year expansion as many industries are undergoing a digital transformation within their business that drives demand for IoT capabilities across a broad spectrum of services. Among others, Iot use cases include automating workflows, condition-based monitoring and asset tracking.
Our IoT Products & Services segment represented the significant majority of our sales in fiscal 2020. This segment sells both wired and wireless products that are either embedded into the products of OEMs or as stand-alone products. These offerings allow our customers to connect a wide range of assets to networks. The growth of this segment was driven primarily by our acquisition of Opengear, Inc. ("Opengear") in the first quarter of fiscal 2020. We believe the COVID-19 pandemic has impacted the results of this segment in a couple of material ways. First, the segment historically has many products that are subject to large project-based customer deployments. When the pandemic started during our second fiscal quarter, certain opportunities that were in our sales opportunity pipeline were deferred or delayed, often indefinitely. Second, given the breadth of customers and industries that use our products from this segment, the pandemic presented certain new sales opportunities from customers whose own businesses encountered increased demand for our products, which bolstered our results. The segment has a number of products that are in the mature phase of their life cycle and have been experiencing sales declines for several years. While we expect an ongoing long-term trend of marketplace growth, the segment is susceptible to downturns either because of general macro-economic conditions, the continued development of technology that can make products less competitive or even obsolete and uncertainty or changes in regulatory environments. Given the current uncertainty in macro-economic conditions driven by the ongoing pandemic, including, but not limited to, the uncertain status of large project-based customer deployment opportunities, this segment's results during fiscal 2021 may be inconsistent.
Our IoT Solutions segment contracted in fiscal 2020 as a result of the COVID-19 pandemic and the resulting economic and operational uncertainty it created for many customers and potential customers. The contraction was, not surprisingly, most pronounced in our second and third quarter of fiscal 2020 as customers and potential customers were focused on adjusting the way they conduct day to day operations due to the pandemic. We did see some improvement in new sales in the fourth quarter of fiscal 2020. While we are cautiously optimistic this trend will continue during fiscal 2021, the outlook remains uncertain as the pandemic remains ongoing and macro-economic conditions remain uncertain. During fiscal 2020 we continued to consolidate the product offering from the four acquisitions that make up this segment as we worked to transition customers to a new SmartSense IoT Platform launched in September 2019. This new platform integrates the platforms from the acquisitions and provides redesigned multi-sensor monitoring and reporting that affords user enhanced equipment management abilities with an asset-versus-sensor focus. The new platform is capable of further incorporating data from multiple sensor types into a single monitoring and reporting platform, to deliver real-time and detailed information on critical business assets and equipment.
Strategy
We remain focused on taking steps that we believe will deliver consistent, long-term growth with higher levels of profitability.
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IoT Products & Services Segment
Our IoT Products & Services segment is being managed with an expectation for modest revenue and profitability growth. Following the conclusion of fiscal 2020, we reorganized this business to align our product management and sales personnel along specific product lines (see Note 19 to our Consolidated Financial Statements). We believe this reorganization will bring greater market focus to the product lines. We also continue to drive efforts to pair our hardware offerings with our Digi Remote Manager ® device management platform as well as other support services. These bundled offerings allow customers to monitor and manage the performance of our hardware remotely. We may seek to acquire hardware or other businesses that we believe can improve our market position in this segment.
IoT Solutions Segment
Our IoT Solutions segment is being managed primarily for significant revenue growth. This segment was formed and has grown primarily through acquisitions. While this segment still represents a modest overall portion of total revenues, we have high organic growth expectations and we intend to seek added scale and growth through acquisitions.
This business helps customers monitor temperature and other conditions important to preserve the quality of perishable or other sensitive inventories and tracks the completion of employee tasks. Our efforts have created a market-leading, high-growth hardware enabled service business with a significant recurring revenue base. At present, this marketplace primarily is served by smaller companies that lack the infrastructure to provide hardware-enabled implementation services to customers in as effective and efficient a manner as we are able to do because of our long-standing history as an IoT hardware provider.
As of September 30, 2020, we served over 70,000 customer sites for many leading brands in the following vertical markets: food service, healthcare (primarily pharmacies) and supply chain. We entered these markets aggressively as they share similar needs for continuous monitoring and asset tracking for compliance and regulatory purposes. We believe these markets comprise a large addressable market with low customer penetration.
Acquisitions and Dispositions
Acquisitions
Since 2015, we have acquired four businesses that form the basis of our IoT Solutions segment. Since 2018, we have acquired two businesses that are included in our IoT Products & Services segment.
In October 2015, we acquired Ontario-based Bluenica Corporation ("Bluenica"). Bluenica focused on temperature monitoring of perishable goods in the food industry by using wireless sensors to ensure that quality, freshness and public health requirements are met.
In November 2016, we acquired Pittsburgh-based FreshTemp, LLC ("FreshTemp ® "). FreshTemp ® offered restaurants, convenience stores and other retailers the ability to monitor the temperature of food products automatically through the use of wireless sensors. The company also enabled these businesses to track the completion of operational tasks by their employees that could impact human health and safety in real time.
In January 2017, we acquired Indiana-based SMART Temps,LLC (" SMART Temps ® "). SMART Temps ® provided real-time temperature management for restaurant, grocery, education and healthcare settings. The acquisition significantly expanded our customer base, especially in the pharmacy and education marketplaces.
In October 2017, we acquired Boston-based TempAlert, LLC ("TempAlert"), a provider of automated, real-time temperature monitoring and task management solutions for the healthcare, industrial and food service industries. This acquisition more than doubled the number of customer sites we monitored while enhancing our ability to analyze data collected from our services.
In January 2018, we acquired Tampa-based Accelerated, a provider of secure, enterprise-grade, cellular (LTE) networking equipment and backup connectivity applications. This acquisition expanded our IoT Products & Services segment by enhancing our existing cellular product lines and extended our market reach with a line of commercial routers and network appliance products.
In December 2019, we acquired New Jersey-based Opengear, Inc., a provider of secure IT infrastructure products and software. This acquisition provides products that are complementary to our IoT Products & Services segment.
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Sales Channels
A significant portion of our IoT Products & Services segment sales are made through a global network of distributors, systems integrators and value added resellers ("VARs"). These third parties accounted for 37.5%, 46.1% and 51.3% of our total consolidated revenue in fiscal 2020, 2019 and 2018, respectively. Our IoT Solutions segment does not sell through these channels. We also complete sales of both IoT Products & Services and IoT Solutions through our own dedicated sales organization to OEMs, large enterprise customers and other end user customers which accounted for 62.5%, 53.9% and 48.7% of our total consolidated revenue in fiscal 2020, 2019 and 2018, respectively.
Distributors
Our larger distributors, by sales volume, include Arrow Electronics, Avnet, Bressner Technology GmbH, Digi-Key, Express Systems & Peripherals, Ingram Micro, Mouser Electronics, Solid State Supplies, Symmetry Electronics, Synnex, Tech Data, Tokyo Electron Device and Venco Electrónica S.A. We also maintain relationships with many other distributors both domestically and internationally.
Strategic Sales Relationships
We maintain alliances with other industry leaders to develop and market technology solutions. These include many major communications hardware and software vendors, operating system suppliers, computer hardware manufacturers, enterprise application providers and cellular carriers. Among others, relationships include: AT&T, NXP, Orange, Rogers, Silicon Laboratories, T-Mobile, Telus, Telit, T-Mobile, Verizon, Vodafone and several other cellular carriers worldwide.
We have established relationships with equipment vendors in a range of industries such as energy, industrial, retail, transportation, medical, and government that allow these partners to ship our products and services as component parts of their overall solutions. Our products are used by many of the world’s leading telecommunications companies and Internet service providers, including AT&T, T-Mobile and Verizon.
No single customer comprised more than 10% of our consolidated revenue for any of the years ended September 30, 2020, 2019 or 2018.
Competition
We compete primarily in the communications technology industry. This industry is characterized by rapid technological advances and evolving industry standards. This market can be affected significantly by new product introductions and marketing activities of industry participants. In addition, we may compete with other companies to acquire new businesses or technologies and the competition to secure such assets may be intense. We compete for customers on the basis of existing and planned product features, service and software application capabilities, company reputation, brand recognition, technical support, alliance relationships, quality and reliability, product development capabilities, price and availability. While no competitor offers a comparable range of products and services, various companies do compete with us with respect to one or more of our products or solutions. With respect to many of our product and service offerings, we face competition from companies who dedicate more resources and attention to that particular offering than we are able to do given the breadth of our business. As the marketplace for IoT connectivity products and solutions continues to grow, we expect to encounter increased competition. Some of these competitors may have access to significantly more financial and technical resources than we possess.
Manufacturing Operations
We outsource our manufacturing operations to certain contract manufacturers, which are located primarily in Thailand, China, Mexico and Taiwan. We rely on third party foundries for our semiconductor devices that are Application Specific Integrated Circuits ("ASICs"). We also outsource printed circuit board production. By outsourcing our operations to these manufacturers, we can leverage the manufacturing strength of our vendors, which allows us to focus on new product introductions. In addition, it allows us to reduce our fixed costs, maintain production flexibility and optimize our profits.
Our products are manufactured to our designs with standard and custom components. Most of the components are available from multiple vendors. We have several single-sourced supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. If these suppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect our consolidated results of operations in a material way.
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Seasonality
In general, our business is not considered to be highly seasonal, although our first fiscal quarter revenue is often less than other quarters due to holidays and fewer shipping days.
Research & Development and Intellectual Property Rights
Due to rapidly changing technology in the communications technology industry, we believe a large part of our success depends upon the product and service development skills of our personnel as well as our ability to integrate any acquired technologies with organically developed technologies. While we dedicate significant resources to research and development, many of our competitors are focused on a smaller set of products than us and are likely able to dedicate more resources than us toward the portions of the market in which we compete with them.
Our proprietary rights and technology are protected by a combination of copyrights, patents, trade secrets and trademarks.
We have established common law and registered trademark rights on a family of marks for a number of our products. Our IoT Products & Services primarily are sold under the Digi ® , Rabbit ® and Digi XBee ® brands. We believe that the Digi ® and Rabbit ® brands have established strong identities with our targeted customer base and our customers associate the Digi ® brand with "reliability" and the Rabbit ® brand with "ease of integration." We believe that our customers associate Digi XBee ® with "ease of use." Many of our customers choose us because they are building a very complex system solution and they want the highest level in product reliability and ease of integration and use. Our IoT Solutions are offered under the SmartSense by Digi ® brand, which enables organizations to drive operational excellence through sensor-based insights.
Our patents are applicable to specific technologies and are valid for varying periods of time based on the date of patent application or patent grant in the U.S. and the legal term of patents in the various foreign countries where patent protection is obtained. We believe our intellectual property has significant value and is an important factor in the marketing of our company and products.
HUMAN CAPITAL RESOURCES
Digi International’s workforce consists of approximately 656 employees globally as of September 30, 2020. We consider our relationship with our employees to be good.
Culture
As employees of Digi we are all expected to uphold the following core values that drive our culture:
• Integrity
• Accountability
• Respect and open communication
These core values define the way we do business in our everyday actions and choices. We strive to create a respectful work environment characterized by mutual trust and the absence of intimidation, oppression, discrimination and exploitation.
Talent
Successful execution of our strategy is dependent on attracting, developing and retaining key employees and members of our management team. The skills, experience and industry knowledge of our employees significantly benefit our operations and performance. We continuously evaluate, modify, and enhance our internal processes and technologies to increase employee engagement, productivity, and efficiency.
We are committed to promoting and cultivating an inclusive and diverse culture that welcomes and celebrates everyone without bias. In addition, we look to actively engage within our communities to foster and attain social equity.
Compensation Philosophy
Our compensation philosophy creates the framework and building blocks for our rewards strategy. We have a pay-for-performance culture that ties compensation to the performance of the individual and the company. We provide balanced compensation programs that focus on the following five key elements:
• Pay-for-performance - Reward and recognize leading contributors and high potentials;
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• External market based - Pay levels that are competitive with respect to the labor market in which we compete for talent;
• Internal equity - Providing for fair pay relationships within the Company;
• Fiscal responsibility - Providing affordable programs that are within our budget; and
• Legal compliance - Ensure the organization is legally compliant in all states and countries in which we operate.
Health and Wellness
We are committed to providing a competitive and comprehensive benefits package to our employees. Our benefits package provides a balance of protection along with the flexibility to meet the individual health and wellness needs of our employees.
PRINCIPAL PRODUCTS AND SERVICES
Our primary products and services for each operating segment are:
IoT Products & Services Segment
Hardware Products
Cellular Products – We provide a range of products that use cellular technology such as Long Term Evolution (“LTE”) and LTE Advance Pro to communicate with networks. These products provide a cost-effective alternative to landlines for primary or backup connectivity. They are trusted by global leaders in agricultural, energy medical, lighting, transportation and other industrial markets and include:
• Cellular routers that help enterprise, government and Original Equipment Manufacturers ("OEM") customers with their mission-critical wireless connectivity needs in challenging environments.
• Cellular modules that help OEM customers embed cellular communications abilities into their products so they can deploy and manage intelligent and secure cellular connected products. These modules help OEMs to get their products to market faster and with lower development costs and risks so they can focus on their core competencies instead of on wireless connectivity design.
• Console servers that can be managed by software to provide secure, remote access to network equipment in data centers and at edge locations. These products primarily are used by IT organizations in large enterprises to maximize the availability of services to their customers and employees, and provide business continuity in the event of a network failure. This improves efficiency and reduces the risk of costly outages.
Radio-Frequency (“RF”) Products – These products which are marketed primarily under the Digi XBee ® brand include embedded wireless modules as well as off-the-shelf gateways, modems and adapters. They are used by customers across a broad range of industries. These products offer a wide selection of both standards-based and proprietary wireless protocols including Zigbee, Cellular, Sub-1 GHz, WiFi and Bluetooth to meet diverse application requirements of customers.
Embedded System Products – Marketed under the Digi Connect, ConnectCore ® and Rabbit ® brands these are embedded system on modules ("SOMs") and single board computers that are embedded into customer products in a broad range of industries and applications. These products deliver highly integrated computer platforms with scalable performance, flexible wired and wireless connectivity and complete software platforms. These products are designed and developed with compact form-factors, low power consumption and long product lifecycles. The latest ConnectCore ® products support advanced multi-core processing, security, multimedia, human-machine interface ("HMI") and other emerging technologies like machine learning.
Infrastructure Management Products – These products include serial and Universal Serial Bus (USB) solutions. Our serial servers (also known as device servers and terminal servers) provide secure and reliable serial port-to-Ethernet integration of most devices into wired Ethernet networks. This means that they are capable of converting data received over TCP/IP networks such as the internet and back; thereby eliminating the need for each device to have a physical connection to a computer. We also offer multiple USB solutions whose primary functions are to connect multiple USB devices, allowing them to work over a wired or wireless network without each device needing to plug into its own host computer.
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Services
Digi Remote Manager ® - Digi Remote Manager ® is a recurring revenue cloud-based service that provides a secure environment for customers to manage their connected device deployment. This allows customers to activate, monitor and diagnose a large number of mission-critical devices from a single point of command. Through a "single pane of glass," network managers can edit configurations, update firmware, and schedule and automate tasks from their desktop, tablet or phone.
Wireless Design Services - Our Digi Wireless Design Services provide customers turn-key wireless networking product development, testing, and certification for a wide range of wireless technology platforms and applications.
Technical Services - Our Technical Services provide professional services, data plan subscriptions and enhanced technical support offers to customers. Professional services include solution planning and implementation services to customers who purchase our products such as site planning, implementation management, application development and customer training. Data plan subscriptions are offered to customers wishing to enable cellular connectivity on our products. Enhanced technical support provides priority, in-depth technical support consultations with our experienced support team. These services ensure customers get to market quickly, minimize risk, and ensure customer success with their Digi solution.
IoT Solutions Segment
SmartSense by Digi ® - Our SmartSense by Digi ® is an end-to-end, cost-effective system that uses sensors, gateways and cloud based applications to enable customers in food service (e.g. groceries, schools and restaurants), healthcare (primarily pharmacies) and transportation/logistics to: (i) monitor wirelessly the temperature of food and other perishable or sensitive goods, (ii) monitor facilities or pharmacies by tracking the completion of operating tasks by employees, and (iii) have visibility in the supply chain to product temperature through an end-to-end system for quality control and incident management. Typically, customers receive hardware up-front, including gateways and sensors, and pay a monthly subscription for monitoring sensor data.