What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-02-05 compared with 2020-08-07 · 159 added, 211 removed, 132 unchanged (74% of the section changed)

5 unchanged sentences

The 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 the Company operates, projections of future performance, perceived marketplace opportunities and statements regarding our mission and vision.

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 present outbreak of the COVID-19 pandemic and efforts to mitigate the same, risks related to the economic downturn that commenced during the COVID-19 pandemic and the ability of companies like us to operate a global business, 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, the ability to achieve the anticipated benefits and synergies associated with acquisitions or divestitures (including, but not limited to, our recently announced acquisition of Opengear), 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, our Annual Report on Form 10-K for the year ended September 30, 2019, this filing on Form 10-Q and other filings, could cause the Company's 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, our Annual Report on Form 10-K for the year ended September 30, 2020, this filing 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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We disclaim any intent or obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Presentation of Non-GAAP Financial Measures

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.

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.

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.

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

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, acquisition-related expenses and interest expense from acquisitions 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 reversals, 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 items reflected in the condensed 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.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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A description of our critical accounting policies and estimates was provided in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the fiscal year ended September 30, 2020.

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

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

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We have formed, expanded and enhanced the IoT Solutions segment through four acquisitions.

For further detail on segment performance, see the Revenue by Segment and Cost of Goods Sold and Gross Profit by Segment sections of this Item 2.

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.

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

For fiscal 2020, we established the following key operating objectives:

On October 7, 2020, our Board of Directors approved a reorganization of our IoT Products & Services business segment.

The restructuring plan aligned the business segment's organization around product lines, each with a segment manager.

Under this plan, we recorded a charge of $0.7 million for employee termination charges and eliminated 19 employment positions primarily in the U.S.

during the first quarter of fiscal 2021.

We have grouped our products under the following categories:

Cellular Routers, Console Servers, OEM Solutions and Infrastructure Management.

Consequently, the measure of segment operating income (loss) used by our chief operating decision maker ("CODM") changed.

As a result, our disclosed measure of segment operating income (loss) has been updated.

For further detail on segment performance, see the Revenue by Segment, Cost of Goods Sold and Gross Profit by Segment and Operating Income (Loss) sections of this Item 2.

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;

• delivering growth within our IoT Products & Services segment driven by new product introductions;

• seeking further strategic growth through potential acquisitions, such as our recent purchase of Opengear in the first quarter of fiscal 2020;

• delivering growth within our IoT Products & Services segment through new product introductions;

• identification of strategic growth initiatives through acquisition;

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

As discussed further below, the COVID-19 pandemic is impacting our business operations and may impact our ability to meet these objectives.

Beginning in the second fiscal quarter, Digi implemented a plan to streamline the Company’s operations to more closely align expenses to our projected revenue as well as to position the Company for continued operating performance and profitable growth.

In addition, in April 2020, we announced a number of cost reduction actions:

• We have suspended most new hires, dramatically decreased our travel and discretionary spending, reduced our capital budget and requested price concessions from our largest vendors;

• We have eliminated 21 positions and reconfigured our workforce.

We expect the payments associated with this restructuring to be complete by the fourth quarter of fiscal 2020;

• We have indefinitely suspended our 401(K) matching program in the U.S.

and its equivalent in Canada;

• Our Board of Directors and the executive team have reduced their cash compensation and base salaries by 10% for the next 6 months in exchange for equity.

We utilize many financial, operational, and other metrics to evaluate our financial condition and financial performance.

Below we highlight the metrics for the third quarter of fiscal 2020 that we feel are most important in these evaluations:

• Consolidated revenue increased $9.2 million, or 15.0% in the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019.

Product revenue increased by $9.4 million, or 17.5%, in the third quarter of fiscal 2020 compared to the same period a year ago.

Services revenue decreased by $0.2 million, or 2.6%, in the third quarter of fiscal 2020 compared to the same period a year ago.

Fiscal 2020 includes revenue from our recent acquisition of Opengear which is included in product revenue.

• Gross margin increased as a percentage of revenue to 53.1% in the third quarter of fiscal 2020 as compared to 46.3% in the third quarter of fiscal 2019.

Fiscal 2020 includes gross margin from our recent acquisition of Opengear.

• Net income for the third fiscal quarter of 2020 was $1.8 million, or $0.06 per diluted share.

Net income for the third fiscal quarter of 2019 was $1.6 million, or $0.06 per diluted share.

Below we highlight the metrics for the first quarter of fiscal 2021 that we feel are most important in these evaluations:

• Consolidated revenue increased $10.8 million, or 17.4% in the first quarter of fiscal 2021 compared to the first quarter of fiscal 2020.

Product revenue increased by $8.4 million, or 15.4%, in the first quarter of fiscal 2021 compared to the same period a year ago.

Services revenue increased by $2.4 million, or 30.6%, in the first quarter of fiscal 2021 compared to the same period a year ago.

• Gross margin increased as a percentage of revenue to 56.1% in the first quarter of fiscal 2021 as compared to 48.9% in the first quarter of fiscal 2020.

• Net loss for the first fiscal quarter of 2021 was $0.3 million, or $0.01 loss per diluted share.

Net income for the first fiscal quarter of 2020 was $0.2 million, or $0.01 per diluted share.

Adjusted net income and adjusted net income per share was $9.9 million, or $0.32 per diluted share.

In the third fiscal quarter of fiscal 2019, adjusted net income and adjusted net income per share was $4.6 million, or $0.16 per diluted share.

• Adjusted EBITDA for the third fiscal quarter of 2020 was $10.5 million, or 15.0% of total revenue.

In the third fiscal quarter of fiscal 2019, Adjusted EBITDA was $6.1 million, or 10.0% of total revenue.

Potential Impacts of COVID-19 on Our Business and Operations

The COVID-19 pandemic remains fluid situation that presents a wide range of potential impacts of potential varying durations for different global geographies, including locations where we have offices, employees, customers, vendors and other suppliers and business partners.

To date, during the pandemic we have observed disparate impacts among categories of customers, products and services.

Some product categories have seen increases in demand.

Conversely, some industries such as entertainment, hospitality and retail that purchase our products and services have experienced significant declines in demand for their own products or services and, in turn, have been less inclined to purchase our products and services.

In the first fiscal quarter of fiscal 2020, adjusted net income and adjusted net income per share was $4.5 million, or $0.15 per diluted share.

• Adjusted EBITDA for the first fiscal quarter of 2021 was $13.0 million, or 17.7% of total revenue.

In the first fiscal quarter of fiscal 2020, Adjusted EBITDA was $6.7 million, or 10.7% of total revenue.

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

Given the fact our products and services serve companies across a broad range of industries, we expect our sales will likely experience more volatility as a result of the changing and less predictable fiscal health and operational needs of many customers as a result of the COVID-19 pandemic and the ongoing economic downturn.

Many companies, including many of our suppliers and customers, are reporting or predicting negative impacts from COVID-19 and the economic downturn on future operating results.

But given disparate demands for certain of our products and from customers in varying industries, it remains too early for us to know the exact impact COVID-19 and the economic downturn will have on overall demand for our products and services.

We also cannot be certain how demand may shift over time as the impacts of the COVID-19 pandemic and the economic downturn may go through several phases of varying severity and duration.

Potential Impacts of COVID-19 on Our Business and Operations

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 our third fiscal quarter ended June 30, 2020, we generated $31.8 million of operating cash flow.

As of that date, we had a cash balance of $55 million.

In light of broader macro-economic risks and already known impacts on certain industries that use our products and services, we have taken and are taking targeted steps to lower our operating expenses.

We continue to monitor the impacts of COVID-19 and the economic downturn on our operations closely and this situation could change based on a large number of factors, many of which are not within our control.

We do not expect there to be material changes to our assets on our balance sheet or our ability to timely account for those assets.

Further, in connection with the preparation of this quarterly report on Form 10-Q and the interim financial statements contained herein, we reviewed the potential impacts of the COVID-19 pandemic and the economic downturn on goodwill and intangible assets.

We have determined there to be no material impact at this time.

We have also reviewed the potential impacts on future risks to the business as it relates to collections, returns and other business related items.

During fiscal 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 first fiscal quarter of 2021, 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.

Potential Impacts on Our Supply Chain

To date, restrictions and border closures have not restrained our ability to obtain inventory or manufacture or deliver products or services to customers in any material way.

However, if such restrictions become more severe, they could negatively impact those activities in a way that would harm our business.

Travel restrictions impacting people can restrain our ability to assist our customers with on-site installation activities or product troubleshooting, but at present we do not expect these 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 we do not expect any such impacts to materially change the relationship between costs and revenues.

Proactive Efforts to Mitigate the Negative Impacts of COVID-19 and the Economic Downturn

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.

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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 COVID-19 and efforts to mitigate the same have remained unpredictable and it remains possible that challenges may arise in the future.

The actions we have taken so far during the pandemic include, but are not limited to:

• In locations where government authorities recommend or require or we otherwise believe it is prudent, requiring all employees who can work from home to work from home.

• Increasing our IT networking capability to best assure employees can work effectively outside the office;

• For employees who must perform essential functions in one of our offices:

• Having employees maintain a distance of at least six feet from other employees whenever possible;

• Having employees work in dedicated shifts to lower the risk all employees who perform similar tasks might become infected by COVID-19;

• Having employees stay segregated from other employees in the office with whom they require no interaction;

• Requiring employees to wear masks while they are in the office whenever possible;

• Allowing employees who utilize public transportation to get to and from the office to work on flexible timelines so they can ride public transportation during non-peak use hours;

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.

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

• Increased cleaning of office spaces, surfaces and tools that may come into contact with employees;

• Restricting travel;

• Allowing 72 hours before we open non-essential packages and disinfecting any essential packages before they are opened.

CONSOLIDATED RESULTS OF OPERATIONS

The following table sets forth selected information derived from our interim condensed consolidated statements of operations:

Three months ended June 30, % incr.

Nine months ended June 30, % incr.

($ in thousands) 2020 2019 (decr.) 2020 2019 (decr.)

Three months ended December 31, % incr.

($ in thousands) 2020 2019 (decr.)

Revenue $ 73,146 100.0 % $ 62,317 100.0 % 17.4

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Operating expenses 41,165 56.3 30,947 49.7 33.0

Operating income 2,855 4.1 1,621 2.7 76.1 6,096 3.0 7,964 4.2 (23.5)

Other (expense) income, net (945) (1.4) 31 — NM (2,977) (1.5) 594 0.3 NM

Income before income taxes 1,910 2.7 1,652 2.7 15.6 3,119 1.5 8,558 4.5 (63.6)

Income tax expense (benefit) 144 0.2 4 — NM (859) (0.4) 886 0.4 NM

Net income $ 1,766 2.5 % $ 1,648 2.7 % 7.2 $ 3,978 1.9 % $ 7,672 4.1 % 48.1

Operating loss (146) (0.2) (483) (0.8) 69.8

Other expense, net (594) (0.8) (437) (0.7) NM

Loss before income taxes (740) (1.0) (920) (1.5) 19.6

Income tax benefit (433) (0.6) (1,128) (1.8) NM

Net (loss) income $ (307) (0.4) % $ 208 0.3 % (247.6)

REVENUE BY SEGMENT

Three months ended June 30, % incr.

Nine months ended June 30, % incr.

($ in thousands) 2020 2019 (decr.) 2020 2019 (decr.)

Three months ended December 31, % incr.

($ in thousands) 2020 2019 (decr.)

IoT Products & Services $ 61,780 84.5 % $ 54,613 87.6 % 13.1

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IoT Products & Services

IoT Products & Services revenue increased 25.7% for the three months ended June 20, 2020 as compared to the same period in the prior fiscal year.

This primarily was a result of:

• incremental revenue from our acquisition of Opengear;

• increased sales to significant customers related to our embedded modules;

• increased sales of support services revenue.

This increase partially was offset by:

• decreased sales of our Digi Remote Manager ® and wireless design services.

IoT Products & Services revenue increased 15.7% for the nine months ended June 30, 2020, respectively, as compared to the same period in the prior fiscal year.

IoT Products & Services revenue increased 13.1% for the three months ended December 31, 2020 as compared to the same period in the prior fiscal year.

This primarily was a result of:

• incremental revenue from our acquisition of Opengear;

• increased sales to a significant customer of our cellular products;

• an increase in support services revenue.

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

• increased sales of our console servers primarily due to incremental revenue from our acquisition of Opengear in December 2019;

• increased sales of technical services.

This increase partially was offset by:

• large sales to certain customers in the prior year that did not reoccur in fiscal 2020 for our network and RF products;

• decreased sales of our enterprise and embedded products due to timing and delays in customer purchases;

• decreased sales of our wireless design services.

• decreased sales of our cellular routers primarily related to large sales to an existing customer for our cellular products in the prior year that was not repeated this year.

IoT Solutions

IoT Solutions revenue decreased 35.6% and 28.1% for the three and nine months ended June 30, 2020, respectively, as compared to the same periods in the prior fiscal year.

IoT Solutions revenue increased 47.5% for the three months ended December 31, 2020 as compared to the same period in the prior fiscal year.

This primarily was a result of:

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

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

• for the nine months ended June 30, 2020 compared to the same period in the prior fiscal year, equipment upgrades from existing customers in fiscal 2019 that did not reoccur in fiscal 2020.

This decrease partially was offset by:

• increased recurring revenue from our subscription services.

• additional new and existing customer deployments and equipment upgrades;

• an increase in recurring revenue from our subscription services as we service over 75,000 sites as of December 31, 2020, compared to nearly 67,000 sites as of December 31, 2019.

COST OF GOODS SOLD AND GROSS PROFIT BY SEGMENT

Three months ended June 30, Basis point Nine months ended June 30, Basis point

Three months ended December 31, Basis point

($ in thousands) 2020 2019 inc.

(Decr.) 2020 2019 Inc.

Cost of Goods Sold

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Total cost of goods sold $ 32,127 43.9 % $ 31,853 51.1 % (720)

Three months ended June 30, Basis point Nine months ended June 30, Basis point

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

Three months ended December 31, Basis point

($ in thousands) 2020 2019 inc.

(Decr.) 2020 2019 Inc.

IoT Products & Services $ 35,679 57.8 % $ 26,651 48.8 % 900

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IoT Product & Services

IoT Products & Services gross profit margin increased 770 and 560 basis points for the three and nine months ended June 30, 2020, respectively, as compared to the same periods in the prior fiscal year.

These increases primarily were a result of:

• incremental gross profit from our acquisition of Opengear, which have higher gross margins;

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

For the nine months ended June 30, 2020, this increase partially was offset by:

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

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

IoT Products & Services gross profit margin increased 900 basis points for the three months ended December 31, 2020 as compared to the same period in the prior fiscal year.

This increase primarily was a result of:

• incremental gross profit from increased sales of our console servers, which have higher gross margins;

• a decrease in our cellular products gross profit which typically has lower gross margins;

• increased sales from our technical services, which typically has higher gross margins.

IoT Solutions

The IoT Solutions gross profit margin increased 70 and 20 basis points for the three and nine months ended June 30, 2020 as compared to the same periods in the prior fiscal year.

These increases primarily were a result of:

• one-time non-recurring revenue in the third quarter of fiscal 2020;

The IoT Solutions gross profit margin decreased 250 basis points for the three months ended December 31, 2020 as compared to the same period in the prior fiscal year.

This decrease primarily was a result of:

• higher portion of revenue attributed to hardware product sales, which carry a lower gross margin;

• increased freight and tariff charges incurred in first quarter of fiscal 2021;

• remediation and warranty claims in the first quarter of fiscal 2021 compared to the same period in the prior fiscal year.

This was partially offset by:

• increased recurring subscription revenue, which typically has higher gross margins.

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

Three months ended June 30, $ % Nine months ended June 30, $ %

Three months ended December 31, $ %

($ in thousands) 2020 2019 incr.

(decr.) incr.

(decr.) 2020 2019 incr.

(decr.) incr.

Operating Expenses

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General and administrative 14,415 19.7 % 8,555 13.7 % 5,860 68.5

Restructuring charge (reversal) 91 — % (20) — % 111 NM 129 0.1 % (87) (0.1) % 216 (248.3)

Restructuring charge 733 1.0 % — — % 733 NM

Total operating expenses $ 41,165 56.3 % $ 30,947 49.7 % $ 10,218 33.0

NM means not meaningful

The $7.8 million increase in operating expenses in the third quarter of fiscal 2020 from the third quarter of fiscal 2019 primarily was the result of:

• incremental operating expenses from Opengear;

• an increase in $1.1 million professional and outside services fees which includes a $0.4 million increase in acquisition related expenses;

• a $0.4 million increase in bad debts provision;

• a $0.3 million increase in employee related expenses.

This increase partially was offset by:

• a decrease of $1.1 million in trade shows and related travel expenses as events and travel were restricted due to COVID-19;

• decrease in acquisition earn-out expenses of $0.4 million;

The $19.9 million increase in operating expenses in the first nine months of fiscal 2020 from the first nine months of fiscal 2019 primarily was the result of:

• incremental operating expenses from Opengear;

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

• a $1.6 increase in acquisition expenses;

• a $0.4 million increase in certification testing

This increase partially was offset by:

• a decrease in acquisition earnout expenses of $1.3 million;

The $10.2 million increase in operating expenses in the first quarter of fiscal 2021 from the first quarter of fiscal 2020 primarily was the result of:

• an increase of $5.5 million in earn-out expenses as a result of revenue from Opengear exceeding our previous estimate;

• an increase of $3.6 million in compensation related expenses primarily related to incremental salaries and bonuses from Opengear acquired in December 2019 and additional commission expense due to increased revenue performance of Opengear in the first quarter of fiscal 2021;

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

• a decrease of $1.2 million in trade shows and related travel expenses as events and travel were restricted due to COVID-19;

• a $0.5 million decrease related to employee commission and other employee related costs;

• a reduction of $0.4 million in amortization expense mostly related to certain intangibles that have been fully amortized.

OTHER (EXPENSE) INCOME, NET

Three months ended June 30, $ % Nine months ended June 30, $ %

• an increase in $1.1 million primarily related to incremental amortization due to the acquisition of Opengear acquired in December 2019;

• a $0.9 million increase in professional fees;

• a $0.7 million increase related to severance expense from the restructuring that took place during the first quarter of fiscal 2021.

This increase partially was offset by:

• a decrease of $1.9 in acquisition expenses;

• a decrease of $0.8 million in travel related expenses as events and travel were restricted due to COVID-19.

OPERATING INCOME (LOSS)

Operating loss was $0.1 million for the first quarter of fiscal 2021, compared to an operating loss of $0.5 million for the first quarter of 2020.

IoT Product & Services provided operating income of $1.3 million in the first quarter of fiscal 2021 compared to $4.4 million in the first quarter of fiscal 2020, a decrease of $3.1 million, or 71.1%.

Included in the first quarter of fiscal 2021 was an earn-out adjustment of $5.8 million.

Other drivers for the decrease in operating income are described above in the revenue, gross profit and operating expenses details.

IoT Solutions had an operating loss of $1.4 million in the first quarter of fiscal 2021 compared to an operating loss of $4.9 million in the first quarter of fiscal 2020, an improvement of $3.5 million, or 71.0%.

Drivers for the improvement in operating loss are described above in the revenue, gross profit and operating expenses details.

OTHER EXPENSE, NET

Three months ended December 31, $ %

($ in thousands) 2020 2019 incr.

(decr.) incr.

(decr.) 2020 2019 incr.

(decr.) incr.

Other (expense) income, net

Other expense, net

Interest income $ — — % $ 231 0.4 % $ (231) (100.0)

Interest expense (900) (1.3) % — — % (900) NM (3,066) (1.5) % (94) (0.1) % (2,972) NM

Other (expense) income, net (67) (0.1) % (174) (0.3) % 107 (61.5) (214) (0.1) % 131 0.1 % (345) (263.4)

Total other (expense) income, net $ (945) (1.4) % $ 31 — % $ (976) NM $ (2,977) (1.5) % $ 594 0.3 % $ (3,571) NM

Interest expense (402) (0.5) % (432) (0.7) % 30 (6.9)

Other expense, net (192) (0.3) % (236) (0.4) % 44 (18.6)

Total other expense, net $ (594) (0.8) % $ (437) (0.7) % $ (157) NM

NM means not meaningful

The $1.0 million decrease in other (expense) income, net in the third quarter of fiscal 2020 from the third quarter of fiscal 2019 primarily was the result of:

• an increase in interest expense of $0.9 million related to the balance outstanding under the Credit Facility in connection with the acquisition of Opengear on December 13, 2019 (see Note 8 to the condensed consolidated financial statements);

• a decrease of $0.2 million related to a reduction in interest income.

The $3.6 million decrease in other (expense) income, net in the first nine months of fiscal 2020 from the first nine months of fiscal 2019 primarily was the result of:

• an increase in interest expense of $3.0 million related to the balance outstanding under the Credit Facility in connection with the acquisition of Opengear on December 13, 2019 (see Note 8 to the condensed consolidated financial statements);

• a decrease of $0.3 million related to an increase in foreign currency losses compared to foreign current gains in the prior fiscal year, primarily related to fluctuations in the Euro;

• a decrease of $0.3 million related to a reduction in interest income.

The $0.2 million increase in other expense, net in the first quarter of fiscal 2021 from the first quarter of fiscal 2020 primarily was the result of a decrease in interest income of $0.2 million related to the money market fund that was closed in December 2019.

See Note 10 to the condensed consolidated financial statements for discussion of income taxes.

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

NON-GAAP FINANCIAL INFORMATION

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 Digi.

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

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

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.

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, changes in fair value of contingent consideration, acquisition-related expenses and interest expense related to acquisitions 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.

Management believes that Adjusted EBITDA, defined as EBITDA adjusted for stock-based compensation expense, acquisition-related expenses, restructuring charges and reversals, and changes in fair value of contingent consideration 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 items reflected in the Condensed Consolidated Statements of Operations.

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.

Below are reconciliations from GAAP to Non-GAAP information that we feel is important to our business:

Reconciliation of Net Income to Adjusted EBITDA

Reconciliation of Net (Loss) Income to Adjusted EBITDA

(In thousands)

Three months ended June 30, Nine months ended June 30,

2020 2019 2020 2019

revenue % of total

Three months ended December 31,

revenue % of total

Total revenue $ 73,146 100.0 % $ 62,317 100.0 %

Net income $ 1,766 $ 1,648 $ 3,978 $ 7,672

Interest expense (income), net 878 (205) 2,763 (463)

Income tax expense (benefit) 144 4 (859) 886

Net (loss) income $ (307) $ 208

Interest expense, net 402 201

Income tax benefit (433) (1,128)

Depreciation and amortization 5,050 3,617

Stock-based compensation 1,745 1,600

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

Restructuring charge (reversal) 91 (20) 129 (87)

Changes in fair value of contingent consideration 5,772 259

Restructuring charge 733 —

Acquisition expense 15 1,906

Adjusted EBITDA (1)

Reconciliation of Net Income and Net Income per Diluted Share to

$ 12,977 17.7 % $ 6,663 10.7 %

(1) Beginning in fiscal 2021, Adjusted EBITDA now excludes changes in fair value of contingent consideration.

The prior year presentation has been adjusted to conform to the current year presentation.

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

Reconciliation of Net (Loss) Income and Net (Loss) Income per Diluted Share to

Adjusted Net Income and Adjusted Net Income per Diluted Share

(In thousands, except per share amounts)

Three months ended June 30, Nine months ended June 30,

2020 2019 2020 2019

Net income and net income per diluted share $ 1,766 $ 0.06 $ 1,648 $ 0.06 $ 3,978 $ 0.13 $ 7,672 $ 0.27

Three months ended December 31,

Net (loss) income and net (loss) income per diluted share $ (307) $ (0.01) $ 208 $ 0.01

Amortization 3,961 0.13 2,448 0.08

Stock-based compensation 1,745 0.06 1,600 0.05

Other non-operating expense (income) 67 — 174 0.01 214 0.01 (131) —

Other non-operating expense 192 0.01 236 0.01

Acquisition expense 15 — 1,906 0.06

Acquisition earn-out adjustments — — 378 0.01 (128) — 1,188 0.04

Restructuring charge (reversal) 91 — (20) — 129 — (87) —

Changes in fair value of contingent consideration 5,772 0.19 259 0.01

Restructuring charge 733 0.02 — —

Interest expense related to acquisition 402 0.01 416 0.01

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

Tax effect from the above adjustments (1)

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Diluted weighted average common shares (4)

30,532 29,614

(1) The tax effect from the above adjustments assumes an estimated effective tax rate of 18.0% for fiscal 2021 and 20.2% for fiscal 2020 based on adjusted net income.

(2) For the three months ended June 30, 2020, discrete tax benefits primarily are a result of expiring statute of limitations.

For the nine months ended June 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 three and nine months ended June 30, 2019, discrete tax benefits are a result of expiring statute of limitations of uncertain tax benefits as well as excess tax benefits recognized on stock compensation.

(2) For the three months ended December 30, 2020, discrete tax benefits primarily are a result of excess tax benefits recognized on stock compensation.

For the three months ended December 31, 2019, discrete tax benefits were primarily a result of excess tax benefits on stock compensation and an adjustment of our state deferred tax rate due to the Opengear acquisition.

(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)

(4) Diluted weighted average common shares for the three months ended December 31, 2020 include 1,157,727 common stock options and restricted stock units due to the adjusted net income position.

LIQUIDITY AND CAPITAL RESOURCES

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

As of June 30, 2020, $70 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 third quarter of fiscal 2020, we repaid $30 million of the Revolving Loan.

As of December 31, 2020, $100 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 first quarter of fiscal 2021, we repaid the final $15 million of the Revolving Loan.

For additional information regarding the terms of our Credit Facility, including the Revolving Loan and its subfacilities, see Note 7 to our condensed 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 additional rules for the PPP established after the grant acceptance, we subsequently made the determination to pay back the full amount of the loan of $9.0 million, plus interest.

This payment was made on May 4, 2020.

We expect positive cash flows from operations.

We expect positive cash flows from operations for the foreseeable future.

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 condensed consolidated statement of cash flows for the nine months ended June 30, 2020 and 2019 is summarized:

Nine months ended June 30,

As follows, our condensed consolidated statement of cash flows for the three months ended December 31, 2020 and 2019 is summarized:

Three months ended December 31,

($ in thousands) 2020 2019

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Effect of exchange rate changes on cash and cash equivalents 392 1,772

Net (decrease) increase in cash and cash equivalents $ (37,707) $ 26,080

Cash flows from operating activities decreased $3.4 million primarily as a result of:

• negative changes in operating assets and liabilities (net of acquisitions) of $7.7 million.

This primarily was due to increased inventory and income taxes receivable and earnout payment in excess of original valuation, offset by a decrease in accounts payable in the prior fiscal year and a decrease in accounts receivable;

• a decrease in net income of $3.7 million, partially offset by non-cash adjustments of $8.0 million.

This primarily included a gain in the sale of our former corporate headquarters building in the prior fiscal year and increased depreciation and amortization expense.

Cash flows from investing activities decreased $140.7 million primarily as a result of:

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

• proceeds of $10.0 million for the sale of our corporate headquarters building and $2.5 million proceeds from maturities of our marketable securities both in the prior fiscal year;

• a partial offset to these decreases was $7.9 million related to purchases of property, equipment, and facilities improvements (mostly related to the build-out of our new corporate headquarters space) in the prior fiscal year.

Cash flows from financing activities increased $78.1 million primarily as a result of:

• proceeds, net of payments, of long-term debt of $78.8 million of debt from the Revolving Loan and Term Loan (see Note 8 to the condensed consolidated financial statements);

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

Net decrease in cash and cash equivalents $ (4,866) $ (43,720)

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

• a partial offset to these decreases relates to additional payments of $1.0 million related to acquisition earn-out payments.

Cash flows from operating activities increased $30.4 million primarily as a result of:

• increased changes in operating assets and liabilities (net of acquisitions) of $23.0 million.

This primarily was due to a decrease in accounts receivable due to ramped up collections in the current fiscal year in addition to increased accounts receivable in the prior fiscal year.

There was also an increase in accrued liabilities, partially offset by a decrease in accounts payable in the current fiscal year;

• a decrease in net income of $0.5 million, partially offset by non-cash adjustments of $7.9 million.

These non-cash adjustments include an accrual for additional earn-out provision.

Cash flows from investing activities increased $135.5 million primarily as a result of:

• an increase of $136.1 million related to the purchase of Opengear in the prior fiscal year;

• a partial offset to these decreases was $0.6 million related to additional purchases of property, equipment, and facilities improvements in the prior fiscal year.

Cash flows from financing activities decreased $125.6 million primarily as a result of:

• a decrease of $110.0 related to proceeds of long-term debt from the Revolving Loan and Term Loan in the prior fiscal year (see Note 7 to the condensed consolidated financial statements);

• a decrease of $15.6 million related to payments on long-term debt.

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual obligations at June 30, 2020:

The following table summarizes our contractual obligations at December 31, 2020:

Payments due by fiscal period

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Contingent consideration $ 10,000 $ 10,000 $ — $ — $ —

Revolving loan $ 30,000 $ — $ — $ 30,000 $ —

Term loan $ 47,500 $ 2,500 $ 7,500 $ 37,500 $ —

3 unchanged sentences

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

Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.3 million as of June 30, 2020.

Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.6 million as of December 31, 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.

3 unchanged sentences

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-Q

Item 2. Management’s Discussion and Analysis