DIGI INTERNATIONAL INC 10-Q

ITEM 1. FINANCIAL STATEMENTS DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three months ended December 31, 2020 2019 (in thousands, except per share data) Revenue: Product $ 62,604 $ 54,247 Service 10,542 8,070 Total revenue 73,146 62,317 Cost of sales: Cost of product 27,776 28,491 Cost of service 3,237 2,561 Amortization 1,114 801 Total cost of sales 32,127 31,853 Gross profit 41,019 30,464 Operating expenses: Sales and marketing 14,924 12,061 Research and development 11,093 10,331 General and administrative 14,415 8,555 Restructuring charge 733 — Total operating expenses 41,165 30,947 Operating loss ( 146 ) ( 483 ) Other expense, net: Interest income — 231 Interest expense ( 402 ) ( 432 ) Other expense, net ( 192 ) ( 236 ) Total other expense, net ( 594 ) ( 437 ) Loss before income taxes ( 740 ) ( 920 ) Income tax benefit ( 433 ) ( 1,128 ) Net (loss) income $ ( 307 ) $ 208 Net (loss) income per common share: Basic $ ( 0.01 ) $ 0.01 Diluted $ ( 0.01 ) $ 0.01 Weighted average common shares: Basic 29,374 28,467 Diluted 29,374 29,614 The accompanying notes are an integral part of the condensed consolidated financial statements. 1 Table of Contents DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three months ended December 31, 2020 2019 (in thousands) Net (loss) income $ ( 307 ) $ 208 Other comprehensive income: Foreign currency translation adjustment 1,872 2,660 Other comprehensive income 1,872 2,660 Comprehensive income $ 1,565 $ 2,868 The accompanying notes are an integral part of the condensed consolidated financial statements. 2 Table of Contents DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) December 31, 2020 September 30, 2020 (in thousands, except share data) ASSETS Current assets: Cash and cash equivalents $ 49,263 $ 54,129 Accounts receivable, net 52,500 59,227 Inventories 54,757 51,568 Other current assets 10,742 5,134 Total current assets 167,262 170,058 Property, equipment and improvements, net 13,442 11,507 Operating lease right-of-use assets 16,665 14,334 Intangible assets, net 117,392 121,248 Goodwill 212,366 210,135 Deferred tax assets 566 389 Other non-current assets 1,095 1,011 Total assets $ 528,788 $ 528,682 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 1,972 $ 1,972 Accounts payable 22,472 28,067 Accrued compensation 10,317 9,372 Unearned revenue 11,979 7,691 Contingent consideration on acquired business 10,000 4,228 Current portion of operating lease liabilities 2,776 2,527 Other current liabilities 7,971 7,373 Total current liabilities 67,487 61,230 Income taxes payable 1,895 1,958 Deferred tax liabilities 17,823 17,171 Long-term debt 43,483 58,980 Operating lease liabilities 19,371 16,193 Other non-current liabilities 1,087 1,650 Total liabilities 151,146 157,182 Commitments and Contingencies (see Note 14) Stockholders' equity: Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued and outstanding — — Common stock, $.01 par value; 60,000,000 shares authorized; 36,090,681 and 35,512,843 shares issued 361 355 Additional paid-in capital 285,536 279,741 Retained earnings 170,023 170,330 Accumulated other comprehensive loss ( 21,945 ) ( 23,817 ) Treasury stock, at cost, 6,411,776 and 6,353,094 shares ( 56,333 ) ( 55,109 ) Total stockholders' equity 377,642 371,500 Total liabilities and stockholders' equity $ 528,788 $ 528,682 The accompanying notes are an integral part of the condensed consolidated financial statements. 3 Table of Contents DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three months ended December 31, 2020 2019 (in thousands) Operating activities: Net (loss) income $ ( 307 ) $ 208 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Depreciation of property, equipment and improvements 1,089 1,169 Amortization of intangible assets 3,961 2,448 Stock-based compensation 1,745 1,600 Deferred income tax provision 750 234 Change in fair value of contingent consideration 5,772 259 Provision for bad debt and product returns ( 518 ) 50 Provision for inventory obsolescence 600 455 Restructuring charge 733 — Other 118 161 Changes in operating assets and liabilities (net of acquisitions) ( 5,631 ) ( 28,651 ) Net cash provided by (used in) operating activities 8,312 ( 22,067 ) Investing activities: Acquisition of business, net of cash acquired — ( 136,098 ) Purchase of property, equipment, improvements and certain other intangible assets ( 777 ) ( 196 ) Net cash used in investing activities ( 777 ) ( 136,294 ) Financing activities: Proceeds from long-term debt — 110,000 Payments on long-term debt ( 15,625 ) — Proceeds from stock option plan transactions 3,944 4,160 Proceeds from employee stock purchase plan transactions 334 286 Purchases of common stock ( 1,446 ) ( 1,577 ) Net cash (used in) provided by financing activities ( 12,793 ) 112,869 Effect of exchange rate changes on cash and cash equivalents 392 1,772 Net decrease in cash and cash equivalents ( 4,866 ) ( 43,720 ) Cash and cash equivalents, beginning of period 54,129 92,792 Cash and cash equivalents, end of period $ 49,263 $ 49,072 Supplemental schedule of non-cash investing and financing activities: Transfer of inventory to property, equipment and improvements $ ( 882 ) $ ( 186 ) Contingent consideration recognized related to acquisition of business $ — $ ( 9,100 ) Tenant improvement allowance $ ( 1,000 ) $ — Accrual for purchase of property, equipment, improvements and certain other intangible assets $ ( 452 ) $ — The accompanying notes are an integral part of the condensed consolidated financial statements. 4 Table of Contents DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) Accumulated Additional Other Total Common Stock Treasury Stock Paid-In Retained Comprehensive Stockholders' (in thousands) Shares Par Value Shares Value Capital Earnings Loss Equity Balances, September 30, 2019 34,608 $ 346 6,367 $ ( 54,339 ) $ 266,567 $ 161,919 $ ( 25,515 ) $ 348,978 Net income 208 208 Other comprehensive income 2,660 2,660 Employee stock purchase plan issuances ( 25 ) 214 72 286 Taxes paid for net share settlement of share-based payment awards 89 ( 1,577 ) ( 1,577 ) Issuance of stock under stock award plans 618 6 4,154 4,160 Stock-based compensation expense 1,600 1,600 Balances, December 31, 2019 35,226 $ 352 6,431 $ ( 55,702 ) $ 272,393 $ 162,127 $ ( 22,855 ) $ 356,315 Balances, September 30, 2020 35,513 $ 355 6,353 $ ( 55,109 ) $ 279,741 $ 170,330 $ ( 23,817 ) $ 371,500 Net loss ( 307 ) ( 307 ) Other comprehensive income 1,872 1,872 Employee stock purchase plan issuances ( 25 ) 222 112 334 Taxes paid for net share settlement of share-based payment awards 84 ( 1,446 ) ( 1,446 ) Issuance of stock under stock award plans 577 6 3,938 3,944 Stock-based compensation expense 1,745 1,745 Balances, December 31, 2020 36,090 $ 361 6,412 $ ( 56,333 ) $ 285,536 $ 170,023 $ ( 21,945 ) $ 377,642 The accompanying notes are an integral part of the condensed consolidated financial statements. 5 Table of Contents DIGI INTERNATIONAL INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The unaudited condensed consolidated financial statements of Digi International Inc. ("we", "us", "our", "Digi" or "the Company") have been prepared in accordance with the rules and regulations of the United States Securities and Exchange Commission applicable to interim financial statements. While these financial statements reflect all normal recurring adjustments that are, in the opinion of management, necessary for fair presentation of the results of the interim period, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles ("GAAP") for complete financial statements. These financial statements should be read in conjunction with the financial statement disclosures in our Annual Report on Form 10-K for the year ended September 30, 2020 (the "2020 Financial Statements"). We use the same accounting policies in preparing quarterly and annual financial statements. The quarterly results of operations are not necessarily indicative of the results to be expected for the full year. As described in Note 8, effective with the reorganization announcement on October 7, 2020, 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. Potential Impacts of COVID-19 on our Business The impact of the coronavirus disease 2019 ("COVID-19") pandemic continues to unfold. The extent of the pandemic's effect on our operational and financial performance will depend in large part on future developments, which cannot be reasonably estimated at this time. Future developments include the duration, scope and severity of the pandemic, the actions taken to contain or mitigate its impact both within and outside the jurisdictions where we operate, the impact on governmental programs and budgets, the development of treatments or vaccines, and the timing and level of resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented and rapidly evolving situation, we are unable to predict with any confidence the likely impact of the COVID-19 pandemic on our future operations. For a more detailed discussion see Part I, Item 1 in our Annual Report on Form 10-K for the year ended September 30, 2020 and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of this Form 10-Q. Recently Issued Accounting Pronouncements Adopted In August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-13, Fair Value Measurement - Disclosure Framework (Topic 820). The updated guidance changes the disclosure requirements on fair value measurements. We adopted this standard in the first quarter of fiscal 2021. This standard did not have a material impact on our consolidated financial statements. In June 2016, FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments . The amendments in this update replace the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses. This update is intended to provide financial statement users with more decision-useful information about expected credit losses. We adopted this standard in the first quarter of fiscal 2021, following the modified-retrospective approach. This standard did not have a material impact on our consolidated financial statements. 6 Table of Contents 2. ACQUISITIONS Acquisition of Opengear, Inc. On December 13, 2019, we completed our acquisition of Opengear, Inc. ("Opengear"), a New Jersey-based provider of secure IT infrastructure products and software. Opengear results have been included in our condensed consolidated financial statements within our IoT Products & Services segment since the date of acquisition. During the first quarter of fiscal 2021, we recorded an out-of-period adjustment in connection with the purchase price accounting of Opengear. This balance sheet adjustment resulted in a decrease in fair value of net tangible assets acquired of $ 1.1 million , a decrease of $ 0.3 million to non-current deferred tax liability and an increase to goodwill of $ 0.8 million . Management assessed the impact of this adjustment and believes, after considering both quantitative and qualitative factors, that it is not material to our current or previously issued consolidated financial statements. The following table summarizes the final fair values of Opengear assets acquired and liabilities assumed as of the acquisition date (in thousands): Cash $ 148,058 Contingent consideration 5,100 Total $ 153,158 Fair value of net tangible assets acquired $ 18,096 Identifiable intangible assets: Customer relationships 79,000 Purchased and core technology 18,100 Trademarks 8,000 Deferred tax liability on identifiable intangible assets ( 27,126 ) Goodwill 57,088 Total $ 153,158 The Condensed Consolidated Balance Sheet as of December 31, 2020 reflects the final allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. 3. EARNINGS PER SHARE Basic net (loss) income per common share is calculated based on the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares result from dilutive common stock options and restricted stock units. Diluted net loss per common share is computed by dividing net loss by the weighted average number of common shares. All potentially dilutive common equivalent shares are excluded from the calculations of net loss per diluted share due to their anti-dilutive effect for the three months ended December 31, 2020. 7 Table of Contents 3. EARNINGS PER SHARE (CONTINUED) The following table is a reconciliation of the numerators and denominators in the net (loss) income per common share calculations (in thousands, except per common share data): Three months ended December 31, 2020 2019 Numerator: Net (loss) income $ ( 307 ) $ 208 Denominator: Denominator for basic net (loss) income per common share — weighted average shares outstanding 29,374 28,467 Effect of dilutive securities: Stock options and restricted stock units — 1,147 Denominator for diluted net (loss) income per common share — adjusted weighted average shares 29,374 29,614 Net (loss) income per common share, basic $ ( 0.01 ) $ 0.01 Net (loss) income per common share, diluted $ ( 0.01 ) $ 0.01 For the three months ended December 31, 2020 and 2019, there were 547,045 and 594,447 potentially dilutive shares, respectively. These potentially dilutive shares were related to stock options to purchase common shares that were not included in the above computation of diluted earnings per common share since the options' exercise prices were greater than the average market price of our common shares. In addition, due to the net loss for the three months ended December 31, 2020, there were 1,157,727 common stock options and restricted stock units that were not included in the above computation of diluted earnings per share. 4. SELECTED BALANCE SHEET DATA The following table shows selected balance sheet data (in thousands): December 31, 2020 September 30, 2020 Accounts receivable, net: Accounts receivable $ 57,782 $ 65,027 Less allowance for doubtful accounts 2,987 3,778 Less reserve for future returns and pricing adjustments 2,295 2,022 Accounts receivable, net $ 52,500 $ 59,227 Inventories: Raw materials $ 14,695 $ 14,009 Finished goods 40,062 37,559 Inventories $ 54,757 $ 51,568 5. FAIR VALUE MEASUREMENTS Financial assets and liabilities are classified in the following fair value hierarchy based on the lowest level input that is significant to the fair value measurement: Level 1 (unadjusted quoted prices in active markets for identical assets or liabilities); Level 2 (observable market inputs, other than quoted prices included in Level 1); and Level 3 (unobservable inputs that cannot be corroborated by observable market data). 8 Table of Contents 5. FAIR VALUE MEASUREMENTS (CONTINUED) The following tables provide information by level for financial liabilities that are measured at fair value on a recurring basis (in thousands): Total Fair Value at Fair Value Measurements Using Inputs Considered as December 31, 2020 Level 1 Level 2 Level 3 Liabilities: Contingent consideration on acquired businesses $ 10,000 $ — $ — $ 10,000 Total liabilities measured at fair value $ 10,000 $ — $ — $ 10,000 Total Fair Value at Fair Value Measurements Using Inputs Considered as September 30, 2020 Level 1 Level 2 Level 3 Liabilities: Contingent consideration on acquired businesses $ 4,228 $ — $ — $ 4,228 Total liabilities measured at fair value $ 4,228 $ — $ — $ 4,228 In connection with our acquisition of Bluenica Corporation ("Bluenica") in October 2015, we agreed to make contingent earn-out payments over a period of up to 4 years, subject to achieving specified revenue thresholds for sales of Bluenica products. We paid the final installment of $ 2.9 million during the third quarter of fiscal 2020. In connection with our acquisition of Accelerated Concepts, Inc. ("Accelerated") in January 2018, we agreed to make contingent earn-out payments if specified revenue thresholds for sales of Accelerated products were achieved. We paid the first installment payment of $ 3.5 million in the third quarter of fiscal 2019. The earn-out period for this acquisition ended on January 22, 2020. We paid the final installment of $ 2.4 million in the third quarter of fiscal 2020. In connection with our acquisition of Opengear, we agreed to make contingent payments, based upon certain revenue thresholds (see Note 2 to the condensed consolidated financial statements). We paid the first installment of $ 0.9 million during the third quarter of fiscal 2020. The fair value of the remaining liability for contingent consideration for the acquisition of Opengear was equal to the maximum payout of $ 10.0 million at December 31, 2020 due to a substantial increase in revenue over our previous expectations. We expect to pay this amount during the second quarter of fiscal 2021. The following table presents a reconciliation of the contingent consideration liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) (in thousands): Three months ended December 31, 2020 2019 Fair value at beginning of period $ 4,228 $ 5,407 Contingent consideration recognized for acquired business — 9,100 Change in fair value of contingent consideration 5,772 259 Fair value at end of period $ 10,000 $ 14,766 The change in fair value of contingent consideration reflects our estimates of the probabilities of achieving the relevant targets and is discounted based on our estimated discount rate. The fair value of the contingent consideration at December 31, 2020 was based on the actual achievement of the specified revenue thresholds for Opengear. 9 Table of Contents 6. GOODWILL AND OTHER INTANGIBLE ASSETS, NET Amortizable intangible assets were (in thousands): December 31, 2020 September 30, 2020 Gross carrying amount Accum. amort. Net Gross carrying amount Accum. amort. Net Purchased and core technology $ 76,473 $ ( 57,017 ) $ 19,456 $ 76,011 $ ( 55,482 ) $ 20,529 License agreements 112 ( 112 ) — 112 ( 112 ) — Patents and trademarks 22,936 ( 13,968 ) 8,968 22,836 ( 13,535 ) 9,301 Customer relationships 125,805 ( 36,957 ) 88,848 125,500 ( 34,232 ) 91,268 Non-compete agreements 600 ( 480 ) 120 600 ( 450 ) 150 Total $ 225,926 $ ( 108,534 ) $ 117,392 $ 225,059 $ ( 103,811 ) $ 121,248 Amortization expense was $ 4.0 million and $ 2.4 million for the three months ended December 31, 2020 and 2019, respectively. Amortization expense is recorded on our condensed consolidated statements of operations within cost of sales and in general and administrative expense. Estimated amortization expense related to intangible assets for the remainder of fiscal 2021 and the five succeeding fiscal years is (in thousands): 2021 (nine months) $ 11,616 2022 $ 14,720 2023 $ 12,518 2024 $ 11,815 2025 $ 8,358 2026 $ 8,126 The changes in the carrying amount of goodwill by reportable segments are (in thousands): Three months ended December 31, IoT Products and Services IoT Solutions Total Balance on September 30, 2020 $ 160,365 $ 49,770 $ 210,135 Adjustment (see Note 2) 846 — 846 Foreign currency translation adjustment 834 551 1,385 Balance at December 31, 2020 $ 162,045 $ 50,321 $ 212,366 Goodwill represents the excess of cost over the fair value of net identifiable assets acquired. Goodwill is quantitatively tested for impairment on an annual basis as of June 30, or more frequently if events or circumstances occur which could indicate impairment. We continue to have two reportable segments, our IoT Products & Services segment and our IoT Solutions segment (see Note 8). Effective with the reorganization announcement on October 7, 2020 (see Note 13), our IoT Products & Services business is now structured to include four operating segments, each with a segment manager: Cellular Routers, Console Servers, OEM Solutions and Infrastructure Management. We have concluded that these operating segments along with our IoT Solutions segment constitute separate reporting units and will be tested individually for impairment. As of December 31, 2020, we have performed a qualitative assessment and concluded that there is no impairment or triggering events. For our fiscal 2020 annual impairment test we concluded that the IoT Products & Services segment and the IoT Solutions segment constitute separate reporting units for purposes of the ASC 350-20-35 "Goodwill Measurement of Impairment" assessment and both units were tested individually for impairment. 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, then an impairment loss must be recognized for the excess. Fair values for both reporting units were each estimated on a standalone basis using a weighted combination of the income approach and market approach. 10 Table of Contents 6. GOODWILL AND OTHER INTANGIBLE ASSETS, NET (CONTINUED) The income approach indicates the fair value of a business based on the value of the cash flows the business or asset can be expected to generate in the future. A commonly used variation of the income approach used to value a business is the discounted cash flow (“DCF”) method. The DCF method is a valuation technique in which the value of a business is estimated on the earnings capacity, or available cash flow, of that business. Earnings capacity represents the earnings available for distribution to stockholders after consideration of the reinvestment required for future growth. Significant judgment is required to estimate the amount and timing of future cash flows for each reporting unit and the relative risk of achieving those cash flows. The market approach indicates the fair value of a business or asset based on a comparison of the business or asset to comparable publicly traded companies or assets and transactions in its industry as well as our prior acquisitions. This approach can be estimated through the guideline company method. This method indicates fair value of a business by comparing it to publicly traded companies in similar lines of business. After identifying and selecting the guideline companies, we make judgments about the comparability of the companies based on size, growth rates, profitability, risk, and return on investment in order to estimate market multiples. These multiples are then applied to the reporting units to estimate a fair value. 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. 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. 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 As of June 30, 2020, we had a total of $ 157.1 million of goodwill for the IoT Products & Services reporting unit and $ 49.6 million of goodwill for the IoT Solutions reporting unit. At June 30, 2020, fair value exceeded the carrying value by more than 10% for both reporting units. Implied fair values for both reporting units were each calculated on a standalone basis using a weighted combination of the income approach and market approach. 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 $ 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. 7. INDEBTEDNESS In connection with our acquisition of Opengear, we entered into a syndicated credit agreement with BMO Harris Bank N.A. ("BMO") on December 13, 2019. This agreement provided us with committed credit facilities (the "Credit Facility") totaling $ 150 million. The Credit Facility includes: (i) a $ 50 million term loan (the "Term Loan") and (ii) a $ 100 million revolving loan (the "Revolving Loan"). Prior to May 4, 2020, borrowings under the Credit Facility bore interest rates based on an underlying variable benchmark plus applicable margin based on our total leverage ("ABR"); this interest rate was reset quarterly. Effective May 4, 2020, borrowings under the Credit Facility bear a variable interest rate of LIBOR plus an applicable margin spread from 3.25 % to 1.25 %. The amount of the applicable margin spread is a function of our leverage ratio and is reset monthly. In addition to paying interest on the outstanding balance under the Credit Facility, we are required to pay a commitment fee on the non-utilized commitments thereunder which is also reported in interest expense. Our weighted average interest rate at December 31, 2020 was 0.6 %. We also incurred debt issuance costs under the Credit Facility of $ 2.6 million in the first quarter of fiscal 2020. These issuance costs are being amortized using the straight-line method over the term of the loan and reported in interest expense. Amounts under the Term Loan will be repaid in quarterly installments on the last day of each fiscal quarter. Amortization is 5 % in the first two years, 7.5 % in the next two years and 10 % in the final year. The remaining outstanding balance will mature on December 13, 2024. The Revolving Loan is due in a lump sum payment at maturity on December 13, 2024. The fair values of the Term Loan and Revolving Loan approximated carrying value at December 31, 2020. 11 Table of Contents 7. INDEBTEDNESS (CONTINUED) The following table is a summary of our long-term indebtedness at December 31, 2020 (in thousands): Term loan $ 47,500 Total loans 47,500 Less unamortized issuance costs ( 2,045 ) Less current maturities of long-term debt ( 1,972 ) Total long-term debt, net of current portion $ 43,483 The following table is a summary of future maturities of our aggregate long-term debt at December 31, 2020 (in thousands): 2021 (nine months) $ 1,875 2022 3,438 2023 3,750 2024 4,687 2025 33,750 Total long-term debt $ 47,500 Covenants and Security Interest The agreements governing the Credit Facility contain a number of covenants. Among other thing, these covenants require us to maintain a certain financial ratio (net leverage ratio and minimum fixed charge ratio). At December 31, 2020, we were in compliance with our debt covenants. Amounts borrowed under the Credit Facility are secured by substantially all of our assets. 8. SEGMENT INFORMATION We have two reportable segments: IoT Products & Services and IoT Solutions. Effective with the reorganization announcement on October 7, 2020 (see Note 13), our IoT Products & Services business is now structured to include four operating segments, each with a segment manager. There four operating segments include: • Cellular Routers - box devices (fully enclosed) that provide connectivity typically in a place where the device can be plugged in exclusively using cellular communications. • Console Servers - similar to cellular routers except they are exclusively for edge computing installments and date center applications exclusively using cellular communications. • OEM Solutions - Original Equipment Manufacturers ("OEM") will be a chip, rather than a boxed device. This can come in the form of a stand-alone chip, or from a system on modules ("SOMs"). While cellular is used, other communication protocols can be used such as Zigbee, Bluetooth or Radio-Frequency ("RF") based on application. • Infrastructure Management - includes connect sensors that will be cellular enabled devices that are battery operated, as well as other types of console server applications that are more DAL based compared to Console Servers. They do have some products that are not using cellular communications, but a large part of the portfolio does use cellular communication. We believe these four operating segments have similar qualitative and quantitative factors which allow us to aggregate them under the IoT Products & Services reportable segment. The qualitative factors include similar nature of products and services, production process, type or class of customers and methods used to distribute the products. The quantitative factors include similar operating income (loss). Our CODM reviews and makes business decisions which includes a primary review of operating income (loss) but also includes gross profit. Thus, our measure of segment measure of profit or loss used by our CODM changed. The shared general and administrative costs are now allocated to each operating segment. As a result, our disclosed measure of segment operating income (loss) has been updated for all periods presented. The change to the business segment operating income (loss) aligns with the update to how the CODM assesses performance and allocates resources for our business segments. 12 Table of Contents 8. SEGMENT INFORMATION (CONTINUED) Summary operating results for each of our segments were (in thousands): Three months ended December 31, 2020 2019 Revenue IoT Products & Services $ 61,780 $ 54,613 IoT Solutions 11,366 7,704 Total revenue $ 73,146 $ 62,317 Gross Profit IoT Products & Services $ 35,679 $ 26,651 IoT Solutions 5,340 3,813 Total gross profit $ 41,019 $ 30,464 Operating Income (Loss) IoT Products & Services $ 1,269 $ 4,397 IoT Solutions ( 1,415 ) ( 4,880 ) Total operating loss $ ( 146 ) $ ( 483 ) Depreciation and Amortization IoT Products & Services $ 3,134 $ 1,706 IoT Solutions 1,916 1,911 Total depreciation and amortization $ 5,050 $ 3,617 Total expended for property, plant and equipment was (in thousands): Three months ended December 31, 2020 2019 IoT Products & Services $ 777 $ 190 IoT Solutions* — 6 Total expended for property, plant and equipment $ 777 $ 196 * Excluded from this amount is $ 882 and $ 186 of transfers of inventory to property plant and equipment for subscriber assets for the three months ended December 31, 2020 and 2019, respectively. Total assets for each of our segments were (in thousands): December 31, 2020 September 30, 2020 IoT Products & Services $ 394,315 $ 387,578 IoT Solutions 85,210 86,975 Unallocated* 49,263 54,129 Total assets $ 528,788 $ 528,682 * Unallocated consists of cash and cash equivalents. 13 Table of Contents 9. REVENUE Revenue Disaggregation The following table summarizes our revenue by geographic location of our customers (in thousands): Three months ended December 31, 2020 2019 North America, primarily the United States $ 54,018 $ 47,536 Europe, Middle East & Africa 10,536 8,516 Rest of world 8,592 6,265 Total revenue $ 73,146 $ 62,317 The following table summarizes our revenue by the timing of revenue recognition (in thousands): Three months ended December 31, 2020 2019 Transferred at a point in time $ 64,188 $ 56,300 Transferred over time 8,958 6,017 Total revenue $ 73,146 $ 62,317 Contract Balances Contract Assets Contract assets consist of subscriber assets. These subscriber assets relate to fees in certain contracts that we charge our customers so they can begin using equipment. In these cases, we retain the ownership of the equipment that the customer uses. The total net book value of subscriber assets of $ 2.4 million and $ 2.0 million as of December 31, 2020 and September 30, 2020, respectively, are included in property, equipment and improvements, net. Depreciation expense for these subscriber assets, which is included in cost of sales, was $ 0.5 million and $ 0.3 million for the three months ended December 31, 2020 and December 31, 2019, respectively. We depreciate the cost of this equipment over its useful life (typically three years ). Contract Liabilities The timing of revenue recognition may differ from the timing of invoicing to customers. Customers are invoiced for subscription services in advance on a monthly, quarterly or annual basis. Contract liabilities consist of unearned revenue related to annual or multi-year contracts for subscription services and related implementation fees. These pertain to our IoT Solutions segment and our Digi Remote Manager ® services in our IoT Products & Services segment. Changes in unearned revenue were (in thousands): Three months ended December 31, 2020 2019 Unearned revenue, beginning of period $ 9,341 $ 5,025 Billings 14,267 9,847 Revenue recognized ( 10,542 ) ( 8,070 ) Unearned revenue, end of period $ 13,066 $ 6,802 Remaining Transaction Price Transaction price allocated to the remaining performance obligations represents contracted revenue that has not been recognized. This includes unearned revenue and unbilled amounts that will be recognized as revenue in future periods. As of December 31, 2020, approximately $ 13.5 million of revenue is expected to be recognized from remaining performance obligations for subscription contracts. We expect to recognize revenue on approximately $ 9.1 million of remaining performance obligations over the next twelve months . Revenue from the remaining performance obligations we expect to recognize over a range of two to seven years . 14 Table of Contents 10. INCOME TAXES Our income tax benefit was $ 0.4 million for the three months ended December 31, 2020. Included in this benefit was a net tax benefit discretely related to the three months ended December 31, 2020 of $ 0.3 million. This benefit primarily was the result of excess tax benefits recognized on stock compensation. Income tax benefit was $ 1.1 million for the three months ended December 31, 2019. Included in this benefit was a net tax benefit discretely related to the three months ended December 31, 2019 of $ 1.0 million. This benefit primarily was the result of excess tax benefits recognized on stock compensation and an adjustment of our state deferred tax rate due to the Opengear acquisition. For the three months ended December 31, 2019, our effective tax rate before items discretely related to the period was less than the U.S. statutory rate. This was primarily due to certain research and development tax credits generated in the U.S. Our effective tax rate will vary based on a variety of factors. These include our overall profitability, the geographical mix of income before taxes and related statutory tax rate in each jurisdiction, and tax items discretely related to the period, such as settlements of audits. We may record other benefits or expenses in the future that are specific to a particular quarter such as expiration of statutes of limitation, the completion of tax audits, or legislation that is enacted in both U.S. and foreign jurisdictions. A reconciliation of the beginning and ending amount of unrecognized tax benefits is (in thousands): Unrecognized tax benefits as of September 30, 2020 $ 2,600 Expiration of statute of limitations ( 54 ) Unrecognized tax benefits as of December 31, 2020 $ 2,546 The total amount of unrecognized tax benefits at December 31, 2020 that, if recognized, would affect our effective tax rate was $ 2.4 million, after considering the impact of interest and deferred benefit items. We expect that the total amount of unrecognized tax benefits will decrease by approximately $ 0.1 million over the next 12 months. 11. PRODUCT WARRANTY OBLIGATION The following tables summarize the activity associated with the product warranty accrual (in thousands) and is included on our condensed consolidated balance sheets within current liabilities: Balance at Warranties Settlements Balance at Period October 1 issued made December 31 Three months ended December 31, 2020 $ 942 $ 123 $ ( 100 ) $ 965 Three months ended December 31, 2019 $ 1,012 $ 74 $ ( 87 ) $ 999 12. LEASES All of our leases are operating leases and primarily consist of leases for office space. For any lease with an initial term in excess of twelve months, the related lease assets and lease liabilities are recognized on the condensed consolidated balance sheets as either operating or financing leases at the inception of an agreement where it is determined that a lease exists. We have lease agreements that contain both lease and non-lease components. We have elected to combine lease and non-lease components for all classes of assets. Leases with an initial term of twelve months or less are not recorded on the condensed consolidated balance sheets. Instead we recognize lease expense for these leases on a straight-line basis over the lease term. Operating lease assets represent the right to use an underlying asset for the lease term and operating lease liabilities represent the obligation to make lease payments. These assets and liabilities are recognized based on the present value of future payments over the lease term at the commencement date. We generally use a collateralized incremental borrowing rate based on information available at the commencement date, including the lease term, in determining the present value of future payments. When determining our right-of-use asset, we generally do not include options to extend or terminate the lease unless it is reasonably certain that the option will be exercised. Our leases typically require payment of real estate taxes and common area maintenance and insurance. These components comprise the majority of our variable lease cost and are excluded from the present value of our lease obligations. Fixed payments may contain predetermined fixed rent escalations. We recognize the related rent expense on a straight-line basis from the commencement date to the end of the lease term. 15 Table of Contents 12. LEASES (CONTINUED) The following table shows the supplemental balance sheet information related to our leases (in thousands): Balance Sheet Location December 31, 2020 September 30, 2020 Assets Operating leases Other non-current assets $ 16,665 $ 14,334 Total lease assets $ 16,665 $ 14,334 Liabilities Operating leases Other current liabilities $ 2,776 $ 2,527 Operating leases Other non-current liabilities 19,371 16,193 Total lease liabilities $ 22,147 $ 18,720 The following were the components of our lease cost which is recorded in both cost of goods sold and selling, general and administrative expense (in thousands): Three months ended December 31, 2020 2019 Operating lease cost $ 861 $ 814 Variable lease cost 268 23 Short-term lease cost 32 38 Total lease cost $ 1,161 $ 875 The following table presents supplemental information related to operating leases (in thousands): Three months ended December 31, 2020 2019 Cash paid for amounts included in the measurement of operating lease liabilities $ 911 $ 416 Right-of-use assets obtained in exchange for new operating lease liabilities $ 2,892 $ — Non-cash tenant improvement allowance $ 1,000 $ — At December 31, 2020 the weighted average remaining lease term of our operating leases was 6.3 years and the weighted average discount rate for these leases was 4.6 %. The table below reconciles the undiscounted cash flows for each of the first five years as well as all the remaining years to the operating lease liabilities recorded on the condensed consolidated balance sheet as of December 31, 2020 (in thousands): Fiscal year Amount Remainder of 2021 $ 2,798 2022 3,412 2023 3,148 2024 2,919 2025 2,821 2026 2,591 Thereafter 9,266 Total future undiscounted lease payments 26,955 Less imputed interest ( 4,808 ) Total reported lease liability $ 22,147 16 Table of Contents 13. RESTRUCTURING Q1 FY2021 Restructuring On October 7, 2020, our Board of Directors approved a reorganization of our IoT Products & Services business segment. The restructuring plan aligns the business segment's organization around product lines. 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 three months ended December 31, 2020. Below is a summary of the restructuring charges and other activity (in thousands): Q1 2021 Restructuring Employee Termination Costs Balance at September 30, 2020 $ — Restructuring charge 733 Payments ( 510 ) Foreign currency fluctuation ( 27 ) Balance at December 31, 2020 $ 196 14. COMMITMENTS AND CONTINGENCIES Leases We lease certain of our buildings and equipment under noncancelable lease agreements. Please refer to Note 12 to our condensed consolidated financial statements for additional information. Litigation In November 2018, DimOnOff Inc., a company headquartered in Quebec City, Quebec, Canada ("DimOnOff"), which sells control systems in the building automation and street lighting markets sued us and a former distributor from whom DimOnOff purchased certain of our products. The suit was brought in the Superior Court of the Province of Quebec in the District of Quebec (Canada) and alleges certain Digi products it purchased and incorporated into street lighting systems in a Canadian city were defective causing some of the street lights to malfunction. It alleges damages of just over CAD 1.0 million. We intend to defend ourselves against DimOnOff's claims. At this time we cannot assess the likelihood or amount of any potential loss. In addition to the matter discussed above, in the normal course of business, we are subject to various claims and litigation. There can be no assurance that any claims by third parties, if proven to have merit, will not materially adversely affect our business, liquidity or financial condition. 15. STOCK-BASED COMPENSATION Stock-based awards were granted under the 2020 Omnibus Incentive Plan (the "2020 Plan") beginning January 29, 2020. Prior to that date such awards made in fiscal 2020 were granted under the 2019 Omnibus Incentive Plan (the "2019 Plan"). Upon stockholder approval of the 2020 Plan, we ceased granting awards under the 2019 Plan. Shares subject to awards under the 2019 Plan or any prior plans that are forfeited, canceled, returned to us for failure to satisfy vesting requirements, settled in cash or otherwise terminated without payment also will be available for grant under the 2020 Plan. The authority to grant options under the 2020 Plan and to set other terms and conditions rests with the Compensation Committee of the Board of Directors. The 2020 Plan authorizes the issuance of up to 1,500,000 common shares in connection with awards of stock options, stock appreciation rights, restricted stock, restricted stock units, performance-based full value awards or other stock-based awards. Eligible participants include our employees, our affiliates, non-employee directors of our Company and any consultant or advisor who is a natural person and provides services to us or our affiliates. Options that have been granted under the 2020 Plan typically vest over a four-year period and will expire if unexercised after seven years from the date of grant. Restricted stock unit awards ("RSUs") that have been granted to directors typically vest in one year . RSUs that have been granted to executives and employees typically vest in January over a four-year period. The 2020 Plan is scheduled to expire on January 28, 2030. Options under the 2020 Plan can be granted as either incentive stock options or non-statutory stock options. The exercise price of options and the grant date price of RSUs is determined by our Compensation Committee but will not be less 17 Table of Contents 15. STOCK-BASED COMPENSATION (CONTINUED) than the fair market value of our common stock based on the closing price as of the date of grant. Upon exercise of options or settlement of vested restricted stock units or performance stock units, we issue new shares of stock. As of December 31, 2020, there were approximately 648,815 shares available for future grants under the 2020 Plan. Cash received from the exercise of stock options was $ 3.9 million and $ 4.2 million for the three months ended December 31, 2020 and December 31, 2019, respectively. Our equity plans and corresponding forms of award agreements generally have provisions allowing employees to elect to satisfy tax withholding obligations through the delivery of shares. When employees make this election we retain a portion of shares issuable under the award. Tax with withholding obligations otherwise occur by the employee paying cash to us for the withholding. During the three months ended December 31, 2020 and 2019, our employees forfeited 83,928 shares and 88,723 shares, respectively, in order to satisfy respective withholding tax obligations of $ 1.4 million and $ 1.6 million. We sponsor an Employee Stock Purchase Plan as amended and restated as of December 10, 2019, October 29, 2013, December 4, 2009 and November 27, 2006 (the "ESPP"), covering all domestic employees with at least 90 days of continuous service and who are customarily employed at least 20 hours per week. The ESPP allows eligible participants the right to purchase common stock on a quarterly basis at the lower of 85 % of the market price at the beginning or end of each three-month offering period. The most recent amendments to the ESPP, ratified by our stockholders on January 29, 2020, increased the total number of shares to 3,425,000 that may be purchased under the plan. ESPP contributions by employees were $ 0.3 million for both of the three-month periods ended December 31, 2020 and December 31, 2019, respectively. Pursuant to the ESPP, 25,246 and 24,738 common shares were issued to employees during the three months ended December 31, 2020 and December 31, 2019, respectively. Shares are issued under the ESPP from treasury stock. As of December 31, 2020, 686,468 common shares were available for future issuances under the ESPP. The following table shows stock-based compensation expense that is included in the consolidated results of operations (in thousands): Three months ended December 31, 2020 2019 Cost of sales $ 82 $ 64 Sales and marketing 525 431 Research and development 210 294 General and administrative 928 811 Stock-based compensation before income taxes 1,745 1,600 Income tax benefit ( 365 ) ( 332 ) Stock-based compensation after income taxes $ 1,380 $ 1,268 Stock Options The following table summarizes our stock option activity (in thousands, except per common share amounts): Options Outstanding Weighted Average Exercised Price Weighted Average Contractual Term (in years) Aggregate Intrinsic Value (1) Balance at September 30, 2020 3,393 $ 12.20 Granted 418 16.91 Exercised ( 357 ) 11.06 Forfeited / Canceled ( 69 ) 14.17 Balance at December 31, 2020 3,385 $ 12.86 4.2 $ 20,433 Exercisable at December 31, 2020 1,983 $ 11.28 3.1 $ 15,103 (1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $ 18.90 as of December 31, 2020, which would have been received by the option holders had all option holders exercised their options as of that date. The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. 18 Table of Contents 15. STOCK-BASED COMPENSATION (CONTINUED) The total intrinsic value of all options exercised during the three months ended December 31, 2020 was $ 2.2 million and during the three months ended December 31, 2019 was $ 3.0 million. The following table shows the weighted average fair value, which was determined based upon the fair value of each option on the grant date utilizing the Black-Scholes option-pricing model and the related assumptions: Three months ended December 31, 2020 2019 Weighted average per option grant date fair value $ 7.12 $ 6.56 Assumptions used for option grants: Risk free interest rate 0.51% - 0.54% 1.67% - 1.73% Expected term 6.00 years 6.00 years Expected volatility 44% 36% Weighted average volatility 44 % 36 % Expected dividend yield — — The fair value of each option award granted during the periods presented was estimated using the Black-Scholes option valuation model that uses the assumptions noted in the above table. Expected volatilities are based on the historical volatility of our stock. We use historical data to estimate option exercise and employee termination information within the valuation model. The expected term of options granted is derived from the vesting period and historical information and represents the period of time that options granted are expected to be outstanding. The risk-free rate used is the zero-coupon U.S. Treasury bond rate in effect at the time of the grant whose maturity equals the expected term of the option. As of December 31, 2020, the total unrecognized compensation cost related to non-vested stock options was $ 7.9 million and the related weighted average period over which it is expected to be recognized is approximately 3.1 years. Non-vested Stock Units The following table presents a summary of our non-vested restricted stock as of December 31, 2020 and changes during the three months then ended (in thousands, except per common share amounts): RSUs Number of Awards Weighted Average Grant Date Fair Value Nonvested at September 30, 2020 972 $ 13.20 Granted 254 $ 16.95 Vested ( 221 ) $ 12.93 Canceled ( 46 ) $ 13.16 Nonvested at December 31, 2020 959 $ 14.26 As of December 31, 2020, the total unrecognized compensation cost related to non-vested stock units was $ 12.3 million. The related weighted average period over which this cost is expected to be recognized is approximately 1.8 years. 19 Table of Contents