What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-08-05 compared with 2022-05-06 · 83 added, 69 removed, 218 unchanged (41% of the section changed)

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Forward-Looking Statements

This discussion contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

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

Words such as "assume," "believe," "anticipate," "intend," "estimate," "target," "may," "will," "expect," "plan," "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.

This discussion contains forward-looking statements that are based on management's current expectations and assumptions.

These statements often can be identified by the use of forward-looking terminology such as "assume," "believe," "anticipate," "intend," "estimate," "target," "may," "will," "expect," "plan," "potential," "project," "should," or "continue," or the negative thereof or other variations thereon or similar terminology.

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 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, risks arising from the present war in Ukraine, the impacts of the present global supply chain and transportation difficulties affecting business globally, 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 integrate and realize the expected benefits of acquisitions such as our recently completed acquisition of Ventus, 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.

Among others, these include risks related to the ongoing supply chain and transportation challenges impacting businesses globally, the ongoing COVID-19 pandemic and efforts to mitigate the same, risks related to ongoing inflationary pressures as well as present concerns about a potential recession and the ability of companies like us to operate a global business in such conditions, risks arising from the present war in Ukraine, 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 integrate and realize the expected benefits of acquisitions such as our recently completed acquisition of Ventus, 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, 2021, 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.

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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, 2021.

Results of our Fiscal 2022 Annual Impairment Test

Our goodwill impairment test as of June 30, 2022 indicated no impairment.

SmartSense and Ventus fair values exceeded carrying values by less than 10%.

We will continue to monitor potential impacts that could potentially affect our cash flows and market capitalization.

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.

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.

We are a leading global provider of business and mission-critical IoT connectivity products, services and solutions.

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IoT Products & Services and IoT Solutions.

Our IoT Products & Services segment offers products and services that help original equipment manufacturers ("OEMs"), enterprise and government customers create and deploy, secure IoT connectivity solutions.

Our IoT Products & Services segment offers products and services that help OEMs, enterprise and government customers create and deploy, secure IoT connectivity solutions.

From embedded and wireless modules to console servers as well as enterprise and industrial routers, we provide a wide variety of communication sub-assemblies and finished products to meet our customers' IoT communication requirements.

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We initially formed, expanded and enhanced our SmartSense by Digi business through four acquisitions.

Our recent acquisition of Ventus makes us a leader in the provision of Managed Network-as-a-Service ("MNaaS") solutions that simplify the complexity of enterprise wide area network ("WAN") connectivity for our customers and provides us with a significant base of high margin subscription based recurring revenue.

Our recent acquisition of Ventus makes us a leader in the provision of MNaaS solutions that simplify the complexity of enterprise wide area network WAN connectivity for our customers and provides us with a significant base of high margin subscription based recurring revenue.

Ventus’s portfolio includes cellular wireless and fixed line WAN solutions for an array of connectivity applications in banking, healthcare, retail, gaming, hospitality and other sectors.

Given our belief in the potential of this segment, we intend to make targeted investments in this segment designed to enhance its performance over time.

Given our belief in the potential of this segment, we are making targeted investments in this segment designed to enhance its performance over time.

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)

In fiscal 2022, our key operating objectives include:

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

Below we highlight the metrics for the second quarter of fiscal 2022 that we feel are most important in these evaluations, with comparisons to the second quarter of fiscal 2021:

Below we highlight the metrics for the third quarter of fiscal 2022 that we feel are most important in these evaluations, with comparisons to the third quarter of fiscal 2021:

• Consolidated revenue was $104 million, an increase of 31%.

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• Consolidated operating income was $10.0 million, an increase of 148%.

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

• Net income was $2.8 million, a decrease of 3%.

• Diluted earnings per share was $0.08, compared to $0.09.

• Adjusted EBITDA was $19.5 million, or 20.6% of total revenue, compared to $11.7 million, or 15.1%.

• Gross profit margin was 55.5% versus 53.8%.

Gross profit margin excluding amortization was 56.7% compared to 55.2%.

• Net income was $4.1 million, an increase of 31%.

• Diluted earnings per share was $0.12, compared to $0.09, an increase of 33%.

• Adjusted EBITDA was $21 million, an increase of 82%.

• Adjusted net income and adjusted net income per share was $15.9 million, or $0.45 per diluted share, compared to $8.7 million, or $0.25 per diluted share, an increase of 80%.

Recent Events Impacting Second Quarter Results

Recent Events Impacting Third Quarter Results

Acquisition of Ventus

On November 1, 2021, we acquired Ventus for approximately $350 million in cash.

The acquisition was funded through a combination of cash on hand and debt financing under an amended and restated credit facility committed by BMO Harris Bank N.A (see Note 7 ).

The acquisition was funded through a combination of cash on hand and debt financing under an amended and restated credit facility committed by BMO Harris Bank N.A.

(see Note 7 ).

In the first quarter of fiscal 2022, the preliminary purchase price allocation was recorded, including related determinations of fair value and income tax implications.

As a result, we recorded $117 million of goodwill and $211 million of other intangibles on our condensed consolidated balance sheets.

The results of operations following the acquisition date are now included in our first and second fiscal quarters 2022 results within our IoT Solutions segment.

In the third quarter of fiscal 2022, we recorded a purchase price allocation adjustment to adjust for new information.

As a result, we have $118 million of goodwill and $211 million of other intangibles on our condensed consolidated balance sheets at June 30, 2022.

The results of operations following the acquisition date are now included in our 2022 results within our IoT Solutions segment.

CONSOLIDATED RESULTS OF OPERATIONS

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

Three months ended March 31, % incr.

Six months ended March 31, % incr.

Three months ended June 30, % incr.

Nine months ended June 30, % incr.

($ in thousands) 2022 2021 (decr.) 2022 2021 (decr.)

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Net income $ 4,126 4.0 % $ 3,157 4.0 % 30.7 $ 8,160 2.9 % $ 5,778 2.5 % 41.2

NM means not meaningful

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

REVENUE BY SEGMENT

Three months ended March 31, % incr.

Six months ended March 31, % incr.

Three months ended June 30, % incr.

Nine months ended June 30, % incr.

($ in thousands) 2022 2021 (decr.) 2022 2021 (decr.)

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IoT Products & Services

IoT Products & Services revenue increased 8.7% and 7.6% for the three and six months ended March 31, 2022, respectively, as compared to the same periods in the prior fiscal year.

IoT Products & Services revenue increased 19.4% and 11.7% for the three and nine months ended June 30, 2022, respectively, as compared to the same periods in the prior fiscal year.

This primarily was a result of:

• increased sales of console server and cellular products driven by demand for data center and edge based deployments.

• increased sales of console server and cellular products in both periods driven by demand for data center and edge based deployments and increased OEM sales in the third quarter.

This increase was partially offset by:

• decreased sales of certain embedded products, most notably in the second fiscal quarter.

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

• decreased sales of infrastructure management products, driven by supply chain challenges.

IoT Solutions

IoT Solutions revenue increased 100.0% and 81.7% for the three and six months ended March 31, 2022, respectively, as compared to the same periods in the prior fiscal year.

IoT Solutions revenue increased 93.7% and 85.9% for the three and nine months ended June 30, 2022, respectively, as compared to the same periods in the prior fiscal year.

This primarily was a result of:

• increased recurring revenue from our November 2021 acquisition of Ventus and

• organic sales growth across the Solutions business, resulting in an increase of nearly 10,000 additional sites served with noted strength in the areas of gaming, healthcare and point of sale.

• increased recurring revenue from our November 2021 acquisition of Ventus.

These increases were partially offset by:

• decreased customer implementation sales.

• decreased one-time customer implementation sales, due to significant activity from a few large customers in 2021 that did not recur in 2022.

COST OF GOODS SOLD AND GROSS PROFIT BY SEGMENT

Three months ended March 31, Basis point Six months ended March 31, Basis point

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

($ in thousands) 2022 2021 inc.

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Total cost of goods sold $ 46,091 44.5 % $ 36,523 46.2 % (170) $ 125,196 44.3 % $ 105,495 46.0 % (170)

Three months ended March 31, Basis point Six months ended March 31, Basis point

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

($ in thousands) 2022 2021 inc.

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IoT Product & Services

IoT Products & Services gross profit margin increased 140 basis points for the three months ended March 31, 2022 as compared to the same period in the prior fiscal year.

This increase primarily was a result of:

• changes in product and customer mix, partially offset by increased production and distribution costs due to the continuing supply chain challenges.

IoT Products & Services gross profit margin decreased 90 basis points for the six months ended March 31, 2022 as compared to the same period in the prior fiscal year.

IoT Products & Services gross profit margin decreased 160 basis points for the three months ended June 30, 2022 as compared to the same period in the prior fiscal year.

This decrease primarily was a result of:

• changes in product and customer mix, as well as increased production and distribution costs due to the continuing supply chain challenges.

• increased production and distribution costs due to the continuing supply chain challenges, as well as changes in product and customer mix.

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

IoT Products & Services gross profit margin decreased 130 basis points for the nine months ended June 30, 2022 as compared to the same period in the prior fiscal year.

This decrease primarily was a result of:

• increased production and distribution costs due to the continuing supply chain challenges, as well as changes in product and customer mix.

IoT Solutions

The IoT Solutions gross profit margin increased 650 basis points for the three months ended March 31, 2022 as compared to the same periods in the prior fiscal year.

The IoT Solutions gross profit margin increased 1,530 basis points for the three months ended June 30, 2022 as compared to the same periods in the prior fiscal year.

This increase primarily was a result of:

• increased recurring subscription revenue, including growth from the acquisition of Ventus, which typically has a high gross margin.

The IoT Solutions gross profit margin increased 1,230 basis points for the six months ended March 31, 2022 as compared to the same periods in the prior fiscal year.

• increased recurring subscription revenue, from the acquisition of Ventus, which typically has a high gross profit margin.

The IoT Solutions gross profit margin increased 1,330 basis points for the nine months ended June 30, 2022 as compared to the same periods in the prior fiscal year.

This increase primarily was a result of:

• increased recurring subscription revenue, including growth from the acquisition of Ventus, which typically has a high gross margin.

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

• increased recurring subscription revenue, from the acquisition of Ventus, which typically has a high gross profit margin.

OPERATING EXPENSES

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

Three months ended March 31, $ % Six months ended March 31, $ %

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

($ in thousands) 2022 2021 incr.

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Total operating expenses $ 47,452 45.8 % $ 38,538 48.7 % $ 8,914 23.1 $ 135,954 48.1 % $ 116,789 50.9 % $ 19,165 16.4 %

NM means not meaningful

The $7.3 million increase in operating expenses in the second quarter of fiscal 2022 from the second quarter of fiscal 2021 primarily was the result of:

• incremental operating expenses from recent acquisitions including Haxiot, Ctek and Ventus.

The $10.3 million increase in operating expenses in the first half of fiscal 2022 from the first half of fiscal 2021 primarily was the result of:

• incremental operating expenses from our recent acquisitions of Haxiot, Ctek and Ventus.

The $8.9 million increase in operating expenses in the third quarter of fiscal 2022 from the third quarter of fiscal 2021 primarily was the result of:

• incremental operating expenses, primarily from the acquisition of Ventus.

The $19.2 million increase in operating expenses in the first three quarters of fiscal 2022 from the first three quarters of fiscal 2021 primarily was the result of:

• incremental operating expenses from our acquisitions of Haxiot, Ctek and Ventus.

This increase was partially offset by:

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OPERATING INCOME

Operating income was $7.6 million for the three months ended March 31, 2022, compared to $3.4 million for the three months ended March 31, 2021.

Operating income was $11.4 million for the six months ended March 31, 2022, compared to $3.2 million for the six months ended March 31, 2021.

IoT Product & Services provided operating income of $9.0 million for the three months ended March 31, 2022 compared to $4.6 million for the three months ended March 31, 2021, an increase of $4.5 million, or 97.4%.

IoT Product & Services provided operating income of $13.2 million for the six months ended March 31, 2022 compared to $5.9 million for the six months ended March 31, 2021, an increase of $7.3 million, or 125.0%.

Operating income was $10.0 million for the three months ended June 30, 2022, compared to $4.0 million for the three months ended June 30, 2021.

Operating income was $21.3 million for the nine months ended June 30, 2022, compared to $7.2 million for the nine months ended June 30, 2021.

IoT Product & Services provided operating income of $10.9 million for the three months ended June 30, 2022 compared to $6.1 million for the three months ended June 30, 2021, an increase of $4.8 million, or 78.3%.

IoT Product & Services provided operating income of $24.0 million for the nine months ended June 30, 2022 compared to $12.0 million for the nine months ended June 30, 2021, an increase of $12.1 million, or 101.2%.

Drivers for the changes in operating income for the both the quarter and year-to-date periods are described above in the revenue, gross profit and operating expenses details.

IoT Solutions had an operating loss of $1.5 million for the three months ended March 31, 2022 compared to an operating loss of $1.2 million for the three months ended March 31, 2021, an increase of $0.3 million, or 22.4%.

IoT Solutions incurred an operating loss of $1.8 million for the six months ended March 31, 2022 compared to $2.6 million for the six months ended March 31, 2021, a decrease of $0.8 million, or 31.4%.

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

IoT Solutions had an operating loss of $0.9 million for the three months ended June 30, 2022 compared to an operating loss of $2.1 million for the three months ended June 30, 2021, a decrease of $1.2 million, or 56.5%.

IoT Solutions incurred an operating loss of $2.7 million for the nine months ended June 30, 2022 compared to $4.7 million for the nine months ended June 30, 2021, a decrease of $2.0 million, or 42.5%.

Drivers for the changes in operating loss for the both the quarter and year-to-date periods are described above in the revenue, gross profit and operating expenses details.

OTHER EXPENSE, NET

Three months ended March 31, $ % Six months ended March 31, $ %

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

($ in thousands) 2022 2021 incr.

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Total other expense, net $ (5,392) (5.2) % $ (482) (0.6) % $ (4,910) NM $ (14,716) (5.2) % $ (1,244) (0.5) % $ (13,472) NM

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

Other expense, net, increased $4.2 million and $8.6 million for the three and six months ended March 31, 2022, respectively, as compared to the same period in the prior fiscal year.

NM means not meaningful

Other expense, net, increased $4.9 million and $13.5 million for the three and nine months ended June 30, 2022, respectively, as compared to the same period in the prior fiscal year.

The increase was primarily a result of an increase to our interest expense as we refinanced our revolving loan with a new credit facility in November 2021 and wrote off a portion of the deferred financing fees associated with our prior credit facility to fund the acquisition of Ventus.

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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 our core operating results and financial performance because it excludes items that are significant non-cash or non-recurring expenses reflected in the consolidated statements of operations.

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

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

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

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.

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

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(In thousands)

Three months ended March 31, Six months ended March 31,

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

2022 2021 2022 2021

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(In thousands, except per share amounts)

Three months ended March 31, Six months ended March 31,

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

2022 2021 2022 2021

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(1) The tax effect from the above adjustments assumes an estimated effective tax rate of 18.0% for fiscal 2022 and fiscal 2021 based on adjusted net income.

(2) For the three and six months ended March 31, 2022 and March 31, 2021, discrete tax benefits primarily are a result of excess tax benefits recognized on stock compensation.

(2) For the three and nine months ended June 30, 2022 and June 30, 2021, discrete tax benefits primarily are a result of excess tax benefits recognized on stock compensation.

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

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During the first quarter of fiscal 2022, we repaid all outstanding balances under the credit facility entered into on March 21, 2021.

As of March 31, 2022, $35.0 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.

As of June 30, 2022, $35.0 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.

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.

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

Our second fiscal quarter operating cash flows were negatively impacted by changes in operating assets and liabilities (net of acquisitions) that we do not anticipate in future periods.

Our third fiscal quarter operating cash flows were negatively impacted by changes in operating assets and liabilities (net of acquisitions) that we do not anticipate in future periods.

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 statements of cash flows for the six months ended March 31, 2022 and 2021 is summarized:

Six months ended March 31,

As follows, our condensed consolidated statements of cash flows for the nine months ended June 30, 2022 and 2021 is summarized:

Nine months ended June 30,

($ in thousands) 2022 2021

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Net increase (decrease) in cash and cash equivalents $ (110,917) $ 92,813

Cash flows used in operating activities increased $25.3 million primarily as a result of:

• a decrease in operating assets and liabilities (net of acquisitions) during the period of $37.3 million compared to $4.8 million in the six months ended March 31, 2021 and

• a reduction of $5.8 million in contingent consideration fair value changes.

Cash flows from operating activities decreased $26.6 million primarily as a result of:

• an increase in operating assets and liabilities (net of acquisitions) during the period of $34.6 million compared to a decrease of $3.1 million in the nine months ended June 30, 2021, and

• a reduction of $5.8 million in contingent consideration fair value changes from the nine months ended June 30,2021.

These increases were partially offset by:

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CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual obligations at March 31, 2022:

The following table summarizes our contractual obligations at June 30, 2022:

Payments due by fiscal period

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

Our reserve for uncertain tax positions, including accrued interest and penalties, was $3.0 million as of March 31, 2022.

Our reserve for uncertain tax positions, including accrued interest and penalties, was $2.8 million as of June 30, 2022.

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

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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