Item 1. Business
ITEM 1. BUSINESS
General Background and Product Offerings
Digi International Inc. ("Digi ® ," "we," "our," or "us") was incorporated in 1985 as a Minnesota corporation. We were reorganized as a Delaware corporation in 1989 in conjunction with our initial public offering. Our common stock is traded on the Nasdaq Global Select Market tier of the Nasdaq Stock Market LLC under the symbol DGII. Our World Headquarters is located at 9350 Excelsior Blvd., Suite 700, Hopkins, Minnesota 55343. The telephone number at our World Headquarters is (952) 912-3444.
We are a leading global provider of business and mission-critical Internet of Things ("IoT") connectivity products, services and solutions. We help our customers deploy, monitor and manage critical communications infrastructures that deliver important information in demanding environments with high levels of security and reliability. We have two reportable operating segments under applicable accounting standards: (i) IoT Products & Services; and (ii) IoT Solutions.
Our IoT Products & Services segment offers products and services that help original equipment manufacturers ("OEMs"), enterprise and government customers create and deploy, secure IoT connectivity solutions. From embedded and wireless modules to console servers as well as enterprise and industrial routers, we provide a wide variety of communication sub-assemblies and finished products to meet our customers' IoT communication requirements. In addition, this segment provides our customers with a device management platform and other professional services to enable customers to capture and manage data from devices connected to networks.
Our IoT Solutions segment primarily consists of our Managed Network-as –a-Service (“MNaaS”) business acquired last year via our acquisition of Ventus Wireless, LLC and affiliated entities (“Ventus”) and our SmartSense by Digi ® business. Ventus is a leader in the provision of MNaaS solutions that simplify the complexity of enterprise wide area network (“WAN”) connectivity for customers. The Ventus portfolio includes cellular wireless and fixed line WAN solutions for an array of connectivity applications in banking, healthcare, retail, gaming, hospitality and other sectors. SmartSense offers wireless temperature and other condition-based monitoring services as well as employee task management services. These solutions are focused on the following vertical markets: food service, healthcare (primarily pharmacies and hospitals) and supply chain.
For more in-depth descriptions of our products and services, please refer to the heading "Principal Products and Services" at the end of Part I, Item 1 of this Form 10-K.
Our corporate website address is www.digi.com. In the "Company - Investor Relations" section of our website, we make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, our proxy statement and any amendments to these reports available free of charge as soon as reasonably practicable after these reports are filed with or furnished to the United States Securities and Exchange Commission ("SEC"). Information on our website is not incorporated by reference into this report or any other report we file with or furnish to the SEC.
Ongoing Impacts of Global Macro-Economic Conditions
The impacts of global macro-economic conditions, driven largely by the war in Ukraine and the impacts of the Covid-19 pandemic have disrupted supply chains for a range of goods and services, continue to create significant uncertainty regarding the nearer term outlook for our operations and the markets into which we sell.
To date these conditions have primarily impacted our supply chain in adverse ways that include container ship backlogs, energy shortages in certain parts of the world, and components and material shortages. This has led to shortfalls in available components we need to make products as well as increased costs both to obtain components and to transport components and products. It has also lengthened the timelines for us to fulfill customer orders, increasing our backlog, and in some cases has led to an inability to meet an increasing level of demand for our products. The severity of the disruptions is changing continuously, meaning the impact on our ability to meet demand for particular products in a timely manner has been subject to ebb and flow. In some instances, these disruptions have been material and it is possible more material disruptions will occur. We are taking steps to attempt to mitigate the impact of the disruptions such as placing inventory demand further out into the future to secure our allocations of components, negotiating and engaging with suppliers to reserve components, encouraging customers to place orders earlier than normal due to longer lead times and attempting (in conjunction with customers) to influence political leaders to assure components needed to make products that are essential to the health and well-being of society are prioritized to our customer’s needs by suppliers. At present the ongoing duration and severity of these disruptions is not known. As such, we are unable to predict the ultimate impact of these disruptions on our business and financial results, which could be material.
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We also continuously monitor customer demand for the products and services we sell and have not seen material decreases in demand.
Industry and Marketplace Conditions
We believe the IoT industry is in the midst of a multi-year expansion as many industries are undergoing a digital transformation within their business that drives demand for IoT capabilities across a broad spectrum of services. Among others, IoT use cases include condition-based monitoring of perishable goods, enabling remote work by employees, automating workflows and operations and providing and maintaining secure connectivity and monitoring of operating assets.
Our IoT Products & Services segment represented the majority of our sales in fiscal 2022. This segment sells both wired and wireless products that are either embedded into the products of OEMs or as stand-alone products. These offerings allow our customers to connect a wide range of assets to networks. This segment grew during fiscal 2022, led by increases in our cellular and console server revenues. The segment includes some products that are in the mature phase of their life cycle and have been experiencing sales declines for several years. We manage this segment with more focus on profitability and more modest revenue growth expectations relative to our IoT Solutions segment. Recently we have begun to place more emphasis on the delivery of subscription-based solutions offerings for many of these products.
Our IoT Solutions segment grew significantly in fiscal 2022 primarily because of our acquisition of Ventus in our first fiscal quarter. The segment is comprised primarily of our SmartSense and Ventus offerings. SmartSense provides condition-based monitoring services for perishable goods such as food and medicines for health-care, pharmaceutical and food industry. Ventus provides MNaaS offerings to manage and maintain network connectivity for assets such as ATMs and lottery kiosks. The offerings in this segment are offered on a subscription model and provide us with a stable base of recurring higher-margin revenues.
While our business performed well in fiscal 2022 and we expect an ongoing long-term trend of marketplace growth, each of our business segments is susceptible to downturns either because of general macro-economic conditions, the continued development of technology that can make products less competitive or even obsolete and uncertainty or changes in regulatory environments. Given the current uncertainty in macro-economic conditions, including, but not limited to, potential recessionary conditions, ongoing supply chain disruptions globally and the uncertain status of large project-based customer deployment opportunities, our results during fiscal 2023 may be inconsistent.
Strategy
We remain focused on taking steps that we believe will deliver consistent, long-term growth with higher levels of profitability. This includes continuously reviewing and managing the product and solution offerings we provide to align with customer interests and meet market demand. In addition, acquisitions have helped significantly advance our offerings and driven growth and profitability, in both business segments. Over time we expect to continue to be active in making further acquisitions.
IoT Products & Services Segment
Our IoT Products & Services segment is being managed so our product management and sales personnel are aligned along specific product lines to bring greater market focus and potential growth to the product lines. We also continue to drive efforts to pair our hardware offerings with our Digi Remote Manager ® device management platform as well as other support services. These bundled offerings allow customers to monitor and manage the performance of our hardware remotely. This segment generated over $14 million in annualized recurring revenue (ARR) as of September 30, 2022. Please see "Key Business Metrics" section in Part II, Item 7 for additional details on how ARR is measured.
IoT Solutions Segment
Our IoT Solutions segment is driven by recurring traditionally high margin subscription-based revenues. Following our acquisition of Ventus in the first quarter of fiscal 2022, the segment now represents approximately 25% of total revenues. This segment generated $80 million in ARR as of September 30, 2022. We have high organic growth expectations and we will continue to explore added scale through acquisitions.
SmartSense by Digi helps customers monitor temperature and other conditions important to preserve the quality of perishable or other sensitive inventories and tracks the completion of employee tasks. Our efforts have created a market-leading, high-growth hardware enabled service business with a significant recurring revenue base. At present, this marketplace primarily is served by smaller companies that lack the infrastructure to provide hardware-enabled implementation services to customers in as effective and efficient a manner as we are able to do because of our long-standing history as an IoT hardware provider.
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SmartSense by Digi presently serves many leading brands in the following vertical markets: food service, healthcare (primarily pharmacies) and supply chain. These markets share similar needs for continuous monitoring and asset tracking for compliance and regulatory purposes and we believe they comprise a large addressable market with low customer penetration.
In November 2021, we acquired Ventus Holdings. Ventus is a leader MNaaS solutions that simplify the complexity of enterprise WAN connectivity for an array of applications in banking, healthcare, retail, gaming, hospitality and other sectors.
Acquisitions and Dispositions
Acquisitions
In addition to our fiscal 2022 acquisition of Ventus disclosed above, we have made the following acquisitions from fiscal 2020 through fiscal 2021.
In December 2019, we acquired New Jersey-based Opengear, Inc. ("Opengear ® "), a provider of secure IT infrastructure products and software. This acquisition provides products that are complementary to our IoT Products & Services segment.
In March 2021, we acquired Haxiot, Inc. ("Haxiot ® "), a provider of low power wide area ("LPWA") wireless technology. This acquisition enhanced our IoT Products & Services segment by enhancing Digi's embedded systems portfolio and immediately extending the company's market reach with a complete LoRaWAN-based solutions offering.
In July 2021, we acquired Ctek, Inc. ("Ctek"), a provider that specializes in solutions for remote monitoring and industrial controls. Through the acquisition of Ctek, Digi is uniquely positioned to provide customers with both battery and hardwired options for the control and monitoring of critical infrastructure, furthering Digi’s reach in a rapidly expanding market.
Sales Channels
A significant portion of our IoT Products & Services segment sales are made through a global network of distributors, systems integrators and value added resellers ("VARs"). These third parties accounted for 50.0%, 47.0% and 37.5% of our total consolidated revenue in fiscal 2022, 2021 and 2020, respectively. Our IoT Solutions segment historically has not sold through these channels. We also complete sales of both IoT Products & Services and IoT Solutions through our own dedicated sales organization directly to a wide range of end user customers. This dedicated sales team accounted for 50.0%, 53.0% and 62.5% of our total consolidated revenue in fiscal 2022, 2021 and 2020, respectively.
Distributors
Our larger distributors, by sales volume, include Arrow Electronics, Avnet, Bressner Technology GmbH, Digi-Key, Express Systems & Peripherals, Ingram Micro, Mouser Electronics, Solid State Supplies, Symmetry Electronics, Synnex, Tech Data, Tokyo Electron Device and Venco Electrónica S.A. We also maintain relationships with many other distributors both domestically and internationally.
Strategic Sales Relationships
We maintain alliances with other industry leaders to develop and market technology solutions. These include many major communications hardware and software vendors, operating system suppliers, computer hardware manufacturers, enterprise application providers and cellular carriers. Among others, relationships include: AT&T, NXP, Orange, Rogers, Silicon Laboratories, T-Mobile, Telus, Telit, Verizon, Vodafone and several other cellular carriers worldwide.
We have established relationships with equipment vendors in a range of industries such as energy, industrial, retail, transportation, medical, and government that allow these partners to ship our products and services as component parts of their overall solutions. Our products are used by many of the world’s leading telecommunications companies and Internet service providers, including, among others, AT&T, T-Mobile and Verizon.
No single customer comprised more than 10% of our consolidated revenue for any of the fiscal years 2022, 2021 or 2020.
Competition
We compete primarily in the communications technology industry. This industry is characterized by rapid technological advances and evolving industry standards. This market can be affected significantly by new product introductions and marketing activities of industry participants. It is possible new market entrants could market and sell disruptive technologies that impact one or more of our product or service offerings. In addition, we may compete with other companies to acquire new businesses or technologies and the competition to secure such assets may be intense. We compete for customers on the basis of
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existing and planned product features, service and software application capabilities, company reputation, brand recognition, technical support, alliance relationships, quality and reliability, product development capabilities, price and availability. While no competitor offers a comparable range of products and services, various companies do compete with us with respect to one or more of our products or solutions. With respect to many of our product and service offerings, we face competition from companies who dedicate more resources and attention to that particular offering than we are able to do given the breadth of our business. As the marketplace for IoT connectivity products and solutions continues to grow, we expect to encounter increased competition. Some of these competitors may have access to significantly more financial and technical resources than we possess.
Manufacturing Operations
We outsource our manufacturing operations to certain contract manufacturers, which are located primarily in Thailand, Mexico, Taiwan and China. We rely on third party foundries or companies who rely on third party foundries for our semiconductor devices that are Application Specific Integrated Circuits ("ASICs"). We also outsource printed circuit board production. By outsourcing our operations to these manufacturers, we can leverage the manufacturing strength of our vendors, which allows us to focus on new product introductions. In addition, it allows us to reduce our fixed costs, maintain production flexibility and optimize our profits.
Our products are manufactured to our designs with standard and custom components. Most of the components are available from multiple vendors. We have several single-sourced supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. As disclosed elsewhere, our manufacturing operations, like those of other companies, are dependent on relationships with these suppliers who are also experiencing supply chain disruptions. If these suppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect our consolidated results of operations in a material way. In an effort to mitigate supply chain exposure, we have increased our amount of inventory on hand.
In addition, as a result of the global pandemic, there has been increased attention focused on actions of the Chinese government with respect to how they attempt to mitigate the impacts of the pandemic. Also, as a result of the war in Ukraine, governments around the world have imposed sanctions on Russia and Belarus. These situations could lead to potential adverse impacts on a wide range of businesses and could disrupt the supply of components or end-products that we produce.
In general, our business is not considered to be highly seasonal, although our first fiscal quarter revenue is often less than other quarters due to holidays and fewer business days.
Research & Development and Intellectual Property Rights
Due to rapidly changing technology in the communications technology industry, we believe a large part of our success depends upon the product and service development skills of our personnel as well as our ability to integrate any acquired technologies with organically developed technologies. While we dedicate significant resources to research and development, many of our competitors are focused on a smaller set of products than us and are likely able to dedicate more resources than us toward the portions of the market in which we compete with them. In recent periods, as a result of supply chain constraints, a significant portion of our research & development spending has been focused on the re-design or reconfiguration of existing products using different components. This has lowered our ability to focus on new product development.
Our proprietary rights and technology are protected by a combination of copyrights, patents, trade secrets and trademarks.
We have established common law and registered trademark rights on a family of marks for a number of our products. Our IoT Products & Services primarily are sold under the Digi, Rabbit ® , Digi XBee, and Opengear brands. We believe that the Digi and Rabbit brands have established strong identities with our targeted customer base and our customers associate the Digi brand with "reliability" and the Rabbit brand with "ease of integration." We believe that our customers associate Digi XBee with "ease of use." Many of our customers choose us because they are building a very complex system solution and they want the highest level in product reliability and ease of integration and use. Our IoT Solutions are offered under the Ventus and SmartSense by Digi brands.
Our patents are applicable to specific technologies and are valid for varying periods of time based on the date of patent application or patent grant in the U.S. and the legal term of patents in the various foreign countries where patent protection is obtained. We believe our intellectual property has significant value and is an important factor in the marketing of our company and products.
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HUMAN CAPITAL RESOURCES
Digi’s workforce consists of approximately 790 employees globally as of September 30, 2022. We consider our relationship with our employees to be good.
Culture
As employees of Digi we are all expected to uphold the following core values that drive our culture:
• Integrity
• Accountability
• Respect and open communication
These core values define the way we do business in our everyday actions and choices. We strive to create a respectful work environment characterized by mutual trust and the absence of intimidation, oppression, discrimination and exploitation.
Talent
Successful execution of our strategy is dependent on attracting, developing and retaining key employees and members of our management team. The skills, experience and industry knowledge of our employees significantly benefit our operations and performance. We continuously evaluate, modify, and enhance our internal processes and technologies to increase employee engagement, productivity, and efficiency.
We are committed to promoting and cultivating an inclusive, diverse culture that welcomes and celebrates everyone without bias. In addition, we actively engage within our communities to foster and attain social equity.
Compensation Philosophy
Our compensation philosophy creates the framework and building blocks for our rewards strategy. We have a pay-for-performance culture that ties compensation to the performance of the individual and the company. We provide balanced compensation programs that focus on the following five key elements:
• Pay-for-performance - Reward and recognize leading contributors and high potentials;
• External market based - Pay levels that are competitive with respect to the labor market in which we compete for talent;
• Internal equity - Providing for fair pay relationships within the Company;
• Fiscal responsibility - Providing affordable programs that are within our budget; and
• Legal compliance - Ensure the organization is legally compliant in all states and countries in which we operate.
Health and Wellness
We are committed to providing a competitive and comprehensive benefits package to our employees. Our benefits package provides a balance of protection along with the flexibility to meet the individual health and wellness needs of our employees.
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PRINCIPAL PRODUCTS AND SERVICES
Our primary products and services for each operating segment are:
IoT Products & Services Segment
Hardware Products
Cellular Products – We provide a range of products that use cellular technology such as Long Term Evolution (“LTE”), LTE Advance Pro and 5 th Generation wireless protocols to communicate with networks. These products provide a cost-effective, more flexible alternative to landlines for primary or backup connectivity. They are trusted by global leaders in agricultural, energy medical, lighting, digital signage, gaming, electric charging and transportation, as well as other industrial and enterprise markets including:
• Cellular routers that help enterprise, government, industrial, transportation and OEM customers with their mission-critical wireless connectivity needs in challenging, remote and mobile environments.
• Cellular modules that help OEM customers embed cellular communications abilities into their products so they can deploy and manage intelligent and secure cellular connected products. These modules help OEMs to get their products to market faster and with lower development costs and risks so they can focus on their core competencies instead of on wireless connectivity design.
• Console servers that can be managed by software to provide secure, remote access to network equipment in data centers and at edge locations. These products primarily are used by IT organizations in large enterprises to maximize the availability of services to their customers and employees, and provide business continuity in the event of a network failure. This technology improves efficiency and reduces the risk of costly outages.
Radio-Frequency (“RF”) Products – These products which are marketed primarily under the Digi XBee brand include embedded wireless modules as well as off-the-shelf gateways, modems and adapters. They are used by customers across a broad range of industries. These products offer a wide selection of both standards-based and proprietary wireless protocols including Zigbee, Cellular, Sub-1 GHz, LPWA, WiFi and Bluetooth to meet diverse application requirements of customers.
Embedded System Products – Marketed under the Digi Connect ® , ConnectCore ® and Rabbit brands these are embedded system on modules ("SOMs") and single board computers that are embedded into customer products in a broad range of industries and applications. These products deliver highly integrated computer platforms with scalable performance, flexible wired and wireless connectivity and complete software platforms. These products are designed and developed with compact form-factors, low power consumption and long product lifecycles. The latest ConnectCore products support advanced multi-core processing, security, multimedia, human-machine interface ("HMI") and other emerging technologies like machine learning.
Infrastructure Management Products – These products include serial and Universal Serial Bus ("USB") solutions. Our serial servers (also known as device servers and terminal servers) provide secure and reliable serial port-to-Ethernet integration of most devices into wired Ethernet networks. This means that they are capable of converting data received over TCP/IP networks such as the internet and back; thereby eliminating the need for each device to have a physical connection to a computer. We also offer multiple USB solutions whose primary functions are to connect multiple USB devices, allowing them to work over a wired or wireless network without each device needing to plug into its own host computer. These products also include battery and hardwired options for the control and monitoring of critical infrastructure.
Services
Digi Remote Manager - Digi Remote Manager is a recurring revenue cloud-based service that provides a secure environment for customers to manage their connected device for the full deployment lifecycle. This service enables customers to activate, monitor, diagnose, reset, update and/or upgrade their entire network of mission-critical devices from a single point of command. Through a "single pane of glass," network managers can manage configurations, update firmware, add features and schedule and automate tasks from their desktop, tablet or phone.
Lighthouse ® Management Software - Lighthouse is a recurring revenue cloud-based service that provides a secure environment for customers to manage their network devices by providing secure access to remote networks regardless of how they are connected or how a user interacts with the system. Designed with security, scalability and automation in mind, Lighthouse allows engineers to control every aspect of their network through a central hub.
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Technical Services - Our Technical Services provide professional services, data plan subscriptions and enhanced technical support offers to customers. Professional services include solution planning and implementation services to customers who purchase our products such as site planning, implementation management, application development and customer training. Data plan subscriptions are offered to customers wishing to enable cellular connectivity on our products. Enhanced technical support provides priority, in-depth technical support consultations with our experienced support team. These services ensure customers get to market quickly, minimize risk, and ensure customer success with their Digi solution.
IoT Solutions Segment
SmartSense by Digi - Our SmartSense by Digi is an end-to-end, cost-effective system that uses sensors, gateways and cloud based applications to enable customers in food service (e.g. super markets, schools and restaurants), healthcare (primarily pharmacies and hospitals) and transportation/logistics to: (i) monitor wirelessly the temperature of food and other perishable or sensitive goods, (ii) monitor facilities or pharmacies by tracking the completion of operating tasks by employees, and (iii) have visibility in the supply chain to product temperature through an end-to-end system for quality control and incident management. Typically, customers receive hardware up-front, including gateways and sensors, and pay for an annual subscription for monitoring sensor data.
Ventus
Ventus is a leader in providing comprehensive MNaaS solutions that simplify the complexity of both wireless and fixed-line WAN connectivity. With comprehensive end-to-end security, our portfolio includes an array of connectivity applications in the banking, healthcare, retail, gaming, hospitality and other sectors. Supporting ATMs, gaming, point-of-sale, kiosks, digital signing and retail applications, Ventus works closely with its customers to customize innovative long-term MNaaS solutions.