DIGI INTERNATIONAL INC 10-Q

ITEM 1. FINANCIAL STATEMENTS DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three months ended March 31, Six months ended March 31, 2023 2022 2023 2022 (in thousands, except per share data) Revenue: Product $ 83,819 $ 69,167 $ 165,574 $ 132,965 Service 27,325 25,546 54,876 46,005 Total revenue 111,144 94,713 220,450 178,970 Cost of sales: Cost of product 40,218 34,483 79,830 63,722 Cost of service 7,101 6,943 14,171 12,691 Amortization 953 1,303 2,056 2,692 Total cost of sales 48,272 42,729 96,057 79,105 Gross profit 62,872 51,984 124,393 99,865 Operating expenses: Sales and marketing 20,341 17,776 39,447 33,095 Research and development 15,155 13,819 29,249 27,231 General and administrative 15,201 12,825 31,559 28,176 Total operating expenses 50,697 44,420 100,255 88,502 Operating income 12,175 7,564 24,138 11,363 Other expense, net: Interest expense, net ( 6,393 ) ( 4,463 ) ( 12,364 ) ( 9,361 ) Other income, net 47 139 64 37 Total other expense, net ( 6,346 ) ( 4,324 ) ( 12,300 ) ( 9,324 ) Income before income taxes 5,829 3,240 11,838 2,039 Income tax (benefit) provision ( 70 ) 393 160 ( 1,995 ) Net income $ 5,899 $ 2,847 $ 11,678 $ 4,034 Net income per common share: Basic $ 0.16 $ 0.08 $ 0.33 $ 0.12 Diluted $ 0.16 $ 0.08 $ 0.32 $ 0.11 Weighted average common shares: Basic 35,791 35,015 35,698 34,785 Diluted 36,730 35,608 36,821 35,710 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 March 31, Six months ended March 31, 2023 2022 2023 2022 (in thousands) Net income $ 5,899 $ 2,847 $ 11,678 $ 4,034 Other comprehensive income (loss): Foreign currency translation adjustment 178 52 1,467 ( 160 ) Other comprehensive income (loss) 178 52 1,467 ( 160 ) Comprehensive income $ 6,077 $ 2,899 $ 13,145 $ 3,874 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) March 31, 2023 September 30, 2022 (in thousands, except share data) ASSETS Current assets: Cash and cash equivalents $ 31,660 $ 34,900 Accounts receivable, net 44,900 50,450 Inventories 83,065 73,223 Income taxes receivable 4,778 3,764 Other current assets 4,663 3,871 Total current assets 169,066 166,208 Property, equipment and improvements, net 29,812 27,594 Intangible assets, net 289,441 302,064 Goodwill 341,862 340,477 Operating lease right-of-use assets 14,179 15,299 Other non-current assets 3,388 2,253 Total assets $ 847,748 $ 853,895 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 15,523 $ 15,523 Accounts payable 20,725 32,373 Accrued compensation 12,150 14,576 Unearned revenue 22,576 19,803 Current portion of operating lease liabilities 3,346 3,196 Other current liabilities 9,449 11,036 Total current liabilities 83,769 96,507 Income taxes payable 1,749 2,441 Deferred tax liabilities 6,928 9,666 Long-term debt 214,062 222,448 Operating lease liabilities 15,519 16,978 Other non-current liabilities 5,542 4,342 Total liabilities 327,569 352,382 Commitments and Contingencies (See Note 13 ) 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; 42,324,578 and 41,950,732 shares issued 423 420 Additional paid-in capital 394,036 385,244 Retained earnings 211,753 200,075 Accumulated other comprehensive loss ( 24,587 ) ( 26,054 ) Treasury stock, at cost, 6,463,818 and 6,412,812 shares ( 61,446 ) ( 58,172 ) Total stockholders' equity 520,179 501,513 Total liabilities and stockholders' equity $ 847,748 $ 853,895 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) Six months ended March 31, 2023 2022 (Restated) (1) (in thousands) Operating activities: Net income $ 11,678 $ 4,034 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property, equipment and improvements 3,245 3,292 Amortization 13,702 16,098 Stock-based compensation 6,333 4,259 Deferred income tax (benefit) provision ( 2,739 ) 2,160 Other 107 437 Changes in operating assets and liabilities (net of acquisitions) ( 22,719 ) ( 18,522 ) Net cash provided by operating activities 9,607 11,758 Investing activities: Acquisition of businesses, net of cash acquired — ( 347,522 ) Purchase of property, equipment, improvements and certain other intangible assets ( 2,855 ) ( 1,664 ) Net cash used in investing activities ( 2,855 ) ( 349,186 ) Financing activities: Proceeds from long-term debt — 350,000 Payments of debt issuance costs — ( 13,443 ) Payments on long-term debt ( 9,375 ) ( 109,369 ) Proceeds from stock option plan transactions 1,672 5,598 Proceeds from employee stock purchase plan transactions 1,170 670 Taxes paid for net share settlement of share-based payment options and awards ( 3,654 ) ( 6,408 ) Net cash (used in) provided by financing activities ( 10,187 ) 227,048 Effect of exchange rate changes on cash and cash equivalents 195 ( 666 ) Net decrease in cash and cash equivalents ( 3,240 ) ( 111,046 ) Cash and cash equivalents, beginning of period 34,900 152,432 Cash and cash equivalents, end of period $ 31,660 $ 41,386 Supplemental disclosures of cash flow information: Interest paid $ 14,381 $ 6,570 Income taxes paid, net 3,454 4,535 Supplemental schedule of non-cash investing and financing activities: Transfer of inventory to property, equipment and improvements ( 2,685 ) ( 1,215 ) Accrual for purchase of property, equipment, improvements and certain other intangible assets $ ( 44 ) $ ( 28 ) (1) As described in Note 2 to these condensed consolidated financial statements, we have restated the condensed consolidated statement of cash flows for the six months ended March 31, 2022. 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) Income Equity Balances, December 31, 2021 41,413 $ 414 6,447 $ ( 58,100 ) $ 372,797 $ 181,879 $ ( 22,958 ) $ 474,032 Net income — — — — — 2,847 — 2,847 Other comprehensive income — — — — — — 52 52 Employee stock purchase plan issuances — — ( 19 ) 173 177 — — 350 Taxes paid for net share settlement of share-based payment awards — — 19 ( 383 ) — — — ( 383 ) Issuance of stock under stock award plans 112 1 — — 1,363 — — 1,364 Stock-based compensation expense — — — — 2,242 — — 2,242 Balances, March 31, 2022 41,525 $ 415 6,447 $ ( 58,310 ) $ 376,579 $ 184,726 $ ( 22,906 ) $ 480,504 Balances, September 30, 2021 40,653 $ 407 6,391 $ ( 56,535 ) $ 370,699 $ 180,692 $ ( 22,746 ) $ 472,517 Net income — — — — — 4,034 — 4,034 Other comprehensive loss — — — — — — ( 160 ) ( 160 ) Employee stock purchase plan issuances — — ( 37 ) 334 337 — — 671 Taxes paid for net share settlement of share-based payment awards — — 93 ( 2,109 ) ( 4,299 ) — — ( 6,408 ) Issuance of stock under stock award plans 872 8 — — 5,583 — — 5,591 Stock-based compensation expense — — — — 4,259 — — 4,259 Balances, March 31, 2022 41,525 $ 415 6,447 $ ( 58,310 ) $ 376,579 $ 184,726 $ ( 22,906 ) $ 480,504 Balances, December 31, 2022 42,199 $ 422 6,465 $ ( 60,973 ) $ 389,390 $ 205,854 $ ( 24,765 ) $ 509,928 Net income — — — — — 5,899 — 5,899 Other comprehensive income — — — — — — 178 178 Employee stock purchase plan issuances — — ( 20 ) 194 382 — — 576 Taxes paid for net share settlement of share-based payment options and awards — — 19 ( 667 ) — — — ( 667 ) Issuance of stock under stock award plans 126 1 — — 799 — — 800 Stock-based compensation expense — — — — 3,465 — — 3,465 Balances, March 31, 2023 42,325 $ 423 6,464 $ ( 61,446 ) $ 394,036 $ 211,753 $ ( 24,587 ) $ 520,179 Balances, September 30, 2022 41,950 $ 420 6,413 $ ( 58,172 ) $ 385,244 $ 200,075 $ ( 26,054 ) $ 501,513 Net income — — — — — 11,678 — 11,678 Other comprehensive income — — — — — — 1,467 1,467 Employee stock purchase plan issuances — — ( 40 ) 380 790 — — 1,170 Taxes paid for net share settlement of share-based payment awards — — 91 ( 3,654 ) — — — ( 3,654 ) Issuance of stock under stock award plans 375 3 — — 1,669 — — 1,672 Stock-based compensation expense — — — — 6,333 — — 6,333 Balances, March 31, 2023 42,325 $ 423 6,464 $ ( 61,446 ) $ 394,036 $ 211,753 $ ( 24,587 ) $ 520,179 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 Part I, Item 1 of our Annual Report on Form 10-K for the year ended September 30, 2022 (the "2022 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. 2. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS Our condensed consolidated statement of cash flows for the six months ended March 31, 2022 has been restated for errors made with regard to the cash flow classification of debt issuance costs and debt issuance cost amortization. Immaterial Correction of Prior Period Financial Statements Subsequent to the issuance of the Company's financial statements for the quarter ended March 31, 2022, the Company made certain corrections in the condensed consolidated statements of cash flows related to the debt issuance costs associated with our second and third amended and restated credit agreement entered into in November and December 2021, respectively. We corrected $ 13.4 million of debt issuance cost previously recorded within changes in operating assets and liabilities (net of acquisitions) within the operating activities and correctly presented the cash outflows as payments of debt issuance costs within financing activities. We also corrected $ 2.3 million of amortization of debt issuance costs previously included in payments on long-term debt within financing activities and changes in operating assets and liabilities (net of acquisitions) within operating activities to amortization within operating activities. There was no impact to the condensed consolidated balance sheets, condensed consolidated statements of operations or condensed consolidated statements of comprehensive income as a result of these corrections. The Company determined that this restatement was not material to the condensed consolidated financial statements. 6 Table of Contents 3. EARNINGS PER SHARE The following table is a reconciliation of the numerators and denominators in the net income per common share calculations (in thousands, except per common share data): Three months ended March 31, Six months ended March 31, 2023 2022 2023 2022 Numerator: Net income $ 5,899 $ 2,847 $ 11,678 $ 4,034 Denominator: Denominator for basic net income per common share — weighted average shares outstanding 35,791 35,015 35,698 34,785 Effect of dilutive securities: Stock options and restricted stock units 939 593 1,123 925 Denominator for diluted net income per common share — adjusted weighted average shares 36,730 35,608 36,821 35,710 Net income per common share, basic $ 0.16 $ 0.08 $ 0.33 $ 0.12 Net income per common share, diluted $ 0.16 $ 0.08 $ 0.32 $ 0.11 Digi excludes certain stock options and restricted stock unit awards that would have an anti-dilutive effect on our diluted net income per share calculation. For the three months ended March 31, 2023 and 2022, 609,017 and 1,129,393 shares outstanding were excluded, respectively. For the six months ended March 31, 2023 and 2022, 416,307 and 735,611 shares outstanding were excluded, respectively. 4. SELECTED BALANCE SHEET DATA The following table shows selected balance sheet data (in thousands): March 31, 2023 September 30, 2022 Accounts receivable, net: Accounts receivable $ 53,571 $ 58,967 Less allowance for credit losses 3,004 3,285 Less reserve for future credit returns and pricing adjustments 5,667 5,232 Accounts receivable, net $ 44,900 $ 50,450 Inventories: Raw materials $ 33,362 $ 39,189 Work in process 76 592 Finished goods 49,627 33,442 Inventories $ 83,065 $ 73,223 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). There were no assets or liabilities that are measured at fair value on a recurring basis as of March 31, 2023 or September 30, 2022. 7 Table of Contents 5. FAIR VALUE MEASUREMENTS (CONTINUED) 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 March 31, Six months ended March 31, 2023 2022 2023 2022 Fair value at beginning of period $ — $ 6,200 $ — $ 6,200 Change in fair value of contingent consideration — — — — Fair value at end of period $ — $ 6,200 $ — $ 6,200 In connection with our acquisition of Haxiot, Inc. ("Haxiot") in March 2021, we agreed to make contingent earn-out payments, based upon certain revenue thresholds. The fair value of the remaining liability for contingent consideration for the acquisition of Haxiot was $ 0.0 million at March 31, 2023 and September 30, 2022. In connection with our acquisition of Ctek, Inc. ("Ctek") in July 2021, we agreed to make contingent earn-out payments, based upon certain revenue thresholds. The fair value of the remaining liability for contingent consideration for the acquisition of Ctek was $ 0.0 million at March 31, 2023 and September 30, 2022. 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 March 31, 2023 is based on the probability of achieving the specified revenue thresholds for Ctek. As of March 31, 2023, contingent consideration associated with Ctek remains subject to future performance through December 31, 2023. 6. GOODWILL AND OTHER INTANGIBLE ASSETS, NET Amortizable intangible assets were (in thousands): March 31, 2023 September 30, 2022 Gross carrying amount Accum. amort. Net Gross carrying amount Accum. amort. Net Purchased and core technology $ 85,037 $ ( 57,931 ) $ 27,106 $ 85,016 $ ( 55,854 ) $ 29,162 License agreements 112 ( 112 ) — 112 ( 112 ) — Patents and trademarks 39,802 ( 18,804 ) 20,998 39,711 ( 17,666 ) 22,045 Customer relationships 309,222 ( 67,885 ) 241,337 309,212 ( 58,355 ) 250,857 Non-compete agreements 600 ( 600 ) — 600 ( 600 ) — Order backlog 1,000 ( 1,000 ) — 1,000 ( 1,000 ) — Total $ 435,773 $ ( 146,332 ) $ 289,441 $ 435,651 $ ( 133,587 ) $ 302,064 Amortization expense was $ 6.2 million and $ 7.0 million for the three months ended March 31, 2023 and 2022. Amortization expense was $ 12.7 million and $ 13.4 million for the six months ended March 31, 2023 and 2022, 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 2023 and the five succeeding fiscal years is (in thousands): 2023 (six months) $ 13,317 2024 25,227 2025 21,771 2026 20,593 2027 20,593 2028 20,411 8 Table of Contents 6. GOODWILL AND OTHER INTANGIBLE ASSETS, NET (CONTINUED) The changes in the carrying amount of goodwill by reportable segments are (in thousands): Three months ended March 31, 2023 IoT Products & Services IoT Solutions Total Balance on September 30, 2022 $ 172,931 $ 167,546 $ 340,477 Foreign currency translation adjustment 1,269 116 1,385 Balance on March 31, 2023 $ 174,200 $ 167,662 $ 341,862 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 ). Our IoT Products & Services business is structured to include four reporting units under the IoT Products & Services segment, each with a reporting manager: Cellular Routers, Console Servers, OEM Solutions and Infrastructure Management. Following our acquisition of Ventus in November 2021, we have two reporting units within our IoT Solutions segment: SmartSense and Ventus. Each of these segments was tested individually for impairment during our annual impairment test completed in the third fiscal quarter of fiscal 2022. 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. Results of our Fiscal 2022 Annual Impairment Test As of June 30, 2022, we had a total of $ 32.7 million of goodwill for the Enterprise Routers reporting unit, $ 57.1 million of goodwill for the Console Servers reporting unit, $ 63.7 million of goodwill for the OEM Solutions reporting unit, $ 20.4 million of goodwill for the Infrastructure Management reporting unit, $ 49.5 million of goodwill for the SmartSense reporting unit and $ 118.3 million of goodwill for the Ventus reporting unit. At June 30, 2022, the fair value of goodwill exceeded the carrying value for all six reporting units. SmartSense and Ventus fair values exceeded carrying values by less than 10%. Implied fair value for each reporting unit was 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 along with our unallocated assets 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 $ 852.0 million as of June 30, 2022. This implied a range of control (deficit)/ premiums of ( 5.6 )% to 7.9 %. 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 On November 1, 2021, we entered into a second amended and restated credit agreement with BMO Harris Bank N.A. ("BMO"). This agreement provides us with a senior secured credit facility (the "Credit Facility") consisting of a $ 350 million term loan B secured loan (the “Term Loan Facility”) and a $ 35 million revolving credit facility (the “Revolving Loan Facility”) with an uncommitted option to increase incremental loans under the Credit Facility, subject to an incremental cap. The Revolving Loan Facility includes a $ 10 million letter of credit subfacility and $ 10 million swingline subfacility. Digi may use proceeds of the Revolving Loan Facility in the future for general corporate purposes. This loan replaced our syndicated senior secured credit agreement with BMO that was entered into on March 15, 2021 and replaced the remaining balance of our revolver with this new term loan. This prior agreement provided us with a committed credit facility ("Prior Credit Facility") consisting of a $ 200 million revolving loan. On December 22, 2021, Digi entered into a third amended and restated credit agreement with BMO. Digi refinanced the Term Loan Facility and Revolving Loan Facility under its existing credit agreement entered into on November 1, 2021, but did not receive any additional proceeds from nor modify the amounts of any facilities or subfacilities contained within that credit agreement. 9 Table of Contents 7. INDEBTEDNESS (CONTINUED) Following the December amendment, borrowings under the Term Loan Facility bear interest at a rate per annum equal to LIBOR with a floor of 0.50 % for an interest period of one, three or six months as selected by Digi, reset at the end of the selected interest period (or a replacement benchmark rate if LIBOR is no longer available) plus 5.00 % or a base rate plus 4.00 %. The base rate is determined by reference to the highest of BMO’s prime rate, the Federal Funds Effective Rate plus 0.50 %, or the one-month LIBOR for U.S. dollars plus 1.00 %. The applicable margin for loans under the Revolving Credit Facility is in a range of 4.00 % to 3.75 % for LIBOR loans and 3.00 % to 2.75 % for base rate loans, depending on Digi’s consolidated leverage ratio. 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. Digi elected an interest period of one month for the months of December 2021 through April 2022 and a period of six months effective May 1, 2022. Following the expiration of the election on October 31, 2022, Digi elected an interest period of one month, effective on November 1, 2022 and has elected the same periods each subsequent month. Our weighted average interest rate at March 31, 2023 was 8.62 %. The debt issuance costs and remaining balance under the Prior Credit Facility totaled $ 2.3 million at November 1, 2021. Of this amount $ 1.9 million was written off and included in interest expense upon the entry into the new amendment and $ 0.4 million is being amortized over the term of the amended loan and reported in interest expense. Digi incurred an additional $ 11.7 million and $ 1.7 million in debt issuance costs relating to the November 1, 2021 and December 22, 2021 amendments, respectively. These amounts are being amortized over the term of the amended loan and reported in interest expense. The Term Loan is payable in quarterly installments, with the balance remaining due on November 2, 2028. The Revolving Loan is due in a lump sum payment at maturity on November 2, 2028, if any amounts are drawn. The fair value of the Term Loan and Revolving Loan approximated carrying value at March 31, 2023. Digi made early payments against the term loan of $ 0.6 million and $ 61.3 million in six months ended March 31, 2023 and 2022, respectively. The following table is a summary of our long-term indebtedness at March 31, 2023 and September 30, 2022 (in thousands): Balance on March 31, 2023 Balance on September 30, 2022 Term loan $ 240,625 $ 250,000 Less unamortized issuance costs ( 11,040 ) ( 12,029 ) Less current maturities of long-term debt ( 15,523 ) ( 15,523 ) Total long-term debt, net of current portion $ 214,062 $ 222,448 The following table is a summary of future maturities of our aggregate long-term debt at March 31, 2023 (in thousands): Fiscal year Amount 2023 (six months) $ 8,750 2024 17,500 2025 17,500 2026 17,500 2027 17,500 2028 161,875 Total long-term debt $ 240,625 Covenants and Security Interest The agreements governing the Revolving Loan Facility contain a number of covenants. Among other provisions, these covenants require us to maintain a certain financial ratio (net leverage ratio and minimum fixed charge ratio). At March 31, 2023, we had no amounts drawn on the Revolving Loan Facility. Amounts borrowed under the Credit Facility are secured by substantially all of our assets. 10 Table of Contents 8. SEGMENT INFORMATION We have two reportable segments: IoT Products & Services and IoT Solutions. Our IoT Products & Services business is structured to include four operating segments, each with a segment manager. These four operating segments are: • 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 installations and data center applications (also 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 module or from a systems-on-module ("SOM"). While cellular connectivity is used, other communication protocols can be used such as Zigbee, Bluetooth or Radio-Frequency ("RF") based on application. • Infrastructure Management - includes battery operated, cellular enabled connect sensors as well as other types of console server applications that are more Digi Accelerated Linux ("DAL") based than Console Servers. This operating segment has some products that do not use cellular communications, but a large part of this segment does use cellular communications. Following the acquisition of Ventus on November 1, 2021, IoT Solutions is now comprised of two operating segments: • SmartSense - offers wireless temperature and other condition-based monitoring services for perishable goods such as food or medicine, as well as employee task management services. • Ventus - provides Managed Network-as-a-Service ("MNaaS") solutions that simplify the complexity of enterprise wide area network ("WAN") connectivity via wireless and fixed line solutions. The operating segments included in each reportable segment have similar qualitative and quantitative factors, which allow us to aggregate them under each 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 margins. Our CEO is our Chief Operating Decision Maker and reviews and makes business decisions using consolidated information including operating income and gross profit. Summary operating results for each of our segments were (in thousands): Three months ended March 31, Six months ended March 31, 2023 2022 2023 2022 Revenue IoT Products & Services $ 85,893 $ 71,370 $ 170,235 $ 137,114 IoT Solutions 25,251 23,343 50,215 41,856 Total revenue $ 111,144 $ 94,713 $ 220,450 $ 178,970 Gross Profit IoT Products & Services $ 47,117 $ 38,461 $ 93,138 $ 74,136 IoT Solutions 15,755 13,523 31,255 25,729 Total gross profit $ 62,872 $ 51,984 $ 124,393 $ 99,865 Operating Income (Loss) IoT Products & Services $ 12,965 $ 9,049 $ 25,648 $ 13,165 IoT Solutions ( 790 ) ( 1,485 ) ( 1,510 ) ( 1,802 ) Total operating income $ 12,175 $ 7,564 $ 24,138 $ 11,363 Depreciation and Amortization IoT Products & Services $ 3,046 $ 3,533 $ 6,338 $ 7,162 IoT Solutions 4,800 5,251 9,620 9,484 Total depreciation and amortization $ 7,846 $ 8,784 $ 15,958 $ 16,646 11 Table of Contents 8. SEGMENT INFORMATION (CONTINUED) Total expended for property, plant and equipment was (in thousands): Six months ended March 31, 2023 2022 IoT Products & Services $ 2,260 $ 1,664 IoT Solutions* 508 — Total expended for property, plant and equipment $ 2,768 $ 1,664 * Excluded from this amount is $ 2,685 and $ 1,215 of transfers of inventory to property plant and equipment for subscriber assets for the six months ended March 31, 2023 and 2022, respectively. Total assets for each of our segments were (in thousands): March 31, 2023 September 30, 2022 IoT Products & Services $ 390,753 $ 390,128 IoT Solutions 425,335 428,867 Unallocated* 31,660 34,900 Total assets $ 847,748 $ 853,895 * Unallocated consists of cash and cash equivalents. 9. REVENUE Revenue Disaggregation The following table summarizes our revenue by geographic location of our customers (in thousands): Three months ended March 31, Six months ended March 31, 2023 2022 2023 2022 North America, primarily the United States $ 77,809 $ 73,790 $ 161,274 $ 140,033 Europe, Middle East & Africa 20,414 14,715 36,291 24,874 Rest of world 12,921 6,208 22,885 14,063 Total revenue $ 111,144 $ 94,713 $ 220,450 $ 178,970 The following table summarizes our revenue by the timing of revenue recognition (in thousands): Three months ended March 31, Six months ended March 31, 2023 2022 2023 2022 Transferred at a point in time $ 87,088 $ 72,656 $ 172,574 $ 139,191 Transferred over time 24,056 22,057 47,876 39,779 Total revenue $ 111,144 $ 94,713 $ 220,450 $ 178,970 Contract Balances Contract Related Assets Our contract related assets consist of subscriber assets, which are equipment that we provide to customers pursuant to subscription-based contracts. In these cases, we retain the ownership of the equipment that the customer uses and charge them subscription fees to receive our end-to-end solutions. The total net book value of subscriber assets of $ 17.3 million and $ 16.5 million as of March 31, 2023 and September 30, 2022, respectively, are included in property, equipment and improvements, net. Depreciation expense for these subscriber assets, which is included in cost of sales, was $ 0.9 million and $ 1.1 million for the three months ended March 31, 2023 and 2022, respectively. Depreciation expense for these subscriber assets $ 1.8 million and $ 1.9 million for the six months ended March 31, 2023 and 2022, respectively. We depreciate the cost of this equipment over its useful life. 12 Table of Contents 9. REVENUE (CONTINUED) Contract Assets Contract assets at Digi consist of products and services that have been fulfilled, but for which revenue has not yet been recognized. Our contract asset balances were immaterial as of March 31, 2023 and September 30, 2022. Contract Liabilities The timing of revenue recognition may differ from the timing of invoicing to customers. Customers are invoiced for subscription services 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, as well as product sales that have been invoiced, but not yet fulfilled. Our contract liabilities were $ 25.7 million and $ 24.8 million at March 31, 2023 and 2022, respectively. Of the $ 23.0 million and $ 24.3 million balances as of December 31, 2022 and 2021, Digi recognized $ 5.9 million and $ 5.0 million as revenue in the three months ended March 31, 2023 and 2022, respectively. Of the $ 21.6 million and $ 15.5 million balances as of September 30, 2022 and 2021, Digi recognized $ 10.6 million and $ 10.0 million as revenue in the six months ended March 31, 2023 and 2022, respectively. Remaining Transaction Price As of March 31, 2023, we had approximately $ 106.5 million of remaining performance obligations on contracts with an original duration of one year or more. We expect to recognize revenue on approximately $ 54.6 million of remaining performance obligations over the next 12 months. Revenue from the remaining performance obligations we expect to recognize over a range of two to five years . 10. INCOME TAXES Our income tax expense was $ 0.2 million for the six months ended March 31, 2023. Included in this expense was a net tax benefit discretely related to the six months ended March 31, 2023 of $ 1.7 million. This benefit primarily was the result of excess tax benefits recognized on stock compensation. Our effective tax rate will vary based on a variety of factors. These factors 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, 2022 $ 3,316 Decreases related to: Expiration of statute of limitations ( 649 ) Unrecognized tax benefits as of March 31, 2023 $ 2,667 The total amount of unrecognized tax benefits at March 31, 2023 that, if recognized, would affect our effective tax rate was $ 2.6 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 $ 0.3 million over the next 12 months. 13 Table of Contents 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 other current liabilities: Balance at Warranties Settlements Balance at Period December 31 issued made March 31 Three months ended March 31, 2023 $ 922 $ 78 $ ( 164 ) $ 836 Three months ended March 31, 2022 $ 658 $ 124 $ ( 92 ) $ 690 Balance at Warranties Settlements Balance at Period September 30 issued made March 31 Six months ended March 31, 2023 $ 886 $ 168 $ ( 218 ) $ 836 Six months ended March 31, 2022 $ 707 $ 195 $ ( 212 ) $ 690 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 12 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 expected term of 12 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 assets, 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. The following table shows the supplemental balance sheet information related to our leases (in thousands): Balance Sheet Location March 31, 2023 September 30, 2022 Assets Operating leases Operating lease right-of-use assets $ 14,179 $ 15,299 Total lease assets $ 14,179 $ 15,299 Liabilities Operating leases Current portion of operating lease liabilities $ 3,346 $ 3,196 Operating leases Operating lease liabilities 15,519 16,978 Total lease liabilities $ 18,865 $ 20,174 14 Table of Contents 12. LEASES (CONTINUED) 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 March 31, Six months ended March 31, 2023 2022 2023 2022 Operating lease cost $ 867 $ 945 $ 1,771 $ 1,882 Variable lease cost 343 268 652 541 Short-term lease cost 18 28 43 56 Total lease cost $ 1,228 $ 1,241 $ 2,466 $ 2,479 In November 2021, Digi acquired $ 0.9 million in right of-use assets and assumed $ 0.9 million in lease liabilities from the acquisition of Ventus that are included in the balances at March 31, 2022. Digi acquired $ 0.2 million in right-of-use assets in exchange for new operating lease liabilities in the three and six months ended March 31, 2023. At March 31, 2023, the weighted average remaining lease term of our operating leases was 6.9 years and the weighted average discount rate for these leases was 4.5 %. 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 March 31, 2023 (in thousands): Fiscal year Amount 2023 (six months) $ 2,033 2024 3,954 2025 3,501 2026 3,122 2027 2,043 2028 1,898 Thereafter 5,705 Total future undiscounted lease payments 22,256 Less imputed interest ( 3,391 ) Total reported lease liability $ 18,865 13. COMMITMENTS AND CONTINGENCIES We lease certain of our buildings and equipment under non-cancelable lease agreements. Please refer to Note 12 to our condensed consolidated financial statements for additional information. In the normal course of business, we presently are, and expect in the future to be, subject to various claims and litigation with third parties such as non-practicing intellectual property entities as well as customers, vendors, competitors and/or former employees. 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. In addition, the costs associated with defending ourselves in litigation may be significant regardless of whether the claim has merit. 14. STOCK-BASED COMPENSATION Stock-based awards granted in the first fiscal quarter of 2023 were granted under the amended and restated 2021 Omnibus Incentive Plan (the "2021 Plan"). Such awards made in the first quarter of fiscal 2022 were granted under the 2021 Plan before it was amended and restated at our annual meeting in January, 2022. Shares subject to awards under the 2021 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 2021 Plan. The authority to grant options under the 2021 Plan and set other terms and conditions rests with the Compensation Committee of the Board of Directors. 15 Table of Contents 14. STOCK-BASED COMPENSATION (CONTINUED) As of March 31, 2023, there were approximately 2,340,956 shares available for future grants under the 2021 Plan. Cash received from the exercise of stock options was $ 1.7 million and $ 5.6 million for the six months ended March 31, 2023 and 2022, 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 withholding obligations are otherwise fulfilled by the employee paying cash to us for the withholding. During the six months ended March 31, 2023 and 2022, our employees forfeited 90,985 shares and 630,181 shares, respectively, in order to satisfy respective withholding tax obligations of $ 3.7 million and $ 6.4 million, respectively. 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 that may be purchased under the ESPP to 3,425,000 . ESPP contributions by employees were $ 1.2 million and $ 0.7 million for the six months ended March 31, 2023 and 2022, respectively. Pursuant to the ESPP, 39,979 and 36,987 common shares were issued to employees during the six months ended March 31, 2023 and 2022, respectively. Shares are issued under the ESPP from treasury stock. As of March 31, 2023, 512,869 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 March 31, Six months ended March 31, 2023 2022 2023 2022 Cost of sales $ 161 $ 131 $ 303 $ 217 Sales and marketing 1,072 678 1,923 1,168 Research and development 469 317 917 639 General and administrative 1,763 1,116 3,190 2,235 Stock-based compensation before income taxes 3,465 2,242 6,333 4,259 Income tax benefit ( 737 ) ( 470 ) ( 1,336 ) ( 900 ) Stock-based compensation after income taxes $ 2,728 $ 1,772 $ 4,997 $ 3,359 Stock Options The following table summarizes our stock option activity (in thousands, except per common share amounts): Options Outstanding Weighted Average Exercise Price Weighted Average Contractual Term (in years) Aggregate Intrinsic Value (1) Balance on September 30, 2022 1,790 $ 17.29 Granted 66 40.67 Exercised ( 114 ) 15.24 Forfeited / Canceled ( 34 ) 20.69 Balance on March 31, 2023 1,708 $ 18.23 4.5 $ 15,189 Exercisable on March 31, 2023 1,012 $ 15.60 3.6 $ 11,090 (1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $ 33.68 as of March 31, 2023, which would have been received by the option holders had all option holders exercised their options as of that date. 16 Table of Contents 14. STOCK-BASED COMPENSATION (CONTINUED) The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. The total intrinsic value of all options exercised during the six months ended March 31, 2023 and 2022 was $ 2.6 million and $ 13.9 million, respectively. 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: Six months ended March 31, 2023 2022 Weighted average per option grant date fair value $ 19.92 $ 10.23 Assumptions used for option grants: Risk free interest rate minimum 3.77 % - 3.98 % 1.25 % - 1.82 % Expected term 6.00 years 6.00 years Expected volatility minimum 46 % 45 % - 46 % Weighted average volatility 46 % 46 % 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 March 31, 2023, the total unrecognized compensation cost related to non-vested stock options was $ 6.5 million and the related weighted average period over which it is expected to be recognized is approximately 1.9 years. Non-vested Stock Units The following table presents a summary of our non-vested restricted stock units and performance stock units as of March 31, 2023 and changes during the six months then ended (in thousands, except per common share amounts): RSUs PSUs Number of Awards Weighted Average Grant Date Fair Value Number of Awards Weighted Average Grant Date Fair Value Nonvested on September 30, 2022 742 $ 19.14 27 $ 22.69 Granted 440 40.41 113 40.66 Vested ( 258 ) 17.42 ( 5 ) 22.93 Canceled ( 32 ) 26.51 — — Nonvested on March 31, 2023 892 $ 29.86 135 $ 37.72 As of March 31, 2023, the total unrecognized compensation cost related to non-vested stock units was $ 27.9 million. The related weighted average period over which this cost is expected to be recognized is approximately 2.3 years. 17 Table of Contents