Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
We may be exposed to interest rate risk should we decide to invest in marketable securities. When we held marketable securities, we classified them as available-for-sale and they were carried at fair value. Our investments historically consisted of money market funds, certificates of deposit, commercial paper, corporate bonds and government municipal bonds. Our investment policy specifies the types of eligible investments and minimum credit quality of our investments, as well as diversification and concentration limits which mitigate our risk. We do not use derivative financial instruments to hedge against interest rate risk because the majority of our investments mature in less than one year.
We are exposed to market risks related to fluctuations in interest rates on amounts borrowed under the Credit Facility. As of September 30, 2023, we had $213.6 million outstanding under our Term Loan and $0.0 million outstanding under our Revolving Loan. Following an amendment in December 2021, borrowings under the Term Loan Facility bore interest at a rate based on LIBOR until the discontinuation of LIBOR on June 30, 2023. Following this date, borrowings under the Term Loan Facility are subject to a rate based on the Secured Overnight Financing Rate ("SOFR") with a credit spread adjustment to adjust for the change in reference rate ranging from 0.10% to 0.40%, depending on Digi's interest election. Borrowings under the Term Loan Facility are subject to a rate based on SOFR, 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 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 SOFR 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 SOFR loans and 3.00% to 2.75% for base rate loans, depending on Digi’s consolidated leverage ratio. Based on the balance sheet position for both the Term Loan and Revolving Loan at September 30, 2023, the annualized effect of a 25 basis point change in interest rates would increase or decrease our interest expense by $0.5 million. For additional information, see Note 7 to our consolidated financial statements. For our Credit Facility, interest rate changes generally do not affect the fair value of the debt instruments, but do impact future earnings and cash flows, assuming other factors are held constant. If interest rates remain elevated, we will continue to see interest expenses that are higher than historical amounts.
FOREIGN CURRENCY RISK
We are exposed to foreign currency transaction risk associated with certain sales being denominated in Canadian Dollars and in certain cases, transactions in U.S. Dollars in our foreign entities. We are also exposed to foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated into U.S. Dollars for consolidation. We manage our net asset or net liability position for non-functional currency accounts, primarily the U.S. dollar accounts in our foreign locations to reduce our foreign currency risk. In addition, as foreign currency rates fluctuate, we may from time to time, adjust the prices of our products, services and subscriptions. We have not implemented a formal hedging strategy.
The table below compares the average monthly exchange rates of the Euro, British Pound Canadian Dollar and Australian Dollar:
Fiscal year ended
September 30, % increase
2023 2022 (decrease)
Euro 1.0679 1.1057 (3.4) %
British Pound 1.2183 1.1377 7.1 %
Canadian Dollar 0.7380 0.7768 (5.0) %
Australian Dollar 0.6423 0.7105 (9.6) %
A 10.0% change from the 2023 average exchange rate for the Euro, British Pound, Canadian Dollar and Australian Dollar to the U.S. Dollar would have resulted in an immaterial increase or decrease in fiscal 2023 annual revenue and a 1.0% increase or decrease in stockholders' equity at September 30, 2023. The above analysis does not take into consideration any pricing adjustments we may make in response to changes in the exchange rates.
CREDIT RISK
We have some exposure to credit risk related to our accounts receivable portfolio. Exposure to credit risk is controlled through regular monitoring of customer financial status, credit limits and collaboration with sales management on customer contacts to facilitate payment.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID 34 )
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Report of Independent Registered Public Accounting Firm (PCAOB ID 248)
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Consolidated Statements of Operations
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Consolidated Statements of Comprehensive Income
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Consolidated Balance Sheets
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Consolidated Statements of Cash Flows
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Consolidated Statements of Stockholders' Equity
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Notes to the Consolidated Financial Statements
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Digi International Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Digi International Inc. and subsidiaries (the "Company") as of September 30, 2023, the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows, for the year ended September 30, 2023, and the related notes and the schedule listed in the Table of Contents at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2023, and the results of its operations and its cash flows for the year ended September 30, 2023, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of September 30, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 22, 2023, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Goodwill — Cellular Routers, Smart Sense, and Ventus Reporting Units — Refer to Notes 1 and 3 to the financial statements
The Company’s evaluation of goodwill for impairment involves the comparison of the fair value of each reporting unit to its carrying value. The Company used a combination of the income approach and market approach to estimate fair value, which requires management to make significant estimates and assumptions, specifically related to the determination of discount rates and forecasts of future gross margins and earnings before income taxes, depreciation, and amortization (“EBITDA”) margins used in the income approach. Changes in these assumptions could have a significant impact on the fair value. The goodwill balance was $342.3 million as of June 30, 2023, of which $32.7 million, $48.9 million, and $118.6 million was allocated to the Cellular Routers, Smart Sense, and Ventus reporting units, respectively.
We identified goodwill for the Cellular Routers, Smart Sense, and Ventus reporting units as a critical audit matter because of the significant judgments made by management to estimate the fair value of these reporting units, specifically related to the determination of discount rates and forecasts of future gross margins and EBITDA margins. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing
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audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to selection of the discount rates and future assumptions of gross margins and EBITDA margins.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the discount rates and forecasts of future gross margins and EBITDA margins used by management to estimate the fair value of the Cellular Routers, Smart Sense and Ventus reporting units included the following, among others:
• We tested the effectiveness of controls over management’s goodwill impairment evaluation, including those over the determination of the fair value of the Cellular Routers, Smart Sense, and Ventus reporting units, such as controls related to management’s selection of the discount rates and forecasts of future gross margins and EBITDA margins.
• We evaluated management’s ability to accurately forecast future gross margins and EBITDA margins by comparing actual results to management’s historical forecasts.
• We evaluated the reasonableness of management’s gross margin and EBITDA margin forecasts by comparing the forecasts to:
◦ Historical gross margins and EBITDA margins.
◦ Forecasted information included in Company press releases as well as in industry reports for the Company and certain of its peer companies.
• With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) valuation methodology and (2) discount rates by:
◦ Testing the source information underlying the determination of the discount rates and the mathematical accuracy of the calculations.
◦ Developing a range of independent estimates and comparing those to the discount rates selected by management.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
November 22, 2023
We have served as the Company’s auditor since 2022.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Digi International Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Digi International Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of September 30, 2022, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the two years in the period ended September 30, 2022, and the related notes and consolidated financial statement schedule included under Item 15(a) (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2022, and the results of its operations and its cash flows for each of the two years in the period ended September 30, 2022, in conformity with accounting principles generally accepted in the United States of America.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ GRANT THORNTON LLP
We served as the Company’s auditor from 2016 to 2022.
Cincinnati, Ohio
November 23, 2022
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended September 30,
2023 2022 2021
(in thousands, except per common share data)
Revenue:
Product $ 331,162 $ 290,170 $ 265,805
Service 113,687 98,055 42,827
Total revenue 444,849 388,225 308,632
Cost of sales:
Cost of product 161,451 140,615 124,065
Cost of service 27,233 26,027 13,412
Amortization 3,962 5,297 4,498
Total cost of sales 192,646 171,939 141,975
Gross profit 252,203 216,286 166,657
Operating expenses:
Sales and marketing 81,681 70,366 61,909
Research and development 58,648 55,098 46,623
General and administrative 61,779 58,802 41,825
Change in fair value of contingent consideration — ( 6,200 ) 5,772
Total operating expenses 202,108 178,066 156,129
Operating income 50,095 38,220 10,528
Other expense, net:
Interest expense, net ( 25,236 ) ( 19,690 ) ( 1,385 )
Other income (expense), net 59 98 ( 144 )
Total other expense, net ( 25,177 ) ( 19,592 ) ( 1,529 )
Income before income taxes 24,918 18,628 8,999
Income tax expense (benefit) 148 ( 755 ) ( 1,367 )
Net income $ 24,770 $ 19,383 $ 10,366
Net income per common share:
Basic $ 0.69 $ 0.55 $ 0.32
Diluted net income per common share:
Diluted $ 0.67 $ 0.54 $ 0.31
Weighted average common shares:
Basic 35,820 35,031 32,111
Diluted 36,869 35,995 33,394
The accompanying notes are an integral part of the consolidated financial statements.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year ended September 30,
2023 2022 2021
(in thousands)
Net income $ 24,770 $ 19,383 $ 10,366
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustment ( 957 ) ( 3,308 ) 1,071
Other comprehensive (loss) income, net of tax ( 957 ) ( 3,308 ) 1,071
Comprehensive income $ 23,813 $ 16,075 $ 11,437
The accompanying notes are an integral part of the consolidated financial statements.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
DIGI INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
As of September 30,
2023 2022
(in thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents $ 31,693 $ 34,900
Accounts receivable, net 55,997 50,450
Inventories 74,396 73,223
Deferred tax assets — 3,764
Other current assets 4,112 3,871
Total current assets 166,198 166,208
Property, equipment and improvements, net 29,108 27,594
Identifiable intangible assets, net 277,084 302,064
Goodwill 341,593 340,477
Deferred tax assets 4,884 —
Operating lease right-of-use assets 12,876 15,299
Other non-current assets 3,788 2,253
Total assets $ 835,531 $ 853,895
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt $ 15,523 $ 15,523
Accounts payable 17,148 32,373
Income taxes payable 1,116 96
Accrued compensation 16,427 14,576
Unearned revenue 25,274 19,803
Current portion of operating lease liabilities 3,352 3,196
Other current liabilities 7,138 10,940
Total current liabilities 85,978 96,507
Income taxes payable 2,308 2,441
Deferred tax liabilities 1,812 9,666
Long-term debt 188,051 222,448
Operating lease liabilities 13,989 16,978
Other non-current liabilities 2,905 4,342
Total liabilities 295,043 352,382
Commitments and Contingencies (see Note 16 )
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; 42,501,150 and 41,950,732 shares issued
425 420
Additional paid-in capital 403,735 385,244
Retained earnings 224,845 200,075
Accumulated other comprehensive loss ( 27,011 ) ( 26,054 )
Treasury stock, at cost, 6,436,204 and 6,412,812 shares
( 61,506 ) ( 58,172 )
Total stockholders’ equity 540,488 501,513
Total liabilities and stockholders’ equity $ 835,531 $ 853,895
The accompanying notes are an integral part of the consolidated financial statements.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (CONTINUED)
DIGI INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended September 30,
2023 2022 2021
Operating activities: (in thousands)
Net income $ 24,770 $ 19,383 $ 10,366
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of property, equipment and improvements 6,753 6,644 4,343
Amortization 27,203 30,928 16,534
Stock-based compensation expense 13,286 8,578 8,135
Deferred income tax provision ( 12,739 ) ( 3,387 ) ( 4,598 )
Change in fair value of contingent consideration — ( 6,200 ) 5,772
(Reversal) provision for bad debt and product return ( 2,633 ) 427 2,290
Other, net ( 806 ) ( 188 ) 131
Changes in operating assets and liabilities (net of acquisitions):
Accounts receivable ( 2,925 ) ( 541 ) 11,467
Inventories ( 5,062 ) ( 34,468 ) 5,879
Other assets ( 1,214 ) ( 545 ) ( 1,657 )
Income taxes 4,088 ( 1,305 ) 165
Accounts payable ( 15,503 ) 7,281 ( 5,578 )
Accrued expenses 1,533 11,133 4,474
Net cash provided by operating activities 36,751 37,740 57,723
Investing activities:
Acquisition of businesses, net of cash acquired — ( 347,554 ) ( 19,108 )
Purchase of property, equipment, improvements and certain other intangible assets ( 4,345 ) ( 1,974 ) ( 2,257 )
Net cash used in investing activities ( 4,345 ) ( 349,528 ) ( 21,365 )
Financing activities:
Proceeds from long-term debt — 350,000 617
Payments of debt issuance costs — ( 13,443 ) —
Payments on long-term debt ( 36,375 ) ( 148,118 ) ( 15,624 )
Payments for contingent consideration — — ( 4,200 )
Proceeds from issuances of stock, net of offering expenses — — 73,830
Proceeds from stock option plan transactions 3,926 9,505 8,525
Proceeds from employee stock purchase plan transactions 2,263 1,500 1,214
Taxes paid for net share settlement of share-based payment awards ( 4,314 ) ( 6,662 ) ( 2,120 )
Net cash (used in) provided by financing activities ( 34,500 ) 192,782 62,242
Effect of exchange rate changes on cash and cash equivalents ( 1,113 ) 1,474 ( 297 )
Net (decrease) increase in cash and cash equivalents ( 3,207 ) ( 117,532 ) 98,303
Cash and cash equivalents, beginning of period 34,900 152,432 54,129
Cash and cash equivalents, end of period $ 31,693 $ 34,900 $ 152,432
Supplemental disclosures of cash flow information:
Interest paid $ 26,351 $ 14,209 $ 917
Income taxes paid, net $ 8,693 $ 4,333 $ 3,684
Supplemental schedule of non-cash investing and financing activities:
Accrual for property, equipment, improvements and certain other intangibles assets $ ( 277 ) $ ( 191 ) $ ( 98 )
Tenant improvement allowance $ — $ — $ ( 1,000 )
Transfer of inventory to property, equipment and improvements $ ( 3,889 ) $ ( 6,237 ) $ ( 1,838 )
Liability related to acquisition of business $ — $ — $ ( 6,200 )
Term debt refinanced as credit facility $ — $ — $ 50,000
The accompanying notes are an integral part of the consolidated financial statements.
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