DIGI INTERNATIONAL INC 10-Q

ITEM 1. FINANCIAL STATEMENTS DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three months ended December 31, 2023 2022 (in thousands, except per share data) Revenue: Product $ 77,250 $ 81,755 Service 28,839 27,551 Total revenue 106,089 109,306 Cost of sales: Cost of product 37,766 39,612 Cost of service 6,270 7,070 Amortization 953 1,103 Total cost of sales 44,989 47,785 Gross profit 61,100 61,521 Operating expenses: Sales and marketing 19,647 19,106 Research and development 14,633 14,094 General and administrative 14,687 16,358 Total operating expenses 48,967 49,558 Operating income 12,133 11,963 Other expense, net: Interest expense, net ( 5,661 ) ( 5,971 ) Debt issuance cost write off ( 9,722 ) — Other (expense) income, net ( 26 ) 17 Total other expense, net ( 15,409 ) ( 5,954 ) (Loss) income before income taxes ( 3,276 ) 6,009 Income tax (benefit) provision ( 222 ) 230 Net (loss) income $ ( 3,054 ) $ 5,779 Net (loss) income per common share: Basic $ ( 0.08 ) $ 0.16 Diluted $ ( 0.08 ) $ 0.16 Weighted average common shares: Basic 36,129 35,608 Diluted 36,129 36,859 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 (LOSS) INCOME (UNAUDITED) Three months ended December 31, 2023 2022 (in thousands) Net (loss) income $ ( 3,054 ) $ 5,779 Other comprehensive income: Foreign currency translation adjustment 2,948 1,289 Other comprehensive income 2,948 1,289 Comprehensive (loss) income $ ( 106 ) $ 7,068 The accompanying notes are an integral part of the condensed consolidated financial statements. 2 Table of Contents DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) December 31, 2023 September 30, 2023 (in thousands, except share data) ASSETS Current assets: Cash and cash equivalents $ 31,548 $ 31,693 Accounts receivable, net 61,441 55,997 Inventories 67,590 74,396 Other current assets 4,799 4,112 Total current assets 165,378 166,198 Property, equipment and improvements, net 28,644 29,108 Intangible assets, net 270,921 277,084 Goodwill 342,424 341,593 Operating lease right-of-use assets 12,187 12,876 Deferred tax assets 5,192 4,884 Other non-current assets 3,916 3,788 Total assets $ 828,662 $ 835,531 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ — $ 15,523 Accounts payable 16,679 17,148 Accrued compensation 9,382 16,427 Unearned revenue 31,235 25,274 Current portion of operating lease liabilities 3,216 3,352 Income taxes payable 1,179 1,116 Other current liabilities 8,754 7,138 Total current liabilities 70,445 85,978 Income taxes payable 2,304 2,308 Deferred tax liabilities 1,817 1,812 Long-term debt 194,684 188,051 Operating lease liabilities 13,333 13,989 Other non-current liabilities 4,004 2,905 Total liabilities 286,587 295,043 Commitments and Contingencies (See Note 11 ) 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; 42,748,931 and 42,501,150 shares issued 427 425 Additional paid-in capital 407,330 403,735 Retained earnings 221,791 224,845 Accumulated other comprehensive loss ( 24,063 ) ( 27,011 ) Treasury stock, at cost, 6,500,331 and 6,436,204 shares ( 63,410 ) ( 61,506 ) Total stockholders' equity 542,075 540,488 Total liabilities and stockholders' equity $ 828,662 $ 835,531 The accompanying notes are an integral part of the condensed consolidated financial statements. 3 Table of Contents DIGI INTERNATIONAL INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three months ended December 31, 2023 2022 (in thousands) Operating activities: Net (loss) income $ ( 3,054 ) $ 5,779 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation of property, equipment and improvements 1,813 1,649 Amortization 6,591 6,957 Write-off of debt issuance costs 9,722 — Stock-based compensation 3,106 2,868 Deferred income tax (benefit) provision ( 303 ) 905 Other 349 ( 29 ) Changes in operating assets and liabilities (net of acquisitions) 448 ( 15,449 ) Net cash provided by operating activities 18,672 2,680 Investing activities: Purchase of property, equipment, improvements and certain other intangible assets ( 292 ) ( 963 ) Net cash used in investing activities ( 292 ) ( 963 ) Financing activities: Proceeds from long-term debt 214,062 — Payments on long-term debt ( 233,025 ) ( 4,375 ) Proceeds from stock option plan transactions 225 872 Proceeds from employee stock purchase plan transactions 531 594 Taxes paid for net share settlement of share-based payment options and awards ( 2,169 ) ( 2,987 ) Net cash used in financing activities ( 20,376 ) ( 5,896 ) Effect of exchange rate changes on cash and cash equivalents 1,851 228 Net decrease in cash and cash equivalents ( 145 ) ( 3,951 ) Cash and cash equivalents, beginning of period 31,693 34,900 Cash and cash equivalents, end of period $ 31,548 $ 30,949 Supplemental disclosures of cash flow information: Interest paid $ 4,309 $ 8,466 Income taxes paid, net 72 565 Supplemental schedule of non-cash investing and financing activities: Transfer of inventory to property, equipment and improvements ( 1,105 ) ( 1,512 ) Accrual for purchase of property, equipment, improvements and certain other intangible assets $ ( 10 ) $ ( 17 ) 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 Balance on September 30, 2022 41,950 $ 420 6,413 $ ( 58,172 ) $ 385,244 $ 200,075 $ ( 26,054 ) $ 501,513 Net income — — — — — 5,779 — 5,779 Other comprehensive income — — — — — — 1,289 1,289 Employee stock purchase plan issuances — — ( 20 ) 186 408 — — 594 Taxes paid for net share settlement of share-based payment awards — — 72 ( 2,987 ) — — — ( 2,987 ) Issuance of stock under stock award plans 249 2 — — 870 — — 872 Stock-based compensation expense — — — — 2,868 — — 2,868 Balances, December 31, 2022 42,199 $ 422 6,465 $ ( 60,973 ) $ 389,390 $ 205,854 $ ( 24,765 ) $ 509,928 Balances, September 30, 2023 42,501 $ 425 6,436 $ ( 61,506 ) $ 403,735 $ 224,845 $ ( 27,011 ) $ 540,488 Net loss — — — — — ( 3,054 ) — ( 3,054 ) Other comprehensive income — — — — — — 2,948 2,948 Employee stock purchase plan issuances — — ( 24 ) 231 300 — — 531 Taxes paid for net share settlement of share-based payment awards — — 88 ( 2,135 ) ( 33 ) — — ( 2,168 ) Issuance of stock under stock award plans 248 2 — — 222 — — 224 Stock-based compensation expense — — — — 3,106 — — 3,106 Balances, December 31, 2023 42,749 $ 427 6,500 $ ( 63,410 ) $ 407,330 $ 221,791 $ ( 24,063 ) $ 542,075 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 U.S. 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, 2023 (the "2023 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. EARNINGS (LOSS) 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 December 31, 2023 2022 Numerator: Net (loss) income $ ( 3,054 ) $ 5,779 Denominator: Denominator for basic net income per common share — weighted average shares outstanding 36,129 35,608 Effect of dilutive securities: Stock options and restricted stock units — 1,251 Denominator for diluted net income per common share — adjusted weighted average shares 36,129 36,859 Net (loss) income per common share, basic $ ( 0.08 ) $ 0.16 Net (loss) income per common share, diluted $ ( 0.08 ) $ 0.16 Digi excludes certain stock options and restricted stock unit awards that would have an anti-dilutive effect on our diluted net (loss) income per share calculation. For the three months ended December 31, 2023 and 2022, 1,563,857 and 234,365 shares outstanding were excluded, respectively. 6 Table of Contents 3. SELECTED BALANCE SHEET DATA The following table shows selected balance sheet data (in thousands): December 31, 2023 September 30, 2023 Accounts receivable, net: Accounts receivable $ 66,873 $ 61,880 Less allowance for credit losses 1,407 1,693 Less reserve for future credit returns and pricing adjustments 4,025 4,190 Accounts receivable, net $ 61,441 $ 55,997 Inventories: Raw materials $ 28,649 $ 29,974 Work in process 130 66 Finished goods 38,811 44,356 Inventories $ 67,590 $ 74,396 4. GOODWILL AND OTHER INTANGIBLE ASSETS, NET Amortizable intangible assets were (in thousands): December 31, 2023 September 30, 2023 Gross carrying amount Accum. amort. Net Gross carrying amount Accum. amort. Net Purchased and core technology $ 85,080 $ ( 60,833 ) $ 24,247 $ 85,032 $ ( 59,833 ) $ 25,199 License agreements 112 ( 112 ) — 112 ( 112 ) — Patents and trademarks 40,035 ( 20,421 ) 19,614 39,957 ( 19,888 ) 20,069 Customer relationships 309,241 ( 82,181 ) 227,060 309,196 ( 77,380 ) 231,816 Non-compete agreements 600 ( 600 ) — 600 ( 600 ) — Order backlog 1,000 ( 1,000 ) — 1,000 ( 1,000 ) — Total $ 436,068 $ ( 165,147 ) $ 270,921 $ 435,897 $ ( 158,813 ) $ 277,084 Amortization expense for intangible assets was $ 6.2 million and $ 6.5 million for the three months ended December 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 2024 and the five succeeding fiscal years is (in thousands): 2024 (nine months) $ 19,058 2025 21,781 2026 21,549 2027 20,593 2028 20,411 2029 18,355 7 Table of Contents 4. GOODWILL AND OTHER INTANGIBLE ASSETS, NET (CONTINUED) The changes in the carrying amount of goodwill by reportable segments are (in thousands): Three months ended December 31, 2023 IoT Products & Services IoT Solutions Total Balance on September 30, 2023 $ 173,957 $ 167,636 $ 341,593 Foreign currency translation adjustment 567 264 831 Balance on December 31, 2023 $ 174,524 $ 167,900 $ 342,424 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, IoT Products & Services and IoT Solutions (see Note 6 ). Our IoT Products & Services segment is structured to include four reporting units, 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 IoT Solutions: 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 2023. 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 affect the estimated fair values negatively. 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 within either of our segments, we may be required to record future impairment charges for goodwill. Digi conducted an analysis as of December 31, 2023 and concluded changes in market conditions from the time of the fiscal 2023 test, conducted as of June 30,2023, were not indicative of a reduction in fair value of any of our reporting units. Results of our Fiscal 2023 Annual Impairment Test As of June 30, 2023, 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, $ 64.6 million of goodwill for the OEM Solutions reporting unit, $ 20.4 million of goodwill for the Infrastructure Management reporting unit, $ 48.9 million of goodwill for the SmartSense reporting unit and $ 118.6 million of goodwill for the Ventus reporting unit. At June 30, 2023, the fair value of goodwill exceeded the carrying value for all six reporting units and no impairment was recorded. 5. INDEBTEDNESS On December 7, 2023, Digi entered into a credit agreement (the “Credit Agreement”) with BMO Bank N.A. (“BMO”), as administrative and collateral agent, BMO Capital Markets Corp., BofA Securities, Inc. and MUFG Bank, Ltd., as joint lead arrangers and joint bookrunners, and the several banks and other financial institutions or entities from time to time party thereto as lenders (the “Lenders”). The Credit Agreement provides Digi with a senior secured credit facility (the “Credit Facility”). The Credit Facility includes a $ 250 million senior secured revolving credit facility (the “Revolving Loan Facility”), with an uncommitted accordion feature that provides for additional borrowing capacity of up to the greater of $ 95 million or one hundred percent of trailing twelve month adjusted earnings before interest, taxes, depreciation, and amortization ("EBITDA"). The Credit Facility also contains a $ 10 million letter of credit sublimit and $ 10 million swingline sub-facility. Digi may use the proceeds of the Credit Facility in the future for general corporate purposes. Digi borrowed a total of $ 215 million under the Credit Facility to repay all obligations and to pay related fees and expenses under the Third Amended and Restated Credit Agreement dated as of December 22, 2021 (the “Prior Credit Facility”), by and among Digi, as the borrower, BMO, as administrative agent and collateral agent, BMO Capital Markets Corp., as sole lead arranger and bookrunner, and the other lenders from time-to-time party thereto. The Prior Credit Facility consisted of a $ 350 million term loan B secured loan and a $ 35 million revolving credit facility that included a $ 10 million letter of credit subfacility and $ 10 million swingline subfacility. 8 Table of Contents 5. INDEBTEDNESS (CONTINUED) Borrowings under the Credit Facility bear interest at a rate per annum equal to Term SOFR with a floor of 0.00 % 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 Term SOFR is no longer available) plus the applicable margin or a base rate plus the applicable margin. The base rate is determined by reference to the highest of BMO’s prime rate, the rate determined by BMO to be the average rate of Federal funds in the secondary market plus 0.50 %, or one-month SOFR plus 1.00 %. The applicable margin for loans under the Credit Facility is in a range of 1.75 % to 2.75 % for Term SOFR loans and 0.75 % to 1.75 % for base rate loans, depending on Digi’s total net leverage ratio. The initial borrowings were made at Term SOFR for a one-month interest period plus an applicable margin of 2.50 %. Our weighted average interest rate for our Credit Facility was 7.96 % as of December 31, 2023. In addition to paying interest on the outstanding principal, Digi is required to pay a commitment fee on the unutilized commitments under the Credit Facility. The commitment fee is between 0.20 % and 0.35 % depending on Digi’s total net leverage ratio. Our weighted average Revolving Loan Facility commitment fee was 0.30 % as of December 31, 2023. The Credit Facility is secured by substantially all of the property of Digi and its domestic subsidiaries. The debt issuance costs and remaining balance under the Prior Credit Facility totaling $ 9.7 million at December 7, 2023 were written off and included in other expenses upon the entry into the Credit Agreement. Digi incurred an additional $ 1.3 million in debt issuance costs upon entry into the Credit Agreement, with this amount amortized over the term of the Credit Agreement and reported in interest expense. The Revolving Loan is due in a lump sum payment at maturity December 7, 2028, if any amounts are drawn. The fair value of the Revolving Loan approximated carrying value at December 31, 2023. The following table is a summary of our long-term indebtedness at December 31, 2023 and September 30, 2023 (in thousands): Balance on December 31, 2023 Balance on September 30, 2023 Revolving loan $ 196,000 $ — Term loan — 213,625 Total loans 196,000 213,625 Less unamortized issuance costs ( 1,316 ) ( 10,051 ) Less current maturities of long-term debt — ( 15,523 ) Total long-term debt, net of current portion $ 194,684 $ 188,051 Covenants and Security Interest The Credit Agreement requires Digi to maintain a minimum interest coverage ratio of 3.00 to 1.00 and a total net leverage ratio not to exceed 3.00 to 1.00, with certain exceptions for a covenant holiday of up to 3.50 to 1.00 after certain material acquisitions. The total net leverage ratio is defined as the ratio of Digi’s consolidated total funded indebtedness minus unrestricted cash as of such date up to a maximum amount not to exceed $50 million, to consolidated EBITDA for such period. The Credit Agreement also contains other customary affirmative and negative covenants, including covenants that restrict the ability of Digi and its subsidiaries to incur additional indebtedness, dispose of significant assets, make certain investments, including any acquisitions other than permitted acquisitions, make certain restricted payments, enter into sale and leaseback transactions or grant additional liens on its assets, subject to certain limitations. Amounts borrowed under the Credit Facility are secured by substantially all of our assets. 9 Table of Contents 6. SEGMENT INFORMATION We have two reportable segments: IoT Products & Services and IoT Solutions. IoT Products & Services is structured to include four operating segments, each with a segment manager. These four operating segments are Cellular Routers, Console Servers, OEM Solutions and Infrastructure Management. IoT Products & Services derives revenue from the sale of connectivity products and solutions. These products and solutions include enclosed router devices in Cellular Routers, enclosed devices for edge computing and data center applications in Console Servers, chip modules in OEM Solutions and sensors in Infrastructure Management, as well as our cloud based remote manager application and extended support and monitoring of devices sold. IoT Solutions is comprised of two operating segments. These operating segments are SmartSense and Ventus. IoT Solutions derives revenue from the sale of monitoring and networking service solutions. These solutions include wireless condition-based monitoring services in SmartSense and Managed Network-as-a-Service ("MNaaS") in Ventus. 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 such as operating income and gross profit. Summary operating results for each of our segments were (in thousands): Three months ended December 31, 2023 2022 Revenue IoT Products & Services $ 82,023 $ 84,342 IoT Solutions 24,066 24,964 Total revenue $ 106,089 $ 109,306 Gross Profit IoT Products & Services $ 43,859 $ 46,021 IoT Solutions 17,241 15,500 Total gross profit $ 61,100 $ 61,521 Operating Income (Loss) IoT Products & Services $ 10,341 $ 12,683 IoT Solutions 1,792 ( 720 ) Total operating income $ 12,133 $ 11,963 Depreciation and Amortization IoT Products & Services $ 3,098 $ 3,292 IoT Solutions 4,953 4,820 Total depreciation and amortization $ 8,051 $ 8,112 Total expended for property, plant and equipment was (in thousands): Three months ended December 31, 2023 2022 IoT Products & Services $ 37 $ 637 IoT Solutions* 182 326 Total expended for property, plant and equipment $ 219 $ 963 * Excluded from these amounts are $ 1,105 and $ 1,512 of transfers of inventory to property plant and equipment for subscriber assets for the three months ended December 31, 2023 and 2022, respectively. 10 Table of Contents 6. SEGMENT INFORMATION (CONTINUED) Total assets for each of our segments were (in thousands): December 31, 2023 September 30, 2023 IoT Products & Services $ 382,874 $ 384,018 IoT Solutions 414,240 419,820 Unallocated* 31,548 31,693 Total assets $ 828,662 $ 835,531 * Unallocated consists of cash and cash equivalents. 7. REVENUE Revenue Disaggregation The following table summarizes our revenue by geographic location of our customers (in thousands): Three months ended December 31, 2023 2022 North America, primarily the United States $ 79,695 $ 83,465 Europe, Middle East & Africa 14,390 15,877 Rest of world 12,004 9,964 Total revenue $ 106,089 $ 109,306 The following table summarizes our revenue by the timing of revenue recognition (in thousands): Three months ended December 31, 2023 2022 Transferred at a point in time $ 79,394 $ 85,486 Transferred over time 26,695 23,820 Total revenue $ 106,089 $ 109,306 Contract Balances Contract Related Assets Our contract related assets consist of subscriber assets. Subscriber assets are equipment that we provide to customers pursuant to subscription-based contracts. In these cases, we retain the ownership of the equipment a customer uses and charge the customer subscription fees to receive our end-to-end solutions. The total net book value of subscriber assets of $ 16.7 million and $ 16.6 million as of December 31, 2023 and September 30, 2023, respectively, are included in property, equipment and improvements, net. Depreciation expense for these subscriber assets, which is included in cost of sales, was $ 1.0 million and $ 0.9 million for the three months ended December 31, 2023 and 2022, respectively. We depreciate the cost of this equipment over its useful life. 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 December 31, 2023 and September 30, 2023. Contract Liabilities 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. 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. 11 Table of Contents 7. REVENUE (CONTINUED) Our contract liabilities were $ 35.0 million and $ 23.0 million at December 31, 2023 and 2022, respectively. There were contract liability balances of $ 27.9 million and $ 21.6 million balances as of September 30, 2023 and 2022. Of these balances, Digi recognized $ 7.4 million and $ 6.1 million as revenue in the three months ended December 31, 2023 and 2022, respectively. Remaining Performance Obligation As of December 31, 2023, we had approximately $ 156.9 million of remaining performance obligations on contracts with an original duration of one year or more. We expect to recognize revenue on approximately $ 67.5 million of remaining performance obligations over the next 12 months. We expect to recognize revenue from the remaining performance obligations over a range of two to five years . 8. INCOME TAXES Our income tax benefit was $ 0.2 million for the three months ended December 31, 2023. Included in this was a net tax liability of $ 0.2 million discretely related to the three months ended December 31, 2023. This liability primarily was the result of book stock compensation in excess of recognized tax benefits. 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 tax impacts of stock compensation as there are no open audits during the period. 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, 2023 $ 3,162 Decreases related to: Expiration of statute of limitations ( 32 ) Unrecognized tax benefits as of December 31, 2023 $ 3,130 The total amount of unrecognized tax benefits at December 31, 2023 that, if recognized, would affect our effective tax rate was $ 3.0 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 $ 0.4 million over the next 12 months. 9. PRODUCT WARRANTY OBLIGATION The following tables summarizes the activity associated with the product warranty accrual (in thousands) and is included on our condensed consolidated balance sheets within other current liabilities: Three months ended December 31, 2023 2022 Balance at beginning of period $ 772 $ 886 Warranties accrued 94 90 Settlement made ( 85 ) ( 54 ) Balance at end of period $ 781 $ 922 12 Table of Contents 10. 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 December 31, 2023 September 30, 2023 Assets Operating leases Operating lease right-of-use assets $ 12,187 $ 12,876 Total lease assets $ 12,187 $ 12,876 Liabilities Operating leases Current portion of operating lease liabilities $ 3,216 $ 3,352 Operating leases Operating lease liabilities 13,333 13,989 Total lease liabilities $ 16,549 $ 17,341 The following were the components of our lease cost which is recorded in both cost of goods sold and selling, general and administrative expense (in thousands): Three months ended December 31, 2023 2022 Operating lease cost $ 891 $ 904 Variable lease cost 317 309 Short-term lease cost 27 25 Total lease cost $ 1,235 $ 1,238 At December 31, 2023, the weighted average remaining lease term of our operating leases was 6.3 years and the weighted average discount rate for these leases was 4.5 %. 13 Table of Contents 10. LEASES (CONTINUED) The table below reconciles the undiscounted cash flows for each of the first five years as well as all the remaining years to the operating lease liabilities recorded on the condensed consolidated balance sheet as of December 31, 2023 (in thousands): Fiscal year Amount 2024 (nine months) $ 3,197 2025 3,529 2026 3,139 2027 2,043 2028 1,897 2029 1,840 Thereafter 3,865 Total future undiscounted lease payments 19,510 Less imputed interest ( 2,961 ) Total reported lease liability $ 16,549 11. COMMITMENTS AND CONTINGENCIES We lease certain of our buildings and equipment under non-cancelable lease agreements. Please refer to Note 10 to our condensed consolidated financial statements for additional information. Data Logger Solutions, LLC ("Data Loggers") brought suit in Delaware Superior Court against us and our subsidiary Digi SmartSense, LLC in October, 2020. The suit alleges that Data Loggers has not been paid certain commissions it believes it is owed and will continue to be owed under a Reseller Agreement entered between Data Loggers and TempAlert. SmartSense is the successor of interest of TempAlert and terminated the Reseller Agreement in 2019. Data Loggers claims it is entitled to actual, speculative and punitive damages in connection with its allegations. A trial is scheduled to commence in February 2024. We intend to defend the matter vigorously; however, there can be no assurance that we will be successful in such defense. We are unable to estimate the total costs to defend the matter or the potential liability to us in the event that we are not successful in our defense. In addition to the matters discussed above, in the normal course of business, we are presently, 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 and/or 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. 12. STOCK-BASED COMPENSATION Stock-based awards granted in the first fiscal quarter of 2024 and 2023 were granted under the amended and restated 2021 Omnibus Incentive Plan (the "2021 Plan"). 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. As of December 31, 2023, there were approximately 1,881,637 shares available for future grants under the 2021 Plan. Cash received from the exercise of stock options was $ 0.2 million and $ 0.9 million for the three months ended December 31, 2023 and 2022, respectively. 14 Table of Contents 12. STOCK-BASED COMPENSATION (CONTINUED) 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 three months ended December 31, 2023 and 2022, our employees forfeited 87,792 shares and 71,951 shares, respectively, in order to satisfy withholding tax obligations of $ 2.1 million and $ 3.0 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 $ 0.5 million and $ 0.6 million for the three months ended December 31, 2023 and 2022, respectively. Pursuant to the ESPP, 23,665 and 19,683 common shares were issued to employees during the three months ended December 31, 2023 and 2022, respectively. Shares are issued under the ESPP from treasury stock. As of December 31, 2023, 446,562 common shares were available for future issuances under the ESPP. The following table shows stock-based compensation expense that is included in the consolidated results of operations (in thousands): Three months ended December 31, 2023 2022 Cost of sales $ 181 $ 142 Sales and marketing 1,168 851 Research and development 430 448 General and administrative 1,327 1,427 Stock-based compensation before income taxes 3,106 2,868 Income tax benefit ( 663 ) ( 599 ) Stock-based compensation after income taxes $ 2,443 $ 2,269 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, 2023 1,553 $ 18.52 Granted 87 24.58 Exercised ( 19 ) 24.04 Forfeited / Canceled ( 10 ) 23.17 Balance on December 31, 2023 1,611 $ 18.89 3.8 $ 12,533 Exercisable on December 31, 2023 1,137 $ 16.89 3.3 $ 10,656 (1) The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $ 26.00 as of December 31, 2023, which would have been received by the option holders had all option holders exercised their options as of that date. The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. The total intrinsic value of all options exercised during the three months ended December 31, 2023 and 2023 was $ 0.4 million and $ 1.7 million, respectively. 15 Table of Contents 12. STOCK-BASED COMPENSATION (CONTINUED) The following table shows the weighted average fair value, which was determined based upon the fair value of each option on the grant date utilizing the Black-Scholes option-pricing model and the related assumptions: Three months ended December 31, 2023 2022 Weighted average per option grant date fair value $ 12.44 $ 19.98 Assumptions used for option grants: Risk free interest rate 4.45 % - 4.68 % 3.89 % - 3.98 % Expected term 6.00 years 6.00 years Expected volatility 46 % 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 December 31, 2023, the total unrecognized compensation cost related to non-vested stock options was $ 4.1 million and the related weighted average period over which it is expected to be recognized is approximately 1.5 years. Non-vested Stock Units The following table presents a summary of our non-vested restricted stock units and performance stock units as of December 31, 2023 and changes during the three 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, 2023 846 $ 30.56 135 $ 37.72 Granted 302 24.55 122 24.59 Vested ( 198 ) 26.87 ( 30 ) 37.11 Canceled ( 9 ) 32.07 ( 7 ) 25.15 Nonvested on December 31, 2023 941 $ 29.39 220 $ 30.92 As of December 31, 2023, the total unrecognized compensation cost related to non-vested restricted stock units and performance stock units was $ 24.2 million and $ 1.4 million, respectively. The related weighted average period over which these costs are expected to be recognized was approximately 2.6 years and 0.8 years, respectively. 16 Table of Contents