Our management's discussion and analysis should be read in conjunction with our consolidated financial statements and other information in this Annual Report on Form 10-K. We have omitted discussion of the earliest of the three years covered by our consolidated financial statements presented in this report because that disclosure was already included in our Annual Report on Form 10-K for fiscal 2021, filed with theSEC onNovember 24, 2021 . You are encouraged to reference Part II, Item 7, within that report, for a discussion of our financial condition and result of operations for fiscal 2020 compared to fiscal 2021.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Form 10-Q contains certain statements that are "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995, and within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-Looking Statements
This discussion contains forward-looking statements that are based on management's current expectations and assumptions. These statements often can be identified by the use of forward-looking terminology such as "assume," "believe," "anticipate," "intend," "estimate," "target," "may," "will," "expect," "plan," "potential," "project," "should," or "continue," or the negative thereof or other variations thereon or similar terminology. Among other items, these statements relate to expectations of the business environment in which Digi operates, projections of future performance, perceived marketplace opportunities and statements regarding our mission and vision. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions. Among others, these include risks related to the ongoing supply chain and transportation challenges impacting businesses globally, the ongoing COVID-19 pandemic and efforts to mitigate the same, risks related to ongoing inflationary pressures as well as present concerns about a potential recession and the ability of companies like us to operate a global business in such conditions, risks arising from the present war inUkraine , the highly competitive market in which our company operates, rapid changes in technologies that may displace products sold by us, declining prices of networking products, our reliance on distributors and other third parties to sell our products, the potential for significant purchase orders to be canceled or changed, delays in product development efforts, uncertainty in user acceptance of our products, the ability to integrate our products and services with those of other parties in a commercially accepted manner, potential liabilities that can arise if any of our products have design or manufacturing defects, our ability to integrate and realize the expected benefits of acquisitions such as our recently completed acquisition of Ventus, our ability to defend or settle satisfactorily any litigation, uncertainty in global economic conditions and economic conditions within particular regions of the world which could negatively affect product demand and the financial solvency of customers and suppliers, the impact of natural disasters and other events beyond our control that could negatively impact our supply chain and customers, potential unintended consequences associated with restructuring, reorganizations or other similar business initiatives that may impact our ability to retain important employees or otherwise impact our operations in unintended and adverse ways, the ability to achieve the anticipated benefits and synergies associated with acquisitions or divestitures and changes in our level of revenue or profitability which can fluctuate for many reasons beyond our control. These and other risks, uncertainties and assumptions identified from time to time in our filings with theUnited States Securities and Exchange Commission , including without limitation, those set forth in Item 1A, Risk Factors, of this Annual Report on Form 10-K and other quarterly filings on Form 10-Q and other subsequent filings, could cause our actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. Many of such factors are beyond our ability to control or predict. These forward-looking statements speak only as of the date for which they are made. We disclaim any intent or obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. 23
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a leading global provider of business and mission-critical IoT connectivity products, services and solutions. Our business is comprised of two reporting segments: IoT Products & Services and IoT Solutions.
In fiscal 2022, our key operating objectives included:
•continued growth of both SmartSense by Digi and Ventus that are the base of our IoT Solutions segment;
•delivering growth within our IoT Products & Services segment through new product introductions; and
•integration of our recently acquired Ventus business.
During the course of fiscal 2022, the supply chain difficulties presently impacting businesses globally continued to affect our business. We devoted significant time and resources towards mitigating these impacts during the fiscal year.
We utilize many financial, operational, and other metrics to evaluate our financial condition and financial performance. Below we highlight the metrics for fiscal 2022 that we feel are most important in these evaluations, with comparisons to fiscal 2021:
•Consolidated revenue was
•Consolidated gross profit was
•Gross profit margin was 55.7% versus 54.0%. Gross profit margin excluding amortization was 57.1% compared to 55.5%.
•Consolidated operating income was
•Net income was
•Diluted earnings per share was
•Adjusted net income was
•Adjusted EBITDA was
•Annualized Recurring Revenue, or ARR, was over
•We completed the acquisition of Ventus in the first fiscal quarter of 2022.
Recent Events Impacting Fiscal 2022 Results
Acquisition of Ventus
OnNovember 1, 2021 , we acquired Ventus for approximately$350 million in cash. The acquisition was funded through a combination of cash on hand and debt financing under an amended and restated credit facility committed byBMO Harris Bank N.A . (see Note 7 ). In the first quarter of fiscal 2022, the preliminary purchase price allocation was recorded, including related determinations of fair value and income tax implications. In the fourth quarter of fiscal 2022, we recorded purchase price allocation adjustments to adjust for new information. As a result, in our final purchase price allocation we have$119 million of goodwill and$211 million of other intangibles on our consolidated balance sheets atSeptember 30, 2022 . The results of operations following the acquisition date are now included in our 2022 results within our IoT Solutions segment.
Key trends regarding our existing business
The following trends affected our financial performance in fiscal 2022 and 2021, and we expect these trends will continue to impact our results in the future:
•We believe the market for IoT products and related services is in the midst of a long-term expansion. We believe our IoT Products & Services business is positioned for modest revenue and profitability growth and that our IoT Solutions business is positioned for more significant revenue and profitability growth given the large total addressable market for condition monitoring and asset tracking services that is in earlier stages of adoption. •As recurring revenue from subscription and cloud monitoring services becomes a greater portion of our overall revenue, we expect gross margins to increase as the revenue of incremental subscriptions is not offset at the same rate as expected increases in costs associated with implementing new subscribers. 24
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CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth selected information derived from our consolidated statements of operations, expressed as a percentage of revenue and as a percentage of change from year-to-year for the years indicated:
Year ended September 30, % Increase (decrease) 2022 2021 2022 compared to 2021 Revenue 100.0 100.0 - Cost of sales 44.3 46.0 (1.7) Gross profit 55.7 54.0 1.7 Operating expenses 45.9 50.6 (4.7) Operating income 9.8 3.4 6.4 Other expense, net (5.0) (0.5) (4.5) Income before income taxes 4.8 2.9 1.9 Income tax benefit (0.2) (0.5) 0.3 Net income 5.0 % 3.4 % 1.6 REVENUE BY SEGMENT Year ended September 30, ($ in thousands) 2022 2021 % Increase (decrease) Revenue IoT Products & Services$ 297,645
76.7 %$ 264,173 85.6 % 12.7 IoT Solutions 90,580 23.3 44,459 14.4 103.7 Total revenue$ 388,225 100.0 %$ 308,632 100.0 % 25.8
IoT Products & Services
IoT Products & Services revenue increased 12.7% for fiscal 2022, as compared to fiscal 2021. This primarily was the result of:
•increased sales of console server and cellular products driven by demand for data center and edge based deployments and increased OEM sales in the second half of 2022.
This increase was partially offset by:
•decreased sales of infrastructure management products, driven by supply chain challenges.
IoT Solutions
IoT Solutions revenue increased 103.7% for fiscal 2022, as compared to fiscal 2021. This primarily was the result of:
•the additional recurring revenue from our
This increase were partially offset by:
•decreased one-time customer implementation sales, due to significant activity from a few large customers in 2021 that did not recur in 2022.
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COST OF GOODS SOLD AND GROSS PROFIT BY SEGMENT
Below are our segments' cost of goods sold and gross profit as a percentage of their respective total revenue:
Year ended September 30, Basis point increase ($ in thousands) 2022 2021 (decrease) Cost of Goods Sold IoT Products & Services$ 137,528 46.2 %$ 119,701 45.3 % 90 IoT Solutions 34,411 38.0 % 22,274 50.1 %
(1,210)
Total cost of goods sold$ 171,939 44.3 %$ 141,975 46.0 % (170) Year ended September 30, Basis point increase ($ in thousands) 2022 2021 (decrease) Gross Profit IoT Products & Services$ 160,117
53.8 %$ 144,472 54.7 % (90) IoT Solutions 56,169 62.0 % 22,185 49.9 % 1,210 Total gross profit$ 216,286 55.7 %$ 166,657 54.0 % 170
IoT Product & Services
IoT Products & Services gross profit margin decreased 90 basis points for fiscal 2022 as compared to the prior fiscal year. This decrease primarily was a result of:
•increased production and distribution costs due to the continuing supply chain challenges, as well as changes in product and customer mix.
IoT Solutions
The IoT Solutions gross profit margin increased 1,210 basis points for fiscal 2022 as compared to the prior fiscal year. This increase primarily was a result of:
•additional recurring subscription revenue, from the acquisition of Ventus, which typically has a high gross profit margin.
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OPERATING EXPENSES Below are our operating expenses and operating expenses as a percentage of total revenue: Year ended September 30, $ increase ($ in thousands) 2022 2021 (decrease) % Increase (decrease) Operating expenses: Sales and marketing$ 70,366 18.1 %$ 61,909 20.1 %$ 8,457 13.7 Research and development 55,098 14.2 46,623 15.1 8,475 18.2 General and administrative 58,527 15.1 40,830 13.2 17,697 43.3 Change in fair value of contingent consideration (6,200) (1.6) 5,772 1.9 (11,972) 100.0 Restructuring charges, net 275 0.1 995 0.3 (720) (72.4) Total operating expenses$ 178,066 45.9 %$ 156,129 50.6 %$ 21,937 14.1
The
•incremental operating expenses from our acquisitions of Ventus, Haxiot and Ctek.
This increase was partially offset by:
•a
OTHER EXPENSE, NET
Year ended
$ increase ($ in thousands) 2022 2021 (decrease) % Increase (decrease) Other expense, net: Interest income $ 11 -$ 10 - % $ 1 10.0 Interest expense (19,701)
(5.1) % (1,395) (0.5) (18,306)
1,312.3
Other expense, net 98 - (144) - 242
(168.1)
Total other expense, net$ (19,592) (5.1) %$ (1,529) (0.5) %$ (18,063)
1,181.4
The
•an increase to our interest expense as we refinanced our revolving loan with a new credit facility inNovember 2021 and wrote off a portion of the deferred financing fees associated with our prior credit facility to fund the acquisition of Ventus. (see Note 7 to the condensed consolidated financial statements). INCOME TAXES Our effective income tax benefit rates were (4.1)%, (15.2)% and (12.7)% for fiscal 2022, 2021 and 2020, respectively. Our effective tax rate will vary based on a variety of factors. These include our overall profitability, the geographical mix of income before taxes and related statutory tax rate in each jurisdiction, and discrete events, such as settlement of audits (see Note 12 to our consolidated financial statements).
KEY BUSINESS METRICS
Annualized Recurring Revenue ("ARR") represents the annualized monthly value of all billable subscription contracts, measured at the end of any fiscal period. ARR should be viewed independently of revenue and deferred revenue and is not intended to replace or forecast either item. Digi management uses ARR to manage and assess the growth of our subscription revenue business. We believe ARR is an indicator of the scale of our subscription revenue business and is less subject to seasonality and contract term changes than other metrics. 27
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NON-GAAP FINANCIAL INFORMATION
This report includes adjusted net income, adjusted net income per diluted share and adjusted earnings before interest, taxes and amortization ("Adjusted EBITDA"), each of which is a non-GAAP financial measure.
Non-GAAP measures are not substitutes for GAAP measures for the purpose of analyzing financial performance. The disclosure of these measures does not reflect all charges and gains that were actually recognized by Digi. These non-GAAP measures are not in accordance with, or, an alternative for measures prepared in accordance with GAAP and may be different from non-GAAP measures used by other companies or presented by us in prior reports. In addition, these non-GAAP measures are not based on any comprehensive set of accounting rules or principles. We believe that non-GAAP measures have limitations in that they do not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP. We believe these measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP measures. Additionally, Adjusted EBITDA does not reflect our cash expenditures, the cash requirements for the replacement of depreciated and amortized assets, or changes in or cash requirements for our working capital needs. We believe that providing historical and adjusted net income and adjusted net income per diluted share, respectively, exclusive of such items as reversals of tax reserves, discrete tax benefits, restructuring charges and reversals, intangible amortization, stock-based compensation, other non-operating income/expense, adjustments to estimates of contingent consideration, acquisition-related expenses and interest expense related to acquisition permits investors to compare results with prior periods that did not include these items. Management uses the aforementioned non-GAAP measures to monitor and evaluate ongoing operating results and trends and to gain an understanding of our comparative operating performance. In addition, certain of our stockholders have expressed an interest in seeing financial performance measures exclusive of the impact of these matters, which while important, are not central to the core operations of our business. Management believes that Adjusted EBITDA, defined as EBITDA adjusted for stock-based compensation expense, acquisition-related expenses, restructuring charges and reversals and changes in fair value of contingent consideration is useful to investors to evaluate our core operating results and financial performance because it excludes items that are significant non-cash or non-recurring expenses reflected in the consolidated statements of operations. We believe that the presentation of Adjusted EBITDA as a percentage of revenue is useful because it provides a reliable and consistent approach to measuring our performance from year to year and in assessing our performance against that of other companies. We believe this information helps compare operating results and corporate performance exclusive of the impact of our capital structure and the method by which assets were acquired.
Below are reconciliations from GAAP to Non-GAAP information that we feel is important to our business:
Reconciliation of Net Income to Adjusted EBITDA (In thousands) Year ended September 30, 2022 2021 % of total % of total revenue revenue Total revenue$ 388,225 100.0 %$ 308,632 100.0 % Net income 19,383 5.0 %$ 10,366 3.4 % Interest expense (income), net 19,690 1,385 Income tax (benefit) (755) (1,367) Depreciation and amortization 33,839 20,877 Stock-based compensation 8,578 8,135 Changes in fair value of contingent consideration (6,200) 5,772 Restructuring charge 275 995 Acquisition and integration expense 4,605 2,098 Adjusted EBITDA$ 79,415 20.5 %$ 48,261 15.6 % 28
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Reconciliation of Net Income and Net Income per Diluted Share to Adjusted Net Income and Adjusted Net Income per Diluted Share (In thousands, except per share amounts)
Year ended
2022 2021 Net income and net income per diluted share 19,383$ 0.54 $ 10,366 $ 0.31 Amortization 27,195 0.76 16,534 0.50 Stock-based compensation 8,578 0.24 8,135 0.24 Other non-operating expense (98) - 144 - Acquisition and integration expense 4,605 0.13 2,098 0.06 Changes in fair value of contingent consideration (6,200) (0.17) 5,772 0.17 Restructuring charge 275 0.01 995 0.03 Interest expense, net 19,690 0.54 1,404 0.04 Tax effect from above net income adjustments (1) (9,901) (0.28) (6,627) (0.20) Discrete tax benefits (2) (3,933) (0.11) (2,674) (0.07)
Adjusted net income and adjusted net income per diluted share (3)
$ 59,594 $ 1.66 $ 36,147 $ 1.08 Diluted weighted average common shares 35,995 33,394 (1)The tax effect from the above adjustments assumes and estimated effective tax rate of 18.0% for fiscal 2022 and 2021 based on adjusted net income. (2)For the twelve months endedSeptember 30, 2022 , discrete tax benefits include excess tax benefits recognized on stock compensation and expiring statute of limitations. For the twelve months endedSeptember 30 , 2021,discrete tax benefits include excess tax benefits recognized on stock compensation, an adjustment of our state deferred tax rate due to the Opengear acquisition and expiring statute of limitations. (3)Adjusted net income per diluted share may not add due to the use of rounded numbers.
LIQUIDITY AND CAPITAL RESOURCES
Historically we have financed our operations and capital expenditures principally with funds generated from operations. In fiscal 2021 we issued an equity offering and in fiscal 2022 we issued debt to fund our acquisition of Ventus. Our liquidity requirements arise from our working capital needs, and to a lesser extent, our need to fund capital expenditures to support our current operations and facilitate growth and expansion. OnDecember 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 onNovember 1, 2021 , but did not receive any additional proceeds from nor modify the amounts of any facilities or subfacilities contained within that credit agreement. The credit agreement consists of a$350 million term loan B secured loan and a$35 million revolving credit facility. The$35 million revolving credit facility, which presently has no outstanding balance, includes a$10 million letter of credit subfacility and$10 million swingline subfacility. As ofSeptember 30, 2022 ,$35.0 million remained available under the Revolving Loan, which included$10 million available for a letter of credit subfacility and$10 million available under a swingline subfacility, the outstanding amounts of which decrease the available commitment. For additional information regarding the terms of our Credit Facility see Note 7 to our consolidated financial statements.
Additionally, during the second quarter of fiscal 2021 we sold 4,025,000 shares
of our common stock and received net proceeds of
We expect positive cash flows from operations. We believe that our current cash and cash equivalents balances, cash generated from operations and our ability to borrow under our credit facility will be sufficient to fund our business operations and capital expenditures for the next twelve months and beyond. 29
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As follows, our consolidated statement of cash flows for the years ended
Year ended September 30, ($ in thousands) 2022 2021 Operating activities$ 37,740 $ 57,723 Investing activities (349,528) (21,365) Financing activities 192,782 62,242 Effect of exchange rate changes on cash and cash equivalents 1,474 (297) Net increase (decrease) in cash and cash equivalents$ (117,532) $ 98,303
Cash flows from operating activities decreased
•an increase in operating assets and liabilities (net of acquisitions) during the period of$25.3 million , including a$41.4 million increase in inventory, compared to a decrease of$13.6 million in fiscal 2021,
•a decrease in the fair value of contingent consideration of
•a decrease in the provision for bad debt.
These decreases were partially offset by:
•an increase in the provision for inventory of
•increases in depreciation and amortization expenses, deferred income tax benefits and net income.
Cash flows used in investing activities decreased
•an increase of
Cash flows from financing activities increased
•an increase of
This increase was partially offset by:
•payments of debt issuance costs of
•$73.8 million in proceeds from stock issuance in Q2 2021,
•payments of
•early payments of$100.0 million on the new Term Loan issued inNovember 2021 compared to$15.6 million in debt payments in fiscal 2021 on the previous credit facility (see Note 7 to the condensed consolidated financial statements). 30
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CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at
Payments due by fiscal period Less than 1 ($ in thousands) Total year 1-3 years 3-5 years Thereafter Operating leases$ 22,356 $ 3,835 $ 6,490 $ 4,807 $ 7,224 Revolving loan 250,000 17,500 35,000 35,000 162,500 Interest on long-term debt 82,793 16,778 29,953 24,684 11,378 Total$ 355,149 $ 38,113 $ 71,443 $ 64,491 $ 181,102 The operating lease agreements included above primarily relate to office space. The table above does not include our possible payments for uncertain tax positions. Our reserve for uncertain tax positions, including accrued interest and penalties, was$3.3 million as ofSeptember 30, 2022 . Due to the nature of the underlying liabilities and the extended time often needed to resolve income tax uncertainties, we cannot make reliable estimates of the amount or timing of future cash payments that may be required to settle these liabilities. The above table also does not include those obligations for royalties under license agreements as these royalties are calculated based on future sales of licensed products and we cannot make reliable estimates of the amount of cash payments.
FOREIGN CURRENCY
We are not exposed to foreign currency transaction risk associated with sales transactions as the majority of our sales are denominated inU.S. Dollars. We are exposed to foreign currency translation risk as the financial position and operating results of our foreign subsidiaries are translated intoU.S. Dollars for consolidation. We manage our net asset or net liability position for non-functional currency accounts, primarily theU.S. Dollar accounts in our foreign locations to reduce our foreign currency risk. We have not implemented a formal hedging strategy. During 2022 and 2021, we had approximately$85.8 million and$80.7 million , respectively, of revenue related to foreign customers including export sales, of which$0.8 million were denominated in foreign currencies, predominantly the Canadian Dollar. During fiscal 2020, we had approximately$65.8 million of revenue to foreign customers including export sales, of which$1.7 million was denominated in foreign currencies, predominantly the Euro and British Pound. In future periods, we continue to expect that the majority of our sales will be inU.S. Dollar.
RECENT ACCOUNTING DEVELOPMENTS
For information on new accounting pronouncements, see Note 1 to our consolidated financial statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America . The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, the disclosure of contingent assets and liabilities and the values of purchased assets and assumed liabilities in acquisitions. We base our estimates on historical experience and various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
We believe the following critical accounting policies impact our more significant judgments and estimates used in the preparation of our consolidated financial statements.
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REVENUE RECOGNITION
We recognize hardware product revenue upon transfer of control of goods or services to customers in an amount that reflects the consideration we expect to receive in exchange for those goods or services. We determine the amount of revenue to be recognized through application of the following steps:
•identification of the contract, or contracts with a customer;
•identification of the performance obligations in the contract;
•determination of the transaction price;
•allocation of the transaction price to the performance obligations in the contract; and
•recognition of revenue when or as we satisfy the performance obligations.
Hardware Product Revenue and SmartSense by Digi Equipment Revenue and Associated Installation Fees
Our hardware product revenue is derived primarily from the sale of wired and wireless hardware products to our distributors and direct/original equipment manufacturer ("Direct/OEM") customers. Product revenue generally is recognized upon shipment of the product to a customer. Sales to authorized domestic distributors and Direct/OEM customers typically are made with certain rights of return and price adjustment provisions. Estimated reserves for future credit returns and pricing adjustments are established based on an analysis of historical patterns of credit returns and price adjustments compared to received credit returns and distribution sales for the current period. Estimated reserves for future credit returns and price adjustments are charged against revenue in the same period as the corresponding sales are recorded. Estimated sales returns for our distributor stock rotation program are accounted for under the guidance of ASC 845 Nonmonetary Transactions. Material differences between the historical trends used to determine estimated reserves and actual credit returns and pricing adjustments could result in a material change to our consolidated results of operations or financial position. Equipment revenue from SmartSense by Digi within our IoT Solutions segment is recognized upon shipment of the equipment to a customer. Installation service charges from these sales are recorded when the product is installed.
Subscription and Support Services Revenue
Our SmartSense by Digi® and Ventus subscription revenue is based on contracts with at least an annual term and is recorded on a monthly basis. These subscriptions are generally in a range from one to five years, and may contain an evergreen renewal provision. Generally, our subscription renewal charges per month are the same as the original contract term.
We also derive service revenue from our Digi Remote Manager, a platform-as-a-service ("PaaS") offering, whereby customers pay for services consumed based on the number of devices being managed or monitored. This revenue is recognized over the life of the service term and is included in our IoT Products & Services segment.
Professional Services Revenue
Professional services revenue is derived from ourDigi Wireless Design Services contracts on either on a time-and-materials or a fixed-fee basis. These revenues, which are included in our IoT Products & Services segment are recognized as the services are performed for time-and-materials contracts or as invoiced for fixed-fee contracts.
Contracts with Multiple Performance Obligations
From time to time we have contracts from customers with multiple performance obligations. Our hardware products may be combined with our Digi Remote Manager PaaS offering as well as other support services in an individual contract. Our SmartSense by Digi revenues typically are derived from contracts with multiple performance obligations. These obligations may include: delivery of monitoring equipment that the customer purchases out-right , monitoring services, providing condition alerts of assets being monitored, and recertification of sensor equipment. When we retain ownership of the equipment, we charge an implementation fee to the customer so they can begin using the equipment. In these instances, all revenue derived from the above obligations is recognized over the subscription term of the contract. If the customer purchases the equipment 32
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out-right, that portion of the revenue is recognized at the stand-alone selling price at the time the equipment is shipped and all other revenue is recognized over the subscription term of the contract. We have made an accounting policy election to exclude from the measurement of our revenues any sales or similar taxes we collect from customers.
INVENTORIES
Inventories are stated at the lower of cost or net realizable value, with cost determined using the first-in, first-out method. We reduce the carrying value of our inventories for estimated excess and obsolete inventories equal to the difference between the cost of inventory and its estimated realizable value based upon assumptions about future product demand and market conditions. These estimates are subject to uncertainty and involve the use of historical data and future market expectations. Once the new cost basis is established, the value is not increased with any changes in circumstances that would indicate an increase in value after the re-measurement. If actual product demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required that could result in a material change to our consolidated results of operations or financial position.
Goodwill represents the excess of cost over the fair value of identifiable assets acquired.Goodwill is tested for impairment on an annual basis as ofJune 30 , or more frequently if events or circumstances occur which could indicate impairment. For our quantitative goodwill impairment tests, we determine the estimated fair value of each reporting unit and compare it to the carrying value of the reporting unit, including goodwill. If the carrying amount of a reporting unit is higher than its estimated fair value, an impairment loss must be recognized for the excess. We have two reportable operating segments, our IoT Products & Services segment and our IoT Solutions segment (see Note 4 to the consolidated financial statements). Effective with the reorganization announcement on October 7, 2020 (see Note 10 ), our IoT Products & Services business is now 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 the first fiscal quarter of 2022, IoT Solutions is comprised of two reporting units; Ventus and SmartSense. We have six reporting units that have been tested individually for impairment. The fair value of each reporting unit is determined using a weighted combination of an income and market approach. A discounted cash flow ("DCF") method is utilized for the income approach. In developing the discounted cash flow analysis, our assumptions about future revenues, expenses, capital expenditures, and changes in working capital are based on management's projections, and assume a terminal growth rate thereafter. A separate discount rate is determined for each reporting unit and these cash flows are then discounted to determine the fair value of the reporting unit. The market approach determines a value derived from the guideline company method. This market approach method estimates the price reasonably expected to be realized from the sale of the reporting unit based on comparable companies. 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. We believe we made a reasonable estimate with the assumptions used to calculate the fair values of our two reporting segments. Changes in circumstances or a potential event could negatively affect the estimated fair values. We will continue to monitor potential COVID-19 industry and demand impacts as this could potentially affect our cash flows and market capitalization. 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 ofJune 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. AtJune 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 33
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total market capitalization of$852.0 million as ofJune 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.
CONTINGENT CONSIDERATION
We measure our contingent consideration liabilities recognized in connection with business combinations at fair value on a recurring basis using significant unobservable inputs classified within Level 3 of the fair value hierarchy as defined in ASC 820 "Fair Value Measurement". We used a probability-weighted discounted cash flow approach as the valuation technique to determine the fair value of the contingent consideration on the acquisition date. At each subsequent reporting period, the fair value is re-measured with the change in fair value recognized in general and administrative expense in our consolidated statements of operations. Any amounts paid to the sellers in excess of the amount recorded on the acquisition date will be classified as cash flows used in operating activities. Payments to the sellers not exceeding the acquisition-date fair value of the contingent consideration will be classified as cash flows used in financing activities. INCOME TAXES We operate in multiple tax jurisdictions both in and outside of theU.S. Accordingly, we must determine the appropriate allocation of income to each of these jurisdictions. This determination requires us to make several estimates and assumptions. Tax audits associated with the allocation of this income, and other complex issues, may require an extended period of time to resolve. They also could result in adjustments to our income tax balances that are material to our consolidated financial position and results of operations and could result in potential cash outflows. Liabilities for uncertain tax positions are also established for potential and ongoing audits of federal, state and international issues. We routinely monitor the potential impact of such situations and believe that liabilities are properly stated. Valuations related to amounts owed and tax rates could be impacted by changes to tax codes and our interpretation thereof, changes in statutory rates, our future taxable income levels and the results of tax audits. 34
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